Impact of institution building and foreign direct investment on economic growth

Abstract. This study tests the hypothesis that institution building leads to FDI inflows and promotes economic growth rates. We also compare the estimation results when multiple institutional variables are used, and examine whether broad legal and institutional stability is important and whether specific articles are important for FDI inflows. The results of the verification revealed that (1) institution building leads to FDI inflows and promotes economic growth rates, (2) robust results are obtained regardless of multiple legal and institutional indicators, and (3) among the legal systems, the specific deregulation of capital account regulations, laws affect FDI inflows and economic growth, and (4) the combination of an increase in broad-based legal system stability and the relaxation of capital account regulations together will promote FDI and economic growth. In other words, it is confirmed that investor and public confidence in the government and judiciary for the stability of the extensive legal system, including the protection of property rights, will bring about an inflow of foreign direct investment. (5) While FDI inflows are critical to economic growth, the study found that among institutional factors, improvements in legal and institutional capacity, in particular, are highly effective in bringing about economic growth through a rise in FDI. The importance of both capital account regulations, which are indicators that have a direct impact on foreign investors considering FDI, and legal system indicators, which show the degree of legal compliance by domestic residents, indicates that relaxing capital account regulations alone is not enough to fully promote FDI inflows. It means that the degree of legal compliance of domestic residents must be high to further promote FDI inflows. In other words, FDI inflows will bring economic growth through the maturation of the rule of law.Keywords. FDI; Barro regression; Economic Growth; Institution.JEL. O47; F30; F33; O43