The Differential Impact of Public and Private Governance Institutions on Foreign Investment

What is it about?

This paper examines the respective impacts of public and private governance institutions on foreign direct and foreign portfolio investment inflows. We present two hypotheses: (1) there is a strong correlation between the quality of a country’s public governance institutions and the amount of foreign direct investment (FDI) received while the quality of its private governance institutions has no further discernible impact on this correlation; (2) there is a strong correlation between the quality of a country’s public governance institutions and the amount of foreign portfolio investment (FPI) received while the quality of its private governance institutions has a further positive impact on this correlation. Our findings, which are based on panel data analysis, show both hypotheses to be valid.

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Why is it important?

Several authors have argued that account must be taken of the fact that there are two distinct modes of foreign investment that react differently to host countries’ governance institutions. While this argument is absolutely correct it does not go far enough inasmuch as in addition to the distinction between different types of foreign investment two further distinctions need to be made when analysing international capital flows, namely, those between different types of agent and between different types of governance institution. Our empirical results suggest that foreign investors have different economic functions and therefore make different demands on a country’s governance environment: MNCs who primarily engage in foreign direct investments for production related purposes are mainly interested in the strength of a recipient country’s public governance institutions, while IAMs who typically engage in foreign portfolio investments for asset management reasons will look closely at the strength of all of a recipient country’s governance institutions, public and private.