The impact of culture on FDI disentangled: separating the “level” and the “distance” effects

The most important concern of this paper centers on the question of whether the difference in inward FDI across countries is a result of the fact that destination countries have different cultures, or the fact that they are more distant culturally from the origin country than others? We argue that answering this question requires disentangling the impact of culture, which consists of separating two effects: the “level” (the former) and the “distance” effect (the latter), which are mixed in the literature, leading in this way to biased conclusions in relation to how cultural distance matters for FDI. In this paper we propose an econometric method to separate the two effects of the culture, in which the key is that cultural distance does not depend on the origin country’s culture. Our empirical results indicate a “strong” level effect in the sense that it is a working effect in the case of all the three cultural values we use, and its size is economically significant, as well. The distance effect, however, is at best as important as the level effect but very probably less so, accordingly, it seems that the literature has “overemphasized” the impact of cultural distance.