Abstract
This study investigates the impact of institutional quality on Foreign Direct Investment (FDI) inflows using panel data for low, lower-middle, upper-middle and high-income countries for the sample period of 1996–2016 using the system Generalized Method of Moments (GMM). The empirical results confirm that institutional quality has a positive impact on FDI in all group of countries. The magnitude of the coefficients of control of corruption, government effectiveness, political stability, regulatory quality, rule of law, and voice and accountability for FDI inflows are greater in developed countries than in developing countries. We conclude that institutional quality is a more important determinant of FDI in developed countries than in developed countries. However, GDP per capita, agriculture value-added as a percentage of GDP, and inflation influence FDI inflows negatively in developed countries, while GDP per capita, trade openness, agriculture value-added as a percentage of GDP, and infrastructure have positive and statistically significant impacts on FDI inflows in developing countries. Trade openness as a percentage of GDP and infrastructure positively affect FDI in developed countries. From our analysis, we infer that institutional quality is a more important determinant of FDI in developed countries than in developing countries.
Highlights
The traditional neoclassical growth model claims that differences in countries’ per capita incomes are due to differences in their capital accumulation, which are in turn due to their differing saving rates
It is interesting that agricultural value-added as a percentage of Gross domestic product (GDP) has a positive and statistically significant impact on Foreign direct investment (FDI) inflows in lower-middle-income countries, but it is statistically insignificant for low-income countries
This study investigated the impact of institutional quality on FDI inflows by controlling the effects of inflation, GDP per capita, trade openness as a percentage of GDP, infrastructure, and agriculture value-added as a percentage of GDP in developed and developing countries
Summary
The traditional neoclassical growth model claims that differences in countries’ per capita incomes are due to differences in their capital accumulation, which are in turn due to their differing saving rates. Differences in capital accumulation are due to differences in countries’ saving rates (Solow 1956; Koopmans 1965). Developing countries are characterized by low per capita income, poverty, unemployment, high population growth and low savings rates. Low levels of savings and investments create savings-investment gaps that have negative impacts on economic growth and development. Foreign direct investment (FDI) helps to fill the gap between savings and required level of investment (Sabir and Khan 2018). FDI can directly and indirectly reduce unemployment (Lipsey 2001) and increases productivity by improving the skills and knowledge of workers in the host country
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