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Into the Allocation Puzzle - A Sectoral Analysis

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This paper assesses whether the allocation puzzle - the tendency for capital to flow to countries with relatively low productivity growth - is observed for foreign direct investment (FDI) flows, which should be particularly sensitive to productivity prospects. We look both at aggregate FDI flows and, using a new data set, at FDI flows into the main economic sectors. We make three points. First, we do not find evidence of an allocation puzzle for aggregate FDI flows. Second, we refine the aggregate result and document substantial sectoral heterogeneity. An allocation puzzle is observed in the agriculture, construction, mining/petroleum/utilities and tourism sector. By contrast, we show that countries with faster productivity growth in manufacturing attract more investment in that sector. The link is even stronger for service sectors. Third, we document a role for financial openness: a country with fast productivity growth draws in more FDI into its service sectors only when it is financially open. We conclude with a discussion of some tentative explanations for the results.

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Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 10.02.

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Length: 39 pages
Date of creation: Oct 2010
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Handle: RePEc:szg:worpap:1002

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Cited by:
  1. Luca Antonio Ricci & Thierry Tressel & Dennis B. S. Reinhardt, 2010. "International Capital Flows and Development," IMF Working Papers, International Monetary Fund 10/235, International Monetary Fund.
  2. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Saeed Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows," IMF Staff Position Notes, International Monetary Fund 2010/04, International Monetary Fund.
  3. Salvatore Dell’Erba & Dennis Reinhardt, 2011. "Surfing the Capital Waves: A sector-level examination of surges in FDI inflows," Working Papers, Swiss National Bank, Study Center Gerzensee 11.07, Swiss National Bank, Study Center Gerzensee.
  4. Dennis Reinhardt & Luca Antonio Ricci & Thierry Tressel, 2012. "International Capital Flows and Development - Financial Openness Matters," IHEID Working Papers, Economics Section, The Graduate Institute of International Studies 11-2012, Economics Section, The Graduate Institute of International Studies.

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