INSTITUTIONS AND FOREIGN DIRECT INVESTMENT: A PANEL VAR APPROACH

Abstract

This paper employs a panel vector autoregression (PVAR) model for a panel of 90 developing countries over the period 2000–2016 to empirically examine the relationship between institutional shocks and foreign direct investment (FDI). The study finds that institutional shocks have a negative impact on FDI, with the effect beginning to diminish from the fourth year. This result can be explained mainly by the instability of institutional variables such as regulation of credit, labor and business, and government size, particularly in the case of FDI inflows and outflows. The effect is stronger for FDI inflows, suggesting that investors already established in developing countries are less sensitive to institutional shocks. The results also reveal that the negative impact of institutional shocks on net FDI is driven by instability in the legal structure, property rights, and access to sound money.

Data:
Received: 30 Sep 2020
Revised: 14 Nov 2020
Accepted: 6 Dec 2020
Published: 20 Dec 2020