Foreign Direct Investment, Economic Growth, and Political Instability

Abstract

This paper studies the relationship between FDI and economic growth in a system of simultaneous equations framework. The system of simultaneous equations model exploits that the relationship between FDI and growth is endogenously determined with respect to each other. Our empirical results yield that growth responds significantly positive to FDI. FDI on the other hand does not respond significantly to growth. In addition, we construct several dimensions of political instability and document that political instability has differential effect on FDI and growth. We show that the effect that these dimensions of political instability have on growth and FDI is not different in Sub-Saharan Africa, a region that experiences high incidence of politically instability.