Do natural resources and foreign direct investment tend to erode or support the development of national institutions?

Abstract

This paper explores the relationships between natural resources, foreign direct investment (FDI) and the quality of national institutions, also known as “the rules of the game”. Using a data set of 69 developing countries over the period 1970–2015 to estimate a dynamic panel data model, we find negative and significant effects of natural resources use or extraction on the development of national institutions. We focus on legal and property rights, but these findings also apply to the quality of some other national institutions. Our results align with a theory that abundant natural resources lead to weakened institutions because of the potential for firms to secure monopoly rents. Furthermore, we find that the effects of FDI inflows on institutional development are not robust to controlling for natural resources rents. This suggests that the latter tend to erode institutions regardless of whether those resources are exploited alongside increased foreign investment into the local economy.