Business Climate, Political Risk and FDI in Developing Countries: Evidence from Panel Data

Abstract

The literature on economic development views institutions as a crucial location advantage of host countries aiming to attract foreign investors. The purpose of the paper is to explore empirically the linkages among political risk, business climate and foreign direct investment inflows and to provide better supported results concerning these linkages. For this purpose, we exploit two panel models: a fixed effect model and a dynamic panel model (the Arellano-Bond GMM estimator) for a data sample of 33 developing and transition countries covering the period 1996-2008 and we identify indicators that count the most for the foreign direct investors. These methodological insights lead to the following main results. Firstly, we show that reduced levels of political risk are associated with an increase in FDI inflows. Secondly, the business operation conditions appear as an important determinant of FDI flows, our results indicating that favourable business conditions participate to an increase of the FDI.