Impact of electricity prices on foreign direct investment: Evidence from the European Union

In the course of recent years growing concerns over increasing energy prices have emerged in the context of maintaining Europe’s international competitiveness. In particular, rising electricity price differentials adversely affect firms’ total production costs and ultimately impact their investment decisions. Nonetheless, electricity prices as locational determinants of foreign direct investment (FDI) have received little attention in the literature so far. We address this gap by including electricity prices in the traditional framework of FDI analysis and examine the impact of price variation on net FDI inflows in countries of the European Union (EU). We use a panel of 27 countries for a period of 2003 - 2013 and system generalised method of moments (GMM) as method of estimation. The main findings of the paper confirm that besides tax rates, unit labour costs and competitive disadvantage in secondary education, also electricity prices contribute to eroding competitiveness of the countries. Yet, the effect of electricity prices does not seem to be uniform across the EU. In fact, southwestern countries tend to be more adversely affected than north-eastern, both in the short and long run.