Institutional Quality, FDI, and Productivity: A Theoretical Analysis

Abstract

While many important links between institutional quality and foreign direct investment (FDI) inflows and/or between inward FDI and economic development through productivity growth have been uncovered, the full links between emerging and advanced economies are not yet well understood. This paper develops a model of FDI with an explicit distinction between the two economies where domestic and multinational firms using different technologies compete on the final good market and highlights the institutional quality–FDI–productivity link within a unified theoretical general equilibrium framework. We show that an improvement of institutional quality in the emerging economies induces pervasive technology-upgrading effects in the advanced economies, which generates aggregate productivity gains.