This paper investigates empirically the impact of FDI on economic growth of Turkey and Pakistan over the period of 1975-2004. To analyse the causal relationship between FDI and economic growth, the Engle-Granger cointegration and Granger causality tests are used. It is found that these two variables are cointegrated for both countries studied. Our empirical findings suggest that it is GDP that causes FDI in the case of Pakistan, while there is strong evidence of a bi-directional causality between the two variables for Turkey.Economic growth, foreign direct investment, Granger causality

Kalyoncu, Huseyin

Ozturk, Ilhan

English

Research Papers in Economics

ECONOMIA INTERNAZIONALE, Volume 60, No. 1, 75-82, February 2007 
  1 
 
Foreign Direct Investment and Growth:  
An Empiricial Investigation Based on Cross-Country Comparison 
 
by 
Ilhan Ozturk
1 & Huseyin Kalyoncu
2 
 
 
Abstract 
 
This paper investigates empirically the impact of FDI on economic growth of Turkey and 
Pakistan over the period of 1975-2004. To analyse the causal relationship between FDI and 
economic growth, the Engle-Granger cointegration and Granger causality tests are used. It is 
found  that  these  two  variables  are  cointegrated for  both  countries  studied.  Our  empirical 
findings suggest that it is GDP that causes FDI in the case of Pakistan, while there is strong 
evidence of a bi-directional causality between the two variables for Turkey. 
  
Key words: Economic growth, foreign direct investment, Granger causality, 
 
JEL Classification: O4, F21, C32 
                                                 
1 Senior Lecturer, Faculty of Economics and Administrative Sciences, Cag University, 33800, Yenice, Mersin, 
Turkey.  Email: ilhanozturk@cag.edu.tr  Tel: +90 324 6514800, Fax: +90 324 6514811. 
2 Assist. Prof. Dr., Department of Economics, Niğde University, 51000, Niğde, Turkey.  
Email: hkalyoncu@nigde.edu.tr  
 ECONOMIA INTERNAZIONALE, Volume 60, No. 1, 75-82, February 2007 
  2 
I. INTRODUCTION 
During the fluctuation of capital flows in the 1990s, foreign direct investment (FDI) was 
the  main  source of  flows to developing countries. Unlike other capital  flows, FDI  is  less 
volatile and does not show a pro-cyclical behaviour. It has therefore become the “favourite 
capital inflows” for developing countries. FDI increased rapidly during the late 1980s and the 
1990s in almost every region of the world, revitalizing the long and contentious debate about 
the costs and benefits of FDI inflows. On one hand, many would argue that, given appropriate 
policies and a basic level of development, FDI can play a key role in the process of creating a 
better  economic  environment.  On  the  other,  potential  drawbacks  do  exist,  including  a 
deterioration of the balance of payments as profits are repatriated and negative impacts on 
competition in national markets.  
At present, the consensus view seems to be that there is a positive association between 
FDI  inflows  and  growth  provided  receiving  countries  have  reached  a  minimum  level  of 
educational, technological and/or infrastructure development. However, there is no universal 
agreement  about  the  positive  association  between  FDI  inflows  and  economic  growth. 
Research that focuses on data from only less developed countries (LDC’s) has tended to find a 
clear  positive  relationship,  while  studies  that  have  focused  on  data  from  only  developed 
countries (DC’s), have found no growth benefit for the recipient country. 
As mentioned by Chowdhury and Mavrotas (2005), a large number of empirical studies 
on the role of FDI in host countries suggests that FDI: is an important source of capital, 
complements  domestic  private  investment  which  is  usually  associated  with  new  job 
opportunities; enhances both technology transfer and spillover and human capital (knowledge 
and skill) enhancement boosts overall economic growth in host countries
3. 
Concerning developing countries, macro-empirical work on the FDI-growth relationship 
has shown that—subject to a number of crucial factors, such as the trade regime, the human 
capital base in the host country, financial market regulations, banking system and the degree 
of openness in the economy—FDI has a positive impact on overall economic growth
4. 
                                                 
3 See de Mello (1997, 1999) for a comprehensive survey of the nexus between FDI and growth as well as for 
further evidence on the FDI-growth relationship, Asiedu (2002), Chakrabarti (2001) and Tsai (1994) on the 
determinants  of  FDI,  Blomstrom  and  Kokko  (1998)  for  a  critical review  of  the  role  of  FDI  in  technology 
transfer.  
4 See Balasubramanyam et al. (1996, 1999) and Borensztein et al. (1998), and Nair-Reichert and Weinhold 
(2001) for a critical assessment of the empirical literature. See Aitken and Harrison (1999) and Harrison (1994) 
regarding recent assessments for the micro studies at the firm level that examine the impact of FDI on growth in 
developing countries. 
 ECONOMIA INTERNAZIONALE, Volume 60, No. 1, 75-82, February 2007 
  3 
The rest of the paper is organized as follows: Section II describes the methodology 
employed and the sources of data collected. Section III reports the estimated results, and the 
last section is the conclusion. 
 
II. MODEL SPECIFICATION AND DATA 
We use the following empirical model to investigate the impact of FDI on economic 
growth:  
GDP =  +  * FDI    (1) 
The empirical analysis employs annual data on GDP and FDI for Turkey over the 
period of 1975-2004 and for Pakistan over the period of 1976-2004. The data for Turkey and 
Pakistan are obtained from the World Bank Development Indicators 2004 and WDI Online.  
Figure 1 shows the total amount of FDI as a percentage of GDP for these countries. All the 
variables considered in the model are expressed in natural logarithms. 
 
Figure 1. FDI in Pakistan and Turkey (% of GDP) 
0
0,5
1
1,5
2
2,5
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
Pakistan Turkey
 
 
III. EMPIRICAL RESULTS 
In this section we analyze the time-series properties of the data. We have conducted 
the Augmented Dickey-Fuller (ADF) unit root test. These unit-root tests are performed on 
both levels and first differences of all variables. 
Table I reports the results of non-stationary tests for FDI and GDP series for Turkey 
and Pakistan using Augmented Dickey-Fuller (ADF) test. We reported a constant but no time 
trend result of ADF tests. Test results indicate that the hypothesis of a unit root in FDI and 
GDP  cannot be rejected as a level while the hypothesis of a unit root in FDI and GDP is ECONOMIA INTERNAZIONALE, Volume 60, No. 1, 75-82, February 2007 
  4 
rejected as a first difference at least at the 5 percent level of confidence, indicating that all the 
variables in question are integrated of order one I(1). 
   
Table I: ADF unit roots test results 
  Level  AIC(lag)  First Difference  AIC(lag) 
Turkey:         
FDI  -1,683  -0.350 (0)  -8.759 *  0.908 (0) 
GDP  -0,593  -2.362 (0)  -5.569 *  -2.327 (0) 
Pakistan:         
FDI  -2,184  -0.445 (0)  -5.067 *  -0.272 (0) 
GDP  -1,704  -4.044 (0)  -4.114 *  -3.950 (0) 
                     Note: * denote significiantly at the 5% level. 
 
 
Having  established  that  all  variables  are  integrated  of  the  same  order,  we  have 
conducted the Engle-Granger’s (EG) residual-based ADF test. As the first step of the EG 
cointegration test, we estimated Equation (1) using the OLS method. The second step of the 
EG procedure is to check the stationarity of residuals by using the ADF test. Table II presents 
the results from Engle-Granger (EG) cointegration test. These results indicate that long-run 
equilibrium exists between GDP and FDI for Turkey and Pakistan since test statistics are 
above the 5 percent critical value.   
 
 
Table II: Results for EG Cointegration Tests 
 
Country  Model  ADF 
Pakistan     
  GDP = 7.434 + 0.384* FDI   -2,996 0* 
Turkey     
  GDP = 8.629 + 0.289*FDI   -4,202 0* 
                Notes: * denote significiantly at the 5%  level in ADF column. 
 
 
If there exists a cointegration vector between GDP and FDI, there is causality among 
these variables at least in one direction. The Granger Test for causality is such a technique 
searching the direction of causality between the variables. There are four possible outcomes 
regarding causal relationships between GDP and FDI: uni-directional causality from GDP to 
FDI or vice versa; bi-directional causality between the two variables; and, finally, lack of any 
causal relationship. 
  Table III reports the causality test results for both Turkey and Pakistan. Lag length is 
selected by using the SC criterion. The probability values for F statistics are given on the right 
side of Table III. If these probability values are less than any  level, then the hypothesis 
would be rejected at that level. We found bi-directional causality between GDP and FDI for 
Turkey. On the other hand, we found uni-directional causality running from GDP to FDI for ECONOMIA INTERNAZIONALE, Volume 60, No. 1, 75-82, February 2007 
  5 
Pakistan. The content of policy implications has been determined according to the direction of 
causality between these two variables. 
 
Table III: Results for Granger CausalityTests 
 
Null Hypothesis:  Lag  F-Statistic  Prob.  Result 
Turkey:         
  FDI does not Granger Cause GDP  1  8.05161  0.00870  FDI  GDP 
  GDP does not Granger Cause FDI  8.87343  0.00620   
Pakistan         
  FDI does not Granger Cause GDP  1  0.05412  0.81793  GDP  FDI 
  GDP does not Granger Cause FDI  5.50660  0.02717   
 
 
IV. CONCLUSION 
The paper examines the causal relationship  between  FDI and economic growth by 
using Engle-Granger cointegration and Granger causality tests for Turkey and Pakistan over 
the period 1975-2004. We found that it is GDP that causes FDI in the case of Pakistan, while 
for Turkey, there is a strong evidence of a bi-directional causality between the two variables.  
 
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Foreign Direct Investment and Growth: An Empiricial Investigation Based on Cross-Country Comparison

Foreign Direct Investment and Growth: An Empiricial Investigation Based on Cross-Country Comparison

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