DP687 | Foreign Direct Investment and Trade Interlinkages in the 1990s: Experience and Prospects of Developing Countries

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The paper analyses global trends in foreign direct investment (FDI) and the interlinkages between FDI, trade and competitiveness in host developing countries. The rapid rate of growth and the recent changes in the global patterns of FDI are attributed to both macroeconomic and microeconomic factors, including the persistence of major macroeconomic imbalances among OECD countries as well as changes in the corporate strategies of Transnational Corporations (TNCs) in light of the increased competition for market shares in high-technology sectors and in services. Following the typology of direct and indirect interlinkages that is developed, the substitutability or complementarity of trade and FDI depend inter alia on the type of FDI activity undertaken, and more importantly, on whether FDI has resource-extracting, resource-exploiting or resource-expanding effects. From a policy perspective it is argued that in the presence of mobile factors, the liberalization of trade and capital movements and the maintenance of relatively low wages are necessary, but not sufficient, conditions for attracting FDI to LDCs. The absolute productivity of capital in the host country, risk factors and the `thick-market' externalities play an increasingly important role in determining FDI flows. Finally, the effects of FDI on price competitiveness depends on the allocation of FDI between traded and non-traded sectors in the economy. Preliminary empirical evidence from seven developing countries appears to support the framework of analysis adopted.