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Threshold effects of institutional quality on FDI-economic growth nexus: a panel smooth transition regression (PSTR) model

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Abstract

This study aims to investigate whether threshold effects exist in the tripartite relationship between foreign direct investment (FDI), institutional quality and economic growth. More specifically, it seeks to see whether a certain tipping (threshold) level of institutional quality should be reached to afford the maximal growth-enhancing benefits associated with FDI. The study applies the panel smooth threshold regression model to a sample of 160 countries for the period 2002–2021. The results show that the model has only one threshold for the six transition variables considered, revealing the contingent effect of institutional quality on the FDI-growth nexus. Above the estimated threshold, institutional quality has a positive impact on marginal growth effect of FDI. However, below the threshold, FDI has a significant negative effect on growth. This result supports the viewpoint that a better quality of institutions foster the transmission channels from FDI to host economy via technology transfer or knowledge diffusion, while poor institutional quality leads to a higher home country-uncertainty (i.e. higher cost of doing business) which undermine the FDI-induced growth. This study contributes by exploring the role of institutional thresholds in determining economic growth-FDI dynamics and provides useful insights to policymakers.

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Notes

  1. World Investment Report: United Nations conference on Trade and Development.

  2. Buchanan et al. (2012) was the first using a similar voluminous sample (164 countries), but their investigation has deal with the relationship between institutional quality and FDI, without investigating the impact of their interaction on economic growth.

  3. The theory was formulated by Bertil Ohlin (1899–1979) by expanding the work of his teacher Eli Filip Heckscher (1879–1952).

  4. Although several proxy variable(s) for institutional quality have been suggested in the literature, there is no consensus among experts on which index should be used (see Samadi & Alipourian, 2012 for a review). The most used indicators are stemming from the International Country Risk Guide (ICRG) database and Worldwide Governance Indicators (WGI) database. The WGI project of the World Bank reports aggregate and individual governance indicators, namely “Voice and Accountability” and “Political Stability”, which the bank portrays as constituting the political dimension, “Government Effectiveness” and “Regulatory Quality” the economic dimension, and “Rule of Law and “Control of Corruption” the institutional dimension. The ICRG database, compiled by the Political Risk Services (PRS) Group, provides information on 22 risk indicators grouped in three categories: political, economic and financial risks. These indicators includes political risk, government stability, corruption, military in politics, law and order, democratic accountability, quality of the bureaucracy, among others.

  5. The higher the γ, the sharper is the change from one extreme regime to another. A country with institutional quality level below the threshold point needs an accumulation of efforts in order to stimulate the FDI growth-enhancing effect.

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Authors and Affiliations

  1. Higher Institute of Computer Science and Management, University of Kairouan, Kairouan, Tunisia

    Hassan Guenichi & Neji Al-Eid Omri

  2. LEGI Laboratory, Polytechnique, Marsa, Tunis, Tunisia

    Hassan Guenichi

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Appendix

Appendix

See Tables 9, 10, 11 and 12.

Table 9 Worldwide governance indicators (WGI)
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Table 10 Summary statistics
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Table 11 PSTR estimation with added control variables
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Table 12 The estimation of Hansen’s panel threshold model
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Guenichi, H., Omri, N.AE. Threshold effects of institutional quality on FDI-economic growth nexus: a panel smooth transition regression (PSTR) model. Environ Dev Sustain (2024). https://doi.org/10.1007/s10668-024-04712-4

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