Foreign Direct Investment (FDI) and trade openness are fundamental catalysts of economic growth, as they promote capital accumulation, facilitate technology transfer, and enhance productivity through increased market competition. FDI plays a significant role in capital formation, job creation, and the dissemination of knowledge, while trade openness contributes to more efficient resource allocation, the expansion of product markets, and heightened specialization. Collectively, FDI and trade openness encourage market integration, enabling the global economy to function more effectively by directing resources to their most efficient uses, fostering the production of goods and services at optimal productivity levels, and reducing costs for consumers.

The relationship between FDI inflows and the economic growth of host countries is often seen as beneficial, though it can vary based on several key factors such as technology transfer, local capacity, and the quality of institutions. When effectively managed, FDI can serve as a vital source of capital and knowledge. However, the positive impacts of FDI are largely determined by the host country’s absorptive capacity, which is crucial for maximizing the benefits. Empirical studies investigating the link between FDI and economic growth have yielded mixed results, highlighting a bidirectional relationship in which FDI not only drives economic expansion but also attracts further investment. The arrival of FDI introduces essential capital that can boost labor productivity and significantly enhance overall economic output and development. In this context, FDI plays a vital role in promoting economic progress by providing necessary investment, facilitating the transfer of technology, and creating job opportunities, especially in developing countries. By leveraging these factors, host nations can harness the full potential of FDI to foster sustainable economic growth.

Beyond financial contributions, FDI improves local productivity, encourages innovation, and integrates host economies into global value chains. As economies develop and income levels rise, the potential for higher profitability attracts additional foreign capital, creating a self-reinforcing cycle where growth fuels investment and drives further development. Furthermore, foreign investment connects host countries to global markets, contributing to the establishment of global value chains that diversify exports and bolster their integration into the global economy, as noted by Dollar (2017) [1] in a Brookings feature article. Through these global value chains, host countries gain access to a wider array of economic activities across interconnected regions, allowing local firms to capitalize on significant economies of scale and thereby strengthen their competitive position in the global marketplace.

The World Bank (2021) [2] highlights the crucial role of policies that attract and facilitate FDI entry in enhancing investment promotion capacity. These policies lead to spillover effects through supply chain linkages, bringing new capital, technology, and knowledge into business practices and enabling local firms to withstand competition from global, scalable competitors. Serpa and Krishnan (2018) [3] indicate that firms involved in a supply chain affect one another’s productivity, and productivity spillovers are more significant when the supply chain is more concentrated. Therefore, countries that benefit from productivity improvements resulting from FDI inflow are more likely to pursue policies favoring economic openness.

There is also a notable correlation between trade and economic growth, marked by increased competition, enhanced market efficiency, and rising export-driven demand. Trade openness is widely regarded as a vital engine of growth, as it allows countries to specialize in their strengths and access broader markets. Export-driven growth occurs when a rise in exports fosters greater demand for domestic goods, ultimately boosting national output and income. Moreover, the importation of intermediate goods enables domestic firms to obtain inputs that are either more cost-effective or of superior quality, thereby improving their productivity.

Trade plays a crucial role in enabling countries to focus on sectors in which they possess a comparative advantage. This strategic concentration encourages countries to allocate resources more efficiently, thus enhancing overall productivity. As economies grow, driven by increases in productivity and rising income levels, there is typically a corresponding rise in both import and export volumes. As domestic income increases, consumers and businesses alike tend to demand more foreign goods, reflecting a broader range of choices and access to resources that may not be available locally. Similarly, as nations improve their productive capacity—through technological advancements, innovation, and investment—they also bolster their ability to export goods and services. This interplay between rising domestic demand for imports and enhanced export capacity cultivates a self-reinforcing cycle of economic expansion, in which increased trade ultimately fosters further growth.

Extensive empirical research has consistently demonstrated a positive long-term relationship between trade openness and economic growth. However, it is important to underscore that this relationship is not a universally applicable guarantee. Several factors can significantly moderate or shape the dynamics between trade openness and economic advancement. One crucial element is the quality of governance within a country. Effective governance—characterized by robust institutions, the rule of law, and low levels of corruption—can facilitate smoother trade processes and create a conducive environment for businesses. Countries with strong governance structures are often better positioned to negotiate beneficial trade agreements, enforce regulations, and protect property rights, all of which are essential for maximizing the benefits of trade. Additionally, the structural composition of a nation’s economy plays a pivotal role in determining how effectively it can engage in international trade. For instance, economies that are heavily reliant on a limited range of exports may be more vulnerable to market fluctuations and less able to leverage the advantages of trade. Comparatively, a diversified economic structure can enhance resilience and adaptability, allowing a country to benefit more from trading with diverse partners.

A nation’s level of development plays a significant role in determining its capacity to engage in trade and leverage potential economic growth. Developing countries often encounter challenges such as insufficient infrastructure, limited access to technology, and a shortage of skilled labor, which can impede their ability to compete effectively in the global market. Conversely, more developed nations typically have the necessary infrastructure and resources to enhance their trade activities and promote economic expansion. While substantial research supports the relationship between trade openness and economic growth, it is essential to consider the interactions among governance quality, economic structure, and development level. These factors collectively influence the degree to which a country can participate in trade and ultimately harness the economic benefits that may arise from such engagement.

The relationship between FDI and international trade is inherently complementary and mutually reinforcing. An open trade environment is an attractive determinant of FDI, thereby enhancing overall productivity in the host economy. Trade liberalization frequently stimulates FDI by signaling opportunities for market access. In turn, FDI plays an essential role in expanding international trade and facilitating technology transfer. It can boost exports by establishing multinational networks and enabling the importation of intermediate goods and capital. Furthermore, knowledge spillovers from FDI inflows often disseminate technology and expertise to local suppliers, thereby strengthening the host country’s export competitiveness.

Despite the robust empirical and survey literature examining the growth effects of FDI and trade, a notable gap remains in understanding how various forms of external openness interact with country-specific characteristics to shape development outcomes. Existing research typically analyzes FDI and trade as separate entities, summarizing average effects without adequately addressing how factors such as governance, structural composition, factor endowments, and levels of development collectively shape the impact of openness. A growing body of literature underscores the importance of firm engagement in both FDI and trade for a nuanced understanding of the evolution of global value chains and their associated political ramifications. However, current studies predominantly focus on the implications of FDI for home countries, often overlooking the intricate firm- and product-level interactions between FDI and trade where such interdependencies arise.

A study by Kim, Liao, and Miyano (2025) [4] examines in detail how firms’ FDI alters host countries’ trade profiles, thereby fostering new political coalitions advocating trade liberalization. An analysis of greenfield FDI projects initiated globally in 2003 reveals that host countries experienced an average increase of over 45 export products in the year following these investments. To address challenges in linking firms to specific products, the authors integrate FDI data with Vietnamese customs records, demonstrating that Vietnamese export volumes for FDI-related products surged by 90 percent, while import volumes expanded by 30 percent over the four years following the initial investments.

Moreover, policies such as comprehensive trade agreements that extend beyond tariffs to include elements of investment, intellectual property, and services have demonstrated a remarkable ability to attract FDI, thereby reinforcing a constructive cycle. Collectively, these components contribute to economic growth by attracting increased FDI and sustaining developmental momentum. Consequently, while FDI and trade are distinct activities, they are intricately interconnected, facilitating the cross-border transfer of goods, services, and capital. Rather than functioning as mere substitutes, FDI and trade often stimulate further investment, with foreign investments actively fostering additional growth, particularly in exports. The dynamics of this reinforcing cycle illustrate that FDI enhances trade; foreign investments generate new trade opportunities, enabling multinational enterprises to establish international production networks. For instance, an OECD study indicates that for every dollar of outward FDI, there are two additional dollars in the home country’s exports. Conversely, trade fosters FDI, as liberalized trade policies that reduce tariffs and eliminate barriers make countries more attractive to foreign investors by providing larger and more accessible markets. Ultimately, FDI-driven capacity building introduces advanced technology and capital that enhance local firms’ export capabilities, thereby increasing trade. Key components of this reinforcing cycle include global value chains, which are facilitated by FDI and allow domestic firms to integrate and expand their participation in international trade.

This review aims to contribute to the existing literature by: (i) integrating FDI and trade openness into a cohesive conceptual framework, (ii) systematically organizing the evidence around fundamental conditioning mechanisms that elucidate why similar reforms in openness may lead to diverse growth outcomes, and (iii) explicitly contrasting neoclassical and endogenous growth interpretations of the empirical data. This methodology deepens our understanding of the context in which FDI and trade primarily generate level and convergence effects, as well as when they are likely to impact long-term productivity and innovation. In doing so, this review provides a more coherent synthesis of existing findings and presents clearer theoretical and policy implications compared to previous surveys. It develops an integrated framework that connects FDI, trade openness, and economic growth, uniting theoretical perspectives and empirical evidence that are often considered in isolation.

The central theme of this review is that the growth impact of FDI is critically influenced by its sectoral destinations, specifically, resource-seeking FDI in staple-based economies versus efficiency-seeking manufacturing FDI within global value chains. Notably, this composition has undergone significant changes since the mid-twentieth century. The review extends beyond the conventional focus on unconditional average effects by systematically organizing the evidence around key conditioning mechanisms, such as governance quality, structural composition, factor endowments, and levels of development. These factors help explain why seemingly comparable instances of openness can lead to divergent growth outcomes. This conditional perspective on the FDI–trade–growth nexus provides a more coherent interpretation of the varied empirical evidence and refines the policy implications of external liberalization for countries at different stages of development.