Foreign direct investment, financial development and economic growth in Asian developing countries

Abstract

This research investigates the role of domestic financial development in enhancing the positive effects of foreign direct investment (hereafter, FDI) on economic growth in Asian developing countries. In other words, we examine whether countries with a better domestic financial system can utilize FDI more efficiently. The empirical analysis uses balanced panel data of 24 Asian developing countries in the period 1995-2009. This research applies the various models and techniques in panel data regression. Linear static models for panel data, including constant coefficients model or pooled regression model (POOLED), fixed effects regression model (FEM) and random effects regression model (REM) are employed. We analyze all models and employ several kinds of test including poolability test, Hausman test, LM test, fixed effects tests and Wald tests to select the most appropriated estimated model. The research findings show that FDI alone does not have direct effect on economic growth but does have when combined with financial development. Well-developed domestic financial markets promote the process of technological diffusion associated with FDI in Asian developing countries. Therefore, FDI and domestic financial development are complementary in increasing the rate of economic growth in the region. There is a threshold level of domestic financial development above which FDI starts to have positive impacts on economic growth.