When Does FDI Liberalization Limit Domestic Growth?

• In Event: Domestic Politics, Distributive Concerns, and Foreign Direct Investment Policy

Abstract

An important development model has counseled foreign direct investment liberalization as an inducement to growth. While most countries have liberalized at least in part their markets, allowing foreign firms to enter and to repatriate their profits, these policies have not universally produced the high growth rates forecasted by the model. How do we explain the lackluster performance of some countries that liberalized FDI?
We explore the scope conditions under which FDI inward liberalization either promotes or diminishes growth. We argue that FDI inward liberalization is a form of competition policy (FDI liberalization substitutes for antitrust enforcement). Larger consumer markets whose firms are situated away from the technological frontier are particularly attractive to foreign firms. Consumer surplus increases with inward FDI. FDI inward liberalization, however, reduces domestic producer surplus, and leads less productive domestic firms to exit the market. Because profits accrue to firms abroad, the host country forfeits domestic producer surplus and some domestic production. When this second effect is most pronounced, growth decreases. An innovation of the project is the creation of new measures of government restrictiveness of FDI and other components of the capital account (using the methodology in Quinn 1997). We find that in larger markets (population greater than 50 million) with income per capita less than $22,500 ppp adjusted 2015 dollars, liberalization is generally negatively associated with subsequent five-year growth.

Authors

• Amy Pond, Texas A&M University

• Dennis P. Quinn, Georgetown University