Academic journal article Pakistan Economic and Social Review

The Impact of Foreign Capital Inflows on Economic Growth: Pooled Mean Group Analysis for Developing Countries

Academic journal article Pakistan Economic and Social Review

The Impact of Foreign Capital Inflows on Economic Growth: Pooled Mean Group Analysis for Developing Countries

Article excerpt


Abstract. This study attempts to include all foreign capital inflow variables to analyze their impact on economic growth of 21 developing countries for the period of 1990 to 2013. Modern econometric techniques are applied for data analysis including panel unit root test and pooled mean group (PMG) estimation for short-run and long-run analysis. The results indicate that inflows including net external debt and net official development assistance have significantly negative impact on economic growth of developing countries, while net foreign direct investment and net remittances have positive and significant impact on economic growth in the long-run. The negative sign of error correction term shows the convergence of the variables towards equilibrium in the long-run. The study highlights the need of allocation of foreign resources effectively and efficiently.

Keywords: Capital inflows, Panel Unit Root test, PMG


Foreign capital inflows stimulate the process of economic development and lead towards a healthy economy. Inflows enhance the capacity of production and reduce unemployment with effective allocation of resources. The role of capital inflows is eminent in developing countries because they are deficient in capital, skilled labour and modern technology. The rising trend of capital inflows has been studied by earlier researchers who found mixed results.

Kentor (1998) found negative impact of foreign capital penetration on economic growth in the long-run but revealed positive in the short-run. Chowdhury (2001), Pattillo et al. (2002), Cordella et al. (2005) and Ekanayake and Chatrna (2010) supported the negative effect on economic growth. Capital inflows have also positive impact on economic growth as analyzed by earlier researchers like Berument and Dincer (2004), Tan (2009), Ndambendia and Njoupouognigni (2010) and Karamelikli and Bayar (2015).

Most of the studies have analyzed inflow variables in isolation and found numerous results. With regard to foreign direct investment de Mello (1999), Ciftcioglu et al. (2002), Frimpong and Oteng-Abayie (2006), Akbas (2013) and Dogan (2014) found positive influence of foreign direct investment on economic growth. Ekanayake and Chatrna (2010) analyzed foreign aid spanning the period of 1980 to 2007 for low, middle and upper middle income countries applying GMM and OLS techniques and found negative results with regard to economic growth. On the contrary, Tan (2009) found positive impact of foreign aid on economic growth using pooled mean group estimation technique for 46 developing countries.

As far as remittances, which is a major tool for promoting economic growth, are concerned, positive effect on economic growth are found in existing literature like Paul et al. (2011), Bayar (2015) and Karamelikli and Bayar (2015).

External debt is a tool which is used to bridge the gap between government expenditures and government revenues. It is not only used for budgetary support but also promotes investment in recipient countries. In literature, it is strongly recommended that external debt has a negative effect on economic growth (Chowdhury, 2001; Pattilo et al., 2002; Cordella et al., 2005) due to poor allocation of resources and mismanagement of the governments.

Most of the studies have one point in common that they have not used all the inflow factors in a regression model which may have created the problem of omitted variable bias and inconsistency of parameters.

Fambon (2013) analyzed foreign aid and foreign direct investment and captured their impact on economic growth of Cameroon using autoregressive distributed lag model. He found significant effect of foreign direct investment on economic growth of Cameroon but foreign aid had positive but insignificant impact. Nwaogu and Ryan (2015) applied mix of the inflow variables including FDI, remittances and foreign aid of 53 African and 34 Latin American and Caribbean countries using GMM technique for analysis to observe their relationship with economic growth. …

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