Does Fiscal Policy Impede FDI Inflows in Advanced Economies? The Role of Institutional Quality

The relationship between fiscal policy and foreign direct investment (FDI) inflows in advanced economies remains debated due to a lack of comprehensive studies on this topic. Notably, no research has explored how institutional quality moderates the fiscal policy–FDI nexus in these countries. This paper addresses these gaps by employing the difference GMM Arellano-Bond estimators (one-step and two-step) to examine the effects of fiscal policy, institutional quality, and their interaction on FDI inflows in 37 advanced economies from 2002 through 2022. Our findings reveal intriguing dynamics. While fiscal policy and institutional quality reduce FDI inflows, their interaction increases them. In addition, market size and trade openness are identified as key drivers of FDI, whereas inflation exerts a negative impact. These results offer valuable policy insights for governments in advanced economies, emphasizing the need for carefully calibrated fiscal policies and institutional reforms to attract more FDI inflows.