2 FDI and spillover effects

Another important channel through which FDI can influence economic growth is by generating spillover effects on domestic firms and sectors. Spillover effects refer to the positive or negative externalities that arise from the interaction between foreign and domestic agents in the host economy. For example, FDI can create positive spillovers by transferring knowledge, skills, and technology to domestic firms through linkages, demonstration, and competition effects. FDI can also create negative spillovers by crowding out domestic investment, reducing market share and profits, and increasing wage inequality and environmental degradation.

3 FDI and institutional quality

A third channel through which FDI can impact economic growth is by affecting the institutional quality and policy environment of the host country. FDI can have a direct or indirect effect on the governance, regulation, and legal framework of the host economy, which in turn can influence the investment climate, business confidence, and social welfare. For instance, FDI can have a direct effect by demanding better protection of property rights, contract enforcement, and dispute resolution, or by lobbying for favorable tax incentives, subsidies, and regulations. FDI can also have an indirect effect by contributing to the development of civil society, democracy, and human rights, or by exacerbating corruption, rent-seeking, and political instability.

4 FDI and home country effects

Besides the effects on the host country, FDI can also have implications for the economic growth of the home country. FDI can benefit the home country by increasing its access to foreign markets, resources, and opportunities, as well as by improving its competitiveness, innovation, and learning. FDI can also entail costs for the home country by reducing its domestic investment, employment, and output, as well as by eroding its technological edge, tax base, and national sovereignty.