Absorptive Capacity Effects on the Relationship between Foreign Direct Investment and Economic Growth in Malaysia

There has been plenty of debate on the relationship between foreign direct investment (FDI) and economic growth among scholars. There are many diverse perspectives on how FDI and GDP are related. Although the relationship appears to be different, it depends on the host country's capacity for absorption. In order for host country to exploit spillovers from FDI, it needs to have a minimum amount of absorptive capacity. Therefore, the first focus of the research was on the link between FDI and GDP in Malaysia. Then, absorptive capacity which only limited to human capital, financial development and trade openness was included into the relationship between FDI and economic growth in order to determine the effectiveness of absorptive capacity towards the relationship between FDI and economic growth in Malaysia. In order to analysed the relationship between FDI and economic growth with the presence of absorptive capacity in Malaysia, Automated Regression Distributed Lag (ARDL) techniques was adopted to obtain the results. Based on the results, short run and long run analysis was tested by using ARDL and Error Correction Models (ECM). Thus, ARDL bounds testing was tested to test the presence of cointegration in the models. The results show that the outcome between FDI and GDP are inconclusive which shows that there is no direct relationship between FDI and economic growth. Apparently, by the presence of absorptive capacity, the results of FDI and GDP showing both long run and short run effect. These results proved that the relationship between FDI and economic growth in Malaysia can only be determined when there is minimum threshold of absorptive capacity.