FDI and Economic Growth: The Role of Local Financial Markets*

TLDR

The study investigates how foreign direct investment, financial markets, and economic growth are interrelated, specifically whether stronger financial systems enable more efficient exploitation of FDI. The authors analyze cross‑country data to assess whether improved financial systems enhance the efficient use of FDI. Empirical evidence indicates that FDI alone has an ambiguous effect on growth, but when coupled with well‑developed financial markets, it significantly boosts economic growth, a result that remains robust across alternative specifications.

Abstract

In this paper, we examine the various links among foreign direct investment (FDI), financial markets, and economic growth. We explore whether countries with better financial systems can exploit FDI more efficiently. Empirical analysis, using crosscountry data between 1975- 1995, shows that FDI alone plays an ambiguous role in contributing to economic growth. However, countries with well-developed financial markets gain significantly from FDI. The results are robust to different measures of financial market development, the inclusion of other determinants of economic growth, and consideration of endogeneity.