Location factors of FDI and the growing services economy1

Foreign direct investment (FDI) has increasingly shifted toward the service sector. This change in the industrial composition of FDI and the non‐tradable nature of services may have altered the importance of location factors for investment decisions. To capture potential changes in FDI determinants, a contrasting sectoral analysis is performed. Based on FDI stock data from eight new EU member states for the period 1998–2004, we implement a dynamic panel approach allowing the speed of adjustment to the equilibrium investment level to vary across sectors. Results support our assumption that investment into the service sector, which is characterized by low installation costs, adjusts much faster to its desired level than manufacturing FDI. Thus, government interventions to attract FDI are likely to boost the service sector immediately while having a slower impact on manufacturing FDI. Furthermore, as services are mostly non‐tradable, FDI into this sector is largely based on market‐seeking motives while FDI in the manufacturing sector is also driven by international price competitiveness measured by real unit labour costs.