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channels through which FDI affect economic growth have been uncovered by the new

growth theorists (for example, Markusen, 1995; Lemi and Asefa, 2001; Barro and Sala-I-

Martin, 1995; and Borensztein, et al, 1998). Barro and Sala-I-Martin (1995) and

Borensztein, et al (1998), in particular, have developed a simple endogenous growth

model which demonstrates the importance of FDI in engendering growth through

technological diffusion. Typically, technological diffusion via knowledge transfer and

adoption of best practice across borders is arguably a key ingredient in rapid economic

growth.

And

this

can

take

different

forms.

Imported

capital

goods

may

embody

improved technology. Technology licensing may allow countries to acquire innovations

and expatriates may transmit knowledge. Yet, it can be argued that FDI has greatest

potential as an effective means of transferring technical skills because it tends to package

and integrate elements from all of the above mechanisms. First, FDI can encourage the

adoption of new and improved technology in the production process through capital

spillovers. Second, FDI may stimulate knowledge transfers, both in terms of manpower

training and skill acquisition and by introduction of alternative management practices and

better organizational arrangements.2

2.3

Review of Prior Studies

There is an extensive and controversial literature on factors affecting FDI flow to a host

country.

Grossman

and

Razin

(1984

and

1985)

show

that

apart

from

firm-specific

advantages and motives to internalize externality benefits, host country’s characteristics

are a key determinant of MNCs location of production. In another important study,

Lucas (1990) finds political risk and capital market imperfections as factors responsible

2 The channels through which FDI may be growth enhancing are clearly identified in an excellent survey by de Mello (1997) and in Grossman and Helpman (1991, 1995), Lensink and Morrissey, 2002 and Barro and Sala-I-Martin (1995, 1997).

9

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