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Foreign Investment in Developing Countries: Does it Crowd in Domestic Investment?

  • Manuel Agosin
  • Roberto Machado

This paper assesses the extent to which foreign direct investment (FDI) in developing countries crowds in or crowds out domestic investment. The core of the paper is the development of a theoretical model for investment that includes a FDI variable and its estimation and testing with panel data for the period 1971-2000 and the three decades involved. The model is run for 12 countries in each of three developing regions (Africa, Asia and Latin America). The results indicate that, in all three developing regions, FDI has, at best, left domestic investment unchanged, and that there are several sub-periods for specific regions where FDI displaces domestic investment. In particular, there seems to be crowding out of domestic investment by FDI in Latin America. If these results are in fact correct, they suggests the need for policies to make FDI more effective in enhancing domestic investment in developing countries. The conclusion is that the effects of FDI on domestic investment are by no means always favourable, that simplistic policies towards FDI are unlikely to be optimal and, foremost, that more attention needs to be paid to economic policies that foster the domestic component of total investment.

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Article provided by Taylor & Francis Journals in its journal Oxford Development Studies.

Volume (Year): 33 (2005)
Issue (Month): 2 ()
Pages: 149-162

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Handle: RePEc:taf:oxdevs:v:33:y:2005:i:2:p:149-162
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  1. Rama, Martin, 1990. "Empirical investment equations in developing countries," Policy Research Working Paper Series 563, The World Bank.
  2. Eduardo Borensztein & Jose De Gregorio & Jong-Wha Lee, 1995. "How Does Foreign Direct Investment Affect Economic Growth?," NBER Working Papers 5057, National Bureau of Economic Research, Inc.
  3. Barro, R.J., 1989. "Economic Growth In A Cross Section Of Countries," RCER Working Papers 201, University of Rochester - Center for Economic Research (RCER).
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