The purpose of this paper is to examine the various links among
foreign direct investment, financial markets and economic growth. We model
an economy with a continuum of agents indexed by their level of
ability. Agents have two choices: they can work for the foreign company
in the FDI sector and use their inherited wealth to earn a return or they
can choose to undertake entrepreneurial activities, which are subject to a
fixed set-up cost. Financial markets allow entrepreneurs in the economy to
finance the set-up costs and take advantage of knowledge spillovers from
FDI. In addition to the analytical solution of the model, an empirical
analysis is also provided using cross-country data from different sets of
countries between 1970-1995. To the best of our knowledge there has not
been a theoretical and empirical study on the interaction between financial
markets and FDI spillovers prior to this study. Our empirical evidence
suggests that FDI plays an important role in contributing to economic
growth. However, the level of development of local financial markets is
crucial for these positive effects to be realized.
JEL Classification: F23, F36, F43
BGIE
35 pages
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