Foreign Capital And Economic Development: Does Foreign Aid Increase FDI?

One of the main goals of increasing financial aid to the poorest regions is improving their capacity to attract more Foreign Direct Investments (FDI). The argument is typically built under the assumption that foreign aid and FDI are good complements. In this paper the authors argue that such an argument is incomplete, and show with a theoretical model that the relationship between aid and FDI is indeterminate. Aid may raise the marginal productivity of capital and consequently attract additional private foreign capital if it is used to finance complementary inputs, such as public infrastructure projects and human capital investment.