Foreign Direct investment and Economic Growth In Developing Countries 155 FOREIGN DIRECT INVESTMENT AND ECONOMIC GROWTH IN DEVELOPING COUNTRIES Dosse Toulaboe, Fort Hays State University Rory Terry, Fort Hays State University Thomas Johansen, Fort Hays State University ABSTRACT Theory suggests that foreign direct investment (FDI) contributes to capital accumulation and technological progress and is an important catalyst for industrial development. In the context of an endogenous model, we investigate the impact of FDI on economic growth, and test the hypothesis that the beneficial effect of FDI inflows is stronger in those countries with higher level of economic development. Our results show a strong direct impact of FDI on economic growth in developing countries, as well as an indirect impact through the interaction of FDI with human capital. Additionally, our results suggest that the impact of FDI on economic growth is greater among technological leaders. We conclude that absorptive capacity in the host country is important in allowing FDI to positively and fully impact economic growth. JEL Classifications: F21, F23, O47 INTRODUCTION The contribution of foreign direct investment (FDI) to economic growth in host countries has long been the subject of intense debate. The literature points to its importance in promoting economic growth and, it is actively sought by virtually all countries. The direction and volume of FDI across countries and regions, however, suggest that its attractiveness and efficacy depends on institutional and country- specific factors, including the country’s openness to trade; investment in basic infrastructure and human capital; factor endowment; financial structure; and macroeconomic, political, and social stability. The hypothesis that FDI can play a key role in improving the economic growth of the host country may require, therefore, that a more conducive environment in terms of a sufficient absorptive capability of the advanced technologies be available in the host economy (Borensztein et al, 1998). According to UNCTAD (2006), only one-third of FDI flows in 2006 went to developing countries. In the developing world during the period 2003-05, Asia and Oceania received 21.4 percent of the world FDI inflows, Latin America and the Caribbean received 11.5 percent, and Africa 3.0 percent. In countries that cannot capture the spillover effects from the presence of foreign firms (due to a lack of favorable economic, political, and social climate), FDI may have little or even an adverse effect on economic growth. It appears, therefore, that given the economic, social, and political disparities across countries, the growth effect of FDI will differ across countries. In this context, it is tempting to hypothesize that in East Asian and Latin American countries, with