Abstract
This paper contributes to the literature on the effect of Foreign Direct Investment (FDI) on economic growth by examining the role of financial development as a source of absorptive capacity in the FDI-economic growth relationship in Sub-Saharan Africa (SSA). Using panel data econometric techniques and an unbalanced dataset of 1989-2013, we examine the independent effect of FDI on economic growth, as well as the impact of an interactive relationship between FDI and financial development on economic growth in SSA. We find that FDI does not directly lead to economic growth in SSA. However, the financial system through banking sector development enhances the effect of FDI on economic growth in the region. This finding is linked to the existence of a causal relationship between banking sector development and FDI, which is stronger in the low-income subsample relative to the middle-income subsample and the full SSA sample. We also estimate the threshold financial development levels essential for the expected FDI-economic growth effect to occur. Finally, the study recommends that strategies toward the attraction of foreign capital in SSA must be complemented by measures to develop the domestic financial system.
Highlights
A significant feature of globalization over the last three decades is the remarkable rise in Foreign Direct Investment (FDI), the increase in its relative importance to the economic growth of developing countries
We examine the direct effect of FDI on the growth of the economy and conduct pooled ordinary least square (OLS) estimations using data averaged over the 25-year period 1989-2013 as follows: Yit = b0 + b1INITIAL GDPit + b 2 X it + b3Zit + e it where Y represents real per capita GDP growth rate, INITIAL GDP is specified as the initial level of the log of per capita GDP, X is a vector of variables including population growth rate, the degree of trade openness, and foreign direct investment (FDI)
The Direct Effect of FDI on Economic Growth To examine the direct effect of FDI on economic growth, Table 2 presents the results of OLS and panel models comprising of the fixed effect4 estimates and the dynamic panel regressions, which include the difference Generalized Method of Moment (GMM) and the system GMM estimates
Summary
A significant feature of globalization over the last three decades is the remarkable rise in Foreign Direct Investment (FDI), the increase in its relative importance to the economic growth of developing countries. In 1997, developing countries received 37.2% of FDI global flows (UNCTAD 1998, as discussed in Saggi, 2002). Many countries in the SSA region have pursued inward pro-FDI policies with the aim of deriving benefits such as new technologies, increased employment, capital inflows, and greater contact with foreign markets (Cippolina, Giovannetti, Pietrovito, and Pozzolo, 2012; Görg and Greenaway, 2004; Görg and Strobl, 2005).
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