The Big Question For decades, economists and policymakers have debated: Can foreign companies investing in developing countries help boost their economic growth? While it seems like an obvious “yes,” the reality is far more complex and fascinating.
What We Already Knew
- The 1960s-70s view: Foreign investment might actually hurt poor countries
- The 1980s-90s view: Foreign investment could help, but only under the right conditions
- Recent view: It’s all about whether countries have educated, skilled workers who can learn from foreign companies
The Global Investigation The researcher examined 71 developing countries across Asia, Africa, and Latin America over two decades, looking at:
- How much foreign investment they received
- How fast their economies grew
- How educated their populations were
- How much they traded with other countries
- How much local businesses invested
The Surprising Findings
- The Regional Plot Twist
- Latin American countries benefited significantly from foreign investment
- Asian and African countries showed little to no benefit
- Why the difference? It might come down to how ready each region was to absorb new technologies and knowledge
- The Education Effect
- Countries with better-educated populations got more out of local investment than foreign investment
- Less educated countries actually saw negative effects from domestic investment
- The magic number: Countries needed a human development score above 0.5 to see positive effects
- The Trade Connection
- For less developed countries, international trade was more important than foreign investment
- Exports especially helped these countries grow
- Imports often had a negative effect on growth
The Practical Takeaways
- For Developing Countries
- Focus first on education and skill development
- Don’t assume foreign investment will automatically boost growth
- Consider export promotion as a key strategy
- For Policymakers
- Prioritize human development before aggressively pursuing foreign investment
- Design policies that help local businesses learn from foreign companies
- Balance foreign investment with export promotion
The Bottom Line The research suggests there’s no one-size-fits-all answer. Success depends on having educated workers who can learn from foreign companies and apply that knowledge locally. The key message: Build your people’s capabilities first, then foreign investment can help accelerate growth.
Academic Abstract:
Recent theoretical and empirical advancement on growth accounting and endogenous growth front has emphasized that FDI can be a catalyst for the development of developing countries. The present study has attempted to empirically verify the role of FDI in the growth process of developing countries. Panel data evidence, however, does not find any significant role for FDI in the economic growth of all developing countries. The conclusion remained unchanged even if human development interaction with FDI was included in the model. Estimations for developing groupings, nevertheless, suggest that FDI significantly affects the growth Latin American and the Caribbean countries but not in the case of Africa and Asia. One of the significant observations that this study derived, is that the growth effect of domestic investment is relatively more sensitive than FDI to the level of human development. The study also found that the role of international linkages has a major role in the growth process if the country is at a lower level of human development than a country with a higher level. Developing countries have to pursue a human-development-led-growth strategy supplemented by export-led growth if they want to improve their local productivity as well as that from FDI and maintain their competitive advantages in global markets.
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Full citation: Pradhan, Jaya Prakash (2003), ‘Foreign Direct Investment and Economic Growth in Developing Countries: Further Evidence from Panel Data’, Asian Economic Review, 45 (2), pp. 197–217, Publisher: Indian Institute of Economics.
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