Causal links between trade openness and foreign direct investment: the long-run and short-run analysis of Sri Lanka

Abstract

Introduction

In general, foreign direct investment (FDI) inflows play an increasingly strong impetus for economic development and progress of countries. It is considered as one of the major factors of growth in countries like Sri Lanka, India, and Bangladesh. According to Omisakin et.al. (2009), FDI serves as an important source of funds supply for domestic investment, thus promoting capital formation in the host country. FDI clearly brings investment finance and can contribute to employment. Technology and skills transfer, pioneering of new industries and export markets, formation of new clusters as anchor investors and creation of linkages with, and associated upgrading of competencies of local enterprises are perceived major benefits of FDI (United Nations Conference on Trade and Development, 2004). In the particular case of FDI inflow to Sri Lanka, it can play a major role in the economy. In 2017, net FDI inflows for Sri Lanka were 1,374 million US dollars, an increase from 193 million US dollars in 1998, growing at an average annual rate of 15.34% (Central Bank Annual Report, 2017).

There are many studies showing the relationship between FDI and trade openness for a number of counties. According to Sazali et.al. (2018) trade openness has a positive and significant impact on FDI in Malaysia. Liargovas and Skandalis (2012) found that trade openness contributes positively to the inflow of FDI in developing economies. Athukorala and Karunarathna (2004) found that the direction of causality was not towards FDI to GDP growth and the impact of domestic investment and trade liberalisation have a positive effect on GDP growth. Literature survey revealed the absence of studies on causal links between trade openness and foreign direct investment in Sri Lanka; hence it is a very important area to reach a high economic growth position in the future.