chr. michelsen institute governance and foreign direct investment: regional and sectoral patterns...

Chr. Michelsen Institute

Governance and foreign direct investment:

Regional and sectoral patternsIvar Kolstad

Chr Michelsen Institute14 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

Chr. Michelsen InstituteWhat 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


Does good governance increase FDI?

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Chr. Michelsen InstituteGood governance increases

FDI - So what?

Econometric studies: Governance increases FDI inflows to developing countries

Aggregate studies, do not tell us:1. Which dimensions of governance matter2. Which industries/companies are attracted by

governance factors3. 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, 1989-2000ICRG 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, 1989-2000ICRG and Freedom House governance indicesFDI 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


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 WP2004:2

Econometric study, 57 countries, 1989-2000ICRG 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, 1989-2000KKZ 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

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?

chr. michelsen institute governance and foreign direct investment: regional and sectoral patterns...

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