Institutional Quality and Foreign Direct Investment: Evidence from OECD Countries

The main purpose of this research is to investigate the effect of institutional quality on FDI inflows in the Organization for Economic Cooperation and Development (OECD) countries by using the panel autoregressive distributed lag of pooled mean group (ARDL-PMG) over the period 1996 - 2017. The results reveal that institutional quality is an important factor attracting foreign direct investment (FDI) over the long term to countries with low quality of institutions. In the short term, in contrast, the relationship is not significant. Institutional quality does not play any significant role in attracting FDI to the countries with sound institutions in either long or short terms. When considering components of institutional quality, property rights have the greatest impact on FDI flows. Finally, when considering a non-linear relationship between institutional quality and FDI inflows, we find diminishing returns of institutional quality on FDI flows for the countries with stronger institutions. This paper contributes to the literature by considering both the different individual aspects of institutional quality and a broad composite measure of institutional quality in order to analyse their impact on FDI inflows. Additionally, the study applies the CS-ARDL method as a robustness check, in addition to the ARDL-PMG. The scope of this study is limited as it only examines the impact of institutional quality on overall foreign direct investment (FDI) inflows, rather than analysing sector-specific FDI flows.