Foreign direct investment, financial development and economic growth

Abstract

This article argues that the development of the financial system of the recipient country is an important precondition for FDI to have a positive impact on economic growth. A more developed financial system positively contributes to the process of technological diffusion associated with FDI. The article empirically investigates the role the development of the financial system plays in enhancing the positive relationship between FDI and economic growth. The empirical investigation presented in the article strongly suggests that this is the case. Of the 67 countries in data set, 37 have a sufficiently developed financial system in order to let FDI contribute positively to economic growth. Most of these countries are in Latin America and Asia.

FDI, Regulations and Growth

“…This result is further evidence of the fact that important host country characteristics can lead to a positive impact of foreign investment inflows on growth rates. While Borensztein et al (1998) have singled out educational attainment levels and Hermes and Lensink (2003), Durham (2004) and Alfaro et al (2004) the importance of financial markets, our empirical results support the view that regulations are another fundamental determinant of the beneficial effects of FDI reaped in host economies.…”

“…In essence, Hermes and Lensink (2003), Durham (2004) and Alfaro et al (2004) all find that countries with better financial systems and financial market regulations can exploit FDI more efficiently and achieve a higher growth rate. These studies argue that countries need not only a sound banking system, but also a functioning financial market to allow entrepreneurs to obtain credit to start a new business or expand an existing one.…”

Determinants of Economic Growth in V4 Countries and Romania

“…A possible explanation for the negative effect of FDI on economic growth could be related to the fact that FDI flow consequences are dependent on the technology absorption capacity of the destination states. Other reasons from literature are related to spill over issues (Görg and Greenwood, 2003) or financial conditions specific to receiving countries (Hermes and Lensink, 2003). The positive effects of FDI on economic growth in V4 countries were found by Fifeková and Nemcová (2015).…”

FDI and economic growth: New evidence on the role of financial markets

“…A number of economic models suggest that the relationship between FDI and growth may be contingent on other intervening factors. For instance, the model by Hermes and Lensink (2003) predicts that the impact of FDI on economic growth is contingent on the development of financial markets of the host country. According to the authors, well-functioning financial markets reduce the risks inherent in the investment made by local firms that seek to imitate new technologies and thereby improve the absorptive capacity of a country with respect to FDI inflows.…”