Foreign direct investment, public expenditure and economic growth: the empirical evidence for the period 1970–2001

Abstract

The simultaneous impact of public expenditures and foreign direct investment (FDI) on economic growth is studied. To the best of the authors’ knowledge, this is the first study that takes into account the interaction between FDI and public expenditures in determining the economic growth rate. Using a sample of 105 developing and developed countries for the period 1970–2001, the main findings are (i) FDI, public capital, and private investment play important roles in promoting economic growth, (ii) public non-capital expenditure has a negative impact on economic growth, and (iii) excessive spending in public capital expenditure can hinder the beneficial effects of FDI.

Notes

The hypothesis is based on the assumption that in EP countries, the effective exchange rate on exports equates the effective exchange rate on imports while in IS countries, the latter exceeds the former. As a result, Bhagwati (1978) argued that EP countries would attract a higher volume of FDI.

As cited in Hansen and Tarp (2000), this argument is supported by several studies, including Hadjimichael et al. (1995), Durbarry et al. (1998), Lensink and White (1999) and Burnside and Dollar (2000).

In fact, the dummy variable Dm has been tested with various ratio of public investment ranging from 1% to 7.5%; however, none produce significant coefficients of explanatory variables. Thus, the result is presented here with the ratio of public investment at 8%, 8.5% and 9% only (10% of observations of pubcap have value greater than 8.27%).