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Relationship of FDI and GDP of Bangladesh Introduction Foreign Direct Investment (FDI) is a key component of the global capital

flow that entails world economic growth through investment opportunities. As an investment tool FDI also affect the aggregated growth of the host country. FDI as a share of GDP has become the largest source of capital moving from developed nations to developing ones. FDI inflow usually involves starting new production facilities namely Greenfield investments or purchase of existing business through mergers and acquisitions. In developing nations, equity investments as a percentage of gross national income have been growing in recent years. In spite of FDIs potential to impact on know-how, output and investment, development economists have unexpectedly not interested in finding a strong causal link to economic growth. However, some studies have identified a positive impact, but only if the country has human capital and infrastructural support. Literature Review The Gross Domestic Product (GDP) is a measure of a country's aggregated economic output. It is the final market value of all goods and services finally produced within the territory of a country in a particular year. GDP can be estimated in different ways and in different measurements which would give results with different implication. According to Sullivan and Steven (2003) GDP can be measured in three ways such as the product (or output) approach, the income approach, and the expenditure approach. The expenditure approach measures that all of the product must be bought by somebody and thus the value of the total product must be equal to total expenditures for purchase. Product approach aggregates the outputs of every business to get the total. The income approach measures the sum of all producers' incomes based on the principal that the incomes of the productive factors must be equal to the value of their product. Foreign direct investment (FDI) is the long term capital investment by a country into another country. It usually involves participation in a business entity by means of management, joint-venture, technological know-how and expertise. There are three types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow. Whereas, foreign direct investment stock or FDI Stock is the cumulative number for a given period. FDI and Economic Growth Agrawal (2000) examined the impact of FDI inflows on GDP and found negative impact prior to 1980, mildly positive for early eighties and strongly positive over the late eighties and early nineties. This supported the view that FDI is more likely to be beneficial in more open economies. His study was based on both time-series and cross- section analysis of data from five South Asian countries i.e. India, Pakistan, Bangladesh, Sri Lanka and Nepal.

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Relationship of FDI and GDP of Bangladesh Athukorala (2003) argued that there is no such extreme link between FDI and economic growth in Sri Lanka. However, the study did not imply that FDI is insignificant; rather, the study concluded that the direction of causal relation was not towards from FDI to GDP growth but GDP growth to FDI. Lan (2006) stated that FDI and economic growth are important determinants of each other in Vietnam over the period of 1996-2003. Thus the study concluded that economic growth in Vietnam was viewed as an important factor to attract FDI inflows into Vietnam. Feridun (2004) used Granger test to examine the causality between FDI and GDP in the economy of Cyprus and found that GDP in Cyprus was caused only by the FDI. Further the study suggested that the economic development will depend on the performance in attracting foreign investment in Cyprus. Borensztein, Gregorio and Lee (1998) argued that FDI had a positive growth effect when the country had human capital that allowed it to disseminate FDI spillovers. However, Alfaro et al (2003) argued that FDI promotes economic growth in countries having developed and liberalized financial markets. Methodology and Data GDP data has been obtained from World Bank website (World Development Indicators). Values are based upon GDP in national currency and the exchange rate projections provided by country economists for the group of other emerging market and developing countries. Exchanges rates for different economies are established in the WEO assumptions for each WEO exercise. UNCTAD has the most complete FDI database and it compiles data on bilateral FDI flows - both inflows and outflows. The main sources for UNCTADs FDI flows are national authorities (central banks or statistical office). These data are further complemented by data obtained from other international organizations such as the IMF, the World Bank (World Development Indicators), the Organisation for Economic Cooperation and Development (OECD), and UNCTADs own estimates. Both Remittance and Official Development Assistance (ODA) data are retrieved from the website that compiled from IMF balance of payments data. Empirical Analysis & Interpretations of the Results This section presents the result of regressions of the previously defined measure of GDP using 20 years data of Bangladesh. Table 1 presents descriptive statistics for the variables used in the estimates. Summary statistics in table 3 include the mean and the standard deviation for time period of 1986-2005. Table 1 : Descriptive Statistics Variables GDP FDI Remittance ODA Mean 39972.45 214.00 1648.65 1434.30 Std. Deviation 11321.715 253.848 1066.544 327.677

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Relationship of FDI and GDP of Bangladesh Multiple regressions were run in SPSS using the Least Square Estimation Method to test the set hypotheses or more clearly to test how the independent variables explain the GDP. Before running the regression, examination of the multicollinearity problem was carried out using the Pearson Correlation method. First of all, bivariate (pair-wise) correlations among the independent variables were examined to find out the multicollinearity problem. The existence of correlation of about 0.80 or larger indicates that there is problem of multicollinearity (Lewis-Back 1993). Table 2 presents the Pearson correlation coefficients for the variables used in this estimation. FDI and Remittance have pair-wise coefficient of correlation larger than .80 that indicates multicollinearity. Table 2 : Pearson Correlation Matrix GDP 1.000 FDI .820 1.000 Remittance .940 .766 1.000 ODA -.612 -.649 -.495 1.000

GDP FDI Remittance ODA

Explanatory power of the model as indicated by R2 (multiple coefficient of determination) and adjusted R2 is fairly good. The model explains around 91.9% of the variation in the dependent variable/GDP. The adjusted explanation of the model is about 90.4%. The F value which is a measure of overall significance of the estimated regression and also a test of significance of R2 is 60.57. The F statistic exceeds the critical F value at both 1% and 5% level and thus proves that the independent variables have effect on GDP.

Table 3 : Model Summary R Square .919 Adjusted R Square .904 Std. Error of the Estimate 3509.609 F Change 60.575

a Predictors: (Constant), ODA, Remittance, FDI

Table 4 : Determinants of GDP - Regression Results Unstandardized Coefficients (Constant) FDI Remittance ODA B 32275.465 6.684 8.021 -4.851 Std. Error 5429.383 5.637 1.175 3.231 Standardized Coefficients Beta .150 .756 -.140 5.945 1.186* 6.829** -1.501* .000 .253 .000 .153 t Sig.

a Dependent Variable: GDP *significant at 20% ** significant at 1%

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Relationship of FDI and GDP of Bangladesh The independent variables Remittance and ODA have statistically significant effect on the GDP whereas FDI has statistically insignificant effect on the GDP (Table 4) Thus, the empirical model showing the impact of independent variables on GDP is shown in the following equation: GDP = a+b1FDI + b2Remit + b3ODA +u GDP = 32,275.46 + 6.684FDI + 8.021Remit - 4.851ODA Causality Relation In order to test for direct causality between FDI and economic growth, we perform a Granger causality test using equations (1) and (2):

GDPt = + i GDPt i + i FDI t i + t .. (1)


i =1
k

i =1

FDI t
where

= + i GDPt i + i FDI t i + t ..(2)


i =1 i =1

GDPt and FDI t are stationary time series sequences, and are the respective intercepts, t and t are error terms, and k is the maximum lag length used
in each time series. The optimum lag length is identified using Hsiaos (1981) sequential procedure, which is based on Grangers definition of causality and Akaikes (1969, 1970) minimum final prediction error criterion. If in equation (1)
i =1 k

is significantly different

from zero, then we conclude that FDI Granger causes GDP. Separately, if i =1 in equation (2) is significantly different from zero, then we conclude that GDP Granger causes FDI. Granger causality in both directions is, of course, a possibility. The steps involved in implementing the Granger causality test are as follows (Gujrati, 2007):

1. Regress current GDP on all lagged GDP terms and other variables, if any, but do
not include the lagged FDI variables in this regression. From this regression obtain the restricted residual sum of squares, RSSr. 2. Now run the regression including the lagged FDI terms. From this regression obtain the unrestricted residual sum of squares, RSSur.

3. To test this hypothesis, we apply the F test given by: F =

( RSSr RSSur ) / m RSSur /( n k )

Empirical Study

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Relationship of FDI and GDP of Bangladesh The causality relationship of FDI and GDP has been tested using 20 years data of Bangladesh. GDP constant price in million US dollar is compared with FDI inflow in million US dollar. The null hypothesis in each case is that the variable under consideration does not Granger-cause the other variable Table 2: Granger Causality Test for GDP and FDI Direction of causality FDI GDP GDP FDI F value 2.050 10.738 Decision (H0) Do not reject Reject Causality No Yes

These results suggest that the direction of causality is from GDP to FDI since the estimated F is significant at the 5 percent level; the critical F value is 4.45 (for 1 and 17 df). On the other hand, there is no reverse causation from FDI to GDP since the F value is statistically insignificant at 5 percent level. From Table 1 it is evident that despite the growth rates in both GDP and FDI in the sample years of Bangladesh, we cannot generalize any FDI-Growth causal relationship for Bangladesh. Rather growth seems to stimulate FDI for case of Bangladesh. Conclusion The model explains around 91.9% of the variation in the dependent variable/GDP. The adjusted explanation of the model is about 90.4%. FDI and Remittance have pair-wise coefficient of correlation larger than .80 that indicates multicollinearity compare to ODA. The F statistic proves that the independent variables have effect on GDP. On the other hand Remittance and ODA have statistically significant effect on the GDP whereas FDI has statistically insignificant effect on the GDP. The causal relationship between economic growth and increased FDI in Bangladesh has been revealed here. Using Granger causality test, it is evident that FDI-to-growth causality is absence in Bangladesh. Thus FDI-GDP relation cannot be generalized and must be considered using other factors i.e. trade openness, human capital, infrastructural setup, industrial policy and political regime.

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