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What determines the inflow of foreign direct investment

Október 2012

This paper examines how foreign direct investment (FDI) in a selected group of countries is affected by a range of economic and political factors. The aim is to
illustrate the relationship between FDI and various economic and political indicators. More specifically, the aim is to assess to what degree economic and political variables impact inflow of foreign direct investment. In practical terms, FDI gives an indication of the level of confidence investors have in political and economic conditions within countries. As such it may be regarded as a barometer of economic and political stability. In some instances the level of FDI within a country is even believed to reflect how well politicians manage to fulfill their election promises such as those of attracting foreign investment to
create new jobs and opportunities for their citizens.
The econometrical approach presented in this paper attempts to measure the influences of not only economic factors, that economists have traditionally looked at, but includes political variables as well. Thus the statistical significance of both economic and political variables is measured to better understand what determines the inflow of FDI. By using this combined approach we hope to provide a more complete picture of the interaction of local and global forces that impact investment.
The results show that the market size of the investor’s host country gives the greatest significance, followed by a membership in regional trade agreements. After that comes government efficiency in the host country, i.e. the ability to carry out government decisions effectively. The results also show that the level of skilled labor has an impact on the inflow of foreign direct investment.

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Rannsóknir í félagsvísindum XIII: Hagfræðideild


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