Dynamic Relationships between Foreign Direct Investment Inflows, Financial Development, Institutional Quality, and Economic Growth: Empirical Evidence from Burundi
DOI:
https://doi.org/10.59413/ajocs/v7.i4.9Keywords:
VAR, Financial Development, Foreign Direct Investment, Executive Corruption, Inflation, Institutional Quality, Supply EffectAbstract
This article analyses the dynamic interdependencies between foreign direct investment inflows, financial development, institutional quality, and economic growth in Burundi over the period 1972–2024. Drawing on the poverty vicious circle theory, new institutional economics, and the finance-growth literature, we estimate six structural VAR models with Granger causality tests, impulse response functions, and variance decompositions. Three robust results emerge. First, financial development does not stimulate economic growth according to the classical supply-side pattern of financial services. A one-standard-deviation shock to private-sector credit increases inflation by 2.5 to 2.9 percentage points over a two-year horizon across all specifications and explains 14.5 percent of the variance in ten-year inflation, while reducing economic growth by 1.0 to 1.3 percentage points. Second, economic growth reduces inflation by about 2.8 percentage points over two years and accounts for 15.5 percent of its long-term variance, confirming a dominant agricultural supply effect rather than demand-pull inflation. But after the first two years, inflation continues its upward trend until it becomes stable. Third, institutional quality acts selectively: Granger tests show that only overall institutional quality and executive corruption cause financial development, while political corruption, the rule of law, and liberal democracy have no significant effect. Response functions indicate that an increase in executive corruption reduces financial depth by percentage points over two years, and variance decomposition attributes 8.7 percent of the variance in financial development to executive corruption alone, compared to less than 3 percent for the other institutional dimensions. Foreign direct investment remains causally inert in all models and never explains more than 4 percent of the macroeconomic variance. The results highlight a specific Burundian chain: constraints on executive predation allow for modest financial deepening, which is primarily transmitted to prices rather than productive investment, while growth itself is determined by exogenous agricultural supply shocks. Breaking Nurkse’s vicious cycle therefore requires targeted institutional reforms focused on the executive rather than generic governance reforms.
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