FDI and Total Factor Productivity: Does the trajectory of FDI matter?

Abstract This study revisits the relationship between foreign direct investment (FDI) and total factor productivity (TFP) growth in two distinct ways. First, it employs a dynamic heterogeneous panel threshold model to examine potential threshold effects of FDI on TFP. Second, and more critically, it investigates whether the trajectory of FDI influences this relationship. Using a sample of 71 developed and developing countries over the period 1980–2014, the study reveals new insights. For developing countries, the findings provide some support for a threshold effect and strong evidence for the importance of the FDI trajectory. Notably, the results suggest that the trajectory of FDI is more influential than its level in promoting TFP growth. However, for developed countries, no threshold or trajectory effects are observed. The key policy implication is that maintaining a steady and sustained flow of FDI is essential for enhancing TFP growth, particularly in developing economies.