Governance, Private Investment and Foreign Direct Investment in Developing Countries

This paper uses annual aggregate data for 46 developing countries covering the period 1996–2009 to investigate if FDI crowds out domestic private investment and if alternative elements of governance have differing effects on the relationship between FDI and private investment. Results suggest that total investment (FDI and private) is greater in countries with good governance, there is evidence of crowding out (FDI displaces domestic private investment), and the extent of crowding out is related to governance. Corruption and political instability are the governance indicators that appear to have the greatest impact on investment. Political stability is found to be the most important aspect of governance in terms of the relationship between FDI and domestic private investment: an increase in FDI has the greatest effect on reducing private investment (but increasing total investment) in politically stable regimes.