The Technology Diffusion Effect of FDI on Economic Growth: A Cautionary Note

It has been argued by economists that foreign direct investment (FDI) can promote economic growth in recipients countries, via the capital accumulation effect and the technology spillover effect. However due to the endogeneity of FDI, previous empirical literature on FDI has not convincingly established the causal effects from FDI to economic growth, in particular the technology spillover. This paper attempts to empirically identify the spillover effect of FDI on growth at macroeconomic level by employing geographical variables, the size of the economy and lagged output per worker as instruments. The findings support the view that FDI leads to growth via technology spillover and the impact is economically significant. The interactions between FDI and per capita output level, trade, financial market and human capital are also reexamined. Contrary to findings of previous studies, the evidence in this paper suggests the technological spillover effect of FDI is bigger for countries with lower level of development, weaker financial market and lower level of human capital. ∗Ph.D. candidate, University of British Columbia, Department of Economics, 997-1873 East Mall, BC, V6T1Z1, Canada. Email: [email protected]. I am grateful for comments from Patrick Francois, Ken Jackson and Ph.D. research workshop participants at UBC. All errors are mine.