Foreign direct investment-economic growth link: the role of domestic financial sector development in Bangladesh

Abstract

This paper aims to investigate the links between foreign direct investment (FDI) and economic growth through financial sector’s development (FD) in the case of Bangladesh. Using annual data series of World Bank for the period of 1983-2008, the unrestricted error correction method (UECM) developed by Inder (1993) is employed. FDI alone affects economic growth negatively in the long run. However, FD variable and the interaction term between FD and FDI (FD*FDI) are showing positive impact on GDP growth in the case of Bangladesh. Public investment or public capital stock also stimulates economic growth in the long run. This paper proposes that Bangladesh government should undertake financial reforms to improve the efficiency of the domestic financial sector. Appropriate steps must be taken to further liberalize the capital account to enhance FDI. Care must be taken to ensure efficiency of delivery of services and increase productivity of public investment. This paper convincingly argues that there is a need for case-by- case study on such a project in view of each country’s unique characteristics. To the best of our knowledge, this study seems to be a good and unique contribution in literature with reference to Bangladesh as this is the pioneering attempt that employs UECM for a case study on Bangladesh.