FDI and Growth in Emerging Economies: Is Governance the Game Changer?

This paper re-examines the FDIgrowth nexus by focusing on the role of governance quality as a structural condition shaping how foreign capital is absorbed into developing economies.Using a balanced panel of 53 countries from 20032021, we construct a composite governance index based on all six Worldwide Governance Indicators to capture the systemic nature of institutional quality.Baseline pooled, xed-eects, and random-eects estimates show that both FDI and governance exert independent, positive eects on per capita GDP growth.When interaction terms are introduced, governance signicantly amplies the growth impact of FDI, suggesting that institutional quality serves as an absorptive mechanism rather than a mere control variable.We explore dynamics and address potential endogeneity issues by employing the Generalized Method of Moments (GMM).To investigate nonlinearities, we employ panel threshold regression and fractional polynomial techniques.The threshold model identies statistically signicant governance regimes in which FDI becomes substantially more growth-enhancing, while the fractional polynomial specication reveals an S-shaped relationship between governance and growth, with reform gains strongest in very low and very high governance environments.Across all methods, the results conrm three robust insights: FDI consistently promotes growth, governance strengthens this eect, and the FDIgrowth relationship is fundamentally nonlinear.The ndings underscore that foreign investment yields its highest returns in institutional environments capable of eectively converting external capital into productive domestic outcomes.