Research Summary

Growth and the Quality of Foreign Direct Investment: Is All FDI Equal? (joint with Andrew Charlton)

by Laura Alfaro


In this paper we distinguish different “qualities” of FDI to re-examine the relationship between FDI and growth. Establishing the quality of FDI, however, is a difficult concept. “Quality,” that is the effect of a unit of FDI on economic growth, is a combination and interaction of many different country and project characteristics, those characteristics are hard to measure and the data quality is generally poor. Hence, we broadly differentiate “quality FDI” in several different ways. First, we look at the possibility that the effects of FDI differ by sector. Second, we differentiate FDI based on objective qualitative industry characteristics including the average skill intensity and reliance on external capital. Third, we use a new dataset on industry-level targeting to analyze quality FDI based on the subjective preferences expressed by the receiving countries themselves, since no one characteristic of FDI can determine quality and because the quality of FDI is the interaction of investment and country characteristics. Finally, we use a two-stage least squares methodology to control for measurement error and endogeneity to establish the quality of FDI as determined by countries themselves. Exploiting a new comprehensive industry level data set of 29 countries between 1985 and 2000, we find that the growth effects of FDI increase when we account for the quality of FDI.

Growth and the Quality of Foreign Direct Investment