Some new evidence on determinants of foreign direct investment in developing countries

The authors of this paper expand on earlier studies of the determinants of foreign direct investment (FDI) by empirically analyzing various factors - including political risk, business conditions, and macroeconomic variables - that influence direct investment flows to developing countries. They try to fill a gap in the literature by examining qualitative factors. Using a pooled model of developing countries, they test three groups of hypotheses on what influences direct investment. Tests of the first hypothesis indicate that a qualitative index of political risk is a significant determinant of FDI flows for countries that have historically attracted high FDI flows. For countries that have not attracted such flows, sociopolitical instability has a negative impact on investment flows. Tests of the second hypothesis show that a general qualitative index of business operation conditions is an important determinant of FDI in countries that receive high flows. This country group also shows a positive relationship between taxes on international transactions and FDI flows. Results from tests of the third hypothesis reveal that exports generally, especially manufacturing exports, are significant determinant of FDI flows for countries in which FDI is high. Finally, export orientation is the strongest variable for explaining why a country attracts FDI. This finding is in line with the secular trend toward increasing complementarity between trade and FDI.