Institutional quality, FDI, and productivity: A theoretical analysis

Abstract

While many important links between institutional quality and foreign direct investment (FDI) inflows and/or between inward FDI and economic development through productivity growth have been uncovered, the full links between emerging and advanced economies are not yet well understood. This paper develops a model of FDI with an explicit distinction between the two economies where domestic and multinational firms using different technologies compete on the final good market and highlights the institutional quality-FDI-productivity link within a unified theoretical general equilibrium framework. We show that an improvement of institutional quality in the emerging economies induces pervasive technology-upgrading effects in the advanced economies, which generates aggregate productivity gains.