Impact of domestic investment on the FDI-growth relationship

Empirical puzzle regarding the FDI-growth relationship has recently been explained in terms of the host country’s absorptive capacities. Countries with good absorptive capacity tend to harness benefits while others experience negative impacts from FDI. Nonetheless, extant literature fails to recognize the importance of domestic investment in explaining the growth productivity of foreign capitals. This paper, therefore, examines if the level of domestic investment in developing countries can affect the relationship between growth and FDI inflows. It is unveiled that irrespective of the level of domestic investment, the inflow of foreign capital leads to the displacement of local firms, thereby, experiencing zero or negative net impact of foreign capital on income growth of developing countries. We propose that national leaders must carefully assess MNC’s impact on the local economy before making any decisions regarding FDI and related policies.