Growth Effect of Foreign Direct Investment in Developing Economies: The Role of Institutional Quality

Cristina Jude · Grégory Levieuge

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International Business and FDI Global trade and economics Economic Growth and Productivity

Abstract

Abstract This paper investigates the effect of foreign direct investment (FDI) on economic growth conditional on the institutional quality of host countries. We first develop several theoretical arguments to show that institutional heterogeneity may be an explanation for the mixed results of previous empirical studies. Second, using a panel smooth regression model on a large sample of developing countries, we show that FDI has a positive effect on growth only beyond a certain threshold of institutional quality. To benefit from FDI‐led growth, institutional reforms should thus precede FDI attraction policies. Additionally, some reforms seem to promote faster marginal effects of FDI, while institutional complementarities may lead to an incremental effect on growth.

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References

1990Institutions, Institutional Change and Economic Performance 1998Initial conditions and moment restrictions in dynamic panel data models 1998Law and Finance 1995Initial conditions and moment restrictions in dynamic panel data models 1999Why do Some Countries Produce So Much More Output Per Worker than Others?1998How does foreign direct investment affect economic growth?2004Institutions Rule: The Primacy of Institutions Over Geography and Integration in Economic Development 1999Threshold effects in non-dynamic panels: Estimation, testing, and inference

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