Trade, Foreign Capital, and Productive Capacity Nexus: The Moderating Role of Institutions

Abstract

International trade and foreign capital inflows are considered significant determinants of economic growth. However, despite being the largest recipients of these inflows, South Asian economies fail to achieve sustainable economic development due to rapid changes in macroeconomic dynamics and political instability. The purpose of the study is to examine the impact of trade openness (TRD), foreign direct investment (FDI), and international remittances (REM) on the productive capacity (PC) of South Asian economies, with a focus on the moderating effects of the institutional quality (INQ) on the aforementioned relations. The study uses the sample of four South Asian countries namely: Bangladesh, India, Pakistan, and Sri Lanka for the period from 2000 to 2022. The empirical results show that TRD, REM, and INQ exhibit positive and statistically significant effects on PC. The results highlight the significance of international trade, foreign capital inflows, and INQ in determining the PC of South Asian economies. Notably, the findings indicate that FDI has no impact on the PC of the sample economies. Surprisingly, INQ negatively moderates the relationship between REM and PC. Furthermore, INQ positively moderates the impact of TRD on PC. However, INQ does not moderate the effect of FDI on PC in the sample countries. The conclusion section discusses the policy and practical implications of the study, as well as its limitations.