Working Paper Series: Special Edition of 2016 to 2018 Interns

The study follows with section two exploring the relevant literature on the present topic. Section three considers an important and informative assessment of the stylized facts surrounding the ECCU. While section four speaks to the methodology employed. First, it gives an overview of the empirical model used and the justification of its utilization. Second, it considers the empirical steps undertaken in the VECM framework. In section five, the empirical results are analyzed. The last section concludes the paper with policy recommendations. 2.1 FDI There are two fundamental theories that this research sought to utilize in understanding the ways in which FDI, trade openness and capital formation impact economic growth. The neoclassical growth theory postulates that FDI contributes to economic growth by increasing physical investment and the marginal productivity of capital. In fact, similar findings of Mahran & Al Meshall (2014) concluded that FDI aids in augmenting domestic investment resources thus promoting capital formation. Their work thus shows one theoretical way in which FDI and capital formation are linked. To elaborate, given the law of diminishing rate of returns, countries with lower capital stock are able to increase growth by channeling financing to sectors of the economy that are productive. The endogenous (new growth) theory on the other hand has determined that other factors are at play in determining growth. For instance, FDI allows for transfer of knowledge, human skills, innovative processes and the accumulation of knowledge. Asiedu (2002) noted that FDI can be a source of long-term capital investment into new technologies, managerial skills and marketing capabilities that can augment economic growth as technologies are diffused, employment is created, managerial skills are increased and innovations take place. In addition, Govil (2013) posited that FDI can increase competition as monopoly holds and profits are reduced, which thus results in improved quality and quantity of goods and services offered in the economy. The ultimate end is that economic growth can be invigorated. In casing the experience of Portugal, Andraz & Rodrigues (2010) uncovered a bi-directional causal link between inward flowing FDI and economic growth. Their analysis of such findings went on to suggest that expansion in FDI 2.0 Literature Review and Theoretical Underpinnings

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