Foreign direct investment, real sector growth and financial development

Abstract

AbstractThis paper examines the brinks of financial development at which foreign direct investment (FDI) enhances growth of the real sector. We deploy a newly developed financial development dataset and Lewbel instrumental variable two‐step GMM estimator (IV–GMM), with Kleibergen–Paap robust SEs and orthogonal statistics in establishing our empirical relationships over the period 1990–2017. Initial estimations at the overall level of the real sector, manufacturing, and industry show that FDI has no growth effects, and even worsens growth of the agriculture sector. On decomposing the real sector, we found the interaction between FDI and financial development to enhance the growth of the real sector and its components at face value. However, our marginal effect analysis shows that the growth impact of FDI on the overall real sector, industry, and service sector growth starts at the threshold level of the 25th percentile of financial development, while the growth impact on manufacturing is only evident at the 90th percentile of financial development. Although financial development aids FDI in projecting the growth of the agriculture sector, their interaction cannot wholly eradicate the initial adverse impact from FDI. The results are robust to determinants of growth.