Foreign direct investment, economic growth, and unemployment in Indonesia: A VECM-based analysis with implications for sustainable development
Article Sidebar
Main Article Content
Abstract
Purpose. To analyze the dynamic short-run and long-run relationships between foreign direct investment (FDI), economic growth, and unemployment in Indonesia. Methodology. The study uses a Vector Error Correction Model (VECM) on annual time-series data from 2000 to 2024, using Augmented Dickey-Fuller stationarity tests, Johansen cointegration, Granger causality, and variance decomposition. Results. Findings reveal a stable long-run equilibrium among the variables. However, short-run dynamics show no significant causal impact of FDI on economic growth or unemployment. Instead, unidirectional causality runs from economic growth to FDI, indicating that domestic market expansion drives foreign investment more than FDI drives immediate job creation. Theoretical contribution. This research enriches endogenous growth theory and Okun's Law by showing that, in developing economies, the transmission mechanism from FDI to the real sector is structurally delayed and depends on domestic absorptive capacity. Practical implications. Policymakers should prioritize reorienting FDI toward labor-intensive sectors, enhancing human capital, and implementing labor market reforms to ensure foreign investment translates into inclusive, sustainable job creation aligned with SDGs 8 and 9.
Sustainable Development Goals (SDGs): SDG 8: Decent Work and Economic Growth; SDG 9: Industry, Innovation and Infrastructure; SDG 10: Reduced Inequalities
Downloads
Article Details
This work is licensed under a Creative Commons Attribution 4.0 International License.
This work (article) is licensed under a Creative Commons Attribution 4.0 International License.
References
Abbes, S. M., Mostéfa, B., Seghir, G., & Zakarya, G. Y. (2015). Causal interactions between FDI and economic growth: Evidence from dynamic panel cointegration. Procedia Economics and Finance, 23, 276–290. https://doi.org/10.1016/S2212-5671(15)00541-9
Aitken, B., & Harrison, A. (1999). Do domestic firms benefit from direct foreign investment? Evidence from Venezuela. American Economic Review, 89(3), 605–618. https://doi.org/10.1257/aer.89.3.605
Alfaro, L., Chanda, A., Kalemli-Ozcan, S., & Sayek, S. (2004). FDI and economic growth: The role of local financial markets. Journal of International Economics, 64(1), 89–112. https://doi.org/10.1016/S0022-1996(03)00081-3
Azman-Saini, W. N. W., Law, S. H., & Ahmad, A. H. (2010). FDI and economic growth: New evidence on the role of financial markets. Economics Letters, 107(2), 211–213. https://doi.org/10.1016/j.econlet.2010.01.027
Bank Indonesia. (n.d.). Economic & market data [Data set]. https://www.bi.go.id/en/iru/economic-market-data/default.aspx
Barro, R. J. (1991). Economic growth in a cross section of countries. Quarterly Journal of Economics, 106(2), 407–443. https://doi.org/10.2307/2937943
Belloumi, M. (2014). The relationship between trade, FDI and economic growth in Tunisia: An application of the autoregressive distributed lag model. Economic Systems, 38(2), 269–287. https://doi.org/10.1016/j.ecosys.2013.09.002
Blanchard, O., & Wolfers, J. (2000). The role of shocks and institutions in the rise of European unemployment: The aggregate evidence. The Economic Journal, 110(462), C1–C33. https://doi.org/10.1111/1468-0297.00518
Borensztein, E., De Gregorio, J., & Lee, J. W. (1998). How does foreign direct investment affect economic growth? Journal of International Economics, 45(1), 115–135. https://doi.org/10.1016/S0022-1996(97)00033-0
BPS-Statistics Indonesia. (n.d.). Number and percentage of employment and unemployment [Data set]. https://www.bps.go.id/en/statistics-table/2/MTk1MyMy/number-and-percentage-of-employment-and-unemployment.html
Buckley, P. J., & Casson, M. (1976). The future of the multinational enterprise. Macmillan.
Carkovic, M., & Levine, R. (2005). Does foreign direct investment accelerate economic growth? In T. Moran, E. Graham, & M. Blomström (Eds.), Does foreign direct investment promote development? (pp. 195–220). Institute for International Economics.
Domar, E. D. (1946). Capital expansion, rate of growth, and employment. Econometrica, 14(2), 137–147. https://doi.org/10.2307/1905364
Dos Santos, T. (1970). The structure of dependence. The American Economic Review, 60(2), 231–236. https://doi.org/10.5040/9798216384205.ch-013
Dunning, J. H. (1980). Toward an eclectic theory of international production: Some empirical tests. Journal of International Business Studies, 11(1), 9–31. https://doi.org/10.1057/palgrave.jibs.8490593
Dunning, J. H. (1988). The eclectic paradigm of international production: A restatement and some possible extensions. Journal of International Business Studies, 19(1), 1–31. https://doi.org/10.1057/palgrave.jibs.8490372
Durham, J. B. (2004). Absorptive capacity and the effects of foreign direct investment and equity foreign portfolio investment on economic growth. European Economic Review, 48(2), 285–306. https://doi.org/10.1016/S0014-2921(02)00264-7
Enders, W. (2015). Applied econometric time series (4th ed.). Wiley.
Engle, R. F., & Granger, C. W. J. (1987). Cointegration and error correction: Representation, estimation, and testing. Econometrica, 55(2), 251–276. https://doi.org/10.2307/1913236
Feenstra, R. C., & Hanson, G. H. (1997). Foreign direct investment and relative wages: Evidence from Mexico's maquiladoras. Journal of International Economics, 42(3–4), 371–393. https://doi.org/10.1016/S0022-1996(96)01475-4
Frank, A. G. (1967). Capitalism and underdevelopment in Latin America: Historical studies of Chile and Brazil. Monthly Review Press.
Granger, C. W. J. (1969). Investigating causal relations by econometric models and cross-spectral methods. Econometrica, 37(3), 424–438. https://doi.org/10.2307/1912791
Grossman, G. M., & Helpman, E. (1991). Innovation and growth in the global economy. MIT Press.
Gujarati, D. N., & Porter, D. C. (2009). Basic econometrics (5th ed.). McGraw-Hill.
Harrod, R. F. (1939). An essay in dynamic theory. The Economic Journal, 49(193), 14–33. https://doi.org/10.2307/2225181
Herzer, D., Klasen, S., & Nowak-Lehmann D., F. (2008). In search of FDI-led growth in developing countries: The way forward. Economic Modelling, 25(5), 793–810. https://doi.org/10.1016/j.econmod.2007.11.005
Hsiao, F. S. T., & Hsiao, M.-C. W. (2006). FDI, exports, and GDP in East and Southeast Asia—Panel data versus time-series causality analyses. Journal of Asian Economics, 17(6), 1082–1106. https://doi.org/10.1016/j.asieco.2006.09.011
Hymer, S. H. (1976). The international operations of national firms: A study of direct foreign investment. MIT Press.
Iamsiraroj, S. (2016). The foreign direct investment–economic growth nexus. International Review of Economics & Finance, 42, 116–133. https://doi.org/10.1016/j.iref.2015.10.044
Islam, R. (2004). The nexus of economic growth, employment and poverty reduction: An empirical analysis (Issues in Employment and Poverty Discussion Paper No. 14). International Labour Organization. https://www.ilo.org/publications/nexus-economic-growth-employment-and-poverty-reduction-empirical-analysis
Johansen, S. (1988). Statistical analysis of cointegration vectors. Journal of Economic Dynamics and Control, 12(2–3), 231–254. https://doi.org/10.1016/0165-1889(88)90041-3
Johansen, S., & Juselius, K. (1990). Maximum likelihood estimation and inference on cointegration. Oxford Bulletin of Economics and Statistics, 52(2), 169–210. https://doi.org/10.1111/j.1468-0084.1990.mp52002003.x
Jude, C., & Silaghi, M. I. P. (2016). Employment effects of foreign direct investment: New evidence from Central and Eastern European countries. International Economics, 145, 32–49. https://doi.org/10.1016/j.inteco.2015.02.003
Kharisma, B., Remi, S. S., Wardhana, A., & Silalahi, F. R. (2025). Foreign direct investment, institutional quality and economic growth: Empirical evidence from ASEAN. Jurnal Ekonomi Pembangunan: Kajian Masalah Ekonomi dan Pembangunan, 26(1), 108–125. https://doi.org/10.23917/jep.v26i1.8822
Knotek, E. S., II. (2007). How useful is Okun's law? Economic Review (Federal Reserve Bank of Kansas City), 92(4), 73–103. https://www.kansascityfed.org/documents/955/2007-How%20Useful%20is%20Okun%27s%20Law%3F.pdf
Lee, E., & Vivarelli, M. (2006). The social impact of globalization in the developing countries. International Labour Review, 145(3), 167–184. https://doi.org/10.1111/j.1564-913X.2006.tb00016.x
Lewis, W. A. (1954). Economic development with unlimited supplies of labour. The Manchester School, 22(2), 139–191. https://doi.org/10.1111/j.1467-9957.1954.tb00021.x
Lucas, R. E., Jr. (1988). On the mechanics of economic development. Journal of Monetary Economics, 22(1), 3–42. https://doi.org/10.1016/0304-3932(88)90168-7
MacKinnon, J. G. (1996). Numerical distribution functions for unit root and cointegration tests. Journal of Applied Econometrics, 11(6), 601–618. https://doi.org/10.1002/(SICI)1099-1255(199611)11:6%3C601::AID-JAE417%3E3.0.CO;2-T
MacKinnon, J. G., Haug, A. A., & Michelis, L. (1999). Numerical distribution functions of likelihood ratio tests for cointegration. Journal of Applied Econometrics, 14(5), 563–577. https://doi.org/10.1002/(SICI)1099-1255(199909/10)14:5%3C563::AID-JAE530%3E3.0.CO;2-R
Mankiw, N. G., Romer, D., & Weil, D. N. (1992). A contribution to the empirics of economic growth. Quarterly Journal of Economics, 107(2), 407–437. https://doi.org/10.2307/2118477
Markusen, J. R., & Venables, A. J. (1999). Foreign direct investment as a catalyst for industrial development. European Economic Review, 43(2), 335–356. https://doi.org/10.1016/S0014-2921(98)00048-8
Nguyen, C. P., Nguyen, A. N., Schinckus, C., & Su, T. D. (2021). The influence of foreign direct investment on productivity: An institutional perspective. Review of Development Finance, 11(1), 35–45. https://hdl.handle.net/10520/ejc-rdfin-v11-n1-a3
Okun, A. M. (1962). Potential GNP: Its measurement and significance. Proceedings of the Business and Economic Statistics Section, 98–104.
Pegkas, P. (2015). The impact of FDI on economic growth in Eurozone countries. The Journal of Economic Asymmetries, 12(2), 124–132. https://doi.org/10.1016/j.jeca.2015.05.001
Ricardo, D. (1817). On the principles of political economy and taxation. John Murray.
Romer, P. M. (1986). Increasing returns and long-run growth. Journal of Political Economy, 94(5), 1002–1037. https://doi.org/10.1086/261420
Romer, P. M. (1990). Endogenous technological change. Journal of Political Economy, 98(5, Part 2), S71–S102. https://doi.org/10.1086/261725
Sabir, S., Rafique, A., & Abbas, K. (2019). Institutions and FDI: Evidence from developed and developing countries. Financial Innovation, 5, 8. https://doi.org/10.1186/s40854-019-0123-7
Saidi, Y., Ochi, A., & Maktouf, S. (2023). FDI inflows, economic growth, and governance quality trilogy in developing countries: A panel VAR analysis. Bulletin of Economic Research, 75(2), 426–449. https://doi.org/10.1111/boer.12364
Sims, C. A. (1980). Macroeconomics and reality. Econometrica, 48(1), 1–48. https://doi.org/10.2307/1912017
Solow, R. M. (1956). A contribution to the theory of economic growth. The Quarterly Journal of Economics, 70(1), 65–94. https://doi.org/10.2307/1884513
UNCTAD. (n.d.). Foreign direct investment: Inward and outward flows and stock, annual [Data set]. https://unctadstat.unctad.org/datacentre/dataviewer/US.FDIFlowsStock
United Nations. (2015). Transforming our world: The 2030 agenda for sustainable development. https://sdgs.un.org/publications/transforming-our-world-2030-agenda-sustainable-development-17981
World Bank. (2023). World development indicators [Data set]. https://databank.worldbank.org/source/world-development-indicators