According to the Solow Model, increased saving and investment can lead to economic growth in the medium term. For permanent economic growth, continuous technological progress is required.

Technological progress requires the creation of new ideas and knowledge from the scarce resources of an economy. Schumpeterian model of economic growth specifies that innovation is the result of intentional, costly investment in research and development activities.

The Shumpeterian process of innovation and knowledge creation specifically states that the quantity of innovations generated in the economy is a function of

the supply of resources in the country

profit from innovating

efficiency of R & D activities in terms of the amount of resources necessary to generate an innovation.

the discount factor

Hence, technological progress gets boosted up by international investment. This is because international investment contributes to globalization. Thereby, international investment raises the potential profits from innovation.

The gains for human welfare are greater when innovation is applied throughout the world, rather than only in one country.

Further, international investment reduces the cost of innovation because it facilitates the flow of ideas. For instance, Foreign direct investment(FDI) leads to transfer of technology to the recipient countries. Other forms of investment also facilitates information flows between economies.

Foreign investment also stimulates innovation by increasing competition. For example, Japan’s second largest retailer, Aeon actively adopted methods which the pioneers in the retail industry such as Walmart of U.S. and Carrefour of France had adopted before.

International investment and Economic Growth

Ceteris Paribus, foreign investment is good for growth. Yet, if the foreign borrowing leads to high level of foreign debt, the investment flows can reduce long term growth.

According to Geert Bekaert and Campbell Harvey, letting foreigners invest in local stock markets is good for the economic growth because of the lower cost of loanable funds. However, Joshua Aizenman provides evidence that portfolio investments like equity investments can cause financial crisis. This may retard economic growth.

FDI specially tends to have large technology spillovers. Hence, there is a positive correlation between investment in productive equipment and countries’ rates of economic growth.

Also, the effect of equipment investment on economic growth is stronger in developing economies in the early stages of industrialization than in developed countries.

Thus, foreign investment raises the economy’s steady state of output while embodying new technology. This helps transfer technology from high tech to low tech countries.

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