The Role of Foreign Direct Investment in Transformation

Abstract

In the theoretical literature, various channels are discussed through which FDI may contribute to growth in transforming economies: FDI contributes to national capital stock and increases employment. FDI contributes both to the stock of human and physical capital increasing and modernizing physical capital and creating new working places with the rise of production (Bellak, 1998). Investments in physical capital and an increase in employment in turn create positive real income effect which raises demand for the products of domestic firms. FDI is a channel of technology transfer. The most important contribution of FDI to the economic growth consists in the characteristic of FDI as an important vehicle for knowledge and technology transfer (Borenstein et al. 1995; Blomstroem and Sjoeholm, 1999). FDI raises the productivity of the Foreign Investment Enterprises (FIEs). Combination of advanced managerial skills and technology with domestic labor and inputs result in higher productive efficiency of FIEs and allows them to derive products at lower costs than domestic firms. Thus FIEs are more productive than domestic firms and hence contribute to the growth more than domestic investment. But PIEs can only then be more productive in comparison to domestic firms when the countries possess over the minimum threshold stock of human capital (Bellak, 1998; Borenstein et aI., 1995).