The effect of institutions on the foreign direct investment‐growth nexus: What matters most?

This paper examines the extent to which host‐country institutions influence the relationship between inward foreign direct investment (FDI) and economic growth. We develop a theoretical model to analyse how different types of institutions condition the FDI‐growth relationship and use various institutional proxies to conduct threshold estimations on panel data for 51 developed and developing countries over the period 1991–2016. Our results consistently reveal a robust, contingent effect of political stability on the FDI‐growth nexus, suggesting that, among all the institutional factors considered, the absence of civil conflict or violence in the host economy is most critical in terms of yielding both direct and indirect growth‐enhancing benefits associated with technology transfer and spillover effects from FDI inflows. This finding is pertinent to both developed and developing countries, although the threshold level of political stability required to achieve sizeable growth benefits from FDI tends to be lower for developing countries.