The impact of institutional quality on attracting foreign direct investment in lower-middle income countries, threshold regression model

Abstract

The purpose of this study is to examine the impact of institutional quality on foreign direct investment (FDI) inflows into lower-middle income countries. To achieve this objective, the authors use a dataset comprising 45 lower-middle income countries from 2002 to 2022. The analysis is conducted using dynamic panel estimation (System GMM). The experimental results show that Control of Corruption, Political Stability, Rule of Law, Voice and Accountability enhance FDI inflows, while Regulatory Quality diminishes it in lower-middle income countries. Consequently, these findings contribute implications and policies to help Governments in lower-middle income countries improve FDI attraction, such as intensifying anti-corruption efforts to create a transparent investment environment, implementing policies to stabilize politics, building an effective and fair legal system to protect property rights and individual rights, supporting free trade policies, openness, and citizen rights, and democracy. Moreover, the study also examines the impact of institutional quality on FDI attraction in high-income countries to explore the different effects between the two groups of countries, thereby deriving different policy implications that Governments of both groups of countries need to focus on in addressing FDI attraction issues. Furthermore, to contribute additional research insights, the study conducts threshold regression analysis to evaluate how different institutional quality impacts GDP per capita, thereby providing deeper recommendations on the relationship between GDP per capita and the impact of institutional quality on FDI attraction in lower-middle income countries