Foreign Direct Investment and Economic Growth in Transition Economies: A Panel Data Study

Noting the paucity of studies that relate foreign direct investment (FDI) with economic growth in transition economies, this paper uses panel data for 12 CEE countries covering the period 1991-2002 and estimates a fairly standard growth framework with several different procedures. Seven main points are noted. First, our flexible models reveal a dramatic cross-country heterogeneity in parameters for both FDI and domestic investment. Second, the observed heterogeneity makes it hazardous to articulate a general substantive statement about the role of FDI (or domestic capital) in growth. Third, if a general statement were based on the averages for individual-country estimates, one might say that both FDI and domestic capital contribute substantially to growth in these economies and the role of FDI appears stronger. Fourth, estimates from identical-parameter models show huge differences even from individualcountry averages, particularly for domestic investment. Fifth, a reasonable test indicates absence of any major specification error (or “feedback”) as well as heteroscedasticity. Sixth, fixed-effects and random-effects models, that permit limited parametric variability, yield fairly similar patterns which, however, are different from both identical-parameter and flexible models. Seventh, it is pointed out that even when FDI is observed to have high returns and thus to make a substantial contribution to growth in such aggregate models, it should be recognized that direct returns on FDI generally belong to the foreign investors.