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The role foreign direct investment in economic growth is a controversial one. Economic theories do not yield a specification of an estimable equation or a well defined causality pattern for foreign direct investment and economic growth, and also did not distinguish between economies at different stages of economic and financial development. The empirical evidences are also far from conclusive. This paper takes a time series approach to investigate whether the foreign direct investment promote investment, efficiency and output utilizing 18 global economies at various income levels over the period 1965 to 2004. The growth variables used are real GDP per capita, real gross fixed capital formation per capita and total factor productivity. Using the VAR and VECM models results indicate the following: (1) Inflow of foreign direct investment may act as a driving force behind investment and output in many economies in the long run; (2) Evidence of a role for foreign direct investment in capital accumulation is stronger than efficiency enhancement; and (3) Low and middle income economies tend to depend more on foreign direct investment for growth than high income economies. The findings support the factor accumulation channel instead of the efficiency channel as the primary mechanism through which the foreign direct investment influences macroeconomic outcomes. It further confirms that foreign direct investment matters in development over the long term.
Keywords: Causality, Foreign direct investment, Economic growth, Capital accumulation, Total factor productivity.
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1. INTRODUCTION
Financial development is important to economic growth, as stated by Schumpeter (1911) and more recently by Bencivenga and Smith (1991), Greenwood and Jovanovic (1990) and King and Levine (1993a) in the endogenous growth model. There are two distinct, yet complementary channels that financial development can influence economic growth. The first channel is the "debt accumulation" hypothesis by Bencivenga and Smith (1991). It focuses on the spread of organized finance at the expense of self-finance and the former's ability to overcome indivisibilities through the mobilization of unproductive resources. The second channel, called the "total factor productivity" channel, emphasizes the role of innovative financial technologies in ameliorating the informational asymmetries that hinder the efficient allocation of funds and the monitoring of the resulting projects. This is the idea considered by Greenwood and Jovanovic (1990) and...