THE RESPONSIBILITY OF INVESTMENT CLIMATE AND STATE OF DEMOCRACY TO THE DETERMINANTS OF SECTORAL FDI IN EASTERN EUROPEAN AND CENTRAL ASIAN COUNTRIES: A QUANTITATIVE ANALYSIS USING A DYNAMIC SYSTEM GENERALIZED METHOD OF MOMENTS ESTIMATOR, FOR THE PERIOD 1994-2018

Article: Dr. Sarmita Guha Ray, ―The Responsibility of Investment Climate and State of Democracy to the Determinants of Sectoral FDI in Eastern European and Central Asian Countries: A Quantitative Analysis Using a Dynamic System Generalized Method Abstract: In order to study the responsibility of investment climate and state of democracy to the determinants of sectoral distribution of Foreign Direct Investment (FDI), this study attempts to examine the institutional determinants of the sectoral distribution of FDI in Eastern Europe and Central Asia, focusing on the investment climate and state of democracy. Using a dynamic system generalized method of moments estimator, the study examine twenty-one countries for the period 1994–2018. The analysis of these quantitative findings is that when human capital is controlled for, the host country investment profile has a positive effect on agricultural FDI and the host country state of democracy positively affects agricultural and manufacturing FDI. In addition, services FDI is attracted by educated labor, whereas FDI to other sectors is attracted by cheap labor. Moreover, natural resource endowments have a positive impact on FDI in the sectors of agriculture and manufacturing. controlling for endogeneity and omitted variable biases. The study conduct the analysis in three sectors: agriculture, manufacturing, and services, controlling for the effects of the level of economic development, human capital, and natural resource endowments. The main findings support the hypothesis that when controlling for the endowment of human capital, institutional quality matters more for attracting agricultural and manufacturing FDI to the EECA region than it does for attracting services FDI. More specifically, a country‘s investment profile and democratic accountability, as defined by the International Country Risk Guide ( ICRG ) (PRS Group 2012) affect sectoral FDI differently: the investment profile has a significant positive effect only on agricultural FDI, whereas the state of democracy has a multisector effect on FDI: It positively affects the inward foreign direct flows to both agriculture and manufacturing. The institutional determinants become significant in the determination of services FDI only if human capital is excluded from the study, suggesting that it is in fact the true determinant. The estimates on human capital lead us one step further: they provide evidence FDI being attracted by cheap labor. Since this study is conducted at the sectoral level, it has been able to distinguish between effects on FDI in different The estimates of human capital suggest that foreign direct investment in services industries is attracted by educated labor, whereas FDI flowing to the other sectors is attracted by cheap labor. Natural resource endowments, however, are a stimulus for agricultural and manufacturing FDI, but not for services FDI. institutional effects by sectors, as effects on agricultural, manufacturing, and services FDI. The study employs an empirical model, built of a comprehensive conceptual and theoretical framework. We extend the framework by including two less-studied and less-understood determinants: domestic human capital and domestic natural resource endowments. This Study get a rich and interesting set of results. It demonstrate that when controlling for the quality of human capital, institutional quality matters more for attracting agricultural and manufacturing FDI to the EECA region than for attracting services FDI. A country‘s investment profile and state of democracy affect sectoral FDI in different ways: the investment profile has a significant positive effect on agricultural FDI, whereas the state of democratic accountability positively affects the inward FDI in both the agricultural and manufacturing sectors. Similarly, this Study find that being endowed with natural resources stimulates agricultural and manufacturing FDI, but not services FDI. These results are not completely intuitive. It may seem logical to expect that institutional environments play a bigger role in determination of FDI activities in the services sector rather than in primary and secondary sectors (Xu and Shenkar 2002). However, this assumption would be leaving two factors out. First, the industry of agriculture is heavily regulated and there is typically no good way to capture these regulatory environments with a comparative, cross-country dummy. Thus, investment climate, captured by investment profile partially reflects the regulatory environment in agriculture. Second, our expectation that the institutional environment should play a significant role in the determination of services FDI may also be erroneous. We find that in the region examined by this study, human capital—which may be indirectly related to institutions—rather than the quality of host-country institutions, is the significant determinant of services FDI. This finding supports the hypothesis that in the tertiary sector, FDI is motivated by educated, rather than cheap, labor. This is not the case with manufacturing or primary sector industries, where the evidence points to FDI being motivated by cheap labor. The above results are new FDI the EECA region at