Working Paper Series no. 559: Growth effect of FDI in developing economies: The role of institutional quality

Abstract

This paper investigates the effect of FDI on economic growth conditional on the institutional quality of host countries. We first develop several theoretical arguments to show that institutional heterogeneity may be an explanation for the mixed results of previous empirical studies. Second, using a Panel Smooth Regression model on a large sample of developing countries, we show that FDI has a positive effect on growth only beyond a certain threshold of institutional quality. In order to benefit from FDI-led growth, institutional reforms should thus precede FDI attraction policies. Additionally, some reforms seem to promote faster marginal effects of FDI, while institutional complementarities may lead to an incremental effect on growth.

Cristina Jude and Grégory Levieuge.
June 2015

Classification JEL : F21, C34, F43, O16

Keywords : FDI, growth, heterogeneity, institutional quality, PSTR, Developing economies