Malaysian Foreign Direct Investment and Growth: Does Stability Matter?

The objective of the paper is twofold. First, is to examine causal relationship between foreign direct investment (FDI) and economic growth in Malaysia and second, to look at the impact of FDI on the stability of economic growth and the impact of growth on stability of FDI. Using time series data, the paper implements the recent Toda and Yamamoto’s (1995) non-causality test to establish the direction of causation between the two variables. In addition, the impact of FDI on stability/volatility of economic growth and impact of growth on stability of FDI are tested using Generalised Autoregressive Conditional Heteroskedasticity (GARCH) model. The study found no strong evidence of causal relationship between FDI and economic growth. However, the analysis found evidence that the flow of FDI contributes to less volatility of economic growth and the growth also contributes to less volatility of FDI flow. This indicates that, in the case of Malaysia, FDI does not cause economic growth, vice versa, but FDI does contribute to stability of growth as growth contributes to stability of FDI. Thus policies ensuring the stability of both FDI and growth are important for long-run sustainability of Malaysian economy.