Growth E ffect of FDI in Developing Economies : The Role of Institutional Quality

This paper investigates the effect of FDI on economic growth conditional on the institutional quality of host countries. As we consider institutional heterogeneity to be an explanation for the mixed results of previous empirical studies, we develop several arguments to show that institutional quality modulates the intensity of FDI impact on growth. Using a comprehensive data set for institutional quality, we test this hypothesis on a sample of 94 developing countries over the period 1984-2009. The use of Panel Smooth Transition Regression (PSTR) allows us to identify both the heterogeneity and an endogenous threshold of institutional quality that influence the FDI growth effect. These results have sinificant implications for policy sequencing in developing countries. In order to benefit from FDI-led growth, the improvement of the institutional framework should precede FDI attraction policies