Growth and the Quality of Foreign Direct Investment: Is All FDI Equal

43 Pages Posted: 18 Apr 2007

See all articles by Laura Alfaro

Laura Alfaro

Harvard University

Andrew Charlton

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Date Written: May 2007

Abstract

In this paper we distinguish different qualities of FDI to re-examine the relationship between FDI and growth. We use "quality" to mean the effect of a unit of FDI on economic growth. However, this is difficult to establish because it is a function of many different country and project characteristics which are often hard to measure. Hence, we differentiate quality FDI in several different ways. First, we look at the possibility that the effects of FDI differ by sector. Second, we differentiate FDI based on objective qualitative industry characteristics including the average skill intensity and reliance on external capital. Third, we use a new dataset on industry-level targeting to analyze quality FDI based on the subjective preferences expressed by the receiving countries themselves. Finally, we use a two-stage least squares methodology to control for measurement error and endogeneity. Exploiting a new comprehensive industry level data set of 29 countries between 1985 and 2000, we find that the growth effects of FDI increase when we account for the quality of FDI.

Keywords: foreign direct investment, economic growth, industry data, spillovers, instrumental variables

JEL Classification: F23, F36, F43, O40

Suggested Citation

Alfaro, Laura and Charlton, Andrew, Growth and the Quality of Foreign Direct Investment: Is All FDI Equal (May 2007). HBS Finance Working Paper No. 07-072, Available at SSRN: https://ssrn.com/abstract=981163 or http://dx.doi.org/10.2139/ssrn.981163

Laura Alfaro (Contact Author)

Harvard University ( email )

Cambridge, MA 02138
United States

Andrew Charlton

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

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