FOREIGN DIRECT INVESTMENT AND ITS DETERMINANTS IN EMERGING ECONOMIES

ABSTRACT
This study analyzes determinants of net foreign direct investment (FDI) inflows in emerging
economies between 1978 and 1995. Its theoretical framework is based on the concept of
Institutional FDI Fitness, developed by the author Saskia Wilhelms. Grounded in integrative
theories of foreign direct investment (FDI), the Institutional FDI Fitness theory stipulates that FDI is
determined less by intransigent fundamentals than by institutional variables more amenable to
change, namely policies, laws, and their implementation. The four institutions contributing to FDI
Fitness are government, markets, education, and socioculture.
The FDI Fitness concept is tested in an econometric cross-section across 67 emerging economies.
The econometric analysis shows government and market variables as the most significant
determinants of FDI inflows. Governmental fitness is reflected in economic openness with only
minimal trade and exchange rate controls. Government fitness also means a strong rule of law and
low corruption, based on legal and administrative equity and transparency. Market fitness is
represented by high trade volume, low taxes, high urbanization, and ready availability of credit and
energy.
Given that these determinants reduce incentives for discretionary behavior and rent-seeking, the
results demonstrate that, while investors are willing to negotiate, they seek stability and
transparency, preferring clear-cut and consistently implemented regulations to individual privileges
gained through wheeling and dealing.
The regression analysis hence corroborates the Institutional FDI Fitness theory. The manner in
which policy-makers handle institutions, policies, laws, and their implementation is significantly
more important to foreign direct investors than relatively intransigent factors such as population size
and socioculture. The FDI Institutional Fitness theory suggests that every nation has the opportunity to identify and expand its competitive strengths to increase its share of global foreign direct investment.