Do Financial and Governmental Institutions Play a Mediating Role in the Spillover Effects of FDI?

Abstract

We examine how foreign direct investment(FDI) affects social and technological change in ASEAN countries. By employing fixed-effects and two-stage least squares regressions, we analyze the mediating roles of financial and governmental institutions, which determine absorptive capability. Our results reveal that a composite of the Worldwide Governance Indicators(WGI) does not play a mediating role in the relationship between FDI and technological change. However, the rule of law, which is one of the components of the WGI, has a significant mediating effect in this relationship. We also reveal that financial institutions play a mediating role in this relationship. Contrary to what one can predict, FDI has a negative effect on financial institutions, which reduces FDI’s overall effect on technological change. To maximize FDI’s spillover effects, governments should facilitate the effective functioning of the rule of law and devise strategies to alleviate financing restrictions, which might be an obstacle to foreign direct investment.

Keywords: Spillover effect, Cross-market study, Foreign direct investment, Financial development, Governance, Technological change