Financial Globalization, Convergence and Growth

Using a panel data set covering the period 1970-2004 and 96 countries, we provide empirical evidence that the composition of foreign capital, measured by the ratio FDI over total liabilities, has a positive effect on growth, directly and through convergence. Developing countries benefit relatively more as their initial GDP is smaller. These results are consistent with a neoclassical growth model with credit constraints, in which the composition of foreign capital affects growth through diffusion of technology. Furthermore, we find that it is the composition of foreign capital, and not its volume, that matters for growth and convergence