Foreign direct investment (FDI) is a crucial factor in international economic integration. FDI creates direct, stable and long-lasting links between economies. It promotes the transfer of new technology and know-how between countries, and provides the host economy to promote its products more widely in international markets. FDI is also an extra funding source for investment and, under the right policy environment, it can be an important channel for development of SMEs. Increased FDI inflows to a country can create several positive economic effects. Among others, FDI can affect labour and capital markets, trade patterns and economic growth. It is well known from the theory of host country effects of FDI that in order for FDI to occur, the multinational enterprise (MNE) must have some firm specific advantages compared to the enterprises in the host economy. These firm specific advantages may result in technology transfer from the parent firm to its affiliate in the host country of investment and related spillover effects in the host economy by firms. We survey the recent theoretical and empirical literature, but restrict our attention to the productivity changes that are induced by increased FDI inflows. We review both the aggregate productivity effects, as well as the spillover effects of FDI on SMEs. (C) 2014 The Authors. Published by Elsevier Ltd.