Foreign direct investment, financial development, and economic growth: the case of Malaysia

Abstract

This paper presents, within an endogenous growth model, an analysis of the interaction between foreign direct investment (FDI) and financial development in promoting Malaysia's economic growth. Using a co-integration framework, this study estimates a dynamic endogenous growth function that includes the impact of FDI and financial sector evolution as well as some locational determinants for the sample period spanning from 1970 to 2001. The empirical evidence suggests that foreign direct investment, labour, investment, and government expenditure play a pivotal role in local economic prosperity. More importantly, it is found that the interaction between FDI and financial development exerts a significant effect on the growth performance of Malaysia. Perhaps the strongest result to emerge from our study is the significant role played by FDI–finance interaction in the growth process.

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