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

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

No 1403, Working Papers from Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz

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.

Keywords: FDI; financial market globalization; welfare effects; open-economy growth; middle income trap; two-way capital flows (search for similar items in EconPapers)
JEL-codes: F21 F43 F54 F62 O16 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2014-02-21, Revised 2014-02-21
New Economics Papers: this item is included in nep-fdg, nep-int and nep-opm
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https://download.uni-mainz.de/RePEc/pdf/Discussion_Paper_1403.pdf First version, 2014 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:jgu:wpaper:1403

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