Foreign Direct Investment and Economic Growth: The Role of Domestic Financial Sector

Muhammad Khan

No 2007:18, PIDE-Working Papers from Pakistan Institute of Development Economics

Abstract: Recent theoretical and empirical literature suggests that foreign direct investment (FDI) exerted positive impact on economic growth through the process of technological diffusion. The literature also suggests that the development of the domestic financial system of the host country is an important pre-condition for FDI to have a positive impact on economic growth. A welldeveloped domestic financial sector enhances efficient allocation of financial resources and improves the absorptive capacity of a country with respect to FDI inflows. Particularly, a more developed financial system positively contributes to the process of technological diffusion associated with foreign direct investment. In this study, we examine the link between FDI, domestic financial sector, and economic growth for Pakistan over the period 1972–2005. Empirical analysis is based on the bound testing approach of cointegration advanced by Pesaran, et al. (2001). The results suggest that FDI inflows exerted positive impact on economic growth in the short-run and the long-run if the domestic financial system has achieved a certain minimum-level development. The results further suggest that better domestic financial conditions not only attract foreign companies to invest in Pakistan, but also allow maximising the benefits of foreign investment

Keywords: Foreign Direct Investment; Financial Sector Development; Economic Growth; Technology Spillovers (search for similar items in EconPapers)
JEL-codes: F21 F36 F43 O16 (search for similar items in EconPapers)
Pages: 47 pages.
Date: 2007
New Economics Papers: this item is included in nep-cwa and nep-dev
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (31)

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Working Paper: Foreign Direct Investment and Economic Growth: The Role of Domestic Financial Sector (2007)
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