foreign direct investment, financial development and economic growth

IntroductionLiterature Review

Theoretical Framework: (Hermes Lensink, 2003Data and Context

MethodologyResults

Conclusions

Foreign Direct Investment, Financial Developmentand Growth: The case of Ecuador

Mario Alvaracın Paula

School of Graduate StudiesUniversidad Carlos Tercero de Madrid

September, 2014

Mario Alvaracın Paula FDI, Financial Development and Growth in Ecuador



MethodologyResults

Conclusions

Outline

1 IntroductionThe causal relationship between Financial Development and Economic GrowthWhy is this study important?

2 Literature ReviewFinancial Development and GrowthFDI, Financial Development and Growth

3 Theoretical Framework: (Hermes Lensink, 2003Growth Model with Technological Change

4 Data and ContextSelection of Variables and DefinitionPutting in Context

5 MethodologyBound Test ApproachEstimated Model

6 ResultsStationarity TestEstimation Output

7 Conclusions




MethodologyResults

Conclusions

The causal relationship between Financial Development and Economic GrowthWhy is this study important?

The causal relationship between Financial Developmentand Economic Growth

Schumpeter (1911): Well-functioning Banks are able toidentify entrepreneurs that allow funds to be channeled to themost promising investment projects. Efficiency

Robinson (1952): Economic Growth creates demand forfinancial services, thereby existence of financial development.

Levine et al. (2000): Exogenous components of financialintermediary development are positively associated withEconomic Growth.

FinancialDevelopment => EconomicGrowth.




MethodologyResults

Conclusions

The causal relationship between Financial Development and Economic GrowthWhy is this study important?

Why is this study important?

Neoclasical growth model states that developing countries willexperience rapid convergence with developed countries, oncethey have access to state of the art technologies. But,developing countries can´t assume the cost, so FDI isimportant.

Explore the long run relationship between FDI and economicgrowth, watching if the development of financial sector helpsto capture the absorptive capacity to FDI inflows toward realoutput expansions.

This study aims to observe if financial sector development actas an efficient mechanism when transferring the benefitsembroiled in FDI inflows to enhance economic growth.




MethodologyResults

Conclusions

Financial Development and GrowthFDI, Financial Development and Growth

Financial Development and Growth

Nexus established in Levine (1997), role of financial system

Acemoglu and Zilibotti (1997): Financial developmentpretends to make markets become less incomplete; capitalaccumulation is associated with an increase in the volume offinancial intermediation and services

Rioja and Valev (2003): Relationship may vary according tothe level of financial development.

Russeau and Wachtel (2011): Countries that has experiencedfinancial crisis episodes may not have a clear finance-growthrelationship.




MethodologyResults

Conclusions

Financial Development and GrowthFDI, Financial Development and Growth

FDI, Financial Development and Growth

Hermes and Lensink (2003): The development of the financialsystem of the recipient country is an important preconditionfor FDI to have a positive impact on economic growth.Efficient allocation of resources.

Alfaro et al. (2004): The level of development of localfinancial markets is crucial to canalize the positive effects ofFDI. The link between FDI and growth is causal, where FDIpromotes growth through financial markets.

Many authors conclude that well developed financial marketspromote higher economic growth by absorbing the benefitsembodied in the foreign capital flows, especially FDI




MethodologyResults

Conclusions

Growth Model with Technological Change

The Model

Constant rate of return

Where η represents the cost in research and development, L isthe labor supply, A indicates the level of technology, αmeasures capital´s share of income or the proportion ofcapital income.




MethodologyResults

Conclusions


The Model

FDI is introduced in the model by assuming that there arefixed maintenance costs, equal to 1, and fixed set up costs inη.

The cost of η (research and development) depends on FDI,explicitly the higher FDI inflow leads to a decline in theinnovation costs.

Innovation cost function

η = f (F )

Where F = FDI , and δη/δF < 0




MethodologyResults

Conclusions


The Model

The level of technology (A) is a function of the developmentof the financial sector

(H), A = h(H), where δA/δH > 0.

Constant rate of return




MethodologyResults

Conclusions


The Model

Households maximize a standard inter-temporal utilityfunction, subject to the budget constraint. This gives thewell-known Euler condition for the consumption growth rate

gC = (1/θ)(r − ρ),where θ is the elasticity of marginal utility and ρ is the

discount rate.

Outputs growth rate




MethodologyResults

Conclusions

Selection of Variables and DefinitionPutting in Context

Variables

Dependent Variable

Real GDP growth rate per capita

Independent Variable

Labor force (LF)

Capital stock (CAP)

Foreign direct investment to GDP ratio (net outflows ofinvestment from the reporting economy to the rest of theworld and is divided by GDP, FDI)

Domestic gross investment to GDP ratio (gross fixed capitalformation to real GDP, INV)

Interaction term between the Foreign Direct Investment andfinancial development indicators listed below.




MethodologyResults

Conclusions


Variables

Financial Development Indicators

DEPHT: liquid liabilities of the financial system, known as M2divided by GDP

BANK: commercial and central bank assets (assets of depositmoney banks divided by assets of deposit money banks pluscentral bank assets)

PRIVATE: private credit (credit by deposit money banks andother financial institutions to the private sector divided byGDP)




MethodologyResults

Conclusions


Financial Development and FDI evolution




MethodologyResults

Conclusions


GDPpc annual growth rate




MethodologyResults

Conclusions

Bound Test ApproachEstimated Model

Bound Test Approach

Works on a limited simple size

Use ARDL model for the estimation of long-run relationship

Robust asymptotic on short and long-run parameters can bemade under least squares estimates of an ARDL model

The asymptotic distribution of the F-statistc is non-standardunder the null hypothesis of no cointegration relationshipbetween the examined variables

ARDL model has the advantage of not requiring a preciseidentification of the order of the underlying data




MethodologyResults

Conclusions


Relationship between economic growth and itsdeterminants without investment variable (INV)




MethodologyResults

Conclusions


Relationship between economic growth and itsdeterminants including investment variable (INV)




MethodologyResults

Conclusions


Long-run relationship test

Without INV

H0 : β1 = β1 = ... = β6 = 0

With INV

H0 : β1 = β1 = ... = β7 = 0

F>upper bound value; the null hypothesis of no long runrelationship is rejected and concludes that there existssteady-state equilibrium between these variables

F<lower bound value; the null hypothesis is not rejected

lower bound value< F >upper bound value; the result isinconclusive Mario Alvaracın Paula FDI, Financial Development and Growth in Ecuador



MethodologyResults

Conclusions

Stationarity TestEstimation Output

Results of the Unit Root Test




MethodologyResults

Conclusions


Estimated model using BANK as financial developmentindicator




MethodologyResults

Conclusions


Cointegration Analysis




MethodologyResults

Conclusions


Estimated model using BANK and incliding INV




MethodologyResults

Conclusions


Cointegration Analysis including INV




MethodologyResults

Conclusions

Main Conclusions

It has been determined the existence of long-run levelsrelationship between economic growth and its determinants

The best variable or the completest one is BANK to reflectthe development of the financial system

Including the variable INV changes substantially the effects,principally of FDI on economic growth, as the inclusion of INVrepresents a situation in which a variable affects growth via anefficiency channel

Financial crisis could affect the relationship between FDI,Financial Development and Growth


foreign direct investment, financial development and economic growth

Economy & Finance