Political Risk, Institutions and Foreign Direct Investment: How Do They Relate in Various European Countries?

This paper examines theoretically and empirically the extent to which the decisions by foreign firms to invest in a group of countries are influenced by economic factors, as opposed to political risk and institutional factors. We test our hypotheses on 35 European countries by means of panel regression techniques over the 1995-2008 period. Our results suggest that policies and institutions, which differ widely between countries, when assessed quantitatively from both static and dynamic perspectives, significantly influence the behaviour of investors in their dual decisions about where to invest and how much to invest. Clustering countries into three groups according to levels of economic maturity revealed that the role of “soft” political factors in FDI decisions is less persistent and less predictable than the role of “hard” economic factors.