Foreign Direct Investment, Externalities and Economic Growth in Developing Countries: Some Empirical Explorations

Foreign direct investment (FDI) emerged as the most important source of external resource flows to developing countries over the 1990s and has become a significant part of capital formation in those countries despite their share in the global distribution of FDI remaining small or even declining. FDI usually flows as a bundle of resources including, as well as capital, production technology, organizational and managerial skills, marketing know-how, and even market access through the marketing networks of multinational enterprises (MNEs) that undertake FDI. These skills tend to spill over to domestic enterprises in the host country. Therefore, FDI can be expected to contribute to growth (more than proportionately) compared to domestic investments in the host country. There is now a body of literature that has analysed the effect of FDI on growth in inter-country frameworks and another analysing knowledge spillovers to domestic enterprises from MNEs (see, for example, De Mello, 1997; Kumar and Siddharthan, 1997; Saggi, 2000, for recent reviews of the literature). However, the mixed findings reached by these studies on the role of FDI inflows in host country growth and on knowledge spillovers from MNEs suggest that these relationships are not unequivocal. A major reason for expecting a more favourable effect of FDI on growth is the externality of MNE entry for domestic firms.