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This paper attempts to reconcile the often inconclusive evidence on the impact of FDI on growth by taking two into account the heterogeneity both among industries and among countries. Using a comparable database at the industry level for 35 countries in OECD, Asia and Eastern Europe from 1987 to 2002, we test both stage of development and FDI industrial pattern for the economic impact of FDI on growth. In certain industries and for the catching-up countries, a significant and positive relationship emerges when

FDI interacts with investment or export orientation.


1. Introduction

While in theory the nexus between FDI and growth (in terms of output and productivity) is in general positive, the empirical literature is far less conclusive. Some studies find positive effects from outward FDI for the investing country (Van Pottelsberghe and Lichtenberg, 2001; Nachum et al., 2000), but suggest a potential negative impact from inward FDI on the host country. This results from a possible decrease in indigenous innovative capacity or crowding out of domestic firms or domestic investment. Thus, in their view and in line with the standard literature on the determinants of FDI (i.e. Dunning’s OLI paradigm, see Dunning 1988) inward FDI is intended to take advantage of host country (locational) characteristics instead of disseminating new technologies originating in the sending country. Other studies report more positive findings: Nadiri (1993) finds positive and significant effects from US sourced capital on productivity growth of manufacturing industries in France, Germany, Japan and the UK. Also Borensztein et al. (1998) find a positive influence of FDI flows from industrial countries on developing countries’ growth. However, they report also a minimum threshold level of human capital for the productivity enhancing impact of FDI, emphasizing the role of absorptive capacity. Absorptive capacity or minimum threshold levels in a country’s ability to profit from inward FDI is often mentioned in the literature (see also Blomström et al. 1996). Consequently the effect of FDI depends among other things to a large extent on the characteristics of the country that receives FDI. However, the resulting issue of cross-country heterogeneity has largely been neglected in the literature so far with few exceptions. Blonigen and Wang (2005) stress explicitly cross-country heterogeneity as the crucial factor which determines the effect of FDI on growth. Further, Nair-Reichert and Weinhold (2001) and Mayer-Foulkes and Nunnenkamp (2005) explicitly take up this aspect in their analysis. Our paper will follow their direction and introduce two forms of heterogeneity, differences between countries and differences between receiving industries.

We argue that since host country heterogeneity plays a role, it is equally likely that the impact of FDI on the host economy differs greatly according to the receiving industry. FDI in constant returns to scale industries will have different effects than FDI in increasing returns to scale industries. Likewise, the effect of FDI may be related to the technology and human capital intensity of the industry and other factors. As a very intuitive example, heavy FDI in the extractive sector in Nigeria has not improved the country’s growth performance (Akinlo, 2004). Consequently, the potential for positive spillovers does not solely depend on a country’s overall absorptive capacity, but also on which sectors or industries in the economy receive FDI. Thus, the impact of FDI differs depending on country specific absorptive capacity or stage of development as well as on the sectoral and industrial structure and allocation of FDI. Since the two are in general related, this implies a relationship between the industrial pattern of inward FDI and its effect on the host country. The economy wide effect of industry specific FDI inflows will then further depend on the extent of intra-industry versus inter-industry spillovers.

In this paper we use a unique panel data set at the industrial level for a range of industrialized and catching-up countries to investigate the magnitude of all these factors for the role played by FDI in different manufacturing industries in the economic development of the host economy. Due to measurement issues, interdependencies between various types of spillovers and their complexity, it is difficult to distinguish between different theoretically possible channels of technology transmission in empirical research. Therefore, we will focus on the overall effect of foreign sourced capital on manufacturing productivity growth in addition to the effects of traditional factors (domestic capital and labour) and controlling for other factors. What is new in our analysis is the focus on the industry-level of the economy. To our knowledge, there is very little empirical research on FDI at this level of disaggregation. Disaggregated data on FDI for a large and heterogeneous set of countries rarely exist in a comprehensive and comparable form. If these data exist, they are often plagued with two kinds of problems: On the one hand, the coverage of firms and flows which are recorded as FDI can differ between countries (problems are often caused by the exclusion of reinvested profits in some countries). On the other hand, the classification into industrial activities may differ between countries. We therefore established a comprehensive new data set in order to address adequately the role of industrial FDI patterns.

The paper proceeds as follows: The next section describes the data set. Section 3 revises briefly the theoretical background of the FDI-growth nexus and introduces the estimating framework. The results are summarized in Section 4. Section 5 concludes.