An analysis of the relationship between foreign direct investment and economic growth

Abstract

Employing a panel data modelling technique, we contribute to two critical research issues: what is the link between Foreign Direct Investment (FDI) and economic growth and does the relationship change under different educational, institutional and economic conditions? Overall, the analysis supports the view that FDI has a stronger positive impact on economic growth in countries with a higher level of education attainment, openness to international trade and stock market development, and a lower rate of population growth and lower level of risk. Thus, countries undertaking reform of cross-border capital restrictions and controls and initiating other policy aimed at encouraging FDI need to ensure that broader social policy objectives–such as education and institutional reform–are also undertaken to leverage the benefits from FDI.

Acknowledgements

This article was presented at the 2006 Academy of International Business Conference, Beijing, China, and the 2006 Asian Finance Conference, Auckland, NZ. The authors wish to thank the four conference referees and participants and another anonymous referee, who has helped to improve the clarity and brevity of the article.

Notes

¹ This is reasonable: Graham and Harvey (2001) show that firms typically apply a constant cost of capital when evaluating capital budgeting decisions.

² These X-variables form the basis of the conditioning information set because other studies have employed these variables (or close-related variables) to stand for fiscal, trade, monetary, uncertainty and political-instability indicators. This pool is kept small to make the results more tangible and digestible. The results do not depend importantly on choosing these variables.

³ www.icrgonline.com.

⁴ This can be mathematically proved as follows. Differentiate Y with respect to FDI to obtain: δ _Y /δ_FDI = X. If β ₅ > 0 then FDI would have a stronger effect on Y in a country with a higher level of X.

⁵ See Edison et al. (2002) for a detailed discussion on the advantages of GMM estimator for dynamic panel data.