Foreign direct investment and the domestic capital stock: the good–bad role of higher institutional quality

We investigate heterogeneity between foreign direct investment (FDI) and domestic investment induced by corruption and human capital. Controlling for corruption and human capital, inbound FDI has significant, heterogeneous complementarity effects on domestic investment; the effect of outbound FDI on domestic investment is fluid: substitution and complementarity exist, and change direction over time. The fluid effects of outbound FDI oppose the popular dollar-for-dollar hypothesis. Although lower corruption and higher human capital strengthen, weaken, or do not change the degree of these FDI effects, the data are inconsistent with the hypothesis of a global optimum for corruption or human capital. Corruption and human capital do not appear to be binding constraints in all countries. The role of institutional quality appears consistent with the prediction of the General Theory of Second Best.