Foreign Direct Investment and Relative Capacity : Theory and Evidence

This paper builds upon a leader and follower endogenous growth framework to study intermediary roles played by human capital and technology in triggering the gross-output-enhancing effect of inward foreign direct investment (FDI). Our model develops a number of testable hypothesises to assess how these intermediary factors - the differences between leader and follower countries' capabilities - determine the technology transfer and shorten the gross output gap between the frontier and follower countries. In our empirical work, we employ a country-level panel data that contains 67 countries through 1977-2013 and find that the differences in human capital and technology, which take into account the gap in capacity between the leader and follower countries, are the determinants that trigger the gross-output-enhancing effect of FDI. Our results are robust to the cyclical fluctuations and endogeneity of FDI per se