Does Trust Matter for Foreign Direct Investment Decisions?

Does Trust Matter for Foreign Direct Investment Decisions?

Sibel Bali Eryigit
DOI: 10.4018/978-1-7998-2448-0.ch079
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Factors affecting the investment decisions of multinational companies are heavily researched in the literature. However, the number of studies dealing with the socio-cultural characteristics of host countries among these factors is quite limited. Among the cultural characteristics affecting location decisions, one of the primary cultural characteristics is the general level of trust between individuals. In this scope, this chapter intends to research whether the general level of trust in a society has an effect on the location decisions of foreign investors. In line with this objective, an analysis will be conducted by employing the panel data method for 39 emerging market countries for the period between 1998 and 2011. According to the results of the study, a low general level of trust in the host country represents a significant disadvantage for the attraction of foreign direct investments.
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According to Fukuyama (1995), a nation’s well-being, as well as its ability to compete, is conditioned by a single pervasive cultural characteristic, which is the level of trust inherent in the society. As communities rely on association based on trust, and trust is determined by culture, it may be said that the general level of trust differs in distinct cultures. In fact, there are many studies in the literature advocating that trust and, particularly, the level of social trust are important determinants of the performance of economies.

The first study known to comprehensively address the effects of mutual trust on the economy is “The Moral Basis of Backward Society”, conducted by Banfield and published in 1958. Banfield (1958) attributes the economic backwardness of Southern Italy, in comparison with Northern Italy, to the low general level of trust in the south. Family ties in Southern Italy are very strong, but the other individuals of the society beyond the family exhibit a low level of mutual trust. According to Banfield (1958), the poor general level of trust hampers the communication, cooperation, and interaction between individuals. This prevents the creation of large organizations that would promote economic development. Similarly, La Porta et al. (1997) stated that in large organizations and social structures in which the members interact with each other infrequently, trust was needed to support cooperation. In fact, La Porta et al. (1997) supported this claim by detailing empirical evidence as well.

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