Foreign direct investment, the development of financial systems and economic performance: An empirical study of Asian developing countries : A thesis submitted in partial fulfilment of the requirements for the Degree of Doctor of Philosophy at Lincoln University

Abstract

Following the 2008 global financial crisis, most Asian developing countries (ADC) exhibited a good record of economic performance in 2015 with a 4% GDP growth rate. Foreign direct investment (FDI) and financial development are considered notable determinants of the ADC’ economic development. The presence of higher inward FDI enables host economies to improve their capital accumulation, ameliorate technological knowledge and shorten the burden of external debt. Improvements in financial development could help investors minimize investment risks, hasten transactions and increase the flows of funds to the most productive projects. Ample empirical studies explore the linkages between FDI-Growth and Finance-Growth in a single country or different groups of countries. However, there is a dearth of studies investigating how local financial markets’ development (measured particularly by the banks and stock markets) affects the FDI-Growth nexus in ADC’s economies. The relationship between inward FDI and the development of finance is under researched in this region. Hence, ADCs might not fully exploit the advantages of inward FDI and the development of finance to speed up their economic progress. This study uses the dynamic panel method to investigate the mediating effect of local financial markets’ development on the FDI-growth nexus, and the relationship between inward FDI and finance in 33 ADC from 1986 to 2015. There are several interesting findings. First, based on the system GMM estimator, the results confirm that greater inward FDI and improvements in finance (measured by the banks and stock markets) significantly accelerates ADC economic progress. Secondly, there is a complementary effect between FDI and finance on ADC economic outcomes. This implies that higher levels of finance can help ADC economies strengthen their absorptive capacity to exploit more benefits from inward FDI. Thirdly, based on the dynamic threshold effects model, we document that ADC economies should attain a potential threshold level of finance to improve their absorptive capacity to maximize the technological benefits from inward FDI. Higher levels of finance (represented by the higher financial threshold group) enable local and foreign enterprises to mitigate transaction costs, alleviate investment risks and access low-cost external finance to produce more productive investments. Fourthly, for the FDI-finance linkage, local financial markets also benefit from inward FDI by attracting more overseas ventures and improving their capital resources to allocate to potentially profitable projects. This study’s results suggest that ADC policymakers attracting FDI should formulate their policies and strategies to enhance the development of local financial markets. Greater improvements in the financial markets would help ADC economies provide investors with a more favourable investment environment. This would encourage higher productive entrepreneurial ventures and strengthen ADC absorptive capacity to exploit more technological spill-over transferred by inward FDI to intensify economic prosperity.