FDI and Economic Growth: A Case Study of Indonesia with Dynamic Econometric Model

Abstract

This study looks at the dynamic relationship between foreign direct investment (FDI) and Indonesia's economic development. The main objectives are to identify FDI patterns and trends, evaluate their impact on economic growth indicators such as GDP and employment, and investigate the factors driving FDI flows. This study uses dynamic econometric models, specifically Vector Autoregression (VAR) and Vector Error Correction Model (VECM), to quantify the causal relationship between FDI and economic development. The secondary data, which covers the years 2000–2023, came from the Central Statistics Agency (BPS), Bank Indonesia, and the World Bank and IMF annual reports. The study's conclusions demonstrate that FDI significantly and favorably influences Indonesia's economic growth over the long run. According to impulse response function (IRF) study, FDI steadily boosts GDP, local company productivity, and job creation. Variance decomposition confirms that FDI is the main factor influencing GDP variability, with an increasing contribution over time. The findings also highlight the importance of supportive government policies, namely tax incentives and investment-friendly regulations, and macroeconomic stability in attracting FDI flows. Additionally, FDI helps to improve infrastructure and human resource quality, as well as workforce quality through training and technology transfer. This study backs up earlier research that highlights the significance of foreign direct investment (FDI) as a key contributor to economic growth in developing nations and the necessity of macroeconomic stability and supportive governmental policies to optimize FDI's positive effects on the Indonesian economy.