FDI Inflows – Domestic Investment Relationship in Developing Countries: Does the Governance Environment Matter?

Abstract

FDI inflows play a crucial role in the development agenda of developing countries. Attracting more FDI inflows is one of the priority policies to promote economic growth and create more jobs in these countries. However, FDI inflows can crowd out/in domestic investment, and thus the role of the governance environment is mentioned as a mitigating factor for the negative influence of FDI inflows on domestic investment. This study empirically examines the role of the governance environment in the relationship between FDI inflows and domestic investment for a panel data of 93 developing countries using the two-step system GMM Arellano-Bond estimators. The robustness of estimates is checked by the one-step system GMM Arellano-Bond estimators. The estimated results indicate FDI inflows and governance reduce domestic
investment but their interaction stimulates it. Besides, economic growth, trade openness, and infrastructure are positive determinants of domestic investment in these countries. These findings suggest some important policy implications for governments in developing countries in attracting FDI inflows.