Abstract
The study examines the relationship between foreign direct investment (FDI), financial development, and economic growth in a panel of 95 developed and developing countries from 1983 to 2006. The study moves away from the traditional cross-sectional analysis, and focuses on more direct evidence of the channels via which FDI might help or retard economic growth. Using generalized method of moment (GMM) panel data analysis, we find strong evidence of a positive relationship between FDI inflows into a country and its economic performance. We also find evidence that domestic financial system is a significant prerequisite for FDI to have a positive effect on economic growth. Policy implications are clear. Effort should be made to reform and improve the development of domestic financial system in order to benefit more from the presence of FDI.
Similar content being viewed by others
References
Aitken BJ, Harrison AE (1999) Do domestic firms benefit from direct foreign investment? Evidence from Venezuela. Am Econ Rev 89: 605–618
Aitken B, Hanson GH, Harrison AE (1997) Spillovers, foreign investment and export behavior. J Int Econ 43: 103–132
Akinlo AE (2003) Globalisation, international investment and stock market growth in sub-Saharan Africa, vol 382. Institute of Developing Economies V.R.F Series, Japan External Trade Organization, Japan
Alfaro L, Chanda A, Sebnem KO, Sayek S (2004) FDI and economic growth: the role of local financial markets. J Int Econ 64: 89–112
Alfaro L, Chanda A, Sebnem KO, Sayek S (2010) Does foreign direct investment promote growth? Exploring the role of financial markets on linkages. J Dev Econ 91: 242–256
Arellano M, Bond S (1991) Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Rev Econ Stud 58: 277–297
Arellano M, Bover O (1995) Another look at the instrumental variable estimation of error-component models. J Econom 68: 29–51
Azman-Saini WNW, Law SH, Ahmad AH (2010) FDI and economic growth: new evidence on the role of financial markets. Econ Lett 107: 211–213
Balasubramanyam VN, Salisu M, Sapsford D (1996) Foreign direct investment and growth in EP and IS countries. Econ J 106: 92–105
Baltagi BH (2008) Econometric analysis of panel data. John Wiley and Sons, Chichester
Baltagi BH, Griffin JM (2001) The Econometrics of rational addiction: the case of cigarettes. J Bus Econ Stat 19: 449–454
Baltagi BH, Bresson G, Griffin JM (2003) Homogeneous, heterogeneous or shrinkage estimators? Some empirical evidence from French regional gasoline consumption. Empir Econ 28: 795–811
Baltagi BH, Egger P, Pfaffermayr M (2007) Estimating models of complex FDI: are there third-country effects?. J Econom 140: 260–281
Baltagi BH, Egger P, Pfaffermayr M (2008) Estimating regional trade agreement effects on FDI in an interdependent world. J Econom 145: 194–208
Barro R, Sala-I-Martin X (1995) Economic growth. McGraw-Hill, New York
Baltagi BH, Demetriades PO, Law SH (2009) Financial development and openness: evidence from panel data. J Dev Econ 89: 285–296
Basu P, Guariglia A (2007) Foreign direct investment, inequality, and growth. J Macroecon 29: 824–839
Beck T, Demirguc-Kunt A, Levine R (2000a) A new database on financial development and structure. World Bank Econ Rev 14: 597–605. http://econ.worldbank.org/WBSITE/EXTERNAL/EXTDEC/EXTRESEARCH/0,,contentMDK:20388241~menuPK:665266~pagePK:64165401~piPK:64165026~theSitePK:469382,00.html. Accessed 18 Nov 2010
Beck T, Levine R, Loyaza N (2000b) Finance and the sources of growth. J Financ Econ 58: 261–300
Bekaert G, Harvey CR, Lundblad C (2003) Equity market liberalization in emerging markets. J Dev Econ 66: 465–504
Blejer MI (2006) Economic growth and the stability and efficiency of the financial sector. J Bank Financ 30: 3429–3432
Blomstrom M, Kokko A (1998) Multinational corporations and spillovers. J Econ Surv 12: 247–277
Blomstrom M, Lipsey RE, Zejan M (1992) What explains developing country growth. NBER Working Paper Series no. 4132
Blonigen BA (2006) A review of the empirical literature on FDI determinants. Atl Econ J 33: 383–403
Blundell R, Bond S (1998) Initial conditions and moment restrictions in dynamic panel data models. J Econom 87: 115–143
Bordo MD, Meissner CM (2006) Financial crises, 1880–1913: the role of foreign currency debt. J Bank Financ 30: 3299–3329
Borensztein E, De Gregorio J, Lee J-W (1998) How does foreign direct investment affect economic growth?. J Int Econ 45: 115–135
Buckley PJ, Clegg J, Wang C, Cross AR (2002) FDI, regional differences and economic growth: panel data evidence from China. Transnl Corp 11: 1–23
Calderon C, Liu L (2003) The direction of causality between financial development and economic growth. J Dev Econ 72: 321–334
Carkovic M, Levine R (2005) Does foreign direct investment accelerate growth?. In: Moran TH, Graham EM, Blomstrom M (eds) Does foreign direct investment help promote economic development?. Institute for International Economics, Washington, DC, pp 195–220
Choe JI (2003) Do foreign direct investment and gross domestic investment promote economic growth?. Rev Dev Econ 7: 44–57
De Gregorio J, Guidotti PE (1995) Financial development and economic growth. World Dev 23: 433–448
De Mello LR (1997) Foreign direct investment in developing countries and growth: a selective survey. J Dev Stud 34: 1–34
De Mello L (1999) Foreign direct investment led growth: evidence from time-series and panel data. Oxf Econ Pap 51: 133–151
Demetriades PO, Andrianova S (2004) Finance and growth: what we know and what we need to know. In: Goodhart CAE (ed) Financial development and growth: explaining the links. Palgrave Macmillan, Basingstoke, pp 38–65
Demetriades PO, Luintel KB (1996) Banking sector policies and financial development in Nepal. Oxf Bull Econ Stat 58: 355–372
Durham JB (2004) Absorptive capacity and the effects of foreign direct investment and equity foreign portfolio investment on economic growth. Eur Econ Rev 48: 285–306
Easterly W, Rebelo S (1993) Fiscal policy and economic growth: an empirical investigation. J Monet Econ 32: 417–458
Eller M, Haiss P, Steiner K (2006) Foreign direct investment in the financial sector and economic growth in Central and Eastern Europe: the crucial role of the efficiency channel. Emerg Mark Rev 7: 300–319
Findlay R (1978) Relative backwardness, direct foreign investment, and the transfer of technology: a simple dynamic model. Q J Econ 92: 1–16
Fukase E (2010) Revisiting linkages between openness, education and economic growth: system GMM approach. J Econ Integr 25: 194–223
Ghosh BN (2003) Capital inflow, growth sustainability and financial debacles. East Mediterr Univ 29: 73–97
Giacomo MD (2008) GMM estimation of a structural demand model for yogurt and the effects of the introduction of new brands. Empir Econ 34: 537–565
Goldsmith RW (1969) Financial structure and development. CT Yale University Press, New Haven
Greenwood J, Jovanovic B (1990) Financial development, growth, and the distribution of income. J Polit Econ 98: 1076–1107
Grilli V, Milesi-Ferretti GM (1995) Economic effects and structural determinants of capital controls. Int Monet Fund Staff Pap 42: 517–551
Haddad M, Harrison AE (1993) Are there positive spillovers from foreign direct investment? Evidence from panel data for Morocco. J Dev Econ 42: 51–74
Hermes N, Lensink R (2003) Foreign direct investment, financial development and economic growth. J Dev Stud 40: 142–163
King RG, Levine R (1993a) Finance and growth: Schumpeter might be right. Q J Econ 108: 717–738
King RG, Levine R (1993b) Finance, entrepreneurship and growth: theory and evidence. J Monet Econ 32: 513–542
Kosack S, Tobin J (2006) Funding self-sustaining development: the role of aid and FDI and government in economic success. Int Organ 60: 205–243
Levine R (1991) Stock markets, growth, and tax policy. J Financ 46: 1445–1465
Levine R (1997) Financial development and economic growth: views and agenda. J Econ Lit 35: 688–726
Levine R (1999) Law, finance, and economic growth. J Financ Intermed 8: 8–35
Levine R, Loayza N, Beck T (2000) Financial intermediation and growth: causality and causes. J Monet Econ 46: 31–77
Lipsey RE (1999) The role of FDI in international capital flows. In: Feldstein M (ed) International capital flows. University of Chicago Press, Chicago
McKinnon RI (1973) Money and capital in economic development. Brookings Institution, Washington, DC
Mencinger J (2003) Does foreign direct investment always enhance economic growth?. Kyklos 56: 491–508
Nair-Reichert U, Weinhold D (2001) Causality tests for cross-country panels: a new look on FDI and economic growth in developing countries. Oxf Bull Econ Stat 63: 153–171
Ongena S, Smith DC, Michalsen D (2003) Firms and their distressed banks: lessons from the Norwegian banking crisis. J Financ Econ 67: 81–112
Ranciere R, Tornell A, Westermann F (2006) Crisis and growth: a re-evaluation. J Bank Financ 30: 3331–3348
Rioja F, Valev N (2004) Does one size fit all? A re-examination of the finance and growth relationship. J Dev Econ 74: 429–447
Schich S, Pelgrin F (2002) Financial development and investment: panel data evidence for OECD countries from 1970 to 1997. Appl Econ Lett 9: 1–7
Soto M (2003) Taxing capital flows: an empirical comparative analysis. J Dev Econ 72: 203–221
Todo Y (2003) Empirically consistent scale effects: an endogenous growth model with technology transfer to developing countries. J Macroeconom 25: 25–46
World Bank: (1989) World investment report 1989. Oxford University Press, New York
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Choong, CK. Does domestic financial development enhance the linkages between foreign direct investment and economic growth?. Empir Econ 42, 819–834 (2012). https://doi.org/10.1007/s00181-011-0455-2
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s00181-011-0455-2