Differential Effects of Foreign Direct Investment in East Asia and Other Developing Areas

Abstract:     
This paper compares the effects of foreign direct investment (FDI) inflows to a group of six East Asian economies and a control group of 11 other developing economies. The paper starts by estimating the contemporaneous and lagged effects of FDI in East Asia on capital formation, national saving, imports, exports and economic growth in a five-equation macroeconomic model. Dynamic simulations indicate that, despite the fact that FDI increases domestic investment, the positive direct and indirect (through accelerated growth) effects of FDI on national saving actually leads to an improvement in the current account in the long run. An increase in FDI from zero to 10 percent of GNP worsens the current account from-0.6 percent of GNP to-6.4 percent of GNP in the short run, but improves the current account by +7.6 percent of GNP in the long run. This paper then shows that both the nature and the effects of FDI flows vary significantly between different regions of the developing world. Outside East Asia, FDI has not increased aggregate domestic investment or economic growth. When the sample countries of the control group attracted more FDI inflows, national saving, domestic investment, and the rate of economic growth all declined. Hence, FDI appears to have been immiserizing in these countries. The paper concludes by pinpointing financial sector and foreign exchange distortions as the key variables accounting for the differential impacts of FDI in these two country groups.

JEL Classification: F21, F32, O5

working papers series