Foreign Capital Flows and Human Development in Developing Countries: Does Institutional Quality Matter?

The impact of foreign capital on human development has been at best ambiguous, while that of institutions is undoubtedly favorable. That said, the way foreign capital relates to human development may be affected by the quality of institutions. This paper assesses this very phenomenon in 65 developing countries over the time period 1984-2014. In this regard, this study incorporates three indicators of human development namely, per capita income (PCI), Secondary School Enrollment (SSE) and Life Expectancy (LE). Using two step system GMM estimation technique, we found that the impact of foreign capital varies with respect to the indicators of human development and the type of foreign capital being studied. Both FDI and FPI negatively affect per capita income and secondary school enrollment, while, remittances affect all the indicators of human development positively, except for life expectancy. The interaction between institutions and each type of foreign capital flow exerts a positive influence on all indicators of human development. However, this positive interaction fails to completely eliminate the adverse influence of the capital flows, which reflects inadequacy of existing institutional quality in developing countries and the need for institutional reforms.