Foreign Direct Investment and Total Factor Productivity Growth: Does Distance from Technology Frontier Matter

Abstract

In this paper we examine the effect of Foreign Direct Investment (FDI) on international variation in Total Factor Productivity (TFP) growth rates. In particular, we investigate whether a country's initial distance from technology frontier influences the degree to which a country can benefit from FDI. Adopting a logistic function of technology diffusion, this paper finds that a one standard deviation increase in distance reduces impact of FDI on annual TFP growth rate by 0.50% during the 20 year period. The results are robust to inclusion of other relevant control variables and consideration of endogeneity. Using the sample splitting technique recently developed by Hansen (2000), we also find that if the initial distance of a country exceeds a threshold level, then the follower can catch-up with the leader. On the other hand, for a country below the threshold level, there is significant negative impact of FDI that increases with distance. Consequently, the net benefit from FDI can be infinitesimal for some countries.