Foreign Direct Investment and Economic Growth in the GCC Countries:

A Causality Investigation Using Heterogeneous Panel Analysis

Mahmoud Al-Iriani
**
Department of Economics
Sanaa University
Sanaa, Yemen
Tel: +967-711075777
Fax: +967-1-21374
!-mail: maliriani"ho#mail$%om
Fa#ima Al-&ham'i
Department of Economics
United Arab Emirates University
Al-Ain, United Arab Emirates
Tel:+9!"-#"$"##
%a&:+9!"-#''!(
!-mail: FAl'ham'i"uaeu$a%$ae
**
(orre')ondin* Au#hor
Abstract
Thi' )a)er u'e' re%en# *ro+#h #heorie' and e%onome#ri% #e%hni,ue' #o em)iri%all- #e'# .or #he
a''o%ia#ion /e#+een .orei*n dire%# in0e'#men# and e%onomi% *ro+#h in #he 'ix %oun#rie'
%om)ri'in* #he 1ul. (oo)era#ion (oun%il 21((3$ Theore#i%all-4 re%en# endo*enou' *ro+#h
model' iden#i.- F5I a' one o. #he de#erminan#' o. *ro+#h #hrou*h i#' role in #e%hnolo*i%al
di..u'ion$ 6o+e0er4 #he endo*enei#- o. F5I ma7e' i# )o''i/le #ha# e%onomi% *ro+#h a..e%#'
#he .lo+ o. F5I$ 8e'ul#' o/#ained .rom a he#ero*eneou' )anel anal-'i' indi%a#e a /i-
dire%#ional %au'ali#- /e#+een F5I and 159 in #he )anel o. #he 1(($ Thi' re'ul# 'u))or#' #he
endo*enou' *ro+#h h-)o#he'i'4 a# lea'# .or #hi' *rou) o. %oun#rie'$

!ey words: F5I: !%onomi% 1ro+#h: 9anel %oin#e*ra#ion: 9anel %au'ali#-

"E# classi$ications: F21: F23: (23: (33
%
&' Introduction
The rela#ion'hi) /e#+een .orei*n dire%# in0e'#men# 2F5I3 and e%onomi% *ro+#h i' a
+ell-'#udied 'u/;e%# in #he de0elo)men# e%onomi%' li#era#ure4 /o#h #heore#i%all- and
em)iri%all-$ 8e%en#l-4 rene+ed in#ere'# in *ro+#h de#erminan#' and #he %on'idera/le
re'ear%h on ex#ernali#--led *ro+#h4 +i#h #he ad0en# o. endo*enou' *ro+#h #heorie'
2<arro4 1991: <arro and &ala-i-Mar#in4 199534 made i# more )lau'i/le #o in%lude F5I
a' one o. #he de#erminan#' o. lon* run e%onomi% *ro+#h$ The in#ere'# in #he 'u/;e%#
ha' al'o *ro+n ou# o. #he 'u/'#an#ial in%rea'e in F5I .lo+ #ha# '#ar#ed in #he la#e
1990='4 and led #o a +a0e o. re'ear%h re*ardin* i#' de#erminan#'$
5e')i#e #he %on'idera/le 0olume o. re'ear%h on #he 'u/;e%#4 #here i' %on.li%#in*
e0iden%e in #he li#era#ure re*ardin* #he ,ue'#ion a' #o ho+ F5I rela#e' #o e%onomi%
*ro+#h$ In )ar#i%ular4 a #+o-+a- in#era%#ion ha' /een di'%u''ed in #he li#era#ure o.
F5I-*ro+#h rela#ion'hi)$ >n one hand4 F5I i' /ein* 'een4 /- man-4 a' an im)or#an#
elemen# in #he 'olu#ion #o #he )ro/lem o. '%ar%e lo%al %a)i#al and o0erall lo+
)rodu%#i0i#- in man- de0elo)in* %oun#rie' 25e Mello4 1999: !ller4 e#$ al4 20053$
6en%e4 #he .lo+ o. .orei*n dire%# %a)i#al i' ar*ued #o /e a )o#en#ial *ro+#h-enhan%in*
)la-er in #he re%ei0in* %oun#r-$ Thi' 0ie+ i' %hallen*ed /- man- au#hor'$ For
exam)le4 (ar7o0i% and ?e0ine 220023 'ho+ #ha# #here i' no ro/u'# im)a%# .rom F5I
on *ro+#h i. %oun#r--')e%i.i% le0el di..eren%e'4 endo*enei#- o. F5I in.lo+' and
%on0er*en%e e..e%#' are #a7en in#o a%%oun#$ In addi#ion4 A7inlo 220043 'ho+' #ha# /o#h
)ri0a#e %a)i#al and la**ed .orei*n %a)i#al ha0e no '#a#i'#i%all- 'i*ni.i%an# e..e%# on #he
e%onomi% *ro+#h$ 6e %on%luded #ha# #he re'ul#' 'eem #o 'u))or# #he ar*umen# #ha#
ex#ra%#i0e F5I mi*h# no# /e *ro+#h enhan%in* a' mu%h a' manu.a%#urin* F5I$
>n #he o#her hand4 re%o*ni@in* #he im)or#an%e o. F5I #o *ro+#h4 e%onomi% *ro+#h
i#'el. ha' /een iden#i.ied .re,uen#l- a' an im)or#an# de#erminan#4 .rom amon* #he
0ariou' de#erminan#'4 o. F5I in.lo+ in#o #he ho'# %oun#rie'$ 8a)id *ro+#h o. an
e%onom- mi*h# a##ra%# more F5I /- mul#i-na#ional %om)anie' 2MA('34 a' #he- lo%a#e
ne+ )ro.i# o))or#uni#ie' 26an'en and 8and4 20063$
There.ore4 #+o '#rand' o. re'ear%h ha0e emer*ed: one #ha# di'%u''e' #he e..e%#' o. F5I
on e%onomi% *ro+#h4 and #he o#her re%o*ni@e' #he'e e..e%#' and 'u/'e,uen#l- #rie' #o
(
iden#i.- #he de#erminan#' o. F5I .lo+ #o #he re%ei0in* %oun#rie'$ The )o''i/ili#- o. a
#+o-+a- %au'ali#- /e#+een #he #+o 0aria/le' iden#i.ie' a #hird line o. re'ear%h in #he
F5I li#era#ure4 /u# o. a le''er ma*ni#ude 2(hoe4 20033$
!xi'#in* em)iri%al e0iden%e4 in %on#ra'# +i#h more 'e##led #heore#i%al e0iden%e4 'ho+'
mixed re'ul#' a/ou# #he rela#ion'hi) /e#+een F5I and e%onomi% *ro+#h o. #he ho'#
%oun#rie'4 and #he de#erminan#' o. F5I$ &e0eral rea'on' ma- /e ad0an%ed #o ex)lain
'u%h di')ari#- o. em)iri%al re'ul#'$ To men#ion a .e+4 .ir'#4 #e'#' are #radi#ionall-
%ondu%#ed u'in* da#a 'e#' u'uall- /elon* #o he#ero*eneou' *rou)' o. %oun#rie'$
&e%ond4 )re0iou' '#udie' ha0e u'ed a 0arie#- o. #heore#i%al model'$ Third4 em)iri%al
'#udie' ha0e u'uall- im)lemen#ed a num/er o. di..eren# e%onome#ri% #e%hni,ue' in
#e'#in* and e'#ima#ion$ 6o+e0er4 #hi' di')ari#- in re'ul#' doe' no# )re%lude #he need
.or .ur#her in0e'#i*a#ion o. #he 'u/;e%# a' lon* a' i# i' %learl- indi%a#ed #ha# #he
anal-'i' and #he o/#ained re'ul#' are no# ne%e''aril- *enerali@ed #o o#her %a'e'$
In #hi' )a)er4 +e do no# in#end #o )re'ume ho+ ea%h o. #he #+o 0aria/le' a..e%# #he
o#her$ 8a#her4 our )ur)o'e i' #o #e'# .or #he %au'al rela#ion'hi) /e#+een F5I .lo+ #o
#he 1(( %oun#rie' and #heir e%onomi% *ro+#h$ Thi' '#ud- i' di..eren# .rom #he
)re0iou' li#era#ure on man- *round'$ Fir'#4 #o #he /e'# o. our 7no+led*e4 a )ar# .rom
#he '#ud- /- &adi7 and <ol/ol 2200134 #hi' i' #he .ir'# a##em)# #o in0e'#i*a#e #he %au'al
F5I-*ro+#h rela#ion'hi) in #hi' )ar# o. #he +orld$ &adi7 and <ol/ol 220013 in0e'#i*a#e
#he e..e%# o. F5I #hrou*h #e%hnolo*- ')illo0er' on o0erall #o#al .a%#or )rodu%#i0i#- .or
!*-)#4 Bordan4 Moro%%o4 >man4 &audi Ara/ia and Tuni'ia o0er a 20--ear )eriod$
The- .ind #ha# F5I ha' no# had an- mani.e'# )o'i#i0e ')illo0er' on #e%hnolo*- and
)rodu%#i0i#- o0er and a/o0e #ho'e o. o#her #-)e' o. %a)i#al .orma#ion$ >n #he %on#rar-4
#here are 'ome indi%a#ion' #ha# #he e..e%# o. F5I on #o#al .a%#or )rodu%#i0i#- ha' /een
lo+er #han dome'#i% in0e'#men#' in 'ome o. #he %oun#rie' o0er #he )eriod '#udied4
indi%a#in* a )o''i/l- domina#in* ne*a#i0e %ro+din* ou# e..e%#$ &e%ond4 +e em)lo- a
di..eren# e%onome#ri% a))roa%h .rom )re0iou' '#udie'4 namel- #he he#ero*eneou'
)anel anal-'i'4 +here +e allo+ .or he#ero*enei#- o. d-nami%' in #he 1(( %oun#r-
)anel$ For in'#an%e4 Aair-8ei%her# and Ceinhold 220013 indi%a#e #ha# im)o'in*
homo*enei#- o. %oun#rie' in #he *rou)4 +hen %oun#rie' are in .a%# he#ero*eneou'4
mi*h# lead #o mi'leadin* re'ul#'$ In #ha# dire%#ion4 +e ini#iall- #e'# .or %oin#e*ra#ion
/e#+een our 0aria/le' u'in* #he he#ero*eneou' )anel %oin#e*ra#ion #e'# de0elo)ed /-
)
9edroni 219974199934 +hi%h allo+' .or %ro''-'e%#ional in#erde)enden%- amon*
di..eren# indi0idual e..e%#'$ Aex#4 ra#her #han ado)#in* one )oin# o. 0ie+ or ano#her4
re*ardin* #he dire%#ion o. %au'ali#-4 +e a''ume #ha# #he rela#ion'hi) /e#+een F5I and
*ro+#h ma- run in ei#her or /o#h dire%#ion'$ There.ore4 +e u'e #he he#ero*eneou'
)anel %au'ali#- #e'# #o de#e%# #he dire%#ion o. %au'ali#- /e#+een #he #+o 0aria/le'$
$
' #iterature *eview
There i' %on.li%#in* e0iden%e in #he li#era#ure re*ardin* #he ,ue'#ion a' #o ho+4 and #o
+ha# ex#en#4 F5I a..e%#' e%onomi% *ro+#h$ F5I ma- a..e%# e%onomi% *ro+#h dire%#l-
/e%au'e i# %on#ri/u#e' #o %a)i#al a%%umula#ion4 and #he #ran'.er o. ne+ #e%hnolo*ie' #o
#he re%i)ien# %oun#r-$ In addi#ion4 F5I enhan%e' e%onomi% *ro+#h indire%#l- +here
#he dire%# #ran'.er o. #e%hnolo*- au*men#' #he '#o%7 o. 7no+led*e in #he re%i)ien#
%oun#r- #hrou*h la/or #rainin* and '7ill a%,ui'i#ion4 ne+ mana*emen# )ra%#i%e' and
or*ani@a#ional arran*emen#' 25e Mello4 19993$ Theore#i%all-4 ho+e0er4 in #he %on#ex#
o. ei#her neo-%la''i%al or endo*enou' *ro+#h model'4 #he e..e%#' o. F5I on #he
e%onomi% *ro+#h o. #he re%ei0in* %oun#r-4 di..er in #he re%en# *ro+#h model' .rom
#heir %on0en#ional %oun#er)ar#'$ The %on0en#ional e%onomi% *ro+#h #heorie' are /ein*
au*men#ed /- di'%u''in* *ro+#h in #he %on#ex# o. an o)en ra#her #han a %lo'ed
e%onom-4 and #he emer*en%e o. ex#ernali#--/a'ed *ro+#h model'$ !0en +i#h #he
in%lu'ion o. F5I in #he model o. e%onomi% *ro+#h4 #radi#ional *ro+#h #heorie' %on.ine
#he )o''i/le im)a%# o. F5I #o #he 'hor#-run le0el o. in%ome4 +hen a%#uall- re%en#
re'ear%h ha' in%rea'in*l- un%o0ered an endo*enou' lon*-run role o. F5I in e%onomi%
*ro+#h de#ermina#ion$
1
A%%ordin* #o #he neo-%la''i%al model'4 F5I %an onl- a..e%#
*ro+#h in #he 'hor# run /e%au'e o. dimini'hin* re#urn' o. %a)i#al in #he lon* run$
In %on#ra'# +i#h #he %on0en#ional neo-%la''i%al model4 +hi%h )o'#ula#e' #ha# lon* run
*ro+#h %an onl- ha))en .rom #he /o#h exo*enou' la/or .or%e *ro+#h and
#e%hnolo*i%al )ro*re''4 #he ri'e o. endo*enou' *ro+#h model' 2<arro+ and &ala-i-
Mar#in4 19953 made i# )o''i/le #o model F5I a' )romo#in* e%onomi% *ro+#h e0en in
#he lon* run #hrou*h #he )ermanen# 7no+led*e #ran'.er #ha# a%%om)anie' F5I$ A' an
ex#ernali#-4 #hi' 7no+led*e #ran'.er4 +i#h o#her ex#ernali#ie'4 +ill a%%oun# .or #he non-
dimini'hin* re#urn' #ha# re'ul# in lon* run *ro+#h 25e Mello4 19973$ 6en%e4 i. *ro+#h
1
For an excellent survey of such research, see De Mello (1997).
+
de#erminan#'4 in%ludin* F5I4 are made endo*enou' in #he model4 lon* run e..e%#' o.
F5I +ill .ollo+$ There.ore4 a )ar#i%ular %hannel +here/- #e%hnolo*- ')ill' o0er .rom
ad0an%ed #o la**in* %oun#rie' i' #he .lo+ o. F5I 2<en*oa and &an%he@-8o/le'4 20033$
Ae0er#hele''4 mo'# '#udie' *enerall- indi%a#e #ha# #he e..e%# o. F5I on *ro+#h de)end'
on o#her .a%#or' 'u%h a' #he de*ree o. %om)lemen#ari#- and 'u/'#i#u#ion /e#+een
dome'#i% in0e'#men# and F5I4 and o#her %oun#r--')e%i.i% %hara%#eri'#i%'$ <u%7le- e#$
al4 220023 ar*ue #ha# #he ex#en# #o +hi%h F5I %on#ri/u#e' #o *ro+#h de)end' on #he
e%onomi% and 'o%ial %ondi#ion' in #he re%i)ien# %oun#r-$ (oun#rie' +i#h hi*h ra#e o.
'a0in*'4 o)en #rade re*ime and hi*h #e%hnolo*i%al le0el' +ould /ene.i# .rom in%rea'e
F5I #o #heir e%onomie'$ 6o+e0er4 F5I ma- ha0e ne*a#i0e e..e%# on #he *ro+#h
)ro')e%#' o. #he re%i)ien# e%onom- i. #he- re'ul# in a 'u/'#an#ial re0er'e .lo+' in #he
.orm o. remi##an%e' o. )ro.i#'4 and di0idend' andDor i. #he mul#ina#ional %or)ora#ion'
2MA('3 o/#ain 'u/'#an#ial or o#her %on%e''ion' .rom #he ho'# %oun#r-$ <en*oa and
&an%he@-8o/le' 220033 ar*ue #ha# in order #o /ene.i# .rom lon*-#erm %a)i#al .lo+'4 #he
ho'# %oun#r- re,uire' ade,ua#e human %a)i#al4 'u..i%ien# in.ra'#ru%#ure4 e%onomi%
'#a/ili#- and li/erali@ed mar7e#'$ The 0ie+ #ha# F5I .o'#er' e%onomi% *ro+#h in #he
ho'# %oun#r-4 )ro0ided #ha# #he ho'# %oun#r- i' a/le #o #a7e ad0an#a*e o. i#' ')illo0er'
i' 'u))or#ed /- em)iri%al .indin*' in 5e Mello 219993 and >/+ona 220013$
<oren'@#ein e# al$4 199 *o .ur#her #o 'u**e'# #ha# F5I i' an im)or#an# 0ehi%le .or #he
#ran'.er o. #e%hnolo*-4 %on#ri/u#in* rela#i0el- more #o *ro+#h #han dome'#i%
in0e'#men#$ The- u'e a model o. endo*enou' *ro+#h4 in +hi%h #he ra#e o.
#e%hnolo*i%al )ro*re'' i' #he main de#erminan# o. #he lon*-#erm *ro+#h ra#e o.
in%ome$
The o#her #heme o. em)iri%al re'ear%h o. F5I-*ro+#h rela#ion'hi) %on%en#ra#ed on
iden#i.-in* de#erminan#' o. F5I .lo+ and anal-@in* #he e..e%#' o. #he'e de#erminan#'
on #he a##ra%#i0ene'' o. #he ho'# %oun#r- #o4 and #he 0olume and #-)e4 o. 'u%h .lo+'$
T+o 'e#' o. .a%#or' are .re,uen#l- %i#ed$ The .ir'# 'e# in%lude' #he 'i@e o. #he re%i)ien#
mar7e#4 rela#i0e .a%#or )ri%e'4 and /alan%e o. )a-men#' %on'#rain#' 2<ha'in e# al$4
1994: ?o0e and ?a*e-6idal*o4 2000: ?i)'e-4 20003$ The 'e%ond 'e# in%lude'
in'#i#u#ional .a%#or' 'u%h a' de*ree o. o)enne'' and #rade )oli%ie'4 le*i'la#i0e
en0ironmen# and la+ en.or%emen# 2?ee and Man'.ield4 199634 and #he de*ree o.
e%onomi% and )oli#i%al '#a/ili#- 2<a;oru/io and &o'0illa-8i0ero4 1994: ?i)'e-4 19993$
,
8e%o*ni@in* #he im)or#an%e o. F5I #o #heir *ro+#h4 man- %oun#rie' are u'in* ')e%i.i%
in%en#i0e' #o a##ra%# F5I #o .lo+ in$ Tax /rea7' and re/a#e' are exam)le' o. 'u%h
in%en#i0e' 2Tun* and (ho4 20013$ Ae0er#hele''4 #he e..e%#i0ene'' o. 'u%h in%en#i0e'
ha' /een ,ue'#ioned 21ui'in*er4 19923$
Ce #a7e a 'ome+ha# di..eren# rou#e$ 8a#her #han )re'umin* #he dire%#ion o.
in#era%#ion /e#+een F5I and e%onomi% *ro+#h4 our re'ear%h #rie' #o #e'# .or #he %au'al
rela#ion'hi) /e#+een e%onomi% *ro+#h and F5I$ Ce examine #he exi'#en%e o. 'u%h
in#era%#ion u'in* e%onome#ri% #e%hni,ue' #ha# are 'ui#a/le .or )anel da#a anal-'e'$ Ce
.ollo+ (hoe 220033 in u'in* )anel da#a %au'ali#- #e'#in* me#hod de0elo)ed /- 6ol#@-
!a7in4 Ae+e- and 8o'en 2193$ 6i' re'ul#' )oin# #o+ard' /i-dire%#ional %au'ali#-
/e#+een F5I and *ro+#h4 al#hou*h he .ind' #he %au'al im)a%# .rom F5I #o *ro+#h #o
/e +ea7$ The )ur)o'e o. #hi' )a)er i' a' .ollo+'$ Fir'#4 +e %on'ider and #e'# .or #he
rela#ion'hi) /e#+een F5I and e%onomi% *ro+#h 4 i$e$ *ro+#h o. *ro'' dome'#i%
)rodu%# 21593 in #he 'ix 1(( %oun#rie' '#udied a' one he#ero*eneou' )anel$ The
'#ud- i' /a'ed on a #heore#i%al model #ha# /uild' on a )rodu%#ion .un%#ion +hi%h
allo+' .or F5I #o a))ear a' one o. i#' .a%#or in)u#'$ &e%ond4 +e %on'ider /o#h F5I and
1594 and a##em)# #o ;oin#l- anal-@e #he F5I-*ro+#h h-)o#he'i'$ Third4 +e a##em)# #o
o0er%ome #he 'hor#a*e o. da#a in #he .airl- ne+ /lo%7 o. 1(( %oun#rie' /- em)lo-in*
)anel da#a #e%hni,ue'4 +hi%h %om/ine' /o#h #he #ime dimen'ion and #he %ro''-'e%#ion
dimen'ion o. #he da#a$ The ad0an#a*e o. #hi' a))roa%h i' #ha# i# lead' #o )rodu%e'
more o/'er0a#ion' and4 hen%e4 more de*ree' o. .reedom in e'#ima#ion$ Thi' i'
)ar#i%ularl- im)or#an# +hen e'#ima#ion in0ol0e' #he u'e o. la**ed inde)enden#
0aria/le'$ Thi' re'ul#' in a more e..i%ien# e%onome#ri% e'#ima#ion$ For#h4 a' )anel
%oun#rie' ma- ha0e uno/'er0a/le di..eren%e'4 +e u'e he#ero*eneou' )anel e'#ima#ion
#ha# ha0e /een e0ol0in* re%en#l- in #he )anel da#a li#era#ure4 #o a%%oun# .or %oun#r--
')e%i.i% e..e%#'$ To a%hie0e #ha# *oal +e em)lo- #he he#ero*eneou' )anel uni# roo#
#e'#' de0elo)ed /- Im4 9e'aran and &hin 2I9&3 2200334 and %oin#e*ra#ion #e'#
de0elo)ed /- 9edroni 219974 199934 +hi%h allo+' .or %ro''-'e%#ional in#erde)enden%-
amon* di..eren# indi0idual e..e%#'$ Fi.#h4 'in%e #he %au'ali#- rela#ion'hi) /e#+een F5I
and e%onomi% *ro+#h ma-4 #heore#i%all-4 run in ei#her or /o#h dire%#ion'4 +e +ill
em)iri%all- #e'# .or #he dire%#ion o. %au'ali#- in #he %a'e o. 1(( %oun#rie' u'in*
he#ero*eneou' )anel %au'ali#- #e'#'$ Ender'#andin* %au'al rela#ion' /e#+een F5I and
-
e%onomi% *ro+#h 'hould hel) )oli%- ma7er' )lan #heir F5I )oli%ie' in a +a- #ha#
enhan%e' *ro+#h and de0elo)men# o. #heir e%onomie'$
The remainder o. #he )a)er )ro%eed' a' .ollo+': &e%#ion 3 'ummari@e' #rend' in
*lo/al and 1((F' F5I .lo+'$ &e%#ion 4 ou#line' #he me#hodolo*- u'ed in #hi' '#ud-$
Fir'#4 a #e'# o. #he order o. in#e*ra#ion i' di'%u''ed #o a''e'' #he #ime 'erie' )ro)er#ie'
o. #he 0aria/le' u'ed$ Then4 a he#ero*eneou' )anel #e'# .or #he exi'#en%e o. a lon*-run
rela#ion'hi) amon* #he #ime 'erie' i' ou#lined$ 6a0in* e'#a/li'hed 'u%h a rela#ion'hi)
exi'#'4 1eneral Me#hod o. Momen#' 21MM3 e'#ima#ion #e%hni,ue' i' u'ed #o examine
#he %au'ali#- dire%#ion /e#+een F5I and e%onomi% *ro+#h$ &e%#ion 5 de'%ri/e' #he
da#a u'ed in #he anal-'i'4 and )re'en#' em)iri%al re'ul#' and #heir im)li%a#ion'$
Finall-4 'e%#ion 6 %on%lude' /- 'ome )oli%- re%ommenda#ion' /a'ed on #he em)iri%al
.indin*' in #he main anal-'i'
%' .rends in Global FDI
In a /road 'en'e4 Forei*n 5ire%# In0e'#men# 2F5I3 i' %om)o'ed o. a .lo+ o. %a)i#al4
ex)er#i'e4 and #e%hnolo*- in#o #he ho'# %oun#r-$ Formall-4 i# i' de.ined a' Gan
in0e'#men# made #o a%,uire la'#in* in#ere'# in en#er)ri'e' o)era#in* ou#'ide o. #he
e%onom- o. #he in0e'#orG 2IMF4 19933$ In#ere'#ed re'ear%her'4 %oun#rie'4 and
in#erna#ional or*ani@a#ion' ha0e in%rea'in*l- re%o*ni@ed #he im)or#an%e o. .orei*n
%a)i#al #o *ro+#h$ In our d-nami% a*e o. )ri0a#i@a#ion4 li/erali@a#ion4 and
*lo/ali@a#ion4 F5I ha' emer*ed a' an im)or#an# .orm o. in#erna#ional %a)i#al .lo+$
8e%o*ni@in* #he im)or#an%e o. in0e'#men# +i#h no /order'4 #he Corld <an7 ha'
de0o#ed i#' 2005 i''ue o. GCorld 5e0elo)men# 8e)or#G #o #he i''ue o. #rade and
in0e'#men#4 di'%u''in* in de#ail #he im)or#an%e o. .orei*n %a)i#al .lo+ #o #he
e%onomie' o. #he ho'# %oun#rie'$ A%%ordin* #o #he Corld <an74 G.e+ %oun#rie' ha0e
*ro+n +i#hou# /ein* o)en #o #radeG
2
$
1enerall-4 #here i' a +ide a*reemen# on #he im)or#an%e o. o)enne'' #ha# lead' #o F5I
.lo+'$ 6o+e0er4 #here i' an on*oin* de/a#e a/ou# #he meri#' o. o)enne''$ The de/a#e
ha' /een mo#i0a#ed /- #he re%en# e%onomi% %ri'e' in a num/er o. %oun#rie' o.
2
Corld <an7 2200534 ))$ 64
/
&ou#hea'# A'ia$ Hui%7 and ma''i0e mo0emen#' o. 'hor#-#erm )or#.olio in0e'#men# #ha#
#oo7 )la%e in #he'e %oun#rie' +ere lar*el- /lamed .or #he %ri'e'$ Aone#hele''4 mo'#
o/'er0er' a*ree #o di'#in*ui'h F5I .rom 'hor#-#erm )or#.olio in0e'#men# /e%au'e F5I
i' a lon*-run in0e'#men# and #here.ore i' di..i%ul# #o re0er'e$ 6en%e4 re%o*ni@in* #he
im)or#an%e o. o)enne'' #o e%onomi% *ro+#h4 an in%rea'in* num/er o. %oun#rie' ha0e
ado)#ed more li/eral )oli%ie' #o+ard' #he .lo+ o. .orei*n %a)i#al$ A' a re'ul#4 F5I
in.lo+ #o de0elo)in* %oun#rie' in%rea'ed .rom 0$1 )er%en# o. *lo/al 159 in 1970 #o 3
)er%en# in 2001 2Corld <an74 20053$
>n #he *lo/al le0el4 a.#er a )eriod o. de%linin* #rend'4 *lo/al F5I in.lo+ rea%hed I64
/illion in 20044 in%rea'in* /- 2J o0er i#' le0el in 20034 rai'in* #he '#o%7 o. F5I in
2004 #o an e'#ima#ed le0el o. I9 #rillion$ Fur#hermore4 #here +a' a lar*e in%rea'e in #he
'hare o. de0elo)in* %oun#rie' in F5I in.lo+$ In.lo+' #o de0elo)in* %oun#rie' 'ur*ed
/- 40J4 #o I233 /illion4 +hile #ho'e #o #he *rou) o. de0elo)ed %oun#rie' de%lined /-
14J$ A' a re'ul#4 #he 'hare o. de0elo)in* %oun#rie' in +orld F5I in.lo+' ha'
in%rea'ed #o 36J o. *lo/al F5I4 #he hi*he'# le0el 'in%e 1997 2EA(TA54 20053$ The
o/'er0ed u)#rend in F5I +a' no# e0enl- di'#ri/u#ed amon* di..eren# %oun#rie' o. #he
de0elo)in* +orld$ Chile F5I .lo+ in#o A.ri%a remained '#a/le a# I1 /illion /e#+een
2003 and 20044 A'ia and >%eania +i#ne''ed a 'i*ni.i%an# u)'ur*e durin* #he 'ame
)eriod$ A 'imilar 'i*ni.i%an# u)#rend in F5I in.lo+ +a' re%orded in ?a#in Ameri%a
and &ou#hea'# !uro)e$
Fa%#or' ad0an%ed #o ex)lain #hi' in%rea'e in F5I .lo+ in#o #he de0elo)in* %oun#rie'
in%lude in#en'e %om)e#i#i0e )re''ure' in man- indu'#rie' o. #he 'our%e %oun#rie'4
hi*her )ri%e' .or man- %ommodi#ie'4 +hi%h '#imula#ed F5I #o %oun#rie' #ha# are ri%h
in na#ural re'our%e'4 and hi*her ex)e%#a#ion' .or e%onomi% *ro+#h$ EA(TA5 219963
iden#i.ie' 'ome o. #he mo'# im)or#an# .a%#or' leadin* 'o 'u%h a 'ur*e in *lo/al F5I
.lo+'$ The- in%lude #he in%rea'in* #rend in )ri0a#i@a#ion and #he re'ul#in* .orei*n
.irm=' a%,ui'i#ion o. dome'#i% .irm'4 )rodu%#ion *lo/ali@a#ion4 and *lo/al .inan%ial
in#e*ra#ion$

Amon* de0elo)in* %oun#rie'4 A'ia and >%eania re*ion +ere #he lar*e'# re%i)ien# a'
+ell a' 'our%e o. F5I$ In 2004 F5I in.lo+ #o /o#h re*ion' amoun#ed #o I14 /illion4
I46 /illion more #han in 2003$ Thi' mar7ed #he lar*e'# in%rea'e e0er #o #he'e re*ion'4
+i#h (hina and India *e##in* #he lion 'hare o. #he in%rea'e$ (hina %on#inued #o /e #he
&0
lar*e'# de0elo)in* %oun#r- re%i)ien# +i#h I61 /illion in F5I in.lo+'$ Fur#hermore4 a
ne+ de'#ina#ion o. F5I ha' '#ron*l- emer*ed in Ce'# A'ia +i#h in.lo+' ri'in* .rom
I6$5 /illion #o I9$ /illion /e#+een 2003 and 2004$ (oun#rie' li7e &audi Ara/ia4 &-ria
and Tur7e- +ere iden#i.ied a' #he ma;or re%i)ien#' in #ha# re*ion4 re%ei0in* more #han
hal. o. #he #o#al in.lo+ #o #ha# re*ion$ In addi#ion4 ?a#in Ameri%a and #he (ari//ean
re*i'#ered a 'i*ni.i%an# u)'ur*e o. F5I in.lo+' in 20044 rea%hin* I6 /illion K 44J
more #han i#' le0el in 2003$ F5I in.lo+' #o &ou#h-!a'# !uro)e and #he (I&4 a ne+
*rou) o. e%onomie' under #he Eni#ed Aa#ion' re%la''i.i%a#ion4 *re+ a# an all-#ime
hi*h ra#e o. more #han 40J in 20044 rea%hin* I35 /illion$
A%%ordin* #o EA(TA5 2200534 F5I .ur#her in%rea'e' in F5I #o de0elo)in* %oun#rie'
are ex)e%#ed in #he near .u#ure due #o ex)e%#ed .a0ora/le e%onomi% *ro+#h +ide
')read %on'olida#ion4 %or)ora#e re'#ru%#urin*4 )ro.i# *ro+#h )er'i'#en%e and #he
%on#inua#ion o. #he )ur'ui# o. ne+ mar7e#' /- indu'#rie' in #he 'our%e %oun#rie'$
%'&' FDI in the GCC countries
1(( 21ul. (o-o)era#ion (oun%il3 %oun#rie' ha0e re%o*ni@ed #he im)or#an%e o.
a##ra%#in* F5I and hen%e ha0e ado)#ed ne+ mea'ure' aimin* a# a##ra%#in* .orei*n
%a)i#al and en%oura*in* .orei*n in0e'#men#$ The de0elo)men# )riori#ie' o. 1((
%oun#rie' in%lude a%hie0in* 'u'#ained e%onomi% *ro+#h a+a- .rom oil /- rai'in*
)ri0a#e in0e'#men# ra#e': '#ren*#henin* lo%al #e%hnolo*i%al %a)a%i#ie' and '7ill': and
im)ro0in* #he %om)e#i#i0ene'' o. #heir ex)or#' in +orld mar7e#'4 %rea#in* more and
/e##er em)lo-men# o))or#uni#ie' a+a- .rom *o0ernmen# 'e%#or$ >)enne'' #o .orei*n
%a)i#al and in.lo+ o. F5I ha' /een in')ired /- an ex)e%#a#ion #ha# #he- +ill /rin* in
in0i'i/le .inan%ial re'our%e'4 a##ra%#in* modern #e%hnolo*- and rai'in* #he e..i%ien%-
+i#h +hi%h exi'#in* #e%hnolo*ie' are u'ed$ In addi#ion4 F5I ma- )ro0ide a%%e'' #o
ex)or# mar7e#' and rai'e mar7e#in* %a)a/ili#ie' o. lo%al .irm'$ I# %an al'o u)*rade
'7ill' and mana*emen# #e%hni,ue' and 'e# u) '#a#e-o.-#he ar# #rainin* .a%ili#ie'$
The re%en# )ro.ile o. #he F5I .lo+ in#o 1(( %oun#rie' i' 'ummari@ed in #a/le' 1 and
2$ +hi%h 'ho+ #ha# F5I .lo+ ha' /een an im)or#an# .orm o. in0e'#men# in mo'# o.
1(( %oun#rie'$ A' a )er%en#a*e o. *ro'' %a)i#al .orma#ion4 F5I .lo+ ha' a%%oun#ed
.or more #han #he +orld a0era*e in #+o o. #he 'ix 1(( %oun#rie' 2Ha#ar and
&&
<aharain34 +hile re)or#in* a hi*h 'hare in #he o#her 1(( %oun#rie' in mo'# o. #he
-ear' )re'en#ed$ >n #he o#her hand4 ex%e)# .or #he Eni#ed Ara/ !mira#e'4 F5I '#o%7
ha' a%%oun#ed .or an im)or#an# 'hare %om)ared #o #he 0alue o. 159 in #he'e
%oun#rie'4 and #ha# +a' a))aren# in #he %a'e o. <ahrain4 in +hi%h F5I '#o%7 rea%hed
more #han 74J and 70J4 in 2000 and 2004 o. #he le0el o. 159 re')e%#i0el-$
.able &' 1(( and +orld F5I .lo+' and F5I '#o%7'4 'ele%#ed -ear''
F5I .lo+' a' a )er%en#a*e o. 1ro'' Fixed
(a)i#al .orma#ion
F5I '#o%7' a' a )er%en#a*e o.
159
8e*ionDe%onom- 2002 2003 2004 1990 2000 2004
<ahrain 14$9 27$ 41$1 13$0 74$1 70$5
Lu+ai# 0$2 - 1$9 - 0$5 0$2 1$7 0$7
>man 1$0 15$5 - 0$5 16$2 12$6 14$0
Ha#ar 15$5 13$9 13$4 1$0 10$ 14$6
&audi Ara/ia 1$3 2$0 4$3 13$ $9 $2
Eni#ed Ara/
!mira#e'
9$0 0$2 4$6 2$2 2$0 4$6
1orld 10$6 $3 7$5 $4 1$3 21$7
Develo2ed
economies
10$9 7$9 6$1 $2 16$3 20$5
Develo2ing
economies
9$5 $ 10$5 9$ 26$2 26$4
&our%e: %on'#ru%#ed .rom EA(TA5 2200534 Annex #a/le <$3$
.able ' 8an7in*' /- #he In+ard F5I 9er.orman%e Index4 2004 2 Min:1 4 Max
1403
3
<ahrain 27
Ha#ar 63
3
The EA(TA5 In+ard F5I 9er.orman%e Index i' a mea'ure o. #he ex#en# #o +hi%h a ho'# %oun#r- re%ei0e'
in+ard F5I rela#i0e #o i#' e%onomi% 'i@e$ I# i' %al%ula#ed a' #he ra#io o. a %oun#r-F' 'hare in *lo/al F5I in.lo+' #o
i#' 'hare in *lo/al 159$
&
EA! 104
>man 110
&audi Ara/ia 121
Lu+ai# 13
So)rce: constr)cted from EA(TA5 2200534 Ta/le I 10$
E'in* #he In+ard F5I 9er.orman%e Index )ro)o'ed /- EA(TA54 and )re'en#ed in
#a/le 24 .our o. #he 'ix 1(( %oun#rie' ha0e re%ei0ed a 'hare o. #he *lo/al F5I .lo+'
#ha# 'ur)a'' #heir *lo/al rela#i0e e%onom- 'i@e$ In *eneral4 F5I ha' /een '#ron*l-
)re'en# in #he e%onomie' o. #he 1(( %oun#rie' and4 #here.ore4 #he rela#ion'hi)
/e#+een F5I and e%onomi% *ro+#h in #he'e %our#ier' +arran#' %are.ul anal-'i'4 a' #hi'
rela#ion'hi) ha' no# /een '#udied4 #o #he /e'# o. our 7no+led*e$

(' 3ethodology
The #e'# .or %au'ali#- /e#+een F5I and e%onomi% 21593 *ro+#h in #he 1(( +ill /e
)er.ormed in #hree '#e)'$ Fir'#4 +e #e'# .or #he order o. in#e*ra#ion in #he 159 and F5I
#ime 'erie'$ &in%e #he #ime ')an o. #he indi0idual 'erie' i' rela#i0el- 'hor#4 re%en#l-
de0elo)ed )anel uni# roo# #e%hni,ue' +ill /e u#ili@ed in order #o in%rea'e #he )o+er o.
'u%h #e'#'$ &e%ond4 ha0in* e'#a/li'hed #he order o. in#e*ra#ion in #he 'erie'4 +e u'e
he#ero*eneou' )anel %oin#e*ra#ion #e'# .or #he lon* run rela#ion'hi)' /e#+een #he
0aria/le' in ,ue'#ion$ Finall-4 d-nami% he#ero*eneou' )anel %au'ali#- +ill /e u'ed #o
a''e'' #he 'hor# run %oin#e*ra#ion$ The dire%#ion o. %au'ali#- /e#+een #he #+o
0aria/le' i' #hen in')e%#ed u'in* he#ero*eneou' )anel %au'ali#- #e'#' $
('&' Heterogeneous Panel Unit *oot .est
9anel uni# roo# #e'#' are #radi#ionall- u'ed #o #e'# .or #he order o. in#e*ra#ion
2'#a#ionari#-3 in #he 0aria/le' o. #he da#a 'e#$ I# ha' /e%ome +ell-7no+n #ha# #he
#radi#ional Au*men#ed 5i%7e--Fuller 2A5F3-#-)e #o #e'#' o. uni# roo# 'u..er .rom #he
&%
)ro/lem o. lo+ )o+er in re;e%#in* #he null o. '#a#ionari#- o. #he 'erie'4 e')e%iall- .or
'hor#-')anned da#a$ 8e%en# li#era#ure 'u**e'#' #ha# )anel-/a'ed uni# roo# #e'#' ha0e
hi*her )o+er #han uni# roo# #e'#' /a'ed on indi0idual #ime 'erie'$ A num/er o. 'u%h
#e'#' ha0e a))eared in #he li#era#ure$ 8e%en# de0elo)men#' in #he )anel uni# roo# #e'#'
in%lude: ?e0in4 ?in and (hu 2??(3 2200234 Im4 9e'aran and &hin 2I9&3 2200334
Maddala and Cu 2199934 (hoi 2200134 and 6adri 220003$
From amon* di..eren# )anel uni# roo# #e'#' de0elo)ed in #he li#era#ure4 ??( and I9&
are #he mo'# )o)ular$ <o#h o. #he #e'#' are /a'ed on #he A5F )rin%i)le$ 6o+e0er4 ??(
a''ume' homo*enei#- in #he d-nami%' o. #he au#ore*re''i0e %oe..i%ien#' .or all )anel
mem/er'$ In %on#ra'#4 #he I9& i' more *eneral in #he 'en'e #ha# i# allo+' .or
he#ero*enei#- in #he'e d-nami%'$ There.ore4 i# i' de'%ri/ed a' a M6e#ero*eneou' 9anel
Eni# 8oo# Te'#N$ I# i' )ar#i%ularl- rea'ona/le #o allo+ .or 'u%h he#ero*enei#- in
%hoo'in* #he la* len*#h in A5F #e'#' +hen im)o'in* uni.orm la* len*#h i' no#
a))ro)ria#e$ In addi#ion4 'lo)e he#ero*enei#- i' more rea'ona/le in #he %a'e +here
%ro''-%oun#r- da#a i' u'ed$ In #hi' %a'e4 he#ero*enei#- ari'e' /e%au'e o. di..eren%e' in
e%onomi% %ondi#ion' and de*ree o. de0elo)men# in ea%h %oun#r-$ A' a re'ul#4 #he #e'#
de0elo)er' ha0e 'ho+n #ha# #hi' #e'# ha' hi*her )o+er #han o#her #e'#' in i#' %la''4
in%ludin* ??($
I9& /e*in' /- ')e%i.-in* a 'e)ara#e A5F re*re''ion .or ea%h %ro'' 'e%#ion 2%oun#r-3:
t i
p
*
* t i * i t i i i t i
i
y y y
4
1
4 4 1 4 4
+ + + =

=

213
+here y
i,t
2iO14 24P$$4A: #O1424PP$4T3 i' #he 'erie' .or )anel mem/er 2%oun#r-3 i o0er
)eriod t4 p
i
i' #he num/er o. la*' in #he A5F re*re''ion4 and #he error #erm' t i4

are
a''umed #o /e inde)enden#l- and normall- di'#ri/u#ed random 0aria/le' .or all iF' and
tF' +i#h @ero mean' and .ini#e he#ero*eneou' 0arian%e'
2
i

$ <o#h
i

and #he la* order

in 213 are allo+ed #o 0ar- a%ro'' 'e%#ion' 2%oun#rie'3$ 6en%e4 #he null h-)o#he'i'
#o /e #e'#ed i':
i +
i
= 4 0 :
0

&(
a*ain'# #he al#erna#i0e h-)o#he'i':
.or 'ome iF'$
.or a# lea'# one i$
The al#erna#i0e h-)o#he'i' 'im)l- im)lie' #ha# 'ome or all o. #he indi0idual 'erie' are
'#a#ionar-$ I9& de0elo)ed #+o #e'# '#a#i'#i%' and %alled #hem #he ?M-/ar and #he #-/ar
#e'#'$ The #-/ar '#a#i'#i%' i' %al%ula#ed u'in* #he a0era*e #-'#a#i'#i%' .or
i

.rom #he
'e)ara#e A5F re*re''ion' in #he .ollo+in* .a'hion:
,
p t
bar t
i
,
i
T i
,T
3 2
1
4
Q

=
=
223
+here T i
t
4 i' #he %al%ula#ed A5F '#a#i'#i%' .rom indi0idual )anel mem/er'$ E'in*
Mon#e (arlo 'imula#ion'4 I9& 'ho+ #ha# #he #-/ar i' normall- di'#ri/u#ed under #he
null h-)o#he'i'4 and i# ou#)er.orm' M-/ar in 'mall 'am)le'$ The- #hen u'e e'#ima#e'
o. i#' mean and 0arian%e #o %on0er# #-/ar in#o a '#andard normal R@-/arF '#a#i'#i% 'o #ha#
%on0en#ional %ri#i%al 0alue' %an /e u'ed #o e0alua#e i#' 'i*ni.i%an%e$ The @-/ar #e'#
'#a#i'#i% .or 0-la* i' de.ined a':
3 1 4 0 2
S 0 T 0arU
S3 0 T U 2
Q
Q Q
Q
,
bar t
t E bar t ,
-
i ,T
i T ,T
bar t

=
=
=

233
+here
Q
t
i' a' de.ined /e.ore4
S 0 T U
Q
=
i T
t E
and
S 0 T 0arU
Q
=
i ,T
bar t
are #he mean
and 0arian%e o.
it
t
$ In #heir Ta/le 24 I9& 220033 )ro0ide exa%# %ri#i%al 0alue' o. #he t-
bar
,T
'#a#i'#i% .or 'ome A4T ran*e' and .or #he 14 54 10J %on.iden%e le0el'$ The I9&
uni# roo# #e'# i' u'ed in #hi' )a)er #o #e'# .or '#a#ionari#- o. #he )anel da#a o/#ained .or
#he 1(( %oun#rie'$
('' Heterogeneous Panel Cointegration
&)

=
0
0
:
1

i
i
+

The %on%e)# o. %oin#e*ra#ion +a' .ir'# in#rodu%ed in#o #he li#era#ure /- 1ran*er
21903$ (oin#e*ra#ion im)lie' #he exi'#en%e o. a lon*-run rela#ion'hi) /e#+een
e%onomi% 0aria/le'$ The )rin%i)le o. #e'#in* .or %oin#e*ra#ion i' #o #e'# +he#her #+o or
more in#e*ra#ed 0aria/le' de0ia#e 'i*ni.i%an#l- .rom a %er#ain rela#ion'hi) 2A/adir and
Ta-lor419993$ In o#her +ord'4 i. #he 0aria/le' are %oin#e*ra#ed4 #he- mo0e #o*e#her
o0er #ime 'o #ha# 'hor#-#erm di'#ur/an%e' +ill /e %orre%#ed in #he lon*-#erm$ Thi'
mean' #ha# i.4 in #he lon*-run4 #+o or more 'erie' mo0e %lo'el- #o*e#her4 #he
di..eren%e /e#+een #hem i' %on'#an#$ >#her+i'e4 i. #+o 'erie' are no# %oin#e*ra#ed4
#he- ma- +ander ar/i#raril- .ar a+a- .rom ea%h o#her 25i%7e- e#$ al$4 19913$
Fur#her4 1ran*er 21913 'ho+ed #ha# +hen #he 'erie' /e%ome' '#a#ionar- onl- a.#er
/ein* di..eren%ed on%e 2in#e*ra#ed o. order one34 #he- mi*h# ha0e linear %om/ina#ion'
#ha# are '#a#ionar- +i#hou# di..eren%in*$ In #he li#era#ure4 'u%h 'erie' are %alled
M%oin#e*ra#edN$ I. in#e*ra#ion o. order one i' im)lied4 #he nex# '#e) i' #o u'e
%oin#e*ra#ion anal-'i' in order #o e'#a/li'h +he#her #here exi'#' a lon*-run rela#ion'hi)
amon* #he 'e# o. #he in#e*ra#ed 0aria/le' in ,ue'#ion$ !arlier #e'#' o. %oin#e*ra#ion
in%lude #he 'im)le #+o-'#e) #e'# /- !n*le and 1ran*er 2!1 herea.#er3 21973$
6o+e0er4 #he !1 me#hod 'u..er' .rom a num/er o. )ro/lem'$ Al#erna#i0el-4 !n*le
and Voo 21973 2!V4 herea.#er3 3-'#e) )ro%edure ha0e /een +idel- re%o*ni@ed a'
dealin* +i#h mo'# o. #he'e )ro/lem'$ Ae0er#hele''4 a )ro/lem remain' +hi%h i' #ha#
/o#h !1 and !V me#hod' %anno# deal +i#h #he %a'e +here more #han one
%oin#e*ra#in* rela#ion'hi) i' )o''i/le$ 6en%e4 Bohan'enF' We%#or Au#o 8e*re''ion
2WA83 #e'# o. in#e*ra#ion 2Bohan'en4 193 u'e' a R'-'#em'F a))roa%h #o %oin#e*ra#ion
#ha# allo+' de#ermina#ion o. u) #o r linearl- inde)enden# %oin#e*ra#in* 0e%#or' 2r *-
14 +here * i' #he num/er o. 0aria/le' #e'#ed .or %oin#e*ra#ion3$ The Bohan'enF'
)ro%edure i' u'e.ul in %ondu%#in* indi0idual %oin#e*ra#ion #e'#'4 /u# doe' no# deal +i#h
%oin#e*ra#ion #e'# in )anel 'e##in*'$
8e%o*ni@in* #he 'hor#%omin*' o. #radi#ional )ro%edure'4 #hi' '#ud- u#ili@ed #he #+o
#-)e' o. #he he#ero*eneou' )anel %oin#e*ra#ion #e'# de0elo)ed /- 9edroni 219974
19993 +hi%h4 in addi#ion #o u'in* )anel da#a #here/- o0er%omin* #he )ro/lem o.
&+
'mall 'am)le'4 allo+' di..eren# indi0idual %ro''-'e%#ion e..e%#' /- allo+in* .or
he#ero*enei#- in #he in#er%e)#' and 'lo)e' o. #he %oin#e*ra#in* e,ua#ion$
9edroniF' me#hod in%lude' a num/er o. di..eren# '#a#i'#i%' .or #he #e'# o. #he null o. no
%oin#e*ra#ion in he#ero*eneou' )anel'
4
$ The .ir'# *rou) o. #e'#' i' #ermed M+i#hin
dimen'ionN$ I# in%lude' #he )anel-04 )anel rho2r34 +hi%h i' 'imilar #o #he 9hilli)' and
9erron 2193 #e'#4 )anel non-)arame#ri% 2))3 and )anel )arame#ri% 2ad.3 '#a#i'#i%'$
The )anel non-)arame#ri% '#a#i'#i% and #he )anel )arame#ri% '#a#i'#i% are analo*ou' #o
#he 'in*le-e,ua#ion A5F-#e'#$ The o#her *rou) o. #e'#' i' %alled M/e#+een dimen'ionN$
I# i' %om)ara/le #o #he *rou) mean )anel #e'#' o. Im e# al$ 219973$ The M/e#+een
dimen'ionN #e'#' in%lude .our #e'#': *rou)-rho4 *rou)-))4 and *rou)-ad. '#a#i'#i%'$
The 'e0en o. 9edroniF' #e'#' are /a'ed on #he e'#ima#ed re'idual' .rom #he .ollo+in*
lon* run model:
it
m
*
*it *i i it
& y + + =

=1
243
+here it t i i it
. + =
3 1 2

are #he e'#ima#ed re'idual' .rom #he )anel re*re''ion$
The null h-)o#he'i' #e'#ed i' +he#her i

i' uni#-$ The 'e0en '#a#i'#i%' are normall-

di'#ri/u#ed$ The '#a#i'#i%' %an /e %om)ared #o a))ro)ria#e %ri#i%al 0alue'4 and i. %ri#i%al
0alue' are ex%eeded #hen #he null h-)o#he'i' o. no-%oin#e*ra#ion i' re;e%#ed im)l-in*
#ha# a lon* run rela#ion'hi) /e#+een #he 0aria/le' doe' exi'#$
('%' Causality
9edroniF' he#ero*eneou' )anel %oin#e*ra#ion me#hod #e'#' onl- .or #he exi'#en%e o.
lon* run rela#ion'hi)'$ The #e'#' indi%a#e #he )re'en%e or a/'en%e o. lon* run lin7'
/e#+een #he 0aria/le'4 /u# do no# indi%a#e #he dire%#ion o. %au'ali#- +hen #he 0aria/le'
are %oin#e*ra#ed$ (au'ali#- i' #radi#ionall- #e'#ed /- #he '#andard #+o-'#e) !1
%au'ali#- )ro%edure$ 6o+e0er4 in our )anel 'e##in*'4 #radi#ional e'#ima#ion #e%hni,ue'
+ill re'ul# in in%on'i'#en# )arame#er e'#ima#e' re'ul#in* .rom mea'uremen# error' and
omi##ed 0aria/le )ro/lem'$ There.ore4 +e a))l- #he 1eneral Me#hod o. Momen#'
21MM3 d-nami% )anel e'#ima#or a' de0elo)ed /- 6ol#@-!a7in e#$ al$ 21941993 and
4
Interested readers may refer to Pedroni (2004) for details and mathematical representations of the
tests.
&,
Arellano and <ond 219913$ The 1MM me#hod %an hel) redu%e #he e'#ima#ion /ia'
o.#en inheren# in )anel da#a e'#ima#ion$ I# %on#rol' .or )ro/lem' o.#en a''o%ia#ed +i#h
%ro''-'e%#ional e'#ima#or'$ The'e in%lude uno/'er0ed )ro/lem' a''o%ia#ed +i#h
%oun#r--')e%i.i% and #ime-')e%i.i% e..e%#'4 endo*enei#- in ex)lana#or- 0aria/le'4 and
+hen la**ed de)enden# 0aria/le' are u'ed a' re*re''or'$
To #e'# .or )anel %au'ali#-4 #he mo'# +idel- u'ed me#hod in #he li#era#ure i' #ha#
)ro)o'ed /- 6ol#@-!a7in et/ al/ 21941993$ Their #ime-'#a#ionar- WA8 model i' o.
#he .orm:
it yi
m
*
* it *
m
*
* it * it
) f 0 Y Y + + + + =

=

1 1
0

it &i
m
*
* it *
m
*
* it * it
f 0 Y 0 + + + + =

=

1 1
0
253
+here
it
Y
and
it
0
are #he #+o %o-in#e*ra#ed 0aria/le'4 iO14P$$4A re)re'en#' %ro''-
'e%#ional )anel mem/er'4
it
)
and
it
v
are error #erm'$ Thi' model di..er' .rom #he
'#andard %au'ali#- model in #ha# i# add' #+o #erm'4 f
&i
and f
yi
+hi%h are indi0idual
.ixed e..e%#' .or #he )anel mem/er i$
In #he e,ua#ion' a/o0e4 #he la**ed de)enden# 0aria/le' are %orrela#ed +i#h #he error
#erm'4 in%ludin* #he .ixed e..e%#'$ 6en%e4 >?& e'#ima#e' o. #he a/o0e model +ill /e
/ia'ed$ The remed- i' #o remo0e #he .ixed e..e%#' /- di..eren%in*$ The re'ul#in*
model i':
it
m
*
* it *
m
*
* it * it
) 0 Y Y + + =

=

1 1

it
m
*
* it *
m
*
* it * it
v 0 Y 0 + + =

=

1 1

263
6o+e0er4 di..eren%in* in#rodu%e' a 'imul#anei#- )ro/lem /e%au'e la**ed endo*enou'
0aria/le' in #he ri*h# hand 'ide are %orrela#ed +i#h #he ne+ di..eren%ed error #erm$ In
addi#ion4 he#ero'%eda'#i%i#- i' ex)e%#ed #o /e )re'en# /e%au'e4 in #he )anel da#a4
he#ero*eneou' error' mi*h# exi'# +i#h di..eren# )anel mem/er'$ To deal +i#h #he'e
)ro/lem'4 in'#rumen#al 0aria/le )ro%edure i' #radi#ionall- u'ed in e'#ima#in* #he
model4 +hi%h )rodu%e' %on'i'#en# e'#ima#e' o. #he )arame#er'$
&-
A''umin* #ha# #he
it
)
and
it

are 'eriall- un%orrela#ed4 #he 'e%ond or more la**ed

0alue' o.
it
Y
and
it
0
ma- /e u'ed a' in'#rumen#' in #he in'#rumen#al 0aria/le
e'#ima#ion 2!a'#erl- et/ al$4 19973$ Then4 #o #e'# .or #he %au'ali#-4 #he ;oin# h-)o#he'e'
m * for
*
4$$$$$4 1 0 = =
and
m * for
*
4$$$$$4 1 0 = =
i' 'im)l- #e'#ed$
The #e'# '#a#i'#i%' .ollo+ a (hi-',uared di'#ri/u#ion +i#h 21-m3 de*ree' o. .reedom$
The 0aria/le 0 i' 'aid no# #o 1ran*er-%au'e #he 0aria/le Y i. all #he %oe..i%ien#' o.
la**ed X in e,ua#ion 23 are no# 'i*ni.i%an#l- di..eren# .rom @ero4 /e%au'e i# im)lie'
#ha# #he hi'#or- o. 0 doe' no# im)ro0e #he )redi%#ion o. Y$ A +idel- u'ed e'#ima#or .or
#he '-'#em in 23 i' an in'#rumen#al 0aria/le e'#ima#or4 #he )anel 1enerali@ed Me#hod
o. Momen#' 21MM3 e'#ima#or4 )ro)o'ed /- Arellano and <ond 219913$ Thi' me#hod
ha' /een 'ho+n #o )rodu%e more e..i%ien# and %on'i'#en# e'#ima#or' %om)ared +i#h
o#her )ro%edure'$ The la* len*#h 1 i' %ho'en #o 'a#i'.- #he %la''i%al a''um)#ion'
%on%ernin* #he error #erm$
)' Data and em2irical results
The 1(( i' a ne+ /lo%7 o. %oun#rie'$ &u..i%ien#l- lon* #ime 'erie' in #he 1((4 #ha#
are ne%e''ar- .or %au'ali#- #e'#'4 are no# %urren#l- a0aila/le$ 6o+e0er4 a%7no+led*in*
#he )ro/lem' a''o%ia#ed +i#h 'mall 'am)le'4 )anel da#a are u'ed #o #e'# .or %au'ali#-
/e#+een 159 and F5I$ E'in* )anel da#a allo+' u' #o *ain more o/'er0a#ion' /-
)oolin* #he #ime 'erie' da#a a%ro'' 'e%#ion'4 leadin* #o hi*her )o+er .or #he 1ran*er-
#-)e %au'ali#- #e'#'$ 1(( F5I 'erie' +ere %om)iled .rom EA(TA5 re)or#'$ The
'erie' o. real 159 +ere o/#ained .rom MCorld !%onomi% >u#loo74 2005N$ All da#a
are annual and ')an #he -ear' 1970-2004$
The anal-'i' i' '#ar#ed /- #he #e'# o. #he '#a#i'#i%al )ro)er#ie' o. #he da#a 'erie' u'ed$
Fir'#4 #he order o. in#e*ra#ion in ea%h o. #he 159 and F5I 'erie' i' #e'#ed$ The u))er
)ar# o. Ta/le 'ummari@e' #he #e'# re'ul#' .or #he indi0idual )anel %oun#rie' and 'erie'$
&#andard indi0idual A5F #e'# re'ul#' are in%luded .or #he 'a7e o. %om)ari'on$ The la*
len*#h' +ere %ho'en u'in* A7ai7e In.orma#ion (ri#eria 2AI(3$ The I9& re'ul#'
indi%a#e4 in *eneral4 #ha# #he null o. a uni# roo# .or #he indi0idual 'erie' i' no# re;e%#ed
.or all o. #he 'erie' #e'#ed a# #heir le0el' +i#h a mixed re'ul#' .or #he indi0idual #e'#'$
1i0en #he 'hor# ')an o. #he indi0idual 'erie'4 +e are more %on.iden# #o a%%e)# #he
more )o+er.ul I9& )anel #e'# re'ul#'4 +hi%h undou/#edl- do no# re;e%# #he uni# roo#
null o. uni# roo#' .or #he )anel +i#h 210 o/'er0a#ion'$ >n #he o#her hand4 #he null o.
&/
uni# roo#' i' '#ron*l- re;e%#ed a# #he 1J 'i*ni.i%an%e le0el .or all 'erie' a# #heir .ir'#
di..eren%e$ The re'ul#' '#ron*l- 'u))or# #he %on%lu'ion #ha# #he 'erie' are '#a#ionar-
onl- a.#er /ein* di..eren%ed on%e$ 6en%e4 #he I9& #e'# in #he lo+er )ar# o. Ta/le
indi%a#e' #ha# #he 'erie' are in#e*ra#ed o. order one 4 i$e$4 I213 a# #he 1J 'i*ni.i%an%e
le0el$ In /rie.4 #he #e'# re'ul#' on #he le0el' o. 159 and F5I indi%a#e a .ailure #o re;e%#
#he null o. non'#a#ionari#-$ 6o+e0er4 .ir'#-di..eren%ed 'erie' /e%ome '#a#ionar-
a%%ordin* #o #he I9& #e'# re'ul#'$
6a0in* e'#a/li'hed #ha# #he F5I and 159 'erie' are in#e*ra#ed o. #he .ir'# order4 #he
'e%ond '#e) in #e'#in* #he rela#ion'hi) /e#+een F5I and 159 i' #o #e'# .or #he
%oin#e*ra#ion rela#ion'hi) /e#+een #he #+o 0aria/le'4 in order #o de#ermine i. #here i' a
lon*-run rela#ion'hi) /e#+een #he #+o 0aria/le'$ The #e'# .or #he lon*-run rela#ion'hi)
/e#+een /o#h 0aria/le' u'in* 9edroniF' he#ero*eneou' )anel #e'# +a' %ondu%#ed$
Ta/le 4 re)or#' #he he#ero*eneou' )anel %oin#e*ra#ion #e'# re'ul#'$ I# %an /ee 'een .rom
#he #e'# re'ul#' in #he #a/le #ha# 5 ou# o. 7 o. 9edroniF' '#a#i'#i%' 'i*ni.i%an#l- re;e%# #he
null o. no %oin#e*ra#ion$ Thi' im)lie' a lon* run %o-mo0emen# o. F5I and 159 in #he
lon* run$ Tha# i'4 #here i' a lon*-run '#ead--'#a#e rela#ion'hi) /e#+een F5I and 159
.or #he )anel o. 1(( %oun#rie'4 e0en +hen +e allo+ .or %oun#r--')e%i.i% e..e%#'$
>n%e +e ha0e e'#a/li'hed a %oin#e*ra#ion rela#ion'hi) /e#+een F5I and 1594
#hen +e ma- %on%lude #ha# #here exi#' a lon*-run rela#ion'hi) /e#+een #he #+o
0aria/le'4 e0en i. #he- are indi0iduall- non-'#a#ionar-$ Ce #here.ore )o'#ula#e #ha#
#here i' a 21ran*er3 %au'ali#- /e#+een F5I and 159 a# lea'# in one dire%#ion and
)o''i/l- in /o#h dire%#ion'$ There.ore4 a.#er %on.irmin* #he lon* run rela#ion'hi)
/e#+een our 0aria/le'4 +e nex# #e'# .or #heir %au'ali#- h-)o#he'i'$ Ce deal +i#h #he
)ro/lem o. ;oin# endo*enei#- o. 159 and F5I4 and #he )o''i/ili#- o. #+o-+a-
%au'ali#-4 /- u'in* in'#rumen#al 0aria/le e'#ima#ion4 em)ha'i@in* on #he
he#ero*eneou' a')e%#' o. our )anel$ Tha# i' /e%au'e a''umin* a homo*eneou' )anel
+hen %oun#r- e..e%#' are a%#uall- he#ero*eneou' ma- lead #o o/#ainin* /ia'ed re'ul#'$
Ce al'o %on'ider #he d-nami% na#ure o. #he rela#ion'hi) +hen #e'#in* .or 1ran*er
%au'ali#-$ I*norin* 'u%h d-nami% a')e%# o. #he da#a re)re'en#' Gno# onl- a lo'' o.
)o#en#iall- im)or#an# in.orma#ion /u# %an lead #o 'eriou' mi'')e%i.i%a#ion /ia'e' in #he
e'#ima#ionG 26a,ue and Lim4 20033$
0
.able % A5F and I9& uni# roo# #e'#'
Country GDP FDI
#evel &
st
Di$$erence
#evel &
st
Di$$erence
Constant
Constant
4.rend
Constant
Constant
4.rend
Constant
Constant4
.rend
Constant
Constant 4
.rend
5ahrain -1$3 -2$36 -2$5 -2$34 - 2$41 -4$03*** - 6$4 *** -6$71***
!uwait -2$06 -2$74 -3$91** -3$52* - 2$35 -2$27 - 5$06 *** -5$05***
6man -0$32 -1$0 -3$75** -2$74 - 1$25 -1$74 - 3$96 *** -3$91**
7atar -1$74 -0$63 -2$75 -3$02 - 0$35 -1$21 - 5$72 *** -6$90***
8audi Arabia -2$36 -2$0 -4$29*** -3$32* - 2$90 * -2$5 - 4$2 *** -4$20***
UAE -1$90 -4$61*** -3$05 -5$03 *** - 1$50 -2$09 - 4$77 *** -4$94***
Panel Unit *oot .est 9IP8: test:
-0$63 -1$11 -3$77*** -3$76*** -0$57 -0$75 -9$62*** -9$01***
;otes:
***&i*ni.i%an# a# 1J 'i*ni.i%an%e le0el$
**&i*ni.i%an# a# 5J 'i*ni.i%an%e le0el$
*&i*ni.i%an# a# 10J 'i*ni.i%an%e le0el
.able & 9edroniF' 6e#ero*eneou' 9anel (oin#e*ra#ion Te'# 8e'ul#'
Te'# &#a#i'#i%' Walue
)anel 0-'#a# 0$67
)anel rho-'#a# -1$62**
)anel ))-'#a# -3$03***
)anel ad.-'#a# -3$49***
*rou) rho-'#a# -0$24
*rou) ))-'#a# -3$16***
*rou) ad.-'#a# -3$65***
***&i*ni.i%an# a# 1J le0el **&i*ni.i%an# a# 5J le0el
There.ore4 #o #e'# .or %au'ali#-4 #he 1MM e'#ima#ion )ro%edure a' ou#lined in Arellano
and <ond 219913 i' a))lied #o #he /alan%ed )anel o. #he 'ix 1(( %oun#rie' da#a +i#h
35 annual o/'er0a#ion' .or ea%h %oun#r-$ Thi' )ro%edure deal' +i#h #he e'#ima#ion'
)ro/lem' men#ioned a/o0e$ The e'#ima#ed '-'#em i' o. #he .orm:
it
m
*
* it *
m
*
* it * it
) %D2 3D4 3D4 + + =

=

1 1

it
m
*
* it *
m
*
* it * it
%D2 3D4 %D2 + + =

=

1 1
273
Chere F5I re)re'en#' #he ne# .lo+ o. .orei*n dire%# in0e'#men#4 159 re)re'en#' real
)er %a)i#a *ro'' dome'#i% )rodu%#4 iO 1424P$46 re)re'en# %oun#rie'4 and tO 1424
PP$435 re)re'en# #ime )eriod' 2-ear'3$
The null h-)o#he'e' #e'#ed are:
6 4$$$$$4 1 0 = = * for
*

6 4$$$$$4 1 0 = = * for
*

23
The re'ul#' o. #he 1MM e'#ima#e' o. #he model are re)or#ed in Ta/le 2 $ The #a/le
al'o re)or#' #he #e'#' u'ed #o %hoo'e /o#h #he la* len*#h and #he a))ro)ria#e
in'#rumen#' u'ed in e'#ima#ion$ Fir'#4 de#erminin* #he o)#imal la* '#ru%#ure i' done
u'in* Cald #e'#$ The #e'# re;e%#' #he h-)o#he'i' o. no 'e%ond la* in /o#h #he 159 and
F5I e,ua#ion'4 in .a0or o. #+o la* '#ru%#ure$
.able ' G33 estimation and causality results
To #e'# .or %au'ali#- /e#+een 159 and F5I4 +e #urn #o Cald #e'#$ Ta/le 2 re)or#' #he
e'#ima#ed %oe..i%ien#' and #he Cald #e'# .or #he null o. no %au'ali#- a' re)re'en#ed /-
23$ In #he F5I e,ua#ion4 #he Cald #e'# indi%a#e' #ha# %au'ali#- run' .rom 159 #o F5I
a' #he #e'# re;e%#' #he null o. no %au'ali#- a# #he 1J 'i*ni.i%an%e le0el'$ >n #he o#her
hand4 #he e0iden%e indi%a#e' #ha# %au'ali#- i' runnin* .rom F5I #o 159 in #he 159
e,ua#ion a' +ell$ The Cald re;e%#' #he null o. no %au'ali#- a# #he 'ame 'i*ni.i%an%e
le0el'$ There.ore4 +e ma- %on%lude #ha# in #he 1((4 e0iden%e indi%a#e' a /i-
dire%#ional %au'ali#- runnin* /e#+een 159 and .orei*n dire%# in0e'#men#$
To ma7e 'ure #ha# our %hoi%e o. in'#rumen#' +a' 0alid in e'#ima#ion4 +e #e'# .or #he
o0er-iden#i.-in* re'#ri%#ion' u'in* &ar*an #e'#4 +hi%h i' %ommon #e'# o. #he 0alidi#- o.
in'#rumen#al 0aria/le' u'ed in e'#ima#ion$ The h-)o#he'i' /ein* #e'#ed i' #ha# #he
in'#rumen#al 0aria/le' are un%orrela#ed +i#h re'idual'4 and #here.ore ma- /e u'ed in
Estimated Coe$$icients De2endent <ariable
GDP9 lags: FDI9 lags:
159
i#-1
0$272
20$003
0$11
20$343
F5Ii#-1 -0$001
20$053
-0$442
20$003
159i#-2 -0$232
20$003
0$101
20$243
F5Ii#-2 -0$0002
20$533
-0$272
20$013
Cald ?a* ?en*#h Te'#:
Aull 6-)o#he'i': 2mO13
37$29
20$003
11$6
20$003
&ar*an Te'#F' 9-0alue 20$33 20$993
1ald Causality .est
Aull 6-)o#he'i': F5I doe' no# %au'e 159 159 doe' no# %au'e F5I
49$55
20$003***
4$66
20$003***
Aum/er' in )aren#he'e' are #he )-0alue'$
*** &i*ni.i%an# a# 1J le0el
%
e'#ima#ion$ The '#a#i'#i% i' a'-m)#o#i%all- di'#ri/u#ed %hi-',uared i. #he null
h-)o#he'i' i' #rue$ The re'ul#' 'ho+ #ha#4 +hen u'in* all la**ed 0alue' o. #he 0aria/le'
a' in'#rumen#' .or #O3 and earlier4 #he &ar*an #e'# doe' no# re;e%# #he 0alidi#- o. #hi'
'e# o. in'#rumen#' in /o#h e,ua#ion'$ Thi' im)lie' #he 0alidi#- o. #he in'#rumen#' u'ed
in e'#ima#ion$
+' Conclusion and Policy Im2lications
Thi' )a)er i' de0o#ed #o ex)lore #he dire%#ion o. in#era%#ion /e#+een F5I and
e%onomi% *ro+#h in #he 1(( %oun#rie' u'in* a )anel %oin#e*ra#ion .rame+or7$ In
mo'# o. #he )re0iou' '#udie'4 #he rela#ion'hi) /e#+een F5I and *ro+#h had /een
'#udied )re'umin* %au'ali#- runnin* .rom F5I #o 159 *ro+#h$ The ma;ori#- o. #he
li#era#ure on #he 'u/;e%# u'e *ro+#h model' in #he %on#ex# o. *ro+#h a%%oun#in* #o #e'#
.or #he 'i*ni.i%an%e o. F5I a' an exo*enou' 0aria/le in #he *ro+#h e,ua#ion$ In
addi#ion4 #ime 'erie' da#a a# #he %oun#r- le0el ha0e /een #radi#ionall- u'ed$ In #hi'
ar#i%le4 +e ado)# a di..eren# a))roa%h #o #e'# #he F5I-159 rela#ion'hi)$ 8a#her #han
)re'umin* #ha# F5I i' one o. #he de#erminan#' o. e%onomi% *ro+#h4 +e #e'# .or 'u%h
a''um)#ion$ To %ondu%# 'u%h #e'#4 +e u'e he#ero*eneou'-)anel %oin#e*ra#ion and
%au'ali#- #e%hni,ue' #o #e'# .or #he )o''i/ili#- o. %au'ali#- runnin* .rom F5I #o 159$
In addi#ion4 +e #e'# .or #he )o''i/ili#- o. re0er'e %au'ali#- runnin* .rom 159 #o F5I$
The re'ul#' o/#ained in #hi' re'ear%h4 +hi%h are /a'ed on he#ero*eneou' )anel
%oin#e*ra#ion #e%hni,ue'4 in addi#ion #o #he 1MM e'#ima#or #ha# allo+ .or %oun#r--
')e%i.i% he#ero*enei#- o. all )arame#er'4 indi%a#e a '#ron* %au'al lin7 .rom F5I #o
159 and 0i'e 0er'a$ The re'ul#' indi%a#e #ha#4 in #he 1((4 F5I ha' /een an im)or#an#
.a%#or in #hi' /lo%7F' e%onomi% *ro+#h$ Thi' re'ul# %on.irm' )re0iou' e0iden%e
o/#ained /- a num/er o. +ri#er' .or o#her %oun#rie'4 and i' in a%%ordan%e +i#h #he
endo*enou' *ro+#h h-)o#he'i'$ The 'ame re'ul#' al'o %on.irm #he e..e%# o. #heir hi*h
159 *ro+#h ex)erien%ed durin* mo'# o. #he )eriod '#udied on #he )a%e o. F5I .lo+
in#o #he'e %oun#rie'$ In *eneral4 #he #+o-+a- %au'ali#- /e#+een 159 and F5I ha'
'ome im)li%a#ion'$ >n one hand4 #he e%onomi% *ro+#h o. #he 1(( %oun#rie' ma-
.ur#her /ene.i# .rom F5I in.lo+' #o #he e%onomie' o. #hi' /lo%7 o. %oun#rie'$ The
(
'e%ond i' #ha# 1(( %oun#rie' ma- /ene.i# .rom .ur#her ado)#in* )oli%ie' #ha# a##ra%#'
F5I .lo+' in#o #heir e%onomie'$
In )ar#i%ular4 our .indin*' indi%a#e #ha# +hile F5I )romo#e *ro+#h4 159
*ro+#h al'o a##ra%# more F5I in.lo+'$ In o#her +ord4 hi*her *ro+#h o. 1(( %oun#rie'=
159 i' #he dri0in* .or%e /ehind #he 'ur*e in F5I in.lo+' in addi#ion #o /ein* a
%on'e,uen%e o. #he'e in.lo+'$ Thi' i''ue ha' im)or#an# )oli%- im)li%a#ion'$ The
re'ul#' 'u**e'# #ha# #here i' a )o'i#i0e %orrela#ion /e#+een F5I in.lo+' and *ro+#h in
a /idire%#ional +a-$ Thu'4 i. 159 *ro+#h 'eem' #o a##ra%# more F5I in.lo+'4 #hen
)romo#ional )oli%ie' #o en%oura*e in+ard .lo+' o. F5I onl- ma- /e%ome
unne%e''ar-$ In'#ead4 e..or#' 'hould /e dire%#ed #o o#her )o#en#ial 'our%e' o. *ro+#h$
>n%e *ro+#h i' enhan%ed and '#imula#ed4 .orei*n %a)i#al +ill #hen /e a##ra%#ed$
1(( %oun#rie' 'hould al'o /e 'ele%#i0e in a##ra%#in* F5I$ In %on#ra'# #o o#her
de0elo)in* %oun#rie'4 1(( %oun#rie' ha0e a/undan# .inan%ial re%our'e' and dome'#i%
in0e'#men# %ould .inan%e #heir de0elo)men#$ 6o+e0er4 in.lux o. F5I ha' *rea#
)o#en#ial #o -ield hi*her *ro+#h #hrou*h hi*her e..i%ien%- in )h-'i%al and human
%a)i#al and #hrou*h )o'i#i0e ex#ernali#ie' 'u%h a' .a%ili#a#in* #ran'i#ion and di..u'in*
#e%hnolo*- a' +ell a' in#rodu%#ion o. al#erna#i0e mana*emen# )ra%#i%e'4
or*ani@a#ional arran*emen#4 and im)ro0ed en#re)reneurial '7ill'$ Ae0er#hele''4 F5I
ex#ernali#ie' ma- ha0e #ri0ial e..e%#' i. #he lin7' +i#h lo%al /u'ine'' +ere +ea7$ Thu'4
)oli%ie' 'hould /e ado)#ed #o '#ren*#hen #he rela#ion'hi) /e#+een F5I and dome'#i%
in0e'#men#' and 'u%h rela#ion'hi) ha' #o /e %om)lemen#ar- ra#her #han %om)e#i#i0e$ I#
i' al'o im)or#an# #o ado)# )oli%- mea'ure' #o dee)en #he dome'#i% %a)i#al mar7e#' /-
in%rea'in* 'a0in*' and de0elo)in* a '#ron* dome'#i% in'#i#u#ional in0e'#or /a'e and
'#ren*#henin* #he )ruden#ial 'u)er0i'ion o. .inan%ial mar7e#'$ 9ri0a#i@a#ion i' /ein*
u'ed 4+i#h *rea# 'u%%e'' in man- de0elo)in* %oun#rie'4 a' a 0ehi%le #o dee)en %a)i#al
mar7e#' and en%oura*e .orei*n dire%# in0e'#men#$ Chile all 1(( %oun#rie' '#ar#ed #he
)ro%e'' o. )ri0a#i@in* '#a#e-o+ned en#er)ri'e' and o)enin* u) )ri0a#e in0e'#men#
o))or#uni#- in #ele%ommuni%a#ion'4 air-line'4 #ouri'm4 and 'ome indu'#rie' 'u%h a'
)e#ro%hemi%al'4 %emen#4 and u#ili#ie'4 more e..or# 'hould /e )u# #o ex)edi#e #he
)ro%e'' #o+ard de%rea'in* #he role o. #he *o0ernmen# in #he mar7e# and )ro0idin*
/e##er in%en#i0e' and in'#i#u#ional re,uiremen#' .or )ri0a#e in0e'#men#$
!m)iri%al '#udie'
5
'u**e'# #ha# %a)i#al in.lo+' more /ene.i%ial and %rea#e le''
)ro/lem i. #he- are lon*-#erm4 and in #he .orm o. dire%# in0e'#men#4 indu%ed /-
5
For exam)le 'ee <aharum'hah4 e#$al 220063
)
*ro+#h )ro')e%#' o. #he e%onom-4 in0e'#ed in )h-'i%al a''e#' #han %on'umed and
dome'#i%all- indu%ed$ A' o))o'ed #o 'hor#-#erm )or#.olio in0e'#men#4 lon*-#erm F5I
ha' )o'i#i0e ')ill o0er e..e%# on #he e%onom-$ &hor#-#erm in0e'#men# and )or#.olio
in0e'#men#' are o.#en a''o%ia#ed +i#h in%rea'e in %on'um)#ion and %au'e .ra*ili#- in
#he .inan%ial '-'#em'$ 8e%en#l-4 #he 1(( %oun#rie' ha0e +i#ne''ed 'hor#-#erm
in0e'#men# /oom in e,ui#- and real e'#a#e mar7e#' and o#her lo+ )rodu%#i0i#- and
non-#rada/le 'e%#or$ &u%h in0e'#men# ma- re'ul# in )ro/lem o. %a)i#al ine..i%ien%- and
ma- hinder e%onomi% *ro+#h #hrou*h ex#ernali#- emana#ed durin* /o#h #he 'ur*e and
'udden re0er'al' 2<aharum'hah: 20064 ) 13$ Thu'4 i# i' im)or#an# .or 1(( %oun#rie'
#o im)ro0e #he ,uali#- o. F5I #ha# #he- %an a##ra%#$ Theor-
6
al'o 'u**e'#' #ha#
un%er#ain %a)i#al .lo+' and a more 0ola#ile )ro.ile o. F5I in.lo+' are *ro+#h
re#ardin*$ A%%ordin*l-4 a 7e- )oli%- o)#ion i' #o main#ain a '#ead- '#ream o. .orei*n
%a)i#al .lo+' and #o minimi@e #he .lu%#ua#ion' in #he'e in.lo+'$
The ne+ +a0e o. *lo/ali@a#ion '+ee)in* #hrou*h #he +orld ha' in#en'i.ied #he
%om)e#i#ion .or F5I amon* de0elo)in* %oun#rie'$ Thu' %on%en#ra#ed e..or#' are
needed a# /o#h na#ional and re*ional le0el in order #o a##ra%# 'i*ni.i%an# F5I .lo+' #o
#he 1(( %oun#rie' and im)ro0e )ro')e%#' .or 'u'#ained *ro+#h and de0elo)men#$
1(( %oun#rie' 'hould +or7 #o*e#her #o de'i*n and .ormula#e ade,ua#e )oli%ie' #o
a##ra%# '#a/le in0e'#men# .lo+'$ The- mu'# #a7e )oli%- mea'ure' #ha# +ould
'u/'#an#iall- enlar*e and di0er'i.- #heir e%onomi% /a'e4 )oli%ie' #ha# +ould im)ro0e
lo%al '7ill' and /uild u) a '#o%7 o. human %a)i#al re%our'e' %a)a/ili#ie'4 enhan%e
e%onomi% '#a/ili#- and li/erali@e #heir mar7e# in order #o /ene.i# .rom lon*-#erm F5I
in.lo+'$
The re%en# )a##ern o. F5I .lo+' #o 1(( %oun#rie' ha' /een #o+ard #he oil
'e%#or$ A##ra%#in* F5I #o #he ex#ra%#i0e 'e%#or4 i$e oil 'e%#or4 )ro0ed no# #o /e *ro+#h
enhan%in* a' mu%h a' o#her )rodu%#i0e 'e%#or'
7
$ >il 'e%#or i' o.#en an en%la0e 'e%#or
+i#h li##le /a%7+ard and in+ard lin7a*e' +i#h o#her 'e%#or'$ The 1(( %oun#rie'
%ould /ene.i# .rom in%rea'ed F5I in#o #he oil 'e%#or i. #he 'e%#or i' li/erali@ed and
in#e*ra#ed in#o #he e%onom-$
1ro+#h enhan%in* )oli%ie' %ou)led +i#h 'ound ma%roe%onomi% )oli%ie' .o'#er
a heal#h- ra#e o. re#urn' #o in0e'#men# and hen%e a##ra%# F5I$ To maximi@e #he /ene.i#
o. F5I 1(( %oun#rie' 'hould e'#a/li'h in0e'#men# a*en%ie'4 im)ro0e #he lo%al
6
?en'in7 and Morri''e- 220013
7
&ee A7inlo 220043$
+
re*ula#or- en0ironmen#4 de0elo) #he lo%al .inan%ial mar7e#4 and enhan%e #ran')aren%-
in ma%roe%onomi% )oli%ie'$ A 'ound and #ran')aren# le*al '-'#em *o0ernin* .inan%ial
#ran'a%#ion 'hould /e )u# in )la%e$ A %en#ral /od- or in'#i#u#ion 'hould /e e'#a/li'hed
#o )romo#e and mar7e# in0e'#men# o))or#uni#- and a##ra%# *enuine F5I$
Finall-4 #he'e .indin*' ma- )ro0ide u'e.ul in.orma#ion .or #he .ormula#ion o. a
*eneral '#ra#e*- #ha# %on'ider 1(( %oun#rie' a' /lo%7 +hen ne*o#ia#in* /u'ine''
deal' and a##ra%# .orei*n dire%# in0e'#men#$ I# i' 0er- di..i%ul# .or a 'mall %oun#r-4 +i#h
limi#ed dome'#i% mar7e# #o e'#a/li'h a 0ia/le %a)i#al mar7e# and a##ra%# lar*e-'%ale
in0e'#men#$ A%%ordin*l-4 mone#ar- %oo)era#ion i' re,uired and re*ional %a)i#al
mar7e# 'hould /e 'u))or#ed and in0e'#men# o))or#uni#- 'hould /e )romo#ed a# #he
re*ional le0el$
,
*e$erences
A/adir4 Larim M and Ta-lor4 A$ M$ 19994 M>n #he 5e.ini#ion' o. (o-in#e*ra#ionG
Bournal o. Time &erie' Anal-'i'4 20 223$
A7inlo4 A$ 2004 GForei*n dire%# in0e'#men# and *ro+#h in Ai*eria: An em)iri%al
in0e'#i*a#ion4G Bournal o. 9oli%- Modelin* 264 627K639
Arellano4 M$4 and <ond4 &$ 8$ 219913$ G&ome Te'#' o. &)e%i.i%a#ion .or 9anel 5a#a:
Mon#e (arlo !0iden%e and an A))li%a#ion #o !m)lo-men# !,ua#ion'4G 8e0ie+ o.
!%onomi% &#udie'4 54 277-297$
<ahraumahah4 A$Y and M$A$ Thanoon 220063 GForei*n (a)i#al .lo+ and e%onomi% *ro+#h
in !a'# A'ian (oun#rie'G 56ina Economic 7evie.,17 220063 70-3$
<arro4 8$ B$ and X$ &ala-i-Mar#in4 19954 !%onomi% 1ro+#h4 Ae+ Vor7: M%1ra+-6ill$
<arro4 8 B$4 2199134 G!%onomi% 1ro+#h in a (ro'' &e%#ion o. (oun#rie'4G Huar#erl-
Bournal o. !%onomi%' Wol$ 1064 Ao$ 24 ))$ 407 - 443$
<arro4 8 B$4 and Xa0ier &ala-i-Mar#in4 2199534 !%onomi% 1ro+#h4 M%1ra+-6ill4 <o'#on$
<en*oa4 M$ and <lan%a &an%he@-8o/le' 2200334 GForei*n dire%# in0e'#men#4 e%onomi%
.reedom and *ro+#h: ne+ e0iden%e .rom ?a#in Ameri%a4G !uro)ean Bournal o. 9oli#i%al
!%onom-4 Wol$ 19 220033 529K545
<ha'in4 A$4 Bun4 L$ and 9$ !%onomu4 19944 =A''e''in* #he &u'#aina/ili#- o. Forei*n
5ire%# In0e'#men# Flo+'=4 Corld <an74 In#erna#ional !%onomi%' 5e)ar#men#$
<u%7le-4 9$ B$4 B$ (le**4 and ($ Can* 220023: MThe im)a%# o. in+ard F5I on #he
)er.orman%e o. (hine'e manu.a%#urin* .irm'4N Bournal o. In#erna#ional <u'ine''
&#udie'4 332434 637K655$
(ar7o0i%4 M$ and 8$ ?e0ine 2200234 R5oe' Forei*n 5ire%# In0e'#men# A%%elera#e
!%onomi% 1ro+#hZF Cor7in* 9a)er 2Eni0er'i#- o. Minne'o#a 5e)ar#men# o. Finan%e4
a0aila/le a#: +++DD''rn$%omDa/'#ra%#O3149243$
(hoe4 B$ I$ 2200334 G5o Forei*n 5ire%# In0e'#men# and 1ro'' 5ome'#i% In0e'#men#
9romo#e !%onomi% 1ro+#hZG4 8e0ie+ o. 5e0elo)men# !%onomi%'4 74 14 44K57$
(hoi4 I$4 2001$ Eni# roo# #e'#' .or )anel da#a$ Bournal o. In#erna#ional Mone- and
Finan%e 204 249-272$
5eMello4 ?$8$4 Br$ 219973$ Forei*n dire%# in0e'#men# in de0elo)in* %oun#rie': A
'ele%#i0e 'ur0e-$ Bournal o. 5e0elo)men# &#udie'4 342134 1K34$
5eMello4 ?$8$4 Br$ 219993$ Forei*n dire%# in0e'#men#-led *ro+#h: !0iden%e .rom #ime
'erie' and )anel da#a$ >x.ord !%onomi% 9a)er'4 512134 133K151$
5i%7e-4 5$ A$4 Ban'en4 5$ C$ and Thorn#on4 5$ ($ 219913$ MA 9rimer on (oin#e*ra#ion
+i#h An A))li%a#ion #o Mone- and In%omeN4 8e0ie+ Federal 8e'er0e <an7 o. &T$
?oui'4 73 2234 5-7$
!??!84 M$4 9$ 6AI&&4 and L$ &T!IA!8 220053 GForei*n 5ire%# In0e'#men# in #he
Finan%ial &e%#or: The !n*ine o. 1ro+#h .or (en#ral and !a'#ern !uro)eZG
-
!uro)aIn'#i#u# Cor7in* 9a)er Ao$ 694 Wienna Eni0er'i#- o. !%onomi%' and <u'ine''
Admini'#ra#ion$
!n*le4 8$ F$ and Voo4 <$&$4197$ Fore%a'#in* and Te'#in* in (oin#e*ra#ed &-'#em'4
Bournal o. !%onome#ri%' 354 143-59$
1ran*er4 ($ C4 B$ 21903 ?on* memor- rela#ion'hi)' and #he a**re*a#ion o. d-nami%
model'$ Bournal o. !%onome#ri%'$ 144 227-3$
1ran*er4 ($ C$ B$ 219693$ In0e'#i*a#in* %au'al rela#ion' /- e%onome#ri% model' and
%ro''-')e%#ral me#hod'$ !%onome#ri%a4 354 424K43$
1ran*er4 ($C$ B$4 191$ &ome )ro)er#ie' o. #ime 'erie' da#a and #heir u'e in e%onome#ri%
model ')e%i.i%a#ion$ Bournal o. !%onome#ri%' 164 121-30$
1ui'in*er4 &$4 19924 G8ehor#i% and 8eali#- in In#erna#ional <u'ine'': A no#e on #he
!..e%#i0ene'' o. In%en#i0e'G4 Tran'na#ional (or)ora#ion'4 14 )) 111-23$
6an'en4 6$ and B$ 8and4 20064 G>n #he (au'al ?in7' /e#+een F5I and 1ro+#h in
5e0elo)in* (oun#rie'G4 Corld 5e0elo)men# 294 21-41$
6ardi4 L$4 2000$ Te'#in* .or &#a#ionari#- in 6e#ero*eneou' 9anel 5a#a$ !%onome#ri%
Bournal 34 14K61$
6ol#@-!a7in4 5$4 Ae+e-4 C$ and 8o'en 6$ &$4 199$ The re0enue'-ex)endi#ure nexu':
e0iden%e .rom lo%al *o0ernmen# da#a$ In#erna#ional !%onomi% 8e0ie+ 304 415- 29$
6ol#@-!a7in4 5ou*la'4 Chi#ne- Ae+e-4 and 6ar0e- &$ 8o'en4 21934 M!'#ima#in*
We%#or Au#ore*re''ion' +i#h 9anel 5a#a4N !%onome#ri%a 564 Ao$ 64 Ao0em/er4 ))$ 1371
- 1395$
6'iao4 ($ 2200334 Analysis o$ Panel Data4 (am/rid*e: (am/rid*e Eni0er'i#- 9re''$
Im4 L$&$4 9e'aran4 M$6$4 &hin4 V$4 2003$ GTe'#in* .or uni# roo#' in he#ero*eneou'
)anel'G4 Bournal o. !%onome#ri%' 1154 53-74$
IMF 2199334 G<alan%e o. 9a-men#' ManualG Fi.#h !di#ion 2Ca'hin*#on4 5$($4
In#erna#ional Mone#ar- Fund4 19933
Bohan'en4 &$4 19$ &#a#i'#i%al anal-'i' o. %oin#e*ra#ion 0e%#or'$ Bournal o. !%onomi%'
5-nami%4 124 231-54$
?en'in74 8$4 and >$ Morri''e- 220013$ MForei*n 5ire%# In0e'#men#: Flo+'4 Wola#ili#- and
1ro+#h in 5e0elo)in* (oun#rie'$N Eni0er'i#- o. Ao##in*ham4 (8!5IT 8e'ear%h 9a)er$
?e0ine4 A$4 ?in4 ($ F$4 (hu4 ($ &$4 2002$ Eni# roo# #e'#' in )anel da#a: a'-m)#o#i% and
.ini#e-'am)le )ro)er#ie'$ Bournal o. !%onome#ri%' 104 1-24$
?i)'e-4 8$4 1999$ The lo%a#ion and %hara%#eri'#i%' o. E$&$ a..ilia#e' in A'ia$ A<!8
Cor7in* 9a)er Ao$ 676$ (am/rid*e4 MA
?o0e4 B$4 ?a*e-6idal*o4 F$4 2000$ Anal-'in* #he de#erminan#' o. E& dire%# in0e'#men# in
Mexi%o$ A))lied !%onomi%' 324 1259K 1267$
Maddala4 1$&$4 Cu4 &$C$4 1999$ (om)ara#i0e '#ud- o. uni# roo# #e'#' +i#h )anel da#a
and a ne+ 'im)le #e'#$ >x.ord <ulle#in o. !%onomi%' and &#a#i'#i%' 61$
/
Aair-8ei%her#4 E'ha and 5iana Ceinhold 220013 G(au'ali#- #e'#' .or %ro''-%oun#r-
)anel': a ne+ loo7 a# F5I and e%onomi% *ro+#h in de0elo)in* %oun#rie'$G >x.ord
<ulle#in o. !%onomi%' and &#a#i'#i%'4 63 2234 2001$
>/+ona4 M$4 2001$ 5e#erminan#' o. F5I and #heir im)a%# on e%onomi% *ro+#h in
E*anda$ A.ri%an 5e0elo)men# 8e0ie+ 134 46K 1$
9edroni4 9$4 1997$ 9anel %oin#e*ra#ion4 a'-m)#o#i% and .ini#e 'am)le )ro)er#ie' o.
)ooled #ime 'erie' #e'#'4 +i#h an a))li%a#ion #o #he 999 h-)o#he'i': ne+ 8e'ul#'$ Indiana
Eni0er'i#-4 Cor7in* 9a)er in !%onomi%'4 5e%em/er$
9edroni4 9$4 1999$ (ri#i%al Walue' .or (oin#e*ra#ion Te'#' in 6e#ero*eneou' 9anel' +i#h
Mul#i)le 8e*re''or'$ >x.ord <ulle#in o. !%onomi%' and &#a#i'#i%' 614 653K67$
9erron4 9$4 1991$ Te'#in* (on'i'#en%- +i#h War-in* &am)lin* Fre,uen%-$ !%onome#ri%
Theor- 74 341-6
&adi74 Ali4 and <ol/ol4 Ali$ 20014 (a)i#al Flo+'4 F5I4 and Te%hnolo*- &)illo0er': !0iden%e
.rom Ara/ (oun#rie'$ Corld 5e0elo)men#$ 29 2123: 2111-2125$
Tun*4 &$4 (ho4 &$4 2001$ 5e#erminan#' o. re*ional in0e'#men# de%i'ion' in (hina: an
e%onome#ri% model o. #ax in%en#i0e )oli%-$ 8e0ie+ o. Huan#i#a#i0e Finan%e and
A%%oun#in* 174 167K15$
EA(TA5 2199634 Corld In0e'#men# 8e)or#$ Eni#ed Aa#ion' (on.eren%e on Trade and
5e0elo)men#$ Ae+ Vor7 and 1ene0a4 1996$
EA(TA5 2200534 Corld In0e'#men# 8e)or#$ Tran'na#ional (or)ora#ion' and #he
In#erna#ionali@a#ion o. 8[54 Eni#ed Aa#ion' (on.eren%e on Trade and 5e0elo)men#$
Ae+ Vor7 and 1ene0a4 2005$
Corld <an7$220053 Corld 5e0elo)men# 8e)or#$ GA <e##er In0e'#men# (lima#e For
!0er-oneG4 The Corld <an74 Ca'hin*#on 5$ ($4 2005$
%0