Local Financial Development and the Aid-Growth Relationship

With official development assistance (ODA) set to rise as countries strive to meet the Millennium Development Goals (MDGs), aid effectiveness remains an important area of development policy. An increasing number of studies support the notion that ODA can contribute to growth in a nonlinear relationship. In this paper, we investigate a new hypothesis regarding this relationship: that deeper financial markets in aid-recipient countries facilitate the management of aid flows, thereby enhancing aid effectiveness. An empirical analysis, using a panel data set, finds robust support for the hypothesis.Foreign aid,economic growth,poverty,financial development

Local Financial Development and the Aid-Growth Relationship

With official development assistance (ODA) set to rise as countries strive to meet the Millennium Development Goals (MDGs), aid effectiveness remains an important area of development policy. An increasing number of studies support the notion that ODA can contribute to growth in a nonlinear relationship. In this paper, we investigate a new hypothesis regarding this relationship: that deeper financial markets in aid-recipient countries facilitate the management of aid flows, thereby enhancing aid effectiveness. An empirical analysis, using a panel data set, finds robust support for the hypothesis

How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects of Financial Markets on Linkages

The empirical literature finds mixed evidence on the existence of positive productivity externalities in the host country generated by foreign multinational companies. We propose a mechanism that emphasizes the role of local financial markets in enabling foreign direct investment (FDI) to promote growth through backward linkages, shedding light on this empirical ambiguity. In a small open economy, final goods production is carried out by foreign and domestic firms, which compete for skilled labor, unskilled labor, and intermediate products. To operate a firm in the intermediate goods sector, entrepreneurs must develop a new variety of intermediate good, a task that requires upfront capital investments. The more developed the local financial markets, the easier it is for credit constrained entrepreneurs to start their own firms. The increase in the number of varieties of intermediate goods leads to positive spillovers to the final goods sector. As a result financial markets allow the backward linkages between foreign and domestic firms to turn into FDI spillovers. Our calibration exercises indicate that a) holding the extent of foreign presence constant, financially well-developed economies experience growth rates that are almost twice those of economies with poor financial markets, b) increases in the share of FDI or the relative productivity of the foreign firm leads to higher additional growth in financially developed economies compared to those observed in financially under-developed ones, and c) other local conditions such as market structure and human capital are also important for the effect of FDI on economic growth.

FDI and Economic Growth: The Role of Local Financial Markets*

In this paper, we examine the various links among foreign direct investment (FDI), financial markets, and economic growth. We explore whether countries with better financial systems can exploit FDI more efficiently. Empirical analysis, using crosscountry data between 1975- 1995, shows that FDI alone plays an ambiguous role in contributing to economic growth. However, countries with well-developed financial markets gain significantly from FDI. The results are robust to different measures of financial market development, the inclusion of other determinants of economic growth, and consideration of endogeneity.Foreign direct investment, financial markets, economic growth.

How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects of Financial Markets on Linkages

The empirical literature finds mixed evidence on the existence of positive productivity externalities in the host country generated by foreign multinational companies. We propose a novel mechanism, which emphasizes the role of local financial markets in enabling foreign direct investment (FDI) to promote growth through backward linkages, shedding light on this empirical ambiguity. In a small open economy, final goods production combines the production processes of foreign and domestic firms, which compete for skilled labor, unskilled labor, and intermediate products. In order to operate a firm in the intermediate goods sector, entrepreneurs must first develop a new variety of intermediate good. Innovation and imitation both require capital costs, which must be financed through the domestic financial institutions. The more developed the local financial markets are, the easier it is for credit constrained entrepreneurs to start their own firms. Thus the number of varieties of intermediate goods increases, causing positive spillovers to the final goods sector. As a result the host country benefits from the backward linkages between foreign and domestic firms since the local financial markets allow these linkages to turn into FDI spillovers. Our calibration exercise confirms our analytical results. In particular, the results show that the same amount of increase in FDI, regardless of the reason of the increase, generates three times more additional growth in financially well-developed countries than in financially poorly-developed countries. The calibration exercise also shows the importance of the other local conditions such as market structure and human capital–the absorptive capacities–for the effect of FDI on economic growth.FDI spillovers, backward linkages, financial development, economic growth

How Does Foreign Direct Investment Promote Economic Growth? Exploring The Effects Of Financial Markets On Linkages

The empirical literature finds mixed evidence on the existence of positive productivity externalities in the host country generated by foreign multinational companies. We propose a mechanism that emphasizes the role of local financial markets in enabling foreign direct investment (FDI) to promote growth through backward linkages, shedding light on this empirical ambiguity. In a small open economy, final goods production is carried out by foreign and domestic firms, which compete for skilled labor, unskilled labor, and intermediate products. To operate a firm in the intermediate goods sector, entrepreneurs must develop a new variety of intermediate good, a task that requires upfront capital investments. The more developed the local financial markets, the easier it is for credit constrained entrepreneurs to start their own firms. The increase in the number of varieties of intermediate goods leads to positive spillovers to the final goods sector. As a result financial markets allow the backward linkages between foreign and domestic firms to turn into FDI spillovers. Our calibration exercises indicate that a) holding the extent of foreign presence constant, financially well-developed economies experience growth rates that are almost twice those of economies with poor financial markets, b) increases in the share of FDI or the relative productivity of the foreign firm leads to higher additional growth in financially developed economies compared to those observed in financially under-developed ones, and c) other local conditions such as market structure and human capital are also important for the effect of FDI on economic growth. --

Aid and Foreign Direct Investment: International Evidence

Although the literature on the effects of both aid and foreign direct investment (FDI) on development is vast, the relationship between aid and FDI has not been sufficiently explored. This paper empirically investigates the effect of aid on foreign direct investment in view of the hypothesis that countries that receive aid also become more likely to receive FDI. We further claim, however, that this happens especially in cases of good governance and financial market development, and not necessarily otherwise. To test these hypotheses we employ a panel analysis and control for the factors besides aid that are likely to encourage or discourage the FDI flows, such as stability indicators, openness and the income level. The preliminary findings appear to provide robust empirical support for our hypothesis