Foreign Direct Investment and Growth in Transition Economies

Abstract

Recent studies of developing countries have suggested that the effectiveness of foreign\ndirect investment (FDI) as spur to econo mic growth depends on the availability of "human capital"\nor skilled labour in a host country. In other words, it is primarily the synergy between FDI and\nhuman capital — rather than FDI itself — that acts as a strong stimulant to growth. Since many\ntransition economies such as Ukraine have abundant human capital, this implies that policies that\nencourage FDI may be very beneficial in facilitating economic restructuring and stimulating\ngrowth. This paper provides a thorough empirical investigation of this issue by examining the\nexperience of Ukraine and other transitional economies.\nThe paper provides an overview of Ukraine’s experience with FDI and growth before\nsystematically analyzing the connection between these variables for a panel of transition\neconomies. While the paper finds deficiencies in earlier work examining the synergy between\nFDI and human capital, it finds interesting evidence that is consistent with the synergy\nhypothesis for transition economies. Further, the analysis also suggests that there is a\ncomplementary — rather than substitute — relationship between FDI and domestic investment.\nThus, the presence of FDI may provide new learning opportunities for those making domestic\ninvestments and visa versa. The possibility that it is not large flows of FDI that cause high\neconomic growth rates, but strong growth that acts as a magnet for FDI is also investigated.\nWhile the paper shows that there is little empirical evidence of such reverse causation in\ntransition economies, it also reveals that there is little evidence that FDI stimulates economic\ngrowth beyond the current year. This lack of persistence in the benefits of FDI in transition\neconomies suggests that there may be room for policy initiatives to increase the efficacy of\nFDI.