ABSTRACT
This paper examines the main determinants of Foreign Direct Investment (FDI) in 26 European countries during the period of 1996 to 2012. The previous research reports two groups of explanatory factors: gravity factors (proximity, market size) and factor endowments (infrastructure, human capital). Other factors that are found to have significant effect are trade openness, tax policy and tax incentives, labor costs and regional integration. Using panel data regression analysis of net FDI inflows to 26 European Union (EU) countries, the study reveals significant relationship between FDI and various proxies for different macroeconomic, policy and institutional factors. By distinguishing between Western and Eastern European countries, we provide new evidence that institutional quality differences do matter and may explain the FDI pattern across different European countries. We find that the impact of country-level location factors on FDI is not significantly different across the two regions, whereas the institutional quality effects are more pronounced in the group of Western European countries. When all the countries in the sample are ranked based on the level of FDI dominance, we find that institutional quality and corruption do play an important role in explaining FDI flows. However, cost-related factors such as tax rate and unit labor costs appear to be of high significance only in the group of less developed EU countries.