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

from 2001-2021.

Chapter 1: Introduction (1750)

1.1 General Introduction

• What is FDi- how important is it to the economy? (Aim: 500 words)

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)

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:

π𝑖 = α + βFDI𝑖 + ε𝑖

RGDP𝑖 = α + βFDI𝑖 + ε𝑖

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

𝐻0 : β = 0

𝐻1 : 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.