Infrastructure and FDI: Evidence from District-Level Data in India

Though public infrastructure plays a critical role in attracting Foreign Direct Investment (FDI), identifying this effect remains a challenge largely due to the econometric challenges involved in cross-country analyses. In this paper, we identify this effect by employing a unique dataset of FDI at the district-level in India, which has become one of the largest destinations of FDI in recent years. Our identification strategy exploits cross-sectional variation in infrastructure and FDI flows among close to 600 districts in India. We examine the effect of district-level infrastructure in 2001 on FDI flows into the district during 2002-07. We employ a three-pronged identification strategy. First, in panel regressions that include state fixed effects, we exploit variation among districts within a state and thereby control for state-level endogenous factors. Second, to account for agglomeration as well as cohort-level effects on FDI flows, we examine the effect on FDI flows into a district vis-a-vis that on its neighbouring districts. Finally, we exploit variation within districts in FDI inflows into different sectors depending upon their propensity to attract FDI. Surprisingly, we find that FDI inflows remain insensitive to changes in infrastructure till a threshold level of infrastructure is reached; thereafter, FDI inflows increase steeply with an increase in infrastructure. This threshold effect of "hard" infrastructure that we find contrasts to the uniform effects of "soft" infrastructure identified in recent studies. Our findings have important positive and normative implications.