The Growth Effects of Foreign Direct Investment

The potential benefits from foreign direct investment (FDI) are viewed as important, as technology transfers resulting from FDI can lead to higher productivity of domestic firms, thereby boosting a host country’s growth rate. Economists and policymakers in many developing economies thus believe firmly that FDI plays a key role in the economic convergence process; they expect that inward FDI can bring the introduction of new production processes, advanced knowledge, know-how, employee training, and better management practices. While the question of whether the growth effects of FDI are guaranteed has been discussed for a long time, the empirical evidence in the literature remains oddly inconclusive. One plausible explanation for the mixed findings is the initial differences between home and host countries, which might distort the positive externalities of FDI. But why might we expect these initial differences to matter? And is this explanation supported by the data?

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