The Economic Determinants of Foreign Direct Investment in Developing Countries and Transition Economies

The economic growth rates have dramatically increased indeveloping economies, such as in Latin American, Asian, and EasternEuropean countries, following the financial liberalisation attempt,especially during the 1990s. Foreign direct investment (FDI) has becomean increasingly important element for economic development andintegration of developing countries and transition economies in thisperiod with the world economy. The main purpose of this study is todevelop an empirical framework to estimate the economic determinants ofFDI inflows by employing a panel data set of 17 developing countries andtransition economies for the period of 1989:01-2006:04. In our modelthere are seven explanatory economic variables. They are, respectively,the previous period FDI (the pull factor for new FDI), GDP growth(measures market size), Wage (unit labour costs), Trade Rate (measuresthe openness of countries), the real interest rates (measuresmacroeconomic policy), inflation rate (as country risk and macroeconomicpolicy), and domestic investment (Business Climate). Hence, throughoutthe paper, only the economic determinants (being separated and apartfrom the other studies in the literature) of FDI inflows to developingcountries and transition economies are studied. It is found out that theprevious period FDI which is directly related to the host countries’economic resources is important as an economic determinant. Besides, itis also understood that the main determinants of FDI inflows are theinflation rate, the interest rate, the growth rate, and the trade(openness) rate and FDI inflows give power to the economies of hostcountries. JEL classification: F21, R19, C23 Keywords: Foreign DirectInvestment, the Determinants of FDI, the Developing Countries,Transition Economies, Panel Data Analysis