Moderating Effect of Financial Development on the Foreign Capital Inflows–Growth Nexus: Evidence from Developed and Developing Countries

Elma Satrovıc, Mehmet Zana Duran

Abstract


The relationship between foreign capital inflows and economic growth has received great attention among research community. This is since foreign capital inflows tend to contribute to the national economy in both, developed and developing countries. On the other hand, financial development tends to promote the accumulation of capital especially in developing countries. Hence, there is a necessity to analyze a moderating role of financial development on the relationship between foreign capital inflows and economic growth. Previous research on the matter is limited. Therefore, this study aims to fill in this gap in literature by collecting annual panel data over the period 1993-2015. The relevance of foreign capital inflows (FDI) on economic growth (GDP) is explored in three panels. The first overall panel contains 75countries; the second contains 35 developed countries, while the third panel contains 40 developing countries. Models are initially estimated using linear static panel data estimators. Moreover, dynamic panel data estimators are applied in order to control for possible estimation issues of linear static panel data estimators. Models estimated using linear static panel data estimators are not reported to be significant. Linear dynamic panel data estimators suggest a significant positive effect of foreign capital inflows on economic growth in the models that do not control for moderating impact of financial development. The strongest impact is reported for developing countries. In addition, the empirical findings of this paper suggest a significant positive moderating effect of financial development on the relationship between foreign capital inflows and economic growth suggesting that developed financial systems are recognized as an important determinant of economic growth and foreign capital inflows.


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