Institutional quality, FDI effectiveness, and economic growth in the Gambia

Abstract

This study investigates the dynamic relationship between foreign direct investment (FDI), institutional quality, and economic growth in The Gambia, a small, low-income economy in Sub-Saharan Africa. While FDI is widely regarded as a catalyst for development, its effectiveness is often contingent on the institutional environment of the host country. To estimate the long-run relationship and examine whether institutional quality enhances the effect of FDI on economic growth, this study employs Dynamic Ordinary Least Squares (DOLS), Fully Modified Ordinary Least Squares (FMOLS), and Autoregressive Distributed Lag (ARDL) using annual data from 1996 to 2023. The results confirm that both foreign direct investment (FDI) and institutional quality exert a statistically significant and positive influence on economic growth. However, the interaction term between FDI and institutional quality is statistically insignificant, even after addressing multicollinearity concerns through mean-centering, indicating that institutional quality does not meaningfully moderate the FDI-growth relationship in the Gambian context. These findings highlight the independent roles of FDI and institutional quality in promoting growth, while also highlighting the limitations of existing institutional frameworks in enhancing the developmental impact of FDI. Human capital is identified as a key driver of economic growth, while trade openness shows a negative association. This may reflect structural challenges such as a narrow export base, high import dependency, and limited industrial capacity, which constrain the economy’s ability to benefit from trade. In fragile contexts like the Gambia, openness can intensify trade deficits and external vulnerabilities without enhancing productivity. Policy recommendations include strengthening the quality of institutions through both traditional governance reforms and modern technology-enabled solutions, investing in human capital, promoting export competitiveness, and attracting high-quality FDI to support inclusive and sustained economic growth.