Foreign Direct Investment and Exports Diversification : Are Institutions Spoiling it All for Sub-Saharan Africa?

Using a dynamic panel model and data on 107 countries, this paper investigates the role of institutions in the FDI-export diversification relationship. The results indicate that the effect of FDI on export diversification depends on the quality of institutions. On one hand, for OECD countries where institution quality is higher, FDI promotes export diversification. On the other hand, in SSA, where institutions’ quality is lower, FDI increases specialization. Therefore, it appears that FDI in SSA primarily exhibits a rent seeking behavior. In other words, when institutional risk exists, foreign investors do not take economic risk, and thus they invest in the existing profitable sectors; however, when they do not face institutional risk, they are willing to take on economic risk and invest in new products. The outcomes remain robust to different measures of export diversification, institutions’ quality, and when SSA is replaced by several trade zones in the region