Federal Reserve Bank of Minneapolis Research Department Transition to FDI Openness

Empirical studies quantifying the benefits of increased foreign direct investment (FDI) have been unable to provide conclusive evidence of a positive impact on the host country’s economic performance. I show that the lack of robust evidence is not inconsistent with theory, even if the gains to FDI openness are large. Anticipated welfare gains to increased inward FDI should lead to immediate declines in domestic investment and employment and eventual increases. Furthermore, since part of FDI is intangible investment that is expensed from company profits, gross domestic product (GDP) and gross national product (GNP) should decline during periods of abnormally high FDI investment. Using the model of McGrattan and Prescott (2009) and data from the IMF Balance of Payments to parameterize the time paths of FDI openness for each country in the sample, I do not find an economically significant relationship between the amount of inward FDI a country did over the period 1980—2005 and the growth in real GDP predicted by the model. This finding rests crucially on the fact that most of these countries are still in transition to FDI openness. ∗McGrattan: Federal Reserve Bank of Minneapolis and University of Minnesota. I want to thank seminar participants at the LSE, the European University Institute, OSU, and Yale for their comments on earlier drafts of the paper. I also thank Graham Candler for allowing me time on his parallel computer. The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.