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FOREIGN DIRECT INVESTMENT AND 
ECONOMIC GROWTH IN SMALL ISLAND ECONOMIES: 
THE CASE OF SOLOMON ISLANDS 
 
 
A thesis presented in partial fulfillment of the requirements 
for the degree of 
 
Masters of Arts 
in 
Economics 
 
at Massey University, Palmerston North, 
New Zealand 
 
Elizabeth Versey Ragimana 
2012 
i 
ABSTRACT 
The role of foreign direct investment (FDI) has been recognised as a catalyst in the growth 
of developing nations in that it brings additional sources of capital investment and foreign 
savings. In addition to its primary aim as a source of capital formation, FDI also brings 
productive benefits, which include employment creation, technology transfer and 
associated spillover effects; skills development; trade and competitiveness; and access to 
foreign markets. As such, FDI is viewed in many studies as a key driver of economic 
growth, since it enhances profitability of domestic investment; transforms the host 
country?s ownership structure of total investment; complements funding for domestic 
investment and improves the productive sectors of the economy. 
This study examines several hypotheses relating to the linkage between FDI inflows and 
economic growth in the case of Solomon Islands. First, the study investigates the 
contribution of FDI to economic growth (i.e. the FDI-led growth nexus) in Solomon 
Islands. Second, it examines the main determinants of FDI (i.e. the growth driven-led FDI 
nexus). Finally, the productivity effects of FDI (i.e. the FDI-productivity nexus) on the 
main sectors of primary, manufacturing and services are evaluated. The directions of 
causality between selected variables for these three hypotheses are also examined. 
Using time series data for the period from 1970 to 2010, the autoregressive distributed lag 
approach to cointegration is utilised to evaluate the FDI-led growth nexus and the growth 
driven-led FDI nexus. The Granger causality approach is adopted to evaluate the direction 
of causality between the selected FDI and growth variables. The FDI-productivity nexus is 
analysed using the stepwise and Granger causality approaches for the period 1985-2010. 
The empirical findings of the FDI-growth nexus show that FDI inflows, domestic 
investment, trade openness and labour are major influential factors of economic growth in 
the Solomon Islands. For the growth driven-led FDI nexus, the empirical findings show 
that economic growth, domestic investment, openness, exports, and infrastructure are all 
important determinants of FDI inflows. However, the civil strife and political instability, 
and high inflation deter FDI inflows and are detrimental to economic growth. In the FDI-
productivity nexus, the primary and services sectors benefit the most from the productivity 
effects of FDI inflows complemented by better institutions, education, infrastructure and a 
stable political environment. The findings not only have important policy implications for 
the Solomon Islands but also for other small island economies.  
ii 
ACKNOWLEDGEMENTS 
This study would not have been completed without the guidance, support and help of 
several people and I wish to acknowledge them accordingly.  
First, I owe a great debt of gratitude to Associate Professor Rukmani Gounder, my first 
supervisor for her professional guidance and expert supervision throughout the course of 
this study. Your intellectual inspiration, commitment and encouragements are highly 
appreciated; and the knowledge and research skills you passed on to me will be passed 
further on and will not be lost. I thank my second supervisor Dr. Sam Richardson for his 
comments. Tagio Tumas to you both. 
Second, I would like to express my gratitude to the New Zealand Government for the 
postgraduate scholarship to undertake this study. Many thanks also to Christine Beach and 
Sunlou Luivaie for editing parts of my thesis and Erika Ramirez for her advice on 
econometric modelling. I wish to also extend my appreciation to the Department Staff for 
their helpful comments during the seminar presentation. My appreciation also goes to 
fellow students and Pacifica team at the Manawatu campus for academic support and the 
Solomon Islands community in Palmerston North for moral support.  
Third, I wish to extend my genuine appreciation to the Governors, Managers and Staff of 
the Central Bank of the Solomon Islands for their continued support, particularly, the Chief 
Manager Luke Forau and Staff of the Economics, Research and Statistics Department and 
the Chief Manager Raynick Aquillah and Staff of the International Department for the vital 
statistical data and other useful information. Many thanks also to the Solomon Islands 
National Statistics Office, the Foreign Investment Division, the Inland Revenue Division 
and other major foreign companies for other useful reports.  
Finally, my special thanks go to my husband, Johnstill Ragimana for his understanding, 
patience, love and support from the inception to the completion of this study. Our 
daughters, Venessa and Rozhen, many thanks to you two for your patience and support, 
especially during those moments when mum is away and not there for you. I also 
acknowledge my sister Elsie, brothers Wilson and Gabriel who stood behind me. Last but 
not least, special thanks to my beloved parents: Dad Reverend Ezekiel Leguvaka (in 
memoriam) and mum Rosanna for their long and continued prayers and support for my 
education, always embracing the value of education. I hope this makes you proud. Thus, I 
dedicate this thesis to my parents.   
iii 
TABLE OF CONTENTS 
ABSTRACT .......................................................................................................................... i 
ACKNOWLEDGEMENTS ................................................................................................ ii 
TABLE OF CONTENTS ................................................................................................... iii 
LIST OF TABLES ............................................................................................................... v 
LIST OF FIGURES ............................................................................................................ vi 
LIST OF ABRREVIATIONS ........................................................................................... vii 
 
Chapter One    INTRODUCTION ..................................................................................... 1 
1.1 Background of the Study ........................................................................................ 1 
1.2 Aims and Objectives of the Study .......................................................................... 3 
1.3 Data and Methodology ............................................................................................ 4 
1.4 Outline of Chapters ................................................................................................. 5 
Chapter Two    LITERATURE REVIEW ........................................................................ 7 
2.1 Introduction ............................................................................................................. 7 
2.2 Theories of Economic Growth ................................................................................ 8 
2.2.1 Neoclassical Theory of Growth ..................................................................... 8 
2.2.2 Endogenous Theory of Growth .................................................................... 10 
2.3 Impact of Foreign Direct Investment on Economic Growth ................................ 13 
2.4 The Determinants of Foreign Direct Investment .................................................. 18 
2.5 The Productivity Effects of Foreign Direct Investment ........................................ 22 
2.6 Significance of the Study in the Case of Solomon Islands ................................... 24 
2.7 Summary and Conclusion ..................................................................................... 25 
Chapter Three    AN OVERVIEW OF THE SOLOMON ISLANDS ECONOMY .... 27 
3.1 Introduction ........................................................................................................... 27 
3.2 Macroeconomic Performance of the Solomon Islands ......................................... 29 
3.2.1 FDI Performances and Contributions to Domestic Economy ...................... 32 
3.2.2 Factors Affecting Foreign Investment Flows .............................................. 36 
3.2.3 Solomon Islands Foreign Investment Policy ............................................... 41 
3.3 Foreign Direct Investment and the Trade Sector .................................................. 43 
3.3.1 Solomon Islands Major Exports and Imports .............................................. 44 
3.3.2 Foreign Companies Export Contributions ................................................... 46 
3.3.3 The Import Share of Foreign Companies to Total Imports.......................... 47 
3.3.4 Trade Balance and Terms of Trade .............................................................. 48 
3.4 Foreign Direct Investment - Sectoral Distribution ............................................... 49 
3.4.1 FDI - Country of Origin and Sectoral Distribution ...................................... 49 
3.4.2 Growth and Capital Formation .................................................................... 52 
3.5 Monetary & Fiscal Policies ................................................................................... 53 
3.5.1 Monetary Policy Since 1980s ...................................................................... 53 
3.5.2 Fiscal Policy Measures ................................................................................ 58 
3.6 Implications for Foreign Direct Investment .......................................................... 63 
Appendix Tables A3.1 to A3.6....................................................................................65-66 
Chapter Four  ECONOMIC GROWTH AND FDI:EMPIRICAL  
     INVESTIGATION....................................................................................67 
4.1 Introduction ........................................................................................................... 67 
4.2 Economic Growth and FDI: Brief Literature Review .......................................... 68 
4.3 Empirical Models .................................................................................................. 72 
4.3.1 Growth and FDI Models .............................................................................. 72 
4.3.2 Causality between Growth, FDI and Domestic Investment ......................... 73 
4.4 Data and Methodology .......................................................................................... 74 
iv 
4.4.1 Data .............................................................................................................. 74 
4.4.2 Econometric Methodology........................................................................... 74 
4.5 Empirical Results .................................................................................................. 79 
4.5.1 Unit Root Test .............................................................................................. 79 
4.5.2 Co-integration Test ...................................................................................... 81 
4.5.3 FDI-Growth Nexus: Results ........................................................................ 81 
4.5.4 Causality Results .......................................................................................... 85 
4.6 Conclusion ............................................................................................................ 86 
Appendix Tables A4.1 to A4.6...................................................................................88-89 
Chapter Five    DETERMINANTS OF FOREIGN DIRECT INVESTMENT: 
      SOME EMPIRICAL EVIDENCE ......................................................... 90 
5.1 Introduction ........................................................................................................... 90 
5.2 Determinants of FDI: Brief Literature Review ..................................................... 92 
5.3 Empirical Models .................................................................................................. 94 
5.3.1 FDI Models and hypothesis ......................................................................... 95 
5.3.2 Causality between FDI, Export and Income growth .................................... 98 
5.4 Data and Methodology .......................................................................................... 99 
5.4.1 Data .............................................................................................................. 99 
5.4.2 Econometric Methodology......................................................................... 101 
Estimating the long-run and short-run relationship among variables ............................ 101 
5.5 Empirical results ................................................................................................. 103 
5.5.1 Unit Root Test ............................................................................................ 104 
5.5.2 The ARDL Results ..................................................................................... 105 
5.5.3 Granger Causality through ECM models ................................................... 110 
5.6 Conclusion .......................................................................................................... 112 
Appendix Tables A5.1 to A5.8...................................................................................113-114 
Chapter Six    FDI AND PRODUCTIVITY GROWTH: SOME EMPIRICAL  
    RESULTS ................................................................................................. 115 
6.1 Introduction ......................................................................................................... 115 
6.2 FDI and Productivity Growth: A Brief Literature Review ................................. 116 
6.3 FDI Flows by sectors to the Solomon Islands .................................................... 118 
6.4 Empirical Models ................................................................................................ 121 
6.4.1 FDI and productivity models ..................................................................... 121 
6.4.2 Causality model ......................................................................................... 123 
6.5 Data and Methodology ........................................................................................ 123 
6.5.1 Data ............................................................................................................ 124 
6.5.2 Econometric Methodology......................................................................... 125 
6.6 Empirical Results ................................................................................................ 127 
6.6.1 Unit root test .............................................................................................. 127 
6.6.2 FDI-Productivity nexus .............................................................................. 128 
6.6.3 Causality results ......................................................................................... 134 
6.7 Conclusion .......................................................................................................... 136 
Appendix Tables A6.1 to A6.4...................................................................................138-139 
Chapter Seven   CONCLUSION .................................................................................... 140 
7.1 Introduction ......................................................................................................... 140 
7.2 Summary of discussion and findings .................................................................. 142 
7.3 Policy Recommendations ................................................................................... 145 
7.4 Contributions of the study ................................................................................... 149 
7.5 Further Research ................................................................................................. 150 
BIBLIOGRAPHY ............................................................................................................ 152 
  
v 
LIST OF TABLES 
Table 2.1   The Impact of FDI on Economic Growth: Selected Studies ............................. 16 
Table 2.2   The Determinants of Foreign Direct Investment: Selected Studies .................. 19 
Table 3.1   Selected Pacific Island States GDP Per Capita, at Constant Prices 2000 US$ . 30 
Table 3.2   Solomon Islands Government Finance .............................................................. 59 
Table A3.1  Formal Employment and Total Labour Force ................................................. 65 
Table A3.2  Selected Major Destination of Solomon Islands Exports (%) ......................... 65 
Table A3.3  Selected Major Sources of Solomon Islands Imports (%) ............................... 65 
Table A3.4  Foreign Investors Country of Origin ............................................................... 66 
Table A3.5  Foreign Investment Proposals Sectoral Distribution (%) Share ...................... 66 
Table A3.6  Solomon Islands Tariffs................................................................................... 66 
Table 4.1    Domestic and Foreign Investment to GDP Share (%)...................................... 70 
Table 4.2    Unit Root Test Result ....................................................................................... 80 
Table 4.3    Bounds F-Test Results for FDI and Growth Nexus in Solomon Islands ......... 81 
Table 4.4   Results for FDI-GDP Growth Nexus ................................................................ 82 
Table 4.5    Results of Granger Causality Test among FDI, DINV and GDP ..................... 85 
Table A4.1  Descriptive Statistics, Equation 4.1 (1970-2010) ............................................ 88 
Table A4.2  Descriptive Statistics, Equation 4.2 (1970-2010) ............................................ 88 
Table A4.3  Descriptive Statistics, (1970-1979) ................................................................. 88 
Table A4.4  Descriptive Statistics, (1980-1989) ................................................................. 88 
Table A4.5  Descriptive Statistics, (1990-1999) ................................................................. 89 
Table A4.6  Descriptive Statistics, (2000-2010) ................................................................. 89 
Table 5.1  List of Time Series Variables and Proxies used in the Equation and Sources . 100 
Table 5.2   Unit Root Test Results..................................................................................... 104 
Table 5.3  Bounds F-Test Results for Growth-Led FDI Nexus in Solomon Islands ......... 105 
Table 5.4  Results for the Determinants of FDI in Solomon Islands ................................ 106 
Table 5.5  Granger Causality Results ................................................................................ 111 
Table A5.1  Descriptive Statistics, Equation 5.1a (1970-2010) ........................................ 113 
Table A5.2  Descriptive Statistics, Equation 5.1b (1970-2010) ........................................ 113 
Table A5.3  Descriptive Statistics, (1970-1979) ............................................................... 113 
Table A5.4  Descriptive Statistics, (1980-1989) ............................................................... 113 
Table A5.5  Descriptive Statistics, Equation 5.1a (1990-1999) ........................................ 114 
Table A5.6  Descriptive Statistics, Equation 5.1b (1990-1999) ........................................ 114 
Table A5.7  Descriptive Statistics, Equation 5.1a (2000-2010) ........................................ 114 
Table A5.8  Descriptive Statistics, Equation 5.1b (2000-2010) ........................................ 114 
Table 6.1  FDI Inflows and Economic Sectors in the Solomon Islands ............................ 119 
Table 6.2  ADF Test Results ............................................................................................. 128 
Table 6.3  Estimation Results from Primary Sector .......................................................... 129 
Table 6.4  Estimation Results from Manufacturing Sector ............................................... 131 
Table 6.5  Estimation Results from Services Sector ......................................................... 133 
Table 6.6 Pair-wise Granger Causality Test Results, 1985-2010 ...................................... 135 
Table A6.1 Variable Defination and Data Sources ........................................................... 138 
Table A6.2 Descriptive Statistics, Equation 6.1a (1985-2010) ......................................... 139 
Table A6.3 Descriptive Statistics, Equation 6.1b (1985-2010) ......................................... 139 
Table A6.4 Descriptive Statistics, Equation 6.1c (1985-2010) ......................................... 139 
  
vi 
LIST OF FIGURES 
Figure 3.1  Solomon Islands Annual Real GDP Growth Rate, 1970-2010 ......................... 29 
Figure 3.2  Solomon Islands External Reserves, 1990-2010 ............................................... 31 
Figure 3.3  Solomon Islands Annual Inflation Rate, Constant Prices 1980-2010 ............... 31 
Figure 3.4  Foreign Direct Investment, Net Inflows as percentage of GDP, 1970-2010 .... 32 
Figure 3.5  Foreign Companies Share of Employment, 1970-2010 .................................... 34 
Figure 3.6  FDI Contributions to Total Government Tax Revenues, 1970-2010 ................ 35 
Figure 3.7  FDI Main Types of Tax Contributions, 1970-2010 .......................................... 35 
Figure 3.8  Solomon Islands Major Exports, 1970-2010 .................................................... 44 
Figure 3.9  Solomon Islands Major Imports, 1970-2010 .................................................... 45 
Figure 3.10  Selected Major Foreign Companies Export Share to Total Exports ............... 46 
Figure 3.11  Selected Foreign Companies Import Share to Total Imports  ......................... 47 
Figure 3.12 Solomon Islands Trade Balance, 1970-2010 ................................................... 48 
Figure 3.13  Solomon Islands Terms of Trade, 1979-2010 ................................................. 49 
Figure 3.14 Country of Origin by Foreign Investors  .......................................................... 50 
Figure 3.15  Foreign Direct Investment Proposals by Sectors, 1999-2010 ......................... 51 
Figure 3.16  Public and Foreign Capital Investment Flows ................................................ 52 
Figure 3.17  Solomon Islands Exchange Rates (Units of SI per Foreign Currency) ........... 54 
Figure 3.18  Bank?s Liquid Asset Ratios, 1983-2010 ......................................................... 55 
Figure 3.19  Official Interest Rates, 1980-2010 .................................................................. 56 
Figure 3.20  Commercial Banks Lending to the Government and Private sector ............... 57 
Figure 3.21  Commercial Banks Nominal Deposits and Lending Rates ............................. 58 
Figure 3.22  Solomon Islands Tax Revenues, 1980-2009 ................................................... 61 
Figure 3.23  Duty Exemptions and Remissions, 1980-2010 ............................................... 62 
Figure 4.1  DINV versus FDI .............................................................................................. 71 
Figure 4.2  GDP versus FDI ................................................................................................ 71 
Figure 4.3  GDP versus DINV ............................................................................................ 71 
Figure 6.1  FDI inflows per employed person in different sectors in Solomon Islands .... 120 
  
vii 
LIST OF ABRREVIATIONS 
ADB   Asian Development Bank 
ADF    Augmented Dicky- Fuller Tests 
AIC    Akaike Information Criteria 
ARDL    Autoregressive Distributed Lag to cointergration 
ASEAN   Association of South East Asian Nations 
CBSI   Central Bank of Solomon Islands 
DBSI   Development Bank of Solomon Islands 
DSF   Debt Sustainability Framework 
ECM    Error Correctional Model  
ECT    Error Correction Term 
EU   European Union 
FDI   Foreign Direct Investment 
FIB   Foreign Investment Board 
GATT   General Agreement on Tariffs and Trade 
GDP   Gross Domestic Product 
GMM    Generalised Methods of Moments 
HRPI    Honiara Retail Price Index  
IFS   International Financial Statistics 
IMF    International Monetary Fund 
KPSS   Kwiatowski Philips Schmidt and Shin 
LAR   Liquid Asset Ratio 
LDC    Less Developed Country 
LMIC   Lower Middle Income Country 
MNCs   Multinational Corporations 
NFD   National Fisheries Development 
NPV   Net Present Value 
OECD   Organisation for Economic Co-operation and Development 
OLI   Ownership Location Internationalisation 
OLS    Ordinary Least Square 
OMO   Open Market Operations 
PACER  Pacific Agreement on Closer Economic Relations 
PP   Philips and Perron 
RAMSI  Regional Assistance Mission to Solomon Islands 
RGDP   Real Gross Domestic Product 
SBD$   Solomon Islands Dollar 
SIC   Schwarz Information Criterion 
SIDS    Small Island Developing States 
SINPF   Solomon Islands National Provident Fund 
SINS    Solomon Islands National Statistics 
SOE   State Owned Enterprises  
SPICs   South Pacific Island Countries 
TOT   Terms of Trade 
UNCTAD   United Nations Conference on Trade and Development 
VAR   Vector Autoregressive 
WDI   World Development Indicators 
VEC   Vector Error Correction 
VECM   Vector Error Correction Model 
WTO   World Trade Organisations
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