FDI potential and shortfalls in the MED AND CEECS: determinants and diversion effects

Abstract

This paper examines FDI flows (1994-2004) from the EU (and for comparison from the USA and Japan) to two neighbouring regions: Central and Eastern Europe (CEE) and South Mediterranean (MED) countries. The analysis provides circumstantial evidence that the intensification of FDI in CEE, following integration within the EU, has had no discernible dampening effect on FDI flows directed to MED countries. This hypothesis is confirmed in several empirical analyses. First, a random effect gravity regression for determinants of bilateral FDI flows to a large sample of 84 developed and developing partners shows that when environmental, institutional and policy variables are included in the analysis MED countries are not different from the rest of the sample. Moreover, the actual capital inflow to MED economies is not much far from the flow predicted based on the enlarged gravity equation. This suggests that the low inflow of FDI to the region might correspond to equilibrium condition considering various distortions that economic agents have to face in MED countries. This result is also confirmed by the common trend followed by coefficients obtained interacting yearly with regional dummies for the two areas.