Pakistan Economic and Social Review
Volume XLI, No. 1&2 (2003), pp. 59-75
ANALYSIS OF FACTORS AFFECTING
FOREIGN DIRECT INVESTMENT
IN DEVELOPING COUNTRIES
BUSHRA YASMIN, AAMRAH HUSSAIN
and MUHAMMAD ALI CHAUDHARY*
Abstract. This study has analyzed the volume and determinants of Foreign Direct Investment (FDI) in developing countries of the world. The analysis was based on a sample of 15 developing countries with 5 each from upper middle, lower middle and lower income countries. In general, the flow of FDI to developing countries has followed an uneven path and its volume was modest in the beginning of 1980s but has tended to rise in subsequent years. Following panel data model, we applied three approaches, namely common intercept model, random effects and fixed effects model, to clearly identify the factors affecting FDI in developing countries with different levels of income. The analysis showed that urbanization, GDP per capita, standard of living, inflation, current account and wages are affecting FDI significantly in low income, urbanization, labour force, domestic investment, trade openness, standard of living, current account, external debt and wages in lower middle income and urbanization, labour force, GDP per capita, domestic investment, trade openness and external debt in the sample upper middle income countries. Similarly, country specific dummies have attributed large variations in FDI to institutional and structural differences among the countries analyzed.
Foreign Direct Investment (FDI) has historically contributed to the development of many host countries by way of improving their infrastructure, technical skills, entrepreneur abilities and financial resources in terms of government revenue and foreign exchange. Since FDI is expected *The authors are Lecturer in Economics and a graduate student at Fatima Jinnah Women University, Rawalpindi (Pakistan), and Professor of Economics, respectively.
Pakistan Economic and Social Review
as such to expand opportunities of development, its demand has increased rapidly, especially over the last two decades. The growing shortage of official loans from the international financial institutions and aid from the developing countries has further increased the demand for FDI in Less Developed Countries (LDCs) of the world. Although the volume of FDI in developing countries has increased significantly over time, its distribution has been characterized by large variations between and within different regions of the world. Until mid-1980s, Latin America and the Caribbean were the largest recipients of FDI. However, the situation since late 1980s has reversed and the Asian and Pacific countries have became its recipients. These two developing regions are jointly receiving approximately 85% of FDI flows to developing countries. Individually, in 1998 Africa received 4.5%, Asia 2%, Pacific 46.3%, Latin America and Caribbean 39% and Central and Eastern Europe 10.2% of FDI (UNCTAD, 1999).1 Although the diversity in the magnitude and density of FDI in developing countries has variously been examined, there is still need of systematically analyzing factors affecting it in countries by level of income, which has a direct bearing on the prerequisites of FDI. As such this study has empirically analyzed factors likely to have affected historically the flow of FDI in countries with different levels of income.
Many different factors have affected the volume and distribution of FDI in developing countries of the world. The main beneficiaries of the major FDI inflows have been the countries with political stability (Ghurra and Goodwin, 2000; Root and Ahmed, 1979; De Mello, 1995; Cheng and Kwan, 1999; Schneider and Frey, 1985; Wang and Swain, 1995), favourable policies of tax and subsidies (De Mello, 1999), existence of good business environment, better administrative policies and low level of corruption (Loot, 2000; Ghurra and Goodwin, 2000)....