The Effect of Foreign Direct Investment on Investment in Canada

Abstract

F OREIGN private direct investment has a number of economic effects on the capitalreceiving country. Although these have usually been assumed to be beneficial, several recent papers suggest that the issue may be more complex.' While much of the attention to this subject has come from those concerned with developing countries, these issues have applicability in all countries receiving foreign investment. This article examines foreign investment's effect on the quantity of private investment in the capital-receiving country. Many development models simply assume that a dollar of foreign investment produces an equal increase in investment.2 However, microeconomic analysis suggests that the increase in resources will be split between an increase in investment and an increase in consumption.3 Several recent empirical studies provide support for the latter approach.4 In addition to affecting investment in this way, foreign investment can cause an increase in investment beyond the size of the resource inflow through complementary effects. Moreover, to the extent that investment depends on income through an accelerator type of mechanism, changes in expenditure produced by foreign investment will cause still further changes in investment through changes in income. The purpose of this article is to measure the size of foreign investment's effect on investment in Canada. Moreover, the nature of foreign direct investment's impact will be clarified by tracing through its effect on consumption, exports and imports, as well as on investment. Such an approach not only makes possible a better assessment of the desirability of foreign investment, but suggests ways in which policy makers can effect change.