Foreign Direct Investment and Economic Growth

The mid 1980s saw the convergence of various factors which encouraged the inflow of FDI into Malaysia. Like most other developing countries, the Malaysian government welcome FDI rather than portfolio investment simply because the government believed that FDI would play an important role in Malaysia's economic development. It cannot be denied that FDI has contributed significantly to the Malaysian economy in general and the manufacturing sector in particular. FDI has played a key role in the diversification of the Malaysian economy, as a result of which the economy is no longer precariously dependent on a few primarily commodities, with the manufacturing sector as the main engine of growth. The objective of this thesis is to investigate the causal relationship between foreign direct investment (FDI) and economic growth. The topic is in fact quite old and has been discussed by researchers for the last 3 decades. Interest in this area has been revived in recent years largely due to the recognition that the economy's openness and international capital inflows (particularly FDI) play an increasing role in promoting economic growth in developing countries. Most previous empirical studies have ignored the bi-directional causal relationship between FDI and economic growth. In this study, I employed time series analysis and Granger Causality test to determine the causal relationship between FDI and economic growth in the case of Malaysia. The finding of this thesis is that bidirectional causality exist, between foreign direct investment and economic growth in Malaysia, i.e. while growth in GDP attracts FDL, FDI also contributes to an increase in output