DP2638 The Determinants of Foreign Direct Investment in Transition Economies

Author(s): Alan Bevan, Saul Estrin
Publication Date: December 2000
Keyword(s): EU Accession, Foreign Direct Investment, Transition Economies
JEL(s): C33, F20, P27
Programme Areas: Transition Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2638

Using a panel dataset containing information on FDI flows from market to transition economies, we establish the determinants of FDI inflows to Central and Eastern Europe: country risk, unit labour costs, host market size and gravity factors. In turn, we find country risk to be influenced by private sector development, industrial development, the government balance, reserves and corruption. By introducing structural shift dummy variables for key announcements of progress in EU accession we show that announcements have impacted directly upon FDI receipts but have not influenced country credit ratings. The Agenda 2000 announcement by the European Commission induced a bifurcation between the ?first wave? transition countries and the remainder of our sample. The underlying dynamics of the process illustrate that increases in FDI improve country credit ratings with a lag, hence increasing future FDI receipts. Consequently we suggest that the accession progress has the potential to induce virtuous cycles for the frontrunners but may have serious consequences for the accession laggards.