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International Labor Comparisons

FDI FLOWS, ECONOMIC GROWTH, AND DEVELOPMENT FDI inflows to developing countries have the potential to increase their stock of capital and technological know-how which, in turn, raises the host country’s level of output, labor productivity, and tax revenues. However, FDI flows may have a negative effect on the growth prospects of a country if they give rise to substantial reverse flows in the form of remittances of profits and dividends and/or if the TNCs obtain substantial tax concessions from the host country. These negative effects would be further compounded if the expected positive spillover effects from the transfer of technology are minimized or eliminated altogether because of overly restrictive intellectual property rights and/or the technology that is transferred is inappropriate for the host country’s factor proportions (e.g., too capital intensive). Following the lead of Zhang [2001] and De Mello [1997], the externality (positive or negative) associated with incorporating the stock of FDI can be explicitly modeled via an augmented Cobb-Douglas production function of the following form: (1) Y Af L K E AL K E = = p [, , ] α β αβ 1- – where Y is real output, Kp is the private capital stock, L is labor, and E refers to the externality generated by additions to the stock of FDI. α and β are the shares of 210 EASTERN ECONOMIC JOURNAL domestic labor and private capital respectively, and A captures the efficiency of production. It is also assumed thatα and β are less than one, such that there are diminishing returns to the labor and capital inputs.