Endogenous Determination of FDI Growth and Economic Growth:The OECD Case



1. Introduction

World Bank statistics show that FDI worldwide grew 23.4 percent per annum on average
between 1970-2006 and reached 1.4 trillion dollars in 2006. In the same period, the world
GDP experienced a three percent growth rate per annum on average. The free movement of
capital next to stable growth in recent decades suggests that there may be some positive
relationship between FDI growth and economic growth. The following graph scatter plots
average growth rate of GDP against average growth rate of FDI of OECD countries in the
period 1975-2004 as a possible evidence of this positive relationship.

Figure 1: Average GDP Growth versus Average FDI Growth in OECD Countries

Source: World Development Indicators Online

The positive relationship suggests that (i) FDI grows in those countries whose long-run
growth rates are higher, (ii) those countries that attract higher and higher FDI levels in time
achieves higher long-run growth rates, (iii) the two determine each other simultaneously. The
answer to which explanation is more applicable is especially important for policy makers of
FDI receiving economies. Take, for example, developing countries. Policy makers believe
that increasing FDI inflows is the magical prescription for achieving positive long-run growth
rates. However, if economic growth precedes FDI growth or if FDI growth and economic
growth determine each other simultaneously, the volume of FDI that those policy makers look
forward to without having high growth rates will not be realized in the level they expect.
Besides policy concerns, there is a technical concern. It is important to determine whether
FDI growth rate precedes economic growth or the other way around or whether the two
determine each other simultaneously; without having this information, reliability of uni-
directional analysis cannot be assured.

As stated above, one possible direction of causality is from FDI to economic growth.
On theoretical grounds, it is argued that FDI may affect growth positively because it lowers



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