A study on the moderating role of national absorptive capacity between institutional quality and FDI inflow: evidence from developing countries

Abstract

Numerous studies on foreign direct investment (FDI) as a prime element of capital flow and external finance contribute to foreign physical stock of capital, knowledge spillovers, transfer of technology, and recipient countries’ employment. Developing economies need FDI to boost their economic growth. This study explores the moderating role of national absorptive capacity between FDI inflow and institutional quality (control of corruption, government effectiveness, political stability and the absence of violence, regulatory quality, rule of law, voice and accountability) on a panel of 113 developing countries for 2000–2019. Hausman fixed-effect and random-effect estimation are used in the analysis. The results show that national absorptive capacity (AC) moderates the relationship between FDI inflow and institutional quality dimension. To check robustness, we formed an index of institutional quality (OIQ) dimensions through principal component analysis (PCA) and regressed, demonstrating that AC moderates the relationship between OIQ and FDI. Subsequently, taking BRICS + Pakistan as a sample, we find that the results hold. This study will help form FDI-friendly policy in developing countries.