An Analysis of the Determinants of Foreign Direct Investment in Turkey: The Role of the Institutional Context

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1. Introduction

Since 1980, the Foreign Direct Investment (FDI) inflows to developing countries have been substantially increasing and compared to other capital flows, have remained the largest component of net resource flows to developing countries (UNCTAD 2006a). In these countries, governments believe that FDI will help economic development and they try to attract FDI through policies and investment incentives designed to increase investor interest in an attempt to benefit from the potential economic development. Hence, with the liberalization of many developing economies, FDI has become a crucial medium through which developing economies become unified on a global basis.

On the other hand, despite several efforts of governments, Turkey has never been able to attract the substantial FDI inflows that would be expected from a nation with a strategic location between Europe, the Middle East and Central Asia (2).

In this paper, I conducted a questionnaire survey to explore the mechanisms linking macroeconomic variables and political institutions to FDI flows, and interviewed representatives of Multinational Corporations (MNCs) operating in Turkey in order to understand the reasons of low level of FDI flows into the country.

2. FDI Performance of Turkey from a Comparative Perspective

Turkish FDI levels have stagnated during the 1990s while total FDI worldwide increased by a factor of 12. This lack of interest by multinational companies becomes even clearer when FDI inflows are adjusted to the size of the economy. Over the last decade, the average FDI inflows to middle-income countries in Europe were 1.1 percent of GDP compared to less than 0.5 percent in Turkey. As shown in the following figure, this disparity is considerably greater when Turkey is compared to the countries investors considered to be its main regional competitors: Hungary, the Czech Republic, and Poland.

Fig. 1 reveals the inward FDI stock levels of selected emerging economies as a percentage of GDP. Comparing Turkey with other emerging economies such as Brazil, Mexico, Hungary, Czech Republic, and Poland, it can be argued that the inward FDI performance of Turkey is ineffective. The level of FDI stock in Turkey remained stagnant at approximately 10 percent during the 1990s, fluctuated after 2000 and reached approximately 12 percent in 2005. Whereas inward FDI stock of all other countries increased significantly. Hungary and the Czech Republic are the most successful countries at attracting increasing inward FDI stock. The transition economies of Central and Eastern Europe, although entering the competition in the beginning of the 1990s, attracted more FDI in comparison to Turkey in the period.

Another way to view Turkey's relative FDI performance as a host country is in terms of two indices developed by UNCTAD: The FDI Performance Index and the FDI Potential Index.

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The Inward FDI Performance Index ranks countries by the FDI they receive relative to their economic size. It is the ratio of a country's share in global FDI inflows to its share in global GDP (Table 1) (3). The Index is shown for three-year periods to offset annual fluctuations in the data and covers 141 economies for as much of the period as the data permit; however, some economies in transition could not be ranked in the early years for lack of data or because they did not exist as separate countries (4).

According to the inward performance index, Turkey ranks 95th with a score of 0.917. This low score indicates that Turkey receives less FDI than its relative economic size.

A more complex index, the Inward FDI Potential Index, captures several factors (apart from market size) expected to affect an economy's attractiveness to foreign investors. It is an average of the values of 12 variables (5):

Table 2 demonstrates that, Turkey has a better position than Inward FDI performance index, however, still standing behind other emerging markets. …