Growth effect of foreign direct investment and financial development: new insights from a threshold approach

Abstract

Purpose – The purpose of this study is to examine the effect of foreign direct investment (FDI) on economic growth contingent on the development level of the local financial system in emerging and developing Asia during the period 1996–2017. Design/methodology/approach – The study adopts the threshold approach, namely the panel smooth transition regression (PSTR) model, for the annual data collection of 18 emerging and developing Asian countries in 22 years. The authors analyze the alternative PSTR models on different proxies of financial development (FD). Findings – The results show new findings of two distinct thresholds of FD in the FDI–growth nexus. The growth-enhancing effect of FDI is realized only when the FD lies between the two threshold values. Notably, at very high levels of FD, the beneficial effect of FDI on growth is vanishing. Originality/value – The authors provide new insights into the growth effect of FDI and the role of FD. The estimated nonlinear effect of FDI on growth and the thresholds of FD can be benchmarks for emerging and developing Asia in assessment of their situations. The results suggest important implications to the region in setting the long-run policies to boost the effect of FDI on economic growth.

Keywords

• foreign direct investment
• financial development
• economic growth
• emerging and developing asia
• panel smooth transition regression