Does “investment climate” affect GDP? Panel data evidence using reduced-form and stochastic frontier analysis

Abstract

It is often believed that investment enhances welfare, particularly through channels of capital creation, employment generation, and output growth. Two commonly used measures of a nation’s ability to attract investment are the Global Competitiveness Index (GCI) and the Ease of Doing Business Index (EDBI). This paper attempts to estimate the causal link between these indices and per capita Gross Domestic Product (GDP). A positive relation between these would essentially vindicate the theory that better investment implies better prosperity. Two complementary methods are used for estimating the effects, viz, reduced form analysis and stochastic frontier analysis (SFA). SFA is an appealing method but to have a convincing SFA setup and eventually get at causal estimates, endogeneity issues need to be addressed. Reduced form setting using fixed effects and proxy variables provides the required foundation for the SFA. Overall, we find evidence of a positive relation between GCI and per capita GDP.