Dynamic Effects of FDI, Trade Openness, Capital Formation and Human Capital on the Economic Growth Rate in the Least Developed Economies: Evidence from Nepal

Abstract

The study investigates the linkage between FDI, trade openness, capital formation, human capital, and economic growth rate in Nepal using the vector error correction (VEC) model. The study reveals that a long-run equilibrium relationship exists between variables. Besides, trade openness and FDI have a dynamic positive effect on the GDP per capita growth rate in Nepal. On the other hand, human capital does not appear to be a significant factor, whereas capital formation demonstrates a negative association with rates of economic growth. The VEC based Granger causality test indicates that a unidirectional short-term causal flow runs between FDI, trade openness, and GDP per capita growth rate. However, the impulse response analysis reveals that this relationship is not stable rather volatile over time. The study suggests that Nepal should adopt more liberalized trade policy to attract foreign capitals and to ensure stable economic growth rate. Simultaneously, it needs to invest more in its human capital to reap spillover effects of foreign technologies on other sectors.