Impact of institution building and foreign direct investment on economic growth

Takaharu ISHII


Abstract. This study tests the hypothesis that institution building leads to FDI inflows and promotes economic growth rates. We also compare the estimation results when multiple institutional variables are used, and examine whether broad legal and institutional stability is important and whether specific articles are important for FDI inflows. The results of the verification revealed that (1) institution building leads to FDI inflows and promotes economic growth rates, (2) robust results are obtained regardless of multiple legal and institutional indicators, and (3) among the legal systems, the specific deregulation of capital account regulations,  laws affect FDI inflows and economic growth, and (4) the combination of an increase in broad-based legal system stability and the relaxation of capital account regulations together will promote FDI and economic growth. In other words, it is confirmed that investor and public confidence in the government and judiciary for the stability of the extensive legal system, including the protection of property rights, will bring about an inflow of foreign direct investment. (5) While FDI inflows are critical to economic growth, the study found that among institutional factors, improvements in legal and institutional capacity, in particular, are highly effective in bringing about economic growth through a rise in FDI. The importance of both capital account regulations, which are indicators that have a direct impact on foreign investors considering FDI, and legal system indicators, which show the degree of legal compliance by domestic residents, indicates that relaxing capital account regulations alone is not enough to fully promote FDI inflows. It means that the degree of legal compliance of domestic residents must be high to further promote FDI inflows. In other words, FDI inflows will bring economic growth through the maturation of the rule of law.

Keywords. FDI; Barro regression; Economic Growth; Institution.

JEL. O47; F30; F33; O43.


FDI; Barro regression; Economic Growth; Institution.

Full Text:


Alfaro, L., Chanda, A., Kalenli-Ozcan, S., & Sayek, S. (2004). FDI and economic growth: The role of local financial markets, Journal of International Economics, 64(1), 89-112. doi. 10.1016/S0022-1996(03)00081-3

Ades, A., and Di Terra, R. (1999). Rents, competition, and corruption, American Economic Review, 89(4), 982-993. doi. 10.1257/aer.89.4.982

Alesina, A., Ozler, S., Roubini,N., and Swagwl, P. (1996). Political instability and econnomic growth, Journal of Economic Growth, 1, 189-211. doi. 10.1007/BF00138862

Aoki, M., and Okuno, M. (1996). Comparative System Analysis of Economic System, University of Tokyo Press. (in Japanese)

Arellano, M., and Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations, Review of Economic Studies, 58(2), 277-297. doi. 10.2307/2297968

Asiedu, E., and Lieni, D. (2002). Capital controls and foreign direct investment, World Development, 32(3), 479-490. doi. 10.1016/j.worlddev.2003.06.016

Barro, R.J. (1990). Government spending in a simple model of endogeneous growth. Journal of Political Economy, 98(5), 103-125. doi. 10.1086/261726

Barro, R.J. (1991). Economic growth in a cross-section of countries, Quarterly Journal of Economics, 106(2), 407-443. doi. 10.2307/2937943

Barro, R.J., and Lee, J.W. (1994). International comparisons of educational attainament. Journal of Monetary Economics, 32(3), 363-394. doi. 10.1016/0304-3932(93)90023-9

Barro, R.J., and Sala-i-Martin, X. (1995). Economic Growth, New York McGraw-Hill.

Becker, G.S., and Stigler, G.J. (1974). Law enforcement, malfeasance, and compensation of enforcers, Journal of Legal Studies, 3(1), 1-19. doi. 10.1086/467507

Blundell, R., and Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models, Journal of Econometrics, 87(1), 115-143. doi. 10.1016/S0304-4076(98)00009-8

Clague, C., Keefer, P., Knack, S., and Olson, M. (1997). Institutions and economic performance: property rights and contract enforcement, In Institutions and Economic Development, John Hopkins University.

Davidson, R., and MacKinnon, J. (1993). Estimation and Inference in Econometrics, New York: Oxford University Press.

Davis, K.E. (2004). What can the rule of law variable tell us about the rule of law reforms?, Michigan Journal of International Law, 26, 141-161.

Easterly, W., and Levine, R. (1997). Africa’s growth tragedy: policies and ethnic divisions, Quarterly Journal of Economics, 112(4), 1203-1250. doi. 10.1162/003355300555466

Fukumi, A. (2003). Institutions and economic growth in developing countries, Research for Economics and Business Administration, 52, 1-22. Research Institute for Economics and Business Administration, Kobe University. (in Japanese)

Fukumi, A. (2002). Study of factors of economic growth-Growth regression analysis- Doctoral Dissertation. (in Japanese)

Fukumi. A. (2005). Institutional capacity and direct investment in Latin America, Development Finance Research Institute Bulletin, 26, 27-49. (in Japanese)

Glaeser, E.L., La Porta, R., Lopez-De-Silanes, F., and Shliefer, A. (2004). Do institution cause growth, Journal of Economic Growth, 9, 271-303. doi. 10.1023/B:JOEG.0000038933.16398.ed

Hausmann, R., and Fernandez-Arias, E. (2000). Foreign direct investment: Good cholesterol?, IDB Research Department Working Paper, No.417. [Retrieved from].

Hermes, N., and Johns, C. (1995). Why do some countries produce so much more output per worker than others?, Quarterly Journal of Economics, 114(1), 83-116. doi. 10.1162/003355399555954

Knack, S., and Keefer, P. (1995). Institutions and economic performance: Cross-country test using alternative institutional measures, Economics and Politics, 7(3), 207-227. doi. 10.1111/j.1468-0343.1995.tb00111.x

La Porta, R., Lopez-Silanes, F., Shleifer, A., and Vishney, R.W. (1997). Legal determinants of external finance, Journal of Finance, 52(3), 1131-1150. doi. 10.1111/j.1540-6261.1997.tb02727.x

La Porta, R., Lopez-Silanes,F., Shleifer, A., and Vishney, R.W. (1998). Law and finance, Journal of Political Economy, 106(6), 1113-1156. doi. 10.1086/250042

Lin, J.Y., and Nugent, J.B. (1995). Institutions and economic development. In Handbook of Development Economics, Volume Ⅲ. (Ed. J. Behrman, and T.N. Srinivasan), Amsterdam: North- Holland.

Mauro, P. (1995). Corruption and growth, Quarterly Journal of Economics, 110(3), 681-712. doi. 10.2307/2946696

Modigliani, F., and Perotti, E. (1990). Security versus bank finance: The importance of proper enforcement of legal rules, University Amserdam.

North, D. (1990). Institutions, Institutional Change and Economic Performance, New York: Cambridge University Press.

Rebelo, S. (1991). Long-run policy analisys and long-run growth, Journal of Political Economy, 99(3), 500-521. doi. 10.1086/261764

Rodrik, D. (1999). Institutions for high-quality growth: What they are and how to acquire them, Paper presented at Conference on Second Generation Reforms, 8-9 November, at IMF, Washington D.C:World Bank.

Rodrik, D., Subramanlan, A., and Trebb, F. (2004). Institutions rule: The primacy of institutions over geography and integration in economic development, Journal of Economic Growth, 9, 131-165. doi. 10.1023/B:JOEG.0000031425.72248.85

Rodrik, D. (2005). Growth strategies," in P. Aghion and S. Durlauf (eds), Handbook of Economic Growth, Amsterdam: North Holland.

Rose-Ackerman, S. (1999). Corruption and Government: Causes, Consequences, and Reform, New York: Cambridge Unversity Press.

Svensson, J. (1998). Investment, property rights and political instability: Theory and evidence, European Economic Review, 42(7), 1317-1341. doi. 10.1016/S0014-2921(97)00081-0

Wacziarg, R., and Welch, K.H. (2003). Trade liberalization and growth: New evidence, NBER Working Paper, No.10152. doi. 10.3386/w10152

Wei, S.J. (2000). How taxing is corruption on international investors?, Review of Economics and Statistics, 8281), 1-11. doi. 10.1162/003465300558533

Windmeijer, F. (2005). A finite sample correction for the variance of linear efficient two-step GMM estimators, Journal of Econometrics, 126(1), 25-51. (in Japanese)



  • There are currently no refbacks.


Journal of Economics Library - J. Econ. Lib. - JEL -

ISSN: 2149-2379

Editor: Secretarial:   Istanbul - Turkey.

Copyright © KSP Library