Causal Links between Foreign Direct Investment and Economic Growth in Egypt

Transcription

1 J I B F Research Science Press Causal Links between Foreign Direct Investment and Economic Growth in Egyt TAREK GHALWASH* Abstract: The main objective of this aer is to study the causal relationshi between The Foreign Direct Investments and economic growth of Egyt over the eriod , using the Granger-causality and vector autoregressive methodology. The causality test shows a bidirectional causality between foreign direct investments, and Egytian economic growth. The results conclude that FDI invested in Egyt was not attracted mainly by its economic growth. However, FDI is an imortant factor that stimulates the Egytian economic growth. The Results further suggest that Egytian economic growth deends on the countrywide ability to attract foreign direct caital. Keywords: Foreign Direct Investment, Economic Growth, and Granger Causality. JEL classification: F21; F23; O17; O19 I. INTRODUCTION Does the foreign direct investment (FDI) take recedence over economic growth or economic growth stimulus FDI? This study seeks to examine the relationshi between FDI and economic growth in Egyt. Studying this, the relationshi between FDI and economic growth, is of vital imortance to both academicians and ractitioners. Recently, there has been a growing interest in examining the relationshi between foreign direct investment (FDI) and economic growth, esecially in the develoing countries. Numerous studies document the imortance of foreign direct investment (FDI) on roduction, emloyment, income, rices, exorts, imorts, economic growth, balance of ayments and general welfare of the reciient * Deartment of Economics, Mansoura University, Mansoura, Egyt, tarek.ghalwash@gmail.com JOURNAL OF INTERNATIONAL BUSINESS & FINANCE, 3:2 (2011): 87-96

2 88 / JOURNAL OF INTERNATIONAL BUSINESS & FINANCE country. It facilitates economic integration and growth through technological sillovers (Ponomareva, 2000). The relationshi between foreign direct investment (FDI) and economic growth is a well-studied subject in the economics growth literature, both theoretically and emirically. Though in the theoretical literature the relationshi between FDI and growth is well established, in emirical literature the relationshi between the two variables, esecially the direction of causality is very contradictory. In the theoretical consideration, economic growth may induce FDI inflow when FDI is seeking consumer markets, or when growth leads to greater economies of scale and, hence, increased cost efficiency. On the other hand, FDI may affect economic growth, through its imact on caital stock, technology transfer, skill acquisition, or market cometition. FDI and growth may also exhibit a negative relationshi, articularly if the inflow of FDI leads to increased monoolization of local industries, thus comromising efficiency and growth dynamics. In the emirical consideration, on the link between FDI and economic growth, De Mello (1999) suort the FDI-led growth hyothesis using both time series and anel data estimation of 32 OECD and non- OECD countries over the eriod He estimates the imact of FDI on caital accumulation and outut growth in the reciient economy and attemt to find suort for an FDI-led growth. Wang (2002) exlores what kind of FDI is most likely to contribute significantly to economic growth. Using data from 12 Asian economies over the eriod of , she found that only FDI in the manufacturing sector has a significant and ositive imact on economic growth and attributes this ositive contribution to FDIs sillover effects. Ericsson and Irandoust (2001) examined the causal effects between FDI growth and outut growth for the four OECD countries, Denmark, Finland, Norway and Sweden, alying cross-country analysis. The authors failed to detect any causal relationshi between FDI and outut growth for Denmark and Finland. They suggested that the secific dynamics and nature of FDI entering these countries could be resonsible for these no-causality results. In the recent years, economists and olicy analysts renew their interest in whether the economic growth takes recedence over FDI or FDI is a stimulus for economic growth. Over the ast decade many studies investigate the direction of causality between FDI and GDP (see; Ericsson and Irandoust 2001; Choe, 2003; Hansen and Rand, 2006)1 because the direction of causality has many significant olicy imlications. For examle, the finding of causality running one-way

3 CAUSAL LINKS BETWEEN FOREIGN DIRECT INVESTMENT AND ECONOMIC... / 89 from GDP to FDI signifies that this economy has to investigate to increase their GDP before attract foreign investment. This means that FDI needs sufficient conditions, such as olitical instability, develoed financial markets, and highly educated workforce, to flow into a country. This aer examines the causal relationshi between FDI and economic growth for Egyt over the eriod , using the Granger-causality and vector autoregressive methodology. With the exlosion of growth of FDI over the 1990s, many economists esecially those interested in develoment issues undertook various researches into the relationshis between FDI and economic growth. This resulted in stream of literature focusing on the imact of FDI on the dynamics of growth measured by gross domestic roduct (GDP) in the reciient country. However, to the best of my knowledge, no study has been done to examine the nature of any causal relationshis between FDI and GDP in Egyt. In order to achieve the objectives of the aer, the study adotss Granger-causality aroach. In addition the aer also check for stationary of both FDI and GDP time series variables, using the unit root test. Moreover, I will also use the first difference of vector autoregressive (VAR) scheme model for the causality test between FDI and economic growth. The data for this study is time series data for the eriod 1980 to The main sources of data are the World Bank develoment indicators, UNCTAD statistics 2010 and World Bank indicators -CD ROOM The reviously listed data are collected from various ublications of they Egytian statistical service. This study is organized into five sections. Section 2 discusses the link between FDI and economic growth and the emirical literature on the relationshi between FDI and economic growth are also considered in this section. In section 3, the data and methodology are briefly resented. The aroriate econometric model and result estimation that will be suitable for the case of Egyt is discussed in section4. Finally, section 5 contains the conclusions of the study. II. LITERATURE REVIEW Literature of the causality between FDI and economic growth of develoed and develoing countries concentrates on studying the imact of FDI on the dynamics of growth measured by GDP in the reciient country. A stream of literature of theoretical and emirical research on the link between FDI and economic growth has emerged.

4 90 / JOURNAL OF INTERNATIONAL BUSINESS & FINANCE Theoretical literature ointed out the role of FDI on growth as endogenous variable that generates increasing returns to roduction through the channel of international technology transfer (De Mello, 1997). Thus, attracting more FDI flows to a country should romote domestic economic develoment since such inflows increase domestic caital stock, exand market access, rovide ositive technological sillovers for local industries, and hel accumulate and imrove human caital [see Blomstrom, Lisey and Zejan (1994, 1996), OECD (1999, 2000), and Zhang (1999)]. Hence, if growth determinants, including FDI, are made endogenous in the model, long run effects of FDI will follow. Therefore, a articular channel whereby technology sills over from advanced to lagging countries is the flow of FDI (Bengoa and Sanchez-Robles, 2003). According to the revious studies, the effect of FDI on growth deends on different factors such as the degree of comlementarity and substitution between domestic investment and FDI, and other country-secific characteristics. Buckley et al., (2002) argue that the extent to which FDI contributes to growth deends on the economic and social conditions in the reciient country. Countries with high rate of savings, oen trade regime and high technological levels would benefit from increase FDI to their economies. From the theoretical consideration, it is very difficult to redict whether FDI and economic growth act as substitutes or comlements for each other. Existing emirical studies in the literature use different data and estimation techniques and reort mixed results. During the last twenty years, the existing emirical studies using different data and estimation techniques give mixed results. However, in the available literature, there are mix results regarding the direction of causality between FDI and economic growth (measured by growth in real GDP er-caita). This is articularly due to the differences in receiving countries characteristics and how FDI resond to these characteristics. Blomstoem et al. (1994), investigated the relation between FDI and economic growth in the develoing and develoed countries over the eriod ( ) and found a unidirectional causal relationshi between FDI and economic growth for all develoed countries. In the manner, Zhang (2001) examine the causality between FDI and economic growth by considering 11 develoing countries in East Asia and Latin America. He emloyed cointegration and Granger causality tests. The study revealed that in five of the countries, economic growth is enhanced by FDI but the host country conditions such as trade regime and macroeconomic stability are imortant.

5 CAUSAL LINKS BETWEEN FOREIGN DIRECT INVESTMENT AND ECONOMIC... / 91 On the other hand, Choe (2003) also examine the causality of FDI and economic growth by alying VAR model. In his study, he tests the Granger causality between FDI and GDP from a samle of countries comrising high-income OECD countries and develoing countries over the eriod 1971 to He concludes that overall causality of FDI and GDP is bi-directional. However, more significant effects are observed from economic growth to FDI rather than from FDI to economic growth. Feridum (2004) also examined the causal relationshi between FDI and economic growth for Cyrus from ( ). He emloyed Granger causality and vector autoregression (VAR) method for the study. The results revealed that there is a unidirectional Granger Causality from FDI to economic growth. III. DATA AND METHDOLOGY The objective of this aer is to examine the ossible tyes of casual relationshi between economic growth and FDI in Egyt. Broadly seaking, there are three ossible tyes of this relationshi: First, the case when economic growth in Egyt attract FDI (Growth-driven FDI), Second, the case when FDI imrove the rate of growth in Egyt (FDI - led growth), Finally, The two variables (economic growth and FDI) way casual link between them(or ossibly no causality at all). To investigate the relationshi between foreign direct investment and economic growth in Egyt, we use the data of foreign direct investment and GDP as a roxy of economic growth. Our analysis is based on anel annually data covering FDI inflows into Egyt and GDP of the Egytian economy over the eriod ( ). The data obtained from UNCTAD statistics 2010 and World Bank indicators - CD ROOM 2010 (Descritive Statistics of the data resented in table 1). Table 1 Descritive Statistics GDP Mean Maximum Minimum Std. Dev Skewness Kurtosis Probability FDI

6 92 / JOURNAL OF INTERNATIONAL BUSINESS & FINANCE In this study, economic growth is exressed as growth in gross domestic roduct. Since the economic variable is exressed in constant rices, it imlies that economic growth is exressed in real terms. I adoted real economic growth in order to avoid any monetary influences that can lead to distorted real variables. In addition, our two variables are exressed in logarithms in order to include the roliferative effect of time series. IV. THE EMPIRICAL MODEL AND RESULTS Generally, causality between two economic variables has been tested using Granger causality test (see Granger 1969). Within a bivariate context, the Granger-tye test states that if a variable x Granger causes variable y, the mean square error (MSE) of a forecast of y based on the ast values of both variables is lower than that of a forecast that uses only ast values of y. In order to test for direct causality between FDI and economic growth, we erform a Granger causality test using equations (1) and (2): Y = α + β Y + δ X + η (1) t i t i i t i t i 1 i= 1 t i t i i t i t i 1 i= 1 X = ϕ + γ Y + λ X + µ (2) where Y t and X t reresent the GDP and FDI resectively and they are stationary time series sequences, α and φ are the resective intercets, η t and µ t are white noise error terms, and is the maximum lag length used in each time series. The otimum lag length is identified using Hsiao s (1981) sequential rocedure, which is based on Granger s definition of causality and Akaike s (1969, 1970) minimum final rediction error criterion. If in equation (1) δi is significantly different from zero, then we conclude that FDI Granger causes GDP. Searately, if γ i= 1 i in equation (2) is significantly different from zero, then we conclude that GDP Granger causes FDI. Granger causality in both directions is, of course, a ossibility. In order to aly Granger causality test, the series that belong to variables should be stationary. Therefore; it is necessary to make test for unit roots to examine whether the series for these two variables are i= 1

7 CAUSAL LINKS BETWEEN FOREIGN DIRECT INVESTMENT AND ECONOMIC... / 93 stationary or not. Macroeconomic time series are usually not stationary. Such series are made stationary by calculating logarithms or taking first or second differences. To overcome this roblem, the First ste of my analysis was to examine the stationary of the variables. If all the variables are stationary I(0), then there is no roblem to estimate the coefficients using the variables with initial secification 2. Most commonly used test for the integration order of variables is Augmented Dickey-Fuller test (ADF, 1979). This test are described by the following equations: (ADF) Η = k + ϕ Η 1 + ϕ Η 1 + ε n i t i t t i= 1 where H is the variable under consideration, is the first difference oerator, t catures any time trend, ε t is a random error, and n is the maximum lag length. The otimal lag length is identified so as to ensure that the error term is white noise. If we cannot reject the null hyothesis ϕ = 0 then we conclude that the series under consideration has a unit root and is therefore non-stationary. The results of these tests aear in Table 1. The results of Table 1 suggest that the null hyothesis of a unit root in the time series cannot be rejected at a 5% level of significance in variable levels. Therefore, no time series aear to be stationary in variable levels. However, when the logarithms of the time series are transformed into their first differences, they become stationary and consequently the related variables can be characterized integrated of order one, I(1). According to the results of unit root test, Granger causality test based on equation 1 and 2 was alied in order to determine the resence of the relationshi among variables and its direction. The results of Granger test done for 1 Time lags between the two variables for which unit roots test is carried out are dislayed in the table 2. Table 2 Augmented Dickey-Fuller Unit Root Test Results Level 1st Difference lngdp *** (0.861) (0.000) lnfdi *** (0.731) (0.000) (1) * * *, * * and *denote rejection of null hyothesis at 1%, 5% and 10% level of significance, resectively. (2) P value between arentheses

8 94 / JOURNAL OF INTERNATIONAL BUSINESS & FINANCE As we can see from table 3, the results resented in table 3 we can conclude that the variable economic growth is not Granger cause of FDI with a 5% significant level. At a 10% significance level we can also accet the alternative hyothesis that FDI is Granger cause of economic growth. This result leads us to the conclusion that there is only a oneway casualty running from FDI to GDP. Table 3 Granger Causality Test Results F - Statistics Null hyothesis FDI does not granger cause GDP er caita 5.749** (0.312) GDP er caita does not granger cause FDI (0.853) * Reject the null hyothesis at the 10% level. ** Reject the null hyothesis at the 5% level. *** Reject the null hyothesis at the 1% level. P value between arentheses V. CONCLUDING REMARKS There are many studies investigated to the relationshi between economic growth and foreign direct investment. The urose of this study is to examine the link between FDI and economic growth in Egyt. The aer first resents some stylized facts of theoretical and emirical literatures that are investigated this relationshi between FDI and economic growth. Next, a two ste emirical analysis of the causations between FDI and economic growth is resented in annually data of Egyt from 1975 to 2009, As those variables are integrated in I(1), the VAR framework used to test the causality relationshi between the variables. The results of Granger-causality test show the null hyotheses of FDI does not Granger cause GDP is rejected in 1 year lags, at the 5% and the 10% levels resectively. On the other hand, the null hyotheses of GDP does not Granger cause FDI is not rejected. This leads us to the conclusion that there is only a one-way casualty running from FDI to GDP. This could conclude that FDI invested in Egyt was not attracted by its economic growth. Moreover, FDI is imortant factors that enhance the affect of economic growth in Egyt. Overall, the Results suggest that Egyt s caacity to rogress on economic growth will deend on the country s erformance in attracting foreign caital. It could be argued that the determinants of

9 CAUSAL LINKS BETWEEN FOREIGN DIRECT INVESTMENT AND ECONOMIC... / 95 FDI inflows to the Egyt economy are not only economic and other socio-olitical in nature and relate in articular to levels of activity in the economy lus variables relating to the cost-returns structures, degree of oenness of the economy, and the macroeconomic environment in the country. Notes 1. The interested reader should refer to de Mello (1997, 1999) for a comrehensive survey of the nexus between FDI and growth as well as for further evidence on the FDI growth relationshi. 2. Most of the main macroeconomic variables are non-stationary, integrated of order higher than zero. If the series are non-stationary but co-integrated, then the estimation as an autocorrected model is admissible. If the variables are non-stationary and are not cointegrated then the secification of variables as differences is necessary. References Akaike, H. (1969), Fitting Auto Regression for Prediction, Annals of the Institute of Statistical Mathematics, 21: Akaike, H. (1970), Statistical Predictor Identification, Annals of the Institute of Statistical Mathematics, 22: Bengoa, M., & Sanchez-Robles, B. (2003a), FDI, Economic Freedom and Growth: New Evidence from Latin America. Euroean Journal of Political Economy. Blomstrom, M., R. E. Lisey, and M. Zejan, (1994), What Exlains Growth in Develoing Countries? NBER Discussion Paer No Buckley, P. J., J. Clegg, and C. Wang (2002), The Imact of Inward FDI on the Performance of Chinese Manufacturing Firms, Journal of International Business Studies, 33(4): Choe, J. I. (2003), Do Foreign Direct Investment and Gross Domestic Investment Promote Economic Growth?, Review of Develoment Economics, 7: De Mello, L. R. (1999), Foreign Direct Investment-Led Growth: Evidence from Time Series and Panel Data, Oxford Economic Paers, 51: De Mello, L. R. (1997), Foreign Direct Investment and Outut, A Comarative Study, The International Trade Journal, 15: Dickey, D. A. and Fuller W. A. (1979), Distribution of the Estimators for Autoregressive Time Series with a Unit Root. Journal of the American Statistical Association, 74: Ericsson, J. and M. Irandoust (2001), On the Causality Between Foreign Direct Investment and Outut: A Comarative Study, The International Trade Journal, 15: Feridum, M. (2004), Foreign Direct Investment and Economic Growth: A Causality Analysis for Cyrus, , Journal of Alied Sciences, 4(4):

10 96 / JOURNAL OF INTERNATIONAL BUSINESS & FINANCE Granger, C. W. J. (1969), Investigating Causal Relations by Econometric Models and Cross-sectral Methods. Econometrica, 35: Hansen, H., Rand, J. (2006), On the Causal Links Between FDI and Growth in Develoing Countries, World Economy, 29: Jong, II. C. (2003), Do Foreign Direct Investment and Gross Domestic Investment, Promote Economic Growth, Review of Develoment Economics, 7: OECD (1999), Foreign Direct Investment and the Environment: An Overview of the Literature. Paris: OECD. (2000), The OECD Guidelines for Multinational Enterrises. Paris: OECD. UNCTAD (2009), Handbook of Statistic. Wang, M. (2002), Manufacturing FDI and Economic Growth: Evidence from Asian Economies, Deartment of Economics, University of Oregon Mimeo. World Bank (2010), World Develoment Indicators on CD-ROM, World Bank: Washington, D.C. Zhang, K. (1999), FDI and Economic Growth: Evidence from Ten East Asian Economies. Economia Internazionak 54: Zhang, K. H. (2001), Does Foreign Direct Investment Promote Economic Growth? Evidence from East Asia and Latin America, Contemorary Economic Policy, 19: