Effect of quality of institutions on outward foreign direct investment

Abstract

In this paper we study the effect of quality of institutions in the OECD and Asian host countries on outward foreign direct investment (FDI) stocks of source OECD countries using International Country Risk Guide governance indicators, for the period 1991 to 2001. We find that better institutions in the host countries have an overall positive and significant effect on source countries' outward FDI stocks. The strength and impartiality of the legal system, popular observance of law, strength and quality of bureaucracy and government stability in host countries have a direct effect on source countries' outward FDI stocks. Interestingly, trade changes sign and loses significance in two-stage least squares regressions compared with theoretical expectation. Furthermore, skill proxied by labour abundance in source countries relative to host countries appears to be insignificant in determining source countries' outward FDI stock.