Institutional Determinants of Investment Inflows into Transition Economies

Abstract

This article investigates the relationship between institutional quality and the level of investment inflows into post-communist countries. We attempt to empirically verify the argument that institutional determinants are essential in explaining the variation in investment inflows into transition economies after the demise of socialism in the early 1990s. The role of institutions is assessed using Economic Freedom indices provided by the Heritage Foundation. Consequently, to investigate the progress of institutional quality in transition economies, we further employ indicators developed by the European Bank for Reconstruction and Development. Using a panel data set for 11 transition countries from 1993 to 2013, we conclude that the impact of institutional quality on investment inflows is not negligible, yet much weaker than suggested by the existing theoretical literature. Using a fixed-effects model framework in both regression benchmarks with metrics from the Heritage Foundation and the European Bank for Reconstruction and Development, respectively, we observe that the impact of institutional variables on the level of investment was less significant than expected. Moreover, macroeconomic fundamentals appear to always play a more substantial role than institutional factors.

Do institutions still matter for investors? Impact of institutional determinants on investment inflows into European economies

“…Similarly, Julio et al (2013) assert that improved home institutions are likely to have a material effect on the FDI levels in Portugal while using more recent data, Donu -Janíčko (2015) concluded that the institutional impact on the levels of FDI appears to be generally weaker than it is stated in the existing literature. The macroeconomic conditions seem to play a more dominant role in the decision-making process of the investors.…”