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Throwing the Spanner in the Works: The Mixed Blessing of FDI

Author

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  • Jakob Schwab

    (Department of Economics, Johannes Gutenberg-Universitaet Mainz, Germany)

Abstract

FDI is generally attributed to have positive impact for developing countries. In contrast, this paper shows that foreign capital inflows may cause an economy to be stuck in a middle-income trap. Introducing a simple capital market imperfection into a standard neoclassical (open-economy) model of growth, I show that FDI crowds out domestic investment when countries are still growing. If profitable investments are pursued by foreign capital owners, this does reduce chances for domestic entrepreneurs that they would have otherwise been able to take, by means of economy-wide savings. The long term losses due to the crowding-out effect occur despite the short-term gains that sudden capital inflows entail, as in static models. At the same time, savings that are not invested leave the country in turn, generating reverse capital flows.

Suggested Citation

  • Jakob Schwab, 2014. "Throwing the Spanner in the Works: The Mixed Blessing of FDI," Working Papers 1403, Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz, revised 21 Feb 2014.
    • Handle: RePEc:jgu:wpaper:1403
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    More about this item

    Keywords

    FDI; financial market globalization; welfare effects; open-economy growth; middle income trap; two-way capital flows;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • F54 - International Economics - - International Relations, National Security, and International Political Economy - - - Colonialism; Imperialism; Postcolonialism
    • F62 - International Economics - - Economic Impacts of Globalization - - - Macroeconomic Impacts
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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