FOREIGN DIRECT INVESTMENT AND THE GROWTH OF
TRANSITION ECONOMIES:
Determinants of FDI, the Role Played by Local Financial Markets
and Culture.
Masters Thesis
MSc. INTERNATIONAL ECONOMICS AND BUSINESS
Patrick Hoffmann
(1219553)
UNIVERSITY OF GRONINGEN
GRONINGEN, THE NETHERLANDS
Acknowledgements
I would like to thank my supervisor, dr. Desislava Dikova for her support with writing this thesis. I enjoyed our discussions which mostly took place in the canteen and usually brightened up my days at the University. Although on a very tight schedule herself she managed to review my progress always and was there to guide me all along.
I would also like to thank dr. Padma Rao Sahib for her support on the accompanying Methodology Paper, Prof. Hans van Ees for co-supervision, and Gerwin van der Laan for his effort in coaching me on the statistical program “Eviews”.
Further special thanks go out to my neighbor and good friend Louis Feitsma who always found supporting words in times of difficulties and lack of motivation, thanks Louis I could not have done it without you! The same goes for Tressy Hop who not only spent some evenings in the library with me running SPSS but also has been a constant source of encouragement.
This thesis puts an end to almost seven years that I have spent in Groningen. Having worked for the RUG as a junior docent for three years, actively taking part in the dialogue between faculty and student body as co-founder and chairman of B-yond, then representing the RUG on student fairs in Europe and throughout China for three consecutive years has kept me quite busy and I got to know and love many of the University staff in and around the faculty. I had the time of my life in Groningen thanks to you all at the Rijksuniversiteit!
Er gaat niets boven Groningen.
Abstract
In this thesis, we examine the extent of institutional reforms, advanced factor development, and culture in improving country attractiveness for the location of foreign direct investments (FDI) into transition economies of Central and Eastern Europe, the Balkan region and the Baltic States. We also investigate whether the cultural setting or the financial market development influence economic growth for these countries. Our empirical analysis, using cross-country data from 18 countries over a time period from 1990 to 2006, shows that several selected indicators are found to play significant role in influencing FDI inflows. Culture does matter in the context of FDI attractiveness is our main finding which does not however hold for its influence on GDP growth rates. Institutional development is also significant while our indicators collected for the advanced factors of production did not significantly influence FDI inflows.
We also found that the development of the financial market has a positive and significant effect on the host country GDP growth rate. Domestic credit provided by he banking sector however was negatively related to GDP growth. This conclusion calls for countries to take deliberate policy measures to liberalize and develop the financial sector and ensure that sufficient domestic credit is offered to local firms and not solely to foreign investors.
TABLE OF CONTENTS
Acknowledgements……….……… 2
Abstract………..………..……….. 3
1.
INTRODUCTION………... 6
1.1 Background………..6
1.2 The transition progress of CEE - location advantages and FDI attractiveness………8
1.3 Country effects: FDI and other determinants of growth for transition economies…10 1.4 Purpose of the study……….…..……...12
2.
Literature review………. …14
2.1 Theories of FDI………..14
2.2 FDI Determinants and previous methodological approaches………. 16
2.3 The culture aspect: velvet curtain theory……….. 20
2.4 FDI and growth………...25
2.5 Scope and boundaries of the study………..…... 27
3.
Hypotheses……….. 28
3.1 Host country attractiveness and FDI inflows……….. 28
3.1.1 Relevance of institution building and FDI inflows……….. 29
3.1.2 Informal institutions: Culture and FDI inflows………... 30
3.1.3 Advanced factors of production and FDI inflows……….…31
3.2 Growth-effects……… 32
3.2.1 Culture and its influence on growth……….………. 32
3.2.2 Financial Market development and growth……….……….34
4.
Methodology……… 34
4.1 Sample and Data……… 34
4.1.1 Sample……….. 34
4.1.2 Data sources and definitions………..……… 35
4.2 Dependent and independent variables, controls….……… 36
4.3 Research Design……….……… 40
4.4. Econometric framework……… 41
4.4.1 FDI inflows, Institutional development, Culture, and advanced factors………. 42
4.4.2 Growth models……….. 43
5.
Model Tests……….. 45
6.
Findings………. 46
6.1 Diagnostic Results……… 46
6.2 FDI inflows and country attractiveness the role of Institutions, advanced factors of production and culture……..………. 47
6.3 FDI and growth the role of culture……… 48
6.4 Financial Market Development and growth……….. 49
7.
Discussion and Policy Implications……… 50
8.
Conclusion……….... 52
8.1 Limitations………..53
8.2 Suggestions for future research……… 54
Data Appendix………. 55
References……… 56
Chapter 1
1 Introduction
1.1 Background
Foreign direct investment has increased over the last decades and alongside the researchers’ interest to analyse this modern phenomenon of globalization. Its growth levels far outpaced the levels of trade over similar time periods and researchers have termed it - rightly or wrongly - as the motor of growth for many countries.
The importance of analyzing FDI inflows and their effect on the host economy is twofold. For once since FDI has been increasing fast over the last decades and increasing linkages across developed nations facilitate the efficient function of the new global market, they are also capable of causing recessions affecting multiple economies on the globe. Thus it is important to gain an understanding of the possible benefits and adversaries involved for the global economy. FDI analysis is also important with regards to the effects it has on the host country. Many studies, among which Barrell and Holland (2000), Bedi and Cieslik (2002), Venables (2004), Markusen (2002), Dunning (1996, 2001) have investigated the potential gains and disadvantages resulting from inbound FDI and its effects on the growth rates of host economies.
In past decades the countries of central Eastern Europe have emerged as an attractive location for international investors. Countries, especially those following a path of development and restructuring, seek to attract foreign investments and thus find themselves in a competition for FDI. As they have experienced extended periods of central planning and socialist rule the countries of CEE are behind those developed nations of Western Europe in terms of productivity, income, technical sophistication and institutional development. The governments hope to spark an entrepreneurial development process fuelled by increasing competition and the spill-over of modern management knowledge brought into the economy by foreign investors (Venables, 2004; Markusen, 2002; Bedi and Cieslik, 2002; Kornai, 1990). A countries attractiveness as a location for FDI is thus an important field of focus for governments and policymakers - creating “location advantages” is what matters here (Dunning, 2002; Porter, 1990).
endowments and in particular natural resources or the cost of labour and its productivity, the focus is now more on the quality of institutions of potential host countries, and the advanced factors of production. One of the most prominent scholars in the field of what drives FDI flows and why is John H. Dunning.
Dunning (2002) proclaims a changing world economic scenario in which four events have shaped both the global business landscape and the macroeconomic conditions. The first is the creation of a knowledge economy in which the main source of wealth is no longer natural assets like unskilled labour and land as initially, or created assets such as finance, machinery and equipment but intangible created assets, knowledge, information (Dunning, 2002). The second is the formation of alliances: on a firm level between competitors, suppliers, and other stakeholders across industries and countries, and on a country level between public institutions and national governments. This alliance capitalism implies increased flows of FDI between countries and requires national governments to anticipate dialogue with fellow nations.
The third and according to Dunning the most dramatic development was the liberalization of markets. The fall of the iron curtain, the opening up of China for inbound FDI, the reorientation of national economic policies of many countries of Latin America, Africa and of India marked this period of macro regional integration on a global scale. It resulted in a revitalization of the market system to allocate and harness resources and capabilities in the most efficient way (Dunning, 2002). For the competitive position of a country this vast development implies a shock. Competitive pressures mount as national governments have to anticipate this change and defend or improve their location advantage.
Finally, it is the rise of emerging markets which has changed the composition of the world’s GNP. Emerging markets are predominantly located in Asia and Latin America and they pose a potential competitive threat to the developing economies as the wage rates in these countries are lower and skilled labour increasingly available.
attractiveness of a country consists of a focus on knowledge and knowledge creation, a need to promote global alliances between firms but also countries, liberalizations of markets, and the emergence of ever` more globally influential markets all in competition for location advantages and investors trust.
For the central European countries (CEEs) the increase in FDI over the last ten years was substantial (Eurostat yearbook, 2006). In the period of 1995 until 2000, the inward and outward FDI flows soared from €10.6 Bn to 23.7 Bn while the inward part took up more than 90%. (Eurostat, 2002). Among those ten countries, Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovenia, Slovak Republic some experienced high FDI growth in the first years after the fall of the iron curtain and the beginning of the transition process, while others lagged behind in attracting the investments (Bevan, Estrin and Grabbe, 2001). Most recent figures however show that those who missed out on the initial FDI boom are now also receiving increased FDI inflows such as the Baltic and Balkan countries. On the one hand through the support programmes of the European Union and on the other from investors that target these countries for their investments (Eurostat yearbook 2006).
1.2 The transition progress of CEE - location advantages and FDI attractiveness
The international economics literature has received extensive interest by researchers who investigate the driving factors behind the decisions of MNEs to conduct FDI. Why does FDI flow the way it does? What makes a location more desirable than its alternative? Which factors are the most significant?
Markusen, 2002; Bevan and Estrin, 2000; Bevan et al. 2004; Resmini, 2000; Zinnes, Eliat, and Sachs, 2001).
Recently, scholars have investigated the relationship of transition progress and institution building on countries attractiveness for FDI. Bevan and Estrin (2000), Bevan et.al. (2004) and Bor and v.d. Laar (2004), find a positive relationship between a countries progress on the transition path and its ability to attract FDI. Markusen and Ekholm (2002) discovered a high level of variance in FDI flows to Hungary, the Czech Republic versus the Baltic States, Poland and Slovakia. The authors find that variation in the quality of government and legal institutions is the cause for this variation.
Taking the analysis of Bevan et al (2004) as a starting point we extend the list of FDI determinants by two factors we deem significant. Similar to Bevan et al. (2004), we use a measure for institution building based on data collected by the EBRD. In addition to institutional building predictors, we add to the analysis one important predictor: a measure of advanced factors of production which plays a role in determining countries attractiveness to FDI flows (Zinnes, C., Eliat, Y., and Sachs, J. 2001; Zinnes et.al., 2001).
1.3. Host country effects: FDI and other determinants of growth for transition economies
So far we have looked at how countries can use and improve their location advantages in order to have a better competitive position in attracting FDI. What are the effects of such flows? How can a country profit from inbound FDI? What are adverse effects?
In developing countries especially those in transition, FDI has potentially positive effects on the creation of new jobs and the saving of existing ones. As firms that are undergoing privatization are suited recipients for investments from foreign firms (Jurajda and Terrell, 2003). Further, foreign owned firms usually pay higher wages which can lead to an overall growth of real income. For governments FDI has the potential to increase the tax base and boost exports. Since multinational enterprises (MNE)s often are from industries rich in intangible assets they bring with them features that domestic firms often do not possess, such as managerial expertise, and technological know-how. Moreover, multinational enterprises are usually better organized and hence exert a pressure on domestic firms to restructure faster than would be the case in their absence (Venables, 2004). But apart from the competitive pressures they also bring along superior knowledge that has the potential to affect positively the domestic workforce. Labor training and the provision of social services to local communities are also among the potential benefits that FDI brings (Barrell and Holland, 2000).
To make the connection between FDI and growth is however far from straightforward and various researchers have tried to link the two while others tried to prove them wrong. Blomstrom, Lipsey and Zejan (1994a) find that for FDI positively influences growth only in higher income recipient countries. This supports the notion of the reverse causality, and is often found in the above mentioned FDI determinant analysis: that rapid increases in GDP growth rates lead to increases in FDI inflows as the home market expands and demand increases. Indeed there is substantial empirical literature on this matter (see Chakrabati, 2001; Lipsey, 2000; UNCTAD, 1998; Wagner and Hlouskova, 2005 for a review of the most relevant studies).
and multinational firms and their employees on the other is a crucial component in this technology transfer process. The human capital stock is of central importance in this respect: the economy of interest simply needs the capabilities to be able to absorb any technological novelty or improved management style.
Technological transfer on the one hand requires a certain initial level of knowledge in the host economy, the transfer of funds on the other will rather flow to a well functioning and reliable financial system (Alfaro, Chanda, Kalemli Ozcan, Sayek, 2004). Alfaro et.al., (2004) investigated the role of financial institutions with respect to FDI and growth. Using two samples of 71 and 49 countries the authors find that FDI positively influences growth and, more specifically, that financial markets are crucial for the host countries to realize these potential gains from investment. This result is rather straightforward. Only in economies where capital is available for domestic firms can these firms then invest substantial funds into training of staff and new equipment increasing their competitiveness and reap the benefits from the knowledge introduced to their industries by foreign firms.
Other scholars, for example Barrell and Holland (2000), investigated FDI and labour productivity data and found a positive relationship between the stock of FDI and labour productivity. Further they point out that this contribution was higher than that of domestic investment. Supplier firms in the host economy also see their opportunities increased as they can supply the foreign owned firms.
Romer (1993) brought forward the notion of a knowledge gap that might suppress the income growth rates of developing countries. This gap of ideas may be as important as the traditional inputs since productive advantages in the form of marketing and management skills, distribution, inventory control, payments and information systems, transactions processing, quality control, and employee motivation make all the difference in a competitive economic environment. The author argues that although there are many ways to fill the gap, the most reliable and swift way is by creating a domestic environment that promotes inflows of foreign direct investment (Romer, 1993).
firms increases, the productivity of domestic enterprises was actually declining. Employees with higher training are hired by the foreign firms which are able to pay higher wages. Pavlinek (2004) investigates its effects of FDI inflows on the Polish economy and society and finds that it leads to a bifurcation, increased urbanization, and the exploitation of the workforce and in some cases even a drop in the wage rate, at least for the less skilled workforce. Western European firms some times invest only in the equipment to be able to pull out and invest elsewhere, might labour costs increase by too much (Pavlinek 2004).
1.4.Purpose of the study
The countries of Central Eastern Europe, the Balkans and Baltic states were freed from socialist rule and engaged in restructuring and transition. These countries are a special case in the sense that they opened up for foreign investment and trade having banned or discouraged it in the past decades. Their economies typically have large knowledge gaps in technologically intensive industries, which gaps investors could fill. Also these countries have engaged in a competition among them to attract foreign direct investment and are consequently improving institutional quality in order to support these investments. This paper looks into the development of FDI flows for this special group of countries which are in different stages of transition and offer diverse investment opportunities.
We investigate two basic questions:
1. What is the effect of country attractiveness on FDI inflow? 2. What is the effect of FDI inflow on GDP growth?
Specific research questions:
1.1. How does formal institutional development affect FDI inflow? 1.2. How do advanced factors of production affect FDI inflow? 1.3. How does culture affect FDI inflow?
This particular question will be approached quite differently from incidents in past literature examining the effect of geographic or cultural distance on FDI inflow. We pose the question as to how host country’s location to the west or to the east of the velvet curtain may influence FDI inflow.
The specific questions dealing with the effects of FDI inflow on GDP growth are: 2.1. Does FDI influence the growth rates of countries in transition?
2.2. What is the role of local financial institutions on national growth?
2.3. What is the role of culture (velvet curtain separation of nations) on national growth?
To answer the first three specific questions, the differences between countries attractiveness will be assessed using three different concepts: Institutional building, the development of advanced factors of production, and the location of host countries to the west or to the east of the velvet curtain. As these all result in potential variations in country attractiveness to FDI, we seek to assess their impact on the location decisions of investors.
Hence, this study is exploratory in the sense that the approach is novel to the existing literature on FDI and studies on transition economies in Central Eastern Europe. This thesis should provide the reader with a more recent impression of the developments in the CEE area, in particular casting some light on the latest EU members Bulgaria and Romania.
This thesis will be continued in the following manner:
In the next chapter we will review briefly previous models of FDI and present a prominent macroeconomic model of FDI and MNE activity which will serve us as a basis. Also we will introduce the concept of the velvet curtain – a cultural dividing line – to the reader. Different methodological approaches to FDI and FDI-led growth will also be presented. Keeping the important assumptions in mind we will build up and formulate testable hypothesis in chapter three. Chapter four will be the methodological section where the data and methods of research will be presented. After model tests in chapter five we will present our findings in chapter six. Chapter seven will use these findings to discuss some implications for policymakers and future research; limitations will be discussed in the end. Chapter eight concludes this analysis.
Chapter 2
2 Literature review
2.1 Theories of FDI
In contrast to early studies that focus on the uneven spatial distribution of natural resources, and the stock of capital, more recent contributions to the FDI literature take up supplementary factors into the analysis of where FDI flows and why.
A trade oriented model of FDI is presented by Kiyoshi Kojima, (1973). Based on the concept of the comparative advantage, the authors propose that FDI should source in the home countries disadvantaged industry and flow to the host countries advantaged industry Kojima (1982). It is basically an addition to the neoclassical theory of differences in factor endowments with a focus on trade in intermediate inputs, taking into account the principle of comparative advantage. Kojima and Ozawa (1984) see the novelty in their approach in the fact that countries are able to change or improve their comparative advantage and increase their attractiveness for investors. The entrepreneurial endowments of a country are not fixed and can be altered to improve the potential gains from FDI and trade which have a propensity to broaden the basis for trade and enhance welfare in both home and host countries.
In the context of country attractiveness Porter (1990) highlights the importance of several points. For a country to have a competitive advantage over others the quality and availability of the advanced factors of production, the quality of institutions and the cultural setting, and government policies play a crucial role (Porter, 1990) Zinnes, C., Eliat, Y., and Sachs, J. (2001). Similarly, Dunning (2001) deems the competitive and comparative advantages of countries to be determined by their ability to create and foster the deployment of created assets.
Multinational Firms conducting foreign investments in countries that offered superior business environments. For a countries location advantages this had major implications. Specifically the training of the workforce, the wage rate, infrastructural development, education, and institution quality are some of the latter determinants of country attractiveness that have overtaken the former in importance and these determinants can be altered in the medium to long run (Dunning ,1996; 2001; Porter, 1990; Zinnes et.al. 2001).
Country competitiveness and its ability to provide created assets have important implications not only for domestic and inbound investment for developed economies but also are necessary prerequisites for the upgrading and development of economic activity in most developing countries (Porter, 1990). This holds especially for those which compete with each other for FDI inflows. For the countries of our analysis this marks an important assumption, after having been virtually isolated from the global market by centralist governments their industries subject to low competitive pressures, the countries in transition now find themselves under great pressure from other nations to improve their institutional quality and production capabilities. Given that countries differ in the quality of their advanced factors and institutions, they differ in their competitive advantages thus their ability to attract FDI.
Due to the technological advances and an increasingly complex division of labour, the costs of traversing space relative to market related transaction and co-ordinating costs have been falling in recent decades. It has thus become ever more important for MNEs to choose the location for their investment based on country specific factors that go beyond those related to natural endowments. Building on Porters analysis, Dunning (2001) suggests that the ability of countries to develop a sustainable location advantage hinges on the macro-economic and organizational capabilities and on the quality and availability of created assets, such as R&D. transport and communication infrastructure and a flexible labour market.
2.2. FDI Determinants and previous methodological approaches
the rapid changes in these countries are rather unique and require a different approach from the general analysis of the issue.
Numerous studies have investigated FDI determining factors of countries in development. For countries in transition the following studies seemed most relevant to our analysis.
Studies of Holland and Pain (1998), Bevan and Estrin (2000), and Bevan et.al. (2004) found that FDI inflows are on the one hand encouraged by factors such as interest rates, industrial development, government balance, corruption, and inflation (i.e. the institutional development of the recipient country) but also market size and geographic proximity. Corruption and more generally poor quality of institutions would on the other hand increase transaction costs and reduce business activity, thus FDI. Further, incapable institutions and bad infrastructure (public goods, supplies, etc.) will in turn reduce expected returns on investments (Bloningen, 2005).
Bevan and Estrin (2000) identified four main factors of influence for the FDI inflows to CEE countries. Low unit labour costs, a large market size, the quality of financial institutions, and geographic proximity. Cheap labour and a large market trigger investment, the quality of financial of the recipient country and its geographic proximity also positively influence FDI inflows.
Bevan and Estrin (2004) used cross sectional data over the time period of 1994-1998 for 12 countries in transition. Analyzing the bilateral relationships between source and host country they put their focus on institution building and transition progress. Using data by the EBRD they compared scores for privatization, financial infrastructure, liberalization, regulation, and competition policy, GDP of host and source country and geographic distance with the adjacent FDI inflows. The authors find that institutions do have a positive effect on FDI inflows however with a significance of 6%.
FDI (Bevan et.al., 2004). Brenton Di Mauro and Luecke, (1999), more generally summarize these into an economic freedom index which they find to be positively related to FDI inflows.
Laura Resmini (2000) investigates the determinants of European FDI into CEECs and finds that market size, GDP per capita, population, operations risk index (ORI), and wage differentials are significant at the one per cent level. The author did not find the degree of openness or the size of the manufacturing sector to be of significant importance.
Brada, Kutan, and Yigit (2006) find that progress in economic transition to capitalism, economic policy towards FDI, general macroeconomic performance, and political stability are important determinants of FDI. The authors point to the forward-looking nature of any investment made abroad and the expected long run returns, moreover confidence on these returns. The authors point out that there are also FDI deterring factors to be considered. Political and economic inconsistency increase risk for investors, who fear reduced demand or exports in times of macroeconomic instability, civil war or conflict with neighbouring countries. In the worst case production facilities might be damaged or destroyed. Other risks stem from the depreciated value of the domestic currency which deteriorates the terms of trade for the firm and the value of its invested assets and future profits. The authors conclude that the economic costs of instability in the Balkan region in terms of foregone FDI were substantial (Brada et al., 2006).
In a study by Clausing and Dorobantu (2005), apart from the classical FDI determinants mentioned above for countries close to the European Union (that is EU membership candidate countries) the announcement of candidature for membership of the EU alone directly influences FDI. The findings on this matter were significant and quantitatively important for the inflow of investments.
result lends support to the efficiency seeking motivations of firms when investing into a host country and is in line with our expectations of the relationship between the CEECs and the countries of origin of FDI. The authors also mark the importance of the development of the wage levels in the host country. FDI may lead to an increased demand in labour and hence a bidding up of wages. This may have an adverse effect on subsequent FDI for those countries ahead in the transition process and gives countries with lower development and wages the chance to also receive foreign investments.
From the above studies we can derive that institutions have become an important tool to ensure the smooth running of economic affairs and trade, we therefore include variables that capture the institutional landscape in the CEE and Balkan regions, into our analysis. The enforcement of property rights, the independence of monetary policy by the central bank, the combat against corruption, and the strength and development of the financial system to channel funds to those regions where they are needed most and yield most efficient results are among those most frequently quoted.
In a study on home country environments, corporate diversification and firm performance Wan and Hoskisson (2003) classify countries into different levels of munificence in order to quantify differences across countries and relate these to firm behaviour and performance. The authors assess two aspects, on the one hand factors that encourage transformational processes and on the other hand those that facilitate transactional activities. They define country environment variables to measure the quality of the endowed, advanced and human factors of production. The former covers more traditional factors that are country specific like natural resources, active labour supply and energy sources. The latter two pertain more to the societal and financial institutions i.e. those created assets that both Dunning and Porter believe are important for countries improving their competitive advantage (see also Zinnes et.al., 2001).
markets. Stock market capitalization, domestic credit provided, and the access to venture capital are good indicators. (Chanda, Kalemli Ozcan, Sayek, 2004; Alfaro et.al., 2004).
The human factors have been used in FDI analysis extensively and their relevance is universally accepted (see Borenzstein, De Gregorio and Lee, 1998). Data on secondary or higher education enrolment and the quality of the education system of the host country and R&D personnel are the variables used by Wan and Hoskisson (2003). In addition to the mere institutional building as used by Bevan and Estrin (2004) introduced above we borrow this construct of the advanced factors of production as presented by Wan and Hoskisson (2003) and use it as a co-determinant for FDI inflows to transition countries in our analysis. For the analysis of the role played by local institutions in influencing FDI flows we use the approach of Bevan et.al. (2004), and Brenton Di Mauro and Luecke (1999) who employ the economic freedom index (EFI) as a summary indicator of institutional development.
Furthermore, the approach by Wan and Hoskisson (2003) relates to Williamson (1985) transaction cost theory and Dunning’s (1998) and Porter’s theory of country competition for FDI in a way that makes it useful for our analysis. For the countries of central Eastern Europe there is available data documenting the infrastructure, education, and socio-economic situation, which serves us as an indicator of the quality and nature of the advanced factors of production. A selection of the numerous other approaches and findings regarding institutions as FDI determinants enters our analysis as control variables.
2.3 The culture aspect: velvet curtain theory
Among other scholars, both Porter (1990) and Dunning (2002) recognize the influence of informal institutions on location decisions of MNEs. Culture has always been a much researched but still vague issue in economic modelling. In Dunning’s (1998) theory presented above, trans-national market failures not only stem from information constraints and co-ordination costs but also from those that relate to the establishment and fostering of relationships between individuals. Investors and employees encounter differences in historical and institutional backgrounds, formal institutions, lifestyles, religious ideologies, and business customs and in order to be successful they have to adapt. Further, the formal institutions of any country are embedded in a unique cultural setting which has major implications for its development prospects. In other words, culture manifested in the norms and values, rules and beliefs, trust and behaviour of people determine a countries ability to change advanced factors and embrace FDI inflows in the host economy.
For the countries in transition the changes in regulation and institutions could be swift, their implementation however hinges on how well bureaucrats and policymakers put them into action. The implementation of bureaucratic procedure which is subject to renewed rules or regulation is conditional upon an individual’s capability and mentality. Mentality is a product of a specific history which dates back hundreds of years and cannot be changed over night. Thus for our dual analysis of country attractiveness and growth enhancing effects of FDI inflows, culture is an important dimension to consider as a changed institutional environment will not directly lead to changes in behaviour of the people. How do we define culture for our analysis? How is culture measured?
possible in the current study as pairs of investor-recipient countries cannot be specified in order to examine the effects of cultural distance on FDI inflow.
An alternative approach is suggested here, namely, an application of the velvet curtain cultural division concept which could be indicative of the FDI attractiveness of host countries. In Huntington’s (1996) clash of civilizations he argues that the traditional ideological boundaries cease to matter to international relations and that reinforced cultural boundaries have come up to replace them. The iron curtain divided Europe ideologically and politically in Cold War times. As the ideological division of Europe has disappeared, the cultural division of Europe between Western Christianity, on the one hand, and Orthodox Christianity and Islam, on the other, has re-emerged.
Huntington (reference including the page number of the quote!!!!) redefines civilizations as: “the highest cultural grouping of people and the broadest level of cultural identities people have – short of what distinguishes humans from other species”. The author distinguishes between eight major civilisations: Western, Confucian, Japanese, Islamic, Hindu, Slavic-orthodox, Latin-American, African.
1 = Belarus 6 = Georgia 11 = Poland
2 = Bulgaria 7 = Hungary 12 = Romania
3 = Croatia 8 = Latvia 13 = Slovenia
4 = the Czech Republic 9 = Lithuania 14 = the Slovak Republic
5 = Estonia 10 = Moldavia 15 = Ukraine
Figure 1: The Velvet Curtain
And as far as culture is concerned, this line has strong implications. Peoples to the west and north of this line are either catholic or protestant and share common experiences such as feudalism, the Renaissance, the Reformation, the French Revolution, the Industrial Revolution. Also, these peoples are generally economically better off than those to the east. They see a chance in the European Union to increase involvement in a united European economy and to consolidate common democratic political systems (Huntington, 2002).
The peoples to the east and south of this line are either Muslim or Orthodox. Traditionally from the Tsarist and Ottoman empires they were hardly involved in or even influenced by the shaping events taking place in the rest of Europe. They are economically less advanced and seem less likely to actually develop stable thus reliable political systems. Huntington (2002) argues that the Velvet Curtain of culture has replaced the Iron Curtain of ideology as the most significant dividing line in Europe. Its allocation, according to Huntington, resembles “the bloody borders of Islam” (The clash of Civilizations and the remaking of world order, p. 47).
As far as the instalment and development of institutions is concerned, these borders and their strength naturally play a role in the process. Western institutions to be implemented in the transition economies of Central Eastern Europe is quite a task in a country that is not democratic from the day it has held its first free fair election. The people of the so called new democracies have few legal, political and civic skills and are usually quite anxious about the future because of deeply rooted prejudices towards change (Williams et al., 1997; Huntington, 2002). Whether or not these differences translate into differences in FDI inflows or differences in growth rates is a part of our analysis.
As stated earlier, to the best of our knowledge, there have not been previous attempts of scholars to include this concept into a macroeconomic study. The reasons why the theory of the velvet curtain did not find its place in FDI or growth related studies may be multiple. For once It does not capture nuances of cultural differences to the extent Hofstede’s studies do. The concept of the velvet curtain cultural division also makes the inclusion of nations to the west and to the east of the dividing line mandatory (not many past studies have such focus). This gives our current study a certain exploratory component as it will demonstrate to what extent this new approach is suitable for a study on determinants of FDI inflow and country growth.
2.4 FDI and growth
relationship of technology and growth. This concept provides us with an important link between FDI and host country growth. While FDI constitutes primarily an inflow of physical capital enhancing growth within an economy, according to a number of studies, the technology spill-over has the more pronounced effect on host country growth (Johnson, 2005; Barrell and Holland, 2000). Also for other researchers technology transfer by spill-over from MNE activities are among the most quoted (Kosova, 2005; Bengoa and Sanchez-Robles, 2003).
In a study by Estrin et al. (1997) the authors find that CEE countries are able to experience above home rate investment due to FDI. But the benefits of FDI go far beyond the supply of capital. For the CEE countries of importance are also the “imported” managerial skills, and the improvement of local knowledge about marketing and distribution which transition countries generally lack (Bevan et.al. 2001). Other benefits are training of staff, access to markets and a lower environmental impact. Domestic firms have access to superior technology from MNEs and hence can increase their productivity. This positive externality can enhance a long-run growth rate of the host country.
Barrell and Holland (2000) conducted a panel data analysis for Hungary, Poland and the Czech Republic and find that FDI inflows increase worker productivity in different manufacturing sectors. These findings further suggest that this increase is not primarily caused by the injection of capital but a result of the transfer of intangible assets onto the workforce (Barrell and Holland, 2000) Borensztein, et.al. (1998) find a positive correlation between FDI and growth when examining this issue in the context of less developed countries but also only if certain conditions prevail. The authors find that the human capital stock of the host country is crucial for transferring technology, and only with a certain accomplished threshold level of human capital (proxied by years of schooling of 25 plus males) will FDI have a positive effect on GDP growth. According to their study, the threshold lies between 0.76 and one year of post primary schooling (Borenzstein et.al., 1998; Blomstrom, Lipsey and Zejan,1994)
Alfaro, Chanda, Kalemli-Ozcan and Sayek (2002) have yet another factor to enhance the effects of FDI on host country growth: they deem the well functioning of capital markets as the important feature.
However clear the above arguments might be, the empirical evidence for positive relationships of FDI and host country growth is quite ambiguous. Researchers struggle to find a common formula as the variation in their results across different samples and econometric methodologies is very large results differ greatly with the method used in the analysis. (Lipsey, 2005).
However, other researchers come to different conclusions. De Mello (1999) uses a sample of 32 developed and developing countries in both, a time series and panel data fixed effects estimation and finds only weak indications of a positive relationship between FDI and host country growth. De Mello (1999) uses Granger causality tests to analyse the causality between FDI and economic growth.
The findings of Carkovic and Levine (2002) are clearer in their rejection of any relationship between FDI and growth. In their panel of industrialized and developing countries over the time period of 1960 until 1995 they even take into account different levels of human capital and per capita income of the domestic economy as well as financial market development and the degree of trade openness and still find no evidence that FDI positively influences growth of the host economy (Carkovic and Levine, 2003).
Although most authors confirm that informal institutions, such as the cultural setting of an economy hosting the FDI, influence the intensity of spill-over effects induced by it they do not attempt to empirically test this influence in any way. In our thesis we will employ the concept of the velvet curtain to distinguish the countries in terms of their cultural situation and assess whether this has an influence on the growth rate of the recipient economy.
2.5 Scope and Boundaries of the study
As suggested by Bevan et.al. (2001) well working institutions are a vehicle through which trustworthiness and reliability are signalled to potential investors. Instalment of functioning capital and labour markets, laws protecting (intellectual-) property, possibly trade agreements and a balanced budged are the bottom line in the standard of developed nations and make up their location advantage. Further, institutions provide economic actors with a basis for potentially better policy choices than in their absence. Taking a broader approach to the issue we also include two more aspects into the analysis. Advanced factors of production as created assets of countries are thought to improve a country’s competitive position as a location for FDI. Also culture as an informal institutional variable is possibly influential to the speed of implementation of the formal institutions.
The cultural factor in this thesis will be borrowed from a concept by S. Huntington (1996) and F. Fukuyama (1997). The velvet curtain and its implications on the source-host country relationships will be incorporated into the analysis, and assessed in its importance to explain why some countries receive more FDI while others are missing out. The argument for the inclusion of culture as determinant of host-country growth is the following: the pace of human capital build-up and absorption of technological know-how depends on the cultural specificity of a country—it is likely to be faster to the west of the velvet curtain and slower to the east.
In the next section hypotheses are formulated in two basic directions: the first set is concerned with the determinants of FDI and what is expected from the analysis of the CEECs, while the second set deals with the host country growth rates and whether we can find an indication that FDI has actually led to an increase in the growth rates. We investigate under what cultural circumstances countries in transition grow economically. Also, the quality of financial markets that provides capital for local investments needed to absorb and capitalize on the new knowledge imported by the MNEs will be assessed.
Chapter 3
3. Hypotheses
3.1. Host country attractiveness and FDI inflows
The first part of our analysis employs the concepts and assumptions we made in the previous sections regarding country attractiveness and FDI inflows. In line with previous research in this field we chose three determinants of FDI inflows. First, progress of institution building derived from Bevan et al (2004), to capture the stage of transition of the country, second the cultural situation which the country is in we will borrow the concept of the velvet curtain as specified by Fukuyama (1997) and Huntington (2002). Third we incorporate advanced factors of production (Wan and Hoskisson, 2003). Each section will be concluded with the corresponding hypothesis.
3.1.1 Relevance of institution building and FDI inflows
One of the most prominent scholars in the field of institutional theory is Douglas North. In his article “Institutions” (Journal of economic perspectives, Vol.5, No.1, 1991, p.97) he summarizes the features of institutions in a concise way:
“Institutions are humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions taboos customs traditions, and codes of conduct), and of formal rules (constitutions, laws, property rights). Throughout history institutions have been devised by human beings to create order and reduce uncertainty in exchange.”.
The idea behind creating such a framework of formal and informal rules is to reduce transaction costs. Especially in a setting of repeated transactions in a foreign market it is central for the involved parties to either have perfect information about each other or, since that rarely is the case, to have reliable institutions limiting the scope for adverse rent seeking behaviour. Well developed institutions hence reduce the costs of gathering information, limit uncertainty, promote stability, and thus make economic exchange activities more reliable and in most cases more probable (North, 1990) .
Following North’s proposition that formal and informal institutions reduce transaction costs and facilitate FDI (North 1990) the quality of host country institutions should have important implications for the flows of capital into that country. Since the formal institutions of transition economies were subject to thorough restructuring in the 1990s following freedom of socialist rule, changes were rapid end extensive. The rules governing the market economy itself were a product of this reform (Bevan et. al. 2004). These rules have strong implications on the conduct of business, competition and management practice. This makes the group of CEECs particularly interesting to investigate. However, success in attracting funds hinges on the creation of a business climate that reduces uncertainty and risk for investors and avoids lengthy bureaucratic procedures and multifarious tax systems.
Generally, investors and agents prefer free markets, price liberalisation and well developed competition policy in their investment decisions. Lengthy bureaucratic procedures and negotiations with government authorities, which are often a consequence of under-developed institutions, are consequently detrimental to the location advantage of the country.
Furthermore, the ability to accumulate private (intellectual-) property is the main motivating force in a market economy, and the rule of law is vital to a fully functioning free-market economy. Secure property rights give citizens and investors the confidence to undertake commercial activities, save their income, and make long-term plans because they know that their income and savings are safe from expropriation (Oxley, 1999; Smarzynska, 2002). More generally, countries that provide reliable legal systems and efficient public administration may receive more investment and profit more from it than countries with poor governance.
Hypothesis 1a: Countries that have progressed further in institution building will receive more FDI flows
3.1.2. Informal institutions: Culture and FDI inflows
Institution building has been underway in all countries of Central Eastern Europe, and most countries already have well worked out institutions in place. It is important however, for us to realize that although regulation and law-enforcing structures can change virtually over night, the norms of behaviour and cultural habits of those who implement and exercise them i.e. bureaucrats and policymakers will not change as rapidly. Investors may find it harder to integrate themselves into host country business networks in countries which feature a culture very different to theirs.
Measuring cultural proximity however is challenging. In the past, many scholars employed the dimensions of Hofstede (2001) in this respect. For the particular group of CEECs however, the cultural division alongside the velvet curtain is an appropriate measure of culutral differences. .
We propose that the countries to the west of the velvet curtain will ceteris paribus receive more flows than those to the east of this cultural dividing line. In analogy to the above concepts by Huntington (2002) and Fukuyama (1997) and given that most FDI into CEECs either comes from Western Europe or other western nations those recipient countries to the west of the curtain are culturally closer to the investing ones. As we will specify more in detail in the methodology section those countries which are divided by the curtain (split states), will receive special attention since their potential for future conflict and thus the risk of investing there is the greatest (Huntington, 2002; Fukuyama, 1997).
Hypothesis 1b: Countries to the east of the velvet curtain will receive less FDI than those to the west; Countries divided by the velvet curtain will receive less FDI than those which are not divided.
3.1.3. Advanced factors of production and FDI inflows
The development of a nation and its assets is a determining constraint on a nation’s ability to grow and attract funds. However the form that these assets come in has changed form the mere factor endowments, of which natural resources are the most ancient straightforward ones, to created assets which are a result of institutional attainment and build up of human capital. These created assets are among today’s determinants of investment flows.
Among the advanced factors is the degree of technical sophistication of the host country industry. This refers to the quality of the equipment and the training of the workforce but also to R&D capabilities. Second and especially for developing countries and those in transition of importance is the quality of the physical infrastructure. This encompasses the quality of roads, air traffic, railroads, access to broadband internet, mobile phone subscribers, distribution systems, and power issues. The infrastructural situation that the investor faces when entering a host country, and for which he has to adapt, contributes largely to the costs and technical hitches of any FDI undertaking. Third the advanced factors also include indications of the quality of the capital markets. Stock market capitalization, domestic credit provided, and the access to venture capital are good indicators. Secondary or higher education enrolment and the quality of the education system of the host country and R&D personnel, give a good indication of the overall skill level. (Chanda, Kalemli Ozcan, Sayek, 2004; Alfaro et.al., 2004). The human factors have been used in FDI analysis extensively and their relevance is universally accepted, Borenzstein, De Gregorio and Lee (1998).
Hypothesis 1c: Countries which are better endowed with advanced factors of production will receive more FDI
3.2. Growth effects
Economists agree more uniformly on the important role of institutions in explaining growth rate divergence between countries and growth volatility within countries. Researchers have conducted extensive empirical analysis on the issue of institutions and their influence on per capita income, growth and its volatility.
The Solow models (Solow, 1956) failure to explain the large differences in income levels across countries was interpreted as an outcome of differences in technology. It was not until Romer (1993) and Lucas (1988) that the relationship between technology and growth were analyzed in detail. In their studies technological spill-over was found to be capable of increasing a countries rate of economic growth. Not only does FDI imply an injection of capital into the country but local firms also have the chance to adopt superior MNE technology and management styles that allow more efficient production. These positive externalities that FDI generates can enable a country enhance its long-run growth rate, Borenzstein, De Gregorio and Lee (1998) and Bosworth and Collins (1999).
Host country institutions are the channels through which this spill-over is supported and created. First they signal to investors that the country is a well endowed location for investment and secondly they create an environment in which local entrepreneurs, suppliers and customers can benefit from the investments.
3.2.1 Culture and its influence on growth
Various studies have stressed the importance of human capital in promoting spill-over. Minimum levels of education must be attained in order for FDI to induce growth Borensztein, De Gregorio and Lee (1998). In transaction cost theory, Williamson (1985) also points out the role of informal institutions and culture as important vehicles for improved formal institutions to actually create an advantage. As we have learned in the literature review section and the hypothesis section above, institutional change is important especially for countries in transition. However the introduction of a formal rule or new regulation is not the end of the story. The implementation of a rule is done by humans. Whether these people are against or in favour of changes depends on their values and norms, - their cultural background. The success of introducing institutions similar to those of Western Europe (EU regulation, legislation etc.) in the countries of our sample hinges on the willingness of the population to change their behaviour. This is in line with the location advantage and -competition considerations of Porter and Dunning.
But the influence of culture goes beyond attracting FDI as stated above. A positive and open attitude by the host country population toward other nations enhances growth: as more advanced knowledge is introduced into the economy positive externalities hinge on the willingness of the people to interact with the foreigners and enhance their own skills and managerial capabilities – to build up human capital. Attitudes, values, and beliefs are those informal institutions that influence the populations ability but also willingness to learn and increase productivity. Productivity increases in turn can enhance growth. Taking into consideration the differences in cultures and shared experiences, historic trade- and empire ties along the line of the velvet curtain (Williams, et. al., 1997) we expect a significant difference in the way FDI spills over into growth in these countries.
Hypothesis 2a: Transition economies west of the velvet curtain will experience higher FDI-led GDP growth rates, than those to its east
3.2.2 Financial Market development and growth
promoting privatisation. Well organized financial markets will secure flows of funds and labour to those regions where they are needed most. Other authors found that especially for the set of CEECs the size and quality of the private sector plays a major role in translating investments into growth. Not only does this go for the ability of local firms to capitalize on the technology and managerial know how brought into the economy by foreign firms but also for the restructuring of formerly state owned firms. For these local firms to be able to invest they rely heavily on the local banking sector and other financial institutions to generate capital.
Developed financial institutions are believed to play a significant role in influencing the positive externalities associated with FDI on growth. In economics literature the argument that well-functioning financial markets, by means of lowering transaction costs, ensure that capital is allocated to those investments that yield the highest returns, and therefore enhances growth rates is often stressed, Alfaro et. al. (2003). Also complementary local finance can reduce exchange rate risk for investors on the one hand and boost local demand for costly industrial machinery or simply luxurious goods. (Alfaro, Chanda, Kalemli-Ozcan and Sayek, 2002). In analogy with Bevan et. al. (2004) we therefore claim:
Hypothesis 2b: FDI and financial sector development will jointly have a positive effect on economic growth.
Chapter 4
4 Methodology
4.1 Sample and data 4.1.1 Sample
a path of transition and restructuring. Due to differences in initial conditions institutionally and culturally, the speed and form of restructuring differ as well. With the ultimate goal of membership of the European Union, most governments pushed reforms to improve institutional quality and stability. Privatization and restructuring of formerly state owned enterprises on a massive scale are attracting investors worldwide but predominantly from Western Europe (Eurostat, 2006).
The sample period starts from 1992 until 2005 the start marking the end of the Soviet Union. As data sets are becoming more complete and more recent data is available we hope to be able to obtain a more recent image.
4.1.2 Data sources and definitions
The data are used to measure FDI, growth, privatisation, human capital, financial market development and other indicators of institutional quality. The world development indicators WDI are part of the universities databases on economic performance of countries. They are updated annually by the World Bank and currently provide information up to the year 2005. The second source is the EBRD database which provides us with information on legal issues, infrastructural development and business climates. The third source is the United Nations Centre for Trade and Development (UNCTAD) from which we derive data on our dependent variables, GDP and FDI.
We now turn to the definitions of the data and the relationships we expect them to have to each other.
4.2 Dependent and independent variables, controls
Our dependent variables are foreign direct investment (FDI) for the first, and the annual growth rate of the gross domestic product (GDP growth) for the second and third model.
short-term capital, FDI inflows differ from gross FDI figures which include inflows and outflows (the sum thereof). Another available alternative would be the FDI stocks of a country but these only reveal the total value of investment holdings whereas flows continuously record any injections of capital as a result of changing country attractiveness. We will use annual FDI inflows for our analysis.
Real GDP growth that is, the real growth rate of a nations´ income, is the dependent variable for the second part of our analysis.
There are two sets of independent variables. For the FDI attractiveness analysis we use Institutional development, (INSTDEV), advanced factor endowment (ADVFACTOR) and two dummy variables to capture cultural differences along the velvet curtain (VELVET1) or to capture split state effects (VELVET2).
Institutional development will be estimated using the EBRD index of economic freedom (EFI). It records the extent and quality of national institutions, legislation, and the efficiency of markets. It is a measure compiled by the EBRD yearly to account for the enforceability of property rights in a given country. Contract enforcement and the right to own property are the baseline requirements of an investment. Well functioning institutions on this ground reduce transaction costs and enhance investment flows. The index lies between 0 and 100 with 100 being the best enforced property rights and 0 the weakest. It is compiled by the EBRD for most countries of Central Eastern Europe and the Balkans and covering ten years of time this measure will serve us as a proxy for the quality of host country institutions. with data from the World bank, represent official estimates of out-turns as reflected in publications from the national authorities, the International Monetary Fund, the World Bank and other sources. It was also used in the analysis of the relationship between institutions and FDI inflows by Bevan et.al.(2004).
Advanced factors of production (ADVFACTOR) encompass a variety of variables: The quality of the education system of the host country:
Secondary or higher education enrolment (EDUCATION)
The advanced factors also include indications of the quality of the capital markets. Stock market capitalization, (STOCKS) domestic credit provided (DOMCRED), and inflation (INFLATION) which will be presented below.
The Velvet Curtain variables VELVET1 andVELVET2 are dummy variables separating the sample into three groups. First, those cases that lie to the east of the cultural line from those to the west. According to Huntington (2002) the Velvet Curtain is the most important cultural dividing line of Europe today. Those countries beyond the curtain share different historical and socio-cultural opinions, experiences and beliefs and their economies are usually weaker than those to the west. As most investment into the Region comes from “western” multinationals we expect the countries to the west to better absorb FDI and translate it into growth as they are culturally closer and communication easier. A third group will be the split states, Belarus, Ukraine, which are split internally by differing cultural groups. Since these are promoters of conflict, investors will be hesitant hence we expect FDI inflows to be lower in these countries. The dummy will be inserted twice: VELVET1 with values 0 = to the west of the curtain and 1 = to the east and VELVET2 with values 0 = not split and 1 = split state. We expect FDI to better translate into growth to the west of the curtain and split states to receive less FDI than all other countries.
Domestic credit provided henceforth: DOMCRED will be the credit provided by domestic banks in the economy expressed as a percentage of GDP to put it in relative terms. This variable is especially important, since domestic entrepreneurs rely heavily on external finance when starting up their own firms. And start up of new domestic firms is by many researchers seen as the motor for growth. Other studies however claim that lending by foreign investors in the host country increases the cost of capital and chokes off access for capital for local firms.
The Independent variables are accompanied by a number of control variables from which we will choose depending on our model to be tested. Our control variables are:
enter. We will insert a dummy variable to check for this difference. EU membership (EU) is one of our control variables which will enter the analysis in the form of a dummy taking the form 0 for non membership and 1 for membership. Unfortunately since the last entrants to the EU, Georgia and Bulgaria fall out of our dataset (2006) we can not observe the influence of the event.
Market Size henceforth MARKET will account for the size of the economy. The larger market hence the larger population will attract more FDI, (Dunning, 2002; Markusen 2000, 2002; Venables 2002, Helpman, 1984). We expect FDI to be positively influenced by the market size. We will use population as a proxy for market size. The data comes from the WDI 2005 database.
Our last control variable will be Openness to trade, henceforth open and will be measured by the ratio of Trade/GDP. A countries ability and willingness to engage in trade will attract foreign investors as they seek for a platform for export from their host country production plant. The openness measures trade (sum of exports and imports) as a percentage of GDP. The more facile the conduct of business and the shipping of goods is the better the business climate and the higher the expected FDI inflows. Trade supporting infrastructure and simple tax systems contribute to this openness. We expect its sign to be positive.
Growth models
For our two growth models we will test both independent variables separately. First we will analyse how culture can influence the countries ability to make use of the foreign funds in their economy. The cultural variables VELVET1 and VELVET2 together with FDI inflows will be related to per capita GDP growth. Second, the development of the financial sector in the form of stock market capitalization and domestic credit provided and FDI will be related to per capita GDP growth.
banking sector. The data we use are available from the World Bank New Database on Financial Development and Structure Database (1960-2004)1.
The stocks traded on the national stock market will be related to GDP to give us an idea of the degree (percentage) of stock market capitalisation instead of the absolute values. Domestic credit provided is also related to the size of the economy thus expressed as a percentage of GDP. Data on stock market include variables introduced by Levine and Zervos (1998). These data was also used by Alfaro et al. (2003) and is available in the World Bank Financial Structure Database. For this analysis we utilize Stock market size (STOCKS): equal to the average of listed domestic shares on domestic exchanges in a year as a percentage of GDP thereby capturing the relative size of the stock market of the host economy.
Analogous to the first model, our dependent variable will be annual per capita GDP growth. This data comes from the WDI database (WDI, 2006).
Table 3 gives an overview of the data and some descriptive statistics.
- insert table 3 about here -
4.3 Research Design
4.3.1 Analytical framework
In our analysis we assess the development of those performance indicators we deem important for attracting FDI inflows with the actual flows of funds into the economies. Apart from hard data on infrastructural and institutional development we also include a cultural variable. In a second step we then relate FDI inflows together with other factors to the GDP growth rate. To depict the relationships we seek to analyze view the following diagram.
1
The URL for the database is
