Foreign direct investment spurs emerging economies, says Dallas Fed’s Economic Letter

For immediate release: January 30, 2007

DALLAS—Foreign direct investment (FDI) appears to stimulate the development of emerging economies, according to the January issue of the Federal Reserve Bank of Dallas Economic Letter.

In “Does Foreign Direct Investment Help Emerging Economies?” economist Anil Kumar examines the effects of FDI on the stability, trade, savings, investment and growth of emerging economies, such as China and India.

“The foreign capital has the potential to deliver enormous benefits to developing nations,” writes Kumar. “Besides helping bridge the gap between savings and investment in capital-scarce economies, capital often brings with it modern technology and encourages development of more mature financial sectors.”

After studying 19 emerging economies, Kumar finds that a percentage point rise in the ratio of FDI to GDP leads to a half percentage point increase in domestic investment and three-fourths percentage point increase in domestic savings.

FDI also has an effect on an emerging economy’s GDP. Growth in the GDP of developing economies rises the year after an increase in FDI, according to Kumar.

Countries with barriers to FDI may see increased economic development if they relax those barriers, he adds.

However, there are drawbacks to increased levels of FDI, Kumar writes. Foreign firms could overinvest, hurting domestic producers. Also, the majority of an emerging economy’s best firms may be financed by FDI, leaving only low-productivity firms for the domestic investors.

The January 2007 issue of Economic Letter can be found at www.dallasfed.org.

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