Is FDI Spillover Conditioned on Financial Development and Trade Liberalization: Evidence from UMCs

Abstract

Developing countries take Foreign Direct Investment (FDI) as leverage for economic growth and development as a result of FDI technology spillovers. However, the effect of FDI inflows on economic growth of host countries is conditional on the abilities of those countries in absorbing and accumulating external knowledge. The related literature paid particular attention to the role of the financial system and trade liberalization of recipients. Thus, this paper investigated empirically the intermediary roles of the financial system and trade liberalization as Absorptive Capacity (AC) factors on the FDI led growth nexus. This study provided data evidence from 33 Upper-Middle-income Countries (UMCs) over the period of 1990–2011 to contribute to the existing literature. This empirical study employed the dynamic panel “difference” GMM estimator proposed by Arellano and Bond (1991); since it prevents the biases inherent to economic growth models including auto-correlation, unobserved heterogeneity, and endogeneity between explanatory variables. The results indicated the development of the domestic financial system facilitated FDI technology spillovers in order to enhance the economic growth of UMCs. However, the empirical findings also showed a negative effect of trade openness on stimulating the FDI spillovers.