International Evidence on Governance and Foreign Direct Investment Interactions

Abstract

This study presents new international evidence on the interdependence of governance and foreign direct investment (FDI) inflows based on twelve year data of 173 countries. Results from ordinary least squares and 2-stage least squares show that FDI and governance as proxied by average governance index of World Governance Institute of the World Bank are indeed interdependent. The implication is that FDI and governance go hand in glove i.e., FDI is determined by governance and vice-versa. We also examine the impact of adopting international accounting standards (IFRS) and legal origin of sample countries on FDI and governance. We find a significant impact of adopting international accounting standard (IFRS) and legal origin of the sample countries on governance rather than on FDI. This implies that adoption of IFRS strengthens governance and thereby allows free movement of capital around the world. We find the interdependence even when we control for certain macro economic factors as well as time, region and income factors. These findings have implications for individual governments of the world and international donor organizations to undertake tenable actions to improve the governance of countries.