Institutional trajectories and threshold effects in the relationship between FDI and growth: An application to the the WAEMU zone

Abstract The empirical validation of a significant relationship between institutional quality, Foreign Direct Investment (FDI) and growth in the West African Economic and Monetary Union (WAEMU) zone, characterized by notable institutional instability over the last three decades, is controversial. We propose an original study based on a principal component analysis (PCA) of the PRS Group Institutional Quality Database (ICRG PRS), comprising twelve variables, for six countries in the WAEMU zone over the period 1992-2017. The first three main dimensions allow us to identify converging institutional trajectories, associated with greater permanence of institutions, improvement in the nature of regimes, and the persistence of ambivalence in these processes. These first main dimensions are then used in a linear and then non-linear empirical modeling of the relationship between FDI and growth. We show the existence of a threshold effect associated with the position in the institutional permanence trajectory. In the regime of higher permanence, the favorable effect of FDI is reinforced, while that of the domestic determinants of growth is reduced, suggesting an extraversion dynamic of the determinants of growth. These results illustrate the complexity of the relationship between institutions and macroeconomic dynamics in countries characterized by unstable institutions, and the need to employ specific empirical strategies. JEL classification. C24, C38, E02, F21, O43.