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Foreign direct investment, economic growth, and volatility: a useful model for policymakers

Empirical Economics volume 51, pages 681–705 (2016)Cite this article

Abstract

The explosion of hypotheses addressing empirical relationships between foreign direct investment (FDI) and economic growth is to say the least, confusing. There is the positive view whereby FDI positively affects growth, the negative view where FDI negatively affects growth, and the dependent view where FDI may or may not have an effect on growth at all, but is conditional upon whether certain economic and social conditions are met in the receiving country. In other words, to date, dozens of variables and modeling methods have been used to determine the effect FDI has on economic growth, and all with different results. Essentially, parsimony and ease of interpretation have been replaced with confusion. The central theses of the most important arguments focus on the broad dissemination of FDI, an economy’s absorptive capacity, and how injections tend to depend upon cyclical components. We use existing theory to justify a simpler model using a single determinant that encompasses these characteristics. By interacting past growth with current FDI, policymakers can more easily draw inference from the estimated marginal effect. We prove this by applying the model to pooled, high income, emerging, and developing economy samples in order to gain a clearer picture of exactly to what extent, FDI affects economic growth. And since policy not only takes growth into consideration, but economic stability as well, we also apply our model to volatility. While the results differ across income groups and growth rates, the inference drawn from them is unambiguous.

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Notes

  1. These explanatory variables have also been used by many, for example, Borensztein et al. (1998), Alfaro et al. (2004) and Busse and Groizard (2008).

  2. This program was constructed by David Roodman of the Center for Global Development in Washington, DC.

  3. An instance of this method being employed is Edwards et al. (2006a, b).

  4. Because of the wide variety of definitions of FDI and their measurement scales, it is impossible to provide comparisons of the magnitude of the estimates. For that reason, we have limited ourselves to comparing the direction of the relationships.

  5. Their model substantially differs from ours for they regress volatility growth on the volatility of FDI, among other variables.

  6. To our knowledge, no other paper has analyzed the interactive effect of FDI on growth by separating the countries into the three developmental levels like we do. Balasubramanyam et al. (1999) use a time trend to capture technical progress; Khawar (2005) uses continental dummies; while Li and Liu (2005) use developed/developing country-group dummies.

  7. http://www.realclearmarkets.com/blog/Chile%2520Encaje%2520112009.pdf.

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Authors and Affiliations

  1. North Carolina A&T State University, Greensboro, NC, USA

    Jeffrey A. Edwards & Alfredo A. Romero

  2. Winston Salem State University, Winston-Salem, NC, USA

    Zagros Madjd-Sadjadi

Authors
  1. Jeffrey A. Edwards
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  2. Alfredo A. Romero
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  3. Zagros Madjd-Sadjadi
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Correspondence to Jeffrey A. Edwards.

Appendices

Appendix 1

See Table 1.

Table 1 Descriptive statistics of variables used in regressions
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Appendix 2

See Tables 2 and 3.

Table 2 Pooled fixed-effect OLS and GMM regression results
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Table 3 Estimates from the GMM growth and ARCH volatility regressions
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Edwards, J.A., Romero, A.A. & Madjd-Sadjadi, Z. Foreign direct investment, economic growth, and volatility: a useful model for policymakers. Empir Econ 51, 681–705 (2016). https://doi.org/10.1007/s00181-015-1022-z

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