IR 213 Paper 1 745 words
Hossain Pazooki
FDI & Institutional Development
The quality of institutions is the di erentiating determinant growth levels
across countries. The better the institutions are set up in a country, local and
international (rms are able to perform resulting in more growth and more
subsequent investment. Developing countries have sought to attract foreign direct
investment to boost their growth, but multinational (rms are often skeptical about
the level of investment their willing to commit in the developing world. Aside from
the high levels of political risk, the quality of domestic institutions are often a main
point of concern for international investors, which partly contributes to risk levels as
well. Foreign direct investment is not only beneficial for the world economy as a
whole, but it can facilitate the institutional development of the host country.
Particularly, regional diversi(cation of international investment will have a more
signiticant impact on the symmetrical institutional development in an economy, an
area which many developing countries are struggling in.
Many studies have been conducted on productivity and growth spillovers of
foreign direct investment in the host country. For instance, property right protection
1 and the efficiency of financial markets 2 result in a higher degree of FDI spillovers.
The spillover e ects are often argued to be on the productivity 3 of domestic firm
through various channels; namely, technology transfer 4, competition 5, and
managerial methods 6. Although economic theory supports this view, recent
empirical literature has provided mixed results 7. Some studies have shown higher
productivity growth of local (rms in general 8, but others have demonstrated that
the positive productivity spillovers, if any, are only enjoyed by a very small group of
domestic firm in specific sectors or regions 9 10 11. Similarly, a related strand of
literature has also provided contradictory evidence 12 13 on how FDI a ects economic
IR 213 Paper 1 745 words
Hossain Pazooki
growth both at the domestic and national level. Compared to the large number of
studies on productivity and growth spillovers of foreign direct investment, there is a
smaller literature attempting to understand the interactive relationship between FDI
and local institutions 14. Lack of institutional development results in a higher political
risk for investors. Transnational investors are hesitant to move their capital to less
developed regions due to uncertainty resulting in less capital 8ow in capital scarce
regions of the world; and since the cost of setting up good and efficient institutions
are often high, less prosperous regions of the world will get stuck in an endless
cycle of economic stagnation. Many developing countries seek to attract foreign
investors by improve certain aspects of their governance to reduce political risk
There are several examples of less developed countries that have implemented
