Research on the relationship between provincial foreign direct investment and economic growth: An empirical study in Indonesia

Abstract

The government of Indonesia has exerted a great deal of effort in attracting foreign investments into the country. The benefits of FDI are widely recognized, especially for developing countries, such as Indonesia. However, empirical studies have shown somewhat conflicting results. Many argued that FDI positively influences economic growth while others found otherwise. Therefore, this research seeks to determine the relationship between inward FDI and economic growth in Indonesia using panel data on the provinces from 2008 to 2017. Three absorptive capacities are included into the models. The models are tested using the random/fixed effects model and system GMM to tackle the endogeneity problem. The relationship between FDI and economic growth was found to be negative using both methodologies when the interaction term of FDI and human capital is introduced into the equation. The results are insignificant when the interaction term of FDI and human capital is excluded. This is against commonly held belief regarding FDI. The results of this research pose serious concerns for the government. It shows that strategies that are not based on empirical research might be misleading and harming the economy.