Foreign direct investment and economic development: Theory and evidence

This dissertation consists of four essays on the theme of foreign direct investment. The first chapter is an introduction.;The second chapter examines the welfare and employment effects of foreign direct investment (FDI) on a small developing economy when capital is perfectly mobile between the various sectors. The model incorporates a visible feature of most developing economies, i.e., the phenomenon of rural-urban migration. Departing from conventional assumptions, the urban wage rate is endogenously determined as a function of both the unemployment and rural wage rates. This, combined with the assumption of capital mobility makes the model well-suited to a long-run analysis and distinguishes it from earlier studies. Our findings indicate that an influx of foreign capital reduces unemployment while welfare is unaffected. This contrasts with the conclusions of previous research and suggests that the governments of developing countries may in fact be making a conscious trade-off between unemployment reduction and welfare gain in the long-run, explaining thereby their ongoing attempts to attract foreign investment.;In the third chapter we turn to empirical evidence to analyze data on foreign investment flows and national accounts variables for developing and industrialized countries. We conduct a cross-country growth analysis to investigate the impact over two decades, of foreign direct investment at the 'aggregate' level. Contrary to previous findings, we find a significant, large and positive relationship between foreign direct investment and growth in income per capita. However, the problem of identifying the direction of causality, compounded by the unavailability of suitable instrumental variables, remains. Hence, we go no further than establishing the existence of this relationship.;Chapter four uses a case-study approach to address the problem of causality found in empirical analyses and to gain further insight into the channels through which foreign investment affects the economy. We examine in considerable detail two countries, Brazil and India, comparable in many respects including similar government polices but significantly different in their openness to FDI. We compare the performance of the two countries in income growth, exports and specific industries and conclude that foreign direct investment did indeed play an important role in the economic growth of Brazil and its success in industrializing, working mainly through the channels of technology transfer and export growth, while India suffered from its 'closed-door' policy to foreign investors.;Chapter five concentrates on further identifying the mechanisms by which foreign investment affects growth in recipient countries. We conduct a study of manufacturing plants in Mexico at the level of the individual firm ('micro' level) and test for performance differences embodied in factor productivity between domestic and foreign owned plants. In addition we check for the existence of spillovers at the industry level due to the presence of multinational corporations. In contrast to earlier studies we find no evidence of spillovers but do find a strong direct effect in the form of higher levels of productivity in firms with foreign ownership. This ties in to our earlier results at the aggregate level and suggests that a large part of the relationship between FDI and growth may be attributed to the efficiency and technological superiority of foreign firms, rather than any indirect benefits they may confer in the form of spillovers.