Foreign direct investment in developing countries: productivity growth, dual economies, and location determinants

Abstract

This study revisits the role of Foreign Direct Investment (FDI) in developing countries along two dimensions. First, we empirically analyze the impact of FDI on productivity growth in 30 developing countries for the period 1970 to 2010. We, however, depart from previous studies on the FDI-growth nexus because our approach allows us to focus on the contribution of FDI to aggregate productivity in a developing economy, while considering the reallocation of labor characterized by sizable differentials in the productivity of labor between sectors. When structural change is accounted for, something that previous growth models fail to do, we find interesting results for both regimes of absorptive capacities. Second, this study empirically re-examines the location determinants of greenfield FDI in developing countries. The work done here incorporates South-South FDI exchanges and empirically examines if FDI inflows from the South differ from those that originate in the North. This is done by employing a novel dataset, which is analyzed using an extended gravity equation. We find that FDI flows from the global North differs from those from the global South. On average, investors from the North enter a developing country seeking to benefit from factors that make them more competitive internationally. On the other hand, FDI from the South, on average, is motivated primarily by interests in accessing and exploiting natural resources. That is, North-South FDI is efficiency-seeking while South-South FDI is resource-seeking. We also show that geographical agglomeration plays an important role in attracting FDI from other developing countries as well. We conclude this study by discussing policy implications for home, host and regional countries.