Impact of Institutional Environment on Inward FDI: A Case of Select Emerging Market Economies

Abstract

The tremendous amount of foreign direct investment (FDI) flowing into emerging nations has attracted worldwide attention. These economies are at a same stage of development with similar social, economic and other conditions, but their institutional environment can act as a differentiator in affecting FDI location within these emerging economies. So, this article examines the role of institutional mechanisms in influencing their inward FDI by employing broad-based indicators of institutional environment. The article employs panel data regression (fixed effects) to test the impact of institutional indicators and other variables on FDI inflows and stock of 23 emerging economies from 2006 to 2015. Three indices have been constructed for this purpose, using the methodology of principal component analysis and composite index, from 24 institutional variables. All the three indices, representing three institutional pillars turned significant: ‘Rule of law’ (negative coefficient), ‘Regulatory efficiency’ (positive coefficient) and ‘normative institutional environment’ (negative coefficient). This implies that one of the main motivations for foreign investors to make investment in emerging economies is to take advantage of their weak laws, norms and values. But they also seek a basic enabling environment with minimum burdens as far as the efficiency of regulations is concerned.