How Does US aid affect US vertical and horizontal FDI to developing countries?

In this thesis the relationship between foreign aid and Foreign Direct Investment (FDI) is investigated. In the literature there is no consensus about how foreign aid affects FDI. Theoretically, foreign aid can work as a complement when flowing into infrastructure and institutions ór it can work as a substitute when flowing to the private sector. In this thesis we disaggregate FDI into vertical and horizontal fragmentation of production according to the Knowledge Capital model. We estimate a panel data regression using US manufacturing FDI as a proxy for vertical FDI and US services FDI as a proxy for horizontal FDI. From the results we find that there are differences in the relationship between aid and FDI across regions. In an attempt to explain these differences, we stress that (1) US foreign aid is different than aid from other donors as US aid is mostly donated for geostrategic and global security concerns and (2) infrastructural aid only works for FDI up to a certain development level of a developing country. Regarding the first effect, we indeed see a negative effect of US infrastructural aid on both manufacturing and services FDI for countries with a less durable regime. Infrastructural aid in those countries act as a warning sign for the investment decisions by US multinationals. The results for the effect of the development level of a developing country are not significant for both types of FDI. However, we can infer from the signs of the coefficients that there is a certain level of development in which infrastructural aid turns negative for manufacturing FDI. This is not observed with services FDI.