Role of institutions on the relationship between growth and capital inflow

Abstract

Previous studies indicate that economic growth influences foreign capital inflow in countries with low levels of institutional quality. However, these studies are confronted with modelling and/or inferential problems. Consequently, this study investigates the impact of institutional quality on the economic growth-foreign capital inflow nexus using the asymptotic efficient bias-corrected least square dummy variable methods on data from 163 countries for the period 2002-2015. The results show that economic growth, real income per capita, and foreign reserves impact foreign capital inflow. The study finds the effect of economic growth on capital inflow to be conditional on institutional quality. Specifically, the results show that economic growth does not influence foreign capital inflow in countries with low levels of institutional quality but has a significant positive effect on capital inflow in countries with moderate and high levels of institutional quality. Therefore, countries should enhance their institutional framework by establishing a reliable structure for economic policies and enforcement.