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

Foreign direct investment (FDI) is widely viewed as a potential source of growth, especially in developing economies, yet its growth effects vary substantially across host-country contexts. This study examines how six theoretically derived absorptive-capacity conditions—inflation, public debt, trade openness, political openness, financial development, and economic freedom—shape the FDI-growth nexus in a heterogeneous panel of 87 countries spanning low- to high-income economies over 2001–2021. Baseline two-step System GMM estimates indicate a positive FDI-growth association and identify economic freedom as the most consistently positive moderator and public-debt change as the most consistently negative moderator. Sensitivity analyses confirm the central economic-freedom result across pre-COVID, alternative lag-depth, stricter-endogeneity, harmonized-transformation, and Driscoll-Kraay specifications. The public-debt interaction is also negative across most specifications but becomes statistically insignificant when all moderator changes are specified using a common simple percentage-change transformation. Similarly, the reference FDI-growth coefficient, while positive across the baseline and most sensitivity models, loses statistical significance under the stricter-endogeneity specification, underscoring that these results should be read as evidence on conditional relationships rather than as unconditional causal estimates. Trade openness receives conditional support, political openness remains tentative, and inflation and financial development receive no robust moderation support. Formal slope-homogeneity tests reject homogeneous FDI/moderation slopes across countries, reinforcing a cautious, evidence-weighted interpretation. The findings suggest that attracting FDI alone is insufficient: host-country institutions and macroeconomic conditions shape how foreign capital is converted into growth.