Economic growth and FDI inflows-a stochastic front

ECONOMICGROWTHANDFDIINFLOWS:ASTOCHASTICFRONTIERANALYSISAlbertWijeweera*ThePetroleumInstitute,UAERenatoVillanoBrianDolleryUniversityofNewEngland,AustraliaABSTRACTDespiteplausibletheoreticalgroundsforpresumingapositiverelationshipbetweenforeigndirectinvestmentinflows(FDI)andeconomicgrowth,existingempiricalevidenceonthisnexusisinconclusive.Inanefforttoaddtotheempiricalliterature,thispaperestimatestherelationshipbetweenFDIandtherateofgrowthofGDPusingastochasticfrontiermodelandemployingpaneldatacovering45countriesovertheperiod1997to2004.WefindthatFDIinflowsexertapositiveimpactoneconomicgrowthonlyinthepresenceofahighlyskilledlabour;corruptionhasanegativeimpactoneconomicgrowth;andtradeopennessincreaseseconomicgrowthbymeansofefficiencygains.JELClassifications:C23,F21,F23Keywords:Economicgrowth;foreigndirectinvestmentinflowsCorrespondingAuthor'sEmailAddress:[e-mail],economistsagreethatforeigndirectinvestmentinflows(FDI)leadtoanincreasedrateofeconomicgrowth(see,forexample,Blonigen,2005).Amajorgrowth-enhancingcharacteristicofFDIistheadvancedtechnologythatoftenaccompaniesforeigncapitalinvestment.Inaddition,domesticinvestorscanalsoadoptthisadvancedtechnology.Inotherwords,FDIgeneratespositiveexternalitiesthroughtechnologyspillovers.Atthesametime,increasedforeigncapitalcanhelptonarrowthesavingsgap(i.e.thegapbetweenthedomesticsavingsratioandthedesiredlevelofinvestmentratio).Inshort,FDIshouldexertpositiveeffectsoneconomicgrowth,particularlyindevelopingcountrieswhichsufferfromlowproductivityandcapitalstockdeficiencies(see,forinstance,Johnson,2006).DespitetheseplausibletheoreticalgroundsforanticipatingapositiverelationshipbetweenGDPandFDI,availableempiricalevidenceismixed.Forexample.DeMello(1999)foundthatwhetherFDIcontributestotheeconomicgrowthdependsonprimarilyhostcountrycharacteristics,especiallythequantumofskilledlabour.Borenszteinetal.(1998)alsoestablishedthatalthoughFDIhasapositiveimpacton144GDP,themagnitudeofthiseffectdependsonthelevelofhumancapital.Usingbothcrosssectionandpaneldataanalysis,Johnson(2006)demonstratedthatFDIinflowsboostedeconomicgrowthindevelopingcountries,butnotinadvancednations.Ali'aro(2003)conductedacross-countryanalysisandfoundthattotalFDIexertedanambiguouseffectonhostcountryeconomicgrowth;FDIinflowsintotheprimarysectortendedtohaveanegativeeffectongrowth.NumerousotherempiricalstudieshavealsoprovidedmixedevidenceonthelinkbetweeneconomicgrowthandFDI(Wijeweeraet.al.2007;Zhang2001;Johnson2006).TherelationshipbetweenFDIandtherateeconomicgrowthiscriticallyimportantforpolicymakinginthereal-world.ThepasttwodecadeshavewitnessedamassivesurgeinFDIinflows.Indeed,accordingtoUNCTAD(2005),globalFDIinflowsincreasedfromapproximatelyU$55billionin1980toaroundU$l,400billionin2000.ThisunprecedentedgrowthinFDIinflowshaspromptedacademiceconomistsandpolicymakersaliketodevotemuchmoreefforttounderstandingtheempiricalrelationshipsbetweenGDPgrowthandFDIinflowsinhostcountries.ThepresentpaperseekstocontributetotheempiricalliteratureontherelationshipbetweeneconomicgrowthandFDIflowsinhostnations.Theoreticalfoundationforourstudyrestssquarelyonthewell-knownendogenousgrowthmodel(Romer,1990).Accordingtotheendogenousgrowthmodels,outputisafunctionofthestandardfactorsofproductionplushumancapital.Weemployastochasticfrontiermodel(SFM)toestimatethemodel.TheSFMmodelcontainsfactorinputsvariablesandinefficiencyvariables.Weusecapital,labourandhumancapitalasfactorinputsasv/ellasseveralvariablesasinefficiencyvariables.Wealsoincludeaproxyforthelevelofinfrastructureandaproxyforthelevelofcorruptioninthehosteconomies.ThemajorfocusofthepaperistheroleofFDIinflowsineconomicgrowth.Accordingly,FDIinflowsareincludedasaninefficiencyvariable.Inessence,weinvestigatewhetherFDIenhanceseconomicefficiencyandincreasesrealGDPinahosteconomy.ItisappropriatetoconsiderbrieflyhowthepresentstudycontributestotheempiricalhteratureonFDIandeconomicgrowth.AlthoughanumerousstudieshaveexaminedhowFDIinflowsandGDPinterrelatewitheachother,alargemajorityofthisworkincludesGDPmerelyasanexplanatoryvariableintheFDIdeterminantfunction.Inotherwords,onlyasubsetofstudieshasfocusedmainlyontheeffectsofFDIinflowsontheeconomicgrowthinthehosteconomy.Whilemostoftheavailableliteratureinthisareahasemployedtheleast-squaresmethodtoexaminetherelationshipbetweenFDIandeconomicgrowth,ourstudyemploysastochasticfrontierproductionfunctionapproach.ThisapproachallowsustodistinguishtheeffectsofFDIoneconomicgrowthviatechnicalandefficiencychangeandquantifytheeffectsofFDI,alongwithothervariables,onefficiencylevels.Onlyalimitednumberofmacroeconomicempiricalstudiesusingthestochasticfrontierhavebeenundertaken.Forexample,Iyeretal.(2004)usedthisapproachtoexaminethespillovereffectsofFDIinflowsfor20OECDcountries.Nourzad(2008)employedastochastictranslogproductionfrontiertoestimatetechnicalinefficiencyindiceswhoseconditionalmeanisspecifiedasafunctionofFDIanditsinteractionwithopennessintheeconomy.Inthesamevein,wechosethestochasticfrontierapproachtoexaminewhetherFDIinflowsenhanceeconomicgrowth