The Location Choice of US Foreign Direct Investment: How do Institutions Matter?

We look at the institutional determinants of both within and across country variations in US FDI flows over time. The strength of our approach is that in contrast to the previous work that has focused on average FDI flows across countries, we are able to explain both the variations in FDI flows across and within countries for a given year. Our core hypothesis is that in countries with high quality of contract enforcement, multinationals are more likely to invest in the industries where by their very nature investments are relationship-specific. Conversely, in countries with low quality of contract enforcement, multinationals are more likely to invest in industries where investments are to a large degree not relationship-specific. Using three dimensional panel data for US FDI flows to 50 countries and six sectors for the period 1984-2010, we find strong support for our hypothesis. Our findings suggest that countries which want to attract US FDI in high technology institutions intensive sectors such as transportation and pharmaceuticals should improve their property rights and contracting environment.