FOREIGN DIRECT INVESTMENT AND ECONOMIC GROWTH IN ARAB COUNTRIES (1970-2008): AN INQUIRY INTO DETERMINANTS OF GROWTH BENEFITS

Abstract

This paper investigates the relationship between Foreign Direct Investment (FDI) and economic growth in a group of 16 Arab countries from 1970 to 2008. The empirical analysis also addresses the role of what are identified in the literature as local for deriving growth benefits from FDI. Using a dynamic panel approach, it is found that the impact of FDI on economic growth in Arab countries is limited or negligible. The findings also suggest that financial development, trade openness, human capital and infrastructure quality are not significantly improving Arab countries' capacity to reap growth benefits from FDI. The paper suggests that the preconditions should not be seen as of equal importance. The sectoral composition of FDI plays a critical role in deriving FDI growth benefits which might make it a necessary precondition for FDI to promote economic growth, while other factors such as financial development, trade openness, human capital and infrastructure quality could be seen as sufficient preconditions for reaping FDI growth dividends. The paper's findings have important policy implications as Arab countries can turn to domestic policy solutions to direct FDI inflows to the dynamic sectors and focus not only on FDI quantity but also on FDI quality. Meanwhile, efforts should be made to reform and improve institutional quality, macroeconomic policies, and domestic financial markets.Keywords: FDI, Economic Growth, Arab CountriesJEL classification: F21, O40, O43(ProQuest: ... denotes formulae omitted.)1. INTRODUCTIONCapital is the cornerstone of any production process at both the micro and the macro-economy levels. Capital can be obtained through domestic sources as well as through foreign sources, which is mostly in the form of Foreign Direct Investment (FDI). FDI inflows have multifaceted features which make them preferable to other sources of capital. These features include filling savings-investment gaps, relaxing foreign exchange constraints, and consisting of a bundle which includes not only capital but also technology, knowledge, and marketing and managerial skills (Grossman and Helpman, 1992; Walz, 1997; Pradham, 2003).FDI has become the most stable and the largest component of capital flows to developing countries. As a result, FDI is considered an important element in the economic development process. Yet the role of FDI in the economic growth/ development process has for long been a topic of intense debate. To date, the empirical evidence of the effect of FDI on economic growth is not conclusive.While one stream of research has indicated a positive impact of FDI on economic growth, another stream reports otherwise. A third stream of research suggests that the effect of FDI on a host country's economy is dependent on the country's absorptive capacity in terms of its human capacity and the level of economic and financial development (Hermes and Lensink, 2004; Makki and Somwaru, 2004).FDI flows around the world have dramatically increased in the past three decades. World FDI flows rose from $54 billion in 1980 to $208 billion in 1990, then to $1,401 billion in 2000 before falling to $1,114 in 2009. Arab countries were not an exception to this trend. Total FDI inflows to Arab countries increased from a mere $502 million in 1970 to $1,288 million in 1990, then jumped to $6,056 million in 2000 before soaring to $47.6 and $79.2 billion in 2005 and 2009, respectively (UNCTAD). These trends reflect the increasing importance of FDI flows both for recipient and exporting countries.This paper aims at answering two main questions. First, did FDI inflows contribute to economic growth in Arab countries over the period 1970-2008? Second, can country-specific features and initial conditions explain cross-country variations in the growth benefits of FDI? Answers to these questions provide insights into how changes in economic and institutional conditions can affect FDI prospects for Arab countries, as well as inform policy responses for acquiring growth benefits from FDI in the future. …