Does Financial Sector Development Enhance the Relationship between FDI and Economic Growth? A Comparative Study of East African Countries
DOI:
https://doi.org/10.6000/1929-7092.2016.05.12Keywords:
FDI, Financial Sector Development, Cointegration, CausalityAbstract
This study examines the causal relationship between FDI and GDP growth in a number of East African countries, focusing on the impact of financial sector development on this relationship. There are strong theoretical reasons to believe that a developed financial sector will enhance the impact of FDI on growth, but empirical evidence remains scant. This study looks first at the short term causal relationship between FDI and GDP growth, using a robust methodology that avoids issues associated with Granger causality testing. This testing indicates little evidence of a relationship. Johansen cointegration testing yields little evidence of a long run relationship when a VECM containing just FDI and GDP growth is estimated, however once variables proxying financial sector development and an interaction variable between FDI and financial sector development are included, we find that although FDI and GDP growth may not be cointegrated directly, there is a relationship running through their interaction with the financial sector, and that FDI only appears to have a positive impact on GDP growth in cases where the financial sector is more developed. This finding is in line with the findings of previous researchers, and has important policy implications.References
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Lucas, Robert. 1988. “On the Mechanics of Economic Development.” Journal of Monetary Economics 22: 3-42.
http://dx.doi.org/10.1016/0304-3932(88)90168-7
McKinnon, Ronald and Edward Shaw. 1973. Money and Capital in Economic Development. Washington DC: Brookings Institution.
Schumpeter, Joseph. 1911. The Theory of Economic Development: and Inquiry into Profits, Capital, Credit, Interest and the Business Cycle. Cambridge MA: Harvard University Press.
Stern, Nicholas. 1989. “Financial Development and Economic Growth: Views and Agenda.” Journal of Economic Literature XXXV: 688-726.
Toda, Hiro and Taku Yamamoto. 1995. “Statistical Inference in Vector Autoregressions with Possibly Integrated Processes.” Journal of Econometrics 66: 225-250.
http://dx.doi.org/10.1016/0304-4076(94)01616-8
Walsh, James and Jiangyan Yiu. 2010. “Determinants of Foreign Direct Investment: a Sectoral and Institutional Approach.” IMF Working Paper 187.
http://dx.doi.org/10.1016/S0313-5926(12)50008-1
Akinlo, Anthony and Tajudeen Egbetunde. 2010. “Financial Development and Economic Growth: the Experience of 10 Sub-Saharan African Countries Revisited.” The Review of Finance and Banking 2(1): 17-28
Alfaro, Laura, Areendam Chanda, Sebnem Kalemli-Ozcan, and Selin Sayek. 2006. “How does FDI promote Economic Growth? Exploring the Effects of Financial Markets on Linkages.” NBER Working Paper 12522.
Alfaro, Laura, Areendam Chanda, Sebnem Kalemli-Ozcan, and Selin Sayek. 2004. “FDI and Economic Growth: The Role of Local Financial Markets.” Journal of International Economics 64: 89-112.
http://dx.doi.org/10.1016/S0022-1996(03)00081-3
Al-Yousif, Yousif Khalifa. 2002. “Financial Development and Econo-mic Growth: Another Look at the Evidence from Developing Countries.” Review of Financial Economics 11: 131-50.
http://dx.doi.org/10.1016/S1058-3300(02)00039-3
Bailliu, Jeannine. 2000. “Private Capital Flows, Financial Development and Economic Growth in Developing Countries.” Bank of Canada Working Paper 2000(15).
Baliamoune-Lutz, Mina. 2013. “Financial Development and Income in African Countries. Contemporary Economic Policy 31(1): 163-175.
http://dx.doi.org/10.1111/j.1465-7287.2011.00281.x
Barro, Robert and Xavier Sala-i-Martin. 1995. Economic Growth. New York: McGraw Hill.
Borensztein, Eduardo, José de Gregorio and Jong-Wha Lee. 1995. “How Does Foreign Direct Investment Affect Economic Growth?” NBER Working Paper 5057.
Calderon, Cesar and Lin Liu. 2003. “The direction of Causality between Financial Development and Economic Growth.” Journal of Development Economics 72: 321-334.
http://dx.doi.org/10.1016/S0304-3878(03)00079-8
Carcovick, Maria and Ross Levine. 2005. “Does FDI Accelerate Economic Growth?” pp. 195-220 In Moran, Theodore, Edward Graham and Magnus Blomstrom. Does Foreign Direct Investment Promote Growth? Washington DC: Institute for International Economics.
Chee, Yen Li and Mahendhiran Nair. 2010. “The Impact of FDI and Financial Sector Development on Economic Growth: Empirical Evidence from Asia and Oceania.” International Journal of Economics and Finance 2(2): 107-119.
http://dx.doi.org/10.5539/ijef.v2n2p107
Choong, Chee-Keong, Zulkornain Yusop and Siew-Choo Soo. 2004. “Foreign Direct Investment, Economic Growth and Financial Sector Development: a Comparative Analysis.” ASEAN Economic Bulletin 21: 278-289.
http://dx.doi.org/10.1355/AE21-3B
De Mello, Luiz.1999. “Foreign Direct Investment-Led Growth: Evidence from Time Series and Panel Data.” Oxford Economic Papers 51: 133-151.
http://dx.doi.org/10.1093/oep/51.1.133
Durham, J. Benson. 2004. “Absorptive Capacity and the Effects of Foreign Direct Investment and Equity Foreign Portfolio Investment on Economic Growth.” European Economic Review 48: 285-306.
http://dx.doi.org/10.1016/S0014-2921(02)00264-7
Ewetan, Olabanji and Henry Okodua. 2013. “Is there a Link between Financial Sector Development and Economic Growth in Nigeria?” International Journal of Financial Economics 1(4): 108-118.
Fung, Michael. 2009. “Financial Development and Economic Growth: Convergence or Divergence?” Journal of International Money and Finance 28: 56-78.
http://dx.doi.org/10.1016/j.jimonfin.2008.08.001
Greenwood, Jeremy and Boyan Jovanovic. 1990. “Financial Development, Growth and the Distribution of Income.” Journal of Political Economy 98: 1076-1087.
http://dx.doi.org/10.1086/261720
Grossman, Gene and Ethan Helpman.1991. Innovation and Growth in the Global Economy. Cambridge MA: MIT Press.
Hermes, Niels and Robert Lensink. 2003. “Foreign Direct Investment, Financial Development and Economic Growth.” The Journal of Development Studies 40: 142-163.
http://dx.doi.org/10.1080/00220380412331293707
IMF. 2005. Financial Sector Assessment: a Handbook. International Monetary Fund. http://www.imf.org/external/pubs/ft/fsa/eng/ pdf/cover.pdf
Johansen, Soren and Katarina Juselius. 1990. “Maximum Likelihood Estimation and Inference on Cointegration with Applications to the Demand for Money.” Oxford Bulletin of Economics and Statistics 52: 169-211.
http://dx.doi.org/10.1111/j.1468-0084.1990.mp52002003.x
Kelly, Roger and George Mavrotas. 2001. “Old Wine in New Bottles: Testing Causality between Saving and Growth.” The Manchester School 69: 97-105.
http://dx.doi.org/10.1111/1467-9957.69.s1.6
King, Robert and Ross Levine.1993. “Finance and Growth: Schumpeter Might be Right.” The Quarterly Journal of Economics 108: 717-737.
http://dx.doi.org/10.2307/2118406
Levine, Ross. 1997. “Financial Development and Economic Growth: Views and Agenda.” Journal of Economic Literature 35: 688-726.
Lucas, Robert. 1988. “On the Mechanics of Economic Development.” Journal of Monetary Economics 22: 3-42.
http://dx.doi.org/10.1016/0304-3932(88)90168-7
McKinnon, Ronald and Edward Shaw. 1973. Money and Capital in Economic Development. Washington DC: Brookings Institution.
Schumpeter, Joseph. 1911. The Theory of Economic Development: and Inquiry into Profits, Capital, Credit, Interest and the Business Cycle. Cambridge MA: Harvard University Press.
Stern, Nicholas. 1989. “Financial Development and Economic Growth: Views and Agenda.” Journal of Economic Literature XXXV: 688-726.
Toda, Hiro and Taku Yamamoto. 1995. “Statistical Inference in Vector Autoregressions with Possibly Integrated Processes.” Journal of Econometrics 66: 225-250.
http://dx.doi.org/10.1016/0304-4076(94)01616-8
Walsh, James and Jiangyan Yiu. 2010. “Determinants of Foreign Direct Investment: a Sectoral and Institutional Approach.” IMF Working Paper 187.
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Published
2016-05-05
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Kelly, R. (2016). Does Financial Sector Development Enhance the Relationship between FDI and Economic Growth? A Comparative Study of East African Countries. Journal of Reviews on Global Economics, 5, 145–153. https://doi.org/10.6000/1929-7092.2016.05.12
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