Does Foreign Aid increase Foreign Direct Investment?

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Pablo Selaya, Eva Rytter Sunesen

We examine the idea that aid and FDI are complementary sources of foreign capital. We argue that the relationship between aid and FDI is theoretically ambiguous: aid raises the marginal productivity of capital when used to finance complementary inputs (like public infrastructure and human capital investments), but aid may crowd out private investments when it comes in the shape of pure physical capital transfers. Empirically, we find that aid invested in complementary inputs draws in FDI, while aid invested in physical capital crowds it out. The paper shows that the composition of aid matters for its overall level of efficiency.
Original languageEnglish
JournalWorld Development
Volume40
Issue number11
Pages (from-to)2155–2176
Number of pages44
ISSN0305-750X
DOIs
Publication statusPublished - 2012

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