Cointegration

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Munich Personal RePEc Archive

Bounds testing approach: an
examination of foreign direct investment,
trade, and growth relationships
Joseph Magnus Frimpong and Eric Fosu Oteng-Abayie
9. August 2006

Online at http://mpra.ub.uni-muenchen.de/352/
MPRA Paper No. 352, posted 10. October 2006

BOUNDS TESTING APPROACH: AN EXAMINATION OF FOREIGN DIRECT
INVESTMENT, TRADE, AND GROWTH RELATIONSHIPS

Frimpong Joseph Magnus
KNUST School of Business
Kwame Nkrumah University of Science & Technology
Kumasi – Ghana

Oteng-Abayie Eric Fosu
School of Business
Garden City University College
P.O. Box KS 12775
Kumasi – Ghana

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BOUNDS TESTING APPROACH: AN EXAMINATION OF FOREIGN DIRECT
INVESTMENT, TRADE, AND GROWTH RELATIONSHIPS

Frimpong Joseph Magnus∗
KNUST School of Business, Kwame Nkrumah University of Science & Technology

Oteng-Abayie Eric Fosu
School of Business, Garden City University College

Abstract
Research Paper
Purpose: This paper examines the long-run impact of foreign direct investment and trade on economic growth in Ghana.
Methodology: Using an augmented aggregate production function (APF) growth model, we apply the bounds testing (ARDL) approach to cointegration which is more appropriate for estimation in small sample studies. The data span for the study is from 1970 to 2002. Findings: The results indicated the impact of FDI on growth to be negative which is consistent with other past studies. Trade however was found to have significant impact on growth.

JEL Classification: C32, F14, F21, F39, O11, O4
Keywords: Ghana, ARDL cointegration, unit roots, equilibrium-correction, FDI, Trade



Corresponding author: KNUST School of Business, Kumasi, Ghana; Email: jf_magnus@yahoo.com

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1. INTRODUCTION
According Aryeetey (2005), for a developing country such as Ghana, trade may bring about the upgrading of skills through the importation or adoption of superior production technology and innovation. Exporters learn or adopt better and highly developed production technology and innovation, either through intensive international markets competition or act as subcontractors to foreign business concerns. Producers of import-substitutes in an open economy have to face competition from foreign counterparts. Since their products, within the context of a developing country, are usually capital-intensive, they need to adopt better or more capital-intensive production facilities to survive (Frankel and Romer, 1999). Wacziarg (2001) has argued that trade openness exerts a positive and significant impact on economic growth due to the accelerated accumulation of physical capital, sustained technological transfer and improvement in macroeconomic policies. Inward FDI (foreign capital inflow) is an important vehicle for augmenting the supply of funds for domestic investment thus promoting capital formation in the host country. Inward FDI can stimulate local investment by increasing domestic investment through links in the production chain when foreign firms buy locally made inputs or when foreign firms supply or source intermediate inputs to local firms. Furthermore, inward FDI can increase the host country’s export capacity causing the developing country to increase its foreign exchange earning. FDI is also associated with new job opportunities and enhancement of technology transfer, and boosts overall economic growth in host countries.

Trade and FDI inflows have been widely recognised as very important factors in the economic growth process. Past empirical studies, both cross country and country specific, on

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trade and FDI interaction on growth (Balasubramanyam et al, 1996; Borensztien et al, 1998; Kohpaiboon, 2004; Mansouri, 2005; Karbasi et al, 2005), FDI-growth nexus and trade– growth nexus (Lipsey, 2000 and Pahlavani et al, 2005) have mostly concluded that both FDI inflows and trade promote economic growth. Nevertheless, there are clear indications that the growth enhancing...
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