Inward FDI And Economic Growth

The remarkable growth in FDI has attracted the attention of many researchers, but there is a debate as to whether inward FDI has a positive or negative effect on economic growth. Inward FDI can make a positive contribution to the host country by supplying advanced technology, product and process innovations (Dunning, 1994). Furthermore, inward FDI may create forward and backward linkages as foreign firms transfer technology to local suppliers of intermediate goods and customers (Blomstrom and Kokko, 1997; Saggi, 2000; Zhang, 2001; OECD, 2002). Inward FDI may enhance human capital in the host country by introducing the host country management practices, organizational and marketing techniques (de Mello, 1999; Ericsson and Irandoust, 2001).

Alternatively, there is a risk that foreign technology and working practices cannot accommodate local capacities and needs (Dunning, 1994). Additionally, inward FDI may transfer the host country’s advanced technology to the home country, resulting in a reduction in the comparative advantages of the host country (Dunning, 1994). Another potential drawback is that foreign firms might out-compete local firms and drive local firms out of business, which might lead to foreign firms establish monopolies and raise prices in the host country’s market (Blomstrom and Kokko, 1997; Hill, 2009). Moreover, the balance of payments in the host country may deteriorate if the repatriated profits to the home country are more than the initial capital investment in the host country (Hill, 2009) or if inward FDI promotes imports and limits exports in the host country (Dunning, 1994; Hill, 2009).

There is a wide range of literature examining the causal relationship between inward FDI and economic growth in developing countries (see Herzer et al., 2008 for an overview). However, studies on developed countries are limited (Ericsson and Irandoust, 2001; Ekanayake et al., 2003; Qi, 2007; Iyer et al., 2009).

Using secondary data from World Bank or OECD sources, the study would use statistical and econometric analysis to establish the causal links between inward FDI and economic growth in developed countries. Previous studies apply causality tests based on cointegration test and error correction model (Engle and Granger 1987) or causality test developed by Toda and Yamamoto (1995). This study would extend prior work to ascertain whether the FDI-growth relationship depends on the type of FDI (technology seeking FDI, resource seeking FDI etc), different industries and host country characteristics such as labour market conditions.