Foreign direct investment in economic development : a quantitative study

The impact of foreign direct investment (FDI) on the economic growth of developing economies has long been a controversial topic. Past empirical research in this field has yielded contradictory evidence regarding both direction and nature of such impact. This study aims to shed further light on the quantitative relationship between FDI and the economic growth of recipient developing countries.

To achieve that objective, this research first attempted to determine the association between FDI and the growth rate of GDP based upon pooled data of 59developing countries for years 1960-1963 and 1967-1973. The effect of FDI on the growth rates of exports and GDP by industrial origins were also examined as well as the relation of FDI to gross domestic capital formation and exports of host countries.

The study of the effect of FDI on the growth rates of GDP was carried out by testing the parameters of a Harrod-Domar type growth model which features domestic investment, FDI, the inverse incremental capital-output ratio (ICOR) as principal explanatory variables. Continuous data on these variables were classified into discrete intervals and the analysis of variance (ANOVA) was then applied to determine whether or not variability in the growth rates was significantly related to changes in FDI. For the study of FDI-capital formation and FDI-exports relationships, the standard linear regression approach was used.

This study found that there was a positive, weak, and intricate relationship between FDI and the GDP growth rates in the recipient countries. This relationship, however, is not straightforward since it also depends on the level of domestic investment and the level of ICOR. Both regression and ANOvA results strongly suggest the existence of interaction between FDI and domestic investment on the one hand, and FDI and the ICOR on the other. Further, when taken by itself, FDI does not show any effect on the growth rates. However, when other growth variables, i.e., domestic investment and the ICOR, were taken into account, the relationship between FDI and growth became discernible. The coefficient of FDI in the full model was found significant at the 25 Using dummy variables, the evidence also suggests that FDI tended to stimulate domestic saving in countries having a mining-GDP ratio of above 5 percent (extractive countries). For countries with a mining share below that level (nonextractive), FDI appears to have both displaced and supplemented domestic investment.T This difference may be explained in terms of external effects which tended to be more favorable in the extractive economies. The impact of FDI on exports was found distinctly favorable and there was no evidence that such an impact is different between extractive and nonextractive countries.