The impact of foreign direct investment on economic growth for countries in Latin America

Abstract: This paper examines how Foreign Direct Investment (FDI) affects Economic Growth and Total Factor Productivity (TFP) for recipient countries in Latin America. The study investigates whether FDI generates positive spillover effects, leading to a higher increase in TFP than domestic investments. According to the Schumpeterian model increasing in TFP would lead to a higher economic growth rate (Lucas, 1988; Romer, 1990). Furthermore, the interaction effect between FDI and human capital considers seeing if there is a threshold of human capital that the economy requires in order to absorb the positive external effects FDI might generate. The econometric model relies on a panel study including data from 21 countries in Latin America from 1995-2019, and the main variables originate from The World Bank Data. FDI is expected to affect TFP by elevating education levels positively, but the results on economic growth are ambiguous, with most results not significant. The initial effect of FDI and human capital on TFP is negative, but after accounting for the interaction effect, the percentage of the population graduating from secondary school will have a less negative or positive effect. The interaction effect between FDI and human capital, which is higher than domestic investments, can also demonstrate a positive spillover effect from FDI to recipient countries. Considering endogeneity, autocorrelation, heteroscedasticity, and multicollinearity, the empirical results are robust. Keywords: FDI, TFP, Economic Growth, Human Capital, Latin America, Schumpeterian model