Institutional Quality and FDI in Central and South East European: Evidence from Panel Models and Robustness Checks

This paper examines the impact of institutional quality and selected macroeconomic factors on foreign direct investment (FDI) inflows in 22 Central and South-Eastern European countries over the period 2007-2023. To account for endogeneity, unobserved heterogeneity, and the dynamic nature of FDI, the analysis employs dynamic panel data estimators, namely the Arellano–Bond difference GMM and the Blundell-Bond system GMM. Institutional quality is proxied by six Worldwide Governance Indicators: Control of Corruption, Government Effectiveness, Political Stability, Regulatory Quality, Rule of Law, and Voice and Accountability. In addition, the model controls for key macroeconomic determinants, including GDP per capita, trade openness, inflation, population size, and mobile subscriptions as a proxy for infrastructure development. The empirical results indicate that institutional quality indicators are generally not statistically significant across model specifications, with the exception of political stability, which consistently exhibits a positive association with FDI inflows. In contrast, macroeconomic variables – particularly population size and trade openness – emerge as robust determinants of FDI, while the lagged dependent variable confirms strong persistence in FDI inflows over time. Inflation is found to be positively associated with FDI in some specifications, suggesting that its effect may reflect short-term macroeconomic conditions rather than long-run stability. Overall, the findings suggest that, in Central and South-Eastern Europe, market size and economic openness play a more prominent role in attracting FDI than improvements in institutional quality. The study also highlights potential measurement limitations and structural rigidities that may obscure the observable impact of institutions on FDI, contributing to the ongoing debate on the relative importance of institutional reforms versus macroeconomic fundamentals in transition economies.