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Foreign investment and institutional reform: Portugal in European perspective
As intraregional transaction costs across the globe were reduced, national jurisdictions tended to rely more heavily on business facilitation measures that provide incoming firms with a suitable business environment. It is therefore of utmost importance to understand the role played by the institutional framework on inward Foreign Direct Investment (FDI), as well as to evaluate the potential benefits and costs in terms of FDI inflows of improving/reforming national institutions. This article points out the major institutional gaps between Portugal and the most institutionally advanced countries in the European Union (EU) for those areas impacting FDI positively, and estimates and assesses the expected benefits, the required reform efforts, and the efficiency of reform options corresponding to a convergence of Portuguese institutions with the EU’s best institutional standards. Reform options are evaluated through three distinct institutional databases: the 2013 Index of Economic Freedom, the 2006 Political Risk Rating from the International Country Risk Guide, and the 2013 Doing Business. Our results indicate that institutional reforms promoting a leaner bureaucracy, lowering political risk, corruption, and the constraints on the flow of investment capital, improving the respect and protection of property rights, and promoting a strong and impartial legal environment–institutional areas where Portugal is behind the EU’s best institutional standards–may significantly affect the amount of bilateral inward FDI that is targeted to Portugal. Business friendly regulations per se have an estimated second order effect on FDI. Closing the Portuguese institutional gap vis-à-vis the EU’s most institutionally advanced countries has an estimated effect on FDI that can go up to 60 percent.