ISP Working Paper Number 06-14

Are Government Policies More Important Than Taxation in Attracting FDI

Timothy Goodspeed, Jorge Martinez-Vazquez and Li Zhang, February 2006

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Abstract:

This paper attempts to broaden the existing empirical literature on foreign direct investment by incorporating government expenditures (both investment in infrastructure and consumption) as well as tax, classical location factors, institutional factors that may hinder business investment (such as corruption), and agglomeration effects. We investigate the determinants of FDI inflows in two unbalanced panel data sets of 47 countries from 1995-2002 and 37 countries from 1996-2002. We use fixed country and year effects and examine different infrastructure measures. The evidence indicates that lower taxes, lower corruption, and better infrastructure attract FDI. Government consumption expenditures negatively impact FDI inflows. The magnitude of the response of FDI to our investment in infrastructure is similar to that of corruption and taxes in elasticity terms.