Abstract
This study analyzes the impact of foreign aid on foreign direct investment (FDI) inflows in selected countries in East Asia and South Asia – two regions that have received huge foreign aid as well as FDI inflows. Theoretically, foreign aid can either facilitate FDI by funding projects that raise the marginal productivity of capital, or crowd out FDI as the number of investment opportunities in developing countries is usually limited. Using the FGLS (Feasible Generalized Least Squares) panel estimation methodology with 1995–2012 panel data from 7 East Asian and 7 South Asian countries, this study finds that the impact of foreign aid on FDI is significantly positive and robust across several model specifications. The estimated results also suggest that FDI is significantly affected by corruption control, rate of return, infrastructure, human capital, market potential, and political stability, and East Asia enjoys a locational advantage in attracting FDI vis-a-vis South Asia. These results further our knowledge of the foreign aid-FDI dynamics in developing countries.
Highlights
Foreign aid from developed countries and multilateral organizations (e.g. World Bank, IMF, etc.) has played an important role in the growth dynamics of developing countries in the post-WWII period
Development economists generally hold the view that two important sources of foreign capital can play an important role in the growth dynamics of the recipient countries
The aid-foreign direct investment (FDI) literature holds that foreign aid can either facilitate FDI by funding projects that raise the marginal productivity of capital, or crowd out FDI as the number of investment opportunities in developing countries is usually limited
Summary
Foreign aid from developed countries and multilateral organizations (e.g. World Bank, IMF, etc.) has played an important role in the growth dynamics of developing countries in the post-WWII period. The radical anti-aid view, which grew out of empirical revelation that economic growth in some of the aid recipient countries has been less than satisfactory, argues that foreign aid supplants domestic resources, worsens domestic income inequality and trade balance, funds transfer of inappropriate technology, and in general helps sustain inefficient and corrupt governments in the recipient countries (Griffin & Enos, 1970; & Weisskopf, 1972) Another type of foreign capital that can play a significant role in the growth dynamics of the recipient economies is foreign direct investment (FDI) - capital from private investors and multinational corporations. FDI can help generate domestic investment in matching funds, facilitate transfer of managerial skills and technological knowledge, increase local market competition, create modern job opportunities, and increase global market access for locally produced export commodities
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