Do Institutions matter for attracting foreign direct investment?
Academic literature review
1.1 The position of FDI in international capital flows
Vast research is focused on financial liberalization and capital inflows as a consequence of it. The main findings were that capital inflows volatility is more severe in developing countries than in developed ones, and that this cannot be explained by the level of changes in fundamentals (Broner et al. (2005)). Because of the existing global economy, small negative shocks in one country will lead to asset pricing deterioration worldwide and the total effect would be relatively large; international capital flows are the most significant reason of these changes (Mendoza et al. (2010)). Most of the studies doubt that foreign capital flows are a reliable platform for the development of emerging economies.
However, Foreign Direct Investment (FDI) is claimed to be of a different nature. According to the definition given by the World Bank, it consists of an acquisition of ten percent or more of voting stock (it might be equity capital, significant intercompany borrowing and lending, or earnings reinvestment). Lipsey (2001), in his historical study of 3 financial crises –(Eastern Asian, Mexican and Latin American), proved that FDI is more resilient to downturns in economic conditions than other forms of foreign capital. Moreover, Makki et al. (2004) found a significant positive effect on internal investment and economic growth from FDI. That is consistent with findings of Bosworth et al. (1999) that an extra 1$ of FDI increases internal investment by 1$ on average, which is a lot more than the total impact of only 50 Cents of foreign capital inflows.
Loungani, and Razin (2001) provided a selection of four main sources of benefits for a hosting country: transfer of technology that could not be otherwise acquired; human