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Saturday, 2 July 2011

FDI and Growth

The relationship between foreign direct investment (FDI) and economic growth remains ambiguous. Since the publication of the seminal paper by Barro & Sala-i-Martin (1992) on the determinants of economic growth many thought it would be easy to show that FDI has a positive effect on the economic growth rate of recipient countries. To the surprise and disappointment of many no sound and robust evidence has been found. The latest to have a go is Cipollina et al in their paper FDI and growth: What cross-country industry data say :
In this paper we provide evidence that FDI have a positive and statistically significant growth effect in recipient countries, using a panel of 14 manufacturing sectors for (a sample of) developed and developing countries over the period 1992 -2004. Moreover, we find that this effect is stronger in capital intensive and in technologically advanced sectors, highlighting the importance of sector characteristics.

We find that the growth enhancing effect comes primarily from an increase in total factor productivity (TFP) and from capital accumulation. FDI not only contribute to physical capital accumulation, but also generate positive technological spillovers. Our results are robust to the inclusion of other determinants of economic growth. We also address the issue of potential endogeneity and results are confirmed. Policy implications of our findings are important, especially for developing countries, where the growth enhancing promotion of foreign investment in capital intensive and technologically advanced sectors is at the heart of the debate.
This result is actually not new – it is now well established FDI is more effective where countries are able to harness the technological spillovers. The issue of “sector characteristics” perhaps require more unpacking. In general the big question is how domestic industries are augmented to take advantage of such inflows. It is of course possible that this is easier to do for some sectors than others. But also the question of returns to investment in new capabilities may be higher in some sectors than others. What is clear is that it’s not just a question of the volumes of FDI as we are repeatedly fooled by politicians. The benefits of FDI are not inevitable. This largely explains the current gap between economic growth fuelled by FDI (on paper) and actually poverty reduction which comes through empowerment of the domestic contingent. 

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