The Growth Effect of Foreign Direct Investment: Evidence from Time-Frequency Analysis

Abstract

The impact of FDI inflow on the economy of the host country had not been clearly defined, especially in the empirical literature. Most of the empirical results from past studies are distorted by model misspecification and endogeneity problems. To find a cure for these deficiencies, this study uses an unconventional methodology called wavelet coherence to examine the nexus between FDI inflows and per capita income growth in three African countries (The Gambia, Ghana, and Senegal. Wavelet coherence is a localized correlation in time-frequency space that examines the dynamic nexus between two time series. Most traditional econometric methods that were used to study the nexus between FDI inflows and income assumed that the series are stationary, however, most economic time series are not stationary, hence, this makes most traditional methods ineffective in finding the nexus between FDI and income. The use of wavelet coherence can overcome this challenge because it does not require the assumption of stationarity of the data.The empirical results of the study showed that the impact of FDI inflows depends on the degree to which the FDI is a complement or a substitute for domestic investment. Senegal where FDI complements domestic investment in enhancing growth derived more benefit from FDI inflows than The Gambia where FDI inflows substitute domestic investment and Ghana where FDI inflows had no impact on domestic investment. The causality between per capita income growth and per stock of FDI inflows runs from per stock of FDI inflows or the two series move together.