market. They conclude that the larger the proportion of the economy of an LDC in the
hands of MNCs, the greater the negative externalities.7
However, Firebaugh (1992) has demonstrated that the findings of these earlier
researchers are misleading. He has shown that the negative sign on FDI stock/GDP,
holding flows constant, is due to a denominator effect of flows over stock. The larger the
stock the smaller the investment rate, and vice versa. He argues that flows are positive
and stock negative because smaller investment rates are related to lower economic
investment rates as well as domestic investment rates to be positively and significantly
related to growth, while foreign investment has a smaller impact. He concludes that
domestic investment is more effective than FDI.
While disagreeing with Firebaugh on several points, Dixon and Boswell (1996)
agree that the less-good foreign capital is likely to displace the better domestic capital
over time and thereby contribute towards lower economic growth in the long run. de
Soysa and Oneal (1999), using recent data, find that foreign and domestic investment
concluding that foreign capital is less good than domestic capital based on the absolute
size of the coefficients, because a percentage increase in foreign capital is not of the same
magnitude in terms of dollar value compared with a percentage increase in domestic
Furthermore, they find that FDI is at least three times as productive as domestic
investment dollar for dollar.
Using Granger causality tests they also show that foreign
7 Other studies following this strand include; Boswell and Dixon (1990) London and Williams (1990), Wimberley and Belo (1992). These studies highlight the various transgressions of powerful MNCs in the developing world.