Essays on foreign direct investment and growth: Causality and mechanism

Foreign Direct Investment (FDI) has long been considered to foster growth in developed countries. The role of FDI in developing countries has gained much importance after the debt crisis in the 1980s. In the thesis, I attempt to verify whether FDI indeed is vehicle of growth in the developing countries. The results clearly show that FDI is good for the countries where it meets the proper economic conditions like that of minimum threshold level of human capital and viable production conditions. First, I develop two variations of a theoretical model to explain the economic conditions that foster positive growth in the economy for higher levels of FDI. The key economic factors turn out to be the stock of human capital and the production parameters of the intermediate sectors that use foreign capital. I find that FDI can promote growth if and only if a minimum threshold level of human capital is available in the economy and certain production conditions are satisfied. Second, in the empirical study I have taken a broad step ahead by adopting both time-series and cross-section approaches to explore the causality and mechanism of FDI on economic growth. The causality between FDI and growth of the economy is based on the multivariate autoregression (VAR) techniques taking care of unit-roots problems in the series for each of the sixty-six developing countries. I extend the causality analysis to find the mechanisms and economic channels, mainly export and labor productivity, through which FDI affects growth. I also find that the reverse causality from FDI to export, productivity or growth exists in many developing countries. Third, the causality analyses are further extended using the dynamic impulse responses for each developing country in our sample to determine whether the effects of FDI on growth are positive or negative for any given country. Combining the results from the causality analyses and impulse responses, I develop and estimate a binary response model to calculate the likelihood of a country showing positive effects of FDI on growth. I demonstrate that the empirical results are consistent with the theoretical findings from our model and previous researchers.