The role of governance on foreign direct investment inflows: A new theoretical perspective and cross-country analysis

Abstract

The effect of governance on FDI inflows is firstly through the effect of institutions on investment environment of a country and secondly through the decreasing transaction costs, production costs, and uncertainty. The countries are divided into three clusters. A new theoretical perspective is developed considering governance as a base factor. System GMM methodology is used to deal with endogeneity problem. The empirical analysis covers 32 advanced, 70 developing, and 17 least developedcountries for the period 1996-2010. Improving governance infrastructure as a base factor attracts more FDI in all country clusters. FDI made into advanced countries are efficiency seeking, FDI made into developing countries are market seeking, and FDI made into least developed countries are resource seeking. Finally, it is found that a motivation factor alone may not be sufficient for MNCs to take FDI decision since they also observe governance infrastructure in host countries and any deterioration in governance infrastructure leads to a decreasing amount of FDI inflows. © 2018, IGI Global. All rights reserved.