Foreign Direct Investment and Growth in Transition Economies

Recent studies of developing countries have suggested that the effectiveness of foreign direct investment (FDI) as spur to econo mic growth depends on the availability of "human capital" or skilled labour in a host country. In other words, it is primarily the synergy between FDI and human capital — rather than FDI itself — that acts as a strong stimulant to growth. Since many transition economies such as Ukraine have abundant human capital, this implies that policies that encourage FDI may be very beneficial in facilitating economic restructuring and stimulating growth. This paper provides a thorough empirical investigation of this issue by examining the experience of Ukraine and other transitional economies. The paper provides an overview of Ukraine’s experience with FDI and growth before systematically analyzing the connection between these variables for a panel of transition economies. While the paper finds deficiencies in earlier work examining the synergy between FDI and human capital, it finds interesting evidence that is consistent with the synergy hypothesis for transition economies. Further, the analysis also suggests that there is a complementary — rather than substitute — relationship between FDI and domestic investment. Thus, the presence of FDI may provide new learning opportunities for those making domestic investments and visa versa. The possibility that it is not large flows of FDI that cause high economic growth rates, but strong growth that acts as a magnet for FDI is also investigated. While the paper shows that there is little empirical evidence of such reverse causation in transition economies, it also reveals that there is little evidence that FDI stimulates economic growth beyond the current year. This lack of persistence in the benefits of FDI in transition economies suggests that there may be room for policy initiatives to increase the efficacy of FDI.