Foreign Direct Investment in Developing Countries: Uncertainty, Trade and Welfare

The objectives of this three-essay thesis are first, to analyze the role of economic and political uncertainty in affecting FDI flows; second, to test competing hypotheses that explain the determinants of sales of affiliates of U.S. multinational firms to alternative destinations; and third, to investigate the welfare impact of FDI flow on local firms in a host country. These issues are interrelated, as uncertainty is one of the main impediments in developing countries to attract foreign direct investment, and uncertainty in turn affects business practices of foreign affiliates in a host country. The combined effects of uncertainty and business practices of affiliate firms can be reflected on the welfare effects of foreign affiliates on local firms in developing countries. The results of the study reveal that economic and political uncertainty impedes the flow of FDI only when combined with other instability indicators, such as debt burden. Due to these impacts of uncertainty and motives for international tax minimization, foreign affiliates of U.S. multinational firms trade more with other affiliate firms than non-affiliate persons. Efficiency motives are also observed in host countries where there is improved infrastructure and skilled labor. Business practices of affiliate firms including intra-firm trade and transfer pricing affect the extent of the spillover effects on local firms. The tests for spillover effects of U.S. and Japanese firms show no positive impact on productivity and export of a sample of developing countries