The relationship between foreign direct investment and economic growth in Romania

MSc Student: Stoian AdrianSupervisor: Professor Moisă Altăr

Academy of Economic Studies

Doctoral School of Finance and Banking

Bucharest, July 2008

Contents

1. Introduction2. The goal of this paper3. Literature review4. Methodology5. The data6. Results7. Conclusions

1. Introduction

1.1 The effect of FDI on growth almost generally accepted as a positive one

Studies: Alfaro et. al (2004); Basu et. al (2003);Fedderke and Romm (2006).

1.2 Some controversy brought forth by other studies:Gorg and Greenway (2004); Atiken and Harrison (1999).

2. The goal of this paper

• To determine whether the is a cointegrating relationship

between FDI and economic growth in the Romanian

economy

• To determine the type of this relation (in case it exists)

• What is the direction of causality between the two

variables

3. Literature review (I)

• Cross-country studies: Blomstrom (1994);Borensztein (1998);

• Panel studies: Carkovic and Levine (2005); Nair-Reichert and Weinhold (2001);

• Panel cointegration studies: Basu (2003);• Time series studies for individual

countries: Ramirez (2000); Cuadros (2004);Fedderke and Romm (2006).

3. Literature review (II)

Problems associated with these types of studies:•Cross-country studies: the assumption of identical production functions across countries;•Panel studies: the imposition of homogeneity on the coefficients of the lagged dependent variables;•Panel cointegration studies: still the heterogeneity problem;•Time series studies for individual countries: the use of only one cointegration test

4. Methodology

1. Cointegration analysis: • The Engle-Granger procedure• The ECM test• The Johansen method• The Gregory-Hansen procedure

2. The Phillips-Loretan model3. Granger causality test.

5. Data (1)

Variables considered:

• The logarithm of the real gross domestic product: LogGDP

• The foreign direct investment to GDP ration: FDI/GDP

5. Data (2)

The gross domestic product The FDI/GDP ratio

9000

10000

11000

12000

13000

14000

15000

16000

17000

2000 2001 2002 2003 2004 2005 2006 2007

GDP_SA

.00

.05

.10

.15

.20

.25

.30

2000 2001 2002 2003 2004 2005 2006 2007

FG

5. Data (3)

Table 1The ADF test statistic for GDP and FDI in Romania between 2000 and 2008Q1

GDP FDIt-statistic

2.17Prob.0.99

t-statistic-1.52

Prob.0.50

Table 2The Phillips-Perron test statistic for GDP and FDI-to-GDP ratio in Romania between 2000 and 2008Q1

GDP FDIt-statistic

1.26Prob.0.99

t-statistic-2.41

Prob.0.14

The Engle Granger procedure:

The ADF test for the residuals based on:

5. Results (1)

( / ) , 1,2,...,t t t tLogGDP c FDI GDP e t T

11

ˆˆ ˆk

t t j t j tj

e e e v

5. Results (2)

Table 3Cointegration: the Engle-Granger procedure

ADF-statistic 1% (5%) [10%] critical values

-3.31 -3.64 (-2.95) [-2.61]

5. Results (3)

The ECM test for cointegration

The null of no cointegration is b3=0

2

1 2 3 1 4 1 11

2

0

( / )

( / )

t t t i ti

i t i ti

LGDP b b t b LGDP b FDI GDP LGDP

FDI GDP u

5. Results (4)

Table 4Cointegration: the ECM procedure

ECM-t-statistic 1% (5%) critical values*

-4.66 -4.60 (-3.84)

*Critical values are taken from MacKinnon (1991)

5. Results (5)

The Johansen test

Table 5Cointegration: the Johansen test

– trace statistic 5% critical value

30.14 25.87

λ

5. Results (6)

The Gregory-Hansen procedure•Based on the use of three single equation models

Model 1: The level shift model (C):

Model 2: The slope change model (C/T):

1 1 2 2T

t t t ty y e

1 1 2 2T

t t t ty t y e

4. Results (7)

Model 3: The regime shift model (C/S)

where and

The decision of the Gregory-Hansen procedure

1 1 2 1 2 2 2T T

t t t t t ty y y e

1 2 ( / )t t t ty LogGDP y FDI GDP

0, [ ]1, [ ]t

if tif t

* inf ( )T

ADF ADF

5. Results (8)

The values of the ADF test for Model C

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

2000 2001 2002 2003 2004 2005 2006 2007

ADF_REZIDUURI_M1

Table 6Cointegration: the Gregory-Hansen procedure: Model CADF* – statistic 1% (5%) critical values

-3.65 -5.13 (-4.61)

Critical values are taken from Gregory and Hansen (1996)

5. Results (9)

The values of the ADF test for Model 2

-6.4

-6.0

-5.6

-5.2

-4.8

-4.4

-4.0

2000 2001 2002 2003 2004 2005 2006 2007

ADF_REZIDUURI_M2

Table 7Cointegration: the Gregory-Hansen procedure: Model C/TADF* – statistic 1% (5%) critical values

-6.12 -5.45 (-4.99)Critical values are taken from Gregory and Hansen (1996)

5. Results (10)

Estimating the type of long-run relationship

The Phillips-Loretan single equation ECM

1 2 2, 1, 2,1 1

' ( ' )k l

t t j t j j t j t j tj j

y y b y y y v

5. Results (11)

The first Phillips Loretan equation

where and

1 1' ( ' )

( / )

t t t t

i k

i t i t i ti k

LogGDP y b LogGDP y

FDI GDP

1

/tt t

t

ty

FDI GDP

c

5. Results (12)

Table 8The type of long-run relationship: Phillips and Loretan nonlinear least squares (NLS)

Coefficients of 𝛌 – the independent variable

9.18 (1606) 0.0114 (12.66) 0.50 (0.007) -0.0003 (-0.031)

The numbers in parentheses are the corresponding t-Statistic values

c

5. Results (13)The second Phillips Loretan equation

where and

1 1 1 1 1 1 1 1

1

/ ' ( / ' )t t t t t t

j k

i t j tj k

FDI GDP y b FDI GDP y

LogGDP

1

1

tt

t

ty

LogGDP

1

11

1

1

c

5. Results (14)

Table 9The type of long-run relationship: Phillips and Loretan nonlinear least squares (NLS)Coefficients of 𝛌1 – the independent variable

-21.01 (-5.27) -0.028 (-4.31) 2.00 (5.26)The numbers in parentheses are the corresponding t-Statistic values

1c 1δ 1β

5. Results (15)

Causality testing

where

111 1

11 22 2( / ) ( / )

pt k t

k tkt t t k t k t

LogGDP LogGDP aec

FDI GDP FDI GDP a

1 1 1ˆ ˆˆ/t t t tec FDI GDP c LogGDP

5. Results (16)

Table 10Long-run Granger causality test

t-Value for a1 (LogGDPt) t-Value for a2 (FDIt/GDPt) Conclusion

-1.02576 7.60007* FDIt/GDPt LogGDPt

*denotes the 1% level of significance

6. Conclusions1. The relationship between FDI and economic growth

• The two variables considered in the analysis are cointegrated

• The relationship between the two variables is a positive one

• Causality runs from FDI to economic growth

2. Suggestions for future studies:

• Periodically redo the time series analysis to determine whether the small

share of FDI in the first part of the analyzed period is the cause for not

finding an impact of FDI on growth

• Identify what types of FDI promote growth