Monday, September 26, 2011

FDI, Institutions, and Natural Resources

An interesting recent VOX piece on institutions and FDI. Here is a summary of how institutions impact FDI:
  • Investing in better institutions These are the investors from the South that choose countries with the best possible institutional environment and, in this case, appear not to be deterred by an “institutional distance”. Such large institutional difference is a driving force for the “asset-seeking” nature of FDI, as emerging investors acquire new technologies, brands, and intellectual property. Despite unfamiliarity, such an institutional environment is the most transparent for potential entrants due to the low corruption, sound property rights, and political stability.
  • Investing in similar institutions.These are the investors from the South that choose countries with a similar institutional environment, which helps explain the phenomenon of South-South FDI. When investing in the South, these investors have a comparative advantage due to their experience of working with poor institutions at home.
  • Investing in worse institutions. Although investors from developing countries often invest in countries with similarly poor institutions, they are usually deterred by institutions that are much worse than at home. Yet there is an important exception to this rule. The negative effect of very poor institutions is systematically outweighed by the appeal of natural resources, which appears to be a very important force behind FDI from the emerging economies. Specifically, we find that countries possessing natural resources that are worth more than $4,675 per capita (in the top 10% of our sample) will attract FDI from investors from the South despite a large institutional distance and having worse institutions. To name a few, this concerns countries such countries as Algeria, Azerbaijan, Kazakhstan, Russia, and Venezuela.
So basically, better institutions yield more FDI, unless you happen to have natural resources. I'm skeptical that there should be an interaction between BAD institutions, high resources and more FDI. In other words, I'm not sure that given the choice between two oil-rich countries, an investor would choose the one with lower institutional quality. If they would, then I would want to know what the incentive model is. I'm also going to guess that it depends on the dimension of institutions we're talking about here. A big oil company might like to invest in a less democratic country because in the medium term they may perceive it as a more stable haven for investment than a democracy whose policies may fluctuate with the whims of the so-called "median voter." That company may even like a little corruption in the government, since bribery may be a more efficient means for getting certain things done than following the letter of the law. Here I am more skeptical than in the case of democracy, since corruption tends to favor local interest groups over foreign investors, ceteris paribus. But I seriously doubt that a country with poor credibility, defined by the absence of expropriation risk, legal protection of property rights, and policy stability, would attract more FDI than a country with stronger credibility. Security (the absence of civil war and ethnic tensions for example) is likely to also help FDI, but probably in a secondary (or indirect) role vis a vis credibility.

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