IMPACT OF FOREIGN DIRECT INVESTMENT ON STOCK MARKET GROWTH

Description

THIS PROJECT WORK IS ON IMPACT OF FOREIGN DIRECT INVESTMENT ON STOCK MARKET GROWTH.

Abstract

This study examined the role played by foreign direct investment and business environment on economic growth. The sample contained 39 Sub-Saharan African countries divided into two groups, 21 low incomes and 18 middle incomes from 1992 to 2012. The findings of pooled mean group estimator (PMG) revealed that the impact of foreign direct investment on economic growth was negative and statistically significant in low income and middle income countries. This result implies that more foreign direct investment harms economic growth in Sub-Saharan Africa. In addition, the business environment appeared to have different impact on economic growth with respect to the income level

Introduction

The impact of foreign direct investment (FDI) on economic growth is a well-investigated issue by many economists over around the world especially in the developed countries, while it is less-studied especially in African countries. Foreign direct investment plays an important role in the performance of the economy as a whole. The FDI is expected to have spillover effects among all sectors in the economy of the host country, such as increasing the export of goods and services, importing advance technology, adopting new advanced production processes, decreasing the rate of unemployment by the job creation and increasing the fund and finance for the local investors. These spillover effects could be much higher in a particular business environment such as improved infrastructure stock, high level of human capital and developed financial sector .

The foreign direct investment inflows in Africa is the lowest comparing to other regions, even it increased in recent decades but still lower in the world [3]. Attracting more FDI flows to come-in the region needs more improvement in the business environment such as human capital and infrastructure to gain more advantages from the FDI spillover effects [4,5]. Business environment in African countries is inadequate, since the infrastructure stock and human capital are too low comparing to other regions (See doing business report 2013). Recent reports show that only 27% of African population has access to internet, 22% of African population is telephone subscribers, transportation cost in Africa is the highest in the world and access to electricity in Africa is the lowest in the world [3].

It is most important thing to understand the nature of the impact of FDI and business environment on economic growth. The recent studies are less-focused in African countries, for example [6–13] studied the relationships of interest in different regions, while the studies in Africa are quite rare. So it is very important to fill the gap in addressing this issue in Africa to help policy-makers to develop and introduce effective polices to grow the economy of the region. From this end, the aim of this study is to examine the relationships between foreign direct investment, business environment and economic growth.

The rest of the paper organized as follows. Section 2 literature review, Section 3 outlines our empirical strategy, which encompasses specifying an appropriate dynamic model, econometrics method and describes the various data sets that are utilized in the methodology. Section 4 reports and discusses the econometric results, reports robustness checks, makes comparisons to related literature. Finally, Section 5 summary and conclusion.

Literature Review

The ideas that FDI led economic growth, business environment positively contribute to economic growth remains extremely controversial. This could be due to the use of different samples by different researchers, or due to the problem associated with the methodology used in each study or to the differences in the economy’s characteristics in each single country.

Theoretically, economic growth is a well-studied issue. The role of technological progress has been included in the production function as a determinant of the growth by [14] that is devoted a model of longrun growth to include the price-wage-interest reactions, interest-elastic savings schedule and allowed for the neutral technological change. Extend the Solow model to include the human capital accumulation through years of schooling in the production function [15] . Closely following the work of Solow, Lucas examined the interaction of physical and human capital accumulation on growth. The inclusion of the education human capital in the growth model continued in the work of [16-18] and expanded to include the health human capital in the production function as an important determinant of economic growth [19-21] . In-other side, there are two main theories in the impact of investment on growth which are the Modernization theory and the Dependency theory. The Modernization theory insists that the Third World is underdeveloped and remains in such a state because of its historical failure to industrialize and modernize with technology, the theory consider the lack of the finance as a one of the reasons associated with the failure of those countries. One of the solutions provided by this theory is the foreign direct investment which assumed to have positive impact on economic growth. The Dependency Theory however, is opposed to all the assessments and solutions offered by the Modernization Theory. The Dependency Theory argues that the plight of the Third Worlds as a result of the rapid economic growth and economic development in the First World countries. Thus, the theory believes-in the negative effects of the foreign direct investment on the economic growth .

Empirically, the impact of FDI on growth is subject to the level of existing business environment in the host country. For-instance,  found that FDI by itself have a positive significant impact on growth but countries with well-developed financial market benefits more from FDI. The pervious finding has been confirmed by  they resulted that the positive impact of FDI on economic growth kicks-in only after financial market development exceeds a threshold level, until then the benefits of FDI is non-existent. Moreover, FDI by itself can contribute positively to economic growth and its impact is not subject to a particular environment Moving-forward, the impact of FDI on growth has found to be insignificant in the short-run and the long run as well . A different view has been added to the previous results, which is that FDI have a negative impact on economic growth [, they justified their finding due to the technology-gap and poor business environment in the countries of interest. Moreover, [ found a bi-directional relationship between foreign direct investment and economic growth in 13 selected MENA countries.

The growth equation

Following the contribution of [14–20] and other economists in developing the new growth theory and to search for a set of variables for modeling the growth, a degree of convergence on the most empirical specification has occurred. The explanatory variables for economic growth in those studies are identified to include population, domestic investment, foreign investment, human capital and infrastructure stock. The growth model in this study is therefore:

Pooled mean group technique

According to Pesaran and Smith  the traditional estimators such as fixed-effects, random-effects and generalized method of moments GMM can lead to inconsistent estimates in the long-run due to the slope heterogeneity bias. The PMG is introduced by Pesaran et al.  to overcome this problem associated with those estimators. One advantage of the PMG is that it allows for the short-run dynamic specification to vary across countries, while the long-run coefficients are constrained to be the same.

The data

The study is using a panel of 39 Sub-Saharan Africa countries which divided into two groups of income levels, namely, 21 low income countries and 18 middle income countries in a period time from 1992 to 2012. The data used is obtained from World Development Indicators and African Union. The variables used in this study are real GDP, FDI as a percentage of GDP human capital proxies by secondary school enrollment, the infrastructure (IF) proxied by access to electricity as a percentage of population, gross capital formation (K) and total labor force (L)