Foreign Direct Investment and Economic Growth: A Cross-Country Analysis

It is generally acknowledged that domestic investment boosts economic growth, yet the impact of foreign direct investment (FDI) is not as clear, with some studies suggesting the need for a miniumum threshold level of development in order for FDI to be beneficial. In this paper we conduct an empirical cross-country growth analysis to investigate the impact over two decades, of foreign direct investment at the ‘aggregate’ level, and find that it has a significant and positive relationship with real income per capita, irrespective of any human capital requirements. An interesting observation is that the coefficient on the foreign investment variable is considerably larger than that of the domestic investment variable, suggesting a potentially large role for FDI. However, the problem of establishing the direction of causality, compounded by the unavailability of suitable instrumental variables, remains. Thus, at this point, we go no further than concluding that there is indeed, a large and positive relationship between foreign direct investment and economic growth.