Working Paper: CEPR ID: DP4660
Authors: Klaus Desmet; Juan A. Rojas
Abstract: The standard argument says that in the presence of positive spillovers foreign direct investment should be promoted and subsidized. In contrast, this Paper claims that the very existence of such spillovers may require temporarily restricting and taxing inward FDI. Our argument in favour of gradual liberalization is based on two stylized features of spillovers: first, technology transfers ? and subsequent spillovers ? are limited by the economy?s absorptive capacity; and second, spillovers take time to materialize. By letting in capital more gradually, initial investment has the time to create spillovers ? and upgrade the economy?s absorptive capacity ? before further investment occurs. This allows subsequent capital inflows to benefit from greater technology transfers. As a result, the economy converges to a steady state with a superior technology and a greater capital stock.
Keywords: absorptive capacity; big bang; foreign direct investment; gradualism; liberalization; spillovers; transition economies
JEL Codes: F20; O30; P20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Gradual liberalization of FDI (F21) | Greater technological progress (O49) |
| Gradual liberalization of FDI (F21) | Enhanced absorptive capacity (F35) |
| Enhanced absorptive capacity (F35) | More effective technology transfers (O39) |
| More effective technology transfers (O39) | Economic advancement (O00) |
| Gradual liberalization of FDI (F21) | Higher steady state of technology and capital stock (O49) |
| Temporary restrictions on FDI (F23) | Optimal outcomes (L21) |
| Optimal policy requires taxing foreign investment in early stages (F38) | Subsidizing it later (H29) |