Endogenizing Total Factor Productivity: The Foreign Direct Investment channel in the case of Bulgaria (2004-2013)

This paper estimates the contribution of Foreign Direct Investment (FDI) to the Total Factor Productivity (TFP) of Bulgaria for the period 2004-2013. Since TFP captures the joint efficiency of capital and labor, it is likely to be influenced by investments from abroad. As predicted by theory, a positive relationship between TFP and FDI is documented. The effect of ignoring the implications of this model on the economy is explored through simulations and it is proven that this action leads to a distorted view of the growth path of the economy. The standard Ramsey (optimal) growth model, augmented with the FDI channel is used to compare the speed of convergence to an identical setup without FDI. The results of the study can serve as justification for introduction of policies and development of governmental strategies for attracting FDI inflows.