Do World Bank ranking improvements attract FDI?

These days, I steer clear of debates about estimating the impact of trade agreements. Any public policy conversation that rapidly devolves into whose unrealistic assumptions are better seems like a debate better had behind closed doors at econ seminars and ComicCon. I’ll stick to the text of the agreement, which I can simply read in a single PDF file, thank you very much.

However, Simon Lester highlights an interesting aspect of a recent Peterson Institute study on the TPP. The study attempts to estimate how many non-trade barriers (i.e. regulations and other government actions) might be “actionable” under the agreement. The authors then project increases in FDI that might be triggered by removal of these regulations.

Like Simon, I read the original Peterson report. Like Simon, I don’t understand the non-trade barrier aspect of it.

According to researchers at Tufts University, who analyzed the previous Peterson report on TPP…

The results obtained by  Petri, Plummer and Zhai ( 2012)  depend strongly on the  projected  increase in foreign direct investment, estimated to generate , on average, 33 percent of the TPP ’s  total income gains…

Given  the  difficulty  of  predicting  FDI  flows,  the  authors  estimate  the  FDI  effect through  two series of assumptions . First, the potential increase in FDI stocks is estimated through a parameter  that expresses the impact of changes in the World Bank Doing Business rank. The parameter is  the  same  for  all  participating  countries, implying  the  same  increase  in  stock  of  FDI  for  any  country  that climbs  a  given  number  of  ranks.  Once  the  parameter  is  estimated,  it  is  used  to  calculate  the  potential  change  in  FDI  stocks.  It  is assumed that  signing the  TPP will  put  all  countries above the  ninetieth  percentile of the ranking , and that all FDI stocks will increase  by  at   least  50  percent  of  the  difference  between  the  predicted  level  and  their  current  level. Secondly,  the  “actual”  FDI  increase  is  calculated  from  the  potential  increase , assuming  that the  TPP investment  provisions  eliminate a  maximum  of  two – thirds of  investment  barriers  and  that  each  country  achieve s this , depending  on  the  number  of  FDI  provisions  it  accepts. This  procedure  is  used to  justify the  assumption that  FDI  will  play  a  major  role  in  making the  TPP economically  successful…

I don’t know if a similar procedure is used in the more recent Peterson report, and it’s difficult to compare since the methodology appendices the Tufts crew refer to are not freely available online. (And the Tufts study doesn’t provide page citations, so you can’t reverse engineer through Google Books.)

In any case, the point about the World Bank Doing Business rankings caught me eye, and comes perilously close to my current research interests on investment.

It turns out that the link between changes in World Bank’s rankings and FDI are anything but clear. World Bank economist Dinuk Jayasuriya found the following:

for the average country,  [marginal] improvement in the official Doing Business Rankings is likely to  increase FDI into a country…  Nevertheless, there  appears  to  be  no  evidence  to  suggest  large  improvements  in  Doing  Business  Rankings… attract significantly greater FDI inflows. When  focusing  on  developing  countries  in  isolation, the  relationship  is  insignificant.

In other words, in estimates that included rich countries, minor increases in DB rankings helped things. But when rich countries are taken out of the sample, there’s no benefit to moving up the ranking ladder. And countries don’t appear to get more FDI when they make a lot of improvements rather than just a little.

Similarly, a more recent study by Adrian Corcoran and Robert Gillanders concluded:

 

Regulation has been found to matter for local investment and entrepreneurship and
in this paper we have sought to empirically assess the proposition that better
business regulatory environments, as defined by the World Bank’s Ease of Doing
Business measure, will attract more foreign direct investment. Using data on a large
proportion of the world’s countries we found evidence that this was true on average.
Going deeper, we found that most of this effect can be explained solely by how easy
it is to trade across borders, with other components of doing business having little or
no effect. We also found that the effect was not present in the world’s poorest, and
therefore most eager for FDI, region, Sub-Saharan Africa. Neither was it present for
the OECD.

Again, there are heterogeneous effects depending on what region of the world you are in. And the regulations related outright to trade were more important than those indirectly related, i.e. purely domestic regulations that might affect longer term FDI.

I’m thankfully not a macro or trade modeler – see minutes 5 in this video for Adam Posen’s take on the difference (and minutes 1:40-1:50 for an impromptu debate between Tufts and Peterson folks).

But an emerging literature suggests we don’t yet know much about how FDI is affected by policy changes that are inherently difficult to put into numbers.

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