Economic, Institutional & Political Determinants of FDI Growth Effects in Emerging & Developing Countries

This study investigates the role of income levels, using the World Bank income classification, and political development, using EIU Democracy Index scores, in determining the magnitude of FDI growth effects for a panel of 61 emerging and developing countries for the period 1989 to 2013. It tests a baseline growth model incorporating these variables which is then extended to include FDI interaction effects with human capital, measured using secondary school enrolment data, and political development. The separate growth effects of FDI are then tested separately for each of the three lower World Bank income classifications (Upper-Middle, Lower-Middle and Low Income) followed by three categories of political regime type derived from Democracy Index. The effects of FDI are found to vary significantly between income classifications with the strongest growth effects in Low Income countries and weaker negative effects in Upper-Middle Income countries. The growth interaction effects between FDI and human capital are found to be strongly positive regardless of regime type. Political development in conjunction with FDI appears to suppress the growth effects of FDI in authoritarian countries while enhancing them in ‘hybrid’ democracies. For more democratic countries, human capital is a more important driver of growth than FDI but this is the outcome of strongly positive interaction effects between FDI and human capital outweighing negative effects for human capital on its own. The paper also provides some support for the view that a critical threshold of human capital is required to generate beneficial spillover growth effects from inflows of FDI. This paper provides new and more detailed insights into the growth effects of FDI with particular respect to income classification and political regime type in emerging and developing countries.