Foreign Direct Investments and Their Institutional Quality Factors in Romania and Bulgaria

By Radulescu, Magdalena; Banica, Logica et al. | Romanian Journal of Political Science, Summer 2016 | Go to article overview

Foreign Direct Investments and Their Institutional Quality Factors in Romania and Bulgaria


Radulescu, Magdalena, Banica, Logica, Druica, Elena, Romanian Journal of Political Science


Introduction

There is a wide range of factors which attract foreign direct investments (FDI). The first category includes traditional financial and economic factors, such as tax rates, monetary conditions, market size of the host country, growth potential, purchasing power, cost of production, geographic location and natural resources. The second category includes factors that are related to the political, social and cultural environment of the host countries. While the macroeconomic determinants of FDI have been analyzed to a considerable extent in past empirical work, the role of the institutional factors such as protection of property rights, political stability, educational levels and efficiency of the legal system has been underexplored (Gwenhamo, 2011).

The impact of taxation of FDI has been widely studied, and the results have varied. A series of studies elaborated for the European countries suggests that taxation has a relatively low impact on FDIs as a result of a reduced influence of taxes on relocation costs (Edmiston, Mudd, and Valev, 2003). Leibrecht and Bellak (2005) or Bellak, Damijan and Leibrecht (2009) in their studies elaborated for the Central and Eastern European countries concluded that corporate income tax is a key factor in location decisions of foreign companies and it is as important as the labor cost factor or as the infrastructure. Benassy-Quere, Fontagne, and Lahreche-Revil (2001) studied the sensitivity of FDI to the tax rates for 11 OECD countries over the period 1984-2000, and they concluded that tax rates play a significant role in investment location for FDIs.

In Romania and Bulgaria, the peak of FDI inflows was reached in 2007-2008. Once the crisis erupted, these two countries were faced with large outflows, even if the fiscal environment remained very friendly (see more on various fiscal policy measures during the current economic crisis in Duma, 2015). Bulgaria has the lowest corporate income tax (10%) in the entire European Union (EU), while Romania has the second lowest corporate income tax of 16% among the EU countries. Even after overcoming the crisis and regaining their positive economic growth rates, they were unable to attract large FDI inflows anymore. Therefore, lowering the tax was not a successful strategy in the long-run for both countries mentioned above. That is why we believe it is important to study the impact of non-traditional quality factors on FDI inflows in those two countries

However, we must state that the entire EU was severely hit during the crisis in terms of FDI inflows. Compared with the record peaks reached in 2007, inward flows decreased eight-fold in the entire EU during 2008-2010 (Eurostat, 2011), so Romania and Bulgaria are no exceptions. FDI inflows increased in the EU in 2011, then they dropped again in 2012, and only in 2013 the FDI inflows went up slowly, by 12 % (Eurostat 2014). In the Central and Eastern European region, only Hungary and the Czech Republic regained substantial FDI inflows after 2011, while Romania and especially Bulgaria could not attract large FDI anymore (Eurostat 2014).

Even though Bulgaria has adopted a very liberal legal framework for FDI, the organized crime in business and the bureaucracy have resulted in Bulgaria "lagging behind" when compared to the other Central and Eastern European (CEE) countries in terms of FDI (Glaister and Atanasova, 1998). An extensive discussion on bureaucracy and reforming the civil sector can be found in Abashidze & Selimashvili's recent study (2015).

As origins of the institution-based view, Richard Scott (1995) defined institutions as "regulative, normative, and cognitive structures and activities that provide stability and meaning to social behavior." In this framework, economists have mostly focused on formal laws, rules and regulations (La Porta, Lopez-de-Silanes and Shleifer, 2008 cited in Peng et al., 2009).

The profound differences in institutional frameworks between emerging economies and developed economies force economists to pay more attention to these differences (Li and Peng, 2008; Zacharakis, McMullen and Shepherd, 2007). …

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