Bounds testing approach to cointegration: An examination of the impact of foreign direct investment and trade on growth in Saudi Arabia, 1970-2010

Abstract

It is widely recognized that trade and foreign direct investment (FDI) inflows are important factors in long-term economic growth. Trade openness enhances skills through the adoption of imported superior production technology and innovative processes, and thus exerts a positive and significant impact on economic growth. Similarly, FDI augments and stimulates domestic investment, enhances technology transfer, increases export capacity and foreign exchange earnings, and thus promotes capital formation and long-run growth. This paper examined the empirical relationship between economic growth on one hand and trade and FDI flows on the other hand for Saudi Arabia during the last four decades (1970-2010). The autoregressive distributed lag (ARDL) methods to cointegration and the associated error correction model (ECM) are adopted. The results suggest that human capital, government expenditure, trade openness and infrastructure are important determinants of long run growth in Saudi Arabia. In contrast, FDI together with domestic private investment has impacted negatively on real gross domestic product (GDP). This is attributed partly to the dominant role of the public sector in the economy emanating from the huge oil resources, thereby leaving little room for the domestic and foreign private investment to play their role in the economy, and partly to the concentration of FDI in unproductive sectors. Nonetheless, the interaction of FDI either with government expenditure or with domestic investment could impact positively on growth. Efforts should therefore focus on enhancing the integration between these factors on long-term growth. Privatization, economic liberalization, and diversification measures are expected to provide real opportunities for domestic and foreign investment to play an important role in economic activity and growth. Key words: Saudi Arabia, FDI, unit roots, ARDL cointegration, ECM, trade.