An examination of the relationships between financial development, foreign direct investments and economic growth: The case of Turkey

One of the most important policy targets of every country is to maintain sustainable economic growth. Financial system and foreign direct investments are the two of the main factors to contribute to the sustainable economic growth in an economy. The aim of the thesis is examined the relationships among financial development, foreign direct investment and economic growth. For this purpose, Granger causality test, Co-integration test and VAR model are constructed to investigate short-run and long-run dynamic relationships among these variables using the data for the period 1992Q1-2013Q3. According to Granger causality test results, deposit ratio, which is an indicator of financial development, Granger-causes foreign direct investments in Turkey. The study concludes that other variables (capitalization rate, foreign direct investments and real GDP) do not Granger-cause each other. Moreover, the study determines that there is a weak Granger causality from financial development indicators (deposit ratio and capitalization rate) to the economic growth in Turkey. According to the results of the VAR analysis, variances of both the financial development indicators and the foreign direct investments explain variance of economic growth in the short-run. According to the Johansen co-integration test results, foreign direct investment and deposit ratio positively affect economic growth in the long-run, while capitalization ratio negatively affects economic growth in the long-run. It can be concluded that the bank-based financial system is dominant in the long-run in explaining economic growth in Turkey, while insufficient development of the capital market doesn't contribute to the economic growth in the long-run. Furthermore, although foreign direct investments positively influence economic growth in Turkey, it is not at a sufficient level to influence economic growth. Overall, the study concludes that foreign direct investments and bank-based financial development are the main determinants of long-run economic growth in Turkey.