FDI and Institutions in BRIC and CIVETS Countries: History
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Polyxeni Kechagia

Foreign direct investment (FDI) inflows refer to the net capital inflows invested for the acquisition of at least 10% of an enterprise’s voting stock, assuming that this enterprise operates in an economy different than the investor’s country. In recent years, a number of countries with emerging economies have proceeded to use market-oriented strategies, deregulation and reforms in order to attract more foreign investors and attract FDI inflows.

  • foreign direct investment
  • institutional quality
  • developing economies
  • BRIC
  • CIVETS

1. Introduction

The international capital allocation is determined by the operation of multinational enterprises (MNEs), which hold and control capitals and revenues in two or more countries (Dunning 1973; Dunning and Lundan 2008). Foreign direct investments (FDIs) can be implemented as greenfield (GF) investments, which refer to the creation of a subsidiary abroad from the ground up to take advantage of complementarities, or as cross-border mergers and acquisitions (M&A), which include the transfer of ownership of an existing asset (Moghadam et al. 2019; Li et al. 2021). Additionally, FDIs can be either horizontal, which are applied by MNEs that undertake the same activities in multiple countries, or vertical, which include several fragments of the production process and each stage is located in a country where it is performed at minimum cost (Dunning 1993; Pečarić et al. 2021). FDI inflows could engage in the production of finished products (manufacturing FDI), while, conversely, service FDIs are applicable to MNEs that do not produce goods (Fernandes and Paunov 2012).

The majority of emerging countries have made several reforms in order to increase their attractiveness towards MNEs and foreign investors. FDI inflows are very beneficial for the recipient country because it is empirically proven that they contribute to economic growth and regional development (Chang 2005; Wijeweera et al. 2010; Iwasaki and Suganuma 2015; Pegkas 2015), poverty alleviation (Fowowe and Shuaibu 2014; Ucal 2014; Uttama 2015), job opportunities (Tomohara and Takii 2011; Ucal 2014), positive backward spillovers (Gorodnichenko et al. 2014; Ha and Giroud 2015), etc.
Nevertheless, it is crucial for the recipient countries to improve their governance and political condition (Uttama and Peridy 2010; Alam and Shah 2013), as these significantly affect foreign investors’ decision making (Wong and Tang 2011). Additionally, it can be observed that the top recipient economies, such as China, are obligated to follow certain political strategies in order to maintain their attractiveness (Metaxas and Kechagia 2013; Lemoine 2013). Among the determinants of FDI, the present paper focuses on governance indicators, including voice and accountability (VA), political stability and absence of violence (PV), government effectiveness (GE), regulatory quality (RQ), rule of law (RL) and control of corruption (CC).

2. FDI and Predominant Theories

Several theories have previously been presented on FDI. Among them, Dunning (1981) presented the eclectic paradigm of international production and combined the theory of economic organization and the traditional theory of factor endowments. According to this theory, the propensity for MNEs to invest abroad depends on the competitive advantage compared to local firms, namely ownership, location and internalization (OLI). Similarly, Banga (2006) argued that the competitive advantage of specializing solely in certain products leads to trade between countries and highlighted the importance of exploiting scale economies, while Kindleberger (1969) suggested that FDI flows are attributed to market imperfections. Conversely, in the case of perfect competition, the absence of external economies, costless information and the absence of trade barriers, countries would be involved internationally solely via international trade.
Buckley and Casson (1976) highlighted the importance of expertise and knowledge in several activities carried out by enterprises that are related though flows of intermediate products. Nevertheless, it is difficult to organize these products and, thus, internal markets are created to achieve common control and ownership. Additionally, Caves (1971) concluded that FDIs are related to product differentiation in the home country, while Vernon (1966) argued that enterprises proceed to FDIs to avoid losing markets, and Knickerbocker (1974) observed that several companies might be influenced by a leader’s investment moves.
Finally, local enterprises have better information on the country’s economic environment compared to MNEs. Therefore, FDI flows are performed in case MNEs have a countervailing advantage and in case they sell this advantage to imperfect markets (Hymer 1976). Additionally, it is argued that corruption increases uncertainty and the MNEs decision making, leading to differentiated FDI inflows (Wei 2000). MNEs are more likely to choose to invest their capital in democratic countries to reduce the risk of nationalization (Ahlquist 2006). According to relevant theories, institutional quality is crucial for FDI inflows since inefficient institutions deter capital inflows (Asiedu 2006). 

3. Institutional Quality as an FDI Determinant in Developing and Emerging Countries

The present research focuses on governance and institutions as determinants of FDI inflows arguing that they highly affect the investment decisions of MNEs, according to Jensen (2008), as well as economic growth and total factor productivity (Coe et al. 2009). It is noted that good governance includes several political and institutional conditions that could have a negative influence on the operation of an investment company (Fails 2012) or the business climate, and governance is considered to be the most unpredictable FDI factor (Busse and Hefeker 2007). Anwar and Iwasaki (2021) conducted a meta-analysis and reached the conclusion that foreign investors choose to invest their capitals in risky markets that present modest institutional quality. The majority of the researches reached the conclusion that poor institutions deter FDI in the recipient developing country. 

4. Institutional Quality as an FDI Determinant in BRIC and CIVETS Countries

FDI could help BRICS achieve the economic development of developed countries (Nistor 2015). According to Bose and Kohli (2018), BRICS countries are the most developed group among the emerging economies and, thus, garner more foreign investors. Nevertheless, there are several differences between the group of countries, as well as intragroup differences. Duan (2010) observed that Brazil, India and Russia mostly attract FDI in the tertiary sector, while China in the secondary sector. Similarly, Bose and Kohli (2018) concluded that the services sector attracts more FDI in South Africa and India, Russia and Brazil in manufacturing and services, while China attracts more FDI in manufacturing. Kishor and Singh (2015) also studied FDI in BRICS and suggested that the countries should further improve infrastructure, GDP and investment opportunities.

5. Other Potential Determinant Factors of FDI

According to the eclectic paradigm, the host country’s market size plays a crucial role in attracting foreign investors. It is noted that the interaction between FDI and Gross Domestic Product (GDP) has been a matter of study for several researchers (e.g., Mahmoodi and Mahmoodi 2016; Shah and Ali 2016; Azam and Haseeb 2021). Mehrara et al. (2010) indicated a positive interaction between FDI and GDP in 57 developing economies during 1981–2006. However, Mahembe and Odhiambo (2016) observed that FDI inflows had a positive impact on GDP solely in the middle income countries for the period 1980–2016. Vijayakumar et al. (2010) concluded that FDI and market size are positively related in the case of the BRICS countries. In the present essay, GDP is investigated as a proxy of the host economy’s market size.
Another factor that could affect the FDI inflows into a developing economy is trade openness, which is estimated as the ratio of imports plus exports as a share of GDP. Trade liberalization and its association to FDI inflows has been a subject of study for several researchers. 

6. Current Insights

Firstly, as expected, the coefficient of GDP is positive and statistically significant, which leads to the conclusion that there is a positive effect of GDP on FDI inflows in the studied groups of economies. These results are opposite to the findings of Antwi and Zhao (2013) and Kwoba and Kibati (2016) who concluded that there was a significant negative interaction between FDI and GDP. Contrary to this, Mahmoodi and Mahmoodi (2016), Mehrara et al. (2010) and Sabir et al. (2019) reached similar results and observed that there is a positive association between FDI and GDP.
Additionally, a negative association is observed between FDI and the exchange rate in the BRIC, while, conversely, there is a positive impact of the exchange rate on FDI in the CIVETS. Therefore, a depreciation of the local currency is expected to have a negative influence on FDI inflows in the CIVETS. This finding is in line with the results of Zakari (2017) who concluded that there is a positive relationship between FDI and exchange rate, as well as the results of Kiyota and Urata (2004), who argued that volatility of exchange rates tends to discourage FDI inflows.
With regards to inflation, it is observed that it is negatively related to FDI inflows in the BRIC economies. These findings are in line with the results of Sabir et al. (2019), who also observed that inflation negatively affects FDI inflows in developing economies. However, Tsaurai (2018) achieved contrasting results, observing that there is a positive association between FDI inflows and inflation; nevertheless, the researcher highlighted that the variable is statistically insignificant. Based on the stepwise regression results, inflation is not a determinant FDI factor in the CIVETS economies.
Moreover, it is concluded that trade openness in the BRIC countries attracts FDI inflows. Sabir et al. (2019) also observed a positive association between FDI inflows and trade openness in developing countries, as did Kurul and Yalta (2017). Saidi et al. (2013) also observed that trade openness is positively related to FDI inflows in 20 developed and developing economies during 1998–2011. However, trade openness is not an FDI determinant for the CIVETS. Additionally, Gangi and Abdulrazak (2012) observed a negative association between FDI inflows and VA, as in the case of the CIVETS. The researchers concluded that there was a positive interaction between FDI and RL, which is also observed in the BRIC, a positive impact of RQ on FDI, which is observed in both CIVETS and BRIC, as well as a positive relation between FDI and CC, as in the case of the CIVETS countries. Contrary to the findings here for both groups, the researcher argued that there is a negative association between FDI and PV. Jadhav (2012) highlighted the importance of “tariff jumping” and noted that trade restrictions and low trade openness could positively influence FDI. In addition, MNEs are more likely to choose a more open economy to locate their capital in since trade protection is often related to higher transaction costs. Differences in the institutional variables between the studied groups could be attributed to the heterogeneity and the institutional reforms applied by the countries’ governments.
In conclusion, it is suggested that, in order for the host economies to benefit from FDI inflows, it is crucial to apply a stabilization program and to introduce structural reforms in order to reduce political risk, as proposed by Axarloglou and Pournarakis (2005) as well. Moreover, it is suggested that the improvement in the Asian and Latin American developing economies would ameliorate their investment climate, and thus would attract more foreign investors. Both groups of countries attract a significant amount of FDI, but they do not present economic integration, which could reinforce their security level and development. In addition, both groups have made significant efforts to improve their economic conditions and attract more inflows; however, it is crucial that they sustain their economic development to claim the greatest global inflows.
Another policy implication refers to the economic policy uncertainty (EPU) of the studied groups. On the one hand, according to Mensi et al. (2014), the BRICS stock market depends on the United States (U.S.) stock market’s uncertainty, as well as on commodity markets and global stock. Dakhlaoui and Aloui (2016) reached similar findings and observed that stock market volatility in the BRICS is affected by U.S. economic uncertainty, mainly during periods of economic instability. Additionally, Guo et al. (2018) focused on the BRIC economies and the group of seven (G7) countries to investigate the interaction between stock returns and EPU from 1985 to 2015 and concluded that EPU has a negative impact on the stock markets of China and India. On the other hand, in the aftermath of the global financial crisis and the European debt crisis, Hung (2021) concluded that there was a bidirectional relationship between BRICS stock return and EPU.

7. Conclusions and Suggestions

FDI inflows are influenced by the socioeconomic and political environment of the BRIC and CIVETS economies. It is concluded that market size, as measured by current GDP, is positively related to FDI inflows in both groups of countries. In addition, a negative association has been observed between FDI and inflation solely in the BRIC economies. As for the components of the governance indicators, it is observed that FDI is positively related to PV, RL and RQ in the BRIC countries and positively associated to CC, PV, RQ and GE in the CIVETS. In conclusion, there are policy implications that can be derived for the studied economies. Firstly, considering the positive relationship between trade openness and FDI, it is suggested that recipient countries abolish trade restrictions and barriers and strengthen anti-regulations. Secondly, the local currency should remain stable and flexible in order to prevent fluctuations in the amount of FDI inflows and to protect the host country’s commercial viability. Thirdly, it is suggested that the stability of the host economies’ public institutions should be enhanced so as to encourage foreign investors and multinational companies. Considering that among the BRIC countries, Russia and China have an authoritarian regime, it is suggested that they should focus on improving their political stability and regulatory quality in order to enhance cooperation with other countries and economic organizations. Conversely, the other countries in the group are fractious democracies and it is suggested that they further strengthen rule of law. The CIVETS countries mainly include democratic regimes; it is suggested that Colombia focuses on reducing corruption to hinder exports and development, Turkey and Egypt focus on political stability and the absence of violence, Vietnam can improve government effectiveness and rule of law and Indonesia their regulatory quality. Finally, it is crucial for South Africa to improve their political stability and absence of violence, especially considering increased violent incidents and protests, mainly after Zuma’s imprisonment, while Turkey faces a severe currency and debt crisis, which could influence several institutional variables.

This entry is adapted from the peer-reviewed paper 10.3390/economies10040077

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