Foreign Direct Investment and economic growth in OECD countries

Abstract

The role of inward FDI on economic growth has attracted the attention of researchers for many years as its beneficial impact has been recognised theoretically by scholars and policymakers; however, the empirical evidence remains ambiguous. Hence, the objective of this chapter is to investigate the causal relationship between FDI inflows/outflows and economic growth in developed OECD countries. Investigation of the causal link between FDI inflows and growth has important implications such that if there is a unidirectional causality it would support the FDI-led growth hypothesis. Alternatively, if the causal link runs in the opposite direction, it would imply that economic growth may be a prerequisite for countries to attract FDI. Finally, if the causal process is bi-directional, FDI inflows and growth would have a reinforcing causal relationship. In particular, this chapter contributes to the existing literature by focusing on developed countries as inward/outward FDI has become an increasingly significant factor in influencing the economic activity. In contrast, most previous time-series causality studies focus on developing countries with only a few covering developed countries. However, almost all of the world’s FDI originates from developed countries and the majority of FDI is also located in developed countries. Another feature is that this chapter also tests the causal link between outward FDI and economic growth. Outward FDI might promote the home country’s economic growth as it might yield higher profits, transfer technology and management skills to the home country, expand production abroad, secure raw materials overseas and avoid trade barriers and so on. Following an Introduction, the chapter then reviews FDI trend across OECD countries. Next it discusses the alternative theories and literature exploring the relationship between FDI and economic growth (i.e. the impact of inward FDI on host country’s economic growth, the impact of outward FDI on home country’s economic growth, together with the impact of economic growth on inward/outward FDI). We then describe empirical causality testing methodology, together discussing the empirical results.