Redefining FDI-Growth Relationship under Liberalized Economic Policies Empirical Evidence from Sri Lanka

Abstract

Economic liberalization complimented with export promoting industrial policies attracts FDI than protective policies. However, the contribution of FDI on growth under liberalized economic policies is not sufficiently analyzed. Therefore, we analyze both long run and short run impact of FDI on economic growth in Sri Lanka with special reference to the post-liberalized period of the country. In addition, we compare the impact of domestic capital and FDI on economic growth in the same backdrop. Sri Lanka entered into liberalized economic policies in 1977 by opening its trade account, and in recent years, the policy has extended to the capital and service accounts, as well. In this study, we employ a linear Auto Regressive Distributed Lag (ARDL) model to assess the relationship between economic growth and FDI by employing annual data over the period of 1978 and 2016. The results suggest a positive impact of FDI on both long run and short run growth. However, the contribution of FDI towards growth in Sri Lanka is far below compared to the domestic investments. Thus, we redefine the growth-FDI relationship as follows. Liberal market policies are the necessary condition to enhance FDI-growth relationship. However, it is not the sufficient condition to facilitate economic growth as the positive impact of FDI on growth is moderated by other socio-economic factors.