Economic Growth and Fdi Inflows: A Stochastic Frontier Analysis

By Wijeweera, Albert; Villano, Renato et al. | The Journal of Developing Areas, Spring 2010 | Go to article overview

Economic Growth and Fdi Inflows: A Stochastic Frontier Analysis


Wijeweera, Albert, Villano, Renato, Dollery, Brian, The Journal of Developing Areas


ABSTRACT

Despite plausible theoretical grounds for presuming a positive relationship between foreign direct investment inflows (FDI) and economic growth, existing empirical evidence on this nexus is inconclusive. In an effort to add to the empirical literature, this paper estimates the relationship between FDI and the rate of growth of GDP using a stochastic frontier model and employing panel data covering 45 countries over the period 1997 to 2004. We find that FDI inflows exert a positive impact on economic growth only in the presence of a highly skilled labour; corruption has a negative impact on economic growth; and trade openness increases economic growth by means of efficiency gains.

JEL Classifications: C23, F21, F23

Keywords: Economic growth; foreign direct investment inflows

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

In general, economists agree that foreign direct investment inflows (FDI) lead to an increased rate of economic growth (see, for example, Blonigen, 2005). A major growth-enhancing characteristic of FDI is the advanced technology that often accompanies foreign capital investment. In addition, domestic investors can also adopt this advanced technology. In other words, FDI generates positive externalities through technology spillovers. At the same time, increased foreign capital can help to narrow the savings gap (i.e. the gap between the domestic savings ratio and the desired level of investment ratio). In short, FDI should exert positive effects on economic growth, particularly in developing countries which suffer from low productivity and capital stock deficiencies (see, for instance, Johnson, 2006).

Despite these plausible theoretical grounds for anticipating a positive relationship between GDP and FDI, available empirical evidence is mixed. For example, De Mello (1999) found that whether FDI contributes to the economic growth depends on primarily host country characteristics, especially the quantum of skilled labour. Borensztein et al. (1998) also established that although FDI has a positive impact on GDP, the magnitude of this effect depends on the level of human capital. Using both cross section and panel data analysis, Johnson (2006) demonstrated that FDI inflows boosted economic growth in developing countries, but not in advanced nations. Alfaro (2003) conducted a cross-country analysis and found that total FDI exerted an ambiguous effect on host country economic growth; FDI inflows into the primary sector tended to have a negative effect on growth. Numerous other empirical studies have also provided mixed evidence on the link between economic growth and FDI (Wijeweera et. al. 2007; Zhang 2001; Johnson 2006). The relationship between FDI and the rate economic growth is critically important for policy making in the real-world. The past two decades have witnessed a massive surge in FDI inflows. Indeed, according to UNCTAD (2005), global FDI inflows increased from approximately U$55 billion in 1980 to around U$1,400 billion in 2000. This unprecedented growth in FDI inflows has prompted academic economists and policy makers alike to devote much more effort to understanding the empirical relationships between GDP growth and FDI inflows in host countries.

The present paper seeks to contribute to the empirical literature on the relationship between economic growth and FDI flows in host nations. Theoretical foundation for our study rests squarely on the well-known endogenous growth model (Romer, 1990). According to the endogenous growth models, output is a function of the standard factors of production plus human capital. We employ a stochastic frontier model (SFM) to estimate the model. The SFM model contains factor inputs variables and inefficiency variables. We use capital, labour and human capital as factor inputs as well as several variables as inefficiency variables. We also include a proxy for the level of infrastructure and a proxy for the level of corruption in the host economies. …

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