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Executive summary
The nature of the relationship between a countrys openness to the world economy, in terms of inward foreign direct investment (inward FDI) and foreign trade and its economic growth is still an open question at both academic and practical world. Therefore, in this paper we aim to propose a regression model to estimate the effect of foreign investment and trade on the economic growth in Ecuador and Australia.We propose an OLS regression model which includes the GDP growth as dependent variables, inward FDI, export and imports as explanatory variables (including time lags) in logarithmic functional form.This paper consists of five main parts: Introduction, Literature review, Model specification and estimations, Diagnostic testing and Conclusions. As an introduction we explain that the main reason for this to be a relevant topic is that the relationship between foreign trade and foreign direct investment determines the openness countries have or not to international trade. When then realise a literature review about the explanatory variables we are selecting and their association to the economic growth of a country. They key issues found in this section is that FDI is important to growth as long as it is related to technological spill-overs to the recipient country. This will be come in our conclusions a keystone concept. Further one we explain that in general exports and imports are positively related to economic growth in previous studies. Some analysis do however suggest causality and potential inverse directionality may exist. Then we propose a regression model, for which we analyse the obtained data and decide to difference our data to obtain stationary data. This leads us to have sufficiency to test our model under several modelling tests such as: Ramseys test of functional form, Whites heteroskedasticity test, Durbin-Watsons serial orrelation test, Breusch-Godfrey test for c autocorrelation, Chows structural stability test and Multicollinearity. Our practical interpretations are: for Australias economy, its GDP change in per cent erms, t is as follows: for a 1% change in exports Australias GPD will grow in 0.347511% and for 1% a change in imports, Australias GDP will grow in 0.546359%. or Ecuador a 1% change in F exports, GPD will ncrease in 0.18495% and for a 1% change in imports, Ecuadors GDP will i grow in 0.469392%. et inward foreign direct investment has been found to not be N statistically significant for either f these countries. Our theoretical interpretation is that o during the periods analysed both countries have FDIs that were not always accompanied by technology transfer and in several occasions this FDI must have crowded-out national investment which generated lowered economic growth as a net result. Imports and exports are supported theoretically to increase GDP although these increase behave bidirectional to GDP, that is as a cause and also as a response. The policy advice based on these findings are three: FDI must be accompanied by technology transfer to expressly cause GDP growth. Second, we suggest policy makers to observe and be vigilant of Australias dependency to foreign markets for exports are of large impact to its Economy. For Ecuador the magnitude of the difference of the importance of exports versus imports when analysing their contribution to GDP suggests that commercial balance deficit may be a potential risk. Three, the potential risk of trade deficit can be overcome if in the short run it is due to a substitutions-imports model.