Int Rev Econ

DOI 10.1007/s12232-015-0230-3

RESEARCH ARTICLE

Foreign direct investment, technological innovation

and economic growth: empirical evidence using
simultaneous equations model

Abdelhafidh Dhrifi1,2

Received: 10 April 2014 / Accepted: 28 March 2015

 Springer-Verlag Berlin Heidelberg 2015

Abstract The effect of foreign direct investment on economic growth has been
widely discussed in theoretical and empirical works. While the positive effects of
FDI have been widely known in the theoretical literature, empirical works devel-
oped over the past two decades on the subject led to mixed conclusions. The main
objective of this paper was to clarify this relationship by examining the above
interaction focusing on the role of technological innovation in this relationship. To
do this, a simultaneous equations model describing the interrelationship between
foreign direct investment, technological innovation and economic growth for 83
developed and developing countries is estimated over the period 1990–2012. Our
empirical results show that there is a positive and significant effect of foreign direct
investment on economic growth only for middle- and high-income countries,
whereas for low-income countries foreign direct investment does not have a positive
impact on these economies. Our findings show also that technological innovation
plays an important role in determining the foreign direct investment–economic
growth relationship.

Keywords Foreign direct investment  Technological innovation 

Economic growth  Simultaneous equations models

JEL Classification G20  O32  O40

& Abdelhafidh Dhrifi

Abdelhafidh.dhrifi@gmail.com
1
Department of Economics, Faculty of Economics and Management, Sousse,
University of Sousse, Sousse, Tunisia
2
Unité de recherche: Monnaie, Modélisation, Financement et développement (MO2FID),
Sousse, Tunisia

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1 Introduction

The issue of foreign direct investment (FDI) and political attractiveness remains a
hot topic as globalization is a phenomenon that must constantly be acquired. To
increase their investment capacity, positively affect the balance of payments,
compensate for the lack of national savings and create new opportunities for quality
jobs with better pay or better working conditions, developed and developing
countries generally try to make from FDI one of the strongest pillars in their
development strategy. Economic literature on the subject has identified several
channels through which FDI may positively affect economic performance in host
countries (Sackey et al. 2012; Azman-Saini et al. 2010). In general, FDI can help
host countries exploit their natural endowment, which provides opportunities for
economic development and growth if they are used successfully. Second, extractive
activities usually involve sophisticated technology that not all countries have the
necessary skills to utilize. Multinational enterprises’ participation in these extractive
industries transfers the necessary technology and skills to the host countries which
enables them to overcome technology barriers. Moreover, by assisting them to
overcome these barriers, primary FDI enhances development and economic growth
potential in the host countries by increasing the exports and foreign exchange
earnings required to finance imports of goods and services. In the same vein, Singh
et al. (1995) argue that FDI affects economic growth in the sense that they increase
the stock of domestic capital and provide a range of other resources. These are as
follows: technology, know-how, managerial practices, training and infrastructure
development and marketing goods and services.
However, despite the positive role that FDI can play in producing economic
growth, some analyses highlight the negative impact of FDI inflows on the
incentives to innovate and the balance of payments. Therefore, according to them,
FDI acts negatively on economic growth. Indeed, firms that undertake such
investment hold market power and can therefore restrict competition and economic
performance. Seen from this angle, FDI can generate an inefficient allocation of
resources due to distortions associated with government interventions in the host
country in the form of price control (Raff 2004). Similarly, the arrival of FDI in a
country does not have a favorable impact on local businesses and related expertise.
They may instead undergo a drastic drop in productivity. In general, we can say that
economic literature leads to a controversial result. To clarify this relationship, one
might say that FDI can produce better economic growth if a certain threshold of
technological innovation (TI) is reached.
It is therefore worthwhile investigating the nexus between FDI, technological
innovation and economic growth by considering them simultaneously in a modeling
framework. The present study is different from existing literature identified above in
the following ways. Compared with previous studies, this paper used simultaneous
equations based on structural modeling to study the nexus between FDI inflows,
technological innovation and economic growth for a global panel consisting of 83
countries. However, to the best of our knowledge, none of the empirical studies
have focused on investigating the nexus between FDI, technological innovation and

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economic growth via the simultaneous equations model. The model allows
examining simultaneously the interrelationship between FDI, technological inno-
vation and economic growth. We investigate the three-way linkage between FDI,
technological innovation and economic growth for 83 countries. Specifically, this
study utilizes three structural equations models that allow simultaneously examining
the impact of (1) FDI and technological innovation on economic growth, (2)
economic growth and FDI on technological innovation and (3) FDI and economic
growth on technological innovation. In addition, there was a strong motivation for
us to apply a growth form approach to analyzing the interrelationship between FDI,
technological innovation and economic growth. We were motivated by the fact that
there were no studies that model this interaction using growth form models. Finally,
the main objective of this paper is to clarify the relationship between FDI inflows
and economic growth focusing on the role played by technological innovation using
a simultaneous equations model on a sample composed of 83 developed and
developing countries over the period 1990–2012, which allows us to test the direct
and the indirect impact of FDI and technological innovation on economic growth.
The paper is organized as follows: After an introduction provided in Sect. 1 above, a
brief literature review is carried out in Sect. 2. The model and methodological
framework are explained in Sect. 3. Results are discussed in Sect. 4. The final
section concludes the study and gives some policy implications.

2 Overview of related literature

2.1 The FDI concept

To appreciate the effect of FDI on economic growth, it is necessary to define this

concept: FDI is a direct investment into production or business in a country by an
individual or company of another country. It is an investment of foreign assets into
domestic structures, equipment and organizations. It does not include foreign
investment in the stock markets. Foreign direct investments differ substantially from
indirect investments such as portfolio flows wherein overseas institutions invest in
equities listed on a nation’s stock exchange. Entities making direct investments have
typically a significant degree of influence and control over the company into which
the investment is made. Open economies with skilled workforces and good growth
prospects tend to attract larger amounts of FDI than closed, highly regulated
economies.
FDI can be classified as: inward FDI and outward FDI, depending on the
direction of flow of money. Inward FDI occurs when foreign capital is invested in
local resources. The factors propelling the growth of inward FDI include tax breaks,
low interest rates and grants. Also called direct investment abroad, it includes assets
and liabilities transferred between resident direct investors and their direct
investment enterprises. It also covers transfers of assets and liabilities between
resident and nonresident fellow enterprises, if the ultimate controlling parent is
resident.

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2.2 How FDI and technologic innovation affect economic growth

FDIs are made by large multinational enterprises (MNEs). The general perception of
MNEs is twofold one: First, they play a dominant role in research and development
activities and in generating new technologies, and they have a powerful influence on
local economies. Thus, their activities have stimulated a wide debate, making the
question about the domestic consequences of their activities one of the most
persistent questions asked by researchers in the field, such as Anwar and Sun (2011),
Soltani and Ochi (2012) and Dunning and Lundan (2008).
Economic literature identifies several channels through which FDI contributes to
economic growth. Neoclassical growth theory postulates that FDI inflows increase
the stock of capital in host countries, thereby allowing higher rates of growth than
would be possible from reliance on domestic savings. From the point of view of
endogenous growth theory, technological advancement stimulates economic growth
by creating externalities that compensate for diminishing returns to capital (Romer
1990).
The advent of FDI and the entry of multinational corporations can also improve
the level of productivity in the host countries by training domestic workers and
hence augment the existing human capital in the host economy (De Mello 1997).
When domestic workers are employed, they usually get the chance to acquire
knowledge of the advanced technology and managerial practices used by
multinationals. This knowledge and these skills can be transmitted to the rest of
local economy when these workers leave multinationals and set up their own firms,
or work for other domestic firms. In this way, the switch of multinationals workers
and managers to domestic firms helps increase the productivity level of the domestic
economy and fosters the process of technology transfer.
Literature identifies also that FDI leads to increased competition in the domestic
market which can cause greater efficiency of domestic firms (UNCTAD 1998). In
addition, improved managerial practices may be transmitted to domestic firms that
attempt to imitate foreign firms. In cases where FDI involves training of domestic
labor, the strengthening of human capital would generate positive externalities that
could raise economic growth by allowing host countries access to advanced
technologies not available domestically.
Technology improvements can be transferred through a variety of channels,
including international trade. However, FDI and the activities of MNEs in host
countries represent the major channel through which technology diffusion can take
place (Borensztein et al. 1998) because MNEs conduct most of research and
development around the globe, and therefore, they are among the firms acquiring the
most advanced technology. Moreover, FDI does provide the host economy not only
with advanced technology, but also with the necessary complements of these
technologies, such as management experience and entrepreneurial abilities.
Another way in which technology improvements occur is through competition
between domestic and foreign firms. The advent of more advanced foreign firms
may force domestic firms operating within the same industry to improve their
existing technology and adopt a more efficient and up-to-date one in order to survive
the intense competition with foreign firms (Lipsey 2004). However, it is also

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possible that advanced technology can be transmitted to domestic firms as a result of

demonstration effects. The entry of multinational corporations to the host economy
and the introduction of new products and new technologies would expose domestic
firms to the superior technology of multinationals which may encourage them to
copy and imitate not only the new advanced method of production used by
multinationals, but also their managerial practices and organizational arrangements
(Saggi 2002).
Yet, if theoretical literature expected that FDI can play an important role in
modernizing a national economy and promoting economic growth, empirical
evidence on the existence of such positive productivity externalities is sober.
Empirical literature finds weak support for an exogenous positive effect of FDI on
economic growth, Carkovic and Levine (2005). Findings in this literature indicate
that a country’s capacity to take advantage of FDI externalities might be limited by
local conditions such as the development of the local financial markets or the
educational level of the country, i.e., absorptive capacities. Borensztein et al. (1998)
show that FDI brings technology, which generates higher growth only when the host
country has a minimum threshold of stock of human capital. Alfaro et al. (2004),
Durham (2004) and Hermes and Lensink (2003) provide evidence that only
countries with well-developed financial markets gain significantly from FDI in
terms of their growth rates. In the same context, Bengoa and Sanchez-Robles (2003)
conclude that the effect of FDI on economic growth is positive only when these
countries have adequate human capital, economic stability and liberalized markets.
Another vein of empirical literature on the subject finds a causal relationship
between FDI and economic growth. In addition, Nguyen and Nguyen (2007) have
identified the two-way linkage between FDI and economic growth in which FDI
promotes economic growth, and in turn, economic growth is viewed as a tool to
attract FDI. Anwar and Sun (2011) have also shown that FDI and domestic capital
have a positive significant impact on economic growth. Therefore, Adams (2009)
tested the impact of FDI on economic growth in sub-Saharan Africa and found that
FDI is positively correlated with economic growth. In the same vein of study,
Azman-Saini et al. (2010) explored the systemic link between FDI and economic
growth and approved that FDI by itself has no direct (positive) effect on the output
growth. In contrast, Tang et al. (2008) determined that there is a one-way causality
from FDI to economic growth in China.

2.3 Model and data description

This section specifies the model used to empirically investigate the role played by
technological innovation of a host country in determining the contribution of FDI
inflows to economic growth. It also provides a simple description to the data set
used in the empirical investigation.

2.4 The model

To empirically investigate the impact of FDI on economic growth, one needs to

specify a model that allows capturing the interrelationships that exist among FDI,

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technological innovation and economic growth. In particular, one needs a

simultaneous equations model that allows endogenizing technological innovation
with FDI included as a determinant of technological progress. Therefore, this paper
specifies a basic econometric model that consists of a series of three main equations
describing the behavior of the endogenous variables. In particular, the model
consists of a growth equation, and two other equations: one for technological
innovation and the other for FDI.
The first endogenous variable in the model is economic growth which is
measured as the average of growth rate of real gross domestic product (GDP) per
capita. The GDP growth equation specification follows the commonly accepted
form in the growth literature (Barro 1991) and includes a set of control variables
that have been identified by empirical growth literature as robust determinants of
economic growth (Levine and Renelt 1992). In addition to FDI and technological
innovation, the GDP growth equation includes four variables which are trade
openness defined as the sum of exports and imports as a share of GDP to capture the
degree of international openness. Inflation to capture the macroeconomic stability,
financial development to capture the role of the financial system in promoting
economic growth and the investment share in GDP (Inv) as an important
determinant of growth which is expected to have a positive impact on economic
growth (Al-Sadig 2013; Sauramo 2008).
The second endogenous variable, TI, is technological innovation. The main
indicator of technological innovation used in empirical literature is the number of
personal computers per 100 people (Jalles 2010). We chose this indicator as a proxy
of technological innovation. Following the empirical literature on the determinants
of technological progress, it is worthy to remind that it is related to a set of variables
representing the role of institutions which is measured by the widely used indicator
of Law and Order. Human capital is measured by the rate of secondary school
enrollment, economic growth and research and development expenditure (% of
GDP).
The third endogenous variable in the model, FDI, is FDI which is measured
as the average of FDI net inflows as ratio of GDP over the period 1990–2012.
The specification of the FDI equation includes, in addition to the other two
endogenous variables, GDP per capita growth rate (to capture the role of market
growth potential in encouraging FDI inflows) and the indicator of technological
innovation (to capture the role of technology on attracting FDI) and three other
variables which are identified by economic literature as key determinants of FDI
(Lim 2001; Chakrabarti 2001): TEL is used to approximate the impact of
infrastructure on FDI, as it has positive externalities that increase the
productivity of economic resources. It is expected to have a positive influence.
The average of the tariff rate ‘‘TARIF’’ is included into the model as a proxy of
the impact of trade barriers on FDI. The third variable ‘‘TAX’’ is the average of
the top marginal income tax rate; generally, it is expected to have a negative
effect on FDI.
The complete model used in this study to estimate the impact of FDI on
economic growth has the following diagram:

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GDPGit ¼ a0 þ a1 INFit þ a2 TRADEit þ a3 FDit þ a4 INVit þ a5 TIit þ a6 FDIit þ n1it ð1Þ

TIit ¼ b0 þ b1 SCHit þ b2 INSTit þ b3 RDit þ b4 GDPGit þ b5 FDI þ n2it ð2Þ

FDIit ¼ k0 þ k1 TARIFit þ k2 TAXit þ k3 TELit þ k4 TIit þ k5 GDPGit þ n3it ð3Þ

where GDPG represents the growth of GDP per capita. This indicator has the ad-
vantage of being available on CD-ROM World Bank for the majority of countries and
for a long time. INFit is an indicator of inflation. It is introduced into the model to
capture the impact of macroeconomic stabilization on economic growth. TI design
represents technological innovation index. FDit represents financial development, and
it is measured by the ratio of domestic credit provided by the banking sector relative
to GDP. This indicator is generally used in empirical studies. INV is gross capital
formation share in GDP. TELit is an indicator of infrastructure. According to the
economic literature, Bottlenecks in infrastructure do not allow direct FDI toward local
country. This indicator is measured by the average of the number of telephone
mainlines per 1000 people. RD represents research and development expenditure (%
of GDP). TARIF represents the average of the tariff rate. TAX is the average of the top
marginal income tax rate. TRADEit design represents trade openness, and it is defined
as the sum of exports and imports as a share of GDP. It is introduced into the model to
capture the degree of international openness. TI represents technological innovation.
SCH is the average years of secondary schooling in the total population which
measures human capital. Studies by Barro (1991) emphasize that the level of
education was an important determinant of future economic growth. It is expected that
investment in human capital enhances technological innovation, and finally, INSTit is
an index reflecting the quality of institutions. It is measured by Law and Order—also
called Rule of Law—compiled by International Country Risk Guide (ICRG), which
assesses the strength and impartiality of the legal system, and the popular observance
of the law. This indicator ranges from 0 to 6, with a higher figure indicating a better
quality of the legal system and enforcement of law. In fact, there is a general
agreement that institutional quality, particularly the security of property rights, is one
of the key factors which guarantees long-term economic growth (Knack and Keefer
1995; Rodrik et al. 2004).
Finally, annual time series data, which cover the period 1990–2012 for a sample
composed of 83 developed and developing countries, are utilized in this study. The
data are obtained from different sources, including various series of the world
ICRG, World Bank and International Financial Statistics. The sample size and the
period of our study are limited by the availability of data on control variables.

2.5 Estimation techniques

In a simultaneous equation model, like the one developed in the previous section, a
dependent variable in one equation can be an explanatory variable in other
equations in the model. For example, in Eq. (1), technological innovation is an
explanatory variable, but at the same time this explanatory variable in simultaneous
equation models is endogenous in Eq. (2). It is the same case for the FDI variables

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which appear in the first equation as an explanatory variable and as an endogenous

variable in the third equation. As a consequence, using ordinary least square, OLS,
to estimate the structural equations will result in inconsistent estimates for the
model parameters. Our model is consequently characterized by the presence of an
endogeneity problem of order two, and that is why the estimation by the method of
least squares would be double-registered. This estimation method is based on the
principle of application of the method of least squares in three stages. This
technique aims at solving endogeneity problems by introducing the variables at the
root of these problems as instrumental variables. However, treatment with the
STATA allows a solution using the three-stage least square ‘‘3 SLS’’ method. In
order to do so, a series of econometric tests will be conducted on the usual set of
equations and variables in the estimated model. We are going to proceed as follows:
the identification of the model,1 the stationarity tests and bivariate collinearity.

3 Main results and discussion

Table 1 reports the estimation results of the simultaneous equations model using
the 3 SLS method for the period 1990–2012. The first column presents the
estimation results of the GDP growth equation. In this equation, the parameters of
interest are as follows: the coefficient that describes the effect of FDI and
technological innovation on GDP growth. The estimated coefficient on technology
shows that improving technological innovation by 1 % increases the economic
growth rate by 0.096 %; the estimated coefficient on FDI shows that increasing FDI
inflows by 1 % increases the economic growth rate by 0.33 %. This result is
interpreted in accordance with the endogenous growth models that postulate that
FDI is considered as a catalyst for technological progress and productivity
improvements, and it therefore has a long-term effect on economic growth (OECD
2002). In these models, FDI has an endogenous effect on economic growth because
it creates increasing returns to capital through positive externalities and spillover
effects (De Mello 1997).
As for the explanatory variables, they have the expected sign and are statistically
significant: Trade openness is significantly positive, this result supports the idea that
openness policy through the abolition of trade barriers and free movement of capital
flows is a source of FDI attractiveness. This means that trade openness does
encourage not only economic growth, but also the adoption and dissemination of
advanced technology already present in other countries (North and Thomas 1973).
As for the coefficient of investment, it is significantly positive reflecting that a higher
level of investment share in GDP is associated with a faster economic growth rate.
The second column in Table 1 presents the estimation results of the technological
innovation equation. Overall results show that human capital, as captured by the
average years of secondary schooling in the total population, plays a significant role
in improving technological innovation. The estimated coefficient on institutions
shows that improving institutional quality by 1 % will increase technological

1
For more details on the identification of simultaneous equations model, see Appendix 2.

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Table 1 Results of the effects

Variables GDP Technological FDI
of FDI on GDP growth (full
growth innovation
sample)
INF -0.123 – –
(-1.73)* – –
TRADE 0.125 – –
(1.69)* – –
FD 0.015 – 0.017
(4.4)*** – (2.46)***
INV 1.381 – –
(4.76)*** – –
SCH – 2.23 –
– (2.09)** –
INST – 0.362 –
– (2.59)** –
RD – 0.018 –
– (5.45)*** –
GDPG – 0.072 0.069
– (1.88)** (1.98)**
FDI 0.33 0.362 –
(2.56)** (3.52)** –
TI 0.096 – 0.052
(4.63)*** – (2.72)**
TARIF – – -0.011
– – (-2.03)**
TAX – – -0.063
– – (-1.49)
TEL – – 0.051
– – (3.04)**
Constant 2.054 2.042 2.026
(6.81)*** (5.22)*** (5.41)***
Observations 1079 1079 1079
*** p \ 0.01; ** p \ 0.05; R2 0.17 0.16 0.15
* p \ 0.1

innovation’s rate by 0.3 % and can, consequently, affect economic growth

positively. This suggests that institutional quality plays an important role in
determining economic growth rate by affecting the incentives for technological
progress and innovations. This result is consistent with the opinion of North (1990)
that postulates that the primary cause of underdevelopment and low growth rates,
especially in developing countries, is the failure to develop institutional environ-
ments that effectively define and protect property rights and enforce contracts, while
the sustained growth achieved by developed countries has been the result of sound
institutions that foster exchange and protect property rights. In this context,
Olofsdotter (1998) states that the adoption of new technology imported by FDI can

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be facilitated if high-quality institutions are provided. His empirical results suggest

that the positive impact of FDI on growth is stronger in countries with better
institutional quality, and particularly, administration efficiency. Along the same line
of argument, Durham (2004) finds that institutional quality is a precondition for
FDI, having a positive impact on economic growth. More specifically, Durham
(2004) finds that FDI has a positive impact in countries that have reached a
minimum threshold of property rights protection index.
As regards the coefficient of economic growth, it is positive and statistically
significant as expected. The coefficient of R&D factors, captured by research and
development expenditure, indicates that R&D plays a significant role in improving
technological progress. As regards the coefficient of FDI, it appears to have positive
and significant role in determining the new technology. Furthermore, the results
indicate that a 1 % deviation increase in FDI ratio makes technological innovation
improve by 0.36 %.
The third column in Table 1 shows the estimation result of the FDI equation. As
expected, the results indicate that FDI is affected positively and significantly by
economic growth rate, and negatively and significantly by tariff rates and the log of
income tax rates. The results show also that technological innovation and
infrastructure levels, as captured by telephone line per 1000 people, play significant
roles in stimulating FDI.

3.1 Calculating the total effect of FDI on economic growth

At this stage, it is worth reminding that the main aim of this paper is to test whether
FDI can affect economic growth by positively influencing technological innovation
and to evaluate the significance of any such effect. Mathematically, direct and
indirect effect of FDI on economic growth can be expressed in the following way:
oGrowth oTI
¼ a5 þ a6 ¼ a5  b 5 þ a 6
oFDI oFDI
Table 2 summarizes the results regarding the impact of FDI on economic growth:
As reported in the table, the results show the direct impact of FDI on economic
growth where an increase in FDI by one point leads to an increase in economic
growth by a6 = 0.33 points. As for the indirect impact of FDI on economic growth,
it can be computed by the product of the coefficient of technological innovation in
the economic growth equation and the coefficient of FDI in the technological

Table 2 Total impact of FDI on economic growth

The direct impact The indirect impact of FDI The total impact of FDI
of FDI on economic on economic growth via on economic growth
growth technological innovation

The coefficient a6 (a5 9 b5) a6 ? (a5 9 b5)

The estimated 0.33 0.096 9 0.36 = 0.034 0.33 ? 0.096 9 0.36 = 0.36
coefficient

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innovation equation (a5 9 b5 = 0.096 9 0.36). Thus, the combined effects suggest
that the total impact of FDI on economic growth is equal to the sum of the direct and
indirect effects which is 0.36 and indicates that an increase in FDI by one point
leads to an increase in the rate of the economic growth by 0.36 points.
The results presented in Table 2 make it very clear that FDI has a significant
impact on economic growth beyond its direct and indirect impact—an impact that
works via improving technological innovation. Indeed, a 1 % increase in FDI can
lead to a total increase in GDP growth rate by 0.36 % divided in a direct impact of
0.33 and an indirect impact of 0.034 %. This suggests that the indirect impact is of
considerable volume and is comparable to the direct or traditional impact.
Moreover, the results presented show that technological innovations play an
important role in determining the relationships between FDI inflows and economic
growth through its direct and indirect impacts.
Finally, we believe that our conclusion at the end of this first estimation does not
seem to relate to all the countries of the entire sample. Indeed, the results may differ
due to various institutional and structural characteristics of each economy. The
results of our estimation should be taken with great caution because we used a
heterogeneous sample containing both developed and developing countries that do
not generally have the same structures and economic policies. Therefore, FDI can
promote economic growth in some countries as it can have adverse effects in others.
We therefore find that it is not appropriate to conduct a study on this subject,
considering a sample of countries consisting of ones that do not have more or less
similar characteristics, because it does not allow us to take account of the specific
nature of each country, which may have erroneous results that cannot be
generalized. Besides, the process of separation of the sample might make it
possible to give more accurate results that reflect the heterogeneous characteristics
of the groups studied.
In the following paragraph, the robustness of the results is tested: first, by
subdividing the full sample into three small ones. As a consequence, the results
might be sensitive to the sample choice. More specifically, we try to make a
comparative study of three samples according to the standard income. Following the
classification of the World Bank, we could build a database characterizing three
samples2 around the world during the period 1990–2012: 20 low-income countries,
28 middle-income countries and 25 high-income countries. Although the economic
history of each country cannot be the same, we think that each group of countries we
have chosen are similar in their economic and financial structures as well as the
political, regulatory and social or cultural levels. The reason behind this attempt is
to draw the political implications that will be adopted by all countries. To do so, we
are going to keep the same approach, the same empirical methodology, the same
model and the same period.
The results of the regression models for the three subgroups of countries are
given in Tables 3, 4 and 5 listed below. They allow us to make interpretations and
draw conclusions cautiously.

2
The list of samples is presented in Appendix Table 8.

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The results presented in the tables above show that all the explanatory variables
have almost the expected signs regardless of the considered sample. As regards the
effects of FDI on economic growth, in which we are most interested in these
estimations, they vary depending on the sample chosen. We note specifically that
FDI has a positive and significant effect on economic growth for middle- and high-
income countries, while their effects appear to be negative and significant for low-
income countries. This suggests, contrary to theoretical works which assumed that
FDI is favorable to the GDP growth, that FDI is not always a catalyst for growth,
especially for countries that are characterized by weak legal environments—the
degradation of their macroeconomic environments (levels of inflation, high budget
deficit, etc.) and low regulation of their financial systems. Besides, financial

Table 3 Results of the effects

Variables GDP Technological FDI
of FDI on GDP growth (low-
growth innovation
income countries)
INF -0.454 – –
(-1.43) – –
TRADE 0.535 – –
(1.31) – –
FD 0.356 – 0.154
(6.36)*** – (1.45)
INV 0.47 – –
(2.55)** – –
SCH – 0.45 –
– (3.74)** –
INST – 0.104 –
– (2.88)** –
RD – 0.232 –
– (4.47)** –
GDPG – 0.123 0.136
– (1.88)** (1.98)**
FDI 0.11 0.114 –
(1.16) (1.92)** –
TI 0.017 – 0.012
(1.98)** – (2.86)**
TARIF – – 0.615
– – (1.53)
TAX – – -0.543
– – (-2.49)**
TEL – – 0.051
– – (2.04)**
Constant 6.352 4.944 7.686
(11.88)*** (9.79)*** (12.91)***
Observations 460 460 460
*** p \ 0.01; ** p \ 0.05; R2 0.11 0.10 0.13
* p \ 0.1

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Table 4 Results of the effects

Variables GDP growth Technological FDI
of FDI on GDP growth (middle-
innovation
income countries)
INF -0.454 – –
(-1.43) – –
TRADE 0.535 – –
(1.31) – –
FD 0.356 – 0.437
(6.36)*** – (3.49)**
INV 0.47 – –
(2.55)*** – –
SCH – 0.051 –
– (3.74)** –
INST – 0.195 –
– (3.97)** –
RD – 0.232 –
– (4.47)*** –
GDPG – 0.293 0.314
– (4.64)** (3.58)**
FDI 0.183 0.244 –
(2.11)** (3.29)** –
TI 0.025 – 0.021
(5.35)*** – (4.22)**
TARIF – – -0.023
– – (2.51)**
TAX – – -0.033
– – (-3.57)**
TEL – – 0.29
– – (1.69)**
Constant 4.362 6.587 5.568
(5.68)*** (9.43)*** (7.82)***
Observations 644 644 644
*** p \ 0.01; ** p \ 0.05; R2 0.21 0.19 0.21
* p \ 0.1

constraints in low-income countries may hinder the ability of domestic firms to

benefit from the positive externalities offered by FDI. These results are consistent
with the study of Singer (1950) that stresses that FDI inflows to developing
countries may not have positive impacts on their growth and development potential.
This is because FDI in developing countries goes mainly to primary sectors and not
to manufacturing sectors. These results are also consistent with the study of Saltz
(1992) who found that the relationship between FDI and growth is still negative in
developing countries. His argument is that if FDI results in raising capital in the host
country market, this would imply a redistribution of capital from labor-intensive
industries to capital-intensive ones, creating a net loss of employment and as a result
of consumer demand.

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 A. Dhrifi

Table 5 Results of the effects

Variables GDP Technological FDI
of FDI on GDP growth (high-
growth innovation
income countries)
INF -0.47 – –
(-1.55) – –
TRADE 0.345 – –
(4.14)** – –
FD 0.052 – 0.043
(2.658)** – (2.54)**
INV 0.082 – –
(3.62)** – –
SCH – 0.88 –
– (1.89)** –
INST – 0.096 –
– (6.735)*** –
RD – 0.335 –
– (2.75)*** –
GDPG – 0.022 0.069
– (3.65)** (1.98)**
FDI 0.27 0.31 –
(1.96)** (3.52)** –
TI 0.072 – 0.061
(2.23)** – (1.76)**
TARIF – – -0.011
– – (-2.03)**
TAX – – -0.063
– – (-2.56)**
TEL – – 0.051
– – (3.04)**
Constant 0.964 3.065 2.81
(17.62)*** (13.85)*** (21.38)***
Observations 575 575 575
*** p \ 0.01; ** p \ 0.05; R2 0.1 0.08 0.12
* p \ 0.1

On the same vein, Dutt (1997) argues that primary FDI in developing countries is
attracted to industries which produce less technologically advanced products
competing with similar products from other developing countries, which brings
about deterioration in the host countries terms of trade. Another argument is that, as
mentioned by Lipsey (2004), FDI has a positive impact on economic growth in
high-income countries and does not have a robust impact in low-income ones,
concluding that a host country must reach a certain threshold of economic
development before it can benefit from FDI.
Finally, given that economic openness to international investment is now more
than ever a condition if not sufficient, which is at least necessary, developing
countries are expected to take up the challenge to embark on the path of

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globalization. At the heart of the challenge are the willingness and ability of these
countries to establish a real growth process facilitating the attraction of foreign
investors and to benefit from FDI as a modality of integration in the international
economy. More specifically, prudent policies might involve removing barriers that
prevent local firms from establishing adequate linkages, improving local firms’
access to inputs, technology and financing, and streamlining the procedures
associated with selling inputs. But we might also seek to improve domestic
conditions which should have the dual effect of attracting foreign investment and
enabling host economies to maximize the benefits they get from it.
We think that FDI may promote economic growth only in countries that have
absorptive capacity. Absorptive capacity is determined by factors such as the quality
of human capital, the level of development of the financial sector, technological
development and quality of infrastructure. Low levels of development of human
capital reduce the spillovers from the advanced technology introduced by FDI as
domestic firms will not be able to absorb the new technology. Similarly,
underdeveloped financial markets limit the ability of domestic firms to access
financial resources to undertake investment in new technologies. In the case of
infrastructure, an adequate one is required to support new technologies as well as to
facilitate linkages between FDI and domestic firms.

4 Conclusion and policy implications

Although the literature related to the impact of FDI on economic growth is so vast,
theoretical and empirical developments lead to mixed conclusions. The objective of
the present work is to clarify this relationship by examining the above interaction
focusing on the role played by technological innovation in this relationship for 83
developing and developed countries over the period 1990–2012 using a simulta-
neous equation model. Our analysis suggests that FDI produce direct economic
growth only in middle- and high-income countries which is not the case for low-
income ones. Our finding suggests also that there is an indirect effect of FDI on
economic growth via technological innovation.
The results of the models developed in this paper provide several lessons about
the role played by technological innovation in promoting economic growth: To
increase its share of FDI, economies have to undertake a number of reforms to
strengthen their attractiveness. We must also build local skills such as: the
development of know-how, improving the quality of the workforce, consolidation
and performance of industrial fabric, improving the image of targeted countries
because, regardless of their national origin, investors look for countries that offer a
stable and dynamic macroeconomic framework. For a potential investor, stability
based on a few criteria such as inflation control, the control of public expenditure,
the continuity of the policy ensure the ability to properly assess the future
profitability of a project. This is beneficial for the host countries to focus on
economic calculation in relation to financial calculation. Macroeconomic stability
will foster substantial investment amount, and its technology content and their
effects upstream and downstream local industry. However, an uncertain

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 A. Dhrifi

environment and high risk only attracts investment in low value added. The
macroeconomic dynamism manifested by a high and sustainable growth rate is
obviously an additional pull factor. It guarantees an expansion of local demand. This
argument is particularly important for countries with high population whose
potential domestic market is the advantage of relocating because a growth rate
loosens the constraint created by the narrowness of the market. Moreover, a good
macroeconomic performance is a prerequisite of a high rate of investment and
technical progress which indicates the existence of investment opportunities.
Finally, if the present paper presents a detailed analysis of the direct and the
indirect impact (via technological innovation) of FDI on economic growth, it does
not dissociate between inward and outward FDI. We think that this question may be
the subject of a future research.

Appendix 1: Correlations between the various variables used

in the regression models

INF TRADE FD INV TI FDI

Equation (E1)
INF 1
TRADE -0.213** 1
FD -0.303** 0.198** 1
INV 0.154** 0.121** 0.218** 1
TI -0.364** 0.205** 0.356** -0.364** 1
FDI -0.134 0.421* 0.263** 0.048* 0.141** 1

SCH INST RD GDPG FDI

Equation (E2)
SCH 1
INST -0.104 1
RD 0.088** 0.147** 1
GDPG 0.191** 0.106** 0.055* 1
FDI 0.047* 0.034* 0.421* 0.212** 1

TARIF TAX TEL TI GDPG

Equation (E3)
TARIF 1
TAX 0.095* 1
TEL 0.182** 0.438** 1
TI 0.067 -0.214** 0.274** 1
GDPG 0.147*** 0.129* 0.324** 0.407** 1

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Foreign direct investment, technological innovation…

Appendix 2: Identification of the model

We have three endogenous variables in the model (i.e., W = 3) ‘‘GDPG,’’ ‘‘TI’’ and
‘‘FDI’’ and many exogenous variables: ‘‘TRADE,’’ ‘‘SCH,’’ ‘‘FD,’’ ‘‘INF,’’
‘‘TARIF,’’ ‘‘TAX,’’ ‘‘RD,’’ ‘‘INV,’’ ‘‘INST’’ and ‘‘TEL’’ (i.e., K = 10).
By applying the identification conditions in the first equation, the variables in the
equation of growth give: W = 1, K = 10 and K0 = 6 and r = 0 with W0 is the
number of endogenous variables in an equation, K is the number of exogenous
variables in an equation, and r the number of restriction.
Is therefore: W-W0 ? K-K0 = 3–1 ? 10-6 = 6 [ W-1 = 3-1 = 2, the first
equation is identified.
The second equation has seven exclusion restrictions but no restriction stress.
Consequently W = 3, K = 10, W = 1, K0 = 5 and r = 0, which gives us: W-
W0 ? K-K0 = 3-1 ? 10-5 = 7 [ W-1 = 2, the equation is over-identified.
The third equation has six exclusion restrictions but no restriction stress.
Therefore W = 3, K = 10, W = 1, K0 = 5 and r = 0, this means that W-W0 1 K-
K0 = 3-1 ? 10-5 = 7 [ W-1 = 2, the third equation is over-identified.
Since in our model all the equations are over-identified, the model is over-identified.

Appendix 3

See Tables 6, 7, and 8.

Table 6 Test of stationarity

Variables Model specification Pesaran

INF Model without trend -1.334 (0.051)**

Model with trend -2.061 (0.078)**
TRADE Model without trend -2.117 (0.114)
Model with trend -3.125 (0.102)**
FD Model without trend -7.97 (0.008)***
Model with trend -3.251 (0.071)**
INV Model without trend -3.637 (0.100)*
Model with trend -4.642 (0.083)**
TI Model without trend -1.789 (0.002)***
Model with trend -2.752 (0.003)***
FDI Model without trend -1.523 (0.045)**
Model with trend -2.231 (0.012)**
SCH Model without trend -6.302 (0.046)**
Model with trend -5.061 (0.034)**
INST Model without trend -3.347 (0.071)*
Model with trend -2.221 (0.125)
RD Model without trend -2.84 (0.005)***
Model with trend -2.061 (0.001)***

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 A. Dhrifi

Table 6 continued

Variables Model specification Pesaran

GDPG Model without trend -0.942 (0.036)**

Model with trend -1.086 (0.041)**
TARIF Model without trend -7.444 (0.106)*
Model with trend -6.161 (0.241)
TAX Model without trend -1.343 (0.071)*
Model with trend -2.061 (0.341)
TEL Model without trend -3.392 (0.0645)*
Model with trend -2.061 (0.031)**

The unit root test hypothesis is rejected at *** 1 %, ** 5 %, * 10 %. IPS, Pesaran corresponds to results
of tests of Pesaran (2003)
(.) p value

Table 7 Descriptive statistics

N Minimum Maximum Mean SD

GDPG 1079 -1.08 5.34 0.016 0.040

TAX 1079 0.00 0.28 0.142 0.022
TARIF 1079 0.00 0.36 0.048 0.037
FDI 1079 -4.71 11.8 3.676 2.167
INST 1079 0.217 2.96 0.804 1.003
INF 1079 -0.91 8.98 1.672 3.874
TRADE 1079 0.00 2.20 0.732 0.324
RD 1079 0.62 2.63 1.055 0.153
TI 1079 0.00 84.2 42.22 28.58
TEL 1079 0.00 4.04 1.374 0.456
SCH 1079 0.03 1.00 0.590 0.293
FD 1079 1.94 5.76 2.62 1.072
INV 1079 11.23 48.25 22.56 8.462

Table 8 List of the sample countries

Low income Middle income High income

Bangladesh, Benin, Burkina Algeria, Argentina, Bolivia, Australia, Austria, Belgium,

Faso, Central African Republic,
Congo Democratic Republic,
Ethiopia, Gambia, Guinea,
Haiti, Kenya, Liberia,
Madagascar, Mozambique,
Rwanda, Sierra Leone,
Tanzania, Togo, Uganda and
Zimbabwe
Brazil, Bulgaria, Cameroun,
Chile, Cote d’Ivoire, Ecuador,
Egypt, El Salvador, Honduras,
Indonesia, Malaysia, Mexico,
Morocco, Pakistan, Panama,
Paraguay, Peru, Philippine,
Romania, Sri Lanka,
Thailand, Tunisia, Turkey,
Ukraine and Uruguay
Canada, Denmark, Finland,
France, Germany, Greece,
Hungary, Ireland, Italy, Japan,
Korea Republic, Luxembourg,
Netherlands, Poland, Portugal,
Singapore, Slovenia, Spain,
Sweden, Switzerland, UK and
USA

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Foreign direct investment, technological innovation…

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