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

Abstract

SummaryWe investigate empirically the existence of a heterogeneous relationship 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 relationship. Our empirical results show substantial heterogeneity in the FDI–growth relationship. 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 relationship.