Foreign Direct Investment and Economic Growth: the Importance of Institutions and Urbanization
Author(s)
Hsiao, Cheng; Shen, Yan
Abstract
Economic growth needs capital investment. The well-known Harrod-Domar model implies the following growth-rate relation: g = s[beta], where g denotes the equilibrium rate of growth, s denotes the capital-formation rate, and [beta] is the productivity of capital. Foreign direct investment (FDI) adds gross capital formation and, hence, raises s. The FDI also raises the productivity of capital, [beta], through improved competition, positive technological externalities, and accelerated spillover effects. Therefore, many developing countries have been aggressive in their efforts to attract FDI. However, most theories of FDI determination are developed from the perspective of a multinational corporation. This article argues that, in addition to the standard factors affecting the cost-benefit analysis of an investment project, there are intangibles, such as bureaucracy, degree of openness, stability of the institutions, and urbanization, and that these are just as important in attracting FDI.
