The Effects of Fdi Inflows on Host Country Economic Growth

Topics: Economic growth, Economics, Capital accumulation Pages: 25 (6438 words) Published: January 1, 2013


Numerous researchers have investigated the impact of FDI on economic growth. Unfortunately, the empirical literature has produced conflicting conclusions. Specifically, this paper assesses whether the FDI impact on economic activities in the host countries. This study by using a panel data for 94 countries over the 1991–2010 period, shows that there is not a strong complementary connection between FDI and economic growth. Furthermore, FDI lonely directly don’t promote economic growth by itself, but indirectly does via its interaction terms. There is a strong positive interaction effect of FDI with human capital on economic growth.


Over the past two decades, many countries around the world have experienced substantial growth in their economies, with even faster growth in international transactions, especially in the form of foreign direct investment (FDI). The share of FDI in GDP has grown five-time through the eighties and the nineties in the world, causes of FDI and economic growth as an important subject. FDI is one main source of growth in certain countries. The relationship between FDI and economic growth has been a critical issue for several decades. Some of the policymakers believe that attracting FDI would eventually positively impact on economic development. The effect of FDI on economic growth has been widely discussed in the economic literature. In recent years, the growing interest in this area of ​​research is also consistent with the shift of policy-makers policies towards attracting more FDI. Since the early 1980s, many developing countries eliminated most restrictions on foreign capital flows.

FDI plays an important role in the economy. The most essential role is to increase economic growth by rising domestic capital formation. According to (Krugman & Obstfeld, 2008) FDI functions as a way to bridge the gap between capital demand and supply or other inflows of capital, stimulates the production frontier of a country that usually experience capital shortage. (Yussof & Ismail, 2002) also repeat this sentiment that FDI provided an additional source of capital and expanded host country production activities. The inflows of capital in the form of FDI allow host economies to invest in production activities beyond what could be achieved by investing domestic savings alone.

Some studies have shown that, FDI might doesn’t effect on economic growth directly but indirectly through the interaction with other variables. For example, a study done by (Omran & Bolbol, 2003) found that the relationship between economic growth in Nigeria depends on their or interacted with financial development and level of absorptive capacity. Another research by (Wijeweera, Villano, & Dollery, 2010) studied on 45 countries found that FDI cause growth depends on the level of highly skilled labour. Although the theoretical literature predicts that FDI inflows bring enormous benefits to the host country, empirical studies on the FDI–growth relationship have reported conflicting results (Herzer, Klasen, & Nowak-Lehmann Danzinger, 2006). Some studies have concluded that FDI has a positive growth effect on the host countries (De Mello, 1999 and Choong, Baharumshah, Yusop, & Habibullah, 2010), though others have not found any evidence (Ericsson & Irandoust, 2001) or have found a negative effect (Moran, 1998) on growth. In recent literature, the capacity of countries plays a vital role in the effect of FDI on economic growth.

This paper examines whether FDI affects economic growth in the host country. It differs from existing studies in the following aspects. Firstly, it uses a larger cross country (94 countries) sample over a longer time period (1991–2010). Secondly, In addition to examining a new aspect of absorptive capacity, this paper contributes to...
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