The effect of foreign direct investment on economic growth: Comparison between high income and middle income countries using asymmetric cointegration approach

Abstract

The relationship between foreign direct investment (FDI) and economic growth has been widely debated, however the comparative research between high and middle income countries based on asymmetric cointegration is limited. Therefore, this study examines the impact of foreign direct investment on economic growth by comparing high and middle income countries using yearly time series data set spanning from 1970 to 2014. The paper applies Johansen (1988) procedure for symmetric cointegration, while threshold cointegration test proposed by Enders and Siklos (2001) is used for asymmetric cointegration. Based on the results, developed countries such as Japan and Korea have asymmetrical coefficient of long run equilibrium and both countries shows negative deviation adjust faster when there is a deviation in long run. In contrast, developing countries such as Malaysia and Indonesia shows that the long run equilibrium is symmetrical. This shows that the coefficient of adjustment is equal whether the equilibrium error is positive or negative. Thus, these results have particularly important for policy makers to understand the relationship between FDI and economic growth, especially with regard to the asymmetrical effect. Policy makers need to anticipate the effect of shocks to the economy.