Governance and foreign direct investment: Regional and sectoral patterns

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Governance and foreign direct investment
Regional and sectoral patterns

• Ivar Kolstad
• Chr Michelsen Institute
• 14 June 2005

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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 dont know

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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

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Does good governance increase FDI?
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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

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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 R20042
• Econometric study, 75 countries, 1989-2000
• ICRG and Freedom House governance indices
• Major results
• Political freedom increases FDI
• Religious tensions deter FDI

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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.

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How to attract a specific industry

• Kolstad and Villanger (2004), Social development
  and industry level FDI, CMI report R20041
• 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

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The rise of service sector FDI
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How to attract service industries

• Kolstad and Villanger (2004), Determinants of
  foreign direct investment in services, CMI
  working paper WP20042
• 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

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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.

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Attracting FDI to the Caribbean

• Kolstad and Villanger (2004), Promoting
  investment in small Caribbean states, CMI working
  paper WP20049
• 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

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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

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What we do not know

1. How to attract responsible companies to a country
2. Bilateral FDI data How do differences in
   governance between host and source country affect
   FDI flows?
3. How does FDI in different industries affect
   growth?
4. Is Africa different in terms of impact of
   governance on FDI?
5. How do trade openness and infrastructure interact
   to affect exports and FDI?