In this study, we investigate whether outbound foreign direct investment (OFDI) either augments or impedes domestic public and private investment, incorporating the role of institutional quality into the context of developed and emerging countries. To this end, we apply a cross-sectional-autoregressive-distributed lag (CS-ARDL) approach to analyze panel data from the period 1996–2017. Our empirical findings suggest that OFDI augments private capital formation for developed countries. Institutional quality (IQ) is found to be a driving factor that promotes private capital formation in the established economies of developed countries. However, OFDI has a negative association with the public capital formation in the established economies of developed countries, while IQ has a positive association with it. In the context of emerging economies, OFDI is found to be too insignificant to have an effect on private and public capital formation. Interestingly, IQ has a detrimental effect on both private and public capital formation in emerging economies. Our findings are robust. The empirical findings of this study imply that institutional quality should continue to be improved in developed countries, while it should surpass a certain threshold for emerging economies to promote domestic capital formation.

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We explore whether foreign direct investment outflows augment or obstruct public or private capital in developing countries by decomposing domestic capital into private and public capital. While developed countries are the primary source of foreign direct investment outflows (FDIOs), developing economies have become the primary source of FDIO over the past 30 years. We apply cross-sectional autoregressive distributed lag (CS-ARDL) methods to overcome the issue of endogeneity and cross-sectional dependency in our dataset. This study analyzes the interaction effects of foreign direct investment and institutional quality (IQ) in promoting aggregate domestic capital formation in developing countries. Our empirical results show that FDI outflows augment private capital formation and additionally, IQ also upsurges private capital formation. Conversely, as per results, FDI outflows obstruct public capital formation, and IQ crowds out public capital formation significantly while private capital crowds out FDI inflows. As per result estimations, we notice that FDIO crowds in private capital formation, thus we conclude that the private sector controls the majority of the sectors for developing countries and the role of the public sector is quite minimal. We conclude that private and public capital possess different attributes; thus clubbing them together might result in aggregation bias. Our result estimations provide several useful policy implications.