Foreign direct investment in the financial sector and economic growth in Central and Eastern Europe: The crucial role of the efficiency channel

We examine the impact of financial sector FDI (FSFDI) on economic growth via the efficiency channel. We estimate a panel data model for 11 Central and Eastern European countries in a cross-country growth accounting framework over 1996 to 2003. We find a hump-shaped impact of FSFDI on economic growth. Medium FSFDI supports growth if human capital suffices. Above a certain threshold, crowding-out of local physical capital via foreign bank entry slows growth. We combine the FDI-growth and the finance-growth-literature and conclude that the level and quality of foreign investment influences the financial sectors' contribution to growth in emerging markets.