Relationship Between FDI and Economic Growth in the Presence of Good Governance System: Evidence from OECD Countries

Abstract

This study analyses the relationship between foreign direct investment (FDI) and economic growth in the presence of good governance system in the Organization for Economic Co-operation and Development (OECD) countries. The dataset comprised of the years 1996–2013. Fixed effect model and the Generalized method of moments (GMM) estimator are used in this study. The result of the study unveils that all the variables have a significant positive association with economic growth. Moreover, the study establishes the interaction terms which also depict a positive effect on economic growth. Further, the Granger causality test shows that the bidirectional causal relationship exists between the FDI and regulatory quality (REQ) on economic growth, whereas the unidirectional causal relationship is found among the corruption control, political stability (POS), voice and accountability (VAC), government effectiveness (GOE) and economic growth. Finally, it can be concluded from the above results that the more the countries maintain their institutional quality the better will be the economic growth and the FDI inflows. This result gives valuable policy implications, which the government should use to improve the economic growth. Further, the result obtained from this study is beneficial for policymakers who can draft effective government policies which will foster the economic growth rate of the country. Last but not least, there is a need to improve the REQ which can only be improved subject to changes in the laws of corruption.