FDI Inflow and Impact on Economy


Several scholars and policy makers agree that Foreign Direct Investment (FDI) inflows have significant positive impacts on the economic development aspects of the host country. Apart from the direct capital used to finance its supplies, Cho (2003) asserts that FDI can be a key source of valuable know-how and technology as well forging linkages with domestic enterprises; this can play an instrumental role in jumpstarting the economy. Using these arguments as a theoretical basis, both developed and developing nations have provided numerous incentives, which act as the determinants of FDI, in order to foster FDI in their economies (Choe 2003).

However, recently, the merits associated with the FDI and the effectiveness of the incentives offered to foreign corporations is becoming questioned. This debate is further fuelled by the fact that empirical evidence linking FDI to positive economic spillovers for host nations is unclear at both the macro and micro levels (De Mello 1999). When surveying existing literature, Hanson (2001) asserts that the evidence, that links FDI to positive economic spillovers, is rather weak. Gorg & Greenwood (2002), when reviewing microdata relating to the spillovers from foreign firms to domestic firms, concludes that the effects are generally negative. However, Lipsey (2002) took a rather favorable point of view when reviewing micro literature and pointed out evidence of positive impacts ensuing from FDI. Nevertheless, Lipsey (2002), when reviewing macrodata, concluded that there is no consistent relationship between FDI inward flows and economic growth and Gross Domestic Product (GDP). In this regard, Lipsey (2002) argued that it is imperative to analyze the various scenarios that tend to either promote or hinder economic spillovers from FDI inflows. It is apparent that there is clear evidence regarding the interplay between FDI and economic growth.

This primary purpose of this research is to investigate the role that FDI plays in Saudi Arabia’s economy, particularly with regard to the causality between FDI and associated macroeconomic variables and the key determinants of the FDI. In addition, the paper analyzed the sectoral distribution of FDI in Saudi Arabia.

Research Questions

The following research questions will be used:

  1. What are the key determinants of FDI and their relative significances that help in attracting FDI in Saudi Arabia?
  2. How do FDI inflows vary across the key economic sectors in Saudi Arabia and what are the reasons for these variations?
  3. How does FDI affect to the economic growth of Saudi Arabia?

Theoretical Framework

In this study, the most important emphasis will be on the impact of FDI on economic growth. There are several studies that have investigated this relationship. Nevertheless, with regard to this research, the theoretical orientation used is derived from Borenstein, De Gregorio & Lee (1988). The authors maintained that sufficient absorptive capability and necessary technology of the host/receiving nation is needed for FDI attraction. Moreover, correlation and reasoning will be used as the primary elements of this research, especially when determining the linkages between the variables of both economic growth and FDI inflows.

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The study will adopt a quantitative research design, which entails the use statistical analysis techniques to model relationships between variables. For the aims of this research, historical data will be used, wherein secondary data will be sourced from government records, statistical bulletins, business and academic journals.

Graphs and Correlation Coefficients

According to Dees (1998), the most ideal statistical technique to model the relationship between FDI and GDP is the Granger causality test, which is deployed to determine whether a time series data can be helpful in predicting another. In the context of this study, time series data relating to GDP and FDI in Saudi Arabia will be correlated to predict whether an increase in FDI inflows in Saudi Arabia can result in an increase in GDP (Hermes 2003). In order to determine the key determinants of FDI and their relative significances in Saudi Arabia, this paper will analyze how significant the known FDI determinants (GDP, trade openness, business costs in Saudi Arabia, infrastructure, institutions and government policies, and human capital/labor endowments in Saudi Arabia) are in attracting FDI in the country (Johnson 2005). This will be done by comparing the means of the resultant FDI inflows with regard to the independent FDI determinants in order to determine their mean contribution to the FDI inflows in Saudi Arabia. In addition, a comparative analysis will be undertaken across various economic sectors in Saudi Arabia to determine which sectors are FDI-attractive with the aim of providing justifications for these sectoral variations. This will involve comparing the mean volumes of FDI inflows across various sectors (Johnson 2005).

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Variables Selection

This study will gather information regarding FDI inflows in Saudi Arabia for the last five years and the respective economic conditions at the time. The main economic variables such as GDP, infrastructure and profitability among others will be evaluated to determine the key determinants of FDI in Saudi Arabia. In addition, their variations will be imperative in highlighting the impact that FDI has on Saudi Arabia’s economic growth, with a particular consideration between the linkage between GDP and FDI.

Data Analysis

As aforementioned, data analysis will make use of Granger Causality tests (for FDI and GDP) and through the use of comparing means (for sectoral distribution of FDI and the significance of the key determinants with regard to attracting FDI). The Granger causality tests will be used to determine whether FDI inflows in Saudi Arabia can be used to predict the country’s economic growth. The study will then assess this behavior and make inferences as to whether the current and past FDI predicted the behavior of economic growth measured using GDP. 

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