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Economic AnAlysis & Policy, Vol. 42 no. 1, mArch 2012

Foreign Direct Investment, Economic Growth and Financial Sector Development in Small Open

Developing Economies

Oluwatosin Adeniyi1 and Olusegun OmisakinDepartment of Economics and Business Studies, Redeemer’s University,

P. O. Box 7914, Ikeja. PMB 3005, Redemption City,

Nigeria

and

Festus O. Egwaikhide and Abimbola Oyinlola Department of Economics,

University of Ibadan, Ibadan, OyoState,

Nigeria

Abstract: Thepresentpaperexaminesthecausallinkagebetweenforeigndirectinvestment(FDI)andeconomicgrowth-inCote’d’Ivoire,Gambia,Ghana,NigeriaandSierraLeone-withfinancialdevelopmentaccountedforovertheperiod1970-2005withinatrivariateframeworkwhichappliesGrangercausalitytestsinavectorerrorcorrection(VEC)setting.Threealternativemeasuresoffinancialsectordevelopment-totalliquidliabilities,totalbankingsectorcreditandcredittotheprivatesector-wereemployedtocapturedifferentramificationsoffinancialintermediation.OurresultssupporttheviewthattheextentoffinancialsophisticationmattersforthebenefitsofforeigndirectinvestmenttoregisteroneconomicgrowthinGhana,GambiaandSierraLeonedependingonthefinancialindicatorused.Nigeria,ontheotherhand,displaysnoevidenceofanyshort-orlong-runcausalflowfromFDItogrowthwithfinancialdeepeningaccompanying.Insum,therefore,whatshouldbeofutmosturgencyisconcertedeffortsinmostofthesecountries,whichhavetypicallybeeninthethroesofeconomicreforms,toupgradetheirfinancialstructuretobetterpositionthemtoreapthedesirablegrowthpromotingeffectsofFDIflows.

I.INTrODuCTIONMyriadsofopinionsexistontheimportanceofforeigndirectinvestment(FDImosttimesafterhere)foreconomicgrowth.Thestandardview,however,appearstoprovidesupportfortheexistenceofacloseassociationbetweeninvestmentandeconomicprosperity.FDIcanpositivelyaffectgrowthbyanoutwardshiftintheeconomy’sproductionpossibilitiesfrontier1 Correspondingauthor:saino78@yahoo.com

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typicallyvianewtechnologytransferandspilloverefficiency(Blomstromet al.1994,KokkoandBlomstrom1995,Mansfieldandromeo1980,andKokko1994).However,developingcountries, especially those in sub-SaharanAfrica (SSA),witnessed systematicdeclines ininvestmentratesfromtheearly1980s(Oshikoya1994).Formostofthesecountries,particularlythoseinECOWAS2,thelowerinvestmentrateshavearguablyprecipitatedpooreconomicgrowth.ThegrowthrateofrealpercapitaGDPwasnegative,inthe1980sand1990s,forinstance,forthemajorityofSSAeconomies(Ndikumana2000).

TheissueofconcernhasbeentheneedforabetterunderstandingofthechannelsthroughwhichFDIworkstoimpacteconomicgrowthpositively(LemiandAsefa2003).ThereceivedwisdomappearstobethattheinfluencearisesfromtheabsorptivecapacityoftheFDI-receivingcountryratherthansomeautomaticadjustmentofeconomicgrowthtochangesinthelevelsofFDI.However,thisabsorptivecapacityhasbeenviewedfromdiverselensesintheliterature.Moststudieshaveessentiallyattemptedtoexplainthiscapacityintermsofcommercialpoliciesandhumancapital(see,forinstance,Balasubramanyamet al.1996andBorenszteinet al.1998).Attentioninrecenttimesseemstohaveshiftedtotheroleoftherecipienteconomy’sfinancialmarketintheFDI-Growthnexus3(seeAlfaroet al.2004,Choonget al.2004,HermesandLensink2003andOmranandBolbol2003forinsightfuldiscussionsonthislineofresearch).

Basedontheforegoing,anumberofinterestingquestionscometomindvidelicet:TowhatextentdoesFDIinfluencegrowthinECOWAScountries?Isthereanyroleforthedomesticfinancialmarket?Are individualcountriesunique in termsof theFDI-growthassociationwithfinancialdevelopmentintervening?.Thus,thecoreaimofthisinquiryistoexaminetherelationshipbetweenFDIandeconomicgrowth,whilecontrollingfortheplausibleimpactofthedegreeoffinancialsectorsophistication.

Althoughquiteanumberofextantstudieshavedealtwithsomeaspectsofthisissue,thepresentstudyisdistinctonafewcounts.One,thisarticletakesaninventivelookattheFDI-growth-financialdevelopmentlinkage.Asfarasweknow,empiricalworksonthistripartiterelationshiparehardlyavailablewithspecificreferencetoagroupofECOWAScountries.Two,sinceacountry-by-countrytime-seriesapproachisadopted4,policyprescriptionsaremorelikelytobebasedonevidencespeculiartoeachcountry.Thisisundoubtedlymoreuseful

2 TheEconomicCommunityofWestAfricanStates(ECOWAS)isaregionalgroupoffifteencountrieswhichwasfoundedin1975withthemandateofpromotingeconomicintegrationviatheprimaryobjectivesofimprovedeconomiccompetitivenessthroughopenandcompetitivemarkets,convergenceofmacroeconomicpolicies,creationofacommonmarket,sectoralpolicycoordinationaswellasharmonizationoffiscalpolicies.Itsoverridingfocusremainstheachievementofcollectiveself-sufficiencyforthememberstates,withinthissingletradingbloc,bymeansofaneconomicandmonetaryunion.

3 Onatheoreticalbasis,thefinancialsectorhasasignificantbearingonthepatternoflong-runeconomicgrowthparticularlythroughtheimpactoffinancialsectorservicesonbothcapitalaccumulationandinnovationswithrespecttotechnology.Thesefinancialsectorservicesinclude,butarenotlimitedto,savingsmobilization,acquisitionofinformationaboutopportunitiesforprofitableinvestments,monitoringofmanagers,exertingcorporatecontrolaswellasthefacilitationofriskamelioration.

4 Itisnoteworthy,atthisjuncture,thatthepreponderanceofearlierstudiesonthesubjectusedcross-sectionapproachesintheiranalysis.However,theestimatesemergingfromsuchcross-countrygrowthregressionsmoreoftenthannotdisregardimportantinterveningcountry-specificfactors.Hence,aproperassessmentofcausalrelationshipsinadynamicsense,whichtime-seriestechniquesarewellsuitedtocapture,isrequiredtounearththecausallinkagesamongthevariablesofinterest.This,ofcourse,iswithaviewtoenhancingunderstandingonthelinkagesbetweenFDIandgrowth(withfinancialdevelopmentintervening)especiallyonanindividualcountrybasis.

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than the somewhatmisleading generalisations across regional groupings pervasive in theempiricalliterature.Finally,theuseofmultiplemeasuresoffinancialdevelopmentmighthavefar-reachingimplicationsforwhichelementsofthefinancialsectortofocusoninindividualcountriesifsustainedgrowthistobeachieved.

As a foretaste of the ensuing results, economic growth and foreign direct investmentareonlycausallyrelatedwhen(i)totalsizeofthebankingsectorisusedastheinterveningfinancialindicatorinbothGambiaandGhana;(ii)credittotheprivatesectorisadoptedinGhanabutnotinSierraLeone;and(iii)thefinancialindicatorseemsnotasimportantasthedestinationsectorofFDIflowstoNigeria.Thus,anypolicyrecipeshouldaccordinglykeeppotentialheterogeneityamongthesecountriesinfocus.

Thus, this paper investigates how financial sector development influences the FDI-growthrelationship in fiveECOWAScountriesover theperiod1970-2005.5Therestofthepaperisstructuredasfollows.Sequeltothisintroductorydiscussion,Section“StylizedFactsonFDI,GrowthandFinancialSectorDevelopmentinSelectedECOWASCountries”presentsthetrendsinFDI,growthandtheextentoffinancialsystemadvancementinthesampledcountries.Section“ABriefLiteraturereview”containsareviewoftheliteratureontheFDI-growthlinkage,whilesection“Measurement,DataSourcesandEconometricMethodology”detailsthedatasourcesandeconometricapproachemployed.Theresultsarepresentedanddiscussedinsection“EmpiricalFindingsandDiscussion”,whilethesixthandfinalsectionconcludes.

II.STyLIzEDFACTSONFDI,GrOWTHANDFINANCIALSECTOrDEVELOPMENTINSELECTEDECOWASCOuNTrIES

ThissectionfirstdelvesbrieflyintoadescriptionofobservedtrendsinglobalFDIflowsbeforeadetailednarrativeofthetrendsinFDI,economicgrowthandfinancialdevelopmentintheselectedECOWAScountriesisundertaken.Thisportrayalisthepreoccupationofwhatfollows.

2.1 FDI Flows in a Global Context

Although,asTable 1makesclear,thelargerchunkofglobalFDIflowsweredestinedfortherichercountries,theportiondomiciledindevelopingcountriesundulatedaround30percentonaveragebetween1991and2002.Inparticular,the1990switnessedsignificantincreasesintheflowofforeigndirectinvestmenttodevelopingcountriesoftheworld.However,thebalanceofevidencestillappearstosupporttheconclusionthattheinflowhasbeenuneven.ThispatternremainspalpableinspiteofpolicyinitiativesinanumberofAfricancountriesandthesignificantimprovementsinthefactorsgoverningFDIflows.Thesefactorsinclude,butarenotrestrictedto,economicreform,democratisation,privatisationandenduringpeaceandstability.Someexplanationshave,however,beengivenintheliteratureforAfrica’ssmall

5 TheECOWAScountriesselectedforuseinthisstudyarenamelyCote’d’Ivoire,Ghana,Gambia,NigeriaandSierraLeone.Annualtime-seriesobservationsonthekeyvariablesofinterestwereobtainedovertheperiod1970to2005foreachcountry.Theavailabilityofconsistentdatainformedthechoicesofboththesampleperiodandcountries.

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shareintheglobalFDIflows.TheseexplanationsrangefrombiasagainstAfricabecauseofitsriskstotheadoptionofinappropriatepoliciesamongotheridentifiedfactors.

Table1:ShareofGlobalForeignDirectInvestmentinflows,1991-2002(inpercent)

1991-96 1997 1998 1999 2000 2001 2002World 100.00 100.00 100.00 100.00 100.00 100.00 100.00Developedcountries 60.80 55.96 68.84 76.42 80.44 71.54 70.69Developingcountries

35.98 40.10 27.88 21.25 17.66 25.42 24.90

Africa 1.81 2.21 1.30 1.13 0.61 2.28 1.69LatinAmericaandCaribbean

10.64 15.20 11.96 10.03 6.85 10.16 8.60

Asia 23.36 22.64 14.57 10.06 10.20 12.96 14.59Pacific 0.16 0.04 0.05 0.03 0.01 0.02 0.02CentralandEasternEurope

3.22 3.95 3.28 2.33 1.89 3.04 4.41

LDCs 0.67 0.71 0.67 0.55 0.25 0.68 0.80

Sources:ThefiguresdisplayedwerelargelyculledfromuNCTAD(2003)andAjayi(2006)

Tofurtherreinforcetheforegoinglineofargument,acloserglanceatthedataalsorevealssomeregionaldisparitiesinFDIflowsevenacrossdevelopingcountries.WhileAsiaaswellasLatinAmericaandtheCaribbean,asseenfromTable 2,jointlyaccountedforabout94percentoftheaggregateflowstoalldevelopingcountriesintheperiod1991-1996withAfricareceivingameagre5.0percent.AlsostrikingistheslumpintheshareofAfricafrom5.3percentto3.5percentbetween1999and2000beforeeventuallysettlingataround7percentin2002.

Table 2:ShareofFDIFlowstodevelopingcountriesbyregion,1991-2002(inpercent)

1991-96 1997 1998 1999 2000 2001 2002Developingcountries 100.00 100.00 100.00 100.00 100.00 100.00 100.00Africa 5.03 5.52 4.67 5.33 3.45 8.96 6.78LatinAmericaandCaribbean

29.58 37.92 42.89 47.21 38.75 39.98 34.55

Asia 64.93 56.46 52.27 47.33 57.75 50.98 58.58Pacific 0.45 0.10 0.17 0.12 0.05 0.08 0.09CentralandEasternEurope

8.94 9.85 11.75 10.97 10.72 11.94 17.71

LDCs 1.84 1.76 2.39 2.61 1.39 2.69 3.23

Sources:ThefiguresdisplayedwerelargelyculledfromuNCTAD(2003)andAjayi(2006)

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Withparticularreferencetogrowth,therecordinAfrica,onaverage,hasbeenatbestlessthanmodest.Eventhedecadeofthe1980shasoftenbeenappositelylabelledasa“lost”oneforthemajorityofcountriesinthecontinent.ThescarcityofthenecessarycapitalflowsforsustainedeconomicgrowthhasbeenpinpointedasonemajorcloginthewheelofeconomicprosperityAfrica-wide.FDI,acriticalcomponentoftheseflows,accordingtoAjayi(2006)hasthepotentialtoaccelerategrowthandeconomictransformation.Although,FDItodevelopingcountriesasawholeappearstohaverisenovertheperiodbetween1991and2002,theseflowshavebeenlargelyunevenwithAfricaatthelowestrungoftheladder.Forinstance,Africa’sshareoftotalFDItodevelopingcountriesplummetedfromabout19percenttoalittlelessthan10percentbetweenthe1970sand1980s,anddeclinedinthe1990stoanannualaverageof4percent(uNCTAD2003).

Figure 1:FDIandEconomicGrowthinSelectedECOWASCountries,1975-2005

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Thispoorperformance,on thebasisofFDI inflowmetric,howevermaskssignificantdisparities not only amongAfrican countries in general but also ECOWAS countries inparticular.Nigeria,chieflyduetoitslargeoilsector,hastraditionallybeenoneofthebiggestrecipientsofFDIinflowstoAfrica.Mostothercountriesinthesub-regionhavehoweverbeenunabletoattractsubstantialamountsofforeigncapital.Figure 1displaystheproportionofFDIinthetotaloutput(fdigdp)oftheselectedcountriesaswellasthetrendsinthegrowthofrealGDPpercapita(gdppcgr).

2.2 Pattern of FDI Flows in the Selected ECOWAS Countries

FromFigure 1,higherFDIflowsarecloselyassociatedwithfavourablegrowthperformanceinCote’d’Ivoire.TheFDIsharesof1.06%and1.77%areaccountable,inpart,forthesurgeineconomicgrowthfrom-0.13%to3.49%in1974and1975,respectively.Also,thedecadeof the1980s, characterisedbyadroughtof foreign investment flows, coincidedwith aneraofnegativegrowthratesinCote’d’Ivoire.InthecaseoftheGambia,thepicturewhichunfoldsissomewhatdifferentasitisdifficulttoconcoctthesamemovementsobservedforCote’d’Ivoire.Inspecificterms,althoughFDIflowsdeclinedsteadily(albeitstillpositive)between1989and1992,resultinginpoorgrowthrecords,thesubsequentincreaseinFDIflowsoverthefollowingfouryearswasnotsufficienttoreversethenegativegrowthtrendthatstoodat-1.22%.

Anotherglimpseatthefigurereveals,however,thatGhana,NigeriaandSierraLeoneeachsharestrikingsimilaritiesaswellassharpcontrastswiththepatternsobservedinthecaseofCote’d’IvoireandGambia.Thus,thestatisticsseemtounearthconsiderabledifferencesamong theseECOWAScountries, implying that thepotentialFDIpossesses in fosteringeconomicgrowthcoulddifferinsignificantwaysacrossthesecountries.Thereis,therefore,theneedtodigabitfurtherintotheeconomicpeculiaritiesofindividualcountries.Inrespectofthis,onekeyfactorthatdistinguisheseconomiesistheextenttowhichthefinancialmarketisdeveloped.ItisusuallyopinedthatawellfunctioningfinancialsystemisanimportantelementoftheabsorptivecapacityrequiredintherecipienteconomyforFDItospurgrowth.

2.3 Financial Development in ECOWAS

reportedinTable 3arethreeimportantindicatorsoffinancialdevelopmentinthefiveselectedECOWAScountries.Theindicatorsvarywidelyacrossthecountries.ThetotaldomesticbankcredittoGDPratioduringthe1975-84period,rangedfrom26.3to44.3percentinGhanaandGambia,respectively.

Allthethreefinancialindicatorswerepositiveforallthesampledcountriesandinthesub-periodspresented inTable 3. It isalsonoteworthy thatnoclearpatternemergeswithrespecttotheimportanceoffinancialmarketvariablesbothacrosscountriesandovertimeineachcountry.WhiletotalliquidliabilitiestoGDPforSierraLeonefellfrom21.0percentin1975-84to17.5percentin1985-94,thesameindicatordeclinedlessmarkedlyinNigeriafrom26.9percentto26.0percentoverthesamesub-periods.

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Table 3:FinancialMarketIndicators(in%ofGDP)forSomeSelectedECOWASCountries,1975-2005a

CountryDomesticCreditprovidedbythebankingsector LiquidLiabilities Credittotheprivatesector

1975-84 1985-94 1995-05 1975-84 1985-94 1995-05 1975-84 1985-94 1995-05Cote’d’Ivoire 39.44 42.72 22.49 29.28 28.82 23.95 39.05 33.08 15.89Gambia 44.34 15.00 17.17 24.74 23.30 35.66 20.51 12.69 12.58Ghana 26.26 21.17 28.22 20.35 16.56 26.34 3.26 4.23 10.87Nigeria 26.45 32.37 16.49 26.87 26.03 20.88 12.53 12.51 13.39SierraLeone 32.09 34.10 46.80 21.00 17.50 16.16 6.55 3.60 3.06aSource:Author’scomputationfromIMF’sInternationalFinancialStatistics,2007

Intermsofclaimsexclusivetothedomesticprivatesector,Cote’d’Ivoireappearstohavethemost sophisticated financial system relative to the other countries.Broadly speaking,thisdominanceisexhibitedacrossmeasuresalthoughthetotalsizeof thefinancialsectorseemstohavedeclinedasexhibitedbythefallintheM3/GDPratiofromanaverageof29.3percentin1975-84toalittleabove23percentin1995-2005.SierraLeoneperformsworst,particularlyinthe1995-05sub-period,withthelowestprivatesectorcredit.ThisimpliesthatcreditconstraintsarerelativelymorebindingonSierraLeone’sprivatesectoroperators.Thecountryis,however,almostatparwithGhanawithregardoneoftheothertwomeasures-M3toGDPratio-offinancialsectordevelopment.

Hence,evenwithsimilaroverallfinancialsectorsizeanddepositmoneybankcreditinthesecountries,therearestilldisparitieswithregardoverallabilityofthefinancialsectortotargettheprivatesectorwithaviewtostimulatinginvestmentandsubsequentgrowth.Insum,therefore,acountrybycountryassessmentoftheextentoffinancialsectorsophisticationiscrucialtotheunderstandingofhowFDI,viaitsinteractionwithfinancialdevelopment,mayexertpositiveinfluenceongrowth.6Topursuetheseissuesfurther,themeasurementofvariables,sourcesofdataandeconometrictechniqueusedarethepreoccupationofwhatfollows.

III.ABrIEFLITErATurErEVIEW

AhugebodyofliteratureexistsontheinfluenceofFDIoneconomicgrowth.TheviewshaveevolvedfromtheearliercapitalaccumulationargumentstorecentsupportfortheroleofFDIininternationaltechnologytransfer.ThisliteratureexploresvariousaspectsofthespillovereffectsofFDIsuchas(i)technologytransfer(ii)introductionofnewprocesses(iii)productivitygainsand(iv)openingofnewmarketopportunities(Alfaro,et al.2004;Egwaikhideet al.2005).7Apartfromprovidingdirectfinancing,FDIalsoplaysasignificantroleinpromotinggrowthviatechnologytransferandimprovedmarketaccess(GrossmanandHelpman,1995;BarroandSala-I-Martin,1997).LensinkandMorrissey(2001)discussinconsiderabledetailthechannels

6 Thevariedattainments,of thesecountries, in termsof financialsectordevelopment lendcredence to theappropriatenessofatimeseriesframeworkforthisanalysis.Crosssectionalaswellaspanelapproachesmayobscuresuchinfluencesandthusmakegeneralisationofresultsincredible.

7 Saggi(2000)containsanexcellentsurveyontheevidenceofthespillovereffectsofFDI.

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-imitation,competition,linkagesandtraining-throughwhichtechnologytransferinfluencesgrowth.HermesandLensink(2003)provideanexplicitlinkamongFDI,economicgrowthandfinancialsectorevolution.Theintuition,whichappearsfairlyclear,isthatanincreaseintotalFDIflowsresultsinlowerfixedset-upcostsaswellasariseintherateofreturnonassets.Thisservesasanincentiveforfirmstomakefurtherinvestments.However,thisoutcomeistoalargepartdeterminedbytheefficiencywithwhichthebankingsectorchannelsfinancialresourcesfromsurplustodeficitunitsoftheeconomy.Inthisway,therefore,FDIcontributespositivelynotonlytotheaccumulationofcapitalbutalsotheprocessofeventualgrowthviatheefficientfunctioningofthedomesticfinancialsector.

AlthoughsomeempiricalliteraturesuggestapositivecorrelationbetweenFDIandgrowth(seeLipsey1999),severalotherspositthatnosuchlinkageexists.Theresultsofthelatterstrandofevidences,inAitkenandHarrison(1999),showthattheneteffectofFDIonfirmlevelproductivityisnegligible.TheyconcludethatwhileFDIincreaseswithin-plantproductivityfortherecipientfirm,ittendstolowerthatoflocally-ownedplantstherebycastingdoubtonthepositivespillovereffects.However,theearliestattempts,usingaggregatedata,atestablishingaFDI-growthlinkageseemtohaveviewedtheimpactofFDIoneconomicgrowthfromtheperspectiveofthemarketsizeoftherecipienteconomy.

Whileanumberofsuchstudiesreportedapositiveandstatisticallysignificantrelationship(for instance,GreenandCunningham1975,Schneider andFrey1985,yu1990amongafewothers),Nigh(1985)foundnosignificanteffectofFDIonthepathofeconomicgrowth.Also,atthenationallevel,Balasubramanyam,et al.(1996),Borensztein,et al.(1998)andCarkovicandLevine (2003) find thatFDIeffectsongrowtharenotnecessarilypositive.ThislargelyambiguouspicturesuggeststhattheinfluenceofFDIongrowthiscontingentonadditionalfactorswithintheFDI-receivingeconomy(Durham,2004).Theinitial levelofdevelopment,existingstockofhumancapitalandtradepolicyregimearekeyamongthehostcountryfactorscitedconsideredintheliterature(Blomstromet al.1992,Borenszteinet al.1998,Balasubramanyamet al.1996).Specifically,inanauthoritativeexplanationoftheimportanceofhostcountrycharacteristics,Balasubramanyamet al.(1996)arguedthatthehightechnologywhichFDItypicallyembodiestendedtoserveasaconduciveclimefortheestablishmentofintellectualpropertyrights.Moreaptlyput,themoretheweightattachedtocreatinglegislationbackedguidelinesforprotectingpropertyrights,thehigherthewillingnessofforeignfirmstofollowthroughwithhightechnologyinvestments.

Tofurtherunderscorethecrucialroleofhumancapital,Borenszteinet al.(1998)pointoutthatinadditiontotheaforementionedlevelofinvestments,awell-trainedandadequatelymotivatedworkforceisrequiredasacomplement.Attheheartoftheirargumentisthefactthatthespillovereffectsfromtheadoptionofnewtechnologycanonlybeenjoyedbydomesticfirmsifthehosteconomyhasattainedacertainthresholdintermsofhumancapitaldevelopment.Substantialresearcheffortshave,however,beengearedtowardsunderstandingtheroleofdomesticfinancialmarketsinthissetup(detailsinHermesandLensink2003,OmranandBolbol2003,Alfaroet al.2004,Durham2004andAng2008).8Also,HermesandLensink(2003)appeartohavepopularisedthenotionthatthesophisticationofthefinancialsectorin

8 Complementaryempiricalevidences,fortheinterestedreader,canalsobefoundinKingandLevine(1993a,b);Becket al(2000a,b);Levineet al(2000)andthereferencestherein.

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thehostcountryisakeyprerequisiteforthepositiveeffectsofFDItoregisteroneconomicgrowth.TheyreckonedthattheresourcesaremoreefficientlyallocatedwithinavibrantfinancialsystemandthisinsomesenseenhancestheabsorptivecapacityofaFDI-receivingcountry.Intworelated,albeitindependent,studies,Alfaroet al.(2004)andChoonget al.(2004)alsocometothesimilarconclusionthatlackofdevelopmentoffinancialstructures-bothmarketsandtheassociatedinstitutions-canlimitaneconomy’spreparednesstoreapthebenefitsfrompotentialFDIspillovers.

Basedontheselatterstudies,financialdevelopmentenhancesaneconomy’scapacitytogainfromFDIinthreemainways.First,hostcountryentrepreneurswithlimitedaccesstodomesticfundsareabletobuynewmachines,adoptstate-of-the-arttechnologyandattractskilledlabourowingtoexpandedcreditavailability.Second,domesticfinancialsectordevelopmenteasesthecreditconstraintfacedbyforeignfirmsandthusaidsintheextensionofinnovativeactivitiestothedomesticeconomy.Finally,theexistenceofanefficientfinancialsystemfacilitatesFDIincreatingbackwardlinkageswiththerestoftheeconomyparticularlydomesticsuppliersofproductioninputs.Thus,domesticfinancialsystemsophisticationpotentiallyplaysakeyroleinanhosteconomy’sabilitytoabsorbthebenefitsofFDI.Finance,throughitsinteractionwithFDI,thenentersasanexplanationforeconomicgrowth.

Therefore,whiletheliteratureamplycoversthelinkagebetweenforeigndirectinvestmentandgrowthinbothdevelopedanddevelopingcountries,thespecificstrandthatdemonstratesaroleforfinancialdevelopmentintheFDI-growthnexusisatbestrudimentary.Furthermore,mostofthesetypicallyscantempiricalattemptswereconductedeitherpurelyfordevelopedcountriesorwithsamplesofcountriesthatincludeafewfromAfrica.Tofillthisvoid,therefore,thepresentpaperdelvesintoanumberofissuesquiteinventively.First,theFDI-growth-financialdevelopmentlinkageisexaminedwithspecificreferencetoagroupofECOWAScountries.Asfarasweknow,empiricalworksonthistripartiterelationshiparehardlyavailablefor this regional grouping. Second, a country-by-country time-series approach is adoptedimplyingthatpolicyprescriptionsaremorelikelytobebasedonevidencespeculiartoeachcountry.Thirdandnottheleast,weusemultiplemeasuresoffinancialdevelopmenttoreflectthevariationsinthepolicyimplicationsrelatabletotheseconceptuallydistinctindicatorsoffinancialsystemadvancement.

IV.MEASurEMENT,DATASOurCESANDECONOMETrICMETHODOLOGy

Thissectioncontains thedescriptionof themeasuresusedforeconomicgrowth,FDIandfinancialsectordevelopment.Also,thesourcesofdataaswellasdetailsoftheeconometricapproachusedintheempiricalanalysisareoutlined.

Financial deepening is conventionally viewed as the process which culminates inimprovements in the quality and quantity aswell as the efficiency of financial services.However,sincetheseservicesaremultifarious,usingasinglemeasuretocapturetheireffectmaynotbeinformativeenough.Asaresult,threealternativeindicatorsoffinancialmarketsophisticationwithaviewtoascertainingtherobustnessofensuingfindingsareexplored.

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ThethreemeasuresaretheratioofM3/GDP,domesticcredittotheprivatesectorasashareofGDPandtotaldomesticcreditprovidedbythebankingsectorasapercentageofGDP.Thesealternativemeasuresoffinancialdevelopmentareusedinordertocapturethediversityofopinionsontheprecisedefinitionoffinancialsectordevelopment.TheratioofM3/GDP captures the total liquid liabilities of the financial system by broadly includingkeyfinancialinstitutionssuchasthecentralbank,depositmoneybanksandothernon-bankfinancialinstitutions(NBFIs).Itisthusanencompassingmeasureoftheoverallsizeofthefinancialsector(Alfaroet al.2004).Thesecondindicator,domesticcredittotheprivatesector,distinguishesbetweentheendusersoftheclaimsoffinancialintermediaries.Itincludesonlytheclaimsontheprivatesector.TotalbankingsectorcreditasapercentageofGDP,thethirdmeasure,excludesnon-bankcredittotheprivatesectorandmaybelesscomprehensivethanthesecondmeasure(claimsontheprivatesectorasaratioofGDP). InkeepingwiththestandardpracticethestudyusesthegrowthofrealGDPpercapitaasaproxyforeconomicgrowthwhile,theshareofFDIinGDPisthemeasureofFDIflows.

Thedataweretransformedtonaturallogarithmsfortheconventionalstatisticalreasons.AlldatawerecollectedfromtheWorldBank’sWorld Development Indicators,2007andtheIMF’sInternational Financial Statistics Yearbook,2007.AppendixTable A summarisesthedefinitionandsourcesofthedataused.

Intermsofeconometricmethodology,thecointegrationapproachoffersusefulinsightstowardstestingforcausalrelationships.Inprinciple,twoormorevariablesareadjudgedtobecointegratedwhentheyshareacommontrend.Hence,theexistenceofcointegrationimpliesthatcausalityrunsinatleastonedirection(Granger1988)9.Theoretically,weconsiderthefollowingVAroforderP:10

1 1 1...t t p t p tY AY A Yµ ε− − −= + + + + (1)

where tY isa3X1vectorofI(1)variablesnamelyGDPpercapitagrowth,FDIandourmeasuresoffinancialdevelopment(FD).Ifthesevariablesshareacommonlong-runtrend,itfollowsfromGranger’srepresentationtheoremthattheVArmodelcanbeexpressedinVECMspecificationas:

1 1 1 1 1...t t p t p t tY Y Yµ ε− − − + −∆ = + Γ ∆ + + Γ ∆ + Π + (2)

where∆ isthedifferenceoperator,and tε isavectorofindependentlyandidenticallydistributeddisturbanceterms.IftherankofΠ liesdiscretelybetween1and3,thenadecompositioninto∏=αß ispossible.Equation(2)canthenbere-writtenas:

'1 1 1 1 1... ( )t t p t p t tY Y Yµ α β ε− − − + −∆ = + Γ ∆ + + Γ ∆ + + (3)

wheretherowsofβ areuniquecointegratingvectorsandtheα ’sareindicativeoftheextentof adjustment towards equilibrium.The explicit form of equation (3) is presented in the

9 Causalitynotwithstanding,however,cointegrationfailswithrespecttoprovidinganindicationofthedirectionofcausalitybetweenvariables,ataskwhichthevectorerrorcorrectionmodel(VECM)accomplisheswithamazingdispatch.

10 Therestofwhatfollows,withregardeconometricapproach,drawssubstantiallyfromAbu-BaderandAbu-Qarn(2008).

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trivariateVArmodelbelow:1 1 1

1 1 1, , 1 11, 1, 12, 2, 13, 3, 11 1 1 1

p p pr

t h h t k t k k t k k t k th k k k

Y ECT Y Y Yµ α β β β ε− − −

− − − −= = = =

∆ = + + ∆ + ∆ + ∆ +∑ ∑ ∑ ∑ (4)

1 1 1

2 2 2, , 1 21, 1, 22, 2, 23, 3, 21 1 1 1

p p pr

t h h t k t k k t k k t k th k k k

Y ECT Y Y Yµ α β β β ε− − −

− − − −= = = =

∆ = + + ∆ + ∆ + ∆ +∑ ∑ ∑ ∑ (5)

1 1 1

3 3 3, , 1 31, 1, 32, 2, 33, 3, 31 1 1 1

p p pr

t h h t k t k k t k k t k th k k k

Y ECT Y Y Yµ α β β β ε− − −

− − − −= = = =

∆ = + + ∆ + ∆ + ∆ +∑ ∑ ∑ ∑ (6)

where , 1h tECT − isthe h therrorcorrectiontermwhichistheoneperiodlagoftheresidualsfromtheh thcointegrationequation. ,ij kβ reflectstheeffectofthe k thlagofvariable j onthecurrentvalueofvariable i : ,i j∀ = FDI,GDP,FD.

Itispertinenttonotethatinadditiontoprovidingindicationonthedirectionofcausation,theVECMalsoenablestheidentificationofshort-andlong-runcausality.Inthesystemofequationspresentedinequations(4)to(6),long-runcausalityinthecointegrationframeworkisconsideredusingat-testonthenullhypothesis:

0 ,: 0 1,...,j hH forh rα = = (7)

whilecausalityovertheshort-runhorizonisexaminedbyconductingasimilarF-teston:

0 ,1 , 1: ... 0ij ij pH β β −= = (8)

Arejectionofeitheroneorbothofthesehypotheseslendscredencetotheconclusionofcausality,intheGrangersense,betweenthevariablesunderscrutiny.

V.EMPIrICALFINDINGSANDDISCuSSION

Thissectionispreoccupiedwiththepresentationandattendantdiscussionoftheresultsoftheunitrootandcointegrationtestsconducted.Itfurtherexplicatestheintuitionunderlyingthefindingsemergingfromtheestimatederrorcorrectionmodels.

5.1 Stationarity Tests

Cointegrationistypicallyintheoffingwheneachvariableisintegratedofthesameorder1d ≥ .Thisnecessary,butrarelysufficient,conditionimpliesthattheseriesshareacommon

trend.Hence,asapreliminarystep,weascertainwhethermeanreversionischaracteristicofeachvariableusingADFtest(DickeyandFuller,1979).Thisisconducted,withinterceptonlyandinterceptandtrendrespectively,onthelevelsandfirstdifferenceoftheseries.Wefindthatallthevariablesarestationaryondifferencingonce.11ThisfindingofI(1)isconsistentacrossthecountries.

11 Theresults,notreportedforthesakeofbrevity,obtainedusingthePhillips-PerronaswellasDF-GLSunitroottestsaresimilartotheAugmentedDickeyFullerstatistics.

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5.2 Analysis of Cointegration

Thenextstep is toformally test forcointegrationamongtherelevantvariables.Here,weadoptJohansen’smaximumlikelihoodbasedapproach.usinganoptimallagstructureintheunrestrictedVAr,thefindingsshowthat;(i)theexistenceofalong-runassociationbetweenFDIandeconomicgrowthissupportedforSierraLeoneonly;and(ii)uniquecointegrationrelationshipsarefoundinmorecountrieswhenspecificmeasuresoffinancialdevelopmentareusedasinterveningvariables.Forinstance,withtotalbankingcredit,cointegrationwassupportedforNigeria,while inbothGhanaandSierraLeone,FDI,economicgrowthandcredittotheprivatesectorshareacommonlong-termtrend.Also,intermsofoverallfinancialsectorsize(M3-to-GDP),cointegrationwasfoundfortheGambiaandGhana.Insum,supportisgarneredforcointegrationinatleastonecountryirrespectiveofthemeasureoffinancialsectordevelopmentused(TheresultsoftheunitrootandcointegrationtestsarereportedinAppendixBandC,respectively).

5.3 Vector Error Correction Model Findings

Sequeltotheacceptanceofcointegrationintheprecedingsection,theanalysisproceedswiththeestimationofavectorerrorcorrectionmodel.Theresults,whicharepresentedinTables4,5and6,areindicativeofthetri-variatecausalrelationshipamongforeigndirectinvestment,economicgrowthandfinancialindicatorsinsome12oftheselectedcountries.Specifically,the findings reported inTable 4 tend to support the non-existence of a causal flow fromeitherforeigndirectinvestmentorfinancialdevelopment-proxiedbytotalbankingsectorcredit(lbk)-toeconomicgrowthinNigeria.AcloserpeeprevealsstatisticallyinsignificantcoefficientsonboththelaggedFDIandbankingsectorcredit.Also,theerrorcorrectionterm–albeitwiththeapriorisign–aswellastheF-statisticintheeconomicgrowthequationpointtoarejectionofcausalityfrombothvariablestoeconomicgrowth13.Itishardlyevidentthatforeigndirectinvestmentandeconomicgrowtharecausallylinkedeveninthepresenceoffinancialsectordevelopment.rather,theresultsaresuggestiveofimprovementsinthetotalcreditofthefinancialsystemwheneffortsatattractingFDIaresuccessful.Theforegoingrejection of causality fromboth variables to economic growth is in sharp contrast to theconclusionsdrawninthestudiesbyChoonget.al(2004)andHermesandLensink(2004),forbothofthesepapersfoundtheevolutionofthefinancialsectorsignificantinexplainingeconomicgrowthviathechannellingofthespillovereffectsfromforeigndirectinvestment.AplausiblereasoninthespecificcaseofNigeriacouldbetheresource-seekingnatureofFDIflows.Thebulkofinvestmentofthisclassaretargetedattheoilandgassectorwhichhasbeentypicallycharacterisedbyacuteweaknessesintermsofbothforwardandbackwardlinkages

12 Itispertinenttonote,here,thatonlycountrieswherealong-runassociationamongthevariablesofinterestwasfoundarereferredto.TheoverallpictureisthatthereiscointegrationwhenatleastonemeasureoffinancialsectordevelopmentisusedforGambia,Ghana,NigeriaandSierraLeone.Ontheflipside,however,thesevariableswerenotcointegratedregardlessofthefinancialindicatoremployedforCote’d’Ivoire.

13 However,thereisacausalflowrunningfromFDItofinancialdevelopmentwhichisauthenticatedbytheerrorcorrectiontermandthelagged(first)FDIintheequationwithfinancialdepthasdependentvariable.Thestatisticalsignificanceis,however,weakasonlyatthe10percentlevelisarejectionofcausalitynotpossible.

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withtherestoftheeconomy.Thus,reformmeasuresaimedatfosteringeconomicprosperityinNigeriashouldfocusprimarilyoncreatingtherequiredlinkages,whileviewingfinancialsystemoverhaulingmerelyasacomplementarypartoftheoverallreformagenda.

Table 4:Error-CorrectionModel/CausalityTestBetweenΔlinc,ΔfdiandΔlbk(Nigeria)

VariablesinequationDependentvariablesΔlinc Δfdi Δlbk

Constant -0.0011(-0.1069) 0.1313(0.3370) -0.0183(-0.3405)Δlinc(-1) -0.0192(-0.7133) 0.1530(0.2548) 0.1231(-0.1058)Δlinc(-2) 0.0412(0.2090) -0.2791(-0.7241) -0.8013(-0.7982)Δfdi(-1) 0.0071(1.0696) 0.5358(-2.1961)** 0.0625(1.8592)***Δfdi(-2) 0.0066(0.9698) -0.3154(-1.2536) -0.0195(-0.5623)Δlbk(-1) -0.0534(-1.3724) 0.7036(1.1827) 0.4056(2.0450)**Δlbk(-2) 0.0122(0.3358) -0.7821(-1.3263) -0.1785(-0.9648)ECMt–1 -0.0767(-0.7133) 0.6768(0.4244) -0.0231(-1.8809)***F-statistic 0.6157(0.4631) 1.3509(0.2144) 1.6798(0.3347)R2 0.17 0.31 0.38Loglikelihood 47.3660 57.3447 0.1559AkaikeAIC -2.7149 4.5065 0.5409SchwarzSC -2.3377 4.8837 0.9181Notes:linc,fdiandlbkrepresentgrowth,foreigndirectinvestmentandbankingcredittotheprivatesectorrespectively.Δisthedifferenceoperator.*,**and***standforstatisticalsignificanceatthe1%,5%and10%levelsinthatorder.Thet-valuesareinparenthesiswhiletheF-statisticsareaccompaniedbytheircorrespondingprobabilityvalues.Themaximumlaglengthof2,employedinallestimations,waschosenonthebasisoftheconventionalkeyinformationcriteria.

Theindicatoroftheoverallsizeofthedomesticbankingsector(lm3)istheinterveningvariablebetweenforeigndirectinvestmentandeconomicgrowthinTable 5.Acursoryglanceatthetableshowsthereisclear-cutevidenceofacausalassociationbetweenforeigndirectinvestmentandeconomicgrowth.While,intheGambiancase,boththelaggedtermsofthedirectinvestmentwerestatisticallysignificantatmostatthefivepercentlevel,onlythesecondperiodlagofthisvariablewassignificantlydifferentfromzeroforGhana.

Intermsofmagnitude,thecoefficientsonthelaggedFDItermsaresimilarforbothofthesecountriesalthoughthesignsareopposite.Bothcountriesalsodisplayappreciablespeedwithrespecttoconvergencetothelong-runequilibriumfollowinganyperturbation.Precisely,about34and36percentofadjustmentstowardsthesteadystatearemadewithinayearinGhanaandtheGambia,respectively.Conversely,forboththeFDIandfinancialdevelopmentequations,nocausalitywasdetected for thecountries, except amarginally significant (at10percent)firstlagofeconomicgrowthinGhana’sFDIequation14.Therefore,inalignment

14 TheerrorcorrectiontermsallappearwiththewrongsignssavetheFDIequationforGambia.Thecoefficient,insignificantfromastatisticalstandpoint,of-0.1903impliesaboutone-fifthsofadjustmentstothelong-runaremadein1year.

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Tabl

e 5:Error-CorrectionModel/CausalityTestBetweenΔlinc,ΔfdiandΔlm3

(Gam

biaandGhana)

Variablesin

equation

Dependentvariables

(Gam

bia)

Dependentvariables

(Ghana)

Δlinc

Δfdi

Δlm3

Δlinc

Δfdi

Δlm3

Constant

0.0061(1.2177)

0.4493(0.9018)

0.0295(1.1025)

-0.0005(-0.0699)

-0.0093(-0.0522)

0.0087(0.3483)

Δlinc(-1)

-0.0080(-0.0561)

0.4865(1.6603)

-0.3759(-0.4949)

0.3706(2.5319)**

0.7095(1.9438)***

0.6921(1.2417)

Δlinc(-2)

0.1043(0.6752)

-0.4646(-1.4692)

-0.6687(-0.8145)

-0.0051(-0.0306)

-0.2181(|-1.1536)

0.2035(0.3201)

Δfdi(-1)

0.0056(2.6703)**

-0.3338(-1.6080)

0.0011(0.0978)

-0.0097(-1.3601)

-0.1989(-1.0245)

0.0196(0.7184)

Δfdi(-2)

0.0067(3.0367)*

-0.0731(-0.3332)

0.0124(1.0556)

-0.0164(-2.5730)**

0.0944(-0.5455)

0.0019(0.0773)

Δlm3(-1)

-0.0773(-1.8909)***

-0.8524(-0.7045)

-0.3041(-1.3985)

0.0054(0.1039)

0.1713(0.1218)

-0.0888(-0.4495)

Δlm3(-2)

-0.0083(-0.2203)

-0.2215(-0.3263)

0.0611(0.3038)

0.1111(2.2857)**

0.4599(1.1084)

0.0087(0.3483)

ECM

t–1

-0.3604(-4.0823)*

-0.1903(-0.2506)

0.1723(0.3671)

-0.3429(-3.3699)*

0.7931(1.3758)

0.3061(0.7901)

F-statistic

3.5576(0.1153)

1.9422(0.7433)

1.0971(0.3189)

3.7790(0.1015)

1.8449(0.1875)

0.5729(0.0709)

R20.50

0.35

0.24

0.51

0.34

0.14

Loglikelihood

78.3033

-73.3399

23.1657

66.6798

-42.2015

22.5551

AkaikeA

IC-4.2608

4.9296

-0.9191

-3.5564

3.0425

-0.8821

Schw

arzSC

-3.8980

5.2924

-0.5563

-3.1936

3.4053

-0.5193

Notes:linc,fdiandlm

3representgrowth,foreigndirectinvestmentandtotalliquidliabilitieso

fthebankingsectorinthatorder.Δ

isthedifference

operator. *,**and***standforstatisticalsignificanceatthe1%,5%and10%levelsinthatorder.Thet-valuesareinparenthesisw

hiletheF

-statistics

areaccompaniedbytheircorrespondingprobabilityvalues.Themaximum

laglengthof2,employedinallestim

ations,w

aschosenonthebasisof

theconventionalkeyinformationcriteria.

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Tabl

e 6:Error-CorrectionModel/C

ausalityTestBetweenΔlinc,ΔfdiandΔlpv

(GhanaandSierraLeone)

Variablesin

equation

Dependentvariables

(Ghana)

Dependentvariables

(SierraLeone)

Δlinc

Δfdi

Δlpv

Δlinc

Δfdi

Δlpv

Constant

0.0011(0.2166)

0.0086(0.0496)

0.0204(0.5025)

-0.0048(-0.3299)

0.2566(0.3280)

0.0042(0.1119)

Δlinc(-1)

0.2394(1.9340)***

0.1193(2.2573)**

0.8810(0.9524)

0.0655(0.3166)

0.8805(0.7042)

0.7597(1.4000)

Δlinc(-2)

-0.1212(-0.9240)

-0.1995(-0.9809)

-0.5113(-0.5066)

0.1167(0.5752)

-0.9215(-0.5394)

1.1367(2.1352)**

Δfdi(-1)

-0.0054(-0.9712)

-0.2962(-1.6401)

0.0227(0.5344)

-0.0003(0.0722)

0.3207(1.3554)

0.0096(0.8411)

Δfdi(-2)

0.0119(-2.3622)**

-0.1502(-0.9173)

0.0154(0.3985)

0.0013(0.4187)

0.3725(2.2548)**

0.0069(0.8635)

Δlpv(-1)

0.0974(-3.0459)*

1.6835(1.6126)

-0.1537(-0.6245)

0.0683(0.8953)

0.2200(1.7481)

-0.2456(-1.2263)

Δlpv(-2)

-0.0054(-0.1714)

0.6024(0.5796)

-0.5717(-2.3335)**

0.0631(0.7835)

0.7816(2.9337)**

-0.3510(-1.6612)

ECM

t–1

-0.5007(-4.4220)*

0.7796(1.5640)

-0.8276(-2.0979)**

-0.0110(-0.1776)

-0.2186(-4.8358)*

0.0709(0.4357)

F-statistic

7.3489(0.0876)

1.9756(0.0636)

1.4935(0.2817)

0.5302(0.4371)

11.2144(0.6533)

2.8287(0.0919)

R20.67

0.36

0.29

0.12

0.75

0.44

Loglikelihood

73.2117

-41.8082

5.8765

40.3340

-91.3666

8.5039

AkaikeA

IC-3.9522

3.0187

0.1287

-1.9596

6.0222

-0.0305

Schw

arzSC

-3.5894

3.3815

0.4915

-1.5968

6.3850

0.3322

Notes:linc,fdiandlpvdenotegrowth,foreigndirectinvestmentandcredittothep

rivatesectorrespectively.Δisthed

ifferenceoperator.*,**an

d***

standforstatisticalsignificanceatthe1%

,5%and10%

levelsinthatorder.Thet-valuesareinparenthesiswhiletheF-statisticsareaccom

panied

bytheircorrespondingprobabilityvalues.Themaximum

laglengthof2,employedinallestim

ations,w

aschosenonthebasisoftheconventional

keyinformationcriteria.

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withthesubmissionsofAlfaroet al.(2004)andDurham(2004),forGhanaandtheGambiawelldevelopedfinancialmarkets-particularlyintermsoftheoverallsize-promoteeconomicperformancebyabsorbingthebenefitsembodiedinFDIflows.Amajorimplicationisthatthesecountriesneedtocontinuewiththeemphasisonfinancialsectorreformsasanintegralpartoftheiroveralleconomicrestructuring.

Withaviewtomorepreciselycapturingtheefficiencyofthedomesticfinancialinstitutionsin channelling funds to theprivate sector, financial development is alsoproxiedby thepercentageofdomesticprivatesectorcreditinGDP(lpv)15.Table 6containstheresultsontheFDI-Growthnexususingthethirdfinancialindicator.Moststrikingisthelackofsupportforcausalityflowing,intheshort-run,fromeitherfinancialdevelopmentorforeigndirectinvestmenttoeconomicgrowthinSierraLeone.

Also,fromalong-termperspective,itisdifficulttoargueforanassociationastheerrorcorrectiontermisinsignificantwithahardlycredibleindicationasregardspeedofadjustment.Onlyabout1.0percentofthedeviationfromequilibriumiscorrectedperyear!Thecontrarietyis,however,obviousforGhana.Intheshort-run,boththeprivatesectorcreditandFDIarecausallylinkedwitheconomicgrowth.Inasimilarfashion,thelong-runcomovementofthesevariablesisevidentfromthestatisticalsignificanceoftheerrorcorrectionterminthegrowthequation16.Abouthalfoftheadjustmenttotheequilibriumstateisachievedannually.Thus,directingmorefinancialresourcestothedomesticprivatesectormightnotyieldthedesiredgrowthoutcomeinSierraLeone.Thismightbe,inlargepart,duetotherelativelysmallersizeoftheeconomytogetherwiththeattendantminiatureparticipationofprivateenterprisesinthedeterminationofthetrajectoryofeconomicgrowth.InGhana,however,thepotentialforfinancialdevelopmenttoabsorbthegrowthenhancingbenefitsembeddedinFDIflowsisfarfromtrivial.Attemptsatmakingthefinancialsectormoreresponsivetothefinancingneedsoftheprivatesectorwillaidthelatterinextendingtechnologicalinnovationstoothersectorsoftheeconomy.Thiswillinturnleadtoanoverallimprovementinproductivityacrosssectorsandultimatelyhighergrowthtrajectoryfortheeconomy.

VI.CONCLuSION

ThisempiricalenquiryemployedtheVECmodeltoexaminetheforeigndirectinvestment-financialdevelopment-growthnexusforasampleoffiveECOWASeconomies.Foreigndirectinvestmenthasbeenarguedtohavepositivespillovereffectsontheperformance,asmeasuredherebyeconomicgrowth,ofrecipienteconomies.Thesebenefitsarehoweverdependentonthe

15 Theviewthattheprivatesectormoreefficientlymakesinvestmentdecisionsvis-à-visthepublicsectorhasalonghistoryineconomics.Theintuitionremainsthatdevotinghigherproportionsofavailableresourcestothepublicsectorhasasupshotthecrowdingoutofprivateinvestment.Thechanneloftransmission,ofcourse,workingparticularlyviaincreasesintheinterestrateatequilibrium.

16 Althoughtheemphasis,inthisstudy,inprincipleisonprovidingexplanationforeconomicgrowth,afewinterestingresultsarealsodiscerniblefromTable6.Forinstance,economicgrowthissignificantinexplainingFDIflowsintheshort-runinGhanaeventhoughnocausallinkageexistsoverthelongerhorizon.InSierraLeone,itisdomesticprivatesectorcreditthatGrangercausesFDIintheshort-run.Theerrorcorrectiontermisalsostatisticallyimportant.Also,whilethereisevidenceforlong-runcausalityrunningfromFDIandeconomicgrowthtoprivatesectorcreditinGhana,itisdifficulttoferretoutsuchrelationshipinthecaseofSierraLeone.

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existenceofcertainpreconditionsinthedomesticeconomy.Marketsize,humancapital,tradeorientation,legalframeworkarechiefamongotherprerequisitesthattheearlierliteratureonthesubjectmatterhavemaderecourseto.Theroleofdomesticfinancialsystemdevelopmenthasbeenaccentuated,however,inmorerecentempiricalenquiries.Therefore,theprincipalaimofstudywastoexaminethecausalrelationshipbetweenforeigndirectinvestmentandeconomicgrowthwithfinancialdeepeningasaninterveningfactorinsomeselectedcountries.Weprobedthisissuedifferentlyinatleastthreeways.First,weinnovatebyconsideringthistripartiteassociationwithanentirelyECOWASsample.Second,weattemptpolicyprescriptionsona country-by-countrybasis to enablegravitation towardsmoreuseful interventionsbypolicymakersintheseeconomies.Finally,robustnessisascertainedthroughtheuseofanarrayoffinancialdevelopmentindicatorswithobviouspolicyimplications.

Weemployannualtimeseriesdata-oneconomicgrowth,foreigndirectinvestmentaswellasthreealternativemeasuresoffinancialsystemrefinement-overtheperiodspanning1970to2005withinavectorerrorcorrectionframework.Theresultsrevealedlackofsupportforbothshort-andlong-runinfluenceofFDIflowsoneconomicgrowthinthepresenceofcredittothedomesticprivatesector(ourfinancialindicator)intheSierraLeoneaneconomy.Contrariwise,inGhana,growthandforeigninvestmentflowsarebetterlinkedbyasupportivedomesticprivatesectorengenderedbysoundintermediatingfinancialinstitutions.Theoverallsizeofthefinancialsector-proxiedbytotalliquidliabilities(lm3)-mattersfortheFDI-growthinteractioninbothGhanaandGambia(Althoughthespeedofadjustmenttowardsequilibriumismarginallyslowerintheformer).Atlength,FDIflowsinNigeriaappeartobe resource-seeking and hence possessminimal growth effects regardless of the level offinancialdevelopment.Therearesomebroadimplicationsarisingfromthesefindings.Themostimportantofwhichisthatattemptsbythesecountriestoadoptuniformpolicyagendacouldbecounterproductive.Sincewefindallindicatorsoffinancialdeepeningimportantasinterveningvariablesinatleastonecountry17,therelevantcomponentsofthefinancialstructureshouldbestrengthenedin individualcountries.Tosumup,policyprescriptionsshouldbeembarkedupononacase-by-casebasissincetherearereasonstoacceptastruethenotionofconsiderableheterogeneityintheunderlyingeconomicstructuresofthesecountries.Afewextensionsseeminterestingavenuesforfutureresearch.Theintroductionofthresholdsintothemodellingexercisecouldproveaseeminglydauntingbutultimatelyrewardingactivity.Also,sincetheestimationapproachusedisineffectualintermsofgaugingthestrengthofcausalityout-of-sample,innovationaccountingtechniquesparticularlyforecasterrorvariancedecomposition(VDC’s)couldbemoresuitablyadopted.Finally,theincorporationofbreaksinbothindividualseriesandthecointegratingvectorsmaybeaninterestingpursuit.

17 Theexception,ofcourse,beingCote’d’Ivoirewherethenon-existenceofacointegrationrelationshipprecludedtheanalysisofbothlong-runcomovementsandshort-rundynamicsamongthevariablesincludedinthestudy.

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APPENDIXA:DATADEFINITIONANDSOurCES

Variables Definition Source

CredittothePrivateSector(lpv)

ThevalueofcreditsbyfinancialintermediariestotheprivatesectordividedbyGDP.Thisexcludescredittothepublicsectoraswellascrossclaimsofonegroupofintermediariesonanother

InternationalFinancialStatistics

TotalLiquidLiabilities(lm3) Currencyplusdemandandinterestbearingliabilitiesoffinancialintermediariesandnon-bankfinancialinstitutionsdividedbyGDP

InternationalFinancialStatistics

TotalBankingSectorCredittothePrivateSector(lbk)

CreditbydepositmoneybankstotheprivatesectorasaratioofGDP

InternationalFinancialStatistics

Growth(linc) OutputLeveland/orgrowthasmeasuredbytherealpercapitaGDP,constantdollars

WorldDevelopmentIndicators

ForeignDirectInvestment(fdi) Thenetinflowofinvestmenttoacquirealastingmanagementinterest(10%ormoreofvotingstock)inanenterpriseoperatingintherecipienteconomy.Itisthesumofequitycapital,reinvestmentofearnings,otherlong-termcapitalandshort-termcapital

InternationalFinancialStatistics

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APPENDIXB:AuGMENTEDDICKEy-FuLLEruNITrOOTTESTrESuLTSFOrTHESELECTEDCOuNTrIES

Cote d Ivoire

VariableLevels FirstDifference

DecisionDrift Drift&Trend Drift Drift&Trendlinc -0.2268 -1.9045 -3.8313* -3.7331** I(1)fdi -2.6915 -3.0219 -8.1563* -8.0324* I(1)lbk -0.7512 -1.0345 -4.0577* -5.0802* I(1)lpv 0.1355 -2.5621 -4.6068* -5.1033* I(1)lm3 -2.1111 -3.1912 -7.2451* -7.1833* I(1)

Gambia

VariableLevels FirstDifference

DecisionDrift Drift&Trend Drift Drift&Trendlinc -2.0072 -1.9926 -5.9100* -5.9108* I(1)fdi -0.2274 -3.0076 -9.3107* -5.9278* I(1)lbk -1.9761 -2.1733 -3.9290* -3.8845** I(1)lpv -1.8300 -2.0288 -6.3933* -6.2906* I(1)lm3 -1.2994 -2.1142 -8.4283* -8.3396* I(1)

Ghana

VariableLevels FirstDifference

DecisionDrift Drift&Trend Drift Drift&Trendlinc -1.2883 3.8522** -4.9472* -5.1999* I(1)fdi -1.6489 -1.8523 -3.5154** -4.2835* I(1)lbk -2.0014 -1.9476 -5.9831* -5.9678* I(1)lpv -0.6377 -1.5217 -4.9862* -5.7874* I(1)lm3 -1.1449 -1.3415 -6.0244* -5.9983* I(1)

Nigeria

VariableLevels FirstDifference

DecisionDrift Drift&Trend Drift Drift&Trendlinc -1.6771 -1.8508 -4.4742* -4.4756* I(1)fdi -1.8321 -2.0015 -3.4391** -3.6869** I(1)lbk -2.6575 -2.0572 -3.8801* -4.4054* I(1)lpv -2.1447 -1.9712 -6.3035* -6.3359* I(1)lm3 -2.6823 -2.3291 -4.1040* -4.4090* I(1)

Sierra Leone

VariableLevels FirstDifference

DecisionDrift Drift&Trend Drift Drift&Trendlinc -1.0531 -1.3306 -5.0243* -4.9707* I(1)fdi -2.1406 -2.3218 -5.7218* -5.6999* I(1)lbk -2.8052 -2.7214 -6.3626* -6.4238* I(1)lpv -1.8440 -2.5241 -7.4266* -7.3675* I(1)lm3 -1.8395 -1.8596 -6.26598 -6.1588* I(1)Notes:Inatablesabove*,**indicatesignificanceatthe1%and5%levelsrespectively.Thecriticalvaluesforallmodelsareasfollows;(i)Levels-driftanddriftandtrend-are-3.6329,-2.9484,-2.6129and-4.2436,-3.5443,-3.2047atthe1%,5%and10%levelsofsignificanceinthatorder.(ii)FirstDifferences-driftanddriftandtrend-are-3.6394,-2.9511,-2.6143and-4.2529,-3.5485,-3.2071attherespectivesignificancelevels.

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APPENDIXC:JOHANSENCOINTEGrATIONTESTrESuLTS

Table C1:ForeignDirectInvestmentandEconomicGrowth

Countries H0 : rank = p λMax λTrace

Cote’d’Ivoire p =0p <=1

6.7210.916

7.6370.915

Gambia p =0p <=1

7.4120.097

7.5090.097

Ghana p =0p <=1

9.5153.573

13.0893.573

Nigeria p =0p <=1

8.4873.111

11.5983.111

SierraLeone p =0p <=1

16.295*1.754

14.541*1.754

Notes:Thecriticalvaluesforthemaximumeigenvaluestatistics(λMax)andthetracestatistics(λTrace)are14.327and3.841aswellas14.265and3.841atrank p <0and p =0respectively.*,**representsignificanceatthe5%and1%levels.

Table C2: ForeignDirectInvestment,EconomicGrowthandDomesticCreditProvidedbytheBankingSector

Countries H0 : rank = p λMax95% c.v λTrace

95% c.v

Cote’d’Ivoire p =0p <=1p <=2

13.613 7.862 1.335

21.132 14.265 3.841

22.810 9.197 1.335

29.797 15.495 3.841

Gambia p =0p <=1p <=2

16.839 4.936 0.197

21.131 14.265 3.841

21.972 15.133 0.197

29.797 15.495 3.841

Ghana p =0p <=1p <=2

16.297 7.537 3.036

21.131 14.265 3.841

26.871 10.573 3.036

29.797 15.495 3.841

Ghana p =0p <=1p <=2

18.081 8.164 3.186

21.131 14.265 3.841

31.431* 13.350 3.186

29.797 15.495 3.841

Sierra Leone p =0p <=1p <=2

17.564 8.176 1.812

21.131 14.265 3.841

27.552 9.988 1.812

29.797 15.495 3.841

Notes:*,**indicatestatisticalsignificanceatthe5%and1%levelsrespectively.c.visusedhereasanacronymforcriticalvaluesagainstwhichthecomputedvaluesarejuxtaposed.

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Table C3: Foreign DirectInvestment,EconomicGrowthandCredittothePrivateSector

Countries H0 : rank = p λMax95% c.v λTrace

95% c.v

Cote’d’Ivoire p =0p <=1p <=2

16.086 7.513 0.701

21.132 14.265 3.841

24.299 8.213 0.701

29.797 15.495 3.841

Gambia p =0p <=1p <=2

9.472 3.562 0.297

21.132 14.265 3.841

13.331 3.859 0.297

29.797 15.495 3.841

Ghana p =0p <=1p <=2

33.106** 11.485 2.966

21.132 14.265 3.841

49.557** 16.452* 4.966*

29.797 15.495 3.841

Ghana p =0p <=1p <=2

9.426 8.020 2.151

21.132 14.265 3.841

19.597 10.171 2.151

29.797 15.495 3.841

Sierra Leone p =0p <=1p <=2

23.266 6.777 2.232

21.132 14.265 3.841

32.275* 9.009 2.232

29.797 15.495 3.841

Note:SameasinTable C2above.

Table C4:ForeignDirectInvestment,EconomicGrowthandTotalLiquidLiabilities

Countries H0 : rank = p λMax95% c.v λTrace

95% c.v

Cote’d’Ivoire p =0p <=1p <=2

17.364 5.624 0.770

21.132 14.265 3.841

23.758 6.394 0.769

29.797 15.495 3.841

Gambia p =0p <=1p <=2

20.629 10.753 0.006

21.132 14.265 3.841

31.388* 10.759 0.006

29.797 15.495 3.841

Ghana p =0p <=1p <=2

22.143* 9.088 1.209

21.132 14.265 3.841

32.440* 10.297 1.209

29.797 15.495 3.841

Ghana p =0p <=1p <=2

17.273 7.191 2.971

21.132 14.265 3.841

27.435 10.161 2.971

29.797 15.495 3.841

Sierra Leone p =0p <=1p <=2

18.456 6.052 2.755

21.132 14.265 3.841

27.264 8.807 2.755

29.797 15.495 3.841

Note:SameasinTable C2above.