REGIONAL COOPERATION AND ECONOMIC INTEGRATION

FDI FLOWS IN SOUTH EASTERN EUROPE
3. Data and methodology
Panel data set is used for the assessment of the determinants of foreign direct investments
(FDI). This data set includes data for eight Southeastern European countries, Albania,
Bosnia and Herzegovina, Bulgaria, Croatia, Macedonia, Montenegro, Romania and
Serbia. Since the observed period is from 1995 – 2008, the data is consisted of total 112
observations (8 countries*14 years). The main data source was the official statistical data
published by EBRD. The index of economic freedom and its components was taken from
the official data of Heritage foundation.
Originally, the research includes 32 variables: foreign direct investments as dependent
variable and exports of goods and services, imports of goods and services, merchandise
exports, consumer prize index, current account as percentage from GDP, employment,
currency exchange rate, fixed-line penetration rate, GDP, GDP per capita, general
government balance, general government debt, general government expenditure, industrial
gross output, internet users, labour force, population, unemployment, general index of
economic freedom 7 , business freedom index, trade freedom index, fiscal freedom index,
government size index, monetary freedom index, investment freedom index, financial
freedom index, property rights, freedom from corruption, external debt as percentage of
GDP, gross average monthly earning in economy, large scale liberalization and index and
overall infrastructure reform index as independent variables.
Augmented Dickey-Fuller unit root test was performed on all variables, after which, some
of the variables were transformed in order to become stationary. Variable transformation is
presented in Appendix A. Appendix B contains the coefficients of the unit root test.
To determine the effect of these variables on foreign direct investment, panel data regression
model is used. Panel data regression model takes time series for observed period of 14
years for 8 countries. One way to take into account the “individuality” of each country
or each cross-sectional unit is to let the intercept vary for each country but still assume
the slope coefficients are constant across time. In literature, this model is known as fixed
effects (regression model). The term “fixed effects” is due to the fact that, although the
intercept may differ across individuals (here the 8 countries), each individual’s intercept
does not vary over time, it is time invariant (Gujarati, 2003, pp.642).
By performing series of regressions with different variables included and excluded from the
model, we have reached the best regression equation. This conclusion was made according
to the statistical significance of the regression coefficients and coefficient of determination.
7 Index of economic freedom is calculated by the Heritage foundation and Wall Street Journal. Economic freedom
is the fundamental right of every human to control his or her own labor and property. In an economically free
society, individuals are free to work, produce, consume, and invest in any way they please, with that freedom both
protected by the state and unconstrained by the state. In economically free societies, governments allow labor,
capital and goods to move freely, and refrain from coercion or constraint of liberty beyond the extent necessary to
protect and maintain liberty itself. Ten components of economic freedom are used to calculate this index, assigning
a grade in each using a scale from 0 to 100, where 100 represent the maximum freedom. The ten component
scores are then averaged to give an overall economic freedom score for each country. The ten components of
economic freedom are: business freedom, trade freedom, fiscal freedom, government size, monetary freedom,
investment freedom, financial freedom, property rights, freedom from corruption and labor freedom.
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