FDI Dynamics in Saudi Arabia: Economic Growth and Investment Inflows

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Table of Contents

Research Question
Multiple Regression Model
Hypothesis
Problem with Using OLS
Table of Descriptive Statistics
Table of Results

Research Question

The Kingdom of Saudi Arabia has been encouraging foreign direct investment (FDI) as a strategy for boosting the economy over the last decades. Foreign direct investments are an important component of any economy and massive investments are required in order for any economy to grow. However, the inflows of FDI can be affected by many factors such as political stability (or instability), business environment, and security status are among the many factors that have been shown to affect the inflows of foreign direct investment by directly affecting the rate of return on investment. Investors would want to invest in an environment in which the rate of return is high.

This study aimed at answering the question: does economic growth rate have any effect on the inflows of foreign direct investment in the Kingdom of Saudi Arabia? The study is important because many studies that have analyzed the relationship between economic growth and FDI have examined the effect of FDI on economic growth. Very studies have actually examined the role played by economic growth in influencing FDI inflows. This study will therefore help to narrow the gap that exists in the economic growth-FDI literature.

Multiple Regression Model

The multiple regression model being estimated is as follows:

Where:

FDI is the flow of foreign direct investment into the countries

GDP is the growth in gross domestic product

Inf_rate represents the rate of inflation

Int_rate represents the rate of interest on USA dollars

β₀is the constant and β₁ – β₃represent the coefficients on the explanatory variables

FDI is the dependent variable while GDP, inflation rate and interest rate are the independent variables. Of the three independent variables, GDP is the key variable of interest.

Hypothesis

The hypothesis of this study is that an increase in GDP leads to an increase in the FDI flows of the country. I expect that the coefficient of GDP will be positive, that is,

β₁ > 0. Besides the key variable of interest, it is also expected that inflation rate will have a negative impact on FDI flows. Therefore, the coefficient of inflation rate is expected to be negative; that is,

β₂ < 0. Third, the author expects that interest rate will have a positive impact on FDI flows. The coefficient of interest rates is therefore expected to be positive; β₃ < 0.

Problem with Using OLS

The problem with using OLS to estimate equation (1) is that OLS is limited to cross-sectional data only. The variables in equation 1 have properties of time series data because they are usually collected on an annual basis. Therefore, examining the trend of these variables over a longer period of time would enable us to establish any meaningful relationship between the variables. Using OLS on equation 1 would not give the reality about the relationships. This is because the data have been collected at a point in time (2008) and this fails to show how the data trend over time. To overcome this problem, the author data on the variables over a period of five years and given the fact that five observations (the GCC countries) were used, this called for the use of panel data techniques, specifically the fixed effects model.

Table of Descriptive Statistics

*Table 1: Table showing the descriptive statistics of the dependent and independent variables*

The table above shows the descriptive statistics for all the variables included in estimating equation 1. In STATA 10, producing the table of descriptive statistics is done using the following command: sum varlist where varlist refers to all the variables used in the equation beginning with the dependent variable and followed by all the independent variables. Unfortunately, the sum command (which is short form of summarize) does not give the median but it gives the other four statistics (mean, standard deviation, minimum and maximum).

Table of Results

*Table 2: Results of the multiple regression model*

The table above shows the results produced by STATA 10 after running the multiple regression model represented by equation 1. The table gives, among other things, the coefficients of the independent variables. One interprets both the sign and the magnitude of the coefficients. The coefficients of GDP and interest rate are positive while that of inflation rate is negative, all of which support the author’s a priori expectations. The coefficients can be interpreted as follows: a one unit increase in GDP leads to an increase in FDI by 6.49 units; a one unit increase in inflation rate leads to a decrease in FDI by 106 units; and a one unit increase in interest rate leads to an increase in FDI by 66527.58 units.

The model in equation 1 was later analyzed using the fixed effects model but only the key variable of interest – the GDP – was included as an independent variable. The fixed effects model gave the results shown in table 3 below. The results imply that there are some unobservable effects in Saudi Arabia (country 5) which tend to increase FDI flows by 5908.297 units as GDP increases by 1 unit.

*Table 3: Results of the fixed effects model*

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