Foreign Direct Investment and Spillovers: Gradualism May Be Better

30 Pages Posted: 3 Dec 2004

See all articles by Klaus Desmet

Klaus Desmet

Southern Methodist University (SMU); Centre for Economic Policy Research (CEPR)

Juan Rojas

European Stability Mechanism

Multiple version iconThere are 2 versions of this paper

Date Written: October 2004


The standard argument says that in the presence of positive spillovers foreign direct investment should be promoted and subsidized. In contrast, this Paper claims that the very existence of such spillovers may require temporarily restricting and taxing inward FDI. Our argument in favor of gradual liberalization is based on two stylized features of spillovers: first, technology transfers - and subsequent spillovers - are limited by the economy's absorptive capacity; and second, spillovers take time to materialize. By letting in capital more gradually, initial investment has the time to create spillovers - and upgrade the economy's absorptive capacity - before further investment occurs. This allows subsequent capital inflows to benefit from greater technology transfers. As a result, the economy converges to a steady state with a superior technology and a greater capital stock.

Keywords: Foreign direct investment, gradualism, big bang, spillovers, liberalization, absorptive capacity, transition economies

JEL Classification: F20, O30, P20

Suggested Citation

Desmet, Klaus and Rojas, Juan, Foreign Direct Investment and Spillovers: Gradualism May Be Better (October 2004). CEPR Discussion Paper No. 4660. Available at SSRN:

Klaus Desmet (Contact Author)

Southern Methodist University (SMU) ( email )

6212 Bishop Blvd.
Dallas, TX 75275
United States

Centre for Economic Policy Research (CEPR)

United Kingdom

Juan Rojas

European Stability Mechanism ( email )

6a Circuit de la Foire Internationale

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