## _wp11192 - 1. FDI Inflows to EMEs 1990–2008

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---

### I. Introduction and motivation
- Purpose:
  - Identify which external (global push) and domestic (country-specific pull, especially policy-driven) factors drive FDI inflows to emerging market economies (EMEs).
- Sample and period:
  - Sample: 46 countries.
  - Period: 1990 to 2009 for most countries (covers the global financial crisis for preliminary assessment).
- Extended scope:
  - Examines a wide range of economic policies (including corporate tax rates, tariffs, exchange rate policy, and FDI-related capital account restrictions) and political stability/conflict using professional risk indices and a domestic conflict event database.

### A. Trends in FDI inflows to EMEs (1990–2008)
- Overall pattern:
  - Total inflows as a percentage of total emerging market GDP shows a sustained trend increase.
- Surge and trough episodes:
  - First episode: started in 1990 and reached a peak in 1999.
  - Decline: began in 2000 and reached a trough in 2003.
  - Second episode: 2003–07, reaching a peak of 4 percent of total emerging market GDP just before the global financial crisis in 2008.
- Cross-country incidence:
  - Number of countries in an inflow episode increased starting in 1995, peaked in 1998.
  - During 2004–06, the number of EMEs in an FDI inflow episode reached 16.
- Relationship with advanced economies and global conditions:
  - Growth in G-7 countries coincided with the first surge in the 1990s; slowdown in 2000–01 contributed to decline in FDI inflows.
  - Persistently low global interest rates during surge periods reduced financing costs for investment projects and mergers and acquisitions.
  - Global risk aversion and heightened uncertainty (VIX index) played a significant role; significant negative relationship observed notably after 2006.
- Cross-country dispersion:
  - Surge episodes were broad-based but uneven; examples:
    - Egypt, Turkey, Russia, and India: relatively stable inflows until mid-2000s, then sharp surge.
    - Thailand and China: initial surge in the 1990s but not another surge after 2005.

### II. Empirical framework and data — explanatory variables
- Identification strategy:
  - Controls for common time trends across countries to capture global push factors.
  - Country-specific pull factors grouped into: 1) fixed/structural factors, 2) political factors, 3) macroeconomic factors, and 4) economic policy variables.
- Global push factors (examples and measures):
  - Growth in capital-exporting countries: 3-year moving average of real GDP growth in G-7 countries.
  - International liquidity: average real (ex-post) interest rates in G-7 countries.
  - Risk environment: natural logarithm of the VIX index.
- Country-specific pull factors (selected measures):
  1. Fixed/structural:
     - Log of PPP-adjusted GDP per capita in 1989.
     - Average years of school attainment in 1990.
     - Oil-exporter dummy: 1 if share of oil exports in total exports exceeds 20 percent.
     - Location dummies: Middle East and North Africa, Asia, Latin America, Central and Eastern Europe.
  2. Political environment and institutions:
     - ICRG ratings: government stability, internal and external conflict, law and order, bureaucracy quality (component ranges vary; higher = lower risk).
     - CNTS event variables: General strikes; Major government crises; Revolutions; Anti-government demonstrations.
  3. Macroeconomic environment:
     - Real GDP growth; Inflation dummy (1 if inflation above 10 percent); Exports/GDP; Change in real effective exchange rate.
  4. Economic policy variables:
     - Corporate tax rates (statutory), average tariff rates on manufactured goods, exchange rate classification (AREAR), AREAR dummies for restrictions on FDI inflows and on liquidation/repatriation.

- Estimation approach:
  - Dynamic partial-adjustment model for FDI inflows (FDI as percent of GDP).
  - Two-step system GMM estimator of Blundell and Bond (1998).
  - Instruments: lags of predetermined pull factors; time-varying common push factors assumed exogenous.
  - Arellano-Bond AR(2) tests reported across specifications.

### III. Key empirical observations and regression evidence
- Lagged persistence:
  - Lagged FDI/GDP coefficients vary by specification; examples:
    - Column [1] Table 1: 0.452*** [0.086].
    - Range in Table 2 columns [1]–[7]: 0.748*** [0.055] to 0.349*** [0.092].
    - Table 4 policy specifications include 0.670*** [0.069], 0.368*** [0.114], 0.364*** [0.089], 0.728*** [0.057], 0.727*** [0.059], 0.598*** [0.113], 0.635*** [0.103].
- Global push factors:
  - Real Growth Rate in G-7 (3-year MA): positive and significant in many specifications.
    - Examples (Table 1): Column [1]: 0.413*** [0.062]; Column [2]: 0.673*** [0.189]; text interpretation: a one percent increase in G-7 growth rates increased FDI inflows by 0.4 percent of GDP.
  - Real Interest Rate in G-7: negative and significant in several specifications.
    - Examples: Column [1] Table 1: -0.316*** [0.071]; Column [3]: -0.28*** [0.069].
  - Log of VIX index: mixed; Table 2 column [1]: -0.909*** [0.28]; Table 1 columns: small or not significant in some specifications.
- Fixed/structural pull factors:
  - Education (years in 1990): consistently positive and significant.
    - Examples: Table 1 Column [3]: 0.319** [0.106]; Column [4]: 0.351** [0.123]; Table 2 examples: 0.170*** [0.047], 0.201*** [0.052], 0.255*** [0.072].
    - Text interpretation: every additional year of schooling increases the FDI-to-GDP ratio by about 0.3 percentage points.
  - Log of GDP per capita in 1989 (PPP): negative coefficients in some columns (Table 1 Column [3]: -0.408 [0.287]; Column [4]: -0.455 [0.327]).
  - Regional effects: Central and Eastern Europe dummy positive and highly significant:
    - Column [3] Table 1: 1.322*** [0.501]; Column [4]: 1.438** [0.572] — ~1.3–1.4 percent of GDP.
- Political and institutional factors:
  - Composite ICRG political risk: positive and significant.
    - Examples Table 2: 0.038** [0.017]; 0.044** [0.020].
  - Disaggregated components:
    - Conflict (higher = less conflict): positive (e.g., 0.05* [0.029]; 0.069** [0.03]).
    - Government Stability: 0.115* [0.063] in one specification.
    - Law and Order, Bureaucracy Quality: not consistently significant.
  - Event indicators (CNTS):
    - General Strikes (lagged): -0.26*** [0.078]; -0.195** [0.091] — large negative lagged effect.
    - Major Government Crises: -0.295*** [0.098]; -0.314** [0.099] — about -0.3 percent of GDP decline.
    - Revolutions: -0.232* [0.119]; -0.191 [0.132].
    - Anti-Government Demonstrations: -0.071** [0.035]; -0.064 [0.035].
- Macroeconomic environment:
  - Major Government Crises: negative and significant in Table 3 (examples: -0.383*** [0.100]; -0.392*** [0.134]).
  - Inflation dummy (inflation less than 10 percent): negative but not statistically significant in Table 3 (examples: -0.239 [0.686]; -0.342 [0.766]; -0.448 [0.796]).
  - Exports/GDP and change in REER: coefficients small and statistically insignificant in Table 3 (examples: Exports/GDP 0.017 [0.023]; change in REER -0.031 [0.039]).
- Economic policies (Table 4 highlights):
  - Corporate Tax Rate:
    - Coefficients: -0.11*** [0.027], -0.096*** [0.018], -0.105*** [0.019] — highly significant negative effect.
    - Interpretation: lower statutory corporate tax rates associated with higher FDI inflows.
  - Average Tariff Rate on Manufactured Goods:
    - Coefficients: -0.022* [0.012] (tariff-only), -0.012 [0.017] (combined), -0.024 [0.016] (other column).
    - Text interpretation: cutting tariff rates by 10 percentage points leads to predicted increase in FDI of about 0.22 percent of GDP.
  - Exchange rate classification:
    - Exchange Rate Fixed: positive and significant in multiple specifications:
      - Examples: 0.609** [0.298]; 0.518** [0.253]; 0.558** [0.266].
      - Text statement: having a fixed exchange rate increases equilibrium inflows by 0.96 percent of GDP.
    - Exchange Rate Floating: negative coefficients (examples: -0.247 [0.282]; -0.253 [0.30]; -0.241 [0.278]) — not all statistically significant.
  - Restrictions on FDI inflows:
    - Restriction on FDI inflows 1: -0.465* [0.28] — significant negative effect.
    - Restriction on FDI inflows 2: -0.416 [0.257] — negative but not significant.
  - Major Government Crises remain negative and significant in policy specifications (examples: -0.301** [0.132]; -0.358*** [0.112]; -0.353*** [0.111]).
- Model diagnostics and samples (selected):
  - Num. of Countries reported across tables: commonly 46; some columns 44 or 45.
  - Arellano-Bond Test (AR(2), p-level) examples: Table 1: 0.92, 0.86, 0.81, 0.75; Table 2: 0.18, 0.16, 0.17, 0.16, 0.83, 0.77; Table 3: 0.92, 0.98, 0.81; Table 4: 0.14, 0.67, 0.85, 0.17, 0.17, 0.26, 0.29.

### Main conclusions and policy implications
- Crisis impact:
  - The global financial crisis led to a substantial contraction in FDI inflows to EMEs; FDI inflows remained subdued in many countries.
  - Both global push factors and economic policies had significant effects on FDI inflows, especially during 2008–09 when G-7 growth declined and uncertainty increased.
- Policy-relevant pull factors with quantitative evidence:
  - Corporate tax rates:
    - Coefficients: -0.11***, -0.096***, -0.105*** — lowering statutory corporate tax rates associated with higher FDI inflows.
  - Tariff liberalization:
    - Tariff coefficient example: -0.022* [0.012]; cutting tariffs by 10 percentage points predicted to raise FDI by about 0.22 percent of GDP.
  - Exchange rate stability:
    - Exchange Rate Fixed coefficients ~0.518–0.609**; fixed regimes associated with higher equilibrium inflows (text: increase by 0.96 percent of GDP).
  - Capital account restrictions:
    - Restrictions on FDI inflows show negative effects (example: -0.465* [0.28]).
  - Political stability and human capital:
    - Education: each additional year of schooling increases FDI-to-GDP by about 0.3 percentage points.
    - Political instability/conflict: Major Government Crises ~ -0.3 percent of GDP; General Strikes ~ -0.20 percent of GDP (lagged).
- Recommended policy considerations:
  - Consider tax policy (statutory corporate tax rates) and tariff liberalization as tools to attract FDI, acknowledging statutory rates do not capture special incentives.
  - Maintain exchange rate stability (fixed/managed regimes reduce exchange rate risk) to support FDI inflows.
  - Reduce restrictions on FDI inflows (foreign ownership controls) to avoid negative effects on FDI.
  - Address political instability and conflict to prevent FDI losses; policies that promote inclusive growth may help reduce domestic conflict and support sustained FDI.
  - Complementary measures to translate higher FDI into growth and social benefits:
    - Investments in infrastructure and human capital.
    - Improvements in governance, labor markets, and financial intermediation.
    - Establishment of social safety nets.

### Limitations and avenues for future research
- Data and measurement limitations:
  - Statutory corporate tax rates do not capture special tax incentives.
  - Ease of doing business and other business environment measures limited by historical coverage and comparability.
- Scope limitations:
  - Analysis focuses on policy impacts on FDI inflows but does not investigate the channels linking higher FDI to growth and social outcomes.
- Potential extensions:
  - Expand policy variable coverage and sectoral detail to yield additional insights.

*Source: _wp11192 - 1. FDI Inflows to EMEs 1990–2008 and 4. Economic Policies (PDF chapter content provided).*

### 1. FDI Inflows to EMEs 1990–2008 .......................................................................................

### _wp11192 - 1. FDI Inflows to EMEs 1990–2008 .......................................................................................

### I. Introduction and motivation
- FDI is viewed by policy makers in developing and emerging market economies (EMEs) as a tool to finance development, increase productivity and import new technologies.
- FDI inflows are considered relatively stable compared to other capital inflows, providing a buffer against sharp reversals in portfolio inflows during crises (for example, the crisis experienced in 2009).
- Key empirical focus: which external (global) and domestic (country-specific, especially policy-driven) factors drive FDI inflows to EMEs.
- Sample: 46 countries, period from 1990 to 2009 for most countries, covering the global financial crisis for preliminary assessment of crisis effects on FDI inflows.
- This paper extends existing literature by examining a wide range of economic policies (including corporate tax rates, tariffs, exchange rate policy, and FDI-related capital account restrictions) and political stability/conflict using professional risk indices and a domestic conflict event database.

### A. Trends in FDI inflows to EMEs (1990–2008)
- Overall trend:
  - Total inflows as a percentage of total emerging market GDP shows a sustained trend increase.
- Surge episodes identified:
  - First episode: started in 1990 and reached a peak in 1999.
  - Decline: total flows declined starting in 2000 and reached a trough in 2003.
  - Second episode: 2003–07, reaching a peak of 4 percent of total emerging market GDP just before the global financial crisis in 2008.
- Number of countries experiencing inflow episodes:
  - The number started to increase in 1995 and reached its peak in 1998.
  - During 2004–06, the number of EMEs in an FDI inflow episode reached 16.
- Relationship with advanced economies:
  - Growth in G-7 countries coincided with the first surge in the 1990s; the slowdown in 2000–01 appears to have contributed to the decline in FDI inflows.
  - Persistently low global interest rates during the surge periods reduced financing costs for investment projects and mergers and acquisitions.
- Risk and volatility:
  - Global risk aversion and heightened uncertainty (measured by the VIX index) play a significant role in explaining FDI inflows.
  - The unconditional correlation between the VIX index and FDI inflows is small, but a significant negative relationship is observed during certain periods, notably after 2006.
  - FDI inflows plunged when uncertainty increased to unprecedented heights.
- Cross-country dispersion:
  - Although surge episodes were broad-based, variation among EMEs increased, with some countries receiving significantly larger inflows.
  - Examples: Egypt, Turkey, Russia, and India had relatively stable inflows until the mid-2000s, then experienced a sharp surge; Thailand and China had an initial surge in the 1990s but not another surge after 2005.

### II. Empirical framework and data — explanatory variables
- Explanatory variables grouped into global push factors and country-specific pull factors.
- Identification strategy:
  - Controls for common time trends across countries to capture global push factors.
  - Country-specific pull factors grouped into: 1) fixed/structural factors, 2) political factors, 3) macroeconomic factors, and 4) economic policy variables.

- Global push factors:
  - Growth in capital exporting countries:
    - Use the 3-year moving average of real GDP growth in G-7 countries to capture effects of developed-country business cycles on FDI.
  - International liquidity:
    - Use the average real (ex-post) interest rates in G-7 countries; lower interest rates are expected to increase FDI flows.
  - Risk environment:
    - Use the natural logarithm of the VIX index to capture global risk appetite.

- Country-specific pull factors:

  1. Fixed or structural factors:
     - Size of domestic market:
       - Use the log of the PPP-adjusted gross domestic product per capita in the host country in 1989 to capture domestic market size effects.
     - Education:
       - Use average years of school attainment in 1990 (Barro and Lee (2010) dataset).
     - Role of oil sector:
       - Dummy equals one if the share of oil exports in total exports exceeds 20 percent.
     - Location dummies:
       - Middle East and North Africa, Asia, Latin America, Central and Eastern Europe.

  2. Political environment and institutions:
     - Use several ICRG political risk ratings and components: government stability, internal and external conflict, law and order, and bureaucracy quality.
       - Ratings range from 0 to 12 or 0 to 4 depending on the component; higher rating indicates lower risk.
     - Use event-based domestic conflict variables from the Cross-National Time-Series Data Archive (CNTS):
       - General strikes (major strikes involving 1,000 or more workers and more than one employer aimed at national government policies).
       - Major government crises (rapidly developing situations that threaten to bring down the current regime).
       - Revolutions (forced change in the top government elite).
       - Anti-government demonstrations.

  3. Macroeconomic environment:
     - Real GDP growth: high growth can attract FDI; acknowledge potential feedback effects from FDI to growth.
     - Inflation:
       - Dummy variable equals one if inflation during that year has been higher than 10 percent.
     - Exports to GDP:
       - Share of exports to GDP used as a proxy for export orientation and competitiveness.
     - Real exchange rate:
       - Use change in the real exchange rate to assess competitiveness effects on FDI.

  4. Economic policy variables:
     - Corporate tax rates and tariffs considered as policy variables that can promote or deter FDI.
     - Exchange rate policy and FDI-related capital account restrictions are also included.

### III. Key empirical observations highlighted in text
- Results are broadly consistent with previous literature on the role of global push factors and business cycles in capital-exporting advanced economies.
- This paper finds a more important role for economic policies—especially corporate tax rates—as drivers of FDI inflows.
- The paper carefully attempts to quantify the effects of political stability and conflict on FDI using both professional risk indices and a domestic conflict event database.
- Methodological note on episode identification:
  - Inflow episodes identified following the October 2007 World Economic Outlook (WEO) methodology:
    - An inflow episode is identified if in any given year total capital inflows as percentage of GDP exceed trend inflows by more than one standard deviation.
    - Trend inflows for each country are calculated using the HP-filter with a smoothing parameter of 100.
    - If there are less than two years between two inflow episodes, they are considered part of the same inflow episode.

*Source: _wp11192 - 1. FDI Inflows to EMEs 1990–2008 (PDF chapter content provided).*

### 4.      Economic Policies:

### _wp11192 - 4.      Economic Policies:

### Measures and policy variables
- Trade policy: average tariff rates imposed on manufactured goods used as proxy for trade liberalization; effect on FDI may differ by orientation (domestic market vs exports).
- Exchange rate classification: IMF’s de facto classification with 8 regime classifications combined into three categories: fixed (classifications 1-4), managed (classifications 5-7), and floating (classification 8); dummies constructed for classifications.
- Restrictions in capital account transactions related to FDI: two AREAR indicators used: 1) whether there were any restrictions on FDI inflows; 2) whether there were any controls on liquidation of direct investment. (Results for restrict2 are not reported as they were not significant.)
- Inflation: many sample countries experienced hyperinflation; relationship between FDI and inflation conjectured to be nonlinear, so a binary indicator of inflation performance (inflation less than 10 percent) is used.
- Corporate tax rates: statutory corporate tax rates from KPMG after 1999 extended using IMF Fiscal Affairs Department database back to mid-1990s; caveat that special tax incentives are not captured by statutory rates.
- Other policy measures: ease of doing business and other business environment measures noted as potentially important but limited by data comparability and coverage.

### Empirical model and estimation
- Dynamic partial-adjustment model for FDI inflows (FDI as percent of GDP) with push factors (tX), pull factors (tiY), country fixed effects, and time effects:
  - Equilibrium FDI expressed as function of push and pull factors plus unobserved fixed/time-varying factors.
  - Speed of adjustment parameter: 1 = βρ (if equals zero, immediate adjustment; as it approaches one, FDI inflows become more persistent).
- Estimation approach:
  - Two-step system GMM estimator of Blundell and Bond (1998) used to address bias from lagged dependent variable and endogenous regressors.
  - Lags of exports to GDP ratio, real GDP growth, inflation dummy and real exchange rate used as instruments for predetermined pull factors.
  - Time-varying common push factors assumed exogenous.
  - Arellano-Bond AR(2) tests reported across specifications; time restrictions used to limit instruments.

### Key regression results — Push and fixed pull factors (Table 1)
- Lagged FDI/GDP (FDI/GDP (Lag)):
  - Column [1]: 0.452*** [0.086]
  - Column [2]: 0.381*** [0.078]
  - Column [3]: 0.417*** [0.09]
  - Column [4]: 0.345*** [0.085]
- Real Growth Rate in G-7 (3-year MA):
  - Column [1]: 0.413*** [0.062]
  - Column [2]: 0.673*** [0.189]
  - Column [3]: 0.393*** [0.062]
  - Column [4]: 0.616*** [0.204]
  - Interpretation: a one percent increase in G-7 growth rates increased FDI inflows by 0.4 percent of GDP (reported in text).
- Real Interest Rate in G-7:
  - Column [1]: -0.316*** [0.071]
  - Column [2]: -0.379 [0.376]
  - Column [3]: -0.28*** [0.069]
  - Column [4]: -0.316 [0.382]
- Log of Vix index:
  - Column [1]: -0.159 [0.282]
  - Column [2]: -0.205 [1.451]
  - Column [3]: -0.219 [0.281]
  - Column [4]: -0.478 [1.485]
- Log of GDP per capita in 1989 (PPP):
  - Column [3]: -0.408 [0.287]
  - Column [4]: -0.455 [0.327]
- Education (years) on 1990:
  - Column [3]: 0.319** [0.106]
  - Column [4]: 0.351** [0.123]
  - Interpretation: every additional year of schooling increases the FDI-to-GDP ratio by about 0.3 percentage points (text).
- Regional dummies:
  - Central and Eastern Europe Dummy: 1.322*** [0.501] (col [3]) and 1.438** [0.572] (col [4]) — positive and highly significant (1.3–1.4 percent of GDP).
- Sample and diagnostics:
  - N8 / 41 / 84 etc. reported in table (exact formatting retained in table reproduction).
  - Num. of Countries: 46 / 46 / 45 / 45 across columns.
  - Arellano-Bond Test (AR(2), p-level): 0.92, 0.86, 0.81, 0.75.

### Political and institutional factors (Table 2)
- Lagged FDI/GDP:
  - Ranges from 0.748*** [0.055] to 0.349*** [0.092] across columns [1]–[7].
- Real Growth Rate in G-7 (3-year MA): mixed signs across specifications; positive and significant in some (e.g., 0.402*** [0.059] in column [5]).
- Log of Vix index: -0.909*** [0.28] (col [1]); other columns show varying magnitudes and significance.
- Education (years) on 1990: consistently positive and significant (examples: 0.170*** [0.047]; 0.201*** [0.052]; 0.255*** [0.072]).
- Political Risk (ICRG composite):
  - Positive and significant: 0.038** [0.017] and 0.044** [0.020] (columns using Political (ICRG)).
  - Interpretation: more favorable political/institutional environment leads to more FDI inflows.
- Disaggregated political components (columns 3-4):
  - Conflict: 0.05* [0.029] and 0.069** [0.03] — positive (note: ICRG conflict variable is higher if less conflict).
  - Government Stability: 0.115* [0.063] in one specification.
  - Law and Order, Bureaucracy Quality: not significant.
- Event indicators (columns 5-7):
  - General Strikes (lagged): -0.26*** [0.078] and -0.195** [0.091] — large negative effect with a lag.
  - Major Government Crises: -0.295*** [0.098] and -0.314** [0.099] — about -0.3 percent of GDP decline.
  - Revolutions: -0.232* [0.119] and -0.191 [0.132].
  - Anti-Government Demonstrations: -0.071** [0.035] and -0.064 [0.035].
- Arellano-Bond Test (AR(2), p-level) values reported: e.g., 0.18, 0.16, 0.17, 0.16, 0.83, 0.77.

### Macroeconomic environment (Table 3)
- Lagged FDI/GDP:
  - 0.427*** [0.081], 0.477*** [0.072], 0.349*** [0.115] across columns [1]–[3].
- Real Growth Rate in G-7 (3-year MA): 0.635*** [0.219], 0.617** [0.255], 0.184 [0.398].
- Major Government Crises: -0.383*** [0.100], -0.392*** [0.134], -0.350 [0.229].
- Inflation Dummy (inflation less than 10 percent): -0.239 [0.686], -0.342 [0.766], -0.448 [0.796] — negative but not statistically significant.
- Exports of goods and services/GDP: 0.017 [0.023] and 0.086 [0.066] — positive but insignificant.
- Change in Real Effective Exchange Rate: -0.031 [0.039] — negative but not significant.
- Num. of Countries: 46 across columns; N values and Num. of Instruments reported; Arellano-Bond AR(2) p-levels: 0.92, 0.98, 0.81.

### Economic policies (Table 4)
- Lagged FDI/GDP across specifications: 0.670*** [0.069], 0.368*** [0.114], 0.364*** [0.089], 0.728*** [0.057], 0.727*** [0.059], 0.598*** [0.113], 0.635*** [0.103].
- Average Tariff Rate on Manufactured Goods:
  - Coefficient: -0.022* [0.012] in tariff-only specification; -0.012 [0.017] in combined; -0.024 [0.016] in another column.
  - Interpretation in text: Cutting tariff rates by 10 percentage point leads to a predicted increase in FDI of about 0.22 percent of GDP.
- Corporate Tax Rate:
  - Coefficients: -0.11*** [0.027], -0.096*** [0.018], -0.105*** [0.019] — highly significant negative effect.
  - Interpretation in text: corporate tax rates have a highly significant effect on FDI, consistent with tax competition evidence.
- Exchange rate dummies:
  - Exchange Rate Fixed: 0.609** [0.298], 0.518** [0.253], 0.558** [0.266] — having a fixed exchange rate increases equilibrium inflows by 0.96 percent of GDP (text statement).
  - Exchange Rate Floating: -0.247 [0.282], -0.253 [0.30], -0.241 [0.278] — negative impact.
- Restrictions on FDI inflows:
  - Restriction on FDI inflows 1: -0.465* [0.28] — significant negative effect.
  - Restriction on FDI inflows 2: -0.416 [0.257] — negative but not significant.
- Major Government Crises: negative and significant across policy specifications (example: -0.301** [0.132], -0.358*** [0.112], -0.353*** [0.111]).
- Combined policies specification: when all policies included (except capital controls), corporate tax and exchange rate fixation remain significant; tariff and capital controls show mixed significance.
- Sample sizes and diagnostics:
  - N values: 673, 714, 848, 416, 426, 593, 593 across columns; Num. of Countries: 46, 44, 46, 46, 46, 44, 44; Num. of Instruments vary; Arellano-Bond AR(2) p-levels: 0.14, 0.67, 0.85, 0.17, 0.17, 0.26, 0.29.

### Main conclusions and policy implications
- The global financial crisis led to a substantial contraction in FDI inflows to emerging market economies; FDI inflows remained subdued in many countries.
- Both global push factors and economic policies had significant effects on FDI inflows, especially during 2008–09 when G-7 growth declined and uncertainty increased.
- Statistically important pull factors:
  - Lowering corporate tax rates associated with higher FDI inflows (corporate tax rate coefficients: -0.11***, -0.096***, -0.105***).
  - Lower tariff rates associated with higher FDI inflows (tariff coefficient example: -0.022*).
  - Stable (fixed/managed) exchange rate associated with higher FDI inflows (Exchange Rate Fixed coefficients ~0.518–0.609**); floating regimes show negative coefficients.
- Political stability and education:
  - Education: each additional year of schooling increases FDI-to-GDP by about 0.3 percentage points.
  - Political stability: political risk indices and event measures show that conflict and major political instability substantially reduce FDI (examples: Major Government Crises ~ -0.3 percent of GDP; General Strikes ~ -0.20 percent of GDP lagged).
- Policy recommendations and considerations (as discussed in the source):
  - Consider tax policy (statutory corporate tax rates) and tariff liberalization as tools to attract FDI, recognizing statutory rates do not capture special incentives.
  - Maintain exchange rate stability (fixed/managed regimes reduce exchange rate risk) to support FDI inflows.
  - Reduce restrictions on FDI inflows (foreign ownership controls) to avoid negative effects on FDI.
  - Address political instability and conflict to prevent FDI losses; policies that promote inclusive growth may help reduce domestic conflict and support sustained FDI.
  - Complementary measures to translate higher FDI into growth and broad social benefits include investments in infrastructure and human capital; improvements in governance, labor markets, and financial intermediation; and establishment of social safety nets.
- Limitations and future research:
  - Data limitations prevented inclusion of many potentially relevant policy measures (e.g., ease of doing business metrics with sufficient historical coverage).
  - Statutory corporate tax rates do not capture special tax incentives.
  - Analysis focuses on impact of policies on FDI inflows but does not investigate the channels linking higher FDI to growth and social outcomes.
  - Expanding policy variable coverage could yield additional insights.

*Source: _wp11192 - 4.      Economic Policies*

### REFERENCES

### _wp11192 - REFERENCES

### Key References
- Alfaro, Laura, Areendam Chanda, Sebnem Kalemli-Ozcan and Selin Sayek, 2004, ―FDI and Economic Growth: The Role of Local Financial Markets,‖ Journal of International Economics, 64, 2004, pp. 84-112.
- Alfaro, Laura, Sebnem Kalemli-Ozcan and Vadym Volosovch, 2007, ―Capital Flows in a Globalized World: The Role of Policies and Institutions,‖ in Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, edit. by Sebastian Edwards, May 2007, pp. 19–72.
- Barro, R. and Jong-Wha Lee, 2010, ―A New Data Set of Educational Attainment in the World, 1950–2010, NBER Working Paper No. 15902.
- Blundell, Richard and Stephen Bond, 1998, ―Initial Conditions and Moment Restrictions in Dynamic Panel Data Models,‖ Journal of Econometrics, Vol. 87, pp. 115–143.
- Borensztein, E., J. DeGregorio, and J-W. Lee, 1998, ―How Does Foreign Direct Investment Affect Economic Growth?‖ Journal of International Economics, Vol. 45, pp.115–135.
- Calvo, Guillermo, Leonardo Leiderman and Carmen M. Reinhart, 1996, ―Inflows of Capital to Developing Countries in the 1990s, The Journal of Economic Perspectives, Vol. 10, No. 2, (Spring, 1996), pp. 123–139.
- Campos, Nauro F. and Yuko Kinoshita, 2003, ―Why Does FDI Go Where It Goes? New Evidence From the Transition Economies,‖ IMF Working Paper 03/228.
- Campos, Nauro F. and Yuko Kinoshita, 2008, ―Foreign Direct Investment and Structural Reforms: Evidence from Eastern Europe and Latin America,‖ IMF Working Paper 08/26.
- Cheng, L. and Y. Kwan, 2000, ―What are the Determinants of the Location of Foreign Direct Investment? The Chinese Experience,‖ Journal of International Economics, Vol. 51, pp. 379–400.
- Chai, Jingquing, and Rishi Goyal, 2008, ―Tax Concessions and Foreign Direct Investment in the Eastern Caribbean Currency Union,‖ IMF Working Paper 08/257.
- Dabla-Norris, Era, Jiro Honda, Amina Lahreche and Genevieve Verdies, 2010, ―FDI Flows to Low- Income Countries: Global Drivers and Growth Implications,‖ IMF Working Paper 10/132 (Washington: International Monetary Fund).
- Demekas, Dimitri G., Balazs Horvath, Elina Ribakova and Yi Wu, 2005, ―Foreign Direct Investment in southeastern Europe: How (and How Much) Can Policies Help?‖ IMF Working Paper 05/110 (Washington: International Monetary Fund).
- Devereux, M. P., B. Lockwood and M. Redoano, 2008, ―Do Countries Compete Over Corporate Tax Rates,‖ Journal of Public Economics, 92, pp.1210–1235.
- Faria, Andre and Paolo Mauro, 2004, ―Institutions and the External Capital Structure of Countries,‖ IMF Working Paper, 04/236 (Washington: International Monetary Fund).
- Hein, S., 1992, ―Trade Strategy and the Dependency Hypothesis: A Comparison of Policy, Foreign Investment, and Economic Growth in Latin America and East Asia,‖ Economic Development and Cultural Change 40 (3): 495–521.
- International Monetary Fund, 2007, World Economic Outlook, Chapter 3, October 200:Managing Large Capital Inflows (Washington).
- International Monetary Fund, 2010, Western Hemisphere Department Regional Economic Outlook, Spring 2010.
- Klemm, Alexander and Stefan Van Parys, 2009, ―Empirical Evidence on the Effects of Tax Incentives,‖ IMF Working Paper, 09/136 (Washington: International Monetary Fund).
- Kose, Ayhan, Eswar Prasad, Kenneth Rogoff, and Shang-Jin Wei, 2009, ―Financial Globalization: A Reappraisal,‖ Staff Papers, International Monetary Fund, Vol. 56 (1), pp.8–62.
- Kose, Ayhan, Eswar Prasad, and Ashley Taylor, 2009, ―Thresholds in the Process of Financial Integration,‖ NBER Working Paper No. 14916.
- Lucas, R., 1993, ―On the Determinants of Direct Foreign Investment: Evidence from East and Southeast Asia‖ World Development, 21 (3): 391–406.
- Piatkowski, Marcin and Mariusz Jarmuzek, 2008, ―Zero Corporate Income Tax in Moldova: Tax Competition and Its Implications for Eastern Europe,‖ IMF Working Paper, 08/203 (Washington: International Monetary Fund).
- Roodman, David, 2006, ―How to Do xtabond2: An Introduction to ―Difference‖ and ―System‖ GMM in Stata,‖ Center for Global Development Working Paper No: 103.
- Roodman, David, 2008, ―A Note of the Theme of Too Many Instruments,‖ Center for Global Development Working Paper No: 125.
- Rummel, Rudolph J., 1963, ―Dimensions of Conflict Behavior Within and Between Nations,‖ General Systems Yearbook, VIII, 1963, 1–50.
- Schindler, Martin, 2009, ―Measuring Financial Integration: A New Data Set,‖ Staff Papers, International Monetary Fund, Vol. 56, No.1, 2009, pp. 222–238.
- Schneider, F. and B. Frey, 1985, ―Economic and Political Determinants of Foreign Direct Investment,‖ World Development, 13 (2): 161–175.
- Singh, Harinder and Kwang W. Jun, 1995, ―Some New Evidence on Determinants of Foreign Direct in Developing Countries,‖ Policy Research Working Paper No: 1531, World Bank, November 1995.
- Slemond, Joel, 2004, ―Are Corporate Tax Rates, or Countries, Converging?‖ Journal of Public Economics, 88, 1169–1186.
- United Nations Conference on Trade and Development (UNCTAD), 2009, ―Assessing the Impact of the Current Financial and Economic Crisis on Global FDI Flows,‖ April 2009.
- Walsh, James P. and Jiangyan Yu, 2010, ―Determinants of Foreign Direct Investment: A Sectoral and Institutional Approach,‖ IMF Working Paper 10/187.
- Wei, S.J., 2000, ―Local Corruption and Global Capital Flows,‖ Brookings Papers on Economic Activity, 2000 (2), pp.303–54.
- Zee, H.H., J.G. Stotsky, and E. Ley, 2002, ―Tax Incentives for Business Investment: A Primer for Policy Makers in Developing Countries,‖ World Development, Vol. 30(9), pp. 1497-1516.

### Appendix: Identification of Inflow Episodes (Methodology)
- FDI gap: deviation of FDI inflows as percent of GDP from its trend, calculated by the HP-Filter with a smoothing parameter that equals 100.
- Episode rule: A year is identified as an inflow episode if the FDI inflow during that year has been higher than the trend flow plus one standard deviation of the FDI gap for that country.
- Adjacency rule: If there is less than two years between two episodes for any country, all the adjacent years are treated as part of the same inflow episode.
- The table in the source lists episodes identified using this method for all countries in the sample.

### Table 1 - FDI Inflow Surges and The EME Country Coverage
- Algeria: 2001, 2004
- Argentina: 1999
- Brazil: 1998-2000
- Bulgaria: 2006-2007
- Chile: 1999
- China, P.R.: Mainland: 1993-1995
- Colombia: 1997, 2005-2008
- Costa Rica: 1998, 2006-2007
- Croatia: 1999-2001
- Czech Republic: 1999, 2002, 2005
- Dominican Republic: 1998, 2008
- Ecuador: 1998-1999
- Egypt: 2006-2007
- El Salvador: 1998, 2007
- Estonia: 1998, 2005
- Guatemala: 1998, 2001
- Hungary: 2007
- India: 2008
- Indonesia: 1996-1997, 2005
- Israel: 2000, 2006
- Jamaica: 1999-2003, 2008
- Jordan: 2000, 2005-2006
- Kazakhstan: 1993, 2001
- Korea, Republic of: 1998-2000, 2004
- Latvia: 1996-1997, 2006-2007
- Lebanon: 1997, 2003
- Lithuania: 2998, 2006
- Malaysia: 1992, 2007
- Mexico: 1995, 2001
- Morocco: 1994, 2003
- Pakistan: 1996, 2006-2007
- Panama: 1997-1998, 2006
- Peru: 1994-1996
- Philippines: 1998-2000, 2006
- Poland: 2000, 2006-2007
- Romania: 1998, 2004-2006
- Russian Federation: 1992, 1999, 2007-2008
- Slovak Republic: 2000-2002
- South Africa: 1997, 2001
- Sri Lanka: 1993, 1997
- Thailand: 1998-1999
- Tunisia: 1993, 2006
- Turkey: 2001, 2006-2007
- Ukraine: 2005
- Uruguay: 2006
- Venezuela, Rep. Bol.: 1991, 1997-1998

### Table 2: Some Variable Definitions and Data Sources (Selected)
- Definitions of ICRG Political Risk Variables:
  - Political Risk: The composite political risk variable is the sum individual rating scores for law and order, government stability, conflict and bureaucracy quality.
  - Law & Order: “Two measures comprising one risk component. Each sub-component equals half of the total. The "law" sub-component assesses the strength and impartiality of the legal system, and the "order" sub-component assesses popular observance of the law.”
  - Conflict: This variable is the sum of external conflict and internal conflict ratings. Both ratings scores can range between 1 and 12. Therefore the overall conflict rating varies from 2 to 24.
  - External Conflict: “A measure of the risk to the incumbent government and to inward investment, ranging from trade restrictions and embargoes through geopolitical disputes, armed threats, border incursions, foreign-supported insurgency and full-scale warfare.”
  - Internal Conflict: “A measure of political violence and its actual or potential impact on governance, taking into consideration such factors as whether threats exist, whether they have political objectives, the size and strength of support, and the geographic nature of the conflict.”
- Variable Definitions and Sources (as listed):
  - FDI (as % of GDP): IFS, World Investment Report Database
  - Real growth rates in G-7 countries weighted by PPP-adjusted GDP shares.: WEO
  - Nominal interest rate adjusted by inflation, weighted by PPP-adjusted GDP shares.: WEO
  - Log of the VIX index: Bloomberg
  - Log of PPP-adjusted GDP per capita in 1989: WEO
  - Exports to GDP (in %): WEO
  - Real effective exchange rate appreciation: INS database
  - Real GDP growth rate: WEO
  - Years of Average Education: Barro and Lee (2010)
  - Dummy variable that equals 1 if the share of oil exports is higher than 20 percent: WEO
  - Dummy variable that equals 1 if inflation has been above 10 percent: WEO
  - Effective Tariff Rates on Manufactured Goods: World Development Indicators, World Bank
  - Exchange rate classification (dummies for floating, managed and fixed exchange rates): AREAR Database
  - Dummy for the existence of restrictions on FDI inflows: AREAR Database
  - Dummy for the existence of restrictions on the repatriation of profits: AREAR Database
  - Conflict: ICRG
  - Government Stability: ICRG
  - Law and Order: ICRG
  - Bureaucracy Quality: ICRG
  - General Strikes: Cross-National Time-Series Data Archive (CNTS)
  - Major Government Crises: Cross-National Time-Series Data Archive (CNTS)
  - Revolutions: Cross-National Time-Series Data Archive (CNTS)
  - Anti-Government Demonstrations: Cross-National Time-Series Data Archive (CNTS)
  - Highest marginal corporate tax rate: KPMG's Corporate and Indirect Tax Rate Survey, PricewaterhouseCoopers's Worldwide Tax Summaries Online, IMF's Fiscal Affairs Department

### ICRG Subcomponent Scales (selected)
- Government Stability: The point score ranges from 1 to 12.
  - “A measure of the government's ability to stay in office and carry out its declared program(s), depending upon such factors as the type of governance, cohesion of the government and governing parties, approach of an election, and command of the legislature.”
- Bureaucracy Quality: The score ranges from 1 to 4.
  - “Institutional strength and quality of the bureaucracy is a shock absorber that tends to minimize revisions of policy when governments change. In low-risk countries, the bureaucracy is somewhat autonomous from political pressure.”

### Definitions of Domestic Conflict Events (CNTS / Rummel 1963)
- Source: Cross-National Time-Series Data Archive (CNTS), which derives most of its events from the New York Times. Event variable definitions adopted from Rummel (1963).
- General Labor Strikes: “Any strike of 1,000 or more industrial or service workers that involves more than one employer and that is aimed at national government policies or authority.”
- Major Government Crises: “Any rapidly developing situation that threatens to bring the downfall of the present regime – excluding situations of revolt aimed at such overthrow.”
- Revolutions: “Any illegal or forced change in the top government elite, any attempt at such a change, or any successful or unsuccessful armed rebellion whose aim is independence from the central government.”
- Anti-government Demonstrations: “Any peaceful public gathering of at least 100 people for the primary purpose of displaying or voicing their opposition to government policies or authority, excluding demonstrations of a distinctly anti-foreign nature.”

*Source: _wp11192 - REFERENCES*

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