Academic journal article The Journal of Developing Areas

Foreign Direct Investment, Financial Development, and Economic Growth: A Cointegration Model

Academic journal article The Journal of Developing Areas

Foreign Direct Investment, Financial Development, and Economic Growth: A Cointegration Model

Article excerpt

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

Numerous empirical time-series studies have been conducted to test for FDI inflow determinants. Most of these conclude that FDI contributes positively to the stimulation of economic growth, and they also highlight the importance of transferring advanced technology, efficiency, productivity, and knowledge diffusion to the host countries. Furthermore, several studies provide evidence that countries with a minimum stock of human capital, in conjunction with a well-functioning financial market mechanism and well-developed financial institutions, can absorb FDI more efficiently and gain significantly from FDI in terms of their economic growth rates.

Nevertheless, although the relationship between FDI and economic growth has been investigated thoroughly for developed and developing countries, there is still a limited number of studies that examine such a relationship for less developed countries with a less technologically advanced culture, where FDI seems to have a limited impact-even if it is positive-on economic growth. This is endorsed by the fact that the overall FDI impact in the host country is subject to a number of FDI flow-determining factors, including the trade system, the threshold level of human capital, the degree of openness in the economy, the sufficient absorptive capacity of the financial system, and so on.1

We believe that, while evidence varies from one country to another, cross- country regressions currently employed to test for the FDI-growth nexus are insubstantial. Therefore, in order to improve our understanding of the causal relationship between financial development and economic growth, it is essential to perform studies on individual countries using a diverse set of financial measures. This will generate predictions on how fundamental, country-specific determinants can shape/reshape FDI behavior. A country-specific study that is based solely on economic grounds will provide more precise estimates of the causal relationship between variables, even within a group of less developed countries trading in a small market, i.e. differences in economic sizes and economic growth rates in terms of Gross Domestic Growth (GDP) per capita. As a result, the use of time-series studies that rely on country-specific characteristics to measure for the causal relationship between the targeted variables would provide a better estimation of the impact between variables (see Jung, 1986; Demetriades and Hussein, 1996; Luintel and Khan, 1999; Chakrabarti, 2001; Blonigen and Wang, 2005; Hakro and Ghumro, 2011).

For Jordan, the FDI inflow trend has been very impressive in the last two decades. In this regard, in order to finance and stimulate economic growth, successive Jordanian governments have recognized that FDI inflow is essential, given limited natural resources and the heavy reliance on external financing. Moreover, in order to transform the economy into a fully market-oriented framework, many liberal economic and investment reform programs have been adopted by the government, including, for example, liberalization, privatization, capital deregulation policies, the establishment of free zones during the 1990s, and the introduction of Investment Promotion Law No. 16/1995 (see Section 3 for more details).2 However, given such liberalized actions, a test is needed to explore to what extent these actions facilitate the fairer and more efficient distribution of financial resources in order to promote short-term and/or long-term economic growth.

Earlier literature on FDI in Jordan is either superficial or theoretical, and its scope is quite limited in analyzing the trend and explaining the economic constraints that may theoretically cause variations in FDI inflow. The literature also uses simple Ordinary Least Square (OLS) estimation models, which fall short of applying the short-run as well as the long-run dynamic process of their techniques of predicting, causal directions, and the inclusion of market equity and bank measure indices. …

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