Bilateral FDI Flows: Threshold Barriers and Productivity Shocks

Abstract

A positive productivity shock in the host country tends typically to increase the volume of the desired foreign direct investment (FDI) flows to the host country, through the standard marginal profitability effect. But, at the same time, such a shock may lower the likelihood of making any new FDI flows by the source country, through a total profitability effect, derived from the a general-equilibrium increase in domestic input prices. This is the gist of the theory that we develop in the article. For a sample of 62 OECD and non-OECD countries over the period 1987–2000, we provide supporting evidence for the existence of such conflicting effects of productivity changes on bilateral FDI flows. We also uncover sizeable threshold barriers in our data set. (JEL codes: F2, F3)