Foreign Direct Investment in Emerging and Transition European Countries

This study examines the determinants of both inward and outward FDI for twenty emerging and transition economies in Europe (ETEE) over the period 1995-2001. We adopt a comparative perspective by explicitly comparing the determinants of FDI in ETEEs with alternative samples of both developed and other developing countries. Particular attention is paid to measures of governance and institutional change, including privatization, as determinants of both inward and outward FDI. We use a relatively broad measure of governance compared to other investigations of the direct investment process in emerging European countries. By and large, the determinants of foreign direct investment for our sample of ETEE countries are similar to those for other developing countries and, indeed, for developed countries as well. We find that governance is an important determinant of both capital outflows and capital inflows for all countries. However, we also identify ETEE-specific determinants. In particular, joining the EU, or even the prospect of joining the EU, promotes inward FDI (a halo effect), and this phenomenon particularly characterizes the former Communist countries. We interpret this result as suggesting the potential importance of a “locking in” effect with respect to governance. That is, political integration into developed Europe provides longer-term assurances to foreign investors that institutional changes undertaken by transition economies will not be reversed.