International Productivity Differences and the Roles of Domestic Investment, FDI and Trade

This paper calculates Theil's entropy index to measure the extent of productivity differences across 92 countries for the period from 1970 to 2003. While there is evidence of increasing differences in productivity across these countries, we observe different patterns when we group the countries by income levels. These differences seem to be decreasing among middle income developing and developed countries, whereas they seem to be widening among low and high income developing countries. The results of our multivariate time series analysis also suggest that FDI increases productivity differences among low and high income developing countries, whereas GDI reduces these differences among low income countries in the long-run. Granger causality test results indicate that while an increase in GDI leads to a decline in growth of trade, a higher growth of trade appears to be important for attracting FDI to middle income countries. Furthermore, a reduction in productivity differences and a higher FDI growth lead to higher growth of trade in developed countries.