Impact of FDI and Its Absorption Capacity on the National Innovation Ecosystems: Evidence from the Largest FDI Recipient Countries of the World

Published date01 May 2023
Date01 May 2023
Subject MatterArticles
Impact of FDI and Its
Absorption Capacity
on the National
Innovation Ecosystems:
Evidence from the
Largest FDI Recipient
Countries of the World
Naveed Ul Haq1
Foreign direct investment (FDI) improves economic growth by stimulating native
investment, facilitating technology transfers in the recipient country and increas-
ing human capital development, thus playing a vital role in economic development.
On the other hand, innovation is also considered one of the major drivers for the
economic growth of a country. This study empirically investigates the impact of
FDI and its absorption capacity on the national innovation system of the world’s
top five largest FDI recipient countries for the period of 1990–2016. Using two-
stage analysis (DEA and Tobit regression), we found that research and develop-
ment expenditures, researchers in the host country and the number of patents,
trademark and industrial design applications are positive drivers of the national
innovation systems. Moreover, the FDI inflows positively impact the innova-
tion efficiency in the host countries. However, the strength of this relationship
depends on the availability of the absorption capacity of FDI in the host country.
The result shows that the global financial crisis and inflation negatively impact
the FDI inflows and innovation efficiency in the sample countries. It concludes
that FDI inflows and the country’s strength of domestic absorption capacity are
essential drivers for developing national innovation ecosystems.
JEL Codes: F1, F4, G10, M21
1Off‌ice of Research Innovation and Commercialization, University of Management and Technology,
Lahore, Pakistan.
Corresponding author:
Naveed Ul Haq, Off‌ice of Research Innovation and Commercialization, University of Management and
Technology, Lahore, Pakistan.
Foreign Trade Review
58(2) 259–288, 2023
© 2022 Indian Institute of
Foreign Trade
Reprints and permissions:
DOI: 10.1177/00157325221077007
260 Foreign Trade Review 58(2)
FDI inflows, national innovation systems, absorption capacity of FDI, innovation,
complementary assets, FDI recipient countries
Foreign direct investment (FDI) plays a signicant role in developing the economic
growth of its recipient country. Over the last two decades, numerous developing
countries have devoted signicant attention to encouraging the inows of FDI to
boost the economy (Zaman et al., 2012). The theoretical prospects for FDI inows
suggest that FDI is a combination of capital stocks, technology and technical know-
how, which expands the market access, provides positive technical spillovers and
improves human capital, hence promoting the economic growth of a country (Blom-
ström et al., 1994; K. H. Zhang, 1999). FDI inows play a signicant role in the eco-
nomic development of its recipient country. Whether local or foreign, investment in
a county depends on different factors, and any change or move in the direction of
these factors results in a signicant change in investment. Investors always prefer to
invest in a healthy and safe environment. Any unfavourable move in this environ-
ment makes the investor too much conscious. The investment becomes risky, and
investors lose condence in the host country due to political instability (Khachoo
& Khan, 2012). FDI has been recognised mainly as a growth-enhancing factor in
developing countries because it offers many advantages to the host country, that is,
increases the stock of human capital, used for maintaining the current account de-
cit, eases the access of new technologies, introduces new modern technologies and,
ultimately, boosts the national innovation system (Falki, 2009). The impact of FDI
on the host country has been the empirical investigation in the economics literature.
The economic theory suggests two significant impacts of the FDI on the host
country. First, inward FDI is considered an essential channel of technology trans-
fer because multinational enterprises are more productive and innovative, and
they invest more in research and development (R&D) activities than domestic
enterprises. However, technology transfer cannot be taken for granted, and it will
depend on the capacity of the firms to adopt and apply new technologies. The
economic environment mainly allows knowledge transmission among domestic
and foreign firms (Antonietti et al., 2015). The economic theory also suggests that
FDI may have a pro-competitive effect on its host country. The entry of multina-
tional firms boosts the competition in the domestic market and pushes domestic
firms to search for new technologies, productivity improvements and utilisation
of resources efficiently to compete with foreign firms (Kiriyama, 2012).
In order to gain the supposed advantages from the multinational firms, the
governments of many countries offer different types of financial supports, that is,
financial assistance, tax reliefs and some other types of benefits to attract foreign
firms, since these policies infer high costs for public finance and they are justified
only if the positive externalities on the host economy from FDI are significant.
However, the impact of FDI on the host economies remains an open question.

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