2.1 Theoretical explanations of FDI

The theoretical explanations of FDI largely stem from traditional theories of international trade that are based on the theory of comparative advantage which largely depends on differences in factors endowments between countries. Multinational companies are usually attracted to a particular country attracted by the comparative advantage that the country or region offers. For instance, multinational companies may establish foreign subsidiaries in one country to take advantage of its lower labour costs or they may be attracted to a country because of its large market size. Thus, in their basic form, traditional theories of international trade help to give some explanation of FDI. However, the traditional trade theories do not provide full answers to why multinational companies prefer to operate in a foreign country rather than exporting or licensing, which are alternatives to FDI.

Several different frameworks have evolved for analyzing the determinants of FDI. The theory of portfolio investment (the neoclassical financial theory of portfolio flows) is one of the earliest explanations of FDI. The basis for this explanation lies in interest rate differentials between countries. Capital, according to this explanation, moves in response to changes in interest rate differentials between countries/regions and multinational companies are simply viewed as arbitrager of capital from countries where its return is low to countries where it is high. This explanation, however, fails to account for the cross movements of capital between/across countries. In practice, capital moves in both directions between countries. In addition, that capital is only a complementary factor in direct investment and that this theory does not explain why firms go abroad contribute to the criticism of the neoclassical theory of portfolio investment (Harrison et al, 2000).

Vernon’s product life cycle theory is another explanation of FDI worthy of some discussion. This theory focuses on the role of innovation and economies of scale in determining trade patterns. It states that FDI is a stage in the life cycle of a new product from its invention to maturity. A new product is first manufactured in the home country for the home market. When the home market is saturated, the product is exported to other countries. At later stages, when the new product reaches maturity and loses its uniqueness, competition from similar rival products becomes more intense. At this stage producers would then look for lower cost foreign locations. This theory shows how market seeking and cost reduction motives of companies lead to FDI. It also explains the behaviours of multinational companies and how they take advantage of different countries that are at different levels of development. Additionally, it has been noted that Vernon’s theory perceives foreign direct investment as a defensive strategy by firms to protect their existing market position (Dunning 1993). Knickerbocker (1973), following Vernon’s theory, also argues that there is follow-the-leader type of defensive FDI especially in industries characterized by oligopoly. His argument relies on uncertainty and risk aversion behaviour of oligopolists. His theory suggests that firms go abroad because of oligopolistic reaction which is “an interactive kind of corporate behaviour by which rivals in industries composed of a few large firms counter one another’s moves by making similar moves themselves” (Knickerbocker, 1973). However, this theory does not explain why FDI is more efficient than exporting or licensing for expanding abroad.

Hymer’s (1976) pioneering study on multinational companies draws attention to the role of multinational companies as global industrial organizations. Hymer’s major contribution was to shift attention away from neoclassical financial theory. He argued that the need to exercise control over operation is the main motive for FDI than the mere flow of capital. Capital is used to facilitate the establishment of FDI rather than an end in itself. He states that for firms to engage in cross border activities, they must possess some kind of monopolistic advantages. The advantages result from a foreign company’s ownership of patents, know how, managerial skills and so on and these advantages are unavailable to local companies. His argument relies on the existence of market imperfections, such as difficulty of marketing and pricing know how, or in some cases market may not exist for such products, or if they exist, they may involve huge transaction costs or time-lags. In such cases it would be more efficient for the company to engage in direct investment than exporting or licensing. FDI will allow the companies to control and exploit their monopoly power to the full. Hymer’s argument led the way to the development of internalisation theory. According to this theory the firms internalize their activities whenever there are inefficiencies in dealing with the external market and FDI would occur when this internalisation involves operation across countries (Harrison et al, 2000).

By incorporating Hymer’s explanations and various other theories of FDI, Dunning’s eclectic paradigm provides a general explanation for the determinants of FDI. Dunning (1993) identified three factors which must be satisfied before engaging in cross border activities.

� The ownership advantages of a firm: These advantages are firm specific as they are assumed to be exclusive to the firm that owns them. These advantages arise from firms possessing proprietary technology or other unique intangible assets, and the firm’s ability to coordinate complementary activities such as manufacturing and distribution. These kinds of advantages give foreign firms more power over their local counterparts.

� Internalisation advantages: These advantages refer to the firm’s ability to internalise its activities, which can be done through market transactions. Through internalisation, the firm can reduce its transaction costs. Moreover, the firm can retain exclusive rights to its assets and it maintains its competitive advantage.

� Location specific advantages: these advantages include host countries natural resource endowments, superior infrastructure, and macroeconomic stability. These location advantages determine the profitability with which the ownership advantage and internalisation advantage of the firm should be combined.

From these three advantages if only one is met, then firms will rely on exports, licensing or the sale of patent, to service foreign market. Thus, the generalised predictions of the eclectic theory are that a firm can only capture a foreign market through FDI if it has the capacity to exploit simultaneously all the three advantages.

In Dunning’s eclectic theory, the ownership and internalization advantages are firm specific features whilst the location advantages are country specific characteristics which the host country can influence directly. In general, countries that have location advantages can attract more FDI. But firms do not undertake FDI only for the presence of location specific advantages in the host country. Their location choice decisions consider the profitability with which the ownership and internalisation advantage can be combined with the location ones. Dunning (1993) pointed out that the principal objective of firms in undertaking foreign production is to advance their long-term profitability. In addition to the profitability motives, some firms may undertake FDI as part of their corporate strategies. For instance, some firms may try to spread or reduce risks, and to match competitors’ actions. In general Dunning (1993) identified three possible motives for FDI:

� Market seeking FDI: refers to FDI for the purpose of serving local and regional markets. Host countries’ characteristics that can attract market-seeking FDI include market size of the host country, per capita income and growth (potential) of the market.

� Resource/asset seeking FDI: refers to FDI for the purpose of acquiring resources which are not available in the home country. Such resources include natural resources, availability of raw materials, and productivity and availability of skilled and unskilled labour.

� Efficiency seeking FDI: This kind of FDI occurs when the firm can gain from the common governance of geographically dispersed activities, especially in the presence of economics of scale and scope and diversification of risk.

The above there motives of FDI are categorized under economic determinants of FDI. Besides these economic determinants, there are also two other crucial determinants of FDI: host country FDI policy framework and business facilitation. According to the 1998 World Investment Report, the policy framework for FDI includes: economic, political and social stability, rules regulating entry and operation of FDI, standard of treatment of foreign affiliates, policies on functioning and structure of the markets, international agreement on FDI, privatization policy, trade policy and tax policy. Business facilitation refers to the ease with which business can be conducted in the host country. The most important business facilitations include investment promotions and incentives, hassle costs related to corruption and administrative efficiency, development of financial institutions, enforceability of contracts and protection of property rights, and quality of life (UNCTAD, 1998).

2.2 Empirical evidence on the determinants of FDI⁷

On the determinants of FDI in Africa, most studies argue that FDI inflow is attracted largely by natural resource endowments. Almost 40 percent of FDI has been in the primary sector, particularly oil and mineral extraction business. Countries like Angola, Botswana, Namibia and Nigeria have received foreign investment targeted at the oil and minerals sectors of their economy (Basu and Srinivasan, 2002). Morisset (2000) reports that, on a survey conducted on 29 African countries, there is a high correlation between FDI inflows and total value of natural resources in each country.

Though natural resource abundance is a common factor explaining much of the FDI inflows, the few successful African countries have also put particular attention to the creation of favourable economic, social and political

⁷ Since this study attempts to identify factors determining foreign direct investment in Ethiopia, the review of the empirical literature is made to focus largely on determinants of FDI in developing countries in general and Africa in particular.

environment for FDI. Other countries, such as Mauritius and Seychelles, which are not endowed with natural resources have managed to attract FDI by tailoring their FDI policies through liberalization, export orientation, tax incentives and other investment incentives. Moreover, some countries like Lesotho and Swaziland have attracted FDI because they are near to South Africa and investors wishing to serve the large market in South Africa have located their subsidiaries in these countries (UNCTAD, 1998; Basu and Srinivasan, 2002).

Empirically, Root and Ahmed (1979) analyzed the determinants of non-extractive direct investment inflows for 70 developing countries over the period 1966-70. Their analysis focuses on testing the significance of the economic, social and political variables in explaining the determinants of FDI. They concluded that developing countries that have attracted the most non-extractive direct foreign investment are those that have substantial urbanisation, a relatively advanced infrastructure, comparatively high growth rates and per capita GDP, and political stability. Asiedu (2002) has also expressed a similar view analysing the impact of natural resources, infrastructure and openness to trade on FDI flows to Sub-Saharan Africa. Her findings indicate that FDI in Africa is not solely determined by availability of natural resources and that governments can play an important role in directing FDI through trade reform, macroeconomic and political stability, efficient institutions and improvement in infrastructure.

Several other studies find that countries that are open attract more FDI. In most studies openness is measured by the ratio of exports (or exports plus imports) to GDP. Singh and Jun (1995) find export orientation (export as percentage of GDP) to be the strongest factor explaining why a country attracts FDI. Chakrabarti’s (2001) finds openness to trade, measured by exports plus imports to GDP, being positively correlated with FDI. Morisset (2000) finds a positive and significant correlation between trade openness and the investment climate for 29 African countries. Studying factors that significantly influence the long-run investment decision-making process of investors in 19 Sub-Saharan African countries, Bende-Nabende (2002) finds market growth, export-orientation policy and liberalization as the most dominant long-run determinants of FDI. Salisu (2003) finds openness to trade having positive and significant effect on FDI in Nigeria while Tsikata et al (2000) find export-orientation as a significant determinant of FDI inflows to Ghana. Asiedu (2002), using exports plus imports to GDP as a proxy to openness, comes to a similar conclusion for Sub-Saharan African host countries. Focusing on manufactured goods, primary commodities and services, Kandieru and Chitiya (2003) analyse the impact of openness on FDI in 51 African countries. Their findings indicate that FDI responds significantly to increased openness in the whole economy and in the services sector in particular. In general, the empirical evidence supports the theoretical argument in favour of favourable government policies and liberal trade regimes as important determinants of FDI.

From the theoretical point of view market size, which is usually measured by real per capita income, plays an important role in attracting FDI, especially market seeking FDI. However, the empirical evidence for market size as a determinant of FDI has mixed results. Obwona (2001) finds market size to be a significant determinant of FDI in Uganda. Investigating the determinants of FDI on developing and developed countries, Chakrabarti (2001) concludes that host country market size, measured by per capita GDP, has positive and significant effect on FDI.⁸ On the other hand, however, Salisu (2003) finds both per capita income and growth rate of GDP to be statistically insignificant determinants of FDI in Nigeria while Tsikata et al (2000) fail to support the market size as an important determinant of FDI in Ghana.

It has been argued that macroeconomic stability, government policies and political variables are more important determinants of FDI in Africa than the market variables. Schneider and Frey (1985) used politico-economic model which simultaneously includes economic and political determinants of FDI in explaining the flow of foreign direct investment in 80 less developed countries. They find that the most important determinant of FDI is a country’s level of development, measured by real per capita GNP and the balance of payments. The higher the per capita income and the lower the balance of payments deficit, the higher the amount of foreign direct investment attracted. Regarding the political determinants of FDI, Schneider and Frey conclude that political instability significantly reduces the inflow of foreign direct investment. Lemi and Asefa (2001) also arrive at similar conclusions. Their study examines the impact of economic and political uncertainty on foreign direct investment flow to 31 African countries. Their study indicates that for U.S. manufacturing FDI in particular, political stability and government policy commitment are the most important factors. Moreover economic factors such as labour, trade connection, size of the export sector, external debt, and market size of the countries are found to be significant determinants of FDI flows to African countries. These findings are in line with the findings of Agodo (1975) who finds that the U.S private investors’ corporate decisions to undertake manufacturing investments in Africa are essentially determined by the expected rates of return on investment, political stability and favourable investment climate, the size of the domestic market, the presence of needed raw materials, and infrastructure. Lee (2003) draws particular attention to the effectiveness of government policies towards foreign direct investment activity. Using an index that reflects a country’s general regulatory environment and treatment for foreign businesses for a cross section of 153 developing and developed countries over the period 1995-2000, his findings indicate that while a country’s market size and openness to trade are crucial factors for foreign investment flows, government policies play an important role to FDI inflows. Corruption is also another key concern of foreign investors on top of political and policy instability. The World investment Report (1999) reports that factors most frequently mentioned by foreign investors in Africa, as having a negative influence on investment are bribery, high administrative cost of doing business and access to capital. Empirically, Salisu (2003) analyses the impact of corruption on FDI in Nigeria and finds corruption having a significant detrimental effect on FDI. In general, greater red tape,

8

Agodo (1975), Schneider and Frey (1985), Morisset (2000), Lemi and Asefa (2001), and Lee (2003) are some of the other studies with evidence in support of the hypothesis that large market size encourages FDI.

more restrictive performance requirements, an unstable political situation, or economic instability would make the host country less attractive for FDI (Lim, 2001).

Human capital, both in terms of quantity and quality, is another important factor particularly in promoting labour intensive and export oriented FDI. Noorbakhsh et al (2001), using secondary school enrolment ratio and the number of accumulated years of secondary and tertiary education in the working age population as a proxy to human capital, find human capital to be a significant determinant of FDI inflows for 36 developing countries. Lewis (1999) also provides support to the proposition that human capital in host countries is a key determinant of foreign direct investment in developing countries. He notes that education, especially in technical discipline, provides least developed countries with the skills that are required by the multinational companies. Nunnenkamp (2002) has analysed globalization-induced changes in the relative importance of foreign direct investment in developing countries. His findings indicate that traditional market-related determinants are still dominant factors but the availability of local skills has become a relevant pull factor of FDI in the process of globalization. Salisu (2003) also finds low level of human capital, as measured by the illiteracy rate, having a discouraging effect on FDI in Nigeria.

3.1 The pre-1991 period

This period marked the introduction of the command system of economic management in 1974. The mainly liberal policies of the pre-1974 Imperial/feudal era were replaced with centralised policies that discouraged market economy and private property. The land reform measure that was undertaken in 1975 was one of the major policy reforms that took place immediately. Land was nationalised and private ownership of land ceased. Medium-size and large enterprises were also nationalized. The government also nationalized and subsequently reorganized private banks and insurance companies. In general, the economic performance of the pre-1991 period was characterised by three phases. During the first phase of the regime 1974-78, economic performance was poor due to the emerging new policies and the nationalisation measures. Average annual growth rate of GDP was 0.3 percent and per capita growth was negative. During the second phase of the regime, 1978-80, the economy began to recover and the growth rate increased to 4.6 percent. This period was characterised by stability and it also benefited from good weather, agricultural production increased at an average annul rate of 3.6 percent. But in the third phase 1980-1985, the economy performed badly again. The major reason for this bad economic performance was the severe drought that affected almost all regions of the country. After this period the economy continued to stagnate. To tackle the structural problems of the country the government eventually adopted a long-term plan called the ten-year perspective plan. The aim of the plan was to reduce the share of agriculture in GDP, increase the share of industry, increasing foreign exchange earnings, diversification of the country’s export sector and real GDP growth of 6.9 percent per annum during the target period. However, most of the targets were not realised. Growth remained at about 2 percent and GDP per capita was negative during the pre-1991 period (Geda and Degefe, 2002)

During the pre-1991 period, the investment climate in general and FDI in particular was not encouraging. The problems of political instability, insecurity, and the nationalisation of major industries severely discouraged foreign private investment. Realizing the importance of FDI, the government then tried to revive it through the 1983 Joint Venture Proclamation. The proclamation offered incentives such as a five-year period of income tax relief, import and export duty relief, tariff protection and repatriation of profits and capital. However, the proclamation failed to attract foreign investors. In 1989, the government revised the 1983 proclamation by allowing majority foreign ownership in many sectors. It also attempted to provide more protection to investors. However, the political instability and the prolonged civil war at the time further discouraged FDI. The political instability got worse and it consequently led to the overthrow of the Derg regime in 1991.

3.2 The post-1991 period

The post-1991 period began with the coming to power of TPLF/EPRDF in 1991 and the adoption of the WB/IMF sponsored Structural Adjustment Programme soon after. Among the set objectives were/are: reducing macroeconomic imbalances, eliminating structural distortion, upgrading the country’s human capital and infrastructure as well as poverty reduction. The government implemented a series of reform measures in order to change the command economic system that had been in place to a free market economy, to speed up the integration of the economy into the world economy and to encourage the wider participation of the private sector in the development process of the national economy (FDRE-MOFED, 2002). The specific measures taken to promote the export sector and participation of the private sector include the following:

�Deregulation of domestic prices �Devaluation of the national currency by 141.55 percent, from 2.07

birr per dollar to 5 birr per dollar; �Liberalisation of the foreign exchange market �Elimination of Export taxes except for coffee; �Lowering of Maximum import duties from 230 percent to 60

percent; �Simplification of Export licensing regulation and procedure; �Provision of adequate incentives, strengthening and enhancing

institutional support for the export sector.

Increasing the role of the private sector in the economy being one of the main objectives of the government, the privatisation programme was started in 1994. The government established the Ethiopian Privatisation Agency (EPA) which has the power and duties to transfer state-owned enterprises to private ownership. To date, the government had privatised 200 enterprises to domestic and foreign investors (AFDB/OECD, 2003). The government has also adopted “agriculture-led industrialization as a central plank of its development programme, with a focus on productivity growth on small farms and labour-intensive industrialization” (Economic Commission for Africa, p.83, 2002). Except for the two year period of conflict with Eritrea (1998-2000), the reform measures have brought about some positive changes. Economic growth during this period (1992-2001) has improved with an average rate of 5 percent. GDP per capita also has grown by 2.4 percent per annum and the rate of inflation declined from 21 percent in 1992 to less than 5 percent in 2001. By 2000/01 total investment accounted for 16 percent of GDP (Geda and Degefe, 2002; Economic Commission for Africa, 2002). A more recent study by the IMF puts the overall GDP growth rate at 4 percent over the period 1991-2003 which fares relatively better than the growth performance during the pre-1991 period that stood at 2.8 percent (Andrews, et al. 2005).

Although domestic investments constitute the main component of capital formation in Ethiopia, accounting for about 64 percent of total investment, FDI has started to play some role in the country following the 1992 liberalisation programme (see Table 1 in the appendix). The reforms as well as the government introduction of investment guarantee schemes and incentives have helped to raise the share of inward FDI in total investment form 0.04

percent in 1992 to 27 percent in 1997 (Figure 1). However, the war with Eritrea in particular has disrupted the rising trend of FDI inflows.⁹

< table 1 here >

< figure 1 here>

According to Ethiopian Investment and Innovation Policy Review (UNCTAD, 2002), the Middle East accounted for the largest share of the post-1992 FDI projects in the country. This was followed by the European Union as the second largest source of FDI to Ethiopia over the period 1992 to1998 (see Table 2 in the appendix).

< table 2 here >

3.3 Regulatory and institutional framework of FDI in Ethiopia

Implementing market oriented development strategies encourages the role of the private sector involvement in the development process. In order to encourage, promote and expand private investment in the country, the Ethiopian government has set out some private sector development initiatives. These initiatives are about enabling the enhanced utilisation of the country’s resources through the growth of private businesses by providing predictable and enabling environment (FDRE-MOFED, 2002). The programme highlights the importance of competitiveness as a key to success for sustained economic development in the country. Some of the important factors mentioned as a basis for competitiveness include conducive investment climate, which focuses on macro-economic stability, sound policy and regulatory framework for the private investment sector and strong institutions that run and support the system.

4.1 Definitions of variables

The World Bank World Development Indicators (2003) defined FDI as the net amount invested or reinvested by non-residents to acquire a lasting interest (10 percent or more of voting stock) in enterprises in which they exercise significant managerial control. There are a number of FDI variables included in World Development Indicators data set: net FDI, BOP in current U.S. $; net FDI inflows as percent of gross capital formation; net FDI inflows BOP in current U.S $ and net FDI inflows as percent of GDP. IN line with the approach used in the FDI literature, the dependent variable used in this study is the net foreign direct investment inflows as a percentage of GDP.

The choice of independent variables is constrained by data availability, as is mostly the case with time-series data in developing countries. For example, time-series data on some of the factors such as tariff rates, trade taxes, real effective exchange rate, real wages, and corruption index that are used in some studies of this nature are not readily available for Ethiopia over the (entire) study period. Not withstanding this constraint, this study uses the following variables that are commonly used in studies of FDI.

Market Size: the market size hypothesis states that multinational firms are attracted to a larger market in order to utilise resources efficiently and exploit economies of scale (Chakrabarti, 2001). Market size has been represented by real per capita GDP and growth rate of real GDP (as market growth potential). Real GDP per capita and Real GDP growth rates are included in the regression as measures of market attractiveness and FDI is expected to be positively related to these two variables.¹⁰

¹⁰ The IMF International Financial Statistics Year Book reports GDP values using the local currencies, so annual average exchange rate is used to convert the local currency values into US$ equivalent. The nominal values of GDP were, then, converted into real value using GDP deflator.

Export orientation: openness promotes FDI, and one indicator of openness is the relative size of the export sector (Singh and Jun, 1995).¹¹

Macroeconomic stability: there is a widespread perception that macroeconomic stability shows the strength of an economy and provides a degree of certainty of being able to operate profitably (Balasubramanyam, 2001). Inflation rates and exchange rates are used as proxy variables for macroeconomic stability. Low inflation and stable exchange rates are expected to have a positive impact on FDI. As pointed out earlier, data on real exchange rate is not readily available. As a result, only the rate of inflation (based on consumer price index) is included to capture the effect of macroeconomic stability on FDI.

Infrastructure: infrastructure covers many dimensions ranging from roads, ports, railways and telecommunication systems to the level of institutional development. The availability of well-developed infrastructure will reduce the cost of doing business for foreign investors and enable them to maximise the rate of return on investment (Morriset, 2001). Therefore countries with good infrastructures are expected to attract more FDI. It is a standard practice to measure infrastructure by the number of telephone lines per 1000 people in a country. Asiedu (2004) argues that this measure does not include mobile phones. Moreover, it only captures existing infrastructure and fails to take into account potential infrastructure. Taking this into account Gross fixed capital formation (percent of GDP) has been included to proxy infrastructure development in addition to number of telephones.¹² These two variables are expected to be positively correlated with FDI.

Human capital: human capital is considered to be an important factor for location strategies of multinational companies. When investing for the long term in another country, multinational companies have in mind the human resources in the host country. Large, efficient, educated population is a requirement for an attractive investment. The more educated the population is, the more likely it is for a country to attract more FDI (Lewis, 1999). In this study, human capital is measured by adult illiteracy rate (percent of people aged 15 and above). This indictor is expected to be negatively correlated with FDI.

Liberalisation: liberalisation of trade and FDI regimes are assumed to have a positive influence on the inflow of FDI since they facilitate a freer trade and investment in conjunction with the repatriation of dividends and profits to home countries (Bende-Nabende, 2002). As explained in section three, Ethiopia has been introducing some liberalisation measures since 1991 and a dummy variable is used to capture the effect of the change in policy environment on FDI. The dummy variable assumes a value of 0 for the preliberalisation period (i.e. up to 1990) and 1 for the post liberalisation period

¹¹ The ratio of trade to GDP is often used as a measure of openness in some studies but this measure was not found to have a significant effect in this study. ¹² Gross fixed capital formation includes land improvements, construction of roads, railways, schools, and industrial and commercial buildings (Asiedu, 2004)

(from 1991 onwards). The dummy variable is expected to have a positive sign.

4.2 Model specification

The general form of the model estimated has the following form:

FDI = f (RGDPG,RGDPC , EXP , INF,ILLIT,GFCF,TELE,LIB ) …………… (1)

Where RGDPG = Growth Rate of Real Gross Domestic Product

RGDPC = Real Gross Domestic Product per capita

EXP = Exports as percentage of GDP (measures openness)

INF = Annual rate of inflation based on consumer price index

ILLIT = Rate of adult illiteracy

GFCF = Gross Fixed Capital Formation (as percent of GDP)

TELE = Telephone lines per 1000 people

LIB = Measure of liberalisation (dummy variable)

Since this study covers the period 1974-2001 and the variables discussed in the previous section constitute time-series information, the appropriate modelling strategy is one involving time-series analysis. The model employed can be given by

FDI_t =α+β RGDPG_t +β₂ RGDPC +β₃ Exp +β₄ Inf_t +β₅ Illit_t +β₆Tele +

1 t

β Gfcf +β Lib +ε_t

78

….……. (2)

An important consideration to be made in relation to estimating the model given in equation (2) is to do with the existence of spurious regression. Granger and Newbold (1974) have shown that results based on models such as the one given in equation (2) may give rise to ‘spurious regressions’. Spurious regressions occur when results from the model show promising diagnostic test statistics even where the regression analysis has no meaning (Gugarati, 2003). Because of this problem, the first step in any time-series analysis is to test for the stationarity of variables. As can be seen in the appendix, appropriate tests of stationarity and co-integration have been conducted to rule out ‘spurious regression’ in our study.

The stationarity and co-integration tests we have conducted suggest that model (2) should be estimated using the differenced variables¹³ The final short run model estimated therefore has the following form:¹⁴

ΔFDI_t =α+β RGDPG_t +β₂ ΔRGDPC +βΔExp +β₄ ΔInf_t +β₅ ΔIllit_t +β₆ ΔTele +

13 t

βΔGfcf +β Lib +ε_t

78

¹³ Hence we can only look at short run relationships among these variables. ¹⁴ Δ denotes first difference. RGDPG is stationary in level, so it is included as it is.

……… (3)

Based on this short run model, four regressions have been carried out to examine the determinants of FDI.¹⁵ The next section analyses the results from the four regressions.