Foreign Direct Investments and Economic Growth – Investigating the place of Financial Stability

Abstract

The role of financial stability in the relationship between foreign direct investments (FDI) and economic growth is extensively examined in this study to provide a much-needed understanding of the extent of financial stability required for economies in Sub-Sahara Africa (SSA) to reap positive benefits from FDI, if at all it has any relevance in the nexus. Annual data on forty-six (46) SSA economies for thirteen years (from 2006 to 2018) is used in the investigation. The two-step System Generalized Method of Moments (SGMM) estimator is demonstrated to be a suitable technique for this study. Departing from the usual approach which depends on contemporaneous flows, stocks of FDI are generated and used in this study to account for both contemporaneous values and their lags in establishing the relationship. The study reveals that FDI stocks as well as financial stability do have significant negative effects on economic growth as stand-alone factors. When FDI stocks and financial stability are interacted, however, a positive relationship ensues, implying that FDI stocks cause SSA economies to grow in the presence of stable financial systems and otherwise. Further investigation of this interaction shows that the impact of FDI stocks on these economies, at the margins, tend to change with the level of financial stability. That is, at low levels of stability (below the regional mean), the combined effects are negative and significant. These effects gradually change from negative to positive as the level of financial stability rises beyond one standard deviation above the mean, although not with significant coefficients. It is thus clearly demonstrated that the place of a stable financial system in ensuring sustained economic growth in SSA cannot be overemphasized, as the absence thereof may allow other factors to adversely affect these economies, which would have been beneficial otherwise.