Critical Issues of Economic Development of Emerging Markets

**3**

**1. Introduction**

**Chapter 1**

*Pascal Salin*

**Abstract**

Humanism

Liberalism, the Only True

Liberalism is often criticized because it is said that it is concerned only by economic problems (and not more general human problems) and because it is in favor of selfishness. This is wrong and, in fact, liberalism is, on the contrary, the necessary consequence of a universal and valid conception of ethics. The foundation of liberalism consists in the fact that everyone must be respectful of the legitimate rights of any person (as regards, for instance, his body, his mind, and his legitimate property rights). Therefore, it implies that one ought to be respectful of another person either if this person is generous or if he is selfish (one is not obliged to be selfish, but one has the right to be selfish). Thus, liberalism is founded on the fundamental universal ethics and it is respectful of the individual conceptions of personal ethics. It is not in favor of selfishness, but in favor of individualism. This is why it must be said that liberalism is the only humanistic approach of social problems. However, many people consider that it is ethically justified to impose a redistribution policy to decrease so-called "social inequalities." But, so doing, a state is not respectful of the legitimate property rights of those who are obliged by legal constraint to pay taxes.  But it is not the case whenever this transfer of resources is made by using coercion. And it must be added that it has negative consequences. Those who benefit from the redistribution policy are less induced to make productive efforts. And those who have to pay the taxes are also less induced to develop their productive activities. Therefore, the production of resources is diminished by the redistribution policy and all the members of a society (for instance a country) suffer from this non-ethical policy.

**Keywords:** liberalism, ethics, individual rights, redistribution policy

The discredit from which liberalism suffers in our time, in many countries, is an astonishing and appalling phenomenon. In reality, this discredit is based on caricatures of liberalism, complacently spread by those who have an interest in fighting it or who are unaware – sometimes voluntarily – of what is the true liberalism. Thus, it is claimed that liberalism is supporting rich people against poor people, that it gives human beings the sole objective of seeking material benefits, that it advocates selfishness, etc. Nothing could be further from the truth, and that is why all those who love the truth should be concerned about learning more about liberalism [1]. Unfortunately, all people have very rarely the opportunity to make this intellectual re-examination, and I am struck, for example, by the fact that all young people who

#### **Chapter 1**

## Liberalism, the Only True Humanism

*Pascal Salin*

#### **Abstract**

Liberalism is often criticized because it is said that it is concerned only by economic problems (and not more general human problems) and because it is in favor of selfishness. This is wrong and, in fact, liberalism is, on the contrary, the necessary consequence of a universal and valid conception of ethics. The foundation of liberalism consists in the fact that everyone must be respectful of the legitimate rights of any person (as regards, for instance, his body, his mind, and his legitimate property rights). Therefore, it implies that one ought to be respectful of another person either if this person is generous or if he is selfish (one is not obliged to be selfish, but one has the right to be selfish). Thus, liberalism is founded on the fundamental universal ethics and it is respectful of the individual conceptions of personal ethics. It is not in favor of selfishness, but in favor of individualism. This is why it must be said that liberalism is the only humanistic approach of social problems. However, many people consider that it is ethically justified to impose a redistribution policy to decrease so-called "social inequalities." But, so doing, a state is not respectful of the legitimate property rights of those who are obliged by legal constraint to pay taxes.  But it is not the case whenever this transfer of resources is made by using coercion. And it must be added that it has negative consequences. Those who benefit from the redistribution policy are less induced to make productive efforts. And those who have to pay the taxes are also less induced to develop their productive activities. Therefore, the production of resources is diminished by the redistribution policy and all the members of a society (for instance a country) suffer from this non-ethical policy.

**Keywords:** liberalism, ethics, individual rights, redistribution policy

#### **1. Introduction**

The discredit from which liberalism suffers in our time, in many countries, is an astonishing and appalling phenomenon. In reality, this discredit is based on caricatures of liberalism, complacently spread by those who have an interest in fighting it or who are unaware – sometimes voluntarily – of what is the true liberalism. Thus, it is claimed that liberalism is supporting rich people against poor people, that it gives human beings the sole objective of seeking material benefits, that it advocates selfishness, etc. Nothing could be further from the truth, and that is why all those who love the truth should be concerned about learning more about liberalism [1]. Unfortunately, all people have very rarely the opportunity to make this intellectual re-examination, and I am struck, for example, by the fact that all young people who discover by chance a correct explanation of what liberalism is are amazed by its intellectual coherence and the solidity of its ethical foundation.

#### **2. Liberalism, ethics, individual rights and redistribution policy**

Liberalism consists into developing ideas based on individual behavior and individual aims to analyze or to promote the working of a society. And this is why liberalism must be considered as a true humanism, since humanism means a way of thinking or acting coherently with what human beings are. And humanism can be considered as the foundation of ethics since ethical actions and thoughts imply to be respectful of the very nature of human beings.

Indeed, liberalism is both a method of analysis and an ethic. It is a method of analysis because it consists in thinking – and this should be obvious – that we can only understand the functioning of a society by having a realistic vision of what a human being is, of his deep nature, of his behavior. A society is not a kind of great machine, but a collection of men and women who have – each of them – their own individuality, but who interact one with the other and are therefore, from this point of view, necessarily in solidarity with each other. Just to give an illustration of the problem, economists quite often develop analyses of what is called "macroeconomics." But they possibly define discretionary concepts – such as "national income" – which may not have any link with individual behaviors. Thus they may deduct economic proposals which are not respectful of individual behaviors and aims so that they may not be efficient and, above all, they may not be coherent with ethics. To avoid such errors, many intellectuals are in favor of what is called praxeology, that is, the science of human action. Such is the case, in particular, of Ludwig von Mises in his book, *Human action*, [2] and more generally of the so-called Austrian economic theory (initially developed by Ludwig von Mises and Friedrich Hayek [3, 4]). They rightly consider that it is necessary to begin any social analysis by using realistic assumptions about the behavior of individuals.

As regards liberal ethics [5] it implies that there is a universal duty to be respectful of everyone's legitimate rights. Of course, each of us also has his or her own personal moral principles regarding how to behave with others. These personal morals are highly respectable, provided, however, that they are not incompatible with the universal ethic of respect for the legitimate rights of others.

It may be said that liberal values are Christian values or at least are fully compatible with them. It is Christianity which has enabled the emergence of individual freedom in the Western world and which has, moreover, enabled economic takeoff and enabled countless masses to escape from poverty. With Christianity, as with liberalism, a human being is not just a cog in the great social machine, but a person who deserves respect as such.

Liberalism and Christianity share a common basis in terms of universal values. But, of course, within this general framework each can develop its own moral concepts. Thus, Christianity considers altruism as a virtue. But this is not incompatible with liberalism. Indeed, a liberal must be intransigent with the universal duty to respect the rights of others, but he does not claim to suggest a particular conduct to human beings, for example, to suggest – or, even less, to impose – altruistic or selfish behavior toward this or that person or category of persons. He considers that this is a matter of personal responsibility and that it is his duty to respect such personal ethics as long as it does not contradict the universal duty to be respectful of the rights of others. That is why it is absurd to say that liberalism supports selfishness. Based on an absolute respect for individuals, liberalism refrains from making judgments about the conduct and opinions of individuals unless they infringe the legitimate rights of

**5**

been the only real enemy of totalitarianism!

and peaceful society?

Should not the trust we place in human beings and in their extraordinary capacities lead us to hope that all these confusions, lies, and the resulting disasters will be dispelled and that, as free beings, they will be able to live in a harmonious

However many people believe that there are so-called inequalities between the members of a society (for instance the members of a country) and that it is the important role of a State to decide a redistribution policy. It is understandable that

*Liberalism, the Only True Humanism*

*DOI: http://dx.doi.org/10.5772/intechopen.93235*

many people bear the burden of taxes without knowing it.

ously, as they are led to see this role as being played by the State.

others. Thus, it will consider a person's generous behavior to be perfectly respectable. But it will challenge the State's claim to redistribute resources through the use of coercion, which in itself constitutes an infringement of the freedom and rights of individuals. Solidarity is worthy of respect when it is voluntary; it is not worthy of respect when it is compulsory. In the latter case, moreover, it is all the less not a moral value since in reality, it is most often used as a means for politicians to serve their own personal interests: They obtain votes in elections by distributing the resources they have taken by force from certain taxpayers. And this is all the more questionable since

By giving to itself a virtual monopoly in the exercise of solidarity, the State destroys natural solidarity. It destroys the incentives to work, save, innovate, and undertake in order to create resources (since it takes a large part of the fruits of all efforts), which undermines the prosperity of all and harms the poorest in particular. At the same time, however, it destroys the propensity of individuals to act gener-

This shows how wrong it is to claim that liberalism is attached to material values, that it defends the rich against the poor, the powerful against the oppressed. It is, on the contrary, state interventionism which, by depriving individuals of the full exercise of their freedom, provokes a war of all against all. As the famous French economist [6] put it so well at the beginning of the nineteenth century, "The State is the great fiction through which everyone tries to live at the expense of everyone else." It should therefore come as no surprise if, in a country like France, one has the feeling that most citizens are embittered, demanding, and frustrated: their fate now depends only marginally on their own efforts and sense of responsibility, it depends on what the State will take from them and give to them in this war of all against all. What a contrast with what would be a perfectly liberal society based on the freedom of each individual and therefore on individual responsibility! Such a society, totally respectful of the rights of each person, would be peaceful and prosperous. It would allow everyone to live according to his own moral principles, his own goals, and his own decisions. Could we not then trust human beings to build, through their interactions, the peaceful society that each of us deeply desires within our society? And should we not be surprised that citizens hand over so many decisions concerning their lives to men and women who are not chosen for their sense of ethics or, for that matter, for their skills, but more often than not for the promises they make and who are financed by the catching of resources which they did not create and which therefore do not belong to them? It should not be surprising, moreover, that in this immoral world built by statesmen, we find all sorts of corruption scandals and illicit enrichment throughout the world.  They do not hesitate to disguise reality and present liberalism as something it is not. In this terribly politicized world in which we find ourselves unfortunately, the confusion of ideas reaches an incredible level. One comes to reproach so-called liberal policies (which are not liberal) for the failures due to state interventionism. As Marine Le Pen – the head of a nationalist extreme-right political party in France – has said, one even comes to claim that liberalism is totalitarianism, even though it is and always has

#### *Liberalism, the Only True Humanism DOI: http://dx.doi.org/10.5772/intechopen.93235*

*Emerging Markets*

discover by chance a correct explanation of what liberalism is are amazed by its

Liberalism consists into developing ideas based on individual behavior and individual aims to analyze or to promote the working of a society. And this is why liberalism must be considered as a true humanism, since humanism means a way of thinking or acting coherently with what human beings are. And humanism can be considered as the foundation of ethics since ethical actions and thoughts imply to be

Indeed, liberalism is both a method of analysis and an ethic. It is a method of analysis because it consists in thinking – and this should be obvious – that we can only understand the functioning of a society by having a realistic vision of what a human being is, of his deep nature, of his behavior. A society is not a kind of great machine, but a collection of men and women who have – each of them – their own individuality, but who interact one with the other and are therefore, from this point of view, necessarily in solidarity with each other. Just to give an illustration of the problem, economists quite often develop analyses of what is called "macroeconomics." But they possibly define discretionary concepts – such as "national income" – which may not have any link with individual behaviors. Thus they may deduct economic proposals which are not respectful of individual behaviors and aims so that they may not be efficient and, above all, they may not be coherent with ethics. To avoid such errors, many intellectuals are in favor of what is called praxeology, that is, the science of human action. Such is the case, in particular, of Ludwig von Mises in his book, *Human action*, [2] and more generally of the so-called Austrian economic theory (initially developed by Ludwig von Mises and Friedrich Hayek [3, 4]). They rightly consider that it is necessary to begin any social analysis by using realistic assumptions about the behavior of individuals. As regards liberal ethics [5] it implies that there is a universal duty to be respect-

ful of everyone's legitimate rights. Of course, each of us also has his or her own personal moral principles regarding how to behave with others. These personal morals are highly respectable, provided, however, that they are not incompatible

It may be said that liberal values are Christian values or at least are fully compatible with them. It is Christianity which has enabled the emergence of individual freedom in the Western world and which has, moreover, enabled economic takeoff and enabled countless masses to escape from poverty. With Christianity, as with liberalism, a human being is not just a cog in the great social machine, but a

Liberalism and Christianity share a common basis in terms of universal values. But, of course, within this general framework each can develop its own moral concepts. Thus, Christianity considers altruism as a virtue. But this is not incompatible with liberalism. Indeed, a liberal must be intransigent with the universal duty to respect the rights of others, but he does not claim to suggest a particular conduct to human beings, for example, to suggest – or, even less, to impose – altruistic or selfish behavior toward this or that person or category of persons. He considers that this is a matter of personal responsibility and that it is his duty to respect such personal ethics as long as it does not contradict the universal duty to be respectful of the rights of others. That is why it is absurd to say that liberalism supports selfishness. Based on an absolute respect for individuals, liberalism refrains from making judgments about the conduct and opinions of individuals unless they infringe the legitimate rights of

with the universal ethic of respect for the legitimate rights of others.

person who deserves respect as such.

**2. Liberalism, ethics, individual rights and redistribution policy**

intellectual coherence and the solidity of its ethical foundation.

respectful of the very nature of human beings.

**4**

others. Thus, it will consider a person's generous behavior to be perfectly respectable. But it will challenge the State's claim to redistribute resources through the use of coercion, which in itself constitutes an infringement of the freedom and rights of individuals. Solidarity is worthy of respect when it is voluntary; it is not worthy of respect when it is compulsory. In the latter case, moreover, it is all the less not a moral value since in reality, it is most often used as a means for politicians to serve their own personal interests: They obtain votes in elections by distributing the resources they have taken by force from certain taxpayers. And this is all the more questionable since many people bear the burden of taxes without knowing it.

By giving to itself a virtual monopoly in the exercise of solidarity, the State destroys natural solidarity. It destroys the incentives to work, save, innovate, and undertake in order to create resources (since it takes a large part of the fruits of all efforts), which undermines the prosperity of all and harms the poorest in particular. At the same time, however, it destroys the propensity of individuals to act generously, as they are led to see this role as being played by the State.

This shows how wrong it is to claim that liberalism is attached to material values, that it defends the rich against the poor, the powerful against the oppressed. It is, on the contrary, state interventionism which, by depriving individuals of the full exercise of their freedom, provokes a war of all against all. As the famous French economist [6] put it so well at the beginning of the nineteenth century, "The State is the great fiction through which everyone tries to live at the expense of everyone else." It should therefore come as no surprise if, in a country like France, one has the feeling that most citizens are embittered, demanding, and frustrated: their fate now depends only marginally on their own efforts and sense of responsibility, it depends on what the State will take from them and give to them in this war of all against all.

What a contrast with what would be a perfectly liberal society based on the freedom of each individual and therefore on individual responsibility! Such a society, totally respectful of the rights of each person, would be peaceful and prosperous. It would allow everyone to live according to his own moral principles, his own goals, and his own decisions. Could we not then trust human beings to build, through their interactions, the peaceful society that each of us deeply desires within our society? And should we not be surprised that citizens hand over so many decisions concerning their lives to men and women who are not chosen for their sense of ethics or, for that matter, for their skills, but more often than not for the promises they make and who are financed by the catching of resources which they did not create and which therefore do not belong to them? It should not be surprising, moreover, that in this immoral world built by statesmen, we find all sorts of corruption scandals and illicit enrichment throughout the world.  They do not hesitate to disguise reality and present liberalism as something it is not. In this terribly politicized world in which we find ourselves unfortunately, the confusion of ideas reaches an incredible level. One comes to reproach so-called liberal policies (which are not liberal) for the failures due to state interventionism. As Marine Le Pen – the head of a nationalist extreme-right political party in France – has said, one even comes to claim that liberalism is totalitarianism, even though it is and always has been the only real enemy of totalitarianism!

Should not the trust we place in human beings and in their extraordinary capacities lead us to hope that all these confusions, lies, and the resulting disasters will be dispelled and that, as free beings, they will be able to live in a harmonious and peaceful society?

However many people believe that there are so-called inequalities between the members of a society (for instance the members of a country) and that it is the important role of a State to decide a redistribution policy. It is understandable that some people find it difficult to accept large differences in incomes and living conditions, and the fight against inequality therefore seems sympathetic. But beyond feelings, what is called "inequalities" must be rigorously analyzed. In a country, there is not one big central distributor who would have created all the wealth and who could distribute it in an egalitarian way. There is a multitude of individuals who create their wealth thanks to their efforts of work, savings, entrepreneurial risktaking, etc. What characterizes a human society is not inequality, but diversity. All human beings are different and the wealth they create is unequal because they differ in age, talents, abilities to make efforts, life choices, etc. However, all members of a society are "united," for example, because we cannot have prosperous employees if we discourage their employers by overloading them with exorbitant taxes.

At some point in time the situations of all individuals are obviously diverse ("unequal"). But these relative situations change and it is important to give everyone a chance. It is interesting to note, for example, that according to many studies in the United States a significant proportion of those who have high incomes at one point in time have much lower incomes a few years later. On the contrary, there is a significant progress for those with low incomes.

The feeling of solidarity exists in the hearts of human beings and there have always been private initiatives to take care of the weakest people. This voluntary solidarity has a moral basis: those who practice it sacrifice resources they have created to help others. This has nothing to do with the so-called compulsory "solidarity" practiced by representatives of the State and public organizations, which is done with the money of individuals (even if some have a sincere desire to help others). And one can always suspect that they are pursuing personal goals: getting votes in elections. This is why, for example, in most countries, an income tax has progressive rates: politicians do not lose much electoral support by taxing a small number of high-income people heavily in the name of fighting inequality. But in fact they are hurting everyone. Indeed, in a free society, those with high incomes are the ones who create the most wealth through their talent, their productive efforts, and their ability to take risks. They create jobs, and they introduce technical progress which increases everyone's purchasing power. But if they are too much taxed, they are discouraged from making efforts or they go into exile, depriving their country of opportunities for growth, which is detrimental to everyone. And it would be better if, by reducing this policy of fighting inequality, one could finally see a strong growth, a rapid increase in wages and full employment. The important thing is that everyone should be able to become richer, especially the poorest people, whatever is the evolution of "inequalities."

Many people – and specially politicians – claim to be in favor of "social justice." But it is important to analyze what is meant by "social justice" and the remarks made above can help to develop such an analysis. There are two very different definitions of "social justice." The first one is concerned by what could be called "universal ethics," namely being respectful of individual rights. On the other hand, the specific and personal ethics of each individual is inspiring the second definition of "social justice": it consists in comparing the actual situation of individuals and to decide subjectively that some specific differences are fair or not. This second definition is the most widely accepted one and usually, when speaking of "social justice" people care mainly about the monetary incomes of individuals. According to a personal judgment – more or less shared by a great number of people – one considers that the differences between individual incomes must be more or less diminished. Now, some more characteristics of both definitions must be clarified in order to have a rigorous analysis of this problem.

Let us first consider the first definition of social justice. We just mentioned that it means that individual rights are respected by everyone. But it is not sufficient to

**7**

misleading.

*Liberalism, the Only True Humanism*

legitimate.

*DOI: http://dx.doi.org/10.5772/intechopen.93235*

which have been created by partners in exchange).

reduction of inequality as being a morally justified policy.

person and therefore universal morality.

care about respecting rights, since individual rights have to be ethically founded for a situation respectful of rights to be ethically justified. In fact, let us assume that there is a society in which most properties have been got by stealing them; it is obvious that, in such a case, there is no justification for respecting property rights! This means that it is important to determine in which cases property rights are

The basic principle of ethics consists in claiming that individuals are free, which means that they are not subject to the constraint of other people, that is, they are the owners of themselves. But one is not his own owner if ever he is not the owner of the goods and services he is creating by using his mind and his physical activities. Therefore, it must be considered that legitimate property rights are those which are obtained by acts of creation (and obviously, by exchanging goods and services

Thus, the first definition of social justice can potentially be accepted by everyone all over the world (at least if people agree about the legitimacy of property rights). But, as regards the second definition of social justice – namely a comparison of the standard of life of individuals in a society – each individual has a different definition of what he considers as socially fair. There is therefore a very important problem, namely the coherence between these different opinions. As, very likely, all individuals have different opinions about "solidarity" there cannot be an "universal" criterion of what should be considered as "social justice," that is, the fair distribution of resources. It is then assumed that social justice in the distribution of incomes can be defined by a majority of votes in a democratic system. Nowadays, when speaking of social justice one implicitly means redistributive activities (social policy), which refers to the second meaning of social justice. It is implicitly assumed that social justice implies a reduction of inequalities. In the term "equality" or "inequality," there is an implicit value judgment. This is why one considers the

Libertarians are frequently critical of egalitarian policies so that it is often claimed that they promote selfishness, and that liberalism must be challenged for ethical reasons. But human beings are characterized by their diversity and this is why one should, on the one hand, talk about diversity rather than inequality and, on the other hand, be respectful of this diversity inherent to human nature. The term of inequality would be justified if the fate of all individuals – and in particular their standard of living – was determined by a central authority owning all resources and able to "distribute" them more or less "equally." But it is not the case – fortunately – in a free society and that is why the expression "income redistribution" is totally

However, contrary to what is often claimed, liberalism is not supporting the freedom of anyone to do anything, but the freedom to act while respecting the legitimate rights of others. This freedom to act implies the freedom to implement one's own personal ethics, but only if it is legitimate and if it is respectful of universal ethics. It is the case if someone who holds legitimate property rights on certain resources uses a portion of these resources to help another person; his acts are then in accordance with his personal morality without being damaging to universal morality. This behavior is totally moral and respectable. But someone who steals goods to a person to give his loot to another person – because his personal morality induces him to help the latter – violates the property rights of the first

Now, it is exactly the same with "inequalities policies": Statesmen (politicians and bureaucrats) levy, thanks to coercion, resources from some people (known as citizens) to give them to others. In doing so, they undermine universal morality and therefore we must accept the idea that a policy aiming at the reduction of "inequalities" is

#### *Liberalism, the Only True Humanism DOI: http://dx.doi.org/10.5772/intechopen.93235*

*Emerging Markets*

some people find it difficult to accept large differences in incomes and living conditions, and the fight against inequality therefore seems sympathetic. But beyond feelings, what is called "inequalities" must be rigorously analyzed. In a country, there is not one big central distributor who would have created all the wealth and who could distribute it in an egalitarian way. There is a multitude of individuals who create their wealth thanks to their efforts of work, savings, entrepreneurial risktaking, etc. What characterizes a human society is not inequality, but diversity. All human beings are different and the wealth they create is unequal because they differ in age, talents, abilities to make efforts, life choices, etc. However, all members of a society are "united," for example, because we cannot have prosperous employees if

we discourage their employers by overloading them with exorbitant taxes.

significant progress for those with low incomes.

people, whatever is the evolution of "inequalities."

order to have a rigorous analysis of this problem.

At some point in time the situations of all individuals are obviously diverse ("unequal"). But these relative situations change and it is important to give everyone a chance. It is interesting to note, for example, that according to many studies in the United States a significant proportion of those who have high incomes at one point in time have much lower incomes a few years later. On the contrary, there is a

The feeling of solidarity exists in the hearts of human beings and there have always been private initiatives to take care of the weakest people. This voluntary solidarity has a moral basis: those who practice it sacrifice resources they have created to help others. This has nothing to do with the so-called compulsory "solidarity" practiced by representatives of the State and public organizations, which is done with the money of individuals (even if some have a sincere desire to help others). And one can always suspect that they are pursuing personal goals: getting votes in elections. This is why, for example, in most countries, an income tax has progressive rates: politicians do not lose much electoral support by taxing a small number of high-income people heavily in the name of fighting inequality. But in fact they are hurting everyone. Indeed, in a free society, those with high incomes are the ones who create the most wealth through their talent, their productive efforts, and their ability to take risks. They create jobs, and they introduce technical progress which increases everyone's purchasing power. But if they are too much taxed, they are discouraged from making efforts or they go into exile, depriving their country of opportunities for growth, which is detrimental to everyone. And it would be better if, by reducing this policy of fighting inequality, one could finally see a strong growth, a rapid increase in wages and full employment. The important thing is that everyone should be able to become richer, especially the poorest

Many people – and specially politicians – claim to be in favor of "social justice." But it is important to analyze what is meant by "social justice" and the remarks made above can help to develop such an analysis. There are two very different definitions of "social justice." The first one is concerned by what could be called "universal ethics," namely being respectful of individual rights. On the other hand, the specific and personal ethics of each individual is inspiring the second definition of "social justice": it consists in comparing the actual situation of individuals and to decide subjectively that some specific differences are fair or not. This second definition is the most widely accepted one and usually, when speaking of "social justice" people care mainly about the monetary incomes of individuals. According to a personal judgment – more or less shared by a great number of people – one considers that the differences between individual incomes must be more or less diminished. Now, some more characteristics of both definitions must be clarified in

Let us first consider the first definition of social justice. We just mentioned that it means that individual rights are respected by everyone. But it is not sufficient to

**6**

care about respecting rights, since individual rights have to be ethically founded for a situation respectful of rights to be ethically justified. In fact, let us assume that there is a society in which most properties have been got by stealing them; it is obvious that, in such a case, there is no justification for respecting property rights! This means that it is important to determine in which cases property rights are legitimate.

The basic principle of ethics consists in claiming that individuals are free, which means that they are not subject to the constraint of other people, that is, they are the owners of themselves. But one is not his own owner if ever he is not the owner of the goods and services he is creating by using his mind and his physical activities. Therefore, it must be considered that legitimate property rights are those which are obtained by acts of creation (and obviously, by exchanging goods and services which have been created by partners in exchange).

Thus, the first definition of social justice can potentially be accepted by everyone all over the world (at least if people agree about the legitimacy of property rights). But, as regards the second definition of social justice – namely a comparison of the standard of life of individuals in a society – each individual has a different definition of what he considers as socially fair. There is therefore a very important problem, namely the coherence between these different opinions. As, very likely, all individuals have different opinions about "solidarity" there cannot be an "universal" criterion of what should be considered as "social justice," that is, the fair distribution of resources. It is then assumed that social justice in the distribution of incomes can be defined by a majority of votes in a democratic system. Nowadays, when speaking of social justice one implicitly means redistributive activities (social policy), which refers to the second meaning of social justice. It is implicitly assumed that social justice implies a reduction of inequalities. In the term "equality" or "inequality," there is an implicit value judgment. This is why one considers the reduction of inequality as being a morally justified policy.

Libertarians are frequently critical of egalitarian policies so that it is often claimed that they promote selfishness, and that liberalism must be challenged for ethical reasons. But human beings are characterized by their diversity and this is why one should, on the one hand, talk about diversity rather than inequality and, on the other hand, be respectful of this diversity inherent to human nature. The term of inequality would be justified if the fate of all individuals – and in particular their standard of living – was determined by a central authority owning all resources and able to "distribute" them more or less "equally." But it is not the case – fortunately – in a free society and that is why the expression "income redistribution" is totally misleading.

However, contrary to what is often claimed, liberalism is not supporting the freedom of anyone to do anything, but the freedom to act while respecting the legitimate rights of others. This freedom to act implies the freedom to implement one's own personal ethics, but only if it is legitimate and if it is respectful of universal ethics. It is the case if someone who holds legitimate property rights on certain resources uses a portion of these resources to help another person; his acts are then in accordance with his personal morality without being damaging to universal morality. This behavior is totally moral and respectable. But someone who steals goods to a person to give his loot to another person – because his personal morality induces him to help the latter – violates the property rights of the first person and therefore universal morality.

Now, it is exactly the same with "inequalities policies": Statesmen (politicians and bureaucrats) levy, thanks to coercion, resources from some people (known as citizens) to give them to others. In doing so, they undermine universal morality and therefore we must accept the idea that a policy aiming at the reduction of "inequalities" is

immoral in principle. Although statesmen are using their monopoly of legal constraint so that this coercion is legal, it is however immoral since it is an attack on legitimate property rights (and this is why one must consider as a moral duty to cut taxes as much as possible). It may be that, in doing thus, some statesmen try to implement their own personal morality, but anyhow they infringe universal morality. On the other hand, it is well known that, so doing, they often pursue personal goals. Thus, to be elected or re-elected, they transfer resources to a large number of voters at the expense of a minority. As we already said, it is for this reason that the progressive tax – immoral and unequal by nature – does exist. And the fact that politicians are elected by a majority of voters do not give them legitimacy since one can always find a majority to violate the legitimate rights of a minority as far as the exercise of legal constraint is possible.

Furthermore, equality is defined arbitrarily from a single criterion, namely income at some point of time. However the objectives of individuals are varied (they do not concern only monetary income), their age is different and therefore their experience and their capital (which are the sources of their incomes). Let us imagine that all individuals be identical, there would, however, be an inequality in incomes according to the age of each person.

Of course, some are victims of physical or mental disabilities and human history shows that charity has always existed in such cases. This charity, decided personally by each individual, is extremely respectable, unlike so-called public charity (which, moreover, is vitiated by prospects concerning elections and which therefore leads to new inequalities between those who thus come to power – claiming to take in charge poverty – and those who must undergo public choices).

Frédéric Bastiat has been a member of the French Parliament and he sat on the benches of the left. Left members of the Parliament applauded him when he advocated economic freedom to improve the life standard of the poorest people. Is that inconceivable in the present period? Improving the life standard of everyone, especially the most vulnerable, is possible and desirable. But we must take the means to do so. Liberalism is the best mean.

#### **Author details**

Pascal Salin Mont Pèlerin Society, University Paris-Dauphine, France

\*Address all correspondence to<EMAIL_ADDRESS>
© 2020 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/ by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

**9**

*Liberalism, the Only True Humanism*

[1] Salin P. Libéralisme. Paris: Odile

[2] Mises, L E von. Human Action: A Treatise on Economics by Ludwig Von Mises. New Haven: Yale University

[3] Hayek, F. Law, Legislation and Liberty - A New Statement of the Liberal Principles of Justice and Political Economy, 1973, 1976, 1976; (republished in 2012 by Routledge)

[4] Hayek, F. The Fatal Conceit: The Errors of Socialism. Independent Publishing Platform: The University of

[5] Rothbard, M N. The Ethics of Liberty. Odile Jacob: New York

[6] Bastiat, F. "The Law", "The State", and Other Political Writings, 1843-1850. Indianapolis: Liberty Fund Inc, 2012.

Chicago Press, 1988.

University Press, 2003.

**References**

Jacob, 2000.

Press, 1949.

*DOI: http://dx.doi.org/10.5772/intechopen.93235*

*Liberalism, the Only True Humanism DOI: http://dx.doi.org/10.5772/intechopen.93235*

#### **References**

*Emerging Markets*

immoral in principle. Although statesmen are using their monopoly of legal constraint so that this coercion is legal, it is however immoral since it is an attack on legitimate property rights (and this is why one must consider as a moral duty to cut taxes as much as possible). It may be that, in doing thus, some statesmen try to implement their own personal morality, but anyhow they infringe universal morality. On the other hand, it is well known that, so doing, they often pursue personal goals. Thus, to be elected or re-elected, they transfer resources to a large number of voters at the expense of a minority. As we already said, it is for this reason that the progressive tax – immoral and unequal by nature – does exist. And the fact that politicians are elected by a majority of voters do not give them legitimacy since one can always find a majority to violate the legitimate rights of a minority as far as the exercise of legal constraint is possible. Furthermore, equality is defined arbitrarily from a single criterion, namely income at some point of time. However the objectives of individuals are varied (they do not concern only monetary income), their age is different and therefore their experience and their capital (which are the sources of their incomes). Let us imagine that all individuals be identical, there would, however, be an inequality in

Of course, some are victims of physical or mental disabilities and human history shows that charity has always existed in such cases. This charity, decided personally by each individual, is extremely respectable, unlike so-called public charity (which, moreover, is vitiated by prospects concerning elections and which therefore leads to new inequalities between those who thus come to power – claiming to take in charge

Frédéric Bastiat has been a member of the French Parliament and he sat on the benches of the left. Left members of the Parliament applauded him when he advocated economic freedom to improve the life standard of the poorest people. Is that inconceivable in the present period? Improving the life standard of everyone, especially the most vulnerable, is possible and desirable. But we must take the

© 2020 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/ by/3.0), which permits unrestricted use, distribution, and reproduction in any medium,

**8**

**Author details**

Mont Pèlerin Society, University Paris-Dauphine, France

incomes according to the age of each person.

means to do so. Liberalism is the best mean.

poverty – and those who must undergo public choices).

\*Address all correspondence to<EMAIL_ADDRESS>
provided the original work is properly cited.

Pascal Salin

[1] Salin P. Libéralisme. Paris: Odile Jacob, 2000.

[2] Mises, L E von. Human Action: A Treatise on Economics by Ludwig Von Mises. New Haven: Yale University Press, 1949.

[3] Hayek, F. Law, Legislation and Liberty - A New Statement of the Liberal Principles of Justice and Political Economy, 1973, 1976, 1976; (republished in 2012 by Routledge)

[4] Hayek, F. The Fatal Conceit: The Errors of Socialism. Independent Publishing Platform: The University of Chicago Press, 1988.

[5] Rothbard, M N. The Ethics of Liberty. Odile Jacob: New York University Press, 2003.

[6] Bastiat, F. "The Law", "The State", and Other Political Writings, 1843-1850. Indianapolis: Liberty Fund Inc, 2012.

**Chapter 2**

**Abstract**

and Why?

business transactions.

transition economies

**1. Introduction**

**11**

*Sabina Silajdzic and Eldin Mehic*

Institutions, Culture and Foreign

Direct Investment in Transition

Economies: Does Culture Matter

The aim of this research is to analyse the importance of cultural and institutional determinants in attracting FDI to transition countries. We rely on gravity econometric framework and examine the impact of cultural and institutional factors on FDI using bilateral FDI flows between home (i.e. major trading partners) and eight transition economies in the period 2000–2018. We study this relationship in an integrated framework considering principal gravity forces, traditional FDI determinants, policy and institutional factors. We provide strong and robust evidence that cultural factors, depicted in Hofmann cultural indices, influence MNCs' locational decisions. Other things held constant, specific cultural features seem more important than formal institutions, which seems at odds with standard neoclassical propositions, and shed some new light on the way we understand international

**Keywords:** FDI, cultural factors, institutional factors, gravity model,

economies is the principal question investigated in this research.

Foreign Direct Investments (hereinafter: FDI) has been largely found to positively affect economic growth in transition economies. Increases in FDI have been associated with productivity and export growth of local companies via knowledge spillovers and complementary effects on domestic investment. The impact of FDI on economic growth seems, however, conditional on the level of human capital and absorptive capacity of a host economy. Determinants of FDI in transition economies have been intensely researched highlighting the importance of traditional factors, institutions and policy choices in determining locational decisions of multinational corporations (MNCs). Although informal institutions and cultural factors have increasingly been characterised as important factors that off-set for the underdeveloped institutional capacity of transition economies, the impact of cultural ties on FDI remains fairly under researched. Informal economic structures and cultural similarities emanate trust and enable strong business ties across borders. How important are these factors in explaining differences in FDI flows among transition

#### **Chapter 2**

## Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture Matter and Why?

*Sabina Silajdzic and Eldin Mehic*

### **Abstract**

The aim of this research is to analyse the importance of cultural and institutional determinants in attracting FDI to transition countries. We rely on gravity econometric framework and examine the impact of cultural and institutional factors on FDI using bilateral FDI flows between home (i.e. major trading partners) and eight transition economies in the period 2000–2018. We study this relationship in an integrated framework considering principal gravity forces, traditional FDI determinants, policy and institutional factors. We provide strong and robust evidence that cultural factors, depicted in Hofmann cultural indices, influence MNCs' locational decisions. Other things held constant, specific cultural features seem more important than formal institutions, which seems at odds with standard neoclassical propositions, and shed some new light on the way we understand international business transactions.

**Keywords:** FDI, cultural factors, institutional factors, gravity model, transition economies

#### **1. Introduction**

Foreign Direct Investments (hereinafter: FDI) has been largely found to positively affect economic growth in transition economies. Increases in FDI have been associated with productivity and export growth of local companies via knowledge spillovers and complementary effects on domestic investment. The impact of FDI on economic growth seems, however, conditional on the level of human capital and absorptive capacity of a host economy. Determinants of FDI in transition economies have been intensely researched highlighting the importance of traditional factors, institutions and policy choices in determining locational decisions of multinational corporations (MNCs). Although informal institutions and cultural factors have increasingly been characterised as important factors that off-set for the underdeveloped institutional capacity of transition economies, the impact of cultural ties on FDI remains fairly under researched. Informal economic structures and cultural similarities emanate trust and enable strong business ties across borders. How important are these factors in explaining differences in FDI flows among transition economies is the principal question investigated in this research.

Culture, in a broader sense, means a pattern of behaviour based on values and beliefs that develops over time in a particular society. While culture in a narrower sense represents the way of life of a social group, i.e. a society that includes language, tradition, knowledge, customs, laws, art and other tangible and intangible features of social life that are passed down through generations, cultural is of course subject to change. Culture includes a set of values and attitudes of a homogeneous group of people that are passed down from generation to generation, and these patterns of behaviour change rather slowly.

well as informal norms, set of beliefs, systems of values, customs considered also an important feature of the institutional environment of a given country. Different scholars perceive differently the relative importance of these various components, including the role played by formal and informal rules and conventions as well as the importance of and role played by organisations, encompassing both economic

*Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture…*

They are competing theoretical perceptions and different values attached to institutions and organisations in the contemporary literature [1–3]. Generally, institutions are perceived as frames or rules of the game while organisations are defined as social agents constituting and carrying these rules [2]. Importantly, the relationship between institutions and organisations is not a straight forward one. There is a general consensus among scholars that institutions principally evolve in response to market- related imperfections, and as such, institutions are considered a mechanism to enhance efficiency associated with economic transactions. However, whether institutions evolve primarily in response to changes in values, perception and attitudes embodied in organisations (i.e. various social agents) including theirs' perceived inefficiencies in functioning of the market, or whether institutional development can be viewed as principally exogenous process where norms dominantly govern actions of social agents is still a debated issue [1–3]. Relate to this is a question whether institutional development is constrained by organisations' preferences and capacities? Arguably the answer to these questions depends on how we perceive institutions and how do we value the relative importance of institutions *vis*

The theoretical conceptualisation of institutions has mostly favoured the stream of literature which views institutions as frames or rules of the game which both guide and constrain actions of social agents i.e. organisations of various sorts including political and economic agents that make up societies. This stream of literature suggests the dichotomy between institutions and organisations. Accordingly institutions reveal formal and informal rules and conventions which set the structures within which, and upon which societal agents act [1, 2]. More precisely, the dichotomy in the words of [2] implies a clear conceptual distinction between institutions and organisations as follows; institutions define 'the rules' of the game and organisations are 'the players' by whom the game is played. Similarly, [4] suggests that institutions provide the set of rules defining frames within which organisations act. This is where the importance of cultural dimensions become crucial in understanding the institutional performance and in particular the differences in economic performance among countries amid similar institutional devel-

In this respect, 'good' institutions are only necessary but not sufficient condition to promote successful change within a society and/or to achieve desired societal goals. This view implies that although institutions evolve in response to market failures encompassing various forms of imperfections related to economics transactions and exchange they evolve in particular socio-historical context, and in accordance with prevailing preferences, norms and ethics of organisations that embody, interpret and influence the institutional conditions i.e. the specific

(endogenous) rule setting [5]. These endogenous norms and values of a society have been embedded in what we call informal institutional structures of the economy. Put differently, formal institutions are embodied in culture, and culture matters for understanding the link between formal and informal institutional setting of individual countries [2, 6, 7]. The culture of a society determines informal behavioural patterns of economic agents, and by that the quality and the efficiency of formal institutions. This is to say that institutions, e.g. the relevance of formal rules, adherence to formal principles and legal provisions rests within organisation and

and social agents of various sorts.

*DOI: http://dx.doi.org/10.5772/intechopen.95326*

*a vis* organisations.

**13**

opment and/or quality of institutions.

The importance of cultural factors has been increasingly emphasised in the FDI literature. In particular, the impact of cultural distance between home and host countries has found to be significant in number of studies investigating the role of culture in explaining FDI flows. However, few studies concentrated on the transition economies of Central and Eastern Europe. These countries are viewed as specific in terms of both scope of economic and institutional transformation, and specific (common) legacies of socialism. We contribute to recent literature on FDI in transition economies, by analysing the significance of broad set of institutional and cultural indicators ought to influence MNC decisions on where to invest. A special reference is given to the discussion on the relationship between formal and informal institutions, assumed to be predominantly depicted in cultural dimensions of a specific country. In addition, the relevance of specific Hofstede cultural dimension to foreign firms is brought to the fore. Having said this, the hypothesis tested imply 'favourable cultural context' that is, specific cultural characteristics that are assumed to be preferred by foreign firms. We posit somewhat universal aspects of culture related to Hofstede cultural dimensions that constitute favourable cultural environment to foreign firms. Furthermore, we make use of the gravity model and the panel data framework to examine the importance of relative differences between home and host country characteristics in explaining bilateral FDI stock. The gravity-panel empirical framework allows us to draw important and detailed conclusions with respect to the relative importance of formal institutions vs. cultural aspects to foreign firms. Our dataset includes 10 source countries (i.e. major trading partners) and 8 home countries (transition economies of Central Eastern and South East Europe for which the cultural indicators were available).

This paper is structured as follows. Next we elaborate on basic theoretical propositions underpinning the mechanism of institutional and cultural influence on FDI, with special reference to empirical work on the matter. In discussion theoretical and empirical issues, we present the conceptual framework for the empirical strategy used in this analysis discussing number of important issues including interplay between culture institutions and FDI, definitions and measurement issues, and research hypothesis. The third section relates to the empirical analysis where detailed description of the model, data and variables and methodology employed is provided and followed by the interpretation of the empirical results. The conclusion follows.

#### **2. Institutions, culture and FDI: conceptual framework and literature review**

#### **2.1 Institutions: what they are and why they are important?**

Institutional environment often encompasses political systems, policy making and policy enforcing institutional structures which determine economic structures at the national and sub-national levels. It includes institutional setting that provides formal rules of the game and sets forth the incentives to economic/societal agents as

#### *Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture… DOI: http://dx.doi.org/10.5772/intechopen.95326*

well as informal norms, set of beliefs, systems of values, customs considered also an important feature of the institutional environment of a given country. Different scholars perceive differently the relative importance of these various components, including the role played by formal and informal rules and conventions as well as the importance of and role played by organisations, encompassing both economic and social agents of various sorts.

They are competing theoretical perceptions and different values attached to institutions and organisations in the contemporary literature [1–3]. Generally, institutions are perceived as frames or rules of the game while organisations are defined as social agents constituting and carrying these rules [2]. Importantly, the relationship between institutions and organisations is not a straight forward one. There is a general consensus among scholars that institutions principally evolve in response to market- related imperfections, and as such, institutions are considered a mechanism to enhance efficiency associated with economic transactions. However, whether institutions evolve primarily in response to changes in values, perception and attitudes embodied in organisations (i.e. various social agents) including theirs' perceived inefficiencies in functioning of the market, or whether institutional development can be viewed as principally exogenous process where norms dominantly govern actions of social agents is still a debated issue [1–3]. Relate to this is a question whether institutional development is constrained by organisations' preferences and capacities? Arguably the answer to these questions depends on how we perceive institutions and how do we value the relative importance of institutions *vis a vis* organisations.

The theoretical conceptualisation of institutions has mostly favoured the stream of literature which views institutions as frames or rules of the game which both guide and constrain actions of social agents i.e. organisations of various sorts including political and economic agents that make up societies. This stream of literature suggests the dichotomy between institutions and organisations. Accordingly institutions reveal formal and informal rules and conventions which set the structures within which, and upon which societal agents act [1, 2]. More precisely, the dichotomy in the words of [2] implies a clear conceptual distinction between institutions and organisations as follows; institutions define 'the rules' of the game and organisations are 'the players' by whom the game is played. Similarly, [4] suggests that institutions provide the set of rules defining frames within which organisations act. This is where the importance of cultural dimensions become crucial in understanding the institutional performance and in particular the differences in economic performance among countries amid similar institutional development and/or quality of institutions.

In this respect, 'good' institutions are only necessary but not sufficient condition to promote successful change within a society and/or to achieve desired societal goals. This view implies that although institutions evolve in response to market failures encompassing various forms of imperfections related to economics transactions and exchange they evolve in particular socio-historical context, and in accordance with prevailing preferences, norms and ethics of organisations that embody, interpret and influence the institutional conditions i.e. the specific (endogenous) rule setting [5]. These endogenous norms and values of a society have been embedded in what we call informal institutional structures of the economy. Put differently, formal institutions are embodied in culture, and culture matters for understanding the link between formal and informal institutional setting of individual countries [2, 6, 7]. The culture of a society determines informal behavioural patterns of economic agents, and by that the quality and the efficiency of formal institutions. This is to say that institutions, e.g. the relevance of formal rules, adherence to formal principles and legal provisions rests within organisation and

Culture, in a broader sense, means a pattern of behaviour based on values and beliefs that develops over time in a particular society. While culture in a narrower sense represents the way of life of a social group, i.e. a society that includes language, tradition, knowledge, customs, laws, art and other tangible and intangible features of social life that are passed down through generations, cultural is of course subject to change. Culture includes a set of values and attitudes of a homogeneous group of people that are passed down from generation to generation, and these

The importance of cultural factors has been increasingly emphasised in the FDI literature. In particular, the impact of cultural distance between home and host countries has found to be significant in number of studies investigating the role of culture in explaining FDI flows. However, few studies concentrated on the transition economies of Central and Eastern Europe. These countries are viewed as specific in terms of both scope of economic and institutional transformation, and specific (common) legacies of socialism. We contribute to recent literature on FDI in transition economies, by analysing the significance of broad set of institutional and cultural indicators ought to influence MNC decisions on where to invest. A special reference is given to the discussion on the relationship between formal and informal institutions, assumed to be predominantly depicted in cultural dimensions of a specific country. In addition, the relevance of specific Hofstede cultural dimension to foreign firms is brought to the fore. Having said this, the hypothesis tested imply 'favourable cultural context' that is, specific cultural characteristics that are assumed to be preferred by foreign firms. We posit somewhat universal aspects of culture related to Hofstede cultural dimensions that constitute favourable cultural environment to foreign firms. Furthermore, we make use of the gravity model and the panel data framework to examine the importance of relative differences between home and host country characteristics in explaining bilateral FDI stock. The gravity-panel empirical framework allows us to draw important and detailed conclusions with respect to the relative importance of formal institutions vs. cultural aspects to foreign firms. Our dataset includes 10 source countries (i.e. major trading partners) and 8 home countries (transition economies of Central Eastern and South East Europe for which the cultural indicators were available). This paper is structured as follows. Next we elaborate on basic theoretical propositions underpinning the mechanism of institutional and cultural influence on FDI, with special reference to empirical work on the matter. In discussion theoretical and empirical issues, we present the conceptual framework for the empirical strategy used in this analysis discussing number of important issues including interplay between culture institutions and FDI, definitions and measurement issues, and research hypothesis. The third section relates to the empirical analysis where detailed description of the model, data and variables and methodology employed is provided and followed by the interpretation of the empirical results. The conclusion

patterns of behaviour change rather slowly.

*Emerging Markets*

follows.

**12**

**and literature review**

**2. Institutions, culture and FDI: conceptual framework**

**2.1 Institutions: what they are and why they are important?**

Institutional environment often encompasses political systems, policy making and policy enforcing institutional structures which determine economic structures at the national and sub-national levels. It includes institutional setting that provides formal rules of the game and sets forth the incentives to economic/societal agents as agencies that is with people who implement those rules. This stream of literature, which identifies culture as important aspect of formal institutions, may help us disentangle the relationship between formal and informal institutions, and, in particular, may help us comprehend how societies with similar quality of formal institutions have divergent economic outcomes.

resource allocation. The conventional economic wisdom implied that former centrally planned economies needed to develop institutions which underpin free market transactions and well functioning of the markets as quickly as possible. The importance of institutional environment conducive to rapid market development has been put high on the transition reform agenda. The initial institutional development in transition economy context reflected the establishment of institutions fundamental to free-market economies including setting proper incentives through policies of macroeconomic-stability, price liberalisation, denationalisation and privatisation, as well as through institutions underpinning effective financial sector reform and private sector growth. The prevailing conceptualisation of institutions at the time envisaged that institutions are somewhat easily transferable, exogenously created whereby institutions are built following best practices elsewhere [13]. However, over the course of transition, growing empirical evidence on the matter of institutional change in transition suggested that the important historical, political and social factors have played a role. The empirical studies pointed to the interrelatedness and interdependence between institutions and diverse political, cultural and economic contexts of a given country [8]. Among others, the initial institutional conditions and institution-related legacies, as well as cultural dimensions largely influenced the pace and character of institutional development in

*Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture…*

Despite these efforts, we do have a limited understanding of the processes and lack meaningful explanation on the diverging pattern of institutional development among countries including TEs. Analysing relationship between formal and informal institutions may help disentangle differences in institutional performance among transition economies. Such analysis is fairly constrained by number of difficulties including conceptualisation of the relationship, as well as data limitations and number of measurement issues related to informal institutions of the economy. We believe that indicators of cultural dimensions may help comprehend at least some aspect of this complex relationship. In view of this, we argue, that it is important to study institutions in an integrated framework, and point to the

In this paper, an attempt is made to illuminate the importance of formal institu-

tions relative to the distinctive cultural features of a society in comprehending differences in FDI flows across transition economies. We use a narrow-definition of institutions and focus on institutions revealing principally formal rules specifically related to FDI such as the rule of law and corruption. Relying on previous empirical work, we emphasise the importance of corruption [15–18], regulatory and governance indicators [19–21], as well as legal indicators in our empirical analysis. We identify institutional variables to be included in the model based on these results, and include three institutional variables (Corruption, Good governance and Rule of Law and Efficiency). Since we investigate the impact of institutional factors on FDI in transition economies, we do not use Political stability variable amid low variation in the data, and relatively similar Political stability index across CEE transition economies. In the light of the forgoing discussion, however, we acknowledge that by the way we measure institutional dimension in this analysis we possibly do not account for complex informal social structures (including social ethics and norms, preferences and capabilities of organisations) which may well influence the outcomes of institutional environment in a given country. This is why we include cultural indicators (Hofstende Cultural Dimensions) in the analysis in order to account for important aspects of both institutional and cultural behaviour of individual (host) countries that may influence FDI flows in transition economies. While there is considerable number of studies analysing the impact of formal institutions on FDI, very little empirical research has been done on the importance

transition economies (see [11, 14]).

*DOI: http://dx.doi.org/10.5772/intechopen.95326*

relevance of cultural factors.

**15**

As pointed by [8], it is possible that societies with identical institutional setting perform differently assuming that societal agents are not 'passive' but influence and determine the outcomes of any particular institutional structure in relation to their competences and preferences as well as in relation to what is called informal institutions. The latter include rather endogenous institutional features or their evolution such as norms, social ethics, prevalence of (old) institutional legacies, initial institutional conditions, institutional and individual's values and competences. This would imply that it does not suffice to develop 'quality' institutions in the form of extensive and desirable legislative and institutional infrastructures, or 'optimal'set of rules, but also necessary organisational capabilities that affect policy impacts and subsequent institutional change. Institutional development should be perceived as a long-term process of societal change, a one that certainly involves the development of 'better' or 'improved' conventions but importantly the process that rests on the commitment and competences of prevailing human and organisations kinds involved in those processes.<sup>1</sup>

Here it is important to emphasise that theoretic perspective of institutions matters for: (i) our understanding of the evolutionary dynamics of institutional development and change; ii) the importance of informal institutional structures and their link with formal institutions; as well as iii) the way we measure institutions in our empirical analysis. As pointed by [8]: "*Whether institutions are viewed as endogenous to the relevant domain or exogenously set in the polity may have significant implications for the role of public policy*." This is to say that if institutions are exogenous than we could relatively easily transplant the best practices of other (more advanced) countries in the forms of formal rules and conventions and anticipate increases in efficiency and welfare. If the reverse is true, and if institutions evolve principally in relation to a country specific historical, political and cultural context assuming interdependence among institutions, constrained and influenced by informal norms and social ethics, competences and capabilities of human and organisation kind, then the intended outcomes and consequences of any institutional conditions would vary considerably in relation to these important but intrinsic features of a given country. These raise important considerations for researches analysing the role of institutions in economic performance as well as international business.

The comparison of transition institutional reform, particularly the evidence revealing contrasting experiences and institutional performance across countries, however, led to doubts and seriously questioned the conventional wisdom of straightforward transplantation of practices of developed market economies [9–11]. Contrary to what has been expected, the years of transition saw institutional building and reform as exceptionally challenging and complex. The initial years of transition witnessed the remarkable differences in institutional progress among transition economies (EBRD, 2001). Empirical evidence point to the highly intrinsic and endogenous nature of institutional development including the varying institutional performance among transition economies [9–12]. Transition economies were faced with the necessity to reform their economic and institutional structures on a large scale moving from centrally planned to free market economic system and

<sup>1</sup> Commitment implies willingness whereby individuals perceive the benefits associated with 'good' institutions.

#### *Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture… DOI: http://dx.doi.org/10.5772/intechopen.95326*

resource allocation. The conventional economic wisdom implied that former centrally planned economies needed to develop institutions which underpin free market transactions and well functioning of the markets as quickly as possible. The importance of institutional environment conducive to rapid market development has been put high on the transition reform agenda. The initial institutional development in transition economy context reflected the establishment of institutions fundamental to free-market economies including setting proper incentives through policies of macroeconomic-stability, price liberalisation, denationalisation and privatisation, as well as through institutions underpinning effective financial sector reform and private sector growth. The prevailing conceptualisation of institutions at the time envisaged that institutions are somewhat easily transferable, exogenously created whereby institutions are built following best practices elsewhere [13]. However, over the course of transition, growing empirical evidence on the matter of institutional change in transition suggested that the important historical, political and social factors have played a role. The empirical studies pointed to the interrelatedness and interdependence between institutions and diverse political, cultural and economic contexts of a given country [8]. Among others, the initial institutional conditions and institution-related legacies, as well as cultural dimensions largely influenced the pace and character of institutional development in transition economies (see [11, 14]).

Despite these efforts, we do have a limited understanding of the processes and lack meaningful explanation on the diverging pattern of institutional development among countries including TEs. Analysing relationship between formal and informal institutions may help disentangle differences in institutional performance among transition economies. Such analysis is fairly constrained by number of difficulties including conceptualisation of the relationship, as well as data limitations and number of measurement issues related to informal institutions of the economy. We believe that indicators of cultural dimensions may help comprehend at least some aspect of this complex relationship. In view of this, we argue, that it is important to study institutions in an integrated framework, and point to the relevance of cultural factors.

In this paper, an attempt is made to illuminate the importance of formal institutions relative to the distinctive cultural features of a society in comprehending differences in FDI flows across transition economies. We use a narrow-definition of institutions and focus on institutions revealing principally formal rules specifically related to FDI such as the rule of law and corruption. Relying on previous empirical work, we emphasise the importance of corruption [15–18], regulatory and governance indicators [19–21], as well as legal indicators in our empirical analysis. We identify institutional variables to be included in the model based on these results, and include three institutional variables (Corruption, Good governance and Rule of Law and Efficiency). Since we investigate the impact of institutional factors on FDI in transition economies, we do not use Political stability variable amid low variation in the data, and relatively similar Political stability index across CEE transition economies. In the light of the forgoing discussion, however, we acknowledge that by the way we measure institutional dimension in this analysis we possibly do not account for complex informal social structures (including social ethics and norms, preferences and capabilities of organisations) which may well influence the outcomes of institutional environment in a given country. This is why we include cultural indicators (Hofstende Cultural Dimensions) in the analysis in order to account for important aspects of both institutional and cultural behaviour of individual (host) countries that may influence FDI flows in transition economies.

While there is considerable number of studies analysing the impact of formal institutions on FDI, very little empirical research has been done on the importance

agencies that is with people who implement those rules. This stream of literature, which identifies culture as important aspect of formal institutions, may help us disentangle the relationship between formal and informal institutions, and, in particular, may help us comprehend how societies with similar quality of formal insti-

As pointed by [8], it is possible that societies with identical institutional setting perform differently assuming that societal agents are not 'passive' but influence and determine the outcomes of any particular institutional structure in relation to their competences and preferences as well as in relation to what is called informal institutions. The latter include rather endogenous institutional features or their evolution such as norms, social ethics, prevalence of (old) institutional legacies, initial institutional conditions, institutional and individual's values and competences. This would imply that it does not suffice to develop 'quality' institutions in the form of extensive and desirable legislative and institutional infrastructures, or 'optimal'set of rules, but also necessary organisational capabilities that affect policy impacts and subsequent institutional change. Institutional development should be perceived as a long-term process of societal change, a one that certainly involves the development of 'better' or 'improved' conventions but importantly the process that rests on the commitment and competences of prevailing human and organisations kinds

Here it is important to emphasise that theoretic perspective of institutions matters for: (i) our understanding of the evolutionary dynamics of institutional development and change; ii) the importance of informal institutional structures and their link with formal institutions; as well as iii) the way we measure institutions in our empirical analysis. As pointed by [8]: "*Whether institutions are viewed as endogenous to the relevant domain or exogenously set in the polity may have significant implications for the role of public policy*." This is to say that if institutions are exogenous than we could relatively easily transplant the best practices of other (more advanced) countries in the forms of formal rules and conventions and anticipate increases in efficiency and welfare. If the reverse is true, and if institutions evolve principally in relation to a country specific historical, political and cultural context assuming interdependence among institutions, constrained and influenced by informal norms and social ethics, competences and capabilities of human and organisation kind, then the intended outcomes and consequences of any institutional conditions would vary considerably in relation to these important but intrinsic features of a given country. These raise important considerations for researches analysing the role of

institutions in economic performance as well as international business.

The comparison of transition institutional reform, particularly the evidence revealing contrasting experiences and institutional performance across countries, however, led to doubts and seriously questioned the conventional wisdom of straightforward transplantation of practices of developed market economies [9–11]. Contrary to what has been expected, the years of transition saw institutional building and reform as exceptionally challenging and complex. The initial years of transition witnessed the remarkable differences in institutional progress among

transition economies (EBRD, 2001). Empirical evidence point to the highly intrinsic and endogenous nature of institutional development including the varying institutional performance among transition economies [9–12]. Transition economies were faced with the necessity to reform their economic and institutional structures on a large scale moving from centrally planned to free market economic system and

<sup>1</sup> Commitment implies willingness whereby individuals perceive the benefits associated with 'good'

tutions have divergent economic outcomes.

*Emerging Markets*

involved in those processes.<sup>1</sup>

institutions.

**14**

of culture, and cultural factors in determining FDI. Furthermore, we study the impact of institutional and cultural factors on FDI in an integrated framework, where we assess the relative importance of formal institutions vs. cultural factors.

Therefore, relying solely on formal institutions, and formal institutional indicators of one country, including various legal indicators that are of specific interest to FDI, when analysing the importance of formal institutions, may be associated with ambiguities and uncertain 'policy' implications. This is not to say that formal institutions are of less importance, but it is at least important to acknowledge that 'good' institutions are embodied in culture.  This means that overtime, cultural changes influence acceptance of formal institutions as values of a society in general, and society at large adheres to these formal 'rules of the game'. Along the lines of these theoretical propositions, [6] investigates both direct and indirect effect of culture on FDI, and finds that culture impact FDI indirectly through its impact on formal institutions, as well as directly. The indirect impact of culture on FDI is mediated via formal institutions, which confines the hypothesis that culture 'shape formal institutions'. Essentially, the impact of cultural factors is found to be more important than the impact of formal institutions. Similarly, a recent study by [27] finds significant and greater effect of cultural factors

*Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture…*

(embeddedness vs. autonomy; hierarchy vs. egalitarianism, mastery vs. harmony) than formal institutions in cross-country regressions. Both studies render support to

Culture seems to reveal hidden behavioural patterns that underpin societal prosperity, including society relation to and the perception of responsibility, ethics and trust. The idea that these norms affect companies' efficiency and growth prospects cannot be dismissed. On the contrary, these factors should be perceived as important determinants of FDI that not only minimise transaction costs, but also enhance productivity potential of foreign affiliates, and/or simply create an environment conducive to business growth. Such an environment is perceived as friendly and or familiar market from MNC perspective. What kind of information MNC search for when deciding about new investment site is important? Do managers look at formal institutional indices, or have other sources of knowledge and information that reveal 'true' that is prevailing aspects of social relations, ethics and norms? Studying the impact of formal institutions on FDI, in an integrated framework in which we control for cultural factors, along with traditional FDI determi-

In what follows we discuss in greater detail the relevance of culture in international business and briefly review past empirical research on the role of culture in

According to the literature cultural dimension can influence foreign direct investments in two ways. First theoretical proposition suggest that more culturally diverse societies tend to be perceived as favourable cultural environment by MNC, while the second theoretical proposition implies that foreign investors prefer to invest in cultures similar to their own. These two distinct theoretical perspectives imply first that more culturally diverse societies positively impact foreign direct investments, and second that lower cultural distance between home and host countries positively affects FDI. As for the former, culturally diverse countries reflect on more open and welcoming societies that are viewed positively by foreign companies. As for the latter cultural difference between home and host countries is often associated with high transaction cost arising from uncertainty

the theoretical propositions underlying the importance of cultural factors in comprehending role played by formal institutions, as well as that distinctive

features of national cultures influence FDI flows.

*DOI: http://dx.doi.org/10.5772/intechopen.95326*

nants, becomes of crucial importance.

**2.3 What role for culture in attracting FDI**

attracting FDI.

and lower FDI.

**17**

#### **2.2 Culture and its relevance for understanding institutions-FDI nexus**

Informal institutions are often considered important determinant of FDI since they could compensate for the deficiencies associated with underperforming or poor quality formal institutions. Despite this, they are often overlooked in the FDI literature whereby the emphasis is given to the quality of formal institutions per se. The rationale behind is that while formal institutions ensure efficiency of foreign operations in a new environment, informal institutions mostly favour local economic agents. Local agents are assumed to have better access to political and local facilities and processes. Given this, reliance on informal institutions in ensuring efficient economic transactions is least favoured by MNCs. A study by [22, 23] have shown that institutional development in transition economies has had an impact on foreign investors'strategic decisions, arguably their entry modes, whereby quality of formal institutions seems of greater importance for establishing wholly owned ventures. The study by [22] reveals evidence that quality of institutions does seem to impact type of ownership related to FDI, where poor institutional development is more likely to result in network- types of FDI (i.e. joint-ventures, contracts). This is why the FDI literature mostly emphasise the relevance of formal institutions as locational advantage as reliance on informal institutions tend to increase transaction costs of foreign investors relative to domestic agents. The cultural features seem to have been disregarded as important factors which influence the way in which markets develop and evolve.

Notwithstanding this, in this paper we argue that cultural dimension is important determinant of FDI, in the sense that culture 'shape' formal institutions (see for instance [24]). Cultural dimensions of a society depict ways in which 'nations' tend to understand the rules and norms of social behaviour. The role played by formal institution(s) within a society and their relative importance *vis a vis* informal social structures (e.g. social networks, linkages) is deeply rooted cultural phenomena. The perception of formal institutions that prevails among general public, on this particular matter, is important to be understood, when examining the relationship between formal institutions and FDI. Having said this, culture may reflect on 'tacit' aspects of general-purpose or more specific 'market-enhancing' institutions within countries. The diverse and distinct concepts of social behaviour, present important features of a society that not only influence and model the behaviour of local economic agents, but affect the quality and the efficiency of formal institutions. Reliance on informal institutions as opposed on formal institutions may well be associated with weak and malfunctioning formal institutional structures. On this ground it seems reasonable to posit that informal institutions reflected in cultural dimensions are also likely to influence MNC's decisions on where to invest.

Overall, we strongly believe that the essential question on the matter of cultureinstitutions-FDI nexus, is to what extent 'formal institutions' and the why we measure them, reflect society's adherence to formal rules, as opposed to society's 'modus operandi' e.g. collective actions, practices, behaviours that may contradict formal codes of conduct? Here it is worthwhile mentioning the theory of 'institutional stickiness' which firmly explains the relationship between culture and institutions [25]. The authors posit that formal institutions are stuck to what they call *'metis',* which may be defined as 'values' that are largely 'exogenous' to people and that shape our social relations and constitute important unwritten behavioural patterns.

#### *Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture… DOI: http://dx.doi.org/10.5772/intechopen.95326*

Therefore, relying solely on formal institutions, and formal institutional indicators of one country, including various legal indicators that are of specific interest to FDI, when analysing the importance of formal institutions, may be associated with ambiguities and uncertain 'policy' implications. This is not to say that formal institutions are of less importance, but it is at least important to acknowledge that 'good' institutions are embodied in culture.  This means that overtime, cultural changes influence acceptance of formal institutions as values of a society in general, and society at large adheres to these formal 'rules of the game'. Along the lines of these theoretical propositions, [6] investigates both direct and indirect effect of culture on FDI, and finds that culture impact FDI indirectly through its impact on formal institutions, as well as directly. The indirect impact of culture on FDI is mediated via formal institutions, which confines the hypothesis that culture 'shape formal institutions'. Essentially, the impact of cultural factors is found to be more important than the impact of formal institutions. Similarly, a recent study by [27] finds significant and greater effect of cultural factors (embeddedness vs. autonomy; hierarchy vs. egalitarianism, mastery vs. harmony) than formal institutions in cross-country regressions. Both studies render support to the theoretical propositions underlying the importance of cultural factors in comprehending role played by formal institutions, as well as that distinctive features of national cultures influence FDI flows.

Culture seems to reveal hidden behavioural patterns that underpin societal prosperity, including society relation to and the perception of responsibility, ethics and trust. The idea that these norms affect companies' efficiency and growth prospects cannot be dismissed. On the contrary, these factors should be perceived as important determinants of FDI that not only minimise transaction costs, but also enhance productivity potential of foreign affiliates, and/or simply create an environment conducive to business growth. Such an environment is perceived as friendly and or familiar market from MNC perspective. What kind of information MNC search for when deciding about new investment site is important? Do managers look at formal institutional indices, or have other sources of knowledge and information that reveal 'true' that is prevailing aspects of social relations, ethics and norms? Studying the impact of formal institutions on FDI, in an integrated framework in which we control for cultural factors, along with traditional FDI determinants, becomes of crucial importance.

In what follows we discuss in greater detail the relevance of culture in international business and briefly review past empirical research on the role of culture in attracting FDI.

#### **2.3 What role for culture in attracting FDI**

According to the literature cultural dimension can influence foreign direct investments in two ways. First theoretical proposition suggest that more culturally diverse societies tend to be perceived as favourable cultural environment by MNC, while the second theoretical proposition implies that foreign investors prefer to invest in cultures similar to their own. These two distinct theoretical perspectives imply first that more culturally diverse societies positively impact foreign direct investments, and second that lower cultural distance between home and host countries positively affects FDI. As for the former, culturally diverse countries reflect on more open and welcoming societies that are viewed positively by foreign companies. As for the latter cultural difference between home and host countries is often associated with high transaction cost arising from uncertainty and lower FDI.

of culture, and cultural factors in determining FDI. Furthermore, we study the impact of institutional and cultural factors on FDI in an integrated framework, where we assess the relative importance of formal institutions vs. cultural factors.

**2.2 Culture and its relevance for understanding institutions-FDI nexus**

markets develop and evolve.

*Emerging Markets*

patterns.

**16**

Informal institutions are often considered important determinant of FDI since they could compensate for the deficiencies associated with underperforming or poor quality formal institutions. Despite this, they are often overlooked in the FDI literature whereby the emphasis is given to the quality of formal institutions per se. The rationale behind is that while formal institutions ensure efficiency of foreign operations in a new environment, informal institutions mostly favour local economic agents. Local agents are assumed to have better access to political and local facilities and processes. Given this, reliance on informal institutions in ensuring efficient economic transactions is least favoured by MNCs. A study by [22, 23] have shown that institutional development in transition economies has had an impact on foreign investors'strategic decisions, arguably their entry modes, whereby quality of formal institutions seems of greater importance for establishing wholly owned ventures. The study by [22] reveals evidence that quality of institutions does seem to impact type of ownership related to FDI, where poor institutional development is more likely to result in network- types of FDI (i.e. joint-ventures, contracts). This is why the FDI literature mostly emphasise the relevance of formal institutions as locational advantage as reliance on informal institutions tend to increase transaction costs of foreign investors relative to domestic agents. The cultural features seem to have been disregarded as important factors which influence the way in which

Notwithstanding this, in this paper we argue that cultural dimension is important determinant of FDI, in the sense that culture 'shape' formal institutions (see for instance [24]). Cultural dimensions of a society depict ways in which 'nations' tend to understand the rules and norms of social behaviour. The role played by formal institution(s) within a society and their relative importance *vis a vis* informal social structures (e.g. social networks, linkages) is deeply rooted cultural phenomena. The perception of formal institutions that prevails among general public, on this particular matter, is important to be understood, when examining the relationship between formal institutions and FDI. Having said this, culture may reflect on 'tacit' aspects of general-purpose or more specific 'market-enhancing' institutions within countries. The diverse and distinct concepts of social behaviour, present important features of a society that not only influence and model the behaviour of local economic agents, but affect the quality and the efficiency of formal institutions. Reliance on informal institutions as opposed on formal institutions may well be associated with weak and malfunctioning formal institutional structures. On this ground it seems reasonable to posit that informal institutions reflected in cultural dimensions are also likely to influence MNC's decisions on where to invest.

Overall, we strongly believe that the essential question on the matter of culture-

institutions-FDI nexus, is to what extent 'formal institutions' and the why we measure them, reflect society's adherence to formal rules, as opposed to society's 'modus operandi' e.g. collective actions, practices, behaviours that may contradict formal codes of conduct? Here it is worthwhile mentioning the theory of 'institutional stickiness' which firmly explains the relationship between culture and institutions [25]. The authors posit that formal institutions are stuck to what they call *'metis',* which may be defined as 'values' that are largely 'exogenous' to people and that shape our social relations and constitute important unwritten behavioural

#### *2.3.1 Cultural diversity and religion as cultural factors influencing FDI*

Alesina [28] argues that high level of ethnic, linguistic and religious diversity requires well functioning governments and as such is positively associated with FDI. Additionally, more culturally diverse society is more tolerable and less reluctant to foreigners, which is perceived positively by MNCs. A number of research investigate the impact of religious factors including religion diversity and pluralism [29, 30] religious similarity [31, 32] and religious groups [31, 33] on FDI and find that religion does influence FDI. Accordingly, religious pluralism is found to be positivelly associated with FDI and thus more important compared to religious similarity, while a study by [31] finds positive relationship between all monotheistic religious groups (Catholic, Protestant and Orthodox Christian) and FDI, but for Islam. According to the results of their study, significantly negative relationship is thus suggested between Buddhism and FDI. No doubt, the results of their study suggest that MNCs are not indifferent to culture, broadly represented by diverse religious groups, and that only certain religious groups are positively associated with FDI. However, the empirical evidence on the matter is scarce and far from uniform to draw any sensible conclusions.

fails to sensibly reflect on the important cultural dimensions that are of relevance when studying the link between culture and FDI. This is to say, that it is fairly improper (invalidate) to a priori assign that certain religious groups are indifferent to economic growth or adversely oriented toward foreigners, unless we truly conceptualise and measure links between prevailing religious beliefs and some 'relevant' economic categories or attitudes. Most studies investigating the link between religious groups and FDI fall short of addressing this issue. We first need to conceptualise on, and empirically establish the link between certain believes and attitudes including individual aspirations for growth, attitudes toward risk and competition, attitudes toward other groups/individuals and specific religious groups, as suggested by Guiso et al. study [33], before we examine the relationship

*Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture…*

*DOI: http://dx.doi.org/10.5772/intechopen.95326*

between supposedly distinct religious groups and FDI or economic growth. The empirical evidence on the matter is far from consistent and far from its mature phase. In light of this discussion, we argue that although religion constitute important cultural dimension of a society, it may well be inappropriate and misleading to include religious group(s) as dummy variables in regression equations to estimate the effect of culture on FDI. In contrast, considering religious diversity or similarity across nations may reflect on cultural distance that could be associated with costs of transition to new business or cultural environment. Most empirical studies have, in fact, followed this line of reasoning where, cultural similarity is considered important, *a priori* positive determinant of FDI, as we discuss below.

*2.3.2 The relevance of cultural proximity (distance) as determinant of FDI*

and Singh index on inward FDI in South Korea.

**19**

Kogut and Singh [35], posit that foreign investors prefer investing in countries culturally similar to their own. Sharing similar attitudes and values implies better knowledge of the local market, customers and business practices. Greater cultural differences between the host country and the source country lead to higher costs of doing business in another culture, such as the cost of obtaining information or the cost of searching to discover the specifics of the local bureaucracy [31]. This theoretical proposition has dominated the research on culture and FDI. Most empirical studies analyse the impact of cultural distance per se on FDI, and hypothesise that cultural similarity between home and host countries positively affects FDI flows. Accordingly, the principal question investigated by researcher refers to the effect of 'cultural distance' on FDI. Siegel and Licht [35] in their analysis using instrumental variables (social factionalization, dominant religion, 19th century war experience, previous communist rule) measure how cultural distance in terms of egalitarianism vs. hierarchy affects FDI flows. The analysis is based on a 2005 Schwartz study [36]. The results obtained explain that the egalitarian distance has a negative and statistically significant impact on FDI flows. Similarly, [35] conduct a comprehensive analysis on the impact of cultural distance on FDI. They rely on 'egalitarianism vs. hierarchy' dimension of culture developed by Schwarz [36] and argue that the greater the distance between culture of origin and destination country the greater the difficulty in interacting with stakeholders in the host country. The results of their study confirm the negative and significant impact of cultural distance on FDI. Moreover, [31] study suggest that foreign investors from developed countries are negatively affected by greater 'cultural distance' when investing in developing and transition economies. Lee, Shenkar, and Li [37] come to similar conclusions when it comes to the impact of cultural distance measured by Kogut

Number of empirical studies uses cultural proximity as determinant of FDI, relaying on common language, common history (e.g. colonial legacy, socialist past), and common border as cultural proxies. Most studies find significant and positive

In this paper we, however, argue that, while religious believes may influence attitudes toward free market, competition or foreign investors, it may be fairly misleading to associate specific attitudes and values to individual religious groups per se, based on our assumptions, generalisation and even pre-assumptions about religious constituencies of individual nations. This tendency to assign specific societal attributes to certain religious groups such as is the case of the La Porta et al. study [34], which prescribe and impose 'low institutional quality, institutional inefficiency, political and economic instability, high level of corruption and tax invasion etc.', to reside and prevail within the so called 'hierarchical religious'such as Catholicism, Orthodox Christianity and Islam is rather forged, deceptive and ambiguous.

Certainly, a genuine and reasonable approach to study religious aspects of cultural dimension and its relationship to FDI and/or economic growth need be based on attitudes toward certain economic concepts and principles, as well as on values assigned to those, including wealth and growth, competition-rivalry and struggle, market openness and foreign investors. In case, significant differences assigned to those concepts, could be associated with specific religious believes or related valuesystems, then we could sensibly argue of the prevailing religiously rooted 'cultural' differences. This is to say, that we need to investigate the link between religious beliefs and values assigned to aforementioned economic concepts. How differently are these concepts perceived and valued by different religious groups need be the principal question investigated, and not something a priori assumed and assigned to specific religious groups. In line with this reasoning, for instance, Guiso, Sapienza and Zingales [33] conclude that Catholics and Protestants are more positively associated with attitudes favouring market-efficiency and economic growth, while Muslims are found to be negatively associated with competition. Last but not lease, if we consider far-reaching cultural differencies existing within supposedly homogenous religious groups across different nations, such as is the case of Islamic countries (Malasya vs. Tukey vs. Saudi Arabia vs. Iran), or cultural differences across supposedly Catholic states such as is the case of Ireland vs. Poland vs. (South) Italy, we clearly face the measurement problem that may bias the results. This could partly explain why number of studies including [34] failed to find significant impact of religious groups per se on either economic growth or FDI. The notable exception is the aforementioned study by Lucke and Eichler [31].

Overall, in this paper we argue that analysis of cultural influence on FDI, that measure cultural diversity via dichotomous variables depicting religious group(s)

#### *Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture… DOI: http://dx.doi.org/10.5772/intechopen.95326*

fails to sensibly reflect on the important cultural dimensions that are of relevance when studying the link between culture and FDI. This is to say, that it is fairly improper (invalidate) to a priori assign that certain religious groups are indifferent to economic growth or adversely oriented toward foreigners, unless we truly conceptualise and measure links between prevailing religious beliefs and some 'relevant' economic categories or attitudes. Most studies investigating the link between religious groups and FDI fall short of addressing this issue. We first need to conceptualise on, and empirically establish the link between certain believes and attitudes including individual aspirations for growth, attitudes toward risk and competition, attitudes toward other groups/individuals and specific religious groups, as suggested by Guiso et al. study [33], before we examine the relationship between supposedly distinct religious groups and FDI or economic growth.

The empirical evidence on the matter is far from consistent and far from its mature phase. In light of this discussion, we argue that although religion constitute important cultural dimension of a society, it may well be inappropriate and misleading to include religious group(s) as dummy variables in regression equations to estimate the effect of culture on FDI. In contrast, considering religious diversity or similarity across nations may reflect on cultural distance that could be associated with costs of transition to new business or cultural environment. Most empirical studies have, in fact, followed this line of reasoning where, cultural similarity is considered important, *a priori* positive determinant of FDI, as we discuss below.

#### *2.3.2 The relevance of cultural proximity (distance) as determinant of FDI*

Kogut and Singh [35], posit that foreign investors prefer investing in countries culturally similar to their own. Sharing similar attitudes and values implies better knowledge of the local market, customers and business practices. Greater cultural differences between the host country and the source country lead to higher costs of doing business in another culture, such as the cost of obtaining information or the cost of searching to discover the specifics of the local bureaucracy [31]. This theoretical proposition has dominated the research on culture and FDI. Most empirical studies analyse the impact of cultural distance per se on FDI, and hypothesise that cultural similarity between home and host countries positively affects FDI flows.

Accordingly, the principal question investigated by researcher refers to the effect of 'cultural distance' on FDI. Siegel and Licht [35] in their analysis using instrumental variables (social factionalization, dominant religion, 19th century war experience, previous communist rule) measure how cultural distance in terms of egalitarianism vs. hierarchy affects FDI flows. The analysis is based on a 2005 Schwartz study [36]. The results obtained explain that the egalitarian distance has a negative and statistically significant impact on FDI flows. Similarly, [35] conduct a comprehensive analysis on the impact of cultural distance on FDI. They rely on 'egalitarianism vs. hierarchy' dimension of culture developed by Schwarz [36] and argue that the greater the distance between culture of origin and destination country the greater the difficulty in interacting with stakeholders in the host country. The results of their study confirm the negative and significant impact of cultural distance on FDI. Moreover, [31] study suggest that foreign investors from developed countries are negatively affected by greater 'cultural distance' when investing in developing and transition economies. Lee, Shenkar, and Li [37] come to similar conclusions when it comes to the impact of cultural distance measured by Kogut and Singh index on inward FDI in South Korea.

Number of empirical studies uses cultural proximity as determinant of FDI, relaying on common language, common history (e.g. colonial legacy, socialist past), and common border as cultural proxies. Most studies find significant and positive

*2.3.1 Cultural diversity and religion as cultural factors influencing FDI*

uniform to draw any sensible conclusions.

*Emerging Markets*

Alesina [28] argues that high level of ethnic, linguistic and religious diversity requires well functioning governments and as such is positively associated with FDI. Additionally, more culturally diverse society is more tolerable and less reluctant to foreigners, which is perceived positively by MNCs. A number of research investigate the impact of religious factors including religion diversity and pluralism [29, 30] religious similarity [31, 32] and religious groups [31, 33] on FDI and find that religion does influence FDI. Accordingly, religious pluralism is found to be positivelly associated with FDI and thus more important compared to religious similarity, while a study by [31] finds positive relationship between all monotheistic religious groups (Catholic, Protestant and Orthodox Christian) and FDI, but for Islam. According to the results of their study, significantly negative relationship is thus suggested between Buddhism and FDI. No doubt, the results of their study suggest that MNCs are not indifferent to culture, broadly represented by diverse religious groups, and that only certain religious groups are positively associated with FDI. However, the empirical evidence on the matter is scarce and far from

In this paper we, however, argue that, while religious believes may influence attitudes toward free market, competition or foreign investors, it may be fairly misleading to associate specific attitudes and values to individual religious groups per se, based on our assumptions, generalisation and even pre-assumptions about religious constituencies of individual nations. This tendency to assign specific societal attributes to certain religious groups such as is the case of the La Porta et al. study [34], which prescribe and impose 'low institutional quality, institutional inefficiency, political and economic instability, high level of corruption and tax invasion etc.', to reside and prevail within the so called 'hierarchical religious'such as Catholicism, Orthodox Christianity and Islam is rather forged, deceptive and ambiguous.

Certainly, a genuine and reasonable approach to study religious aspects of cultural dimension and its relationship to FDI and/or economic growth need be based on attitudes toward certain economic concepts and principles, as well as on values assigned to those, including wealth and growth, competition-rivalry and struggle, market openness and foreign investors. In case, significant differences assigned to those concepts, could be associated with specific religious believes or related valuesystems, then we could sensibly argue of the prevailing religiously rooted 'cultural' differences. This is to say, that we need to investigate the link between religious beliefs and values assigned to aforementioned economic concepts. How differently are these concepts perceived and valued by different religious groups need be the principal question investigated, and not something a priori assumed and assigned to specific religious groups. In line with this reasoning, for instance, Guiso, Sapienza and Zingales [33] conclude that Catholics and Protestants are more positively associated with attitudes favouring market-efficiency and economic growth, while Muslims are found to be negatively associated with competition. Last but not lease, if we consider far-reaching cultural differencies existing within supposedly homogenous religious groups across different nations, such as is the case of Islamic countries (Malasya vs. Tukey vs. Saudi Arabia vs. Iran), or cultural differences across supposedly Catholic states such as is the case of Ireland vs. Poland vs. (South) Italy, we clearly face the measurement problem that may bias the results. This could partly explain why number of studies including [34] failed to find significant impact of religious groups per se on either economic growth or FDI. The notable

exception is the aforementioned study by Lucke and Eichler [31].

**18**

Overall, in this paper we argue that analysis of cultural influence on FDI, that measure cultural diversity via dichotomous variables depicting religious group(s) impact of cultural proximity along geographical distance on FDI [32, 38]. Lopez-Duarte and Vidal-Suarez [39] analyse how language distance affects the choice between greenfield investments and acquisitions when investing in other countries. 383 foreign direct investments from Spain in 44 different countries in the period 1989–2003 were analysed. The authors find strong support for the role of language distance as the main factor causing transaction costs. The results suggest that investors avoid acquisitions as a way of investing in countries characterised by high language distance. Bandelj [40] analysed the cultural connections (presence of a national minority) between investors and recipients of investments (hosts). It measures how the presence of national minorities affects the movement of FDI between pairs of countries. Bilateral flows of 11 Central and Eastern European countries (recipients of investments) and 27 investor countries were analysed. The author came to the conclusion that cultural ties that have historically been formed due to the presence of national minorities of the host country in the investor country, and vice versa, positively and statistically significantly affect FDI flows between the two countries.

attributed to individual national cultures as 'core' to comprehending the

*Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture…*

ii. The importance of analysing the impact of institutional and cultural factors in an integrated empirical framework in which we take control of both institutional and cultural factors and examine their relative importance on

In view of the possible biases associated with the 'cultural distance variable' constructed by subcontracting the origin form destination country cultural scores, we refrain from using 'cultural distance' variable in our empirical analysis. On the contrary, we postulate the importance of specific and intrinsic cultural features that reflect on deep cultural traits and different cultural models, developed by Hofstede [48, 49] to be important determinant of FDI. In what follows, we discuss the relevance of Hofstede cultural factors as determinants of FDI inflows. The impact of these factors has been fairly under-researched in transition economy context.

**2.4 Which cultural factors matter for FDI and why: measurement issues**

We postulated earlier that culture is important aspect of informal institutions. As such culture is associated with way formal institutions function, their quality and efficiency. Apart from this, local culture is associated with 'social risk' of investment and transition to a new market embedded in social relations. Risks associated with cross-border business go beyond economic analysis and economic risks. The social characteristics are important determinant of FDI in that they influence operational and the external environment of business, influencing business success factors in the long run. Social characteristics depicted in cultural dimensions of a society are considered important to the internationalisation process ([50] as companies do not perform their businesses in isolation from other firms and/or networks of firms [51] nor do they construct their internal capabilities in isolation. Local work ethics, values and attitudes affect business performance of foreign companies through social relations of the workforce. All economic activities are 'submerged in social relations' [52]. Social characteristics and relations are embedded in cultural dimen-

Research on culture attempted to define important elements and dimensions of national culture relating to both conscious and unconscious set of beliefs, values and norms that reflect general attitudes and preferences of a society. Hofstede study and the model of national culture presents a systematic and pioneering work on the matter, that had a major influence on understanding cultural differences among nations [52]. Hofstede introduced four cultural dimensions of a society, namely Power Distance (PDI); Masculinity (MAS); Individualism (IDV); and Uncertainty Avoidance (UAI). The fifth cultural dimension, Long term orientation (LTO) was later developed and added as additional variable by Hofstede and Bond (1988). Further research on cultural dimension and its measurement resulted in the development of the Globe cultural dimensions (Global Leadership and Organisational Behaviour Effectivness, Kogut and Singh's Index of cultural distance [53] and Schwarz Value Survey [36]. The literature has critically assessed various aspects of these cultural indices, including the Hofstede work on culture and cultural dimensions [54–56]. Most of criticism is related to the problem of time invariant nature of cultural indices including Hofstende cultural dimensions, and lack of genuine (socio) anthropological aspect of culture. In this research we follow arguments

presented in [57] on the rationale of using Hofstede cultural indicators

cultural influences on FDI

*DOI: http://dx.doi.org/10.5772/intechopen.95326*

FDI

**and hypothesis**

sions of a society.

**21**

Although, the results of majority of studies on cultural distance and FDI support the hypothesis that greater cultural distance negatively affects FDI, and that cultural proximity plays important role in attracting FDI, studies by Voyer and Beamish [41], Grosse and Trevino [42] find that cultural distance does not exert significant negative impact on FDI, and that cultural distance does not seem to influence FDI flows. Tang [43] reports mixed results on the impact of all cultural distance variables (four Hofstede cultural indicators) on FDI and concludes that 'cultural difference does not always imply cultural conflict'. In similar vein, Barkema, Bell, and Pennings [44] (following [45]) argue that the risks arising from cultural differences can be overcome because investors can learn over time how to deal with those differences. According to them, experienced investors, both from developed and developing countries, ultimately do not consider cultural differences a significant obstacle.

Analysing the impact of cultural distance on foreign direct investment has, however, proven to be quite complex resulting in inconclusive and even contradictory empirical evidence. Part of the reason can be attributed to the fact that authors use different measures of culture from which they construct cultural distance variable, rendering support to the need to understand the mechanism underpinning the influence of 'cultural distance' on FDI. Moreover, the problem of measurement of cultural distance variable has been investigated by van Hoorn and Maseland [46]. The authors analyse the implications of using 'cultural distance' variable, defined as a difference between home and host country scores of one or more cultural dimensions, on robustness of the empirical results obtained. They conclude that one cannot compare the impact of this 'cultural distance variable' on FDI for different countries of origin. Following the conclusions emanating from their study, Kapas and Czegledi [47] construct a 'cultural distance' variable taking into account the problem of 'the mixed impact of cultural distance and the culture in the host country' when constructing cultural distance variable. Essentially, the results of their study suggest that the impact of culture measured in levels on FDI is greater than the impact of 'cultural distance' variables. The results of their study along the van Hoorn and Maseland [46] study clearly suggest the possible bias effect of earlier studies analysing the impact of 'cultural distance' on FDI.

In light of this discussion and in view of the important insights arising from the previous empirical work, in this study we analyse the impact of culture on FDI in transition economies while highlighting the following:

i. The importance of cultural features of host economy that are independent of culture of the origin country, that is of specific values that could be

*Institutions, Culture and Foreign Direct Investment in Transition Economies: Does Culture… DOI: http://dx.doi.org/10.5772/intechopen.95326*

> attributed to individual national cultures as 'core' to comprehending the cultural influences on FDI

ii. The importance of analysing the impact of institutional and cultural factors in an integrated empirical framework in which we take control of both institutional and cultural factors and examine their relative importance on FDI

In view of the possible biases associated with the 'cultural distance variable' constructed by subcontracting the origin form destination country cultural scores, we refrain from using 'cultural distance' variable in our empirical analysis. On the contrary, we postulate the importance of specific and intrinsic cultural features that reflect on deep cultural traits and different cultural models, developed by Hofstede [48, 49] to be important determinant of FDI. In what follows, we discuss the relevance of Hofstede cultural factors as determinants of FDI inflows. The impact of these factors has been fairly under-researched in transition economy context.

#### **2.4 Which cultural factors matter for FDI and why: measurement issues and hypothesis**