Foreign direct investments, institutional quality, and economic growth

ABSTRACT

Institutional quality is considered to be an important factor in boosting economic growth of a country. This paper explores the role of institutional quality in economic growth and more specifically the role it plays via the channel of foreign direct investments. This paper uses a larger dataset of 104 countries and applies GMM estimation method to a dynamic panel data to evaluate the direct impact of institutional quality on economic growth and the indirect impact of institutional quality on economic growth through enhancing the FDI-induced economic growth. This paper provides evidence that both FDI inflows and institutional quality cause stronger economic growth. The FDI-led growth, however, was only experienced in the low and middle-income countries. In these countries, better institutional quality was also found to be enhancing the FDI-led economic growth. An important finding of this paper is that in the high-income countries, FDI was found to slow down the economic growth. The results are robust and consistent for individual institutional quality indicators and controlling for endogeneity.

KEYWORDS:

• Foreign direct investments
• institutional quality
• economic growth
• GMM

JEL CLASSIFICATIONS:

• E23
• F23
• F43

Disclosure statement

No potential conflict of interest was reported by the author.

ORCID

Arshad Hayat http://orcid.org/0000-0002-7543-4490

Notes

1 Gorg and Greenaway (2004) reviewed a large number of firm-level studies conducted on FDI spillovers and found that a mere 24% reported a positive spillover.

2 WGI indicators database and methodology can be accessed at http://info.worldbank.org/governance/wgi/#home

3 World Bank database can be accessed from http://databank.worldbank.org/data/home.aspx