Samuel G. Edoumiekumo
Keywords: Economic growth, FDI, Granger causality, cointegration
Empirical works on the role of FDI in developing countries, Nigeria inclusive, reveal that FDI has contributed to the growth and development of less developed countries(LDC) (Shiro 2005). FDI is an important source of capital, complements domestic private investment, and enhances technology transfer (Abdur and George 2003).
In this paper the focus is on the causal relationship between foreign direct investment and economic growth and not to lay emphasis on the contributions of FDI to economic development. It seeks to contribute significantly to literature by using an ‘innovative econometric’ methodology to study the direction of causality between FDI and economic growth which goes beyond existing literature.
Theoretical frame-work and literature review
The product life cycle theory assumes the following dimensions: (1) the introduction stage which has to do with innovation, production and sales in the original country. (2) Stage 2 is referred to as the growth stage which is characterized by increase in export by the innovating country, more competition, increase in capital intensity and some foreign production. (3) The maturity stage is the third stage which has to do with decline in exports from the innovating country, more product standardization, more capital intensity and increased competitiveness of price, and (4) stage 4 is the decline stage which is characterized by concentration of production in LDCs and innovating country becoming net importer.
The limiting criticism of the product life-cycle is that the growing process of globalization and integration of the world economy however, invalidates this theory. This is because since globalization is aimed at breaking trade barriers the innovating country can easily employ cheap factors of production from the LDCs. However, this theory is also in line with the classical theory. The shift of production from one country to another leads to the transfer of capital, advanced technological equipment and skills, improvement in the balance of payments, the expansion of the tax base and foreign exchange earnings, creation of employment, infrastructural development and the integration of the host economy into international markets.
Foreign direct investments consist of external resources, including technology, managerial and marketing expertise and capital. All these generate a considerable impact on host nation’s production capabilities. At the current level of gross domestic product, the success of government’s policies of stimulating the productive base of the economy depends largely on her ability to control adequate amount of foreign direct investments comprising of managerial, capital and technological resources to boost the existing production capabilities.
Foreign direct investment is therefore supposed to serve as means of augmenting Nigeria’s domestic resources in order to carryout effectively, her development programmes and raise the standard of living of her people (Shiro 2005).
According to Nwankwo (1988), factors responsible for the increased need for foreign direct investment by developing countries are:
FDI is now becoming a source of capital for many developing countries. This is becoming a crucial issue particularly in the case of Africa with a very small share of FDI inflows compared to other developing regions (Asiedu, 2003). FDI, according to Abdur and George (2003), has potentially desirable features that affect the quality of growth with significant implications for poverty reduction. Klein et al, (2001) posit that FDI generates revenues and support the development of a safety net for the poor. Adison and Heshmati (2003) also support the view that the determinants of FDI in developing countries clearly suggest the centrality of infrastructure, skills macroeconomic stability and sound institutions for attracting FDI flows. The importance of information and communication technology (ICT) has also been documented in recent empirical works.
FDI-growth relationship studies particularly on developing countries suggest that FDI has a positive impact on economic growth but this also depends on other crucial factors, such as human capital base in the host country, the trade regime and the degree of openness on the economy (Balasubramanyam et al. 1996 & 1999, Borensztein et al. 1998, Niar-Reichert and Weinhold, 2001 and Baliamoune, 2002).
Methodology and data
direction of causality has generally been performed using either the Granger or Sims tests (Granger, 1969 and Sims, 1972). However, as econometric research has shown, such tests focus on time-precedence, rather than causality in the usual sense. Therefore, they are particularly weak for establishing the relation between forward-looking variables - taken literally, they can lead to the conclusion that Christmas cards "cause" Christmas (Abdur and George 2003). Granger tests can still yield some valuable information in terms of time patterns, and can be particularly interesting in a cross-country comparative framework.
Toda and Yamamoto test of 1995, avoid the problems outlined above by ignoring any possible non-stationarity or cointegration between series when testing for causality, and fitting a standard VAR in the levels of the variables (rather than first differences, as is the case with the Granger and Sims causality tests), thereby minimising the risks associated with possibly wrongly identifying the orders of integration of the series, or the presence of cointegration, and minimises the distortion of the tests’ sizes as a result of pretesting (Giles, 1997; Mavrotas & Kelly, 2001). But there is some limitation with the fact that econometric software readily available do not have such test. Therefore, use has to be made of Granger causality test in the E-view econometric software package.
It is an accepted fact that Ordinary Least Square (OLS) regression estimates with non-stationary time series data often produce unacceptable
results, even though the overall results may indicate a high degree of fit (as measured by coefficient of multiple correlation, R2 or adjusted R2 ), high amounts of correlated residuals and statistical significance as measured by the usual t-statistic (Gujirati, 2004). Moreover, many economic variables have a strong tendency to trend over time such that the levels of these variables can be characterized as non-stationary, since they do not have a consistent mean over time. Yet many analyses of unadjusted non-stationary series have been carried out on the assumption that non-stationary series do not matter. Difficulties may arise while performing regression with clearly non-stationary series thus leading to the so called ‘spurious’ results (Granger and Newbold, 1974).
Conventionally, testing for unit root of data always precedes co-integration analysis. Augmented Dickey-Fuller (ADF) test is often employed to determine the degree of integration of variables. This shows how many times a variable should be differenced to attain stationarity (Dickey and Fuller, 1979, 1981).
Data analysis and estimation results
Figure 1: Trend of FDI inflows and GDP growth for the period 1970 - 2007
The empirical results are reported as follows: First, we test for the order of integration for both GDP and FDI using Augumented Dickey Fuller test. In the second step, we run the Johansen co-integration test. Finally, we conduct pairwise Granger causality test to find out the direction of causality between FDI and GDP. The results are given in the appendices. The unit root tests are performed sequentially. The results show that the GDP and the FDI series are integrated at order I(0) and 1(2) respectively. The null hypotheses of the unit root test were all rejected. The results also show that there exist one cointegrating equation indicating the existence of short and long run relationships of the variables. The Granger causality test shows that FDI does Granger cause GDP. On the other hand GDP does Granger cause FDI. This indicates the presence of a bi-directional causality running from economic growth to foreign direct investment and vise versa.
Conclusion and recommendations
The paper employed Granger causality test to evaluate the direction of causality between FDI and economic growth (GDP) using Nigerian data obtained from CBN for a period of 37 years (1970-2007).
The above findings have important policy implications. Understanding the direction of causality between FDI and economic growth is very important for formulating policies to encourage private investors in Nigeria, particularly in this period of economic meltdown, the capital market and banking crisis. In view of our findings, the conventional view which suggests that the direction of causality runs from FDI to economic growth is true in Nigeria. Consequently, policy guidelines which emphasize the importance of FDI for growth and stability in developing countries under the assumption that “FDI causes growth” must be encouraged. Increased attention needs also to be given to the overall role of growth (and the quality of growth) as a crucial determinant of FDI along with the quality of human capital,
infrastructure, institutions, governance, legal framework, ICT and tax systems among others in host countries (Abdur and George 2003).
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