Foreign direct investment as a catalyst for industrial development

How does an FDI project affect local firms in the same industry? Competition in the product and factor markets tends to reduce profits of local firms, but linkage effects to supplier industries may reduce input costs and raise profits. This paper develops an analytical framework to assess these effects. Circumstances in which FDI is complementary to local industry are established, and it is shown how FDI may lead to the establishment of local industrial sectors. These sectors may grow to the point where local production overtakes and forces out FDI plants. Our results are consistent with the experience of a number of industrial sectors in the NICs.