The Relationship between Education and Foreign Direct Investment: Testing the Inverse U Shape

Abstract

The Zhang-Markusen (ZM) theory hypothesizes an inverse U-shaped relationship between human capital and foreign direct investment (FDI). Therefore, low wage countries with low human capital cannot attract FDI. To test this hypothesis, we regress FDI on educational levels across countries while grouping them in different income cohorts. Our findings partly support ZM. Rich countries with high human capital and poor countries with low human capital demonstrate an inverse correlation between FDI and human capital proxies. However, for middle-income and upper middle-income countries, human capital (especially tertiary education) has a positive relationship with FDI.

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