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Does Foreign Aid Increase Foreign Direct Investment?

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  • Selaya, Pablo
  • Sunesen, Eva Rytter

Abstract

We examine the idea that aid and foreign direct investment (FDI) are complementary sources of foreign capital. We argue that the relationship between aid and FDI is theoretically ambiguous: aid raises the marginal productivity of capital when used to finance complementary inputs (like public infrastructure and human capital investments), but aid may crowd out private investments when it comes in the shape of pure physical capital transfers. Empirically, we find that aid invested in complementary inputs draws in FDI, while aid invested in physical capital crowds it out. The paper shows that the composition of aid matters for its overall level of efficiency.

Suggested Citation

  • Selaya, Pablo & Sunesen, Eva Rytter, 2012. "Does Foreign Aid Increase Foreign Direct Investment?," World Development, Elsevier, vol. 40(11), pages 2155-2176.
  • Handle: RePEc:eee:wdevel:v:40:y:2012:i:11:p:2155-2176 DOI: 10.1016/j.worlddev.2012.06.001
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    More about this item

    Keywords

    development aid; foreign direct investment (FDI); foreign capital for development; aid effectiveness;

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F35 - International Economics - - International Finance - - - Foreign Aid
    • H40 - Public Economics - - Publicly Provided Goods - - - General
    • O19 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - International Linkages to Development; Role of International Organizations

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