On the Role of Absorptive Capacity: FDI Matters to Growth

Abstract

The paper studies the e®ects of foreign direct investment (FDI) on economic growth when su±cient provisions of infrastructure is a pre-requisite. In the overlap-ping generations structure setting, we show that technology spillovers via FDI take place only when the host country has the su±cient level of infrastructure. Infras-tructure has a subsequent positive feedback on further investment which leads the country grow faster. If infrastructure falls short of the critical level, however, then FDI has little e®ect on growth as the country is trapped in a low-growth equilibrium. We also present the simulations and empirical results based on panel data for 42 developing countries between 1970 and 2000. They provide support to the model that FDI and infrastructure are complements in a®ecting per capita GDP growth.