Growth effects of FDI and portfolio investment flows to developing countries: a disaggregated analysis by income levels

Abstract

What is the impact of foreign direct investment (FDI) and portfolio investment flows on the economic growth of low-, lower middle- and upper middle-income countries? In this article we address this question using a dynamic panel model and a large data set of 126 developing countries for the period 1985 to 2002. Employing the system-generalized methods of moments (GMM) estimation approach, our findings suggest that only developing countries that have reached a minimum level of economic development and absorptive capacity are capturing the growth-enhancing effects of both forms of investment inflows.

Notes

¹ The notable exceptions are Gruben and Mcleod (1998) and Durham (2004).

² Lucas (1990) suggested that lack of absorptive capacity, interpreted in terms of supply side factors, severely hinders the growth-enhancing effects of capital inflows.

³ A method of moments estimator derives the coefficients from moment restrictions on the covariance between the regressors and the error term. The system GMM estimator combines the differenced equation with a levels equation to form a system GMM, which deals with the problem of simultaneous causation between economic growth and capital flows by allowing the lagged values of the explanatory variables as instruments.

⁴ The purchasing power parity (PPP) GDP is obtained by converting GDP to international dollars using PPP rates. GDP at purchaser's prices is computed as the sum of gross value added by all resident producers plus any product taxes and minus subsidies.

⁵ Interestingly though, Bende-Nabende et al. (2003) also found that the direct long-run impact of FDI on output turned negative in the more economically advanced Japan (insignificant) and Taiwan.

Table 4. FDI flows and economic growth: system GMM estimates