The Effect of FDI on Domestic Investment and Economic Growth: Vector Autoregression Estimation of Causal Effects

Abstract

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There is evidence that foreign direct investment promotes growth in developing economies. At the same time, economic development attracts FDI. Further, FDI inflows may induce investment by national investors. To analyse the effect of FDI inflows on economic growth and domestic investment in developing countries, this paper has applied the vector autoregressive model for five Asian countries – India, Malaysia, Pakistan, Sri Lanka, and Thailand – for the period 1980-2020. In the VAR framework, the relationship between GDP, FDI, exports, infrastructure, and population growth are estimated endogenously by taking two-period lags of each of these variables. The estimated VAR results show that there is a positive impact of FDI on growth in these economies, except Pakistan, and the infrastructure facility is an important factor for attracting FDI. The impact of FDI inflows on domestic investment in India is significantly positive, with a more-than-two-fold increase in investment by the national investors.

Keywords: FDI Inflows, Economic Growth, Domestic Investment, Causality, VAR Estimation

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