The impact of foreign investment, regulatory measures and black markets on a country's economic growth

Journal of the Academy of Business and Economics, Jan, 2003 by Imtiaz Ahmad, Dinesh K. Sharma, Julius A. Alade

ABSTRACT

The study explores the impact of economics and institutional factors on a country's economic growth. These factors include: trade, taxation, government intervention in the economy, monetary policy, foreign investment, banking, wages and price policies, property rights, regulation, and black markets. The study estimates a formulated linear regression model. The results of the regression analysis demonstrate that despite the positive and low level contributions of the variables in a country's overall growth, three of the factors namely, absence of black market, lower level of government intervention, and unrestricted direct foreign investment show a more statistically significant impact on a country's growth (GDP).

1. INTRODUCTION

The phenomenon of value and growth has occupied a central position in the history of economic thought. Economists have considered it a challenge to provide an intellectually convincing and statistically testable explanation for the difference in the value of various commodities at the micro level and reasons behind variation in economic growth that different countries experience at the macro economic level. With the development of marginal analysis and the theory of supply and demand, the problem of valuation has long been laid to rest. The phenomenon of variability in growth on the other hand, has been found to be more intractable. Despite tremendous advances in economic development theory and methodology over the last few decades, the reasons for differences in the growth of GDP within and across nations are still hotly debated (Rostow, 1990). In the ensuing economic debate, these reasons have ranged from esoteric, such as geographic, cultural and environmental determinism to more mundane debate such as quality of human and material resources, differences in saving rates, technological development as well as nations' institutional and political framework.

According to data compiled by Maddison (1995) per capita world output in 1990 dollars for the period 1500 to 1820 increased from $565 to $651. In half such time from 1820 to 1992, on the other hand, it soared to $5145.00. Economists attribute this significant jump in output during the 19th and early 20th century, primarily to technological progress, which was achieved through new product discoveries, innovations, and human and physical capital growth. Although, these developments were spread worldwide, only a few politically and economically dominant more advanced economies benefited a great deal from these developments while the less developed economies of Asian and African nations lagged behind. The cause of poverty in the midst of plenty remained a puzzle throughout the world. Economist from Adam Smith in 1776 to Mancur Olson in 1996 although successfully identified a host of economic and institutional factors that contribute to promoting economic growth in a country, there is, however, disagreement on their relative importance (Smith, 1996 and Olson, 1996). While Adam Smith placed a heavy emphasis on the division of labor, specialization and capital growth through savings and entrepreneurship, David Ricardo championed the cause of free trade through comparative advantage (Ricardo, 1951).

In the decades from 1960s to 1980s, Solow's Growth Model emphasized savings and capital formation (Solow, 1956). During all this time, when economists were engaged in identifying the relative importance of various economic factors, the role of institutional factors in development remained implicitly hidden in the background. It was not until the publication of Paul Romer's article in 1986 that the role of institutional factors in economic development was explicitly acknowledged. Their role on development did not only receive a new impetus in mobilizing other resources for development but their positive influence on long-term growth also became fully recognized. A study conducted jointly by Heritage Foundation and the Wall Street Journal has recently identified and summarized the discussion on the role of institutional factors on development within the framework of the following ten factors (Holmeus et al., 1997). These factors include: (1) Trade Policy (2) Taxation Policy (3) Government Intervention in the Economy (4) Monetary Policy (5) Capital Flows and Foreign Investment (6) Banking Policy (7) Wages and Price Constraints (8) Property Rights (9) Regulation and (10) Black Market.

The focus of our study is two fold. First to evaluate the impact of all ten economic factors on the GDP of 150 countries and secondly to delineate statistically significant factors on a country's growth. The study primarily relies on Heritage Foundation's ranking (Holmeus et al., 1997). However, unlike the Heritage research which is mainly concerned with establishing correlation between an overall combined index of all the ten factors on a country's GDP, our study concentrates on an evaluation of the impact of each individual economic factor on a country's GDP.

2. REVIEW OF LITERATURE