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Impact of foreign direct investment on economic growth: Empirical evidence
from Ghana
Article · January 2013
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International Journal of Academic Research in Accounting, Finance and Management Sciences
Vol. 3, No.1, January 2013, pp. 18–25
ISSN: 2225-8329
© 2013 HRMARS
www.hrmars.com
Impact of foreign direct investment on economic growth:
Empirical evidence from Ghana
Samuel ANTWI1
Ebenezer Fiifi Emire Atta MILLS2
Gifty Atta MILLS3
Xicang ZHAO4
1,4
School of Finance and Economics, Jiangsu University, China
1 4
E-mail: samyantwi@yahoo.com, E-mail: zxc@ujs.edu.cn
2,3
School of Administration, Jiangsu University, China
2 3
E-mail: attamills2003@gmail.com , E-mail: dream200018@yahoo.com
Abstract Foreign direct investment (FDI) has been a vital source of economic growth for Ghana, bringing in capital
investment, technology and management knowledge needed for economic growth. This paper aims to
study the relationship between FDI and economic growth in Ghana for the period 1980-2010 using time
series data. The GDP, GDP growth rate, GNI, Manufacturing Value Added, External Debt Stock, Inflation,
Trade, Industry Value added and Foreign Direct Investment net inflows as percent of GDP (FDI ratio). We
used the simple ordinary least square (OLS) regressions and the empirical analysis is conducted by using
annual data on FDI and other variables over the periods 1980 to 2010. We used annual data from IMF,
International Financial Statistics tables, published by International Monetary Fund. The goal of this study
is to determine the extent to which these variables are related. From this, we can conclude that the
independent variables GDP, GDPg, GNI, MVA, GDPc and TRA are all significant to explain FDI since their
corresponding p-values of the t-statistic are less than 5 percent and thus have an influence of FDI in
Ghana. These findings embrace practical implications for policy makers, government and investors.
Key words FDI, GDP, Inflation, Economic growth, Ghana
1. Introduction
Foreign direct investment (FDI) has played a leading role in many of the economies of the Africa.
There is a widespread belief among policymakers that foreign direct investment (FDI) enhances the
productivity of host countries and promotes development. There are several studies done on FDI and
economic growth. Their findings vary from different methods used on their research, some of the
researchers found that FDI has a positive effect on economic growth. For example is Balasubramanyam et
al (1996) analyzes how FDI affects economic growth in developing economies. Using cross-section data and
OLS regressions he finds that FDI has a positive effect on economic growth in host countries using an export
promoting strategy but not in countries using an import substitution strategy. Olofsdotter (1998) provides a
similar analysis. Using cross sectional data she finds that an increase in the stock of FDI is positively related
to growth and that the effect is stronger for host countries with a higher level of institutional capability as
measured by the degree of property rights protection and bureaucratic efficiency in the host country. De
Mello (1999) only finds weak indications of a positive relationship between FDI and economic growth
despite using both time series and panel data fixed effects estimations for a sample of 32 developed and
developing countries. On the other hand, Zhang (2001) and Choe (2003) analyses the causality between FDI
and economic growth. Zhang uses data for 11 developing countries in East Asia and Latin America. Using
cointegration and Granger causality tests, Zhang (2001) finds that in five cases economic growth is
enhanced by FDI but that host country conditions such as trade regime and macroeconomic stability are
International Journal of Academic Research in Accounting, Finance and Management Sciences
Vol. 3 (1), pp. 18–25, © 2013 HRMARS
important. According to the findings of Choe (2003), causality between economic growth and FDI runs in
either direction but with a tendency towards growth causing FDI; there is little evidence that FDI causes
host country growth. Rapid economic growth could result in an increase in FDI inflows. There is further
study done by Chowdhury and Mavrotas (2003) which examine the causal relationship between FDI and
economic growth by using an innovative econometric methodology to study the direction of causality
between the two variables. The study involves time series data covering the period from 1969 to 2000 for
three developing countries, namely Chile, Malaysia and Thailand, all of them major recipients of FDI with
different history of macroeconomic episodes, policy regimes and growth patterns. Their empirical findings
clearly suggest that it is GDP that causes FDI in the case of Chile and not vice versa while for both Malaysia
and Thailand, there is a strong evidence of a bi-directional causality between the two variables. The
robustness of the above findings is confirmed by the use of a bootstrap test employed to test the validity of
the result. In addition, Frimpong and Abayie (2006) examine the causal link between FDI and GDP growth
for Ghana for the pre and post structural adjustment program (SAP) periods and the direction of the
causality between two variables. Annual time series data covering the period from 1970 to 2005 was used.
The study finds no causality between FDI and growth for the total sample period and the pre-SAP period.
FDI however caused GDP growth during the post –SAP period. This paper aims to study the relationship
between FDI and economic growth in Ghana for the period 1980-2010 using time series data.
1.1. FDI inflow in Ghana
Foreign direct investment (FDI) in developing economies has grown rapidly following financial and
political transformation. To increase their share of FDI inflows, most countries have eased restrictions on
foreign direct investment, strengthened macro stability, privatized state-owned enterprises, instituted
domestic financial reforms, capital account liberalization and granted tax incentives and subsidies. Ghana
for instance through the Free Zones Act, 1995 and the Ghana Investment Promotion Act 1994 has granted
certain tax incentives and investor protection policies to attract foreign investors and also make the
environment conducive for their operations. This initiative and policy taken in Ghana have increased the
number of foreign direct investment and helped in economic growth.
Attracting FDI is a preoccupation of Ghana’s opening up policies and economic reforms. Various
Governments in Ghana have developed various legislations to improve investment conditions and the
business environment in order to attract FDI, putting Ghana in the top ten reformers globally for the
second year in a row, according to the World Bank's Doing Business team. Ghana’s shares of FDI
quadrupled from 2005 to $636M in 2006 and represent 19.4% of gross fixed capital formation according to
2008 World Investment Report (WIR). In 2008, Ghana experienced increased global attention as a result of
hosting the 2008’s Africa Cup, the UNCTAD XII (United Nations Conference on Trade and Development) and
WAIPA (World Association of Investments promotion Agencies) meetings. This attention comes at a time
when the country has had strong GDP growth and significant increases in FDI inflows (World Bank, 2008).
Foreign direct investment (FDI) provides a major source of capital which brings with it up-to-date
technology. It would be difficult to generate this capital through domestic savings, and even if it were not, it
would still be difficult to import the necessary technology from abroad, since the transfer of technology to
firms with no previous experience of using it is difficult, risky, and expensive.
Over a long period of time FDI creates many externalities in the form of benefits available to the
whole economy which most companies cannot appropriate as part of their own income. These include
transfers of general knowledge and of specific technologies in production and distribution, as well as
industrial upgrading, work experience for the labor force and the introduction of modern management and
accounting methods. The establishment of finance related and trading networks, and the upgrading of
telecommunications services may also occur. FDI in services affects the host country's competitiveness by
raising the productivity of capital and enabling the host country to attract new capital on favorable terms
(Lipsey et al, 2010). It also creates services that can be used as strategic inputs in the traditional export
sector to expand the volume of trade and to upgrade production through product and process innovation
(Lipsey et al, 2007). Beyond the initial macroeconomic stimulus from the actual investment, FDI will
influence growth by raising total factor productivity and, more generally, the efficiency of resource used in
the recipient company or economy. This works through three channels: the linkages between FDI and
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Vol. 3 (1), pp. 18–25, © 2013 HRMARS
foreign trade flows, the spillovers and other externalities in relation to the country’s business sector, and
the direct impact on structural factors in the host economy. As countries develop and approach
industrialized nation status, inward FDI contributes to their further integration into the global economy by
engendering and boosting foreign trade flows. Apparently, several factors are at play. They include the
development and strengthening of international networks of related enterprises and an increasing
importance of foreign subsidiaries in MNEs’ strategies for distribution, sales and marketing (Andre-Pascal,
2002).
1.2. Foreign Direct Investment & Its Components
In this research, FDI refers to the monetary resources foreigners invest in companies or their
subsidiaries listed on the Ghana Stock Exchange. The research focus is only on foreign investors who live
outside Ghana and invest their monies into the various companies listed on the Exchange. According to the
literature, FDIs require a business relationship between a parent company and its foreign subsidiary.
Foreign direct business relationships give rise to multinational corporations (MNC). For an investment to be
regarded as an FDI, the parent firm needs to have at least 10% of the ordinary shares of its foreign
affiliates. The investing firm may also qualify for an FDI if it owns voting power in a business enterprise
operating in a foreign country. This assertion by the Economy, Investment and Financial Report of the
Economy Watch website is true but FDI can also be the monetary resources, expertise, machinery
foreigners invest in companies outside their domestic countries. Parent firms setting up subsidiaries
outside their domestic countries do not need to own at least 10% of the ordinary shares of the subsidiary to
provide FDI support, but can owe any percentage of the ordinary shares to provide the support. Foreign
direct investment (FDI) plays an extraordinary and growing role in global business. It can provide a firm with
new markets and marketing channels, cheaper production facilities, access to new technology, products,
skills and financing.
2. Data and Methodology
This section describes the econometrics methods that we use to access the relationship between FDI
and economic growth. We used the simple ordinary least square (OLS) regressions and the empirical
analysis is conducted by using annual data on FDI and other variables over the periods 1980 to 2010. We
use annual data from IMF International Financial Statistics tables, published by International Monetary
Fund to find out the relationship between FDI, GDP, GNI, MVA, EDS, INF, GDPc, TRA and IVA in the case of
Ghana.
2.1. Model Specification and Estimation
OLS framework
FDIi = α + β1GDPi + β2GDPgi + β3GNIi + β4MVA i + β5EDSi + β6INFi + β7GDPCi + β8 TRA i + β9IVA i +εi (1)
Where:
Dependent variable is = FDI
Explanatory variables are:
GDP= Gross Domestic Product
GDPg= Gross Domestic Product growth rate
GNI= Gross National Income
GNI= Gross National Income
MVA= Manufacturing, Value Added
INF= Inflation, Consumer Prices
GDPc= Gross Domestic Product per capita TRA= Trade
IVA= Industry, Value Added i = Time period
β = Coefficients of the Independent variables.
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Vol. 3 (1), pp. 18–25, © 2013 HRMARS
Hypotheses
∂FDI ∂FDI
Hypothesis 1: 〉0 〉 0 This study expects that FDI inflows should have a positive effect
∂GDPg ∂GDP
on Gross Domestic Product and Gross Domestic Product growth rate. If there is an increase in FDI inflow,
there will lead and enhance the economic growth in Ghana. In contrast, if the FDI is negative correlation to
economic growth, it will not help in GDP growth in a country.
∂FDI
Hypothesis 2: 〉 0 Trade leads to specialization and expanding potential markets which allows
∂TRA
domestic firms to take advantage of economies of scale, more competitive. This study expects Trade to
have a positive effect on FDI as the openness to international market affects the probability of foreign
investors.
∂FDI
Hypothesis 3: 〈 0 It is assumed that there is a negative interaction between FDI and External
∂EDS
debt.
∂FDI
Hypothesis 4: 〈 0 High inflation is an indication of economic instability and it destroys the
∂INF
value of money. Value destruction implies a negative impact on economic growth and it can infer that the
impact on FDI is negative.
2.2. Diagnostic Testing
On the other hand, we also apply the diagnostic testing to test the series whether the series are free
from autocorrelation (Breusch-Godfrey Serial Correlation LM Test), heteroscedasticity (Breusch-Pegan-
Godfrey Test) and normality problem (Jarque-Bera Statistics).
Hypothesis 5:
H0: There is no serial correlation in the residuals.
H1: There is serial correlation in the residuals.
Hypothesis 6:
H0: Residuals are homoscedastic
H1: Residuals are heteroscedatic
Hypothesis 7:
H0: Residuals are normally distributed
H1: Residuals are not normally distributed
For Hypothesis 5, 6 and 7 if the computed p-value is greater than 0.05 significant levels, then we do
not reject the null hypothesis and conclude that there is no serial correlation in the residuals, residuals are
homoscedastic and residuals are normally distributed.
Conversely, if the computed p-value is less than 0.05 significant levels, then we reject the null
hypothesis and conclude that there are existing autocorrelation heteroscedasticity and normality problem.
3. Empirical Results and Discussions
The focus of this study is to determine whether the Foreign Direct investments received directly
affect the growth of the Ghanaian economy. The main objective of this research is to ascertain whether
there is a positive or negative impact of FDI on the growth of the Ghanaian.
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Vol. 3 (1), pp. 18–25, © 2013 HRMARS
Table 1. Method of Least Squares
Variable Coefficient Std. Error t-Statistic Prob.
C -9.46E+08 5.37E+08 -1.760808 0.0928
GDP 0.429241 0.126281 3.399091 0.0027
GDPG 28243585 13327515 2.119194 0.0462
GNI -0.364937 0.088541 -4.121682 0.0005
MVA -2.561130 0.482747 -5.305325 0.0000
EDS 0.054380 0.060814 0.894200 0.3813
INF -1209288. 1540538. -0.784977 0.4412
GDPC 3637805. 2183973. 1.665682 0.0106
TRA 1890756. 3963092. 0.477091 0.0382
IVA 0.143076 0.239345 0.597780 0.5564
R-squared 0.963094 Mean dependent var 3.43E+08
Adjusted R-squared 0.947278 S.D. dependent var 7.00E+08
S.E. of regression 1.61E+08 Akaike info criterion 40.88493
Sum squared resid 5.43E+17 Schwarz criterion 41.34750
Log likelihood -623.7164 Hannan-Quinn criter. 41.03571
F-statistic 60.89103 Durbin-Watson stat 2.053094
Prob(F-statistic) 0.000000
R-square has a limit value of 1, and it happens when the regression line fits the observations exactly.
The overall fit of the estimated regression equation to the actual data will be "better" if R-square is closer
to the value of 1. For time series data R-square of .5 might be considered as a reasonable good fit for cross
sectional data Baye (2005). In this research paper, total 96.31% variation in the dependent variable as
shown in table 1 is explained by the explanatory variables. However, the rest of the variation is due to
factors other than the independent variables or residuals. The validity of the model is represented in the
value F-statistics. F-statistic is a measure of total explained variation divided by total unexplained variation.
The higher the F-statistic, the better the overall fit of the regression line through the actual data. Since the
p-value is less than 5 percent, we can conclude that all the independent variables
(here GDPi , GDPgi , GNIi , MVA i , EDSi , INFi , GDPci , TRA i , IVA i ) can jointly explain or influence FDIi .
From the multiple regression models drawn from table 1 the coefficients of the independent
variables are written in the form:
FDIi = α + 0.429241 GDPi + 28243585 GDPgi -0.364937 GNIi -2.561130 MVAi + 0.054380 EDSi -
-1209288. INFi + 3637805.GDPCi + 1890756.TRAi + 0.143076 IVAi + εi (2)
The correlation between FDI and GDP, FDI and GDPg is positive because as FDI is increasing the GDP
and GDPg is also increasing. This positive relationship affirms our hypothesis 1. Trade, TRA is positively
correlated to FDI as illustrated in the nature of TRA’s coefficient therefore failing to reject our hypothesis
2.Increment in trade activities will increase due to foreign direct investment. Hypothesis 3 also confirms our
expectation that EDS is negatively correlated to FDI. A large external debt can negatively influence potential
investors when determining both the location of their foreign investments and the type of investment. For
example, if investors expect that a government with a large external debt will engage in distortion and
unpredictable fiscal policies in order to service their external debt, they will lower expectations of the
returns on their investments. This in turn will limit the country’s foreign direct investment (FDI) inflows,
encourage non-productive short term investments and discourage existing firms from making new
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Vol. 3 (1), pp. 18–25, © 2013 HRMARS
investments and/or engaging in research and innovations. Inflation was noted to have a
negative relationship with FDI because of the nature of inflation’s coefficient from this study. Increase in
inflation will decrease the purchasing power of people, also decrease the demand of goods and services it
will also decrease the supply of goods and services and the resulting investment will also decease.
The independent variable significance can be drawn from the p-value of the t-test of the various
independent variables. For each independent variable to be significant to this study, then its p-value of the
t-statistic must be less than 0.05 or 5 percent. From this, we can conclude that the independent variables
GDP, GDPg, GNI, MVA, GDPc and TRA are all significant to explain FDI since their corresponding p-values of
the t-statistic are less than 5 percent and thus have an influence of FDI in Ghana.
Table 2. Breusch-Godfrey Serial Correlation LM Test
F-statistic 0.027397 Prob. F(2,19) 0.9730
Obs*R-squared 0.089143 Prob. Chi-Square(2) 0.9564
In hypothesis 5, since the p-value (0.9564) of Obs*R-squared is more than 5 percent (p>0.05), we fail
to reject null hypothesis meaning that residuals are not serially correlated which is desirable for a
regression model.
Table 3. Breusch-Pegan-Godfrey Heteroscedasticity Test
F-statistic 6.666641 Prob. F(9,21) 0.0002
Obs*R-squared 22.96294 Prob. Chi-Square(9) 0.0603
Scaled explained SS 12.58611 Prob. Chi-Square(9) 0.1822
In hypothesis 6, the p-value of Obs*R-squared (0.0603) shows that we cannot reject null hypothesis
.So residuals do have constant variance which is desirable in regression meaning that residuals are
homoscedastic.
6
Series: Residuals
Sample 1 31
5 Observations 31
4 Mean -2.69e-08
Median -12245036
Maximum 3.09e+08
3 Minimum -3.24e+08
Std. Dev. 1.35e+08
Skewness 0.218262
2
Kurtosis 3.388794
1 Jarque-Bera 0.441382
Probability 0.801965
0
-2.0e+08 500.000 2.0e+08
Figure 1. Residual Normality Test
Jarque Berra statistics is 0.441382 and the corresponding p value is 0.801965. Since p value is more
than 5 percent we accept null meaning that population residual is normally distributed which fulfills the
assumption of a good regression line in Hypothesis 7.
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4. Conclusions
As a conclusion, foreign direct investment has continued to play a significant role in the Ghanaian
economy. Through the empirical result, the analysis shows that there is a positive relationship between the
FDI and economic growth, which the relationship is found to be significant. The robustness of the result has
been tested using GDP, GDP growth rate, GNI, MVA, EDS, INF, TRA, IVA as dependent variables. These
findings have important policy implication where the government has to be concerned with the importance
of the FDI contribution to economic growth. Economic development of a country can be achieved by
encouraging more foreign direct investment, which it can help to create more employment in the country.
In addition, advance technology in production will train more skilled labor; therefore it will enhance the
productivity and fulfill the satisfaction and demand from the consumers. But, there is a negative effect on
domestic producers, because they lose their market power, since the foreign investor become monopolistic
in the market. This indirectly will make the domestic producer facing the difficulties to survive in the market
in the long term as foreign companies can achieve economy of scale with advance technology.
Therefore, government should impose the relevant policies like joint venture in order to give
opportunities to the domestic producers to become part and enjoy the profit together with foreign direct
investors. This will benefit the local partner as they are exposed to higher technology. Besides, government
plays an important role in maintaining political stability. Because if a new government come in with highly
different policies, foreign direct investors need to adjust their strategies in accordance with those new
policies.
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