Institutions, Foreign Direct Investment and Growth: A Hierarchical Bayesian Approach

Abstract

We investigate empirically the existence of a heterogeneous relation between foreign direct investment (FDI) and economic growth across developing countries. We argue that, across countries, differences in institutional quality are correlated with heterogeneous absorptive capacities and hence a heterogeneous FDI-growth relation. Our empirical results show substantial heterogeneity in the FDI-growth relation. We find that controlling for certain measures of institutional quality reduces the degree of heterogeneity. These findings question the orthodox assumption of a homogeneous return to FDI in the existing empirical literature and highlight the importance of specific aspects of institutional quality in the FDI-growth relation.