The Impact of FDI on the Host Economy

Abstract

The foreign direct investment (FDI) and its impact on performance of domestic firms has been studied in many empirical papers, which, however, present rather ambiguous results. I argue that this is due to some limitations of prevalently used methodology, which does not separate the FDI spillover effects from the changes in competitive environment faced by domestic firms. I propose a novel estimation strategy that allows me to disentangle FDI spillovers from the effects of competition changing in response to the entry of a foreign firm. I consider this issue on the industry level and I compare the effects of FDI to the impact of international trade on the domestic economy. My analysis covers the time period 2001 - 2007 and concerns both Western and Eastern European countries. My identification strategy leads me to confirm the presence of positive spillovers stemming from FDI.