Does inward FDI influence the quality of domestic institutions? A cross-country panel analysis

Domestic institutions are recognized as important in attracting foreign direct investment (FDI) and spurring economic development in host countries, but FDI can also affect and shape domestic institutions. In this paper we use extensive data on the quality of institutions and on inward FDI in 127 countries over a period of 22 years to see whether attracting FDI improves the quality of institutions in the host economies. We distinguish between different types of institution, FDI and country, and we estimate a series of pooled ordinary least squares, fixed effects, and dynamic panel data models to address endogeneity. Our findings suggest that higher amounts of inward FDI improve the average quality of institutions in recipient countries. This holds particularly when the quality of institutions is measured in terms of political stability, regulatory quality and rule of law, and when host countries are developing or transition economies.