Does Financial Sector Development Enhance the Relationship between FDI and Economic Growth? A Comparative Study of East African Countries

Abstract

This study examines the causal relationship between FDI and GDP growth in a number of East African countries, focusing on the impact of financial sector development on this relationship. There are strong theoretical reasons to believe that a developed financial sector will enhance the impact of FDI on growth, but empirical evidence remains scant. This study looks first at the short term causal relationship between FDI and GDP growth, using a robust methodology that avoids issues associated with Granger causality testing. This testing indicates little evidence of a relationship. Johansen cointegration testing yields little evidence of a long run relationship when a VECM containing just FDI and GDP growth is estimated, however once variables proxying financial sector development and an interaction variable between FDI and financial sector development are included, we find that although FDI and GDP growth may not be cointegrated directly, there is a relationship running through their interaction with the financial sector, and that FDI only appears to have a positive impact on GDP growth in cases where the financial sector is more developed. This finding is in line with the findings of previous researchers, and has important policy implications.

Exports, Terms of Trade and Economic Growth: Evidence from Countries with Different Level of Openness

“…In addition, following the evidence presented in Trinh and Quoc (2017) for Vietnam mentioned above, an interesting line of investigation is to point out the effects of the productive structure of led export developing countries on the long run sustained growth. Besides, from the findings presented in Kelly (2016) for a sample of East Africa countries detailed in the introduction, another promissory extension is to consider FDI as a measure of openness, in order to explore its effects on the economic performance of developing countries. An alternative can be to include other criteria of openness previously used in the literature, different to the traditional ratio of (X+M)/GDP, in order to divided the subsamples of countries at different stages of development.…”

“…a region that is mainly composed by low per capita income countries. Similarly, for a sample of East African countries Kelly (2016) finds that FDI promotes growths, but only if they have a developed financial sector. In turn, recently Trinh and Quoc (2017) present evidence for the growth process of Vietnam, a clear example of an opening of market-oriented country which went of having a slow to a fast economic growth during the recent years.…”

Institutional Quality and Foreign Direct Investment Inflows: Evidence from Cross-country Data with Policy Implication

“…Several studies also examine the relationship between foreign direct investment (FDI) inflow and economic growth (Chang, 2010;Anwar et al, 2010;Inekwe, 2013;Mah, 2010;Azman-Saini et al, 2010;Kelly, 2016;Brahim et al, 2014). Chang (2010) finds FDI inflow influences economic growth directly through stimulating domestic investment in the short-run.…”

“…However, they further find that economic freedom is the means which attracts FDI and hence, economic growth. Kelly (2016) finds that FDI inflow has an impact on GDP but it goes through the development of the financial sector. Similarly, Brahim et al (2014) conclude that FDI inflow has an effect on economic growth but conditional to the development of institutions.…”

Foreign Direct Investment - Growth Nexus: The Case of Nigeria

“…For instance, Kelly (2016) investigated the impact of FDI on economic growth using data for East African countries, and applied modern econometric techniques; the result indicates that there is no relationship between FDI and output. Conversely, Adeniyi and Omisakin (2012) investigated the impact of FDI on economic growth using data for East African countries spanning between 1990 and 2005.…”