Foreign capital inflows and economic growth in developed and emerging economies: A comparative analysis

Abstract

This paper attempts to test the impact of foreign capital inflow; foreign direct investment (FDI) and foreign portfolio investment (FPI)) on economic growth in developed and emerging economies. It also explores whether this inflow generate synergies in boosting economic growth. A cross-sectional time series growth regression was used for 21 developed and 19 emerging economies sample from 1980 to 2012. The Generalized-Method of Moments (GMM) estimators developed for dynamic models of panel data were used to avoid spurious conclusions and to add robustness and inferences correction to our results, and to deal with the econometric problem of heteroskedastic error of unknown functional form. Analysis revealed mixed results for the sample. For the initial FDI and FPI impact on growth, FDI poses a positive and significant influence, while FPI reveals a negative and significant influence in both samples. In addition, the results on the population proxy support the classical model where higher growth rate of population would initiates economic progress, while the results for the saving growth proxy support the saving-led growth phenomenon; where higher saving rate would accelerate economic growth. It was also found that the Market Capitalization (MC) proxy was positively correlated with economic growth in both samples, while the results of the stock trading proxy indicate that private capital inflows had a positive effect on growth only for the developed economies. The FPI results indicated that the presence of FPI inflows may not be a precondition to produce a positive spillover effect in both sample economies. Interestingly, we observed that the interactions between FPI and the Market Capitalization (MC), Stock Trading, and growth have provided evidence that equity markets advancements do have positive contributions toward attracting more capital inwards to the host country. Analysis also showed that FDI inflows augment domestic resources of most economies, and hence boosting economic growth. As policy implication, governments should be aware that market liberalization polices would have a different influence on inward net capital based on the composition of the capital inflows desired and the level of economic development, reflecting the necessity of capturing a targeted financial market threshold in order to stimulate capital control to attract FDI and FPI. In emerging economies, the interaction term (FPI*MC) implies that catching a threshold of equity market development would have a positive impact on higher levels of capital inflows, hence countries with advanced equity markets tend to gain more welfare from FPI capital inflows.