Foreign direct investment and its impact on the Thai economy: the role of financial development

This paper examines the roles of foreign direct investment and financial development in the process of economic development using Thailand as the case study. We argue that better developed financial systems allow an economy to exploit the benefits of foreign direct investment more efficiently. The estimation draws upon an unrestricted error-correction model to avoid omitted lagged variable bias, and an instrumental variable estimator to correct for endogeneity bias. Using annual time series data from 1970 to 2004, the results show that financial development stimulates economic development whereas foreign direct investment impacts negatively on output expansion in the long run. However, an increased level of financial development enables Thailand to gain more from foreign direct investment, suggesting that the impact of foreign direct investment on output growth can be enhanced through financial development. The results are robust to different measures of financial development.