Institutions and foreign direct investment: A Panel VAR approach

Abstract

This paper employs panel vector autoregression model (PVAR) for a panel of 90 developing countries over 17 years (2000-2016) to empirically examine the relationship between institutional shocks and foreign direct investment (FDI). The study finds that institutional shocks have a negative impacts on FDI. Generally, the effect begins to mitigate from the fourth year. This result could be explained mainly by the instability of institutional variables « Regulation of credit, labor and business » and « government size » in the case of FDI inflows and outflows. The effect is higher in the case of FDI inflows. This suggests that investors already settled in developing countries are less sensitive to institutional shocks. Also, results reveal that the negative impact of institutional shocks on net FDI is explained by the instability of legal structure and property rights and access to sound money.