Foreign investment’s association with growth varies across national conditions

Foreign direct investment was associated with economic growth in a panel of 87 countries from 2001 to 2021, but the relationship differed according to national conditions. A study using two-step System GMM estimates found that economic freedom was the most consistently positive moderator of the investment-growth relationship, while changes in public debt were the most consistently negative moderator. These are conditional associations, not unconditional causal estimates of foreign investment’s effect on growth.

The analysis included a heterogeneous group of countries spanning low- to high-income economies. Researchers examined six theoretically derived measures of absorptive capacity: inflation, public debt, trade openness, political openness, financial development and economic freedom. Baseline estimates showed a positive FDI-growth association, although the reference FDI coefficient lost statistical significance under a stricter specification addressing endogeneity.

That sensitivity means the main relationship should not be interpreted as proof that attracting foreign capital by itself produces faster growth. Economic freedom provided the study’s clearest moderation result. The researchers identified it as the most consistently positive moderator, rather than the only positive condition, and reported that the result persisted across several checks.

The finding held in analyses using a pre-COVID sample, alternative lag depths, stricter endogeneity controls, harmonized transformations and Driscoll-Kraay specifications. The result therefore had broader support across model choices than the findings for several other conditions. Public-debt change was the most consistently negative moderator in the baseline analysis.

The negative interaction suggested that the FDI-growth relationship tended to be weaker where public debt was increasing. This result was not equally stable: the public-debt interaction became statistically insignificant when all moderator changes were specified using a common simple percentage-change transformation. Its role is consequently more dependent on the model specification than the economic-freedom result.

Trade openness received conditional support in the analysis, meaning that the relationship between foreign direct investment and growth could vary with the degree of openness to international trade. Political openness had only tentative support. Inflation and financial development did not receive robust moderation support.

Together, these findings indicate that the six proposed conditions did not contribute equally to the statistical pattern observed across the country panel. The researchers also conducted formal slope-homogeneity tests, which rejected homogeneous FDI and moderation slopes across countries. In statistical terms, the same relationship could not adequately describe every country in the panel.

This result is consistent with the broader finding that national context matters, although the rejected homogeneity assumption alone does not identify why the relationships differed or establish a causal mechanism. The study has important limits for interpretation. Its panel design combines many countries with different income levels and institutional settings, and several results changed under alternative specifications.

The results therefore do not establish that any particular national condition would generate the same investment-growth pattern in every developing economy. The defensible conclusion is that attracting foreign direct investment alone may be insufficient for the investment to coincide with stronger economic growth. Institutional and macroeconomic conditions appear to shape that relationship, with economic freedom showing the strongest cross-specification support and public-debt change producing the clearest negative baseline moderation signal.

Trade openness and political openness remain more tentative, while inflation and financial development lack robust moderation evidence.

Subject of Research: How national conditions moderate the relationship between foreign direct investment and economic growth in an 87-country panel.

Article Title: Determinants of the relationship between foreign direct investment and economic growth in developing countries

Article References: Dao, T. B. T., & Khuc, V. Q. (2026). Determinants of the relationship between foreign direct investment and economic growth in developing countries. Discover Sustainability. https://doi.org/10.1007/s43621-026-04761-x

Image Credits: AI Generated

DOI: 10.1007/s43621-026-04761-x

Keywords: foreign direct investment, economic growth, economic freedom, public debt, trade openness, political openness, financial development, inflation, panel data, developing countries, Determinants, relationship