FDI and growth revisited: Does absorptive capacity make the difference? evidence on threshold effects

Abstract This paper sheds light on the pivotal role of the absorptive capacity of host economies in the intricate interplay between foreign direct investment (FDI) and economic growth. Drawing on panel data from 46 developed and developing countries spanning 1996–2023, this study delves into the heterogeneous influence of technology gaps, human capital and institutional quality on the relationship between FDI and growth. It uses a multi-method and robust empirical strategy encompassing two-way fixed effects, high-dimensional fixed effects, system GMM, FE-2SLS and panel threshold regressions. The findings show that the growth effects of FDI are conditional rather than uniform. In the linear panel estimates, FDI does not exhibit a clear direct growth effect in the full sample or in developed countries, but it remains positive and significant in developing countries. The threshold results deepen this picture. In developing countries, the effect of FDI becomes much stronger once human capital exceeds 9.35 years of education. Institutional quality and the technology gap also generate threshold effects, although the pattern differs across country groups and is not monotonic. This paper ultimately suggests that governments should not blindly rely on FDI to promote economic growth, but should develop technological capabilities, human capital and institutional quality if foreign investment is to be most effective.