Relationship between FDI and Economic Growth in … between FDI and...Review of Economics & Finance Submitted on 12/October/2011 Article ID: 1923-7529-2012-01-84-13 Nabila Asghar,

Review of Economics & Finance Submitted on 12/October/2011

Article ID: 1923-7529-2012-01-84-13 Nabila Asghar, Samia Nasreen and Hafeez ur Rehman

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Relationship between FDI and Economic Growth in

Selected Asian Countries: A Panel Data Analysis

Dr. Nabila Asghar

Department of Economics, GC University, Faisalabad, PAKISTAN

Cell: +300-4720706, E-mail: [email protected]

Dr. Samia Nasreen

Department of Economics, GC University, Faisalabad, PAKISTAN

Cell: +305-4023992, E-mail: [email protected]

Prof. Dr. Hafeez ur Rehman (Corresponding author)

Department of Economics, University of the Punjab, Lahore-54590, PAKISTAN

Tel: +92-42-99231167 Ext. 115, Cell: +300-4348225, E-mail: [email protected]

Abstract: This study examines empirically the relationship between FDI and economic growth

using heterogeneous panel for the period 1983-2008. The empirical findings of Larsson panel co-

integration show that FDI and economic growth are cointegrated. FMOLS results reveal that FDI

and economic growth are positively related to each other. The results of panel homogeneous

causality hypothesis show the existence of bi-directional causality between FDI and economic

growth while the results of panel homogeneous non-causality hypothesis confirm the existence of

unidirectional causality running from FDI to economic growth in selected panel. The results of

heterogeneous causality hypothesis show the existence of bi-directional causality between FDI and

economic growth only in case of Malaysia. The existence of uni-directional causality running from

FDI to economic growth is observed in cases of Nepal, Singapore, Japan and Thailand whereas the

uni-directional causality is also found running from economic growth to FDI for Pakistan,

Bangladesh and Sri Lanka. However, no causality in any direction is found in cases of India,

Maldives, Indonesia, China, Philippines, Korea Dem and Singapore.

JEL Classifications: C33, F21, F43, N25

Keywords: FDI, Economic growth, Panel data, Cointegration, Asian countries

1. Introduction

In recent years the growth of FDI has served as a catalyst for investment in developing

countries. FDI brings the most needed capital, improved managerial skills, modern marketing

techniques, access to modern technology and global links. Since 1980 both developed and

developing countries have been trying to attract FDI through providing incentives by adopting

greater deregulation policies and reliance on market forces in the economies. Motive of earning

high profit is the main contributing factor that induces firms to invest abroad particularly in those

countries where labour cost is relatively low. Literature reveals that the foreign firms initially face

high investment cost particularly in those countries whose market and institutional conditions are

not familiar to them. However, economic theories suggest number of explanatory variables that

explain why foreign firms invest abroad in the presence of these disadvantages. These theories are

identified as market imperfection hypothesis, internationalization theory and Ownership, Location

and Internalization (OLI) theory as an eclectic approach. Market imperfection hypothesis postulates

that FDI is the direct result of an imperfect global market environment. (For details, refer

Review of Economics & Finance

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Kindleberger, 1969; Hymer, 1972; Horagochi and Toyne, 1990). The Internationalization theory

stresses that in countries FDI takes place because multinationals replace external markets with more

efficient internal one. (For details, see Rugman, 1985, 1986). The eclectic approach points out that

FDI emerges because of Ownership, Internalization and Location advantages.1 In this regard

Dunning (1977) states that firms want to invest in those countries where resulting benefits are much

greater than the possibility of disadvantages of operating in foreign countries. Furthermore,

researchers and policy makers have pointed out that the presence of foreign firms help in expanding

infra structure facilities.

Empirically a lot of controversy has been observed on the relationship between FDI and

Economic Growth as most of the studies either provide mixed results or fail to reach at any definite

conclusion (see, for example, Borenzstein et al., 1998; Charkovich and Levine, 2002). Various

empirical studies highlight a significant role of inward FDI in economic growth of the developing

countries, through its contribution in human resource, capital formation, enhanced organization and

managerial skills, transfer of technologies. (For details, see Barro, 1990; Zhang, 2001; Aitkin and

Harrison, 1999; Markusen and Venables, 1999; Blomstrom et al., 1994). But still existing empirical

evidence on FDI and economic growth nexus is inconclusive and for academicians and policy

makers it has become a basis for analyzing this nexus further by using recent advances in dynamic

modeling. The present study is an attempt to analyze the causal relationship between FDI and

economic growth in selected Asian countries using panel data. The main objective of this study is to

test the direction of causality between FDI and economic growth in selected Asian countries using

panel data analysis. This study is different from previous studies in two ways. Firstly, it employs

Larsson et al. (2001) panel cointegration test for heterogeneous panel and panel FMOLS by Pedroni

(2001) to determine the long-run relationship between the variables. Secondly, it uses panel

causality test of Hurlin and Venet (2001) which gives more accurate results as compared to

traditional Granger causality test.

This study is organized as follows. Section II describes review of previous studies; section III

presents methodology and data sources; section IV provides empirical results and their

interpretation; while the last section concludes.

2. Literature Review

The existing literature stresses on the link of FDI and economic environment of the host

country and points out that economic environment is influenced by the development strategies and

policies followed by the host country. Furthermore, some studies conclude that the causal link

between FDI and economic growth depends upon the characteristics of the host countries such as

human capital, market size, availability of technology (for details see Barro, 1990; Zhang, 2001;

Blonigan and Wang, 2005).

In the past decade, several studies have been conducted by the researchers for investigating the

crucial relationship between FDI and economic growth. These studies have employed recent

econometric techniques including GMM, Random Effect and Fixed Effect models for estimation

using cross-section and panel data of various developed and developing countries of the world. A

review of these studies has provided mixed evidence on the relationship between FDI and economic

growth (for details, see Wijaweera, 2007; Zhang, 2001; Johnson, 2006).

1 OLI theory presented by Dunning (2001) analyzes pre-requisites for FDI to take place and asserts that a firm should have firm-specific advantages (ownership), a location advantage to mobilize this firm specific know how (location) and an incentive to internalize external transaction (internalization).

ISSNs: 1923-7529; 1923-8401 © 2012 Academic Research Centre of Canada

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Balasubramanyam et al. (1996) uses cross sectional data for 46 countries for the period 1970-

85 for analyzing the relationship between FDI and economic growth. Their results show that FDI

has positive impact on economic growth of those countries which have followed inward looking

development strategies.

Borenzstein et al. (1988) uses cross sectional data for 67 developing countries for the period

1970-89. Using seemingly unrelated regression methods they find that FDI has a positive effect on

economic growth due to the both technology diffusion and the magnitude of the relationship is

dependent on the quality of human capital of the host country.

De Mello (1989) concludes that FDI has positive impact on economic growth but this evidence

is weak. Zhang (2001) finds the existence of the positive relationship between FDI and economic

growth and concludes that the magnitude of the above mentioned relationship depends upon host

country’s conditions. Bengoa and Sanchez-Robles (2003) analyze panel data of 18 Latin American

countries and reach to the same conclusion.

Charkovic and Levine (1998) use both panel and cross section data for 72 developing and

developed countries for the period 1960-95 for analyzing the relationship between FDI and

economic growth. They employ OLS and GMM methods of estimation and fail to find the existence

of the relationship between FDI and economic growth.

Johnson (2006) using panel and cross section data of 90 countries concludes that FDI increases

economic growth in developing countries due to technology spillovers but not in developed

economies. The study also examines the impact of FDI on economic growth in primary

manufacturing and services sectors. Alfaro (2003) is of opinion that the benefits of FDI vary across

sectors and the impact of FDI on primary sector is negative and its impact is positive and

ambiguous on manufacturing and services sectors respectively.

Li and Lue (2005) investigate the relationship between FDI and economic growth for eighty

four countries over the period 1970-1999. The study concludes that FDI and human capital both

have positive impact on the economic growth of developing countries. Chowdhury and Mavrotas

(2005) examine the causal link between FDI and economic growth over the period 1969-2000 from

Chile, Malaysia and Thailand. They find bidirectional causality between FDI and economic growth

in Malaysia and Thailand and one-way causality running from economic growth to FDI in Chile.

Kukeli et al. (2006) find a positive relationship between FDI and output in ten Central Asian

and Eastern European countries. Shujie and Wei (2007) find positive impact of FDI on the

economic growth of newly industrialized countries. Pardhan (2009) investigates the causal

relationship between FDI and economic growth in ASEAN countries namely Indonesia Malaysia,

Thailand Singapore and Philippines over the period 1970-2007. The study finds bidirectional

causality between FDI and economic growth except Malaysia.

Herzer et al. (2008) re-examine the FDI-led growth hypothesis for 28 developing countries.

Using Engle-Granger cointegration and error correction model, they fail to find the existence of

long-run and short-run relationship between FDI and economic growth in most of the countries

included in the sample. They find no evidence of causality between FDI and economic growth. Wu

and Hsu (2008) use cross-sectional data of 62 countries for the period 1975-2000 and find positive

and significant impact of FDI on economic growth only when the host countries have better level of

initial GDP and human capital.

Samimi et al. (2010) examine the role of FDI in economic growth of oil importing countries

(OIC) countries using panel data from 2000-2006. The results of panel regression approach show

that FDI and openness contribute positively to the growth performance of OIC countries. Further,

the study finds significant impact of FDI on growth in selected countries.


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3. Econometric Methodology

3.1 Panel Unit Root Tests

The necessary step in panel causality analysis is to check stationary properties of the panel data.

Numerous panel unit root tests are available in econometric literature. However, the most popular

panel unit root tests such as LLC (Levin et al. 2002) and IPS (Im et al., 2003) have been used in this

study.

LLC Test

LLC test is applied to a balanced panel which assumes that the autoregressive coefficients

remain constant for all panel members. This test is derived on the basis of Augmented Dickey

Fuller (ADF) principle. The general equation of LLC test is:

tiijti

j

itiiiti tYYYi

,,

1

1,,

(1)

where Yit is a series for panel country i (i = 1, 2, …, N) over the period t (t = 1, 2, …, T), pi is the

number of lags in the ADF regression and the error term εi,t are assumed to be IID (0, σ2) and also

independent across the units of the sample. The null hypothesis of non-stationary is as follows:

H0: ρi = ρ = 0 and alternative hypothesis is

H1: ρi = ρ < 0 for all i

Levin et al. (2002) suggests that this test does not give efficient estimates when sample size

exceed more than 250 cross-sectional units

3.2 Im, Pesaran and Shin (IPS) Test

Im, Pesaran and Shin (2003) assume that auto-regressive coefficient vary from country to

country. Like LLC test, this test is also based on Augmented Dickey- Fuller principle. The test

equation for IPS test is:

tijti

j

jitiiiti YYYi

,,

1

,1,,

(2)

where series Yi,t (i = 1, 2, …, N; t = 1, 2, …, T) is the series for panel country i over the period t; pi

is the number of lags in the ADF regression and the error terms εi,t are serially correlated. The null

and alternative hypothesis of IPS test are given as

H0: ρi = 0 for all i

H1: ρi < 0 for i = 1, 2, …, N1

ρi = 0 i = N1+1, N1 + 2, …, N

The IPS test-statistic is estimated by:

t

tEtNt

IPSvar

(3)

The terms tE and tvar are generated by simulations and tabulated by IPS.


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3.2.1 The Likelihood-based Panel Cointegration Test

To test the long-run relationship between variables in a heterogeneous panel of 14 Asian

countries, the maximum likelihood-based panel cointegration test developed by Larsson, Lyhagen

and Lothergon (2001) is employed in this study. The LLL method is based on Johansen (1988, 1995)

error-correction representation theorem, which is as

jijti

j

jitiiti YYYi

,,

1

,1,,

1

(4)

To estimate the above model, the multivariate cointegration trace test of Johansen (1988, 1995)

LRit is applied in individual cross-sectional units independently in such a way allowing

heterogeneity in each cross-sectional unit for said panel. The panel trace statistic can be obtained as

the average of N cross-sectional trace statistic.

The null hypotheses of panel cointegration (Larsson et al., 2001) rank test are:

H0: rank rrii for all i = 1, …, N against

H1: rank ki for all i = 1, …, N

The standardized panel cointegration trace test-statistic is given by:

K

NT

LRZVAR

ZKEkH

rHRLN

kHrH

/ (5)

where NTRL is the average of individual cross-section statistic and E(Zk) and Var (Zk) are the mean

and variance of the asymptotic trace statistic reported by Larsson, Lyhagen and Lothgern (2001).

Moreover, the LLL test is one sided and follow Z distribution.

3.2.2 Panel FMOLS

When all variables are cointegrated, the next step is to calculate the long-run estimates. In the

presence of cointegration, OLS estimates do not give efficient results. Therefore, FMOLS presented

by Pedroni (2000, 2001) is applied to estimate long-run coefficients. The panel FMOLS estimator

for the coefficient β is defined as:

iit

T

t

iit

T

t

iit

N

i

NT TYXXXXN ˆ*

1

1

1

2

1

1* (6)

The associated t-statistic is assumed to be normally distributed.

3.3 Panel Causality Test

Hurlin and Venet (2001) developed more advanced version of Granger causality test regarding

panel data models with fixed coefficients. Mathematical equation, which is used for empirical

estimation, is presented below:

tikti

k

k

ikti

k

k

ti xYrY ,,

0

)(

,

1

)(

,

(7)

On the basis of model (9), Hurlin and Venet (2001) causality test is based on following three

major cases.


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3.3.1 Homogenous non-causality hypothesis (HNC)

Homogenous non-causality hypothesis (HNC) assumes non existence of causal relationship

across N. In model (9), the null and alternative hypothesis is defined by

H0: PkNi

k

i ,1,,10)(

H1: ki, such that 0)( k

i

Wald statistic is employed to test these NP (restrictions on cross sectional unit):

]

1[][ 112

PPNNT

RSS

NP

RSSRSSFhnc

(8)

Here RSS2 is the restricted sum of squared residual obtained under H0 and RSS1 is unrestricted

residual sum of squares of equation (10). If the calculated value of F-statistic is less than critical

value, the homogeneous non-causality hypothesis is accepted and the results describe that the

variable FDI is not causing GDP in finite sample set of Asian countries.

3.3.2 Homogenous causality hypothesis (HC)

Homogenous causality hypothesis (HC) assumes that there exist N causality relationships. Null

and alternative hypotheses of homogenous causality are following:

H0: Pk ,1 such that Ni

kk

i ,1,

H1: NjiPk ,1),(,,1 such that k

j

k

i

The Homogenous causality (HC) hypothesis implies that the coefficients of the lagged

explanatory variable Xi,t-K are identical for each lag K and are also different from zero. In order to

test the homogenous causality hypothesis, F statistics is calculated by the following formula:

]

1[]

1[ 113

PPNNT

RSS

NP

RSSRSSFhc

(9)

If the Fhc statistics with P (N − 1) and NT − N (1 + P) − P degrees of freedom is not significant,

the homogenous causality hypothesis is accepted. This implies that the variable FDI is causing GDP

in the N countries of the samples, and that the autoregressive processes are completely homogenous.

3.3.3 Heterogeneous non-causality hypothesis (HENC)

Finally, heterogeneous non-causality hypothesis assumes that there exists at least one and at the

most N − 1 equalities.

HENC being an individual test is realized for each individual country. For each individual

country, we test that all coefficients of the lagged explanatory variable Xi,t−K are equal to zero. Then,

for each i, hypothesis 0k

i , Pk ,1 can be tested by calculating following formula:

]

21[][ 11,2

PPNNT

RSS

P

RSSRSSF

i

henci

(10)

The calculation of F statistic allows identifying the individual country for which there is no

causality relationship.


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3.4 Data Source and Variables

For analyzing FDI and growth linkages, data has been collected from World Development

Indicators (WDI) of World Bank over the period 1983-2008 for the following selected Asian

countries: Pakistan, India, Sri Lanka, Bangladesh, Malaysia, Indonesia, Thailand, Philippines,

Nepal, Japan, China, Singapore, Korea Dem, and Maldives. Both variables, GDP (gross domestic

product) and FDI (inflow of foreign direct investment) are expressed in US Dollars. Furthermore,

GDP and FDI have been transformed in natural logarithms.

4. Empirical Analysis

4.1 Unit Root Test Results

The preliminary step in analyzing the relationship between FDI and economic growth is to check whether the underlying series are stationary at first difference or at level? For this purpose, LLC, IPS panel unit root tests have been applied to the panel of fourteen countries.

The results presented in Table 1 show that both panel series (GDP and FDI) are non-stationary in their level form either with an intercept or with both intercept and trend. However, both series are stationary at their first difference, thus, indicating that both the series are integrated of order 1, i.e. I(1).

Table 1 Panel Unit Root Tests

LLC TEST

Variables Level 1st Difference

Intercept Trend & Intercept Intercept Trend & Intercept

GDP 3.2281 3.9401 –4.7039*** –4.0901***

FDI 1.3195 1.4599 –3.2477*** –2.2455**

IPS TEST

Variables Level 1st Difference

Intercept Trend & Intercept Intercept Trend & Intercept

GDP 6.4554 3.3348 –5.3571*** –4.0308***

FDI –0.7903 –0.1099 –10.8731*** –9.1857*** Note: *** and ** denote rejection of null hypothesis at 1% and 5% level of significance, respectively.

4.2 Panel Cointegration Test Results

Having confirmed the order of integration of the panel series, the next step is to check the

possibility of long-run relationship between variables. For this purpose, cointegration test is applied

both at individual as well as panel level. The Johansen’s maximum likelihood (LR) test has been

applied in each country separately while Larsson et al. (2001) likelihood based panel cointegration

test is employed to the panel of fourteen countries.

The estimated results of Johansen tests are reported in Table 2. The results show that there are

two cointegrating relations at 5% level of significance in India. While for Sri Lanka, Maldives,

Thailand, China and Philippines, one cointegrating relation is identified at 5% level of significance.

However, no cointegrating relation is observed in cases of Pakistan, Bangladesh, Nepal, Indonesia,

Malaysia, Singapore, Japan and Korea Dem. The existence of long-run relationship by applying

individual country cointegration test has not much importance because the major emphasis of this

study is on panel cointegration test.

Results of Larsson et al. (2001) likelihood based (LR) panel test of cointegration are presented

in Table 3. Rejection of panel LR test indicates that the average of individual LR test statistic across

the countries in the panel exhibits the long-run relationship.


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The results reveal that panel likelihood ratio is 6.7973 which is greater than critical value of

1.645 at 5% level of significance. The null hypothesis of no cointegration is rejected at panel level.

Based on the likelihood based panel cointegration test it can be concluded that both GDP and FDI

are cointegrated. Therefore, there exists a unique long-run relationship between FDI and economic

growth among all the selected countries over the sample period.

Table 2 Johansen Cointegration Test

Countries H0 Likelihood ratio 5% critical value p-value

Pakistan R = 0 25.1563 25.8721 0.0612

R ≤ 1 3.4902 12.5179 0.8139

India R = 0 35.6800** 25.8721 0.0022

R ≤ 1 14.6214** 12.5179 0.0219

Bangladesh R = 0 14.0666 25.8721 0.6521

R ≤ 1 4.12392 12.5179 0.7241

Sri Lanka R = 0 28.2819** 25.8721 0.0246

R ≤ 1 3.9226 12.5179 0.7533

Maldives R = 0 46.9006** 25.8721 0.0000

R ≤ 1 6.0553 12.5179 0.4533

Nepal R = 0 14.1699 25.8721 0.6436

R ≤ 1 4.0513 12.5179 0.7346

Indonesia R = 0 16.9249 25.8721 0.4206

R ≤ 1 3.1001 12.5179 0.8644

Malaysia R = 0 16.6530 25.8721 0.4413

R ≤ 1 4.0201 12.5179 0.7392

Thailand R = 0 27.4131** 25.8721 0.0319

R ≤ 1 4.2190 12.5179 0.7102

Singapore R = 0 15.0922 25.8721 0.5669

R ≤ 1 3.5876 12.5179 0.8006

China R = 0 28.8661** 25.8721 0.0206

R ≤ 1 7.4112 12.5179 0.3036

Japan R = 0 17.4273 25.8721 0.3837

R ≤ 1 7.2291 12.5179 0.3212

Philippines R = 0 26.9809** 25.8721 0.0363

R ≤ 1 4.4132 12.5179 0.6818

Korea Dem R = 0 20.4388 25.8721 0.2045

R ≤ 1 2.8294 12.5179 0.8961

Note: ** denotes cointegration at 5% level of significance.

Table 3 Panel Cointegration Test

Hypotheses Likelihood ratio 5% critical value

R = 0 6.7973** 1.645

R ≤ 1 0.4105

Note: ** denotes rejection of null hypothesis at 5% level of significance.


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4.3 Panel FMOLS

The results of country-by-country FMOLS and panel FMOLS are presented in Table 4. The coefficients of FDI in all the countries appear to be positive and significant at 1% level in case of Pakistan, India, Sri Lanka, Bangladesh, Maldives, Malaysia, Singapore, Thailand, China, Philippines and Korea Dem. This is an indication of the positive contribution of FDI in economic growth in selected Asian countries.

Table 4 Panel FMOLS Estimates (Dependant variable: LGDP)

Country Independent Variable

LFDI S.E. t-value

Pakistan 0.38939*** 0.02704 14.3992

India 0.23323*** 0.06061 3.8476

Sri Lanka 0.36518*** 0.05921 6.1670

Bangladesh 0.14495*** 0.01426 10.1602

Nepal 0.09880 0.06888 1.4343

Maldives 0.07776*** 0.02315 3.3591

Indonesia 0.00692 0.01400 0.4945

Malaysia 0.56319*** 0.087824 6.4127

Thailand 0.42646*** 0.048842 8.7314

Singapore 0.72464*** 0.045600 15.8913

China 0.51574*** 0.05244 9.8346

Japan 0.01859 0.05931 0.3135

Philippines 0.26865*** 0.04493 5.9781

Korea Dem 0.40043*** 0.12758 3.1388

Panel 0.29610*** 0.02885 10.2622

Note: *** denotes significance of coefficient at 1% level.

5. Test Results for Panel Causality

5.1 Homogenous Non-Causality and Homogenous Causality

The estimation results of homogenous non-causality hypothesis and homogenous causality

hypothesis are reported in Table 5. The results of homogeneous non-causality hypothesis show that

GDP has no significant impact on FDI. The probable reason of this result may be that on average

economic growth in selected Asian countries is lesser than the certain level of economic growth

required for having positive impact on FDI. Although some of the Asian countries included in the

panel like Pakistan, India, China, Bangladesh, Philippines and Sri Lanka have shown better growth

performance as compared to other low and middle income countries collectively but their growth

appears to be lesser than the world average. Furthermore, for attracting FDI some of these countries

lack better growth determinants like sufficient stock of capital accumulation, quality education,

better institutional setup, liberal trade policies, macroeconomic stability and political stability.

However, the results confirm the existence of unidirectional causality running from FDI to

economic growth in selected panel.

Table 5 Homogenous Non-Causality and Homogenous Casualty

Dependent variables

Homogenous Non-Causality Homogenous Causality LGDP LFDI LGDP LFDI

LGDP – Causality exist*** – Causality exist*** LFDI No causality – Causality exist*** –

Note: *** represents the significance level at 1%.


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After testing the homogenous non-causality hypothesis the next step is to test the homogenous causality hypothesis which assumes homogenous relationship between FDI and economic growth. The results indicate the existence of bi-directional causal relationship between FDI and economic growth. Therefore, it can be concluded that FDI has contributed positively to economic growth of all the selected countries. This brings up the need for formulating and implementing the similar and effective policies for attracting FDI.

5.2 Heterogeneous Causality

Final step in causality analysis is to check heterogeneous causal relationship between FDI and economic growth in each selected country. Results of heterogeneous causality are presented in Table 6. The results show that economic growth has significant impact on FDI inflow in Pakistan, Bangladesh and Sri Lanka. It reveals that flow of FDI is dependent on economic growth. Hypothesis pertaining to unidirectional causal relationship from FDI to economic growth has been accepted only in case of Nepal, Singapore, Japan and Thailand. These findings support the FDI-led growth hypothesis in these countries. Malaysia is the only country where two-way causal relationship between FDI and economic growth is observed which shows that economic growth and flow of FDI are dependent on each other. So any policy aiming to stimulate one of the two variables is likely to have positive impact on other variable both directly and indirectly. However, surprisingly no causality is observed in India, Maldives, Indonesia, China, Philippines and Korea Dem. This indicates that these countries need to formulate and implement better investment policies to obtain the full beneficial effect of FDI inflows on economic growth.

Table 6 Heterogeneous Casualty

Country Variables LGDP Decision LFDI Decision

Pakistan LGDP – – 0.19 No causality LFDI 10.73*** Causality exists – –

India LGDP – – 0.40 No causality LFDI 1.56 No causality – –

Bangladesh LGDP – – 1.11 No causality LFDI 8.96*** Causality exists – –

Sri Lanka LGDP – – 0.98 No causality LFDI 5.15*** Causality exists – –

Maldives LGDP – – 2.09 No causality LFDI 0.21 No causality – –

Nepal LGDP – – 3.56** Causality exists LFDI 0.07 No causality – –

Indonesia LGDP – – 0.05 No causality LFDI 0.01 No causality – –

Malaysia LGDP – – 3.29** Causality exists LFDI 3.64** Causality exists – –

Thailand LGDP – – 3.50** Causality exists LFDI 0.36 No causality – –

Singapore LGDP – – 3.36** Causality exists LFDI 0.76 No causality – –

China LGDP – – 1.72 No causality LFDI 0.17 No causality – –

Japan LGDP – – 4.87*** No causality LFDI 1.94 No causality – –

Philippines LGDP – – 1.01 No causality LFDI 2.32 No causality – –

South Korea Dem

LGDP – – 2.49 No causality LFDI 0.02 No causality – –

Note: *** and ** denote significance at 1% and 5% level of significance, respectively.


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No doubt some of these countries have received massive inflows in the past decade. But the

impact of FDI on economic growth in these countries appears to be quite negligible. For example,

in India and China the impact of FDI on economic growth is not significant although their

economies are booming presently. The probable reasons of this result may be the functioning of

multinational firms which have their vested interests, rising income inequality, environmental

degradation, ethnic tension, corruption and rising transportation cost.

6. Conclusions

The basic purpose of this study is to test empirically the causal relationship between FDI and

economic growth by applying more advanced panel techniques in selected Asian countries for the

period 1983-2008. The empirical results based on panel unit root tests show that both the series are

I(1). Likelihood-based panel cointegration test confirms the existence of long-run relationship

between FDI and economic growth in the panel of fourteen countries. However, at individual level,

Johansen cointegration analysis confirms the existence of long-run relationship only in case of India,

Sri Lanka, Maldives, Thailand, China and Philippine. FMOLS estimates confirm the positive

impact of FDI on economic growth.

Panel homogenous causality hypothesis shows the existence of bi-directional causality between

FDI and economic growth in the selected panel. The results of panel homogenous non-causality

hypothesis describe the existence of one-way causality from FDI to economic growth in panel

countries. The results of heterogeneous causality hypothesis show bi-directional causality between

FDI and economic growth only in case of Malaysia. FDI-led growth hypothesis is valid in four

countries namely, Nepal, Singapore, Japan and Thailand whereas GDP growth-led FDI hypothesis

is accepted in case of Pakistan, Bangladesh and Sri Lanka. However, causality in any direction is

not observed in the case of India, Maldives, Indonesia, China, Philippines and Korea Dem. Based

on the findings of the study, it is recommended that Asian Countries need to formulate sound

investment policies both at national and international level to attract foreign direct investment. The

results of this study may be helpful for academia and policy makers for stressing on the proper use

of FDI for raising the pace of economic growth in Asian countries.

One important point that needs to be mentioned is the absence of conditional variables from the

model and the present study may be helpless in capturing the full impact of FDI on economic

growth. It brings up the need of exploring the relationship between the two variables by including

conditional variables in the model. This seems to be consistent with the literature and suitable to

address the questions involving the causal relationship between FDI and economic growth in

selected Asian countries. It is left on the interested readers to investigate the causal relationship

between the two variables through including appropriate conditional variables in the model using

recent advances in dynamic modeling.

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Relationship between FDI and Economic Growth in … between FDI and...Review of Economics & Finance Submitted on 12/October/2011 Article ID: 1923-7529-2012-01-84-13 Nabila Asghar,