FDI and institutional reform in Portugal

Abstract

This article analyses the effects of several geographic, economic and institutional factors on bilateral inward FDI in Europe. Moreover, it assesses the required reform effort, and the expected benefits, for Portugal to converge with the EU in the institutional variables that are relevant to attract investment. We conclude that good institutions favouring economic freedom and the ease of doing business, and geography, market size and labor costs, affect bilateral inward FDI. Political risk does not lead to significant differences in FDI across the EU. The results are robust to different methods – principal component analysis, factor-based scores and by considering several institutional indicators successively. We also find that most promising reforms arise in the financial system, corruption, property rights, and in some business regulations associated with starting a business. Increasing labor market flexibility to the EU level has also a large impact on inward FDI, but this reform comes at a comparatively higher effort.FDI, Institutional reform, Institutions, Portugal, EU