Foreign direct investment in developing economies

Field: Economics, Econometrics and Finance (Social Sciences)

Purpose The aim of this study was to investigate how the productivity spillover effects of foreign direct investment (FDI) in the Latin American economies are manifested. Specifically, the paper sought to identify the role of foreign presence and government intervention through an industrial policy on total factor productivity in Latin American countries. Design/methodology/approach The analyses in this study were performed in two stages. The first step consisted of decomposing the total factor productivity growth, in technical efficiency change (EC) and technological efficiency change (TC), using the Malmquist Productivity Index (MPI). In the second stage of this research, the specific EC and TC indexes of each country – obtained with the MPI – are used alternately as a dependent variable in a regression analysis with dynamic panel data. The variables were collected from the World Development Indicators database, available in the World Bank database, and cover the period from 1994 to 2014. Findings FDI has contributed to not only the catch-up effect – i.e. to continuous improvements in production processes and products using the same technology – but also in terms of productivity, due to technological innovations and the frontier-shift effect. Industrial policies, such as the FDI attraction, when established in isolation, are not able to contribute to the generation of productivity spillovers, measured in terms of technical and technological efficiency. Research limitations/implications The limitation of the present study lies precisely in the nature of data aggregation that actually limits a more in-depth analysis of the object of study. The available data set for the analysis in this study does not provide a detailed examination of the domestic corporations’ characteristics, the sectors and motivations of multinational corporations of each one of the analyzed economies. Practical implications The outcomes of this research present several practical implications, as its development is based on the recognition that productivity is essential for the development of a country. It remains the Achilles' heel of the Latin American economies, and therefore, it is necessary and essential to move toward a change in its development model and, more specifically, in its industrial policies, with a focus on investment and innovation to achieve the new sustainable development objectives. Among the main challenges presented to governments in the region is the emergence of policies aimed at establishing a sustainable development path through industrial policies capable of accelerating productivity growth. Social implications The evidence presented in this study highlights the importance of better understanding the real effects of state intervention through the use of industrial policy instruments and how they affect foreigners’ investment decisions, as the lack of clear industrial policy orientation that is systematically integrated with MNEs’ operations may result in economic development opportunities below the ideal. Originality/value The research results corroborate the foundations of spillover effects theory and with the recognition that the intensity of the effect of the foreign participation on the performance of economies will depend on the absorption capacity of host economies.