ISSN: 2348-3784
Understanding the Impact of Inward FDI and Economic Growth
J. C. Sharmiladevi
Digital Object Identifier: 10.23837/tbr/2017/v5/n1/149501
With liberalization of trade and markets nations across globe are able to overcome capital scarcity with
inflow of Foreign Direct Investment (FDI). FDI is an important factor in the globalization process as it
provides opportunities and financial challenges around the world promotes stable and lasting economic
links between countries through direct access to investors in home economies to production units of the
host economies. Understanding the influence/impact of inward FDI on economic growth is a dynamic area
to study for researchers, as the empirical evidence on impact of FDI inflow on and economic growth are
mixed, which deserves fresh enquiry. Objective of this paper is to identify the long term equilibrium
relationship among inward FDI and gross domestic product, which will help one to understand the impact
of inward FDI on economic growth. Gross Domestic Product (GDP) is proxied for economic growth. This is
an empirical research and the research design is longitudinal in nature. Results of this study indicate that
there exist a long run cointegrating relationship between inward FDI and GDP, the two variables for the
study period from 1970-2010. 1% change in GDP will raise FDI inflow by 4.37%. The adjustment coefficient
of the Error Correction Term (ECT) is negative and statistically significant indicating positive adjustment
effect, which ensures, that in case of any external shocks, the long term equilibrium can be reverted back,
and willre-ensures equilibriumbetweenFDIinflow andGDP.
Keywords: Foreign Direct Investment, Economic growth, Gross Domestic Product, Cointegration, Vector
In the last two decades, Foreign Direct Investment (FDI) has emerged as one of the major source for
globalization and a significant catalyst for economic growth, transferring technology and knowledge
among participating countries. The liberalization of trade, easing of business barriers, advancement in
technology, accompanied with growing internationalization of goods, services and ideas over the past
two decades made the world economies a globalized one. Emergence of large
availability of skilled
labour accompanied with economical wages,
to investment,
developing countries now have a significant impact on the global economy, particularly
industrialized states. Deregulation of markets, technological innovations and cost
effective communication
tools have allowed investors to
further their participation
competitive markets overseas. FDI is a significant factor in globalization process as it intensifies and
enhances the interaction between states, regions and firms. Currently, the growth of international
production is driven by liberalization of FDI and its related trade policies oriented towards economic
and technological forces. FDI provides opportunities as well as challenges across the world, promotes
stable and long-lasting economic links between countries through direct access to investors in home
economies to production units of the host economies (i.e. the countries in which they are resident).
Within a proper policy framework, FDI assists host countries in developing local enterprises, promotes
international trade through access to markets and contributes to the transfer of technology and know-
how. In addition to its direct effects FDI creates an impact on the development of labour and financial
markets, and influences many aspects of economic performance through its multiple spill-over effects.
Dr. J. C. Sharmiladevi, Assistant Professor, Symbiosis Centre for Management Studies, Symbiosis International
University, Pune, India, E Mail:, Phone: 9130016446/
Understanding the Impact of Inward FDI and Economic Growth
The role played by FDI in the growth process has been a burning topic of debate in several countries
including India
The amount of FDI which India receives is increasing considerably with time, even though it is not
consistent. Many factors play a significant role in influencing the amount of FDI which a nation receives.
The impact study of FDI is a dynamic area for many researchers. The benefits which a nation receives
through FDI can be studied by examining the impact, which FDI created upon the macro and micro
structures of an economy. Among them, understanding the influence/impact of inward FDI on economic
growth is a dynamic area to study for researchers in the faculty of international business. This research
studies the methodology involved in examining the impact of inward FDI on economic growth. The large
increase in the inward and outward flow of FDI across the globe in the past two decades provides a
strong incentive for research on this phenomenon. The choice of research topic has been made in order
to allow for the possibility of finding results that can provide knowledge about the impact of FDI that
mayhelp policymakersof bothhomeandhost countrytotakeappropriatedecisions
During the last decades, the relationship between FDI and economic growth has been extensively
discussed in literatures of international business, which ranges from an unreserved optimistic view to a
systematic pessimism. Many researchers and policymakers believe that FDI boosts growth for host
countries through different development channels. Regarding causality of FDI and economic growth, it
is an ongoing, unsettled and highly debatable/debated issue. The cointegrating and causality of FDI and
economic growth are heterogeneous across countries, and an application of different econometric
methodologies creates variations in test results. Therefore, it is critical to understand these variations
when examiningthe relationshipandcausalitybetween FDIand economicgrowth.
De Mellow (1992) indicates that, though FDI boosts long run growth through technological up gradation
and knowledge spillovers, the extent to which FDI is growth- enhancing depends on the degree of
complementarities and substitution between FDI and domestic investment. Results of this research
conducted in OECD and non OECD countries shows that, impact of FDI on growth depends inversely on
the technological gap between the leaders and followers, although there is sufficient evidence available
to prove that bulk of FDI occurs across technologically advanced economies. His study concluded that
FDI had significantly positive effect on economic growth for countries with high income, facilitates
transfer of advanced technologies and provides resources for training labour force to get new skills. De
Gregorio (1992) studied and identified that technologies and knowledge which are not readily available
to host country investors, are made available, as a result of FDI, and in this way FDI led to productivity
growth throughout the economies. FDI facilitates to create expertise that the country does not possess,
and foreign investors may get access to global markets. Through empirical studies he found that
increasing aggregate investment by 1 percent point of GDP increased economic growth of Latin
American countries by 0.1percent to 0.2 percent in a year, but increasing FDI increased growth by
approximately 0.6 percent a year during the period 1950-1985, thus indicating that FDI is three times
more efficientthan domestic investment.
Borensztein et al (1998) examine the effects of FDI on economic growth at the cross country level using
regression framework, taking data on FDI outflows
from OECD countries as well as sixty-nine
developing countries from 1970-1989. They found that FDI is an important vehicle for adopting new
technologies, contributing relatively more to growth than domestic investment. In addition, they also
found that FDI contributes to economic growth to countries when the labor force has attained certain
level of educational standard. Boon (2001) investigates the causal relationship between FDI and
economic growth for Malaysia. His findings indicate that bidirectional causality exists between FDI and
TSM Business Review, Vol. 5, No. 1, June 2017
Understanding the Impact of Inward FDI and Economic Growth
economic growth besides contributing to an increase in output. Choe (2003) examines the causality of
FDI and gross domestic investment and economic growth by applying the panel VAR model. He argues
that GDI rates and FDI play catalyst role for economic growth through capital accumulation, which is
necessary for long run growth, he analyzes GDI rates and FDI inflows in terms of their relationship to
economic growth, in his empirical study, and he tests Granger causality between FDI inflow and GDI
rates and GDP growth. From a sample of 80 countries comprising high income OECD countries and
developing countries for the period of 1971 to 1995, he concludes that overall causality of FDI and GDI
Chowdhury &Mavrotas (2003) examines the causal relationship between FDI and economic growth for
three developing countries, namely Chile, Malaysia and Thailand from 1969-2000. Their empirical
findings suggest that GDP causes FDI in the case of Chile but FDI does not cause GDP. Anderson (2004)
discusses the potential of FDI inflows to affect host country economic growth. He argues that FDI should
have a positive effect on economic growth as a result of technology spillovers and physical capital
inflows. Performing both cross-section and panel data analysis on a data set covering 90 countries
during the period 1980-2002, the paper finds that FDI inflows enhance economic growth in developing
economies but not in developed economies. Dritsaki et al (2004)investigates the relationship between
Trade, FDI and economic growth in Greece over the period 1960-2002, they found the existence of
cointegrating relationship among the three tested variables. Results of Granger causality test showed
that there is a causal relationship between the examined variables. Hansan and Rand (2005) analyze the
causal links between FDI and GDP in a sample of 31 developing countries in Asia, Latin America and
Africa for the period of 1970-2000. They identified existence of strong causal link running from FDI to
GDP. Their results point out that FDI promotes gross capital accumulation as well as that a higher ratio
of FDI in gross capital formation creates a positive effect on GDP growth. Moreover, FDI has a lasting
impact on GDP, while GDP has no long run impact on the FDI. In that sense FDI causes growth, and they
alsofoundlong-run effectsfromFDI toGDP.
Li and Liu (2005) investigates whether FDI affects economic growth based on panel data of 84 countries
from 1970-1999. They identified a significant endogenous relation between FDI and economic growth
from mid-1980 onwards. Besides, FDI also promotes economic growth with its interaction with human
capital in developing countries. Using partial adjustment and time series data for the period 1976 to
2004, Do (2005) examines the impact of FDI on Vietnamese economy. He found the existence of short
run and long run relationship between FDI and gross domestic product. FDI is shown to have not only
short run but also long run effect on GDP of Vietnam. Daniele and Marani (2007)analyze the underlying
factors of FDI and concluded that FDI plays a positive role in enhancing the economic growth of MENA
countries. Dash and Sharma (2007) found evidence that there is bi-directional causality between FDI
and economic growth. Findings of the study of Adams (2009) are FDI in developing and Sub- Saharan
enhancement of efficiency through
transfer of new technology, marketing and managerial skills,
innovation and best practices. Further, FDI has both benefits and costs and its impact is determined
by the country specific conditions in general and the policy environment in particular in terms of the
ability to diversify, the level of absorption capacity.
Jayachandran and Seilan (2010), suggest that there exist a long term cointegration and causality
relation between FDI inflow, GDP and trade. Bhattacharya and Bhattacharya. S (2011) observed the
existence of long-run relationship between GDP and FDI Inflows. Georgantopoulos and Tsamis (2011)
suggest, the existence of long-run equilibrium relationship among FDI and gross domestic product, but,
there is a one-way causality running from gross domestic product to FDI, indicating that foreign capital
penetration Granger-causes economic growth in Greece. Zhang (2001), examined 11 countries of Asia
TSM Business Review, Vol. 5, No. 1, June 2017