Impact of foreign direct investment on the economic growth and unemployment rate in Malaysia

from 2001-2021.
Literature review

2.1 Foreign Direct Investment

Financial disasters have shown that foreign direct investment (FDI) is resilient. For example,
during the 1997–1998 global financial crises, such investment was surprisingly stable in East
Asian nations. In stark contrast, portfolio equity and debt flows, especially short-term flows,
were subject to significant reversals during the same time period (Dadush, Dasgupta and
Ratha, 2000). Both the Latin American debt crisis of the 1980s and the Mexican crisis of
1994–1995 showed the FDI's ability to withstand financial disasters.

The unrestricted movement of capital across international boundaries is generally favored by

economists because it enables capital to pursue the highest rate of return. There may be
additional benefits to unrestricted money flows (Feldstein, 2000). First, international capital
flows provide an avenue for owners of capital to reduce their risk exposure by diversifying
their portfolios of lending and investment. The integration of international capital markets can
further facilitate the dissemination of optimal corporate governance standards, accounting
regulations, and legal principles. The international transferability of capital restricts the
capacity of governments to carry out detrimental policies. Apart from these potential benefits
generally associated with private capital flows, Feldstein (2000) and Razin and Sadka
(forthcoming) point out that there may be additional gains for host countries that stem from
foreign direct investment (FDI).

 Foreign Direct Investment (FDI) facilitates the dissemination of technology,

especially in the form of innovative capital inputs, which is not achievable through
 financial investments or trade in goods and services. Foreign Direct Investment (FDI)
can also foster competition in the internal input markets.
 The reception of FDI frequently results in personnel training in the exercise of
running the new businesses, thus contributing to the advancement of human capital in
the welcoming country.
 Foreign Direct Investment (FDI) can yield revenues to the host country in the form of
corporate taxes.

Many nations forgo a certain amount of tax revenue through the reduction of corporate tax
rates, as an effort to entice Foreign Direct Investment from other locations. An example of the
potential consequences of inter-country tax competition may be evidenced in the sharp
decrease in corporate tax revenues experienced by some members of the Organization for
Economic Cooperation and Development (OECD). (For a discussion, see the article by Reint
Gropp and Kristina Kostial in this issue). FDI can potentially stimulate investment and
economic growth in host countries through various channels, thus making it a beneficial
occurrence.

FDI and other flows:

Despite the cogent theoretical rationale for the advantages of unbridled capital flows, the
accepted opinion now appears to be that a number of private capital flows can generate
counterbalancing risks. Hausmann and Fernández-Arias (2000) postulate that even if host
nations are inclined to support capital inflow, they may perceive international debt flows,
particularly short-term debt, to be detrimental. The phenomenon of short-term lending from
abroad is mainly motivated by speculative calculations involving divergences in interest rates
and expectations regarding the exchange rate, instead of long-term objectives. The motion of
the banking system can usually be attributed to moral hazard distortions, such as the implicit
promise of a fixed exchange rate, or the propensity of governments to prop up the banking
sector. In times of difficulty, it was the first to flee, and it is accountable for the periods of
economic upsurge and downturn seen in the 1990s. On the contrary, Foreign Direct
Investment (FDI) is generally perceived as being beneficial due to the multiple advantages
that it can bring to a country. Foreign Direct Investment is perceived to be of a more reliable
nature, as it is unlikely to be withdrawn or relocated in the face of economic or geopolitical
turmoil. In contrast to short-term debt, direct investments within a nation are quickly
revaluated in the event of a crisis.

Recent evidence:

Bosworth and Collins (1999) conducted a comprehensive analysis to gauge the impact of
capital inflows on domestic investment in 58 developing countries from 1978-1995. This
sample is comprehensive, encompassing almost all Latin American and Asian nations, in
addition to a multitude of African entities. The authors delineate three varieties of inflows:
FDI, portfolio investment, and other financial flows (primarily bank loans). Bosworth and
Collins' research demonstrates that a dollar increase in capital inflows is correlated to 50
cents increase in domestic investment. (Both capital inflows and domestic investment are
expressed as percentages of GDP.) Despite this overall outcome, there are substantial
disparities between types of inflow. Foreign Direct Investment (FDI) appears to be associated
with a one-to-one spike in domestic investment; there is no clear association between the
portfolio inflows and investment (minimal or negligible effect); and the influence of loans
falls between that of the other two variables. The findings remain consistent both for the data
set consisting of 58 countries, as well as for a smaller group of 18 emerging markets. (See
Chart 2.) Bosworth and Collins postulate whether the apparent rewards associated with
permitting financial markets to freely distribute capital across the boundaries of developing
countries might outweigh the associated dangers. It appears that FDI is highly favorable.

Borensztein, De Gregorio, and Lee (1998) ascertained that Foreign Direct Investment (FDI)
has a positive effect on economic growth only when the host nation's level of education - an
indicator of its capacity to absorb - is substantial. In its latest Global Development Finance
(2001) report, the World Bank collects various findings from other studies that have been
conducted on the relationship between private capital flows and growth, in addition to
providing novel evidence on the same topic. (For a summary, see the article by Deepak
Mishra, Ashoka Mody, and Antu Panini Murshid in this issue). In spite of the data shown in
recent research, other studies indicate that developing countries should be cognizant of not
assuming too much of the positive impacts of Foreign Direct Investment (FDI).

Can a high Foreign Direct Investment (FDI) proportion be indicative of vulnerability?

Hausmann and Fernández-Arias (2000) propose that a high proportion of FDI relative to
other forms of capital inflows may be indicative of a host country's vulnerability rather than
its strength. It has been observed that the proportion of FDI flows in the overall capital
inflows is greater for nations having higher risk, which is usually measured by their credit
rating for sovereign debt or other risk indicators. (see Chart 3). There is evidence to suggest
that its prevalence is higher in nations with weaker institutions. What is the possible
explanation for these seemingly contradictory results? It can be suggested that Foreign Direct
Investment (FDI) is more likely to occur in countries with imperfect or inadequate markets
compared to other forms of capital flows. In such contexts, international investors will tend to
prefer to conduct business directly rather than relying upon the financial activities of local
markets, providers, or legal conventions. Albuquerque (2000) suggests that, from a policy
perspective, countries looking to enhance their access to international capital markets ought
to prioritise the creation of effective enforcement systems as opposed to seeking to attract a
greater level of FDI.

Hausmann and Fernández-Arias (2000) have posited that countries should prioritise
improving the investment climate and market efficiency. It is probable that they will be
recompensed with an investment that progressively becomes more efficient as well as with an
increased influx of capital. Despite the likelihood that FDI constitutes a larger proportion of
total capital inflows in locations where domestic policies and institutions are inadequate, this
does not constitute a justification for censuring FDI itself. It can be stated that, in the absence
of it, the nations that hosted it could have been much less affluent. The occurrence of Fire
Sales, Adverse Selection and Leverage. Foreign Direct Investment (FDI) can be seen as a
transfer of ownership from domestic to foreign residents, but also provides a method for
foreign investors to enact management and control over firms in the host countries; thus, it
can be seen as a corporate governance mechanism. The ceding of sovereignty may not always
be to the host nation's advantage due to conditions which may affect the transfer, such as the
possibility of undesirable selection or becoming unduly leveraged. Krugman (1998)
postulates that sometimes the shift of oversight may take place during a crisis and poses the
question:What are the implications of foreign ownership in terms of the transfer of control
under these conditions? One might ask whether foreign corporations are taking control of
domestic enterprises due to their superior capabilities or simply as a result of their financial
advantage over local investors. Do the liquidations of native enterprises and their holdings
constitute additional stressors to the impacted countries beyond the economic loss brought
about by the crisis itself?

It has been demonstrated by Razin, Sadka, and Yuen (1999) and Razin and Sadka that
Foreign Direct Investment (FDI) may not necessarily bring benefits to the host country, even
in circumstances which are not fire-sale situations. (forthcoming). Foreign Direct Investment
(FDI) provides foreign investors access to essential data concerning the efficacy of the
organisations under their supervision. Investors with privileged information are afforded a
competitive advantage vis-à-vis those without it, and thus have an informational edge over
domestic savers who, in the absence of relevant details, engage in the purchase of domestic
stocks without any capacity for control. Foreign Direct Investors are likely to maintain their
ownership and control of firms with high productivity, leveraging off the superior information
available to them, and divest themselves of firms with lower productivity, likely to be
acquired by uninformed savers. The occurrence of adverse-selection, as with this particular
process, could result in an excessive investment of foreign direct investments. An over-
reliance on leveraging can impede the potential gains derived from Foreign Direct
Investment. FDI establishments generally engage in high levels of domestic investment that
is largely supported by domestic credit market borrowing. The proportion of domestic
investment that is funded by international capital from direct foreign investment (FDI) may
not be as substantial as it appears due to the potential for foreign investors to repatriate funds
acquired from domestic sources, thereby reducing the potential gains from FDI that can be
achieved by foreign-held companies through domestic borrowing.

Reversals in FDI? Recent research has also given fresh context to the evidence supporting
FDI's stability. Even though it is true that the machines are "bolted down" and therefore
difficult to quickly remove from the host nation, financial transactions can occasionally
reverse FDI. For instance, the foreign subsidiary may borrow money domestically using its
collateral before lending it to the parent business. Likewise, the parent company can easily
recall FDI because a sizable portion of it is intercompany debt. There are some additional
circumstances in which FDI might not be advantageous to the recipient nation, such as when
it is directed towards local markets that are heavily protected by tariff or non-tariff barriers.
In these situations, FDI might step up advocacy efforts to maintain the current resource
misallocation. Another possibility is that domestic producers will become more consolidated
as a result of foreign acquisitions, either through takeovers or company failures. Recent
empirical data and economic theory both point to the positive effects of FDI on growing host
nations. However, recent research also highlights some potential risks: it can be undone
through financial transactions; it can be excessive due to adverse selection and fire sales; its
benefits can be restricted by leverage; and a high share of FDI in a country's total capital
inflows may instead reflect the weakness of its institutions than their strength. Although some
of these sources of risk have yet to show their empirical applicability, the potential risks do
seem to support a more nuanced assessment of the probable effects of FDI. The improvement
of the environment for domestic and international investment should be the main goal of
policy advice for developing nations.

2.2 Foreign Direct Investment and Economic Growth

Previous investigations into the influence of Foreign Direct Investment (FDI) on economic
growth and exports have been relatively inadequate when compared to the empirical studies
conducted on the traditional determinants of economic growth. The five primary approaches
to this subject can be broadly classified. An examination of the primary influencers of FDI
was conducted through the application of either temporal-series cointegration or panel data
analysis (Sun and Parikh, 2001; Wang and Swain, 1997). The scope of these investigations
suggested that Foreign Direct Investment can be accounted for by the economic development
and international commerce. Despite the fact that these studies penned in a unidirectional
causal relationship between openness and economic growth on Foreign Direct Investment
(FDI), then gauging the impacts of FDI based on this causal relationship, they typically
disregarded the natural essence of the growth process, as a result of which a single equation
model cannot properly address the simultaneity issue.

The second approach has been explored by researchers who have studied the impact of FDI
on exports or FDI's influence on economic growth, with the empirical results demonstrating
both complementary (positive) and substitutive (negative) effects. There is a demonstrable
correlation between Foreign Direct Investment and economic growth. This finding suggests
that economic growth is a key factor in determining Foreign Direct Investment (FDI) inflows
to a host country (Zhang and Song, 2001; Hejazi and Safarian, 2001; Marchant et al., 2002).
Pfaffermayr (1994) demonstrated a positive correlation between increased Foreign Direct
Investment (FDI) outflows and exports, as well as a negative correlation between export
shocks and FDI outflows. Gopinath et al. (1998) revealed a correlation between FDI and
exports which was negative, but a direct association between FDI and economic growth
which was positive.

The third approach is based on trade and the economic growth. Some of the studies that
examined this relationship are, Bende-Nabende and Ford (1998), Wei et al (2001) and Bende‐
Nabende et al (2001). The empirical results from various studies indicated that exports and
Foreign Direct Investment have an impact on economic growth. Foreign Direct Investment
also has a beneficial impact on economic development, due to its effect on the alteration in
industrial practices. However, Bende-Nabende et al. (2003) uncovered that in certain
countries, FDI had a detrimental effect on economic growth and did not necessarily lend itself
to a meaningful influence on economic growth. The second and third approaches took into
account both potential directional influences, yet were unable to evaluate the correlations
between exports, Foreign Direct Investment and economic growth. The fourth approach
examines the connection between exports and economic growth, focusing on the possibility
that either rapid economic growth caused export growth or that export growth leads to higher
economic growth, some of the studies based on this approach are Yaghmaian and Ghorashi
(1995), Liu (1997), Dawson and Hubbard (2004), and Bende-Nabende et al., (2003). The
fifth approach examines the relationship between the rate of unemployment and economic
growth. This relationship is known as Okun’s law, and some studies on this relation are, Van
Schaik and De Groot (1998), Apergis and Rezitis (2003), Sögner (2001). It was discovered
that there is a negative correlation between unemployment and economic growth within an
economy with imperfect competition, across different periods in which structural shifts occur,
as well as a varying effect.

Kaldor (1963) provided evidence for the existence of mechanisms which may account for
economic growth. The growth of per-capita output and per-capita physical capital over time,
coupled with the ratio of physical capital to output remaining constant over time, as well as a
constant rate of return to capital, are all examples of mechanisms which contribute to
economic growth. The proportion of labour and physical capital within national income
remains constant, while the rate of growth in output per worker varies considerably between
countries. Anwara and Nguyen (2010) have identified multiple factors that influence the
relationship between FDI and economic growth. Certain determinants, such as human capital,
learning through experience, exports, macroeconomic steadiness, and the degree of financial
refinement, as well as public investment, can have a major impact on a nation's economic
prosperity. Suleman et al., (2014) identified a number of determinants of economic growth,
including foreign direct investment, and these are in addition to the determinants that they
discussed. It was reported that foreign direct investment, financial development, public
investment, human capital, trade openness and inflation had a positive influence on economic
growth. Neuhause (2006) asserts that Foreign Direct Investment (FDI) can have a variety of
impacts on technological change, capital stock, and economic growth through three primary
avenues: (a) direct transmission, exemplified by Greenfield Investments, (b) indirect
transmission, exemplified by Ownership Participation, and (c) second-round transmission,
exemplified by Technology Spillover.

In recent years, there has been an abundance of both quantitative and qualitative studies on
the correlation between economic growth and Foreign Direct Investment (FDI). Dees (1998)
conducted research on China which concluded that FDI has an impact on economic
expansion in China through the dissemination of knowledge. Foreign Direct Investment has
had a considerable beneficial effect on China's long-term economic growth, particularly in
terms of technological improvements, notably in the 1990s. Berthélemy and Démurger
(2000) research provides an example of how Foreign Direct Investment (FDI) may have a
beneficial effect on economic growth in ChinaIn this study utilising a Generalized Method of
Moments (GMM) approach, the authors provide novel evidence on the contribution of human
capital to the economic growth of Chinese provinces, emphasising that the adoption of
foreign technologies may be facilitated by human capital. The results of the study
demonstrate that the immediate effect of export growth vanishes when exports and foreign
investment are both taken into consideration within the growth regression. Chakraborty and
Basu (2002) utilised co-integration and an error-correction model to analyse the association
between FDI and economic growth in India, and posited that GDP in India is not a causal
factor of FDI, and the causality was more from GDP to FDI. Alfaro (2003) conducted a
sectoral panel Ordinary Least Squares (OLS) analysis utilising cross-country data from 1981
to 1999 within the same framework. Our primary findings indicate that Foreign Direct
Investment in the primary sector tends to impede economic growth, whereas investment in
the manufacturing sector exhibits a positive correlation with growth. A panel vector
autoregressive model was created by Hsiao and Hsiao (2006) for the countries of China,
Korea, Taiwan, Hong Kong, Singapore, Malaysia, the Philippines, and Thailand. Their
findings show that FDI has one-way impacts on GDP, both directly and tangentially through
exports. By utilising dynamic-panel models, Baharumshah and Thanoon (2006) showed how
FDI positively impacted the development of East Asian countries. In other words, nations that
are effective at luring FDI can finance more investments and expand more quickly than
nations that are unsuccessful at doing so, and there is a two-way causal relationship between
the group's shipments and GDP.

Panel-vector autoregressive models were used by Won et al. (2008) to analyse the case of
newly industrialised Asian economies. Their findings demonstrate that the openness of the
economy, as evidenced by exports and inward FDI, among other things, is the most
significant economic factor assigned to the rapid expansion of these economies. Shahbaz et
al (2017) use statistics collected in Pakistan following the SAP (structural adjustment
programme) to identify the key factors that influence economic growth. Looking into long-
term relationships using the ARDL-bounds testing method to cointegration. The empirical
data provides support for the presence of cointegration, indicating that there are long-term
associations between the variables in question. Analyses of economic growth have revealed
that Foreign Direct Investment, Financial Development, Remittances and Public Investment
have a positive effect, while Trade Openness and Inflation have a dampening effect on the
pace of economic growth. The work of Faras and Ghali (2009) demonstrates that, in the case
of Gulf Cooperation Council (GCC) countries, applying an Ordinary Least Squares (OLS)
panel approach reveals a weak yet statistically significant effect of Foreign Direct Investment
(FDI) inflows on economic growth.

It has been noted by multiple studies that Foreign Direct Investment (FDI) has a significant
positive effect on economic growth in developing countries when taking into account other
influential factors. No research has yet investigated the nonlinear relationships between
Foreign Direct Investment (FDI) and the economic growth of the receiving nation.
Consequently, we have progressed along this avenue and have also exemplified the notion of
export-oriented growth or FDI-driven growth.

2.3 Economic Growth and Unemployment

It is widely accepted among economists that Foreign Direct Investment plays a key role in
stimulating economic growth in both developed and developing nations without changing the
original meaning Denisia's (2010) investigation into FDI furnished a more comprehensive
comprehension of economic mechanisms and the actions of economic actors. The empirical
evidence demonstrated the intricate correlations between Foreign Direct Investment and
economic growth. From a macroeconomic point of view, Foreign Direct Investment (FDI)
can have an impact on employment levels, productivity increases, enhanced competitiveness,
and the transfer of technology. Driffield and Taylor (2000) elucidated a set of findings
pertaining to the effect of inward Foreign Direct Investment (FDI) on the labour market in the
United Kingdom. FDI can be encouraged to reduce structural unemployment, which could be
beneficial.

Lin and Wang (2004) concentrated on the relationship between capital flight and
unemployment in the G-7 nations. Generalized least squares is used to predict the regression
as a set of unique equations for each country (GLS). This empirical study investigates the
most prominent countries in regard to capital outflow, namely the G-7 countries, utilizing
yearly data from 1981 to 2002. It has been established that a negative correlation exists
between Foreign Direct Investment (FDI) and the unemployment rate across all G-7
countries.
In 2012, Schemerer proffered a straightforward multi-sector trade framework incorporating
search impediments in the labor market and the relationship between Foreign Direct
Investment (FDI) and unemployment is examined by analyzing macroeconomic data from 20
countries that are members of the Organisation for Economic Co-operation and Development
(OECD) for unemployment, FDI, and labor market institutions. The data utilized for
examining the 20 countries spanned the period between 1980 and 2003. The findings indicate
that the model implemented in net-FDI is correlated with lower levels of overall
unemployment.

Mpanju (2012) conducted an analysis of the effect of FDI inflows on the generation of
employment in Tanzania from 1990 to 2008. This study employed a case study design with a
quantitatively-oriented research approach, utilizing econometric analysis based on ordinary
least squares (OLS). The findings showed a significant positive association between the
variables, suggesting that FDI significantly affects the distribution of employment
possibilities. Mun, Lin, and Man (2008) utilised the same approach but focused on the
connectio between Malaysia's GDP and FDI. The findings demonstrate a favourable
correlation between the two factors.

Ismail and Latif (2009) examined the numerous interactions among FDI, exports,
unemployment, and GDP during the period of January 2000 to April 2007 in Turkey using the
Vector Autoregression technique of variance decomposition and impulse response function
analysis. These findings suggest that FDI is unable to lower the nation's unemployment rate.
The GDP is positively impacted by changes in exports, albeit this effect is viewed as being
small. The analysis rejects the theory of export-driven economic growth. Growth in the
economy alone will not solve Turkey's unemployment issue.

2.4 Summary

This chapter first explained the importance and impact of FDI on a country. It is highlighted
that the main significance of FDI is related to private capital flows. Besides these benefits,
Foreign Direct Investment (FDI) facilitates technology transfer. It also contributes to the
advancement of human capital. Moreover, Foreign Direct Investment (FDI) can provide
corporate tax revenue for the host nation. There was also short comparison of the FDI and
other flows, and followed by some current evidence to support that FDI contributed to the
economy.

This leads to the second part of the chapter, where the effect of FDI to economic growth was
discussed. Based on several studies, there were five approaches to this subject. The first was
using temporal-series cointegration or panel data analysis, the main FDI influences were
examined. These studies proposed economic progress and international trade explain Foreign
Direct Investment. These studies wrote in a unidirectional causal relationship between
openness and economic growth on Foreign Direct Investment (FDI) and then assessed the
impacts of FDI based on this causal relationship, but they ignored the natural essence of the
growth process, so a single equation model cannot properly address the simultaneity issue.
Researchers who researched FDI's effect on exports or economic growth used the second
technique, finding both complementary and substitutive effects. Trade and economic
expansion are the third approach. Fourth, exports and economic growth are analysed. The
correlation between the unemployment rate and economic growth is examined in the fifth
strategy relating to Okun’s law.

The last part of this chapter conversed the relationship between economic growth and
unemployment. There were several models discussed in this point to evaluate the relationship
between FDI and economic growth which correlates to the unemployment rate. The two
models that will be used in this study is Ordinary Least Squares (OLS), Autoregressive
distributed lag (ARDL) approach. Three hypothesis have been established to be studied. The
first hypothesis is FDI has positive impact on the economic growth of Malaysia. Secondly,
the economic growth is positively associated with the employment rate. Lastly, the FDI gives
a positive impact on the employment rate.
Research Methodology (2000 words)

3.1Simple Ordinary Least Square (OLS) framework

This study uses empirical analysis to look at how foreign direct investment affected
Malaysia's unemployment rate and economic development between 2001-2021. Utilizing
simple ordinary least square (OLS) regressions, annual data on foreign direct investment,
total unemployment, and real gross domestic product are examined. Finding the best-fitting
line for a set of data points is done using the linear regression method known as ordinary least
squares (OLS). It is a well-liked technique because it is simple to employ and yields
respectable outcomes. The ordinary least squares (OLS) approach is a linear regression
method for estimating model parameters that are unknown. By minimising the sum of
squared residuals between the actual and anticipated values, the approach works.

A popular method for calculating the coefficients of linear regression equations that represent
the connection between one or more independent quantitative variables and a dependant
variable is ordinal least squares regression (OLS) (simple or multiple linear regression). The
minimum squares mistake is represented by least squares (SSE). Other methods to OLS
include maximum likelihood and the generalised technique of moments estimator.

According to Michael Lewis-Beck, these examples illustrate the ubiquitous question, "What
is the relationship between variables X and Y?" (Lewis-Beck and Alford, 1980). Using
bivariate regression, a straight line can be fit to a scatterplot of observations on variables X
and Y if the connection is believed to be linear. This relationship between an independent
variable, denoted X, and a dependant variable, denoted Y, can be written as a straight line in
the following formula: where a represents the intercept and indicates where the straight line
intersects the Y-axis (the vertical axis), b represents the slope and indicates the degree to
which the straight line is steep, and e represents the error.

We begin with a remark regarding the notation used in this post. Almost always, in the social
sciences, we do research utilising samples selected from larger populations, such as a 1
percent random sample of the U.S. population. Greek letters such as and are used to designate
the parameters (i.e., the intercept and slope values) expressing the relationship between X and
Y in the wider population, while lowercase Roman letters such as a and b are used to denote
the sample parameters.

In the social sciences, it is commonly assumed that relationships are linear, however this is
not always the case. Certainly, many relationships are not linear. When hypothesising the
nature of a link between two variables, one must be guided by both the employed theory and
an examination of the data. Given that we intend to utilise a straight line to relate variable Y,
the dependant variable, to variable X, the independent variable, the question arises as to
which line to employ. In each scatterplot of X and Y value data, an endless number of straight
lines could be utilised to show the relationship. Which phrase is the best?

The selected straight line must minimise the difference between the expected and actual
values of Y. Specifically, if one were to square the disparity between the observed and
anticipated values of Y for each of the I observations in the sample and then sum these
squared differences, the optimal line would have the lowest sum of squared errors (SSE),
denoted as follows:

Ordinary least squares regression is a statistical technique that generates the solitary straight
line that minimises the total squared error. Using calculus, it is possible to demonstrate that
SSE is the smallest or "least" quantity when the coefficients a and b are determined using the
following formulas (Hamilton 1992, p. 33). These values of a and b are referred to as least
squares coefficients, or occasionally as ordinary least squares coefficients or OLS
coefficients.
 Figure 2: Example of the regression line can be plotted on the above scatterplot (Navarro,
2019)

Equations for the conventional least squares regression

OLS regression model states:

Y = β0 + Σj=1..p βjXj + ε

Y is the dependant variable, β0, is the intercept of the model, X j is the jth explanatory variable
of the model (j = 1 to p), and e is the random error with expectation 0 and variance σ².

In the case of n observations, the estimated value of the dependent variable Y for the ith
observation is given by:

yi = β0 + Σj=1..p βjXij

In addition, before making predictions, our approach must determine the coefficients: we
begin by inputting a table comprising the heights of several plants and the number of days
they have been exposed to sunlight. If you wish to learn more about the computations, please
read the next paragraph.
The objective of the OLS technique is to minimise the sum of squared discrepancies between
observed and predicted values. Thus, the vector of the coefficients can be approximated using
the following formula:

β = (X'DX)-1 X' Dy

y is the vector with the n observed values of the dependant variable, where X is the matrix of
explanatory variables preceded by a vector of 1s, D is a matrix with the wi weights on its
diagonal, and D is multiplied by X.

The vector of anticipated values can be expressed as follows:

y* = Xβ=X (X' DX)-1 X'Dy

Using the following formula, we can equalise the variance 2 of random error.

σ² = 1/(W –p*) Σi=1..n wi(yi - y*i)

where wi is the weight of the ith observation, W is the total of the wi weights, y is the *
vector of the observed values, and y* is the vector of predicted values, and p* is the number
of independent variables to which we add 1 if the intercept is not fixed. The objective of the
ordinary least squares approach, intuitively speaking, is to minimise the prediction error
between the predicted and actual values. One could wonder why we opt to minimise the total
of squared mistakes rather than the sum of errors directly. It takes into account the total of
squared errors rather than the errors themselves because they might be negative or positive
and add up to a value close to zero.

This study uses empirical analysis to look at how foreign direct investment affected
Malaysia's unemployment rate and economic development between 1980 and 2010. Using
Simple Ordinary Least Squares, annual data on foreign direct investment, overall
unemployment, and real gross domestic product are evaluated.

OLS square regressions framework:

π i= α + βFDI i + ε i
RGDP i= α + βFDI i + ε i

where GDP and overall unemployment (π) are the dependant variables. According to the
equation above, FDI has a positive impact on both overall unemployment and economic
growth, as indicated by the positive sign of the FDI coefficient. In Malaysia, a boost in FDI
will result in lower overall unemployment, and vice versa. The following is how the claim is
made:

Hypothesis 1

H 0: β = 0

H 1: β ≠ 0

The null hypothesis is β = 0, where FDI has no effect on overall unemployment and real GDP
compared to its alternative β ≠ 0, which is accepted if the difference is smaller than the lower
bound critical value (0.05). In contrast, the null hypothesis is rejected if the t-statistic value
exceeds the 5% critical threshold, indicating that the independent variable has a significant
impact on the dependent variable.

3.2 Diagnostic Testing

Diagnostic testing is significant to determine if the series is clear from autocorrelation,

heteroscedasticity, and normalcy issues.

Hypothesis 2

H 0: There is autocorrelation among series of observations that are arranged chronologically.

H 1: There is no autocorrelation among the individuals in a set of observations that are

arranged in time.

Hypothesis 3

H 0: The residual term has constant variances.

H 1: The residual term does not have constant variances.

The alternative hypothesis, according to Hypotheses 2 and 3, in which autoregression and
heteroscedasticity exist, is refuted by the null hypothesis, which states that autocorrelation and
heteroscedasticity do not exist. The null hypothesis is accepted if the estimated p-value is more than
0.05 significant levels, demonstrating the existence of autocorrelation and heteroscedasticity.
Contrarily, the null hypothesis is rejected if the estimated p-value is less than 0.05 significant levels,
which indicates that autocorrelation and heteroscedasticity issues exist.

3.3 Unit Root Test:

A time series with a unit root exhibits an unpredictable systematic pattern and is frequently referred
to as a "random walk with drift." A time series with a unit root is also known as a unit root process or
a difference stationary process.

Figure 3: A potential unit root (Stephanie, 2016)

If there is a unit root in the time series, the red line depicts the output decline and path of recovery.
In the case of a trend-stationary series and no unit root, the recovery is displayed in blue.

The mathematics underlying the procedure are what give rise to the term "unit root." A process can
be expressed as a succession of monomials at the most fundamental level (expressions with a single
term). A root is assigned to each monomial. A unit root is one of these roots that equals one.
When evaluating time series, all you need to know is that the presence of unit roots can lead to
significant issues such as:

 Spurious regressions: this issue can lead to r-squared values regardless of whether the data
are uncorrelated.
 Errant behavior: owing to invalid analysis assumptions. t-ratios, for instance, will not follow a
t distribution.
Unit root tests are used to determine whether a time series is stationary. A time series is stationary if
a change in time does not alter the distribution's shape; unit roots are one source of non-stationarity.
It is well-known that these tests have little statistical power. In part, there are numerous tests
because none stands out as the most effective. One of the test that is used on this study is:

Based on linear regression, the Dickey Fuller Test (also referred to as the Dickey Pantula Test). In
cases when serial correlation is an issue, the Augmented Dickey-Fuller (ADF) test might be utilised.
The ADF handles larger and more intricate models. It does, however, have a rather high rate of Type I
errors.

To analyse the result of this study using the unit root test, identifying the nonstationary quality of
each variable is the initial step in producing time series data. Each series must be tested at each level
(log of real GDP, log of, and log of FDI) and in the first difference (growth and FDI rate). Using the
Augmented Dickey-Fuller (ADF) Test, all levels of all variables were examined. Consider the following
equation:

where is our variable of interest, is the time trend and the difference operator, t is the time
trend, and is the white noise residual of zero mean, constant mean, and constant variance;
(α1,α2,β1,...βm) is a set of parameters to be estimated.

If the stationary test is significant, it indicates that the variable series is stationary and no unit
root test is necessary. Hence, the null hypothesis is rejected and the alternative hypothesis is
accepted. If the stationary test is not statistically significant, therefore the variable series is
nonstationary and has a unit root test; hence, the null hypothesis will be accepted. This study's
hypotheses are as follows: