Impact of Foreign Direct Investment and Trade on Economic Growth

Abstract

Foreign direct investment (FDI) and trade are often seen as important catalysts for economic growth in the developing countries. FDI is an important vehicle of technology transfer from developed countries to developing countries. FDI also stimulates domestic investment and facilitates improvements in human capital and institutions in the host countries. International trade is also known to be an instrument of economic growth. Trade facilitates more efficient production of goods and services by shifting production to countries that have comparative advantage in producing them. Our analysis, based on cross sectional data of a sample of 66 developing counties over three decades, indicates that FDI and trade contribute significantly towards advancing economic growth in developing countries. We show that FDI interacts positively with trade and stimulates domestic investment. Sound macroeconomic policies and institutional stability are necessary pre-conditions for FDI-driven growth to materialize. Our results imply that lowering inflation rate, tax rates, and government consumption would promote economic growth in developing countries.