Foreign Investment in Developing Countries: Does it Crowd in Domestic Investment?

Abstract

This paper assesses the extent to which foreign direct investment (FDI) in developing countries crowds in or crowds out domestic investment. The core of the paper is the development of a theoretical model for investment that includes a FDI variable and its estimation and testing with panel data for the period 1971–2000 and the three decades involved. The model is run for 12 countries in each of three developing regions (Africa, Asia and Latin America). The results indicate that, in all three developing regions, FDI has, at best, left domestic investment unchanged, and that there are several sub-periods for specific regions where FDI displaces domestic investment. In particular, there seems to be crowding out of domestic investment by FDI in Latin America. If these results are in fact correct, they suggests the need for policies to make FDI more effective in enhancing domestic investment in developing countries. The conclusion is that the effects of FDI on domestic investment are by no means always favourable, that simplistic policies towards FDI are unlikely to be optimal and, foremost, that more attention needs to be paid to economic policies that foster the domestic component of total investment.View issue table of contentsNext article

Notes

¹ Of course, such foreign investments may be desirable for other reasons, such as introducing competition into stagnant or backward sectors. However, what we are concerned about here is the impact on domestic investment and entrepreneurship. Given the enormous superiority of MNEs over domestic firms in most developing countries, the competition is likely to be one-sided.

² Later we show that the effects of lagged domestic growth on FDI is statistically insignificant.

³ In the Appendix we list the countries and the corresponding sample periods.

⁴ The test does not include the time dummies or the constant.

⁵ Of course, we are dealing with matters of degree. Investment regimes have become pretty liberal throughout the developing world as a consequence of a profound reassessment of the benefits and costs of FDI.

Additional information

Notes on contributors

Manuel R. Agosin

The authors wish to thank Yilmaz Akyüz, Michael Basch, Rodrigo Cubero-Brealey, Valpy FitzGerald, Richard Kozul-Wright, Sanjaya Lall, Norman Loayza, Karl Sauvant and Zbigniew Zimny for useful comments on earlier drafts. We also thank the numerous people who have commented on earlier versions of the paper in seminars at the Inter-American Development Bank, the University of Chile, and at the Latin American and Caribbean Economic Association meetings in Puebla, Mexico, in October 2003.

Roberto Machado

The authors wish to thank Yilmaz Akyüz, Michael Basch, Rodrigo Cubero-Brealey, Valpy FitzGerald, Richard Kozul-Wright, Sanjaya Lall, Norman Loayza, Karl Sauvant and Zbigniew Zimny for useful comments on earlier drafts. We also thank the numerous people who have commented on earlier versions of the paper in seminars at the Inter-American Development Bank, the University of Chile, and at the Latin American and Caribbean Economic Association meetings in Puebla, Mexico, in October 2003.