Is Foreign Aid a Vanguard of Foreign Direct Investment? A Gravity-Equation Approach

Summary This paper investigates whether and how foreign aid facilitates foreign direct investment (FDI) flows into less developed countries. We employ a large data set of source-recipient country pairs and conduct gravity equation-type estimation. Our empirical methodology enables us to examine an effect through which aid from a donor country promotes FDI from the same donor in particular, which we call a "vanguard effect." We find that foreign aid in general does not have any significant effect on FDI. However, when we allow for differences in the size of aid effects across donor countries, we find robust evidence that foreign aid from Japan in particular has a vanguard effect, i.e., Japanese aid promotes FDI from Japan but does not attract FDI from other countries.

[1]  M. Arellano,et al.  Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations , 1991 .

[2]  J. Bergstrand,et al.  A knowledge-and-physical-capital model of international trade flows, foreign direct investment, and multinational enterprises , 2007 .

[3]  Peter Boone,et al.  Politics and the Effectiveness of Foreign Aid , 1995 .

[4]  Aart Kraay,et al.  Governance Matters IV: Governance Indicators for 1996-2004 , 2005 .

[5]  F. Windmeijer.  A Finite Sample Correction for the Variance of Linear Two-Step GMM Estimators , 2000 .

[6]  S. Dey.  THE ROLE OF FOREIGN AID IN DEVELOPMENT , 1959 .

[7]  D. Arase.  Public-Private Sector Interest Coordination in Japan's ODA , 1994 .

[8]  Henrik Hansen,et al.  Aid and Growth Regressions , 2001 .

[9]  Arvind Subramanian,et al.  Aid and Growth: What Does the Cross-Country Evidence Really Show? , 2005, The Review of Economics and Statistics.

[10]  C. Arellano,et al.  The Dynamic Implications of Foreign Aid and its Variability , 2005, SSRN Electronic Journal.

[11]  J. Svensson.  Foreign aid and rent-seeking , 2000 .

[12]  K. Sauvant.  Investment for Development , 2002 .

[13]  Aart Kraay,et al.  Governance Matters VIII: Aggregate and Individual Governance Indicators, 1996-2008 , 2006 .

[14]  Aid and Growth: What Does the Cross-Country Evidence Really Show? , 2005 .

[15]  David Roodman.  How to do Xtabond2: An Introduction to Difference and System GMM in Stata , 2006 .

[16]  P. Egger,et al.  An Econometric View on the Estimation of Gravity Models and the Calculation of Trade Potentials , 2002 .

[17]  Matthias Lutz,et al.  Aid, Governance and Private Foreign Investment: Some Puzzling Findings for the 1990s , 2006 .

[18]  W. Easterly,et al.  New Data, New Doubts: A Comment on Burnside and Dollar&Apos;S "Aid, Policies, and Growth" (2000) , 2003 .

[19]  B. Javorcik.  Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In Search of Spillovers Through Backward Linkages , 2002 .

[20]  P. Egger,et al.  Alternative Techniques for Estimation of Cross-Section Gravity Models , 2005 .

[21]  Stephen R. Bond.  Dynamic panel data models: a guide to micro data methods and practice , 2002 .

[22]  N. Driffield.  Multinational Firms and the Theory of International Trade. , 2004 .

[23]  Selin Sayek,et al.  Aid and Foreign Direct Investment: International Evidence , 2005 .

[24]  David Roodman,et al.  Aid, Policies, and Growth: Comment , 2004 .

[25]  H. Winner,et al.  How Corruption Influences Foreign Direct Investment: A Panel Data Study , 2006, Economic Development and Cultural Change.

[26]  S. Girma.  Absorptive Capacity and Productivity Spillovers from FDI: A Threshold Regression Analysis , 2005 .

[27]  Séverine Blaise.  On the link between Japanese ODA and FDI in China: a microeconomic evaluation using conditional logit analysis , 2005 .

[28]  S. Wei,et al.  How Taxing is Corruption on International Investors? , 1997, Review of Economics and Statistics.

[29]  Shinji Takagi,et al.  Japan's Official Development Assistance: Recent Issues and Future Directions , 2001 .

[30]  R. Blundell,et al.  Initial Conditions and Moment Restrictions in Dynamic Panel Data Models , 1998 .

[31]  Bin Xu,et al.  Multinational Enterprises, Technology Diffusion, and Host Country Productivity Growth , 2000 .

[32]  Xiaming Liu,et al.  Foreign Direct Investment and Economic Growth: An Increasingly Endogenous Relationship , 2005 .

[33]  Y. Todo,et al.  Knowledge Spillovers from Foreign Direct Investment and the Role of Local R&D Activities: Evidence from Indonesia , 2006, Economic Development and Cultural Change.

[34]  Aleš Bulíř,et al.  Volatility of Development Aid: From the Frying Pan into the Fire? , 2006, SSRN Electronic Journal.

[35]  A. Mody,et al.  The Role of Information in Driving FDI Flows: Host-Country Tranparency and Source Country Specialization , 2003 .

[36]  Bruce A. Blonigen,et al.  Estimating the Knowledge-Capital Model of the Multinational Enterprise: Comment , 2002 .

[37]  D. Dollar,et al.  Aid, Policies, and Growth , 1997 .

[38]  T. Curtis,et al.  TRENDS AND RECENT DEVELOPMENT IN FOREIGN DIRECT INVESTMENT IN RUSSIA , 2009 .