Economic Development and the Direction of FDI Flows

Evidence suggests that advanced economies make and attract relatively more FDI as a share of GDP than developing countries. Comparing the composition of international liabilities across countries the paper argues that higher risks and regulatory barriers in developing countries are the primary reasons behind the relatively lower levels of FDI liabilities to GDP in developing countries. The paper uses a model with heterogeneous multinational firms to explain this empirical observations. In the model developed countries make relatively more FDI because the average productivity of firms in these countries is higher, thus there are relatively more firms with sufficiently high productivity levels, that can profitably enter into foreign markets.