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Governance and foreign direct investment: Regional and sectoral patterns. Ivar Kolstad Chr Michelsen Institute 14 June 2005. Why do investors care about governance?. Two extremes: Multinationals seek to exploit countries with weak, ineffective, and corrupt governments
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Governance and foreign direct investment: Regional and sectoral patterns Ivar Kolstad Chr Michelsen Institute 14 June 2005
Why do investors care about governance? Two extremes: • Multinationals seek to exploit countries with weak, ineffective, and corrupt governments • Multinationals seek countries with good governments e.g. due to a less risky operating environment This presentation: • Econometric studies • Four CMI studies • Policy implications • What we don’t know
What is governance – and foreign direct investment? Governance = Political, institutional and legal environment • Macroeconomic: Inflation, budget deficits, exchange rates • Political: Democratization, political freedom, quality of public institutions, corruption • Social: Internal and external conflict • Other: Physical infrastructure Foreign direct investment (FDI) = investment through which a foreign investor acquires a lasting and influential interest in a domestic enterprise
Good governance increases FDI - So what? Econometric studies: Governance increases FDI inflows to developing countries Aggregate studies, do not tell us: • Which dimensions of governance matter • Which industries/companies are attracted by governance factors • What role does governance play in attracting FDI to specific regions/countries
1. Governance? What of it? Which dimensions of governance matter for FDI? Kolstad and Villanger (2004), How does social development affect FDI and domestic investment, CMI report R2004:2 Econometric study, 75 countries, 1989-2000 ICRG and Freedom House governance indices Major results: • Political freedom increases FDI • Religious tensions deter FDI
2. Which industries do we want to attract? • Different industries have different developmental impact: • skill upgrading • technology transfer • CSR? • FDI in different industries attracted by different governance dimensions.
How to attract a specific industry Kolstad and Villanger (2004), Social development and industry level FDI, CMI report R2004:1 Econometric study, 66 countries, 1989-2000 ICRG and Freedom House governance indices FDI data for primary, secondary and tertiary industries Major results: • Democratic accountability increases tertiary sector FDI, but decreases secondary sector FDI • Law and order increases FDI in both secondary and tertiary sector • Internal conflict deters secondary sector FDI • Corruption increases FDI in tertiary sector
How to attract service industries Kolstad and Villanger (2004), Determinants of foreign direct investment in services, CMI working paper WP2004:2 Econometric study, 57 countries, 1989-2000 ICRG and Freedom House governance indices (composite) FDI data: Service sector total, and four major service industries (finance, business, transport, trade) Major results: • Political risk does not affect total service sector FDI • Institutional quality attracts FDI in transport sector
3. How to attract FDI to specific regions/countries “Africa is different … policies that have been successful in other regions may not be equally successful in Africa” (Asiedu, 2002) In particular: • Infrastructure affects FDI in general, but not FDI to Sub-Saharan Africa • Trade openness has a lesser effect on FDI in Sub-Saharan Africa than elsewhere Implication: Tailor policy to specific regions.
Attracting FDI to the Caribbean Kolstad and Villanger (2004), Promoting investment in small Caribbean states, CMI working paper WP2004:9 Econometric study 135 countries, of which 13 Caribbean, 1989-2000 KKZ governance indices Major results: • Political stability increases FDI • Excessive regulation decreases FDI • FDI particularly sensitive to instability in countries like Haiti, Guyana, Dominica, and Grenada
Summing up: Aggregate studies: • Better governance means more FDI Governance dimensions: • Political freedom attracts FDI • Religious tensions deter FDI Industry-specific factors: • Some industries more conducive to development • Different effect of governance on FDI in different industries Region-specific factors: • Africa is different • Caribbean: Stability crucial in some countries
What we do not know • How to attract responsible companies to a country • Bilateral FDI data: How do differences in governance between host and source country affect FDI flows? • How does FDI in different industries affect growth? • Is Africa different in terms of impact of governance on FDI? • How do trade openness and infrastructure interact to affect exports and FDI?