Does Foreign Aid Increase Foreign Direct Investment?

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 infrast...

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Bibliographic Details
Published in:World development 2012-11, Vol.40 (11), p.2155-2176
Main Authors: Selaya, Pablo, Sunesen, Eva Rytter
Format: Article
Language:English
Subjects:
aid effectiveness
Capital investments
Capital transfers
Development aid
Foreign aid
Foreign capital
foreign capital for development
Foreign direct investment
foreign direct investment (FDI)
Foreign investment
Private investment
Productivity
Studies
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Summary: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.
ISSN:0305-750X
1873-5991
DOI:10.1016/j.worlddev.2012.06.001