EFFECTS OF FOREIGN DIRECT INVESTMENT AND FINANCIAL DEVELOPMENT ON THE ECONOMIC GROWTH IN THE EAST AFRICAN COMMUNITY

Abstract

This study aimed to investigate the effect of foreign direct investment and financial development on economic growth in the East African Community (EAC) using panel cross-sectional time-series data collected separately from 5 countries during the period from 1996 to 2015. The role of foreign direct investment(FDI) and financial development (FD) on the growth of an economy has been a topic of study for many researchers in several countries. A positive and negative impact of FDI and financial development has been found depending on countries or regions. A cross-sectional time-series regression analysis was used to measure the degree to which foreign direct investment, financial development, and economic growth are related to each other. The study investigated furthermore the relationship between trade openness, inflation and economic growth in the EAC. Using the Johansen cointegration model, we found between variables a long-run relationship. The study also found that all the variables are non-stationary at the level (0) form but have a unit root and are integrated at first difference I(1) by using the Augmented Dickey-Fuller unit root test for examining the stationarity of variables. The results of regression reveal that FDI has a negative effect on economic growth, it is found also that an increase or decrease in FDI doesn‟t generate economic growth in the countries of the EAC. Findings expose that economic growth is highly determined by domestic credit to the private sector, that the improvement of financial development can transform and generate economic growth in the countries of the EAC. The thesis finally revealed a positive and insignificant effect of trade openness on economic development in the countries of the EAC. It was concluded that inflation has a positive and significant effect on economic growth in EAC‟s countries.