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Foreign direct investment in a macroeconomic framework : finance, efficiency, incentives, and distortions

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  • Fry, Maxwell J.
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    Abstract

    Does foreign direct investment (FDI) increase domestic investment, or does it provide additional foreign exchange for a pre-existing current account deficit, or some linear combination of the two? The author investigates this question for a group of five Pacific Basin countries and a control group of 11 other developing countries. For the sample of all 16 developing countries, the author finds that FDI does not provide additional balance of payments financing for a pre-existing current account deficit. In the control group of 11 developing countries, FDI is associated with reduced domestic investment - implying that FDI to those countries is simply a close substitute for other capital inflows. For the five Pacific Basin market economies, however, FDI raises domestic investment by the full extent of the FDI inflow. The author finds that FDI has a significantly negative impact on national saving in the sample of all 16 developing countries. For the control group, this negative effect is similar in magnitude to FDI's negative effect on domestic investment - implying a zero effect on the current account. But FDI's negative effect on national saving in the five Pacific Basin developing market economies implies that FDI could have more of a negative effect on the current account than through increased domestic investment alone. The author also investigates the impact of FDI on economic growth in these 16 countries, taking into account distortions in the economies. He estimates reduced-form current account equations, and presents an analytical framework for estimating FDI's effect on economic growth in the presence of incentive-disincentive packages and other economic distortions. He illustrates his framework using indicators of foreign trade and financial distortions. His main conclusion: the effect of FDI differs markedly from one group of countries to another. FDI has a negative effect on economic growth in the control group. It has the same positive effect on growth as domestically financed investment does in the Pacific Basin countries. The main cause for the different effect is the low level of distortion in the Pacific Basin countries.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1141.

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    Date of creation: 31 May 1993
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    Handle: RePEc:wbk:wbrwps:1141

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    Related research

    Keywords: Environmental Economics&Policies; Economic Theory&Research; Foreign Direct Investment; International Terrorism&Counterterrorism; Macroeconomic Management;

    References

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    1. Rudiger Dornbusch & Yung Chul Park, 1987. "Korean Growth Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 18(2), pages 389-454.
    2. Fry, Maxwell J., 1989. "Foreign debt instability: an analysis of national saving and domestic investment responses to foreign debt accumulation in 28 developing countries," Journal of International Money and Finance, Elsevier, vol. 8(3), pages 315-344, September.
    3. Feder, Gershon, 1983. "On exports and economic growth," Journal of Development Economics, Elsevier, vol. 12(1-2), pages 59-73.
    4. Alan S. Blinder & Joseph E. Stiglitz, 1983. "Money, Credit Constraints, and Economic Activity," NBER Working Papers 1084, National Bureau of Economic Research, Inc.
    5. Agarwal, Jamuna Prasad & Gubitz, Andrea & Nunnenkamp, Peter, 1991. "Foreign direct investment in developing countries : the case of Germany," Open Access Publications from Kiel Institute for the World Economy 423, Kiel Institute for the World Economy (IfW).
    6. Haddad, Mona & Harrison, Ann, 1993. "Are there positive spillovers from direct foreign investment? : Evidence from panel data for Morocco," Journal of Development Economics, Elsevier, vol. 42(1), pages 51-74, October.
    7. Faini, Riccardo & de Melo, Jaime, 1990. "Adjustment, investment, and the real exchange rate in developing countries," Policy Research Working Paper Series 473, The World Bank.
    8. Cockcroft, Laurence & Riddell, Roger C., 1991. "Foreign direct investment in sub-Saharan Africa," Policy Research Working Paper Series 619, The World Bank.
    9. Assaf Razin & Joel Slemrod, 1990. "Taxation in the Global Economy," NBER Books, National Bureau of Economic Research, Inc, number razi90-1.
    10. Fry, Maxwell J., 1993. "Foreign debt accumulation: financial and fiscal effects and monetary policy reactions in developing countries," Journal of International Money and Finance, Elsevier, vol. 12(4), pages 347-367, August.
    11. Venkataraman Balasubramanyam, 1984. "Incentives and disincentives for foreign direct investment in less developed countries," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 120(4), pages 720-735, December.
    12. Fry, Maxwell J., 1980. "Money, interest, inflation and growth in Turkey," Journal of Monetary Economics, Elsevier, vol. 6(4), pages 535-545, October.
    13. D. F. I. Folkerts-Landau & Donald J. Mathieson & Morris Goldstein & Liliana Rojas-Suárez & José Saúl Lizondo & Timothy D. Lane, 1991. "Determinants and Systemic Consequences of International Capital Flows," IMF Occasional Papers 77, International Monetary Fund.
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    Cited by:
    1. Chuhan, Punam & Claessens, Stijn & Mamingi, Nlandu, 1998. "Equity and bond flows to Latin America and Asia: the role of global and country factors," Journal of Development Economics, Elsevier, vol. 55(2), pages 439-463, April.
    2. Adams, Samuel, 2008. "Globalization and income inequality: Implications for intellectual property rights," Journal of Policy Modeling, Elsevier, vol. 30(5), pages 725-735.
    3. Arslan Razmi, 2005. "The Effects of Export-Oriented, FDI-Friendly Policies on the Balance of Payments in a Developing Economy: A General Equilibrium Investigation," UMASS Amherst Economics Working Papers 2005-03, University of Massachusetts Amherst, Department of Economics, revised Sep 2006.

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