Foreign Direct Investment in the Eurasian Transition States

Abstract

As foreign direct investment (FDI) continues to flow into the transition economies of Eurasia, it becomes possible to specify more extensive and robust models to explain the distribution of foreign capital. This article reports the results of a regression model based upon twenty-six variables that are reduced, through factor analysis, to four factors. Using FDI relative to population as the dependent variable, we find that human and social capital is the most important determinant of the distribution of investments that generally favors the western states over the east, and the states that are highly urbanized over those that are rural. Most important, this factor reinforces the primacy of professional skills and highly developed infrastructure that favor countries such as Poland, Hungary, and the Baltics. Second, we find that natural resources are a necessary condition for the inflow of foreign capital, as exemplified by the oil- and gas-rich states of Central Asia that are unattractive by most other measures. Third, following one decade of reforms, we find that foreign firms respond positively to favorable investment climate, trade policy, and market reforms. Finally, financial depth as measured by money, quasimoney, and credit, while important, falls just short of the one percent level of significance. We conclude with policy recommendations for the conditions that can be altered, including developing human and social capital, specifically, labor skills and infrastructure, and reform policies relevant to privatization, investment, and trade. At the same time, we acknowledge that other determinants that are beyond the control of governments, such as preconditions and the availability of raw materials, will continue to impact the attractiveness of host countries in the region.