Financial Development, Foreign Investment and Economic Growth in Malaysia

By making use of the bank-based theory of financial development, this paper develops a simultaneous equations model that allows one to empirically examine the interrelationship among economic growth, the stock of foreign investment and the stock of domestic capital in Malaysia. The empirical model is estimated by means of the Generalised Method of Moments. The empirical analysis, based on annual data for the period 1970–2007, reveals that the level of financial development has contributed to the growth of the domestic capital stock in Malaysia but its impact on economic growth is statistically insignificant. An increase in the stock of foreign investment in Malaysia has contributed to an increase in the stock of domestic capital and economic growth but the stock of foreign investment is affected significantly only by the level of openness of the economy and its real exchange rate