The effect of FDI on economic growth and the importance of host country characteristics

Abstract

In spite of a large increase in FDI inflows to developing countries, the effect of FDI flows on economic growth remains confusing. The recent contribution of modern economic growth theories in general predicts that FDI can be the main catalyst of economic growth in the receiving countries. Empirical studies, however, produce ambiguous results, and suggest that the growth effects of FDI are conditional on the host country characteristics. The main purpose of this paper is to examine the growth-effect of FDI in a selected sample from developing countries from 1970 to 2005. Particularly, the paper examines the following specific research question: Does FDI contribute to economic growth in developing countries alone or does it depend on its initial conditions? By applying GMM panel data technique, the paper finds that that FDI has in general a positive impact on economic growth, but its magnitude depends on the host country conditions to achieve a economic growth and sustainable development. The results of this paper clearly show that domestic investment, human capital, infrastructure development, financial market development, trade openness and institution quality positively related to economic growth. The results also show that the technology gap is negatively related to economic growth Key words: Foreign direct investment, absorptive capacity, economic growth, GMM panel data framework, developing countries.