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Institutional efficiency, monitoring costs, and the investment share of FDI

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  • Joshua Aizenman
  • Mark M. Spiegel

Abstract

This paper models and tests the implications of institutional efficiency on the pattern of foreign direct investment (FDI). We posit that domestic agents have a comparative advantage over foreign agents in overcoming some of the obstacles associated with corruption and weak institutions. We model these circumstances in a principal-agent framework with costly ex-post monitoring and enforcement of an ex-ante labor contract. Ex-post monitoring and enforcement costs are assumed to be lower for domestic entrepreneurs than for foreign ones, but foreign producers enjoy a countervailing productivity advantage. Under these asymmetries, multinationals pay higher wages than domestic producers, in line with the insight of efficiency wages and with the evidence about the 'multinationals wage premium.' FDI is also more sensitive to increases in enforcement costs. We then test this prediction for a cross section of developing countries. We use Mauro's (1995) index of institutional efficiency as an indicator of the strength of property rights enforcement within a given country. We compare institutional efficiency levels for a large cross section of countries in 1989 to subsequent FDI flows from 1990 to 1999. We find that institutional efficiency is positively associated with the ratio of subsequent foreign direct investment flows to both gross fixed capital formation and to private investment. This finding is true for both simple cross-sections and for cross-sections weighted by country size.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2003-06.

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Date of creation: 2003
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Handle: RePEc:fip:fedfwp:2003-06

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Keywords: Investments; Foreign ; International finance;

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  1. Haddad, Mona & Harrison, Ann, 1993. "Are there positive spillovers from direct foreign investment? : Evidence from panel data for Morocco," Journal of Development Economics, Elsevier, vol. 42(1), pages 51-74, October.
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  4. Markusen, James R., 2002. "Multinational Firms and the Theory of International Trade," MPRA Paper 8380, University Library of Munich, Germany.
  5. Mauro, Paolo, 1995. "Corruption and Growth," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 110(3), pages 681-712, August.
  6. Assaf Razin & Efraim Sadka & Chi-Wa Yuen, 1999. "Excessive FDI Flows Under Asymmetric Information," NBER Working Papers 7400, National Bureau of Economic Research, Inc.
  7. Fosfuri, Andrea & Motta, Massimo & Rønde, Thomas, 1999. "Foreign Direct Investment and Spillovers through Workers' Mobility," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2194, C.E.P.R. Discussion Papers.
  8. Beata K. Smarzynska & Shang-Jin Wei, 2000. "Corruption and Composition of Foreign Direct Investment: Firm-Level Evidence," NBER Working Papers 7969, National Bureau of Economic Research, Inc.
  9. Shang-Jin Wei, 1997. "Why is Corruption So Much More Taxing Than Tax? Arbitrariness Kills," NBER Working Papers 6255, National Bureau of Economic Research, Inc.
  10. Wheeler, David & Mody, Ashoka, 1992. "International investment location decisions : The case of U.S. firms," Journal of International Economics, Elsevier, vol. 33(1-2), pages 57-76, August.
  11. James R. Hines, Jr., 1995. "Forbidden Payment: Foreign Bribery and American Business After 1977," NBER Working Papers 5266, National Bureau of Economic Research, Inc.
  12. Ann E. Harrison & Brian J. Aitken, 1999. "Do Domestic Firms Benefit from Direct Foreign Investment? Evidence from Venezuela," American Economic Review, American Economic Association, vol. 89(3), pages 605-618, June.
  13. Okamoto, Yumiko & Sjöholm, Fredrik, 1999. "FDI and the Dynamics of Productivity: Microeconomic Evidence," Working Paper Series in Economics and Finance 348, Stockholm School of Economics.
  14. Barrell, Ray & Pain, Nigel, 1997. "Foreign Direct Investment, Technological Change, and Economic Growth within Europe," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 107(445), pages 1770-86, November.
  15. Robert E. Lipsey & Fredrik Sjoholm, 2001. "Foreign Direct Investment and Wages in Indonesian Manufacturing," NBER Working Papers 8299, National Bureau of Economic Research, Inc.
  16. Robert E. Lipsey, 2002. "Home and Host Country Effects of FDI," NBER Working Papers 9293, National Bureau of Economic Research, Inc.
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Cited by:
  1. Alessandro Barattieri, 2011. "Estimating Trade and Investment Flows: Partners and Volumes," Cahiers de recherche, CIRPEE 1133, CIRPEE.
  2. Graf Lambsdorff, Johann, 2005. "Consequences and causes of corruption: What do we know from a cross-section of countries?," Passauer Diskussionspapiere, Volkswirtschaftliche Reihe V-34-05, University of Passau, Faculty of Business and Economics.
  3. Frances Ruane & Xiaoheng Zhang, 2007. "Where do MNEs Expand Production: Location Choices of the Pharmaceutical Industry in Europe after 1992," Papers, Economic and Social Research Institute (ESRI) WP211, Economic and Social Research Institute (ESRI).
  4. Roberto Basile & Luigi Benfratello & Davide Castellani, 2005. "Attracting Foreign Direct Investments in Europe: are Italian Regions Doomed?," Development Working Papers 200, Centro Studi Luca d\'Agliano, University of Milano.
  5. Andreia Olival, 2012. "The influence of Doing Business’ institutional variables in Foreign Direct Investment," GEE Papers, Gabinete de Estratégia e Estudos, Ministério da Economia e da Inovação 0048, Gabinete de Estratégia e Estudos, Ministério da Economia e da Inovação, revised Dec 2012.
  6. Lim, Sung-Hoon, 2005. "Foreign investment impact and incentive: a strategic approach to the relationship between the objectives of foreign investment policy and their promotion," International Business Review, Elsevier, vol. 14(1), pages 61-76, February.
  7. Jinjarak, Yothin, 2007. "Foreign direct investment and macroeconomic risk," Journal of Comparative Economics, Elsevier, vol. 35(3), pages 509-519, September.
  8. Hea-Jung Hyun & Hyuk Hwang Kim, 2007. "The Determinants of Cross-border M&As : the Role of Institutions and Financial Development in Gravity Model," Finance Working Papers 21934, East Asian Bureau of Economic Research.
  9. Frances Ruane & Xiaoheng Zhang, 2007. "Location Choices of the Pharmaceutical Industry in Europe after 1992," The Institute for International Integration Studies Discussion Paper Series, IIIS iiisdp220, IIIS.
  10. Belkacem Laabas and Walid Abdmoulah, . "Determinants of Arab Intraregional Foreign Direct Investments," API-Working Paper Series 0905, Arab Planning Institute - Kuwait, Information Center.
  11. Marcella Nicolini, 2007. "Institutions and Offshoring Decision," CESifo Working Paper Series 2074, CESifo Group Munich.
  12. Larrain B., Felipe & Tavares, José, 2007. "Can Openness Deter Corruption? The Role of Foreign Direct Investment," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6488, C.E.P.R. Discussion Papers.
  13. Roberto Basile & Luigi Benfratello & Davide Castellani, 2005. "Attracting Foreign Investments in Europe - are Italian Regions Doomed?," ERSA conference papers ersa05p148, European Regional Science Association.
  14. Nikopour, Hesam & Shah Habibullah, Muzafar & Schneider, Friedrich & Law, Siong Hook, 2009. "Foreign Direct Investment and Shadow Economy: A Causality Analysis Using Panel Data," MPRA Paper 14485, University Library of Munich, Germany.
  15. Duanmu, Jing-Lin, 2011. "The effect of corruption distance and market orientation on the ownership choice of MNEs: Evidence from China," Journal of International Management, Elsevier, Elsevier, vol. 17(2), pages 162-174, June.

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