Effects of FDI Flows on Institutional Development: Does It Matter Where the Investors are from?

Abstract

Global FDI flows to and from developing countries have increased significantly since the 1990s. While developing countries saw this as a positive development, many economists and policy makers in developed countries have raised concerns regarding the institutional effects of developing country investments in other developing countries. In this paper we explore the effects of bilateral FDI flows on institutional development gaps between countries and whether such effects are conditional on the direction of flows including South–South, South–North, North–South, and North–North directions. The empirical results using bilateral flows between 134 countries and a variety of institutional development measures during 1990–2009 suggest that the institutional development effects of FDI flows in any direction including the North–South or South–South directions are not significant. In any case we do not find any significant convergence or divergence effect of FDI flows on the institutional distance between host and home countries. We also fail to find any significant effect of aggregate North–South FDI flows on host country institutions. In contrast, we find that aggregate South–South FDI flows have a significantly negative effect on host country institutions. Furthermore, we find some evidence that South–South FDI flows may be harmful to institutional development in natural resource-rich countries while the opposite is true for North–South flows. Overall, the results suggest that there is no strong evidence of any benevolent or malevolent effects of bilateral FDI flows from developed or developing countries to developing countries.