Does improvement in Doing Business rankings lead to higher FDI?

One would think so. But  Dinuk Jayasuriya of WB says the relation is not as robust.

This study is the first to test such a proposition empirically with Arellano-Bond dynamic panel estimators using the official rankings from 2006 to 2009. The paper shows this relationship is significant for the average country. However, when the sample is restricted to developing countries, the results suggest an improved ranking has, on average, an insignificant (albeit positive) influence on foreign direct investment inflows. Although robust, this result should be taken with caution given that it refers to the average developing country using data across a four-year time period. Finally, the paper demonstrates that, on average, countries that undertake large-scale reforms relative to other countries do not necessarily attract greater foreign direct investment inflows. This analysis may have important ramifications for developing country governments wanting to improve their Doing Business Rankings in the hope of attracting foreign direct investment inflows.

However, as the data set is limited one should not say that DB rankings do not help:

Does this imply developing country governments should focus on compliance and ignore making improvements in Ease of Doing Business altogether when trying to attract FDI? Not necessarily. It is important to note the results of this paper apply for the average developing country using data across a sample of 56 developing countries. Moreover one individual country may reap strong benefits from FDI inflows as a result of improvements in the Doing Business Rankings. A longer time period with richer data will help answer this question for individual countries and perhaps provide more opportunity for changes in the business environment to attract FDI Inflows.

Do the overall results suggest governments can focus on particular institutional areas to attract FDI inflows? Perhaps improvements in the time taken and cost to enforce contracts may assist in this endeavor. However if governments simply focus on this area and neglect others, their Doing Business Rankings will slip. Thus, the Eifert (2009) model could be mis-specified as it fails to consider the aggregate impact of reforms. Moreover, as shown in Table 2, the improvements in the Doing Business Rankings are likely to positively influence FDI inflows. Hence rather than focusing on enforcing contracts, it is possible improvements in the average country’s Doing Business Ranking present a signalling effect to external investors that its business environment is becoming more favorable to foreign investment. This hypothesis is given stronger credence by the fact that Aghion, Philippe, Blundell, Griffith Howitt and Prantl (2008) and Kaplan, Piedra, and Seira (2007) suggest that a combination of reforms has greater impact than business entry reforms in isolation. However, it contradicts the approach used by Busse and Groizard (2008) that only selects Doing Business indicators they believe are strongly related to FDI inflows.

Nice paper.

If DB rankings led to FDI and investor optimism, India should never have been at top of the capital inflow list. But then it is a useful signal to show whether countries are trying to improve their business environments.  May be over a longer term one starts to see the impact of these rankings on FDI flows. May be investors believe India will improves its business environment over the years…

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