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posted on 31 October 2015

Foreign Direct Investment: Financial Benefits Could Surpass Gains In Technology

from the Dallas Fed

-- this post authored by Jian Wang, Janet Koech and Xiao Wang

Many emerging markets offer financial incentives to attract foreign direct investment, believing that such investment provides advanced technology or management skills. However, it appears developing economies such as China could benefit more from multinational corporations' financial resources.

Cross-border capital flows have increased substantially since the 1990s, reaching a peak of 20 percent of world gross domestic product (GDP) in 2007. Multinational corporations provide the majority of the flows, known as foreign direct investment, or FDI.

FDI has long been viewed as a way to promote the productivity of host countries, especially emerging economies. Many less-developed countries attempt to attract FDI by offering tax and other financial benefits. They hope these outside investments will speed movement toward the world technology frontier.

However, FDI's greatest contribution to emerging markets may lie in easier access to global financial markets rather than the mere acquisition of advanced technology. Notably, the financial conditions of local firms in China improved substantially after foreigners acquired the companies, a recent study showed. Relaxed financial constraints allowed the newly purchased firms to increase exports and total output.

In other words, foreign ownership per se does not significantly improve the productivity of local firms, based on a variety of metrics.Instead, the key factor is that capital flows from multinationals abroad help alleviate financial market frictions in the host countries, which enables them to allocate resources more efficiently across firms and sectors.

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Source: eclett/2015/el1509.pdf

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