Multinational Corporations and Institutions

Abstract

This paper examines whether the recent conclusion that foreign direct investment (FDI) has a positive effect on institutions in developing countries depends on a country having reached a certain threshold level of institutional quality. The relevant literature has recently coalesced around the view effects of capital account globalization on growth are elusive; its main benefit is likely to be collateral. We examine the collateral impact on institutions of investment through a multinational corporation and using cross-section analysis. We show FDI’s positive effect on institutions in developing countries is driven by upper middle income countries. When the institutional quality is very low, FDI cannot lift it; when it reaches a middle level, it can. In view of persistent global inequality, and failure of developing countries to catch-up, and recent emphasis on “fundamental” causes of growth (like institutions) as distinguished from “proximate” causes like physical capital, labor in efficiency units, and technology of the Solow model, understanding how institutions may be affected is important.

Keywords: Foreign Direct Investment, Threshold for Collateral Effects, Developing Countries

JEL Classification: F21, F23, O19, O43