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JSPES, Vol. 32, No. 2 (Summer 2007)
pp. 223-249

Foreign Direct Investment, Governance
and Economic Development in Developing Countries

Berhanu Mengistu
Samuel Adams

Old Dominion University, Virginia

How does foreign direct investment (FDI) affect domestic investment and economic growth? What is the importance of institutional infrastructure or governance in promoting growth in developing counties? This study empirically examines these issues for a cross section of 88 developing countries. Using ordinary least squares (OLS) and fixed effects (FE) estimation techniques, the study finds that FDI is positively and significantly correlated with economic growth. The study also finds that FDI has had a greater impact in Asia than in other developing countries. However, FDI has had a net crowding-out effect on domestic investment, which suggests that FDI promotes growth through its efficiency-inducing effects rather than its augmentation of domestic investment. Finally, the study found that a country’s institutional infrastructure is positively and significantly correlated with economic growth.