When does foreign direct investment lead to inclusive growth?

Foreign direct investment (FDI) is widely considered among the most effective instruments for the promotion of economic development. However, not all FDI leads to inclusive economic growth, lifting the welfare of the poorest groups. This paper examines the conditions under which FDI can effectively...

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Bibliographic Details
Published in:World economy 2022-08, Vol.45 (8), p.2394-2427
Main Authors: Kang, Hyojung, Martinez‐Vazquez, Jorge
Format: Article
Language:English
Subjects:
Development strategies
Economic analysis
Economic development
Economic growth
FDI
Foreign companies
Foreign investment
Host country
inclusive growth
Infrastructure
Job creation
Lifting
manufacturing
Optimism
Service industries
Spillover effect
structural change
Welfare
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Summary:Foreign direct investment (FDI) is widely considered among the most effective instruments for the promotion of economic development. However, not all FDI leads to inclusive economic growth, lifting the welfare of the poorest groups. This paper examines the conditions under which FDI can effectively lead to inclusive growth. By using a fixed effects regression with annual data for 67 countries from 1990 to 2015, we find that FDI has a positive effect on inclusive growth when there is a sufficiently large manufacturing sector and infrastructure base in the host country. We also indirectly find that FDI has a positive effect on inclusive growth when the host country has a large service sector. These not very optimistic results emphasise the critical importance of the host country's absorptive capacity. A smaller technological or knowledge gap with the foreign firms is required for FDI to lead to more linkages and spillovers and ultimately job creation for the poor. The results cast doubt on development strategies that rely on FDI as a sufficient policy for inclusive growth.
ISSN:0378-5920
1467-9701
DOI:10.1111/twec.13236