The Role of CESEE Countries
Edited by Marek Belka, Ewald Nowotny, Pawel Samecki and Doris Ritzberger-Grünwald
Chapter 2: Harnessing foreign direct investment to boost economic growth
In response to the financial crisis that emerged in 2008, many governments have been looking for ways to restart economic growth. This chapter argues that inflows of foreign direct investment (FDI) may help both advanced and middle-income countries achieve this objective by boosting local research and development activities and by bringing in knowledge and know-how produced elsewhere. The link between FDI and economic growth was documented a while ago by studies relying on cross-country regressions. In a very widely cited paper, Borensztein et al. (1998) utilize data on FDI flows from industrial countries to 69 developing countries over two decades. They find that FDI contributes to growth to a larger extent than domestic investment. They also show that the contribution of FDI to economic growth is enhanced by its interaction with the level of human capital in the host country. Their results imply that FDI is more productive than domestic investment only when the host country has a minimum threshold stock of human capital. They find no evidence of FDI crowding out domestic investment. Subsequent work in a cross-country setting by Alfaro et al. (2004) has demonstrated that FDI alone plays an ambiguous role in contributing to economic growth, but that countries with well-developed financial markets gain significantly from FDI.
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