Staff Report 454

Transition to FDI Openness: Reconciling Theory and Evidence

Ellen R. McGrattan | Consultant

Revised April 18, 2012

Empirical studies quantifying the economic effects of increased foreign direct investment (FDI) have not provided conclusive evidence that they are positive, as theory predicts. This paper shows that the lack of empirical evidence is consistent with theory if countries are in transition to FDI openness. Anticipated welfare gains lead to temporary declines in domestic investment and employment. Also, growth measures miss some intangible FDI, which is expensed from company profits. The reconciliation of theory and evidence is accomplished with a multicountry dynamic general equilibrium model parameterized with data from a sample of 104 countries during 1980–2005. Although no systematic benefits of FDI openness are found, the model demonstrates that the eventual gains in growth and welfare can be huge, especially for small countries.

RELATED PAPER: Staff Report 455 Technical Appendix: Transition to FDI Openness—Reconciling Theory and Evidence

Published In: Review of Economic Dynamics (Vol. 15, No. 4, October 2012, pp. 437-458)

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