Knowledge Diffusion and Financial Development Thresholds

Foreign direct investment (FDI) has grown strongly as a major form of international capital transfer over the past decades. Countries all over the world compete for direct investment flows, as they are considered less volatile than portfolio investment and are expected to spur long-term growth. The attraction of FDI flows depends inter alia on a number of host country attributes, including macroeconomic, geographical, and institutional variables. Additionally, the extent to which FDI inflows contribute to domestic productivity and long-term growth is conditional on characteristics that shape a countryÕs absorptive capacity. This paper uses country-level data from OECD economies over the 2005-2016 period to empirically gauge the effect that FDI inflows have on recipient country productivity and innovative performance. Furthermore, it examines the potential of threshold effects regarding the development of the host economy financial system insofar as the latter is considered a conducive force for spillover effects. In the vein of the trade-growth literature we measure the effect of the foreign R&D stock weighted by bilateral capital goods imports and FDI flows looking at Total Factor Productivity and Patents per population at the economy-level. The results indicate that the depth and efficiency of the destination country financial system provides a mediation mechanism for the realization of positive externalities associated with MNC presence. Most of the financial variables appear to facilitate knowledge spillovers above a certain threshold value irrespective of that being exogenously or endogenously determined. Finally, this exercise yields fruitful policy lessons for Greek economy. More specifically, the ongoing process of restructuring the stressed domestic financial system combined with the incremental completion of the Banking and Capital Markets Union at the EU level could serve as a conduit for speeding the catch-up process to the technological frontier.