Received: 10 May 2019 Revised: 5 November 2019 Accepted: 18 June 2020

DOI: 10.1002/ijfe.2197

RESEARCH ARTICLE

FDI inflows and economic growth in Arab region:

The institutional quality channel

Omar G. Aziz

Australian National Institute of

Management and Commerce (IMC),
Sydney, Australia
Correspondence
Omar G. Aziz, Australian National
Institute of Management and Commerce
(IMC), Suite 1, Biomedical Building,
1 Central Ave, Eveleigh, NSW 2015,
Australia.
Email: omar.aziz@imc.edu.au
Abstract
This study empirically investigates the possible role of institutional quality in
absorbing foreign direct investment (FDI) flows' spillovers for growth in a
group of Arab countries. The analysis is performed by employing system GMM
estimation in panel data comprising 11 Arab countries over the period
1988–2012. It develops overall indexes of doing business and economic free-
dom indicators using the principal components analysis (PCA) as weights. The
study finds that the quality of institutions plays an important role in enhancing
economic growth via indirect impact by absorbing spillovers of FDI inflows.
On the one hand, the study reveals that greater macroeconomic stability and
financial development have a positive influence on growth. The results of this
study have several implications for policy makers.

KEYWORDS
economic freedom, FDI, GMM estimation, institutional quality, PCA

JEL CLASSIFICATION
F300; O430; C330

1 | INTRODUCTION local enterprises struggle to compete with powerful foreign

Foreign direct investment (FDI) is considered one of the
main channels for the acquisition of technology and knowl-
edge by a recipient country. FDI increases the existing stock
of knowledge in a host country through the transfer of
skills for managerial and organizational practice. It also
promotes the use of more advanced technologies by domes-
tic enterprises through capital accumulation. FDI is
thought to open up export markets and to promote domes-
tic investments through technological spillovers and
resulting increases in productivity (De Mello, 1997, 1999).
However, there is no consensus as to the relationship
between FDI and economic growth. Aitken and Harri-
son (2009), Ahmad and Hamdani (2003) and Sadni-Jallab,
Gbakou, and Sandretto (2008) find no independent link
between FDI inflows and economic growth. FDI may nega-
tively affect growth by reducing domestic investment if
competitors (Ram & Zhang, 2002). Empirical evidence sug-
gests that the positive impact of FDI on growth mainly
depends on initial conditions in the host economy, such as
complementarity between foreign and domestic invest-
ments, export orientation, macroeconomic stability, human
capital and the quality of institutions.1
Before the global financial crisis (GFC), Arab eco-
nomic performance in terms of GDP per capita growth
grew slightly due to increase in oil prices, a wide range of
economic reforms, improvement in the business climate
and privatization (ESCWA, 2008). However, in 2009 the
growth of the region recorded a downturn. This was not
due to the GFC alone, but to factors such as lack of eco-
nomic management, poor social policies, and weak insti-
tutional quality which prevented the efficient distribution
of production factors (World Bank, 2013). Arab econo-
mies experienced low levels of FDI inflows2 associated

Int J Fin Econ. 2020;1–16. wileyonlinelibrary.com/journal/ijfe © 2020 John Wiley & Sons Ltd 1
2 AZIZ
with a decline in the price of oil3 and the level of domes-
tic savings and investment in Arab economies decreased
and so, ultimately, the growth deteriorated. Thus, it is
very important for the Arab governments to diversify
their economies and if they face challenges to increase
the capital flows levels then, the successful key could be
enhancing the current institutional environment which
is what this study attempts to examine.
Many studies have analysed the growth effects of FDI
inflows and its spillovers through different channels such
as new technology process for production, labour training
and skill acquisition, education, exports, institutions and
financial markets.4 These studies mainly focus on the
regions of Asia, Africa, North and South America and
East Europe, however, a little attention has been given in
the research on Arab economies. To the best of my
knowledge there has still been no study conducted to
date for Arab economies on examining the possible role
of institutional quality in absorbing FDI flows' spillovers
for growth.
This study fills in the gap and contributes to the exis-
ting literature in Arab economies by considering wide
range of institutional quality measurements in the analy-
sis: doing business, economic freedom and political risk
along with other important variables such as GFC. The
study contributes to the existing literature on FDI growth
in Arab economies by examining whether FDI affects
growth by itself or through institutional channels. It also
empirically examines the effects of global financial crisis
beside macroeconomic policy and financial development
variables on growth in the Arab region. What makes this
study have a singularity is that it develops overall indexes
for doing business and economic freedom indicators by
computing their weighted average, taking factor loadings
in principal components analysis (PCA) as weights, to
avoid testing partially correlated indices against each
other, which makes this study have advantages compared
to others. For econometric analysis, the current study
employs system GMM (Arellano–Bover/Blundell–Bond)
techniques to deal with issues related to endogeneity,
omission of relevant variables, measurement error, sam-
ple selectivity, or simultaneity.
This study addresses the following main research
questions: What is the effect of FDI inflows on growth?
What is the role of institutions in facilitating the growth
effect of FDI inflows to the Arab region? Are the
enhancements of investor protection, government stabil-
ity and business climate which increase FDI inflows able
to stimulate growth in the Arab region?
This paper is formulated as follows: Section 2 is litera-
ture review. Section 3 describes methodology. Section 4
illustrates the summary statistics, correlation and
stationarity tests. Section 5 discusses the empirical
results. Finally, Section 6 concludes and provides policy
implications.
2 | L I T E R A T UR E R E V I E W
The growth effect of FDI has motivated much empirical
literature that focuses on both industrial and developing
countries. Most early empirical work on the FDI-growth
relationship is based on the neoclassical model of growth
that regards FDI as physical capital in the production
function; however, the endogenous growth model con-
siders FDI as a source of physical capital, technology and
knowledge for host economies. Overall the empirical lit-
erature yields a complex, mixed picture of the relation-
ship between FDI and growth.
Balasubramanyam et al. (1996) investigate the role
which FDI plays in the growth process as a source of
physical capital and spillover in a sample of 46 developing
countries. Their estimation results indicate that FDI has
positive spillover effects on economic growth. They find
that FDI is more effective in improving growth perfor-
mance than domestic capital, followed by exports.
Ahmad and Hamdani (2003) empirically analyse the
effect of FDI on growth in pooled data of 32 developing
countries over the period 1965 to 1992. They find that
FDI plays an important role in the process of economic
growth, but cannot be regarded as more important than
domestic investment.
Azman-Saini, Baharumshah, and Law (2010) argue
that the importance of institutions in the growth process,
in particular the level of economic freedom, can limit a
firm's ability to absorb and internalize new technology
from MNEs. They employ GMM methodology for
85 countries over the period 1975 to 2004, and their
results show that FDI by itself has no direct effect on out-
put growth, and that the effect of FDI is contingent on
the level of economic freedom in the host country. Kherfi
and Soliman (2005) test the effect of FDI on economic
growth in two different regions, Central and Eastern
Europe (CEE), and MENA. They find that FDI has a posi-
tive effect on growth only in EU accession countries,
while the effect of FDI on growth in MENA and non-EU
accession countries is negative. They suggest that EU
membership is considered a driving force for stronger
commitment and more serious reforms, and this percep-
tion may have led to the positive effect of FDI on growth.
Karsalari, Mehrara, and Musai (2013) investigate the
causal relationship between FDI and GDP for MENA
region countries by using panel unit root tests and panel
cointegration analysis over the period 1970 to 2010. Their
results show that GDP drives FDI in the region, not vice
versa. They recommend that in order to exploit FDI
AZIZ
spillovers more efficiently, governments need to encour-
age a stable macroeconomic environment and sound
institutions.
Soumia and Abderrezzak (2013) empirically exam-
ine the effect of FDI on the growth of the Arab
Maghreb Union (AMU) countries over the period 1990
to 2010. Their results suggest that under particular eco-
nomic and financial conditions such as adaption to an
export promotion trade regime, FDI positively affects
growth. Omri and Kahouli (2014) estimate the effects
of FDI and some macroeconomic factors on economic
growth for 13 MENA countries over the period 1990 to
2010 and find that FDI, domestic capital and trade
openness have a positive impact on growth, while gov-
ernment expenditure and inflation have a negative
influence.
3 | METHOD OLOG Y
3.1 | Data5 and variables
This study utilizes panel data from a group of Arab coun-
tries over the period 1988 to 2012.6 Table A1 provides
information about the sources of data and definition.
This study constructs variables to capture the institu-
tional quality in two ways. First, the study computes two
quality indexes using PCA technique. Second, the study
constructs an interactive term between institutional qual-
ity variables and FDI inflows to measure the indirect
effect of FDI inflows on growth. The dependent variable
is the economic growth in this study and it is proxied by
the annual average growth rates of real GDP (Azman-
Saini et al., 2010; Borensztein et al., 1998). The data on
real GDP growth are from the UNCTAD statistics
database.
3.1.1 | Capital indicators
The total capital accumulation for an economy consists
of local and foreign capital. This study uses the percent-
age of gross capital formation growth as a proxy for
domestic investment (Basu & Guariglia, 2007; Bor-
ensztein et al., 1998). The data on domestic investment
are from World Bank's World Development Indicators.
FDI is a component of total investment other than
domestic investment and contributes to economic growth
first by increasing the investment level in the host econ-
omy and second by facilitating the transfer of knowledge
from abroad. (Kotrajaras, 2010; Ram & Zhang, 2002). The
data on FDI inflows are from World Bank's World Devel-
opment Indicators.
3
3.1.2 | Quality of institutions
The quality of institutions can reduce uncertainty and
offer incentives for efficient production by providing
long-term expectations about economic and political con-
ditions (Berggren, Bergh, & Bjornskov, 2012). Well-
developed institutions can increase synergies between
FDI and local firms, hence, promote productivity spill-
overs.7 By contrast, poor institutional quality is often
associated with low investment and slow productivity
growth. It can also limit the interaction between foreign
and local firms, limiting the indirect benefits derived
from FDI (Gwenhamo, Fedderke, & Kadt, 2012; Jude &
Levieuge, 2013). In order to measure the quality of insti-
tutions, this study employs data from various sources:
Ease of doing business from the World Bank, Economic
freedom from the Fraser Institute, and International
Country Risk Guide (ICRG) from the Political Risk Ser-
vices (PRS) Group.
Ease of doing business represents several important
dimensions of the regulatory environment as it applies to
local enterprises.8 A positive reform, as defined in doing
business, is one that makes it faster, cheaper or adminis-
tratively easier for local businesses to start and run opera-
tions, or that increases the protection of property rights,
which enhances investment and, ultimately, growth. Of
the 10 indicators in the database of doing business, seven
are clearly applicable to test linkages between the regula-
tion environment and the economic growth of Arab
economies. The chosen indicators9 are starting a busi-
ness, dealing with construction permits, registering prop-
erty, paying taxes, trading across borders, getting credit
and resolving insolvency.10 To develop an overall index
of regulations for doing business, this study computes a
weighted average for the seven individual indicators of
regulations, taking factor loadings in PCA as weights.11
The higher values in the index reflect higher scores for
institutional quality. The base year is 2004, the first year
of issue for these data. In addition to the quality of regu-
lations variable that it builds, this study also constructs
an interactive term with FDI inflows to ensure that regu-
lations are properly included.12 Importantly, regarding
the intensity of regulations it could be expected that regu-
lations hinder countries' growth from taking advantage
of higher FDI inflows. Thus, this interactive term will
measure the facilitating of business regulation in absorb-
ing FDI inflows' spillover for enhancing growth. If the
coefficient of the interaction term is positive, it implies
that the marginal effect of FDI inflows on growth
depends on the level of doing business.
Economic freedom13 measures the degree to which
the policies and institutions of countries are supportive of
economic freedom; the indicators are size of government,
4 AZIZ
legal system and property rights, access to sound money,
freedom to trade internationally, and regulation of credit,
labour, and business.14 These indicators help to measure
the contribution of economic institutions more thor-
oughly and distinguish it more clearly from political, cli-
matic, locational, cultural and historical factors as
determinants of growth and development (Gwartney
et al., 2014). To obtain an overall index, the study com-
putes a weighted average of the five individual indicators
of economic freedom, taking the factor loadings in the
principal components analysis as weights. Higher values
in the index reflect more economic freedom, which
means high institutional quality. The study also con-
structs an interactive term between economic freedom
and FDI inflows to measure the role of economic free-
dom in influencing the effects of FDI inflows on
growth.15
The ICRG is risk rating system which assigns a
numerical value (risk points) to a predetermined range of
risk components, according to a preset weighted scale,
for each country covered by the system. It measures the
strength of property rights and the repression of corrup-
tion. This study employs three indicators from ICRG,
they are law and order, government stability, and corrup-
tion (Alfaro, Chanda, Kalemli-Ozcan, & Sayek, 2004).
3.1.3 | Dummy variables
World Trade Organization membership
Bahrain, Egypt, Jordan, Kuwait, Morocco, Oman, Qatar,
Saudi Arabia, Tunisia and UAE are members of
WTO.16 Their membership may increase trading activi-
ties and capital inflows, leading to economic growth.
This study uses a dummy variable equal to one for a
WTO member Arab economy starting in the year of
membership, otherwise zero (Beugelsdijk, Smeets, &
Zwinkels, 2008). The dummy examines the relationship
of WTO membership and the growth of Arab econo-
mies. The data on World Trade Organization member-
ship are from www.wto.org.
Global financial crisis (GFC)
In 2008, the GFC generated a recession in global econo-
mies which led to a slowdown in economic activity,
including a decline in trade, oil prices and domestic and
foreign investment inflows. FDI inflows into Arab coun-
tries declined by 15.5% in 2009 as compared to 2008,
declined 16.7% in 2010 as compared to 2009 and declined
32.5% in 2011 as compared to 2010. In 2012, FDI rose to
15.3% as compared to 2011.17 The dummy takes value of
1 over the period 2009 to 2011 and 0 otherwise
(Moriyama, 2010).
3.1.4 | Other variables
This study employs a comprehensive set of variables that
could impact the growth. The definition and data sources
can be founded in Table A1. These variables are Human
capital, inflation, exchange rate, government consump-
tion, trade openness, natural resources, liquid liabilities;
bank size, bank credit, stock market size; stock market
liquidity. Human capital refers to the level of a country's
workforce and it is important for growth (Benhabib &
Spiegel, 1994; Curwin & Mahutga, 2014). Inflation can
create uncertainty about macroeconomic conditions,
which tends to reduce the rate of investment (Blin &
Ouattara, 2009; Kotrajaras, 2010). The volatility of
exchange rate generates uncertainty about the profitabil-
ity of international trade and investment, causing a
reduction in their levels and affecting growth (Anwar &
Nguyen, 2010; MacDonald, 2000). Government consump-
tion includes expenditure that does not directly affect
productivity, and can increase inflation levels and may
contain corruption therefore could lower outputs
(De Gregorio, 1993' Barro & Lee, 1994). Trade openness
could expose a national economy to the stock of global
knowledge and technology which improves the produc-
tivity and increases in exports (Curwin & Mahutga, 2014;
Hassan, Sanchez, & Yu, 2011). The revenue from natural
resources18 promotes economic growth in different ways.
It may finance economic diversification, or be used to
improve infrastructure or develop human capital, all
leading to an increase in the level of outputs
(Ploeg, 2011). However, huge natural resource rents may
create opportunities for rent-seeking behaviour and lack
of transparency in resource sales and revenue spending.
In economies with weak institutions to prevent corrup-
tion these revenues can be directed away from productive
economic activities, causing a downturn in growth
(De Gregorio, 2003; Gylfason & Zoega, 2006; Sachs &
Warner, 1995; Wiens, 2014). The traditional indicator of
financial sector development is the growth of liquid lia-
bilities (M2).19 It refers to the overall size of the formal
financial intermediary system (Demirgüç-Kunt &
Levine, 1996; King & Levine, 1993). Bank size, which
refers to the total sum of demand, time, and savings
deposits. It excludes currency in circulation held outside
the banking system to overcome any shortages that may
arise from the liquid liabilities (M2) indicator
(Ghali, 1999). Bank credit is a direct measure of financial
development as it takes into account credits to the private
sector only not to the public sector. The financial systems
that allocate more credit to private sectors are more
engaged in researching enterprises, exerting corporate
control, providing risk management services, mobilizing
savings and facilitating transactions than are the systems
AZIZ
that simply channel credit to government or state enter-
prises (King & Levine, 1993; Levine, 1997, 2005). A large
stock market size can improve the acquisition of informa-
tion about enterprises, and consequently improves
resource allocation substantially, with implications for
economic growth (Levine, 1997; Levine & Zervos, 1998).
Stock market liquidity can be measured by the turnover
ratio. High turnover is often used as an indicator of low
transaction costs (Arestis, Demetriades, & Luintel, 2001;
Demirgüç-Kunt & Levine, 1996; Kim & Lin, 2013).
3.2 | Econometric estimation
In order to deal with issues related to endogeneity, omis-
sion of relevant variables, measurement error, sample
selectivity, unobserved country specific effects and simul-
taneity bias, the study employs the system (GMM) esti-
mator of Arellano and Bover (1995) and Blundell and
Bond (1998). The empirical model is as follows:
yit = δyi,t − 1 + βx it + uit i = 1, …, N t = 2, …T,
where i denotes a country and t denotes time. δ is scalar,
yit is the annual real GDP growth rate, xit is a set of
explanatory variables which includes domestic and for-
eign capital, macroeconomic policy and institution qual-
ity (Table A1). uit is the error term, which comprises an
unobserved individual effect μi (time-invariant), and the
remainder disturbance vit (time-variant):
uit = μi + νit ,
 
31.56 respectively.
where μi  IID 0, σ 2μ and vit  IID 0, σ 2v independent of
each other and among themselves. The dynamic panel
data regressions described in above Equations (1) and (2)
are characterized by two sources of persistence over time
that is, autocorrelation due to the presence of a lagged
dependent variable yi, t − 1 among the regressors and indi-
vidual effects characterizing the heterogeneity among the
individuals μi.
Arellano and Bond (1991) suggest first-differencing
Equation (1) to eliminate the unobserved effect since the
disturbance μi does not vary with time as follow:


yit −yi,t − 1 = δ yi,t − 1 − yi,t − 2 + βðx it −x i,t − 1 Þ + ðvit − vi,t − 1 Þ:
GMM helps overcome endogeneity by using lagged-
values of the explanatory variables as instruments.
However, first-differencing generates a new statistical
issue that the constructed differenced error term vit
5
is now correlated with the dependent lagged variable
yi, t − 1 − yi, t − 2 which is included as a regressor. As a
solution, Arellano and Bover (1995) and Blundell and
Bond (1998) proposed a system GMM estimator that uses
moment conditions in which lagged differences [Equa-
tion (3)] are used as instruments for the level equation
[Equation (1)] in addition to the use of moment condi-
tions of lagged levels as instruments for the differenced
equation. However, the use of system GMM depends on
two conditions, first is the validity of these additional
instruments, second is the absence of second-order auto-
correlation for vit. To assess these two conditions, Arellano
and Bond (1991) and Arellano and Bover (1995) propose
the Sargan test of over-identification and the Arellano–
Bond AR (2) autocorrelation. The Sargan test of over-
identification tests the validity of the instruments. When
the Sargan test is insignificant, this means the instruments
are not correlated with the residuals; thus, these instru-
ments are valid. Arellano–Bond AR (2) autocorrelation
tests for the absence of second-order autocorrelation and
its result must be insignificant to indicate that there is no
ð1Þ second-order autocorrelation in the residuals.
4 | SUMMARY STATISTICS,
COR RELATION A ND
STATIONARITY TESTS
Table 1 illustrates the summary statistics for the vari-
ables. Economic freedom has the lowest mean of −2.09,
and corruption has the lowest SD of 0.68. The trade open-
ð2Þ ness variable has the highest mean and SD, 92.70 and
Table 2 illustrates the correlation matrix between the
variables. There is high correlation between few vari-
ables: trade openness and exchange rate (−0.52), bank
size and liquid liabilities (0.52), bank credit and trade
openness (0.56), government stability and liquid liabili-
ties (0.56), and law and order and inflation (−0.48). The
study will not include highly correlated variables together
in the same model.
Table 3 shows the panel unit root test (Levine–Lin–
Chu, Im–Pesaran–Shin and Fisher) results. The null
hypothesis of unit root is rejected for the variables: in
other words, the variables are stationary.
ð3Þ
5 | EMPIRICAL RESULTS 2 0
Tables 4–6 report the results for various versions of the
two-step Arellano–Bover/Blundell–Bond GMM estima-
tion in Equation (3). GDP growth is a dependent
variable.
6 AZIZ

TABLE 1 Summary statistics of

Variables Obs. Mean SD Min. Max.
the variables
GDP growth 275 4.88 7.83 −42.45 50.68
Domestic investment 243 10.11 22.18 −60.48 187
Human capital 275 3.28 3.06 −2.96 17.48
FDI inflows 249 19.83 2.20 9.21 24.39
Inflation 218 4.03 4.42 −4.86 25.71
Exchange rate 275 2.69 2.09 0.36 5.73
Government consumption 275 19.98 13.20 5.74 201.02
Trade openness 253 92.70 31.56 38.36 210.16
Natural resources 275 19.43 6.82 11.99 26.54
Liquid liabilities (M2) 273 9.82 1.64 8.06 11.58
Bank size 259 9.75 2.28 7.39 12.23
Bank credit 272 47.20 17.98 16.02 91.60
Stock market size 226 38.67 9.33 28.81 48.85
Stock market liquidity 211 17.70 4.30 13.21 22.42
Doing business 73 3.98 1.91 −3.56 3.82
Economic freedom 129 −2.09 1.78 −5.79 2.24
Government stability 275 8.77 2.06 1.08 11.50
Law and order 275 4.31 1.03 1 6
Corruption 275 2.50 0.68 1 4

Note: Obs. is number of observations. Mean is average. Min. is minimum. Max. is maximum.
GDP growth is the annual real GDP growth rate, Domestic investment is annual growth rate of
gross capital formation, Human capital is annual percentage growth rate of population, FDI
inflows is annual net inflows in US$ (natural logarithm), Inflation is annual percentage rate of
change in CPI, Exchange rate is Official exchange rate (LCU per US$, period average), Govern-
ment consumption is general government final consumption expenditure as percentage of GDP,
Trade openness is sum of exports and imports of goods and services as percentage of GDP, Nat-
ural resources is total natural resources rents as percentage of GDP, Liquid liabilities (M2) is
average annual growth rate in money and quasi money, Bank size is the growth rate of total
bank deposits, Stock market size is stock market capitalization of listed companies as percent-
age of GDP, Stock market liquidity is total value of shares traded during the period divided by
the average market capitalisation for the period (turnover), Doing business is ease of doing busi-
ness index, Economic freedom is index of economic freedom, Government stability is govern-
ment's ability to carry out its declared programs and its ability to stay in office, Law and order is
measure for the country's judicial system and Corruption is measure of inherent corruption
within the political system.

The lagged GDP growth coefficient is positive and
significant, indicating that countries with larger internal
markets grow faster. This finding is in accordance with
Curwin and Mahutga (2014). Domestic investment is
positive and significant. This implies that the higher the
level of domestic investment, the more important is
growth in the Arab region. This finding is consistent
with Omri and Kahouli (2014). The human capital vari-
able has mixed results. This contradicts Benhabib and
Spiegel (1994), who find a positive and significant effect
of human capital on growth. The FDI inflows coefficient
shows mixed results. This result contradicts with those
of Anwar and Nguyen (2010) and Mehic, Silajdzic, and
Babic-Hodovic (2013).
In Table 4 the doing business variable is positive and
significant, which implies the important impact of busi-
ness regulation on growth. The interaction term of doing
business and FDI inflows has a positive and significant
impact on growth. The countries with sound business
regulation are able to absorb FDI inflows' spillover. In
other words, high-quality regulations allow Arab econo-
mies to take advantage of FDI inflows. This finding sup-
ports the view that an improvement in doing business is
needed to facilitate FDI inflow spillovers; hence, the
 AZIZ

TABLE 2 Correlation matrix

Variable 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
1. GDP growth 1
2. Domestic investment 0.42 1
3. Human capital −0.08 −0.05 1
4. FDI inflows 0.10 0.04 −0.05 1
5. Exchange rate 0.01 −0.05 −0.08 0.54 1
6. Inflation 0.15 0.27 −0.13 0.33 0.09 1
7. Government consumption 0.04 −0.08 −0.40 −0.09 −0.25 −0.18 1
8. Trade openness −0.18 −0.09 0.47 −0.12 −0.52 −0.17 −0.08 1
9. Natural resources 0.20 0.27 0.45 −0.03 −0.24 0.02 −0.38 0.06 1
10. Liquid liabilities 0.30 0.33 −0.01 0.15 0.03 0.28 −0.008 −0.16 0.009 1
11. Bank size 0.44 0.25 0.02 0.11 0.02 0.14 0.04 0.004 0.10 0.52 1
12. Bank credit −0.38 −0.35 0.19 −0.26 −0.27 −0.26 0.19 0.56 −0.36 −0.32 −0.21 1
13. Stock market size 0.21 −0.04 −0.09 −0.14 −0.004 −0.08 0.35 −0.19 0.23 −0.12 0.11 −0.002 1
14. Stock market liquidity 0.14 0.24 0.03 0.39 0.18 0.37 −0.03 −0.19 0.19 0.33 0.15 −0.26 0.08 1
15. Doing business 0.20 0.17 −0.03 0.03 0.05 0.16 −0.05 0.006 0.01 0.47 0.34 0.02 0.11 0.21 1
16. Economic freedom −0.34 0.01 −0.07 −0.38 −0.32 0.12 −0.13 0.21 −0.09 −0.26 −0.16 0.23 −0.14 −0.22 0.09 1
17. Government stability 0.28 0.26 0.13 0.35 0.08 0.07 −0.01 0.19 −0.04 0.56 0.48 −0.11 −0.25 0.31 0.31 −0.09 1
18. Law and order 0.13 0.11 −0.06 −0.40 −0.31 −0.48 0.33 −0.01 0.27 −0.04 0.05 −0.06 0.15 −0.27 0.02 0.05 0.007 1
19. Corruption −0.09 −0.07 0.04 −0.26 −0.18 −0.36 0.32 0.35 −0.02 −0.32 −0.01 0.40 0.24 0.16 −0.10 0.11 −0.03 0.17 1

Note: The column number corresponds with the row titles. GDP growth is the annual real GDP growth rate, Domestic investment is annual growth rate of gross capital formation, Human cap-
ital is annual percentage growth rate of population, FDI inflows is annual net inflows in US$ (natural logarithm), Inflation is annual percentage rate of change in CPI, Exchange rate is Official
exchange rate (LCU per US$, period average), Government consumption is general government final consumption expenditure as percentage of GDP, Trade openness is sum of exports and
imports of goods and services as percentage of GDP, Natural resources is total natural resources rents as percentage of GDP, Liquid liabilities (M2) is average annual growth rate in money and
quasi money, Bank size is the growth rate of total bank deposits, Stock market size is stock market capitalization of listed companies as percentage of GDP, Stock market liquidity is total value
of shares traded during the period divided by the average market capitalisation for the period (turnover), Doing business is ease of doing business index, Economic freedom is index of eco-
nomic freedom, Government stability is government's ability to carry out its declared programs and its ability to stay in office, Law and order is measure for the country's judicial system and
Corruption is measure of inherent corruption within the political system.
7
8 AZIZ

TABLE 3 Panel unit root tests

Variables LLC IPS Fisher Decision

GDP growth −10.867* (0.000) −10.346* (0.000) −11.355* (0.000) Stationarity
Domestic investment −6.610* (0.000) −6.235* (0.000) −9.380* (0.000) Stationarity
Human capital −6.964* (0.000) −5.449* (0.000) −8.560* (0.000) Stationarity
FDI inflows −4.010* (0.000) −2.487* (0.000) −6.526* (0.000) Stationarity
Inflation −6.046* (0.000) −5.389* (0.000) −7.716* (0.000) Stationarity
Exchange rate −5.694* (0.000) −2.402* (0.008) −6.772* (0.000) Stationarity
Government consumption −4.710* (0.000) −3.832* (0.000) −7.633* (0.000) Stationarity
Trade openness −0.945 (0.172) −1.558** (0.059) −4.957* (0.000) Stationarity
Natural resources −4.288* (0.000) −3.850* (0.000) −7.830* (0.000) Stationarity
Liquid liabilities (M2) −4.587* (0.001) −4.782* (0.000) −8.393* (0.000) Stationarity
Bank size −5.615* (0.000) −6.554* (0.000) −9.499* (0.000) Stationarity
Bank credit −2.832* (0.002) −1.864** (0.031) −6.242* (0.000) Stationarity
Stock market size −2.846* (0.002) −2.500* (0.006) −4.826* (0.000) Stationarity
Stock market liquidity −1.475*** (0.070) −1.562* (0.059) −5.883* (0.000) Stationarity
Government stability −2.497* (0.006) −2.369* (0.008) −6.607* (0.000) Stationarity
Law and order −4.252* (0.000) −3.360* (0.000) −7.449* (0.000) Stationarity
Corruption −1.786** (0.030) −1.413*** (0.078) −5.893* (0.000) Stationarity

Note: Refer Table A1 for definition of variables. LLC is Levin-Lin-Chu (Adjusted t*), IPS is Im-Pesaran-Shin (w-t-bar) and Fisher is Fisher-
type (Invers normal Z). For LLC the null hypothesis Ho panels contain unit root, while the alternative Ha panels are stationary. IPS Ho: all
panels contain unit root, Ha: some panels are stationary. Fisher Ho: all panels contain unit roots, Ha: at least one panel is stationary. There-
fore, LLC tests for common unit root, while IPS and Fisher test for individual unit roots. p-values in brackets.. *, **, *** denote significance at
the 1, 5 and 10% levels respectively for p-values. The measurement for stationarity: if the variable passes at least two tests, then it is consid-
ered stationary.

benefit from doing business is both direct and indirect.
This result is contrary to Busse and Groizard (2008).
The positive and statistically significant coefficient of
economic freedom implies that less restrictive regulations
lead to higher economic growth. Economic performance
is stronger when economic freedom is high, because it
makes investment more productive. This result is in line
with Bengoa and Sanchez-Robles (2003). Moreover, the
interaction term between economic freedom and FDI
inflows has a positive and significant impact on growth.
This indicates that the effect of FDI inflows on growth
increases when the institutional framework is stronger.
The benefit of economic freedom is also both direct and
indirect. This finding is consistent with Vadlamannati
and Tamazian (2009) and Azman-Saini et al. (2010).
High quality institutions can promote capital accu-
mulation and increase levels of innovation and labour
skills, and reduce transaction costs and risks that could
face investments. Government stability, law and order,
and control of corruption are institutional quality indica-
tors from ICRG: the higher the value of the indicator, the
lower the risk related to that indicator. The government
stability indicator has positive and significant impact on
growth. This result is in accordance with Jude and
Levieuge (2013). The law and order variable is positive
and significant, in line with Berggren et al. (2012). The
coefficient of corruption appears to have a positive and
significant impact on growth. This result is accordance
with Alfaro et al. (2004).
In Table 5, the inflation variable is negative and sig-
nificant. This result is in accordance with Onyeiwu (2003).
The exchange rate adversely affects growth as it has a
negative and significant coefficient. This result is in
accordance with Onwuka and Chaiechi (2013). The coef-
ficient of government consumption is negative and signif-
icant. This result is in accordance with Aghion
et al. (2009). Trade openness is positive and significant.
This result is in accordance with Balasubramanyam
et al. (1996) and Carkovic and Levine (2002).
The WTO membership coefficient is positive and sig-
nificant. The objective of WTO is to help trade flow
smoothly, freely, fairly and predictably, which spurs trade
activity and leads to economic growth in Arab econo-
mies. This result is in line with Beugelsdijk et al. (2008).
The coefficient of the GFC is negative and significant.
During the GFC, FDI inflows to Arab countries declined
 AZIZ

TABLE 4 Determinants of GDP growth (Institutional quality)

Dependent (1) (2) (3) (4) (5) (6) (7)

Lagged GDP growth 0.009 (0.002) 0.009 (0.965) 0.432* (0.000) −0.350 (0.183) 0.146* (0.000) 0.189* (0.000) 0.145 (0.375)
Domestic investment 0.130* (0.005) 0.080* (0.005) 0.047* (0.000) 0.019* (0.037) 0.018* (0.006) 0.009*** (0.086) 0.058* (0.001)
Human capital −0.448 (0.205) 0.353 (0.334) 0.269 (0.145) 0.065** (0.034) 0.137 (0.348) 0.240*** (0.065) −0.028 (0.959)
FDI inflows 1.951*** (0.066) 3.789*** (0.073) 0.541* (0.002) 0.415 (0.489) 0.386*** (0.079) 0.798* (0.000) 1.297* (0.000)
Doing business 0.555*** (0.063) 0.704** (0.012)
FDI inflows × doing business 1.126*** (0.076)
Economic freedom 1.051*** (0.077) 1.370*** (0.080)
FDI inflows × economic freedom 1.585** 0.054
Government stability 1.197** (0.013)
Law and order 1.140* (0.001)
Corruption 1.772* (0.001)
Observation 52 30 88 79 172 216 162
2
Wald Chi 32.30* (0.000) 1,287.17* (0.000) 65.72* (0.000) 94.47* (0.000) 805.82* (0.000) 145.48* (0.000) 237.16* (0.000)
Sargan test 23.49 (0.983) 22.26 (0.326) 81.69 (0.107) 78.10 (0.128) 72.55 (0.300) 27.86 (0.221) 57.59 (0.635)
Arellano–Bond test AR (1) −0.93 (0.351) −1.88*** (0.060) −1.55 (0.121) −0.30 (0.763) −1.73*** (0.083) −1.92** (0.055) −1.36 (0.175)
Arellano–Bond test AR (2) 1.02 (0.307) 1.18 (0.854) 1.54 (0.123) 1.11 (0.269) −0.14 (0.886) −0.77 (0.443) 0.28 (0.782)

Note: GDP growth is dependent variable. Arellano–Bover/Blundell–Bond estimation results. *, **, *** denote significance at the 1, 5 and 10% levels respectively for p-values. Sargan statistic is a
test of the overidentifying restrictions, distributed as chi-square under the null of instrument validity. Arellano–Bond test for no autocorrelation.
9
 10

TABLE 5 Determinants of GDP growth (Economic determinants)

Dependent (1) (2) (3) (4) (5) (6) (7) (8)

Lagged GDP growth 0.105* (0.000) 0.081* (0.000) 0.201* (0.000) 0.125*** (0.097) 0.235* (0.000) 0.119* (0.000) 0.131* (0.000) 0.060*** (0.093)
Domestic investment 0.014** (0.018) 0.021*** (0.083) 0.011** (0.043) 0.051** (0.023) 0.003 (0.544) 0.012** (0.010) 0.010*** (0.091) 0.025** (0.019)
Human capital 0.479* (0.005) 0.912* (0.000) 0.075 (0.724) 0.070 (0.808) 0.257 (0.136) 0.211 (0.206) 0.248*** (0.084) −0.361 (0.447)
FDI inflows 0.494* (0.000) 0.642* (0.000) 1.773* (0.005) 0.358* (0.007) 0.830*** (0.000) −0.085 (0.807)
Inflation −0.406* (0.000)
Exchange rate −0.303* (0.000)
Government consumption −0.272** (0.061)
Trade openness 0.050** (0.050)
WTO membership 2.975** (0.038)
GFC −1.537*** (0.074)
Natural resources 0.203* (0.005)
Observation 216 200 216 227 181 216 216 201
Wald Chi2 187.39* (0.000) 103.38* (0.000) 130.45* (0.000) 52.13* (0.000) 135.15* (0.000) 121.81* (0.000) 290.97* (0.000) 230.41* (0.000)
Sargan test 28.44 (0.200) 46.25 (0.421) 27.60 (0.231) 50.05 (0.280) 56.64 (0.158) 39.55 (0.445) 30.64 (0.164) 55.46 (0.136)
Arellano–Bond test AR (1) −1.48** (0.066) −1.94** (0.052) −2.16** (0.031) −1.92** (0.055) −1.73** (0.053) −1.97** (0.049) −1.99** (0.047) −1.45 (0.124)
Arellano–Bond test AR (2) −0.82 (0.413) −0.78 (0.435) −0.77 (0.439) −0.44 (0.659) 0.37 (0.464) −0.79 (0.431) −0.79 (0.429) −0.91 (0.363)

Note: GDP growth is dependent variable. Arellano–Bover/Blundell–Bond estimation results. *, **, *** denote significance at the 1, 5 and 10% levels respectively for p-values. Sargan statistic is a
test of the overidentifying restrictions, distributed as chi-square under the null of instrument validity. Arellano–Bond test for no autocorrelation.
AZIZ
AZIZ 11

TABLE 6 Determinants of GDP growth (Financial development determinates)

Dependent (1) (2) (3) (4) (5)

Lagged GDP growth 0.146*** (0.066) 0.168* (0.000) 0.661** (0.032) 0.448 (0.169) 0.142 (0.335)
Domestic investment 0.017 (0.293) 0.010*** (0.075) 0.019** (0.031) 0.047** (0.045) 0.026** (0.030)
Human capital 0.217** (0.036) 0.163 (0.406) 1.273 (0.000) 0.008 (0.975) 0.492* (0.002)
FDI inflows −0.170 (0.807) 0.920* (0.007) −0.209 (0.209) −0.666 (0.207) −1.131 (0.108)
Liquid liabilities 0.635* (0.000)
Bank size 0.201* (0.000)
Bank credit 0.133*** (0.061)
Stock market size 0.686** (0.028)
Stock market liquidity 0.788* (0.005)
Observation 198 203 152 197 138
Wald Chi2 114.74* (0.000) 338.27* (0.000) 1,223.91* (0.000) 17.61* (0.000) 214.54* (0.000)
Sargan test 28.25 (0.250) 27.33 (0.242) 38.87 (0.763) 28.07 (0.977) 47.84 (0.675)
Arellano–Bond test AR (1) −1.79*** (0.074) −1.67*** (0.095) −1.47 (0.142) −1.36 (0.175) −1.30 (0.195)
Arellano–Bond test AR (2) 1.62 (0.106) −0.83 (0.408) 1.38 (0.167) 1.24 (0.216) 1.06 (0.288)

Note: GDP growth is dependent variable. Arellano–Bover/Blundell–Bond estimation results. *, **, *** denote significance at the 1, 5 and 10%
levels respectively for p-values. Sargan statistic is a test of the overidentifying restrictions, distributed as chi-square under the null of instru-
ment validity. Arellano–Bond test for no autocorrelation.

by 15.5% in 2009 compared to 2008, 16.7% in 2010 com-
pared to 2009, and 32.5% in 2011 compared to 2010.21
The crisis also affected Arab economies as oil price
decreases created deficits in many Arab countries.22
These factors led o ta slowdown in Arab economic
growth. This result is in line with Moriyama (2010). Nat-
ural resources have a positive and significant impact on
growth. Natural resources revenue can be invested in
industrial projects, infrastructure and technologies which
enhance the efficiency of production. This result is simi-
lar to the findings of Torres, Afonso, and Soares (2012)
but contrary to Sachs and Warner (1995).
In Table 6, financial development indicators appear
to have positive and significant effects on growth. The
liquid liabilities variable is positive and significant. This
result is in line with Levine (2005). The bank size vari-
able has positive and significant impact on growth. This
implies that an advanced bank sector has better capital
allocation, which increases the efficiency of production.
This result is similar to that of Ghali (1999). The bank
credit variable is positive and significant. This is consis-
tent with Anwar and Nguyen (2010). The stock market
size variable has a positive and significant impact on
growth. The size of the stock market is an indication of
its ability to provide information about enterprises, diver-
sify risks and enhance capital allocation, hence, improv-
ing efficient production. This finding is similar to that of
Bilel and Mouldi (2011). The variable of stock market
liquidity is positive and significant. Liquid stock markets
provide a ready exit option for investors, which can foster
more efficient resource allocation and faster growth. This
result is line with Kim and Lin (2013).
The Arellano and Bond test statistics for serial corre-
lation and the Sargan test for overidentifying restrictions
are reported in Tables 4–6. The Arellano and Bond AR
(2) is insignificant, which implies that there is no second-
order autocorrelation in residuals. The Sargan test is
insignificant, which means the instruments are not corre-
lated with the residuals and thus are valid.
6 | C O N C L U S I O N A N D PO L I C Y
IMPLICATIONS
Based on the augmented production function, this study
empirically examines the effect of FDI inflows and insti-
tutional quality variables on growth. The analysis is per-
formed by employing a two-step Arellano–Bover/
Blundell–Bond GMM estimation in panel data of a group
of Arab countries over the period 1988 to 2012.
The results show that high quality institutions play
an important role in enhancing growth. A regulated busi-
ness environment can reduce uncertainty and boost
investment. The interaction term between FDI inflows
and institutional quality variables has positive and signif-
icant impact on the growth, highlighting the indirect
impact of institutions on growth by absorbing spillovers
of FDI inflows. The empirical results also indicate that
12
macroeconomic policy variables the trade openness and
WTO membership variables have a positive and signifi-
cant impact on growth. The GFC dummy variable has a
negative and significant impact on growth.
The results of this study have several implications for
policy-makers. High institutional quality has a direct
impact on economic growth by stabilizing the business
environment, and an indirect impact by absorbing spill-
overs from FDI inflows. Arab economies need to apply
vital reforms to promote their institutional quality. These
reforms could include policies to improve the legal
framework, developing a more effective judicial system
and rule of law, providing transparency and ensuring fair
competition. The reforms must also aim to develop an
efficient business infrastructure by reducing obstacles to
entry business, and streamlining licensing processes,
complex regulations and bureaucratic procedures. The
Arab region needs to restructure their judicial system to
ensure global business standards in terms of simplicity
and time needed to initiate and complete a legal claim.
Arab economies have to reduce political risks by democ-
ratizing their political systems, which may have a positive
effect on their economic growth.
Arab policy makers have to remove trade barriers and
promote economic integration within the region and the
world by strengthening their trade relations and increas-
ing free trade agreements. At the same time, they should
maintain open access to world markets by anchoring
their trade and investment reforms in a multi-lateral
framework such as the WTO to give them greater credi-
bility. The GFC affected the prices of natural resources,
thus Arab economies should adopt alternative policies to
reduce the risks of depending heavily on the oil sector.
This could reduce their vulnerability to external shocks
via oil prices and their heavy reliance on the contribution
of natural resources.
DATA AVAILABILITY STATEMENT
Data is available on request: The data that support the
findings of this study are available on request from the
corresponding author.
ORCID
Omar G. Aziz https://orcid.org/0000-0001-7140-4174
E N D N O T ES
1
Balasubramanyam, Salisu, and Sapsford (1996, 1999); Bor-
ensztein, De Gregorio, and Lee (1998); De Mello (1999); Dur-
ham (2004); Ekanayake and Halikides (2008); Aghion, Bacchetta,
Ranciere, and Rogoff (2009), Alfaro, Kalemli-Ozcan, and
Sayek (2009); Aizenman, Jinjarak, and Park (2013).
2
Arab economies received only 3.3% of global FDI inflows in 2013
(UNCTAD database).
AZIZ
3
In 2013, oil prices started to decline from US$105 to level of US
$55 per barrel in 2015; see OPEC basket price: http://www.
opec.org.
4
Dunning (1993); De Mello (1997); Borensztein et al. (1998); Zhang
and Song (2000); Alfaro (2010).
5
Data is available on request: The data that support the findings of
this study are available on request from the corresponding author.
6
The League of Arab States comprises 22 countries (Algeria, Bah-
rain, Comoros, Djibouti, Egypt, Iraq, Jordan, Kuwait, Lebanon,
Libya, Mauritania, Morocco, Oman, Palestine, Qatar, Saudi Ara-
bia, Somalia, Sudan, Syria, Tunisia, UAE and Yemen). This study
focuses on 11 Arab countries due to data limitation.
7
Sound business regulations are important for the private sector to
achieve overall development. When regulation is transparent, effi-
cient and simple to implement, it becomes easier for enterprises
to compete, innovate and expand, which enhances growth (World
Bank, 2014).
8
Doing business consists of 10 indicators covering various aspects
of the business climate and measuring the complexity and cost of
regulatory processes and the strength of legal institutions: starting
a business, dealing with construction permits, getting electricity,
registering property, paying taxes, trading across borders, getting
credit, protecting investors, enforcing contracts, and resolving
insolvency, see http://www.doingbusiness.org.
9
Each indicator has different numbers of sub-components. For
example, the starting business indicator is the arithmetic mean of
the average number of procedures to start a business, the number
of days, the costs required to complete the process and the paid-in
minimum capital requirement. Please see http://www.
doingbusiness.org, for others variables' sub-components.
10
Before taking the average of the sub-components for each indica-
tor, all sub-components that form the indicator are rescaled to
0–1 by dividing all observations by the highest figure in each of
the sub-components.
11
This way we maximize variation and avoid testing partially cor-
related indices against each other. Using PCA lets the structure
of the data determine how components are pooled to form sepa-
rate indices instead of forcing a specific organization on the data
(Busse & Groizard, 2008). For more about PCA see: Boermans,
Roelfsema, and Zhang (2011) and Villaverde and Maza (2012).
12
The addition of an interaction term may lead to multicollinearity
as interaction terms tend to be strongly correlated with the origi-
nal variables used to construct them (Darlington, 1990). In order
to alleviate this problem, the interaction term is orthogonalized
using the following two-step procedure: first the interaction term
of FDI inflows and doing business is regressed on the FDI
inflows and doing business variables. Second, natural log of the
residuals from the regression in the first step were used to repre-
sent the interaction term (Burill, 2007).
13
In order to receive a high economic freedom rating, a country
must provide secure protection of privately owned property,
even-handed enforcement of contracts, and a stable monetary
environment. It also must keep taxes low, refrain from creating
barriers to both domestic and international trade, and rely more
fully on markets rather than government spending and regula-
tion to allocate goods and resources (Gwartney, Lawson, &
Hall, 2014).
AZIZ
14
Each indicator has different numbers of sub-components. For
example, size of government indicator consists of average num-
bers of the sub-components: government consumption as a share
of total consumption, transfers and subsidies as a share of GDP,
government enterprises' production as share of total output, and
top of marginal tax rates. Please see Gwartney et al. (2014), for
others variables' sub-components.
15
The interaction term is orthogonalized using the following two-
step procedure: first the interaction term of FDI inflows and eco-
nomic freedom is regressed on the FDI inflows and economic
freedom variables. Second, the natural log of the residuals from
the regression in the first step are used to represent the
interaction term.
16
Refer www.wto.org for the year in which Arab economies' joined
WTO membership.
17
Authors own calculations based on UNCTAD statistics FDI
inflows to Arab League States.
18
In 2012, natural resources represented a significant share of Arab
economies' exports (76.5%) and public revenue (77.3%) (Arab
Monetary Fund, 2013).
19
Liquid liabilities consist of currency held outside the banking
system plus demand, time, and saving deposits (other than those
of the central government) of banks and nonbank financial inter-
mediaries (World Bank Indicators, World Bank).
20
For the ease, the variables are classified to groups and presented
in the tables as follow: Table 4 Institutional quality group: doing
business, economic freedom, government stability, law and order
and corruption. Table 5 Economic determinants group: inflation,
exchange rate, government consumption, trade openness, WTO
membership, GFC and natural resources. Table 6 Financial
development determinates group: liquid liabilities, bank size,
bank credit, stock market size and stock market liquidity.
Domestic investment, human capital and FDI inflow are run
with all the above groups.
21
Author's own calculations based on UNCTAD statistics FDI
inflows data to Arab Leagues states.
22
In 2008, due to the global financial crisis, oil prices declined by
US$33 to level of US$61 per barrel (http://www.opec.org).
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How to cite this article: Aziz OG. FDI inflows
and economic growth in Arab region: The
institutional quality channel. Int J Fin Econ. 2020;
1–16. https://doi.org/10.1002/ijfe.2197
16 AZIZ

TABLE A1 Data definition and sources

Variable Definition Sources

GDP growth Annual real GDP growth rate. GDP growth is in percentage. World Bank, World Development Indicators
FDI inflows Annual net inflows in US$. FDI inflows is in natural World Bank, World Development Indicators
logarithm.
Gross Domestic Annual growth rate of gross capital formation based on World Bank, World Development Indicators
investment constant local currency.
Human capital Annual percentage growth rate of population World Bank, World Development Indicators
Exchange rate Official exchange rate (LCU per US$, period average). World Bank, World Development Indicators
Inflation Annual percentage rate of change in CPI. World Bank, World Development Indicators
Government General government final consumption expenditure as World Bank, World Development Indicators
consumption percentage of GDP.
Trade openness Sum of exports and imports of goods and services as World Bank, World Development Indicators
percentage of GDP.
Natural resources Total natural resources rent as percentage of GDP. World Bank, World Development Indicators
Global financial crisis Dummy equal to 1 for years 2009, 2010 and 2011 and zero Author's own calculations.
(GFC) otherwise.
WTO member Dummy equal to 1 from the year that Arab country joined Author's own calculations
the WTO, otherwise 0.
Liquid liabilities (M2) Average annual growth rate in money and quasi money World Bank, World Development Indicators
(percentage).
Bank size The growth rate of total bank deposits. Bank size is in Arab Monetary Fund (AMF)
percentage.
Bank credit Domestic credit to private sector by banks as percentage of World Bank, World Development Indicators
GDP.
Stock market size Stock market capitalization of listed companies as World Bank, World Development Indicators
percentage of GDP.
Stock market liquidity Total value of shares traded divided by the average market World Bank, World Development Indicators
capitalisation (percentage).
Doing business An index represents the quality of the regulatory Author's own calculations based on doing
environment as it applies to local enterprises. Higher business database, World Bank
score indicates higher ease of doing business (natural
logarithm).
FDI inflows × Doing Interaction term between FDI inflows and doing business Author's own calculations based on the two
business index. variables
Economic freedom An index measures the degree to which policies and Author's own calculations based, the Fraser
institutions of countries are supportive of economic Institute
freedom. Higher score indicates higher economic freedom
(natural logarithm).
FDI inflows × Economic Interaction term between FDI inflows and economic Author's own calculations based on the two
freedom freedom index. variables
Government stability Government's ability to carry out its declared programs and ICRG political risk index
its ability to stay in office. It ranges from 0 to 12. A lower
score indicates higher risk and vice versa.
Law and order Measure for the strength and impartiality of the country's ICRG political risk index
judicial system. It ranges from 0 to 6. A lower score
indicates higher risk and vice versa.
Corruption Measure of inherent corruption within the political system. ICRG political risk index
It ranges from 0 to 6. A lower score indicates higher risk
and vice versa.