Critical evalluation of the extent to which institutional factors Essay

Critical evalluation of the extent to which institutional factors influence inward and outward FDI - Essay Example However, it is difficult to measure the various institutional factors and therefore the extent to which it influences inward and outward FDI is a subjective issue. The issue of â€Å"institutional distance† has been found to have an influence on both the inward and the outward FDI. Institutional distance is the difference in the quality of institutions between two or more countries. Quere et al. (2007) studied the determinants of FDI and concluded that â€Å"raising the quality of institutions and making them converge towards those of source countries may help developing countries to receive more FDI, hence help them to catch up, independently of the indirect impact of higher GDP per capita†. It is widely known that good quality institutions have a positive impact on the inflow and outflow of FDI. Some scholars suggest that institutional differences may be a source of comparative advantages, some sectors being more ‘institution-intensive’ than others, and t hat this could be a source of more trade flows. To the extent that trade and FDI are complements, this could raise FDI too. Good governance is one of the institutional qualities which are thought to positively affect the flow of FDI. Globerman and Shapiro (2002) studied the impact of the main components of the governance indicators on both inflows and outflows of a country’s FDI. They concluded that good governance encouraged both FDI inflows and outflows; although the impact of good governance on the outflow of FDI only applies to relatively large and developed countries. However, measuring governance is a subjective task which varies from one research to another. Some studies concentrates on one country yet trade flow involves at least two countries. Since FDI flows can move on either direction, governance of all the countries involved should be scrutinized in order to determine the actual impact of governance on both in-flows and out-flows of FDI. The tax system of a host country is another determinant of FDI. If a tax system of a country is set in a manner that the products and services of foreign firms are more taxed than those of the local firms, the inward flow of FDI is likely to be reduced. This is because the foreign firms would have a challenge in setting the prices of their goods and services; in order to make profits, they might be forced to set their prices above those of the local firms thus leading to lower than expected sales. On the other hand, imposing heavy taxes on the products and services of the local firms may hamper their growth. For this reason, the local firms may not grow to become MNEs and thus affecting the outward FDI. However, heavy taxes on the local firms may lead to investment in other countries where the tax rates of taxation is relatively lower. This will lead to increased out-flow of FDI. Corruption is also another institutional factor which is known to determine the flow of FDI. Many researchers have found that cor ruption increases the cost of investment and lead to reduced expected revenues. Taking corruption to mean â€Å"paying certain individuals in order to get an investment opportunity in the host country†, it would negatively affect the inward flow of FDI. In addition, the misuse of public funds and resources by