The potential of the EU economies in attracting FDI – A composite index based approach

The paper presents a composite index which measures the potential of the 28 European Union (EU) member countries in attracting foreign direct investments (FDI), for the period 2000 – 2012. Several new variables (in respect to other aggregated Indices) linked to the latest development policies of the European Union are considered in the construction process of the proposed index. By comparing several versions of the constructed index with some of the most notorious indicators used to measure the FDI attractiveness, we find that the PCA (principal component analysis) version of our index shows the best performance in tracking the FDI activity of the EU economies. The empirical results show that the FDI activity is concentrated in the developed economies, confirming therefore previous results presented in the literature. The construction methodology of our index allows the identification of the main characteristics of the European economies which should be taken in consideration by the national governments when forging policies for increasing the FDI attractiveness of their economies. Among other practical applications of the proposed index, it can be used as a starting point for identifying benchmark economies which can help policymakers identify best practices and innovative approaches for the areas where their economies are lagging behind.