The role of institutional quality in FDI inflows and carbon emission reduction: evidence from the global developing and belt road initiative countries

Abstract

Achieving economic growth is the primary concern mostly of every country to enhance living standard; however, an increase in economic activities may have environmental consequences. Foreign direct investment is also considered a driver of economic growth while it affects the quality of environment. The role of institutions can be useful to enhance foreign direct investment (FDI) inflow which can in turn increase economic growth and safeguard environmental quality. Based on the ongoing debate, this study attempts whether the quality of institutions plays any role in FDI inflow and in enhancement of environmental quality. For this purpose, this study examines the role of institutional quality in FDI inflows and carbon emission reduction in the global panel, 107 world developing, and 39 Belt and Road Initiative countries for the period of 2002-2019. By using both static and dynamic panel models, the results indicate that governance indicators are important for FDI inflows, but this impact varies in different panels. Overall, institutional quality has a significant and positive impact on foreign direct investment inflow, while energy use reduces it in all panels. Economic growth positively associated with carbon emission, while the square of GDP evidences the environmental Kuznets curve. FDI and trade increase global and developing countries' emissions, while reducing emission in Belt and Road countries. Institutional quality along individual indicators, political stability, rule of law, and regulatory quality are found to be poor governance indicators in all panels, while voice and accountability and control of corruption are weak indicators in Belt and Road countries; however, the interaction term proves that the quality of institutions is regulated by financial development and FDI in carbon emission reduction in all panels. This study has considerable policy significance for countries to carry out strong policy reforms to increase green FDI and improve environmental quality.

Keywords: Environmental quality; Financial development; Foreign direct investment; Institutional quality.