Impact of Natural Environment, Regional Integration, and Policies on FDI

Abstract

FDI is an important source of capital, technology, and skills transfer for both developing and developed economies, this paper explores the effects of three determinants of bilateral FDI, including natural barriers, the “at-the-border” barrier (regional trade agreement), and the “behind-the-border” barrier (domestic regulatory environment). An augmented gravity model is deployed to carry out the test for the inter-OECD and intra-OECD regions in 60 economies for the period 1985 – 2006. The main aim is to study the roles of external institutions vis-à-vis domestic institutions on FDI. We perform several estimation strategies for our panel data analysis, finding geographical, historical, and cultural proximities all explain bilateral FDI significantly, even after controlling for unobserved country-pair heterogeneity and time effect. Using a “catch-all” regulatory environment index and a dummy variable for country-pair membership of RTA, our analysis shows that lax regulatory environment and RTA are seemingly associated with FDI positively in both regions.