On the Role of Absorptive Capacity : FDI Matters to Growth

The paper studies the effects of foreign direct investment (FDI) on economic growth when sufficient provisions of infrastructure is a pre-requisite. In the overlapping generations structure setting, we show that technology spillovers via FDI take place only when the host country has the sufficient level of infrastructure. Infrastructure has a subsequent positive feedback on further investment which leads the country grow faster. If infrastructure falls short of the critical level, however, then FDI has little effect on growth as the country is trapped in a low-growth equilibrium. We also present the simulations and empirical results based on panel data for 42 developing countries between 1970 and 2000. They provide support to the model that FDI and infrastructure are complements in affecting per capita GDP growth