FDI, Productivity and Financial Development

This paper examines the effect of foreign direct investment (FDI) on growth by focusing on the complementarities between FDI inflows and financial markets. In our earlier work, we found that FDI is beneficial for growth only if the host country has well-developed financial institutions. In this paper, we investigate whether this effect operates through factor accumulation and/or improvements in total factor productivity (TFP). Factor ccumulation – physical a human capital – does not seem to be the mai channel through which countries benefit from FDI. I stead, we find that countries with well-developed financial markets ain significantly fr m FDI via TFP improvements. These resul s are consistent with th rec nt findings in the growth literatur that shows the important role of TFP over factors in expl ining cross-countr income differen es.