Abstract
This study examines the impact of institutional quality on foreign direct investment (F.D.I.) by categorising the countries as developed or developing. We measured institutional quality by the sum of control of corruption and rule of law indicators. We provide evidence that institutional quality positively and significantly impacts F.D.I. in developed countries; specifically, we find that a one standard deviation change in governance significantly affects F.D.I. by a factor of 0.2225 (using common law and the lagged values of the independent variables as instruments). Ceteris paribus, the results for the developing countries demonstrate that the institutional quality impact is insignificant because of the weak structure of institutions. Result findings strongly support the significance of governance indicators in attracting F.D.I. inflows. From our results, we infer that the relevance of governance indicators tends to be a key point in attracting F.D.I. inflows.
Highlights
Foreign direct investment (F.D.I.), a key factor of globalisation, is an important stimulator of productivity enhancement, technological advancement, and job creation
We provide evidence that institutional quality positively and significantly impacts F.D.I. in developed countries; we find that a one standard deviation change in governance significantly affects F.D.I. by a factor of 0.2225
The financial crisis of 2008–2009 broke the upward G.D.P. trend in both developed and developing countries. These trends highlighted the vulnerability of developing countries, which were directly influenced by the economic activities in developed countries
Summary
Foreign direct investment (F.D.I.), a key factor of globalisation, is an important stimulator of productivity enhancement, technological advancement, and job creation. With the strong growth in F.D.I. inflows during the last two decades, transitioning and developed nations are interested in institutional reforms in order to attract more F.D.I. Third, foreign investors are showing more interest. Many previous papers and findings have researched the impact of institutional quality on F.D.I. in developing and transition economies. No previous research studies have measured the impact of institutional quality on F.D.I. inflows by categorising the countries as developed or developing countries. We bridge this shortcoming in the literature by categorising the countries as developed or developing to more accurately measure the importance of institutions in attracting F.D.I. inflows.
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