The Joint Effect of Incentives and Institutions On Foreign Direct Investment (FDI): The Case of GCC Countries
Hussein Elkamel
Public Law - College of Law - Sultan Qaboos University
Abstract
GCC countries offer incentives to attract Foreign Direct Investment (FDI) to diversify the economies away from oil and support the growth of non-oil sectors. However, Foreign investors are often skeptical about the quality of the institution when allocating investment in developing countries. The institution may include many aspects such as rule of law, the enforceability of law, corruption, bureaucracy, and rent-seeking. Some developing countries may find it effortless to rely on incentives in attracting foreign investors nevertheless without sufficient protection to foreign investors such incentives may not work effectively. No question regarding the necessity of incentives to attract FDI but their effectiveness upon the quality of Law is a question. There is a positive relationship between the return of investment and the risk associated with it, that is, as the risk increases (poor institution) the investor requires more return (more incentives) to accept that risk. This might indicate a substitution effect between the incentives and the quality of institutions; a country may substitute the lack of good institutions with large incentives to foreign investors as to offset the element of risk, however, this will be costly to the country. In this study, we intend to investigate the role of institutions in determining the effectiveness of FDI incentives in GCC countries. These countries offer a variety of incentives to attract FDI such as financial incentives, exemptions from import duties on raw materials and equipment, and duty-free access to other GCC markets. Nevertheless, negative or positive changes in the institution could potentially affect the effectiveness of these incentives. The FDI inflow to GCC countries varies across years and countries and part of this variation can be explained by institution differences within and across these countries. Further, the interaction effect between incentives and institutions could play an important role. In particular, the study intends to examine the following three assumptions: 1. Incentives have an absolute effect regardless of institution, that is, incentives attract FDI regardless of institution. 2. Incentives have a substitute effect with the institution, that is, incentives attract more FDI by offsetting the lack of good institutions. 3. Incentives have a complementary effect with the institution, that is, incentives attract more FDI in subelement to the good institution. This study will be organized as follows: Section 1 theoretically introduces the role of incentives and institutions in attracting FDI in developing countries with more attention to GCC countries. Section 2 discusses the relevant literature to FDI and its determinants. Sections 3 applies descriptive analysis to examine the validity of the study’s three assumptions. Section 4 concludes with results and policy implications.
Keywords
Incentives, Institution, FDI, GCC countries
