Academic journal article International Journal of Business

Endogenous Specification of FDI and Economic Growth: Cross-Economies' Evidence

Academic journal article International Journal of Business

Endogenous Specification of FDI and Economic Growth: Cross-Economies' Evidence

Article excerpt

I. INTRODUCTION

In order to stimulate economic growth, most economies shift toward more liberalized polices and adopt liberal development oriented actions to attract more capital inflows or Foreign Direct Investment (FDI). These actions are deeply inspired by the latest statistical prospect in the global FDI inflow that reached, despite turmoil in the global economy, more than $1.2-$1.5 trillion in 2011 (a 17% rise compared to 2010), $1.6 trillion in 2012, headed towards $1.8 trillion in 2013 and has been expected to rise to $1.9 trillion in 2014. (1) Such statistical indicators encouraged most developing economies to promote liberalizing measures and relax tight economic policies in order to facilitate supplementary FDI inflows, hence, take advantage of globalization to achieve more integration with other wide-reaching economies.

The theoretical discussions of growth and FDI relationships are centered on two arguments involving a range of positive to negative relationships. Here we will discuss the two arguments and their merits. First, as per the FDI-growth nexus, the affirmative contribution of capital flow towards growth is obvious; however, the type of relationship between FDI and growth is still a debatable issue, since mixed results are reported in the literature. On the one hand, while testing whether FDI determines economic growth, the economic rationale demonstrates that FDI provides externalities in the form of technology transfer and business know-how to the host developing countries, reflecting the chance to have an extensive spillover effect for the whole economy, boosting its overall productivity. Proponents of the FDI-led growth phenomenon validated such an economic rationale, given the educational, technological as well as the infrastructure developments, in conjunction with labor efficiency enhancements and human capital developments achieved by most host countries, Tang et al. (2008), Alfaro et al. (2009), Sun (2011), Umoh et al. (2012) and Ray (2012). On the other hand, there is an expectation that FDI in the incidence of pre-existing trade and price, together with other alterations would affect negatively the allocation of resources, and hence slow down economic growth, Boyd and Smith (1992). Overall, opponents of the FDI-led growth phenomenon argue that FDI crowds out domestic investment and has an adverse effect on growth. In addition, FDI may cause competition deterioration and re-guide the development strategies of the host region/country according to its own course Huang (2003), and Fry (2003).

Second, as per the growth-led FDI nexus, proponents claim that higher growth rates stimulate more FDI inflow given the greater level of profitable possibilities based on a higher progression in demand, hence, economies with low levels of economic growth may also serve as profitable destinations for capital. This view counts economic growth as a determining factor of FDI where higher growth rates, as an indication of country attractiveness, would stimulate more FDI inflows to the host country. Furthermore, FDI would stimulate growth under certain policy conditions including economic stability, trade openness, adequate human capital, developed financial markets and liberalized financial enterprises, in addition to the presence of a well-educated workforce to allow for exploiting the FDI spillover, see Wang and Wong (2004) and Aghion et al. (2006). Moreover, while others believe that high-growth developed economies attract more FDI compared to low-growth developing economies, many studies concluded there exists a bi-directional interaction between the two macroeconomic variables, e.g, Choe (2003), Mencinger (2003), Hansen and Rand (2006) for the former and Basu et al. (2003), Dritsaki et al. (2004) and Saha (2005) for the latter.

An overview of the literature reveals that, though there are few attempts to test for the FDI determinants? in the context of the Economic and Social Commission for Western Asia (ESCWA), none fully test for FDI-growth performance, given the impact of the targeted FDI-growth deriving factors, namely gross domestic saving, exports, human capital, gross fixed capital formation and population growth. …

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