Measuring Spillovers from Alternative Forms of Foreign Investment

Much of the endogenous growth literature has dwelled on evaluating the spillover effects of trade on growth, but much less efforts have been directed towards tracing and quantifying the spillover effects of foreign investments. This paper, in incorporating the effects of various types of foreign investments, namely foreign direct investment (FDI), foreign portfolio investment (FPI) and other foreign investment (OFI) fills this gap in the literature. Adopting the stochastic frontier approach, this paper constructs an OECD frontier based on a panel dataset of 20 OECD countries over the 1981-2000 period. Spillover effects of FDI, FPI, OFI and trade are gauged by their respective contributions towards reducing technical inefficiencies, which are represented by the distance of each country from the constructed frontier. Results from the multiple models examined in the paper indicate that inflows of foreign investment and trade have been instrumental in reducing inefficiencies across OECD countries, whereas outflows of foreign investment exacerbate inefficiencies. The study also confirms some previous findings that the spillover effects of FDI inflows are larger than that of trade but does not find evidence in favour of the view that the spillover effects of trade are overestimated when FDI flows are excluded from the analysis. Moreover, the impact of FDI inflows is larger than those of FPI and OFI inflows. The importance of absorptive capacities of host economies in capturing spillover gains from FDI inflows is also examined. Amongst the various measures of absorptive capacity considered, only human capital was found to be important.