The purpose for this paper is to discuss and evaluate the impact of foreign direct investment (FDI) in on host country economies FDI flows to countries because of lower production costs. An underlying premise is that the beneficial effect of FDI, particularly in terms of economic growth, is stronger when the country's trade policy is oriented outward versus inward (Bhagwati, 1990, p. 219-221). Foreign direct investment (FDI) occurs when a firm invests directly in facilities to produce or market a product in a foreign country. According to the US Department of Commerce, FDI occurs whenever a US citizen, organization, or affiliated group takes an interest of 10 percent or more in a foreign business entity. Once a firm undertakes FDI, it becomes a multinational enterprise. (Hill, 2008, p.229)
There are two different concepts of FDI: one provides the flow of capital across international boundaries; the other is when host-country activities are conducted by entities that are controlled, or partially controlled, in some other country (Lipsey, 2004, p. 334).
A different possibility is that when a firm in country A makes a direct investment in country B, the stock of physical capital and the level of production are unchanged in both countries. Country A owners and managers in industry X, using the skills they have acquired in home production, buy out country B owners with lower skills in that industry and operate the industry X plants in country B more efficiently than before. Country B owners use their capital, released by the buyout, in other industries . . . No net movement of physical or financial capital is necessarily implied, although it could take place. (Lipsey, 2004, p.335)
Political behavior involves government actions concerning FDI ownership, location, and internalization advantages, and may be measured by application of the Eclectic Paradigm, or OLI Model (Twomey, 2000, p. 8). The Generalized Methods of Moments (GMM) may be used as a technique that exploits the time-series variation in data, to account for unobserved country-specific effects (Carkovic & Levine, 2005, p. 197). [1]
Investigating the impact of foreign capital on economic growth has important policy implications. If FDI has a positive impact on economic growth after controlling for endogeneity, then this weakens arguments for restricting foreign investment. If found that FDI does not exert a positive impact on growth, then this would suggest a reconsideration of the rapid expansion of tax incentives, infrastructure subsidies, import duty exemptions to attract FDI (Carkovic & Levine, 2005, p. 197).
The development of a robust domestic financial system is a precondition for the positive growth effects of FDI. Hermes and Lensink (2003), present a model of technological change that may be applied.
There are three types of agents in the model: final goods producers, innovators and consumers. Every producer of final goods rents N varieties of capital good from specialized firms that produce a type of capital good (the innovators). The producer has monopoly rights over the production and sale of the capital goods. The purchase price . . . of the capital good is set by optimising the present value of the returns from inventing (and producing in several periods) (p. 8)
An increase in FDI will lower set-up costs for technology adaptation. This will subsequently increase the rate of return on assets, which will affect greater savings, resulting in a higher growth rate in both consumption and output. The "development of the domestic financial system may also determine to what extent foreign firms will be able to borrow in order to extend their . . . activities in the country" (Hermes & Lensink, 2003, p. 11). This implies that countries should improve their domestic financial systems before allowing FDI (Hermes & Lensink, 2003, p. 44).
Wage "spillovers" occur in host countries when the payment of higher wages by foreign-owned firms results in higher wages in domestically owned firms (Lipsey, 2004, p. 345). Statistically significant differences were found in 3 out of 12 industries in Cóte d'Ivore, a ratio of 1.1 to 1.9; 12 out of 18 in Morocco, a ratio of 1.3 to 2.6; and 8 out of 9 n Venezuela, a ratio of 1.2 to 2.0 (Lipsey, 2004, 347).
Spillover efficiency benefits to the host country occurs when they are able to either purchase or license technology from the foreign investing firms, at a cost to them lower than that of the foreign technology, resulting in efficiency improvements (Blomström, M, Globerman & Kokko, 1999, p. 7; Görg, & Greenaway, 2004, p. 171). Several studies have shown that the presence of foreign-owned activities accelerate the introduction and subsequent adoption of new technology by the host country (Markusen, & Venables, 1999, p. 335). In a study considering the impact of research and development (R&D) upon FDI, examined were how firms determined how they would expand, amount invested in R&D, and decisions on how much to sell in domestic and host-country markets. Findings were that high-technology sectors increased both home- and host-country welfare, particularly when technological spillovers were restricted to the host country (Sanna-Randaccio, 2002, p. 296). In a Chinese study, a positive association existed between the pace of technology diffusion and the share of foreign ownership (Blomström, Globerman & Kokko, 1999, p. 10). Further, FDI could bring about indirect impact on spillover efficiency benefits by altering the host country's market structure. Increased competition can stimulate resource allocation efficiencies that subsequently result in productivity increases (Blomström, & Kokko, 2003). In another study of R&D in pharmaceutical and electronics industries in Japan, Europe and the United States, it was found that, as a result of applying an econometric analyses of 146 FDI, relative market size, along with the host-country's science base were determinants to exploit existing advantages or develop me firm-specific advantages (Kuemmerle, 1999, pp. 1-24).
As a result of FDI, host-country growth has been studied by comparing real gross domestic product (GDP) growth in relation to FDI. Results have indicated the FDI size relative to GDP has no relation to rates of growth (Lipsey, 2004, p. 368). A direct economic feature of FDI is that
(1) It ordinarily affects a net transfer of real capital from one country to another; and (2) it represents entry into a national industry by a firm established in a foreign market. Foreign direct investment occurs in industries characterized by certain market structures in both the "lending" (and home) and "borrowing" (or host) countries. Oligopoly with product differentiation normally prevails where corporations make "horizontal" investments to produce abroad the same lines of goods as they produce in the home market. Direct investment tends to involve market conduct that extends the recognition of mutual market dependence. beyond national boundaries. (Caves, 1971, p. 1).
A study of China's trade and FDI relationships found that China's imports tended to precede FDI from that country, with FDI preceding exports to the investing company (Lipsey, 2004, p. 367). The initial effect was negative, but for all subsequent lagged terms, they were positive, so that the net effect of FDI resulted in an increase in Chinese exports to the investing country (Lipsey, 2004, p. 367).
According to C.Hill(2008, p.248), There are three costs of FDI concern host countries. They arise from possible adverse effects on competition within the host nation, adverse effects on the balance of payment and the perceived loss of national sovereignty.
Adverse effects on competition: The host government may worry about that the subsidiaries of foreign MNEs may have greater economic power than indigenous competitors. (C Hill, 2008, p.248) If it is part of a larger international organization, the foreign MNE may be able to draw on funds generated elsewhere to subsidize its costs in the host market, which could drive indigenous companies out of business and allow the firm to monopolize the market.
Adverse effects on the balance of payment: There are two possible adverse effects of FDI on a host country's balance of payment position. First, set against the initial capital inflow that comes with FDI must be the subsequent outflows of earnings from the foreign subsidiary to its parent company. (C Hill, 2008, p.249) The second issue is that a foreign subsidiary imports a substantial number of its inputs from abroad, which results in a debit on the current account of the host country's balance of payments.
National sovereignty and autonomy: The concern is that key decisions that can affect the host country's economy will be made by a foreign parent that has no real commitment to the host country, and over which the host country's government has no real control.
For the period 1970-1995, a study conducted over 49 less-developed countries, using pooled cross-section and time-series data, examined the effects of several variables: corporate tax rates, tariff rates, exchange rates, and bureaucratic involvement. Multivariate analysis found a statistically relevant relationship between FDI and the measured variables (Gastanaga, et al., 1998, pp. 1219-1314). In a study of post-1991 reformed India, firm-level panel data for 14 different types of industries (see Table 1, below) examined the relationship between FDI and domestic firm productivity, along with exploring any spillover to domestic firms. This was measured by application of a log-linear production function. [2] Analysis of the data found a statistically significant positive relationship about domestic firm productivity (Sarker, 2006, p. 21). Findings included spillover that consistent with superior technology (Sarkar, 2006, p. 2).
Table 1: Types of industries. [3]
Industry Sector
No. of Firms
1. Chemicals & allied products - carbon black, paints, plastics, fertilizers,
120
2. Engineering - power generation, steel, metal
105
3. Domestic appliances and FMCG - decorative, leather products
45
4. Services - trading, telecommunication, construction, entertainment
13
5. Electronics and electrical appliances/equipments
43
6. Food and diary products - coffee, tea, vanaspati, distilleries, sugar
40
7. Computers
21
8. Pharmaceuticals and biotechnology
56
9. Automobiles and auto ancillaries
54
10. Textile
61
11. Cement
19
12. Mining - minerals / refineries / oil exploration/gas
15
13. Paper
13
14. Others - rubber, tyres, miscellaneous,
26
Total
631
A 1996 FDI econometric study in the Czech Republic, Slovakia, Hungary and Poland found that FDI was an important source of external finance for transitional economies because of perceived stableness and safer locations than in the former Soviet states, resulting in the channeling of 70% of European Union FDI into these countries since 1988 (Lansbury, et al., 1996).
In a study conducted over 90 countries for the period 1980-2002, performing both cross-section and panel analyses, it was found the FDI enhances economic growth in developing economies, but not in developed countries (Johnson, 2006, p. 44). Table 2, below, depicts host country conditions for enhancing FDI.
Table 2. Host country conditions for realizing growth enhancing potential of FDI inflows. [4]
Condition
Developed
Undeveloped
Host country level of technology
High
Low
Absorptive capacity of host country firms
High
Low
Per capital stock of real capital
Large
Small
Table 3, below, shows actual data per representative surveyed countries.
Table 3. Inward FDI stocks in high and low growth developing economies. [5]
High Growth Economies
Inward FDI stock per capita in 2003, US$
Low Growth Economies
Inward FDI stock per capita in 2003, US$
Korea, Republic of
918
Congo, Democratic Republic
16
Botswana
499
Liberia
835
Thailand
570
Sierra Leone
5
St. Kitts & Nevis
1422
Saudi Arabia
1159
Singapore
32634
Haiti
27
Antigua & Barbuda
9465
Ivory Coast
224
Cyprus
6348
United Arab Emirates
957
Hong Kong
53968
Niger
37
Madagascar
26
Venezuela
1264
Thailand had been identified as a newly industrialized economy in 1987 as a direct result of Japanese, and subsequently, Taiwanese investments in export-oriented manufacturing (Lim & Pang, 1991, p. 14). During the period 1980-1987, Japanese FDI increased 500% to $182 million (Lim & Pang, 1991, p. 35). This resulted in an unprecedented increase in productive capacity (Thomson, 1999, p. 13). Table 4, below compares reasons for Japanese FDI.
Table 4. FDI Motivations (1980) (%) [6]
Avoiding trade friction
Market expansion
Following clients
Cost superiority
Other
Business machines
96.7
3.3
0.0
0.0
0.0
Machine tools
77.1
14.3
0.0
0.0
8.6
Consumer electric machines
53.6
13.6
10.7
14.3
7.8
Electronic
30.0
32.1
11.3
10.8
15.6
Automobiles
66.0
24.0
0.0
0.0
10.0
Japanese FDI has been characterized by cyclical patterns that reflect Yen movement (Bayoumi, & Lipworth, 1997, p. 12). These sectors are dominated by foreign multinational enterprises (MNE) (Thomson, 1999, p. 26). Table 5, below, depicts summary statistics applying GMM for the period 1960-1995:
Table 5. Summary Statistics, 1960-1995 [7]
Mean
Standard Deviation
Minimum Value
Maximum Value
Growth rate
1.89
1.81
(2.81)
7.16
Years of school
5.01
2.51
1.20
11.70
Inflation rate
0.16
0.18
0.04
0.91
Government size (government consumption/GDP
0.15
0.05
0.07
0.31
Openness to trade (exports + imports/GDP)
0.60
0.37
0.14
2.32
Black market premium
0.23
0.49
0.00
2.77
Private credit
0.40
0.29
0.04
1.41
FDI (as share of GDP)
0.01
0.01
0.00
0.04
During the period January-March 2010, FDI increased 30.5% over the same quarter in the previous year (Thailand Business News, 2010). Project investment value increased 137% over the same quarter in the previous year, valued at 44.39 billion Baht, with 24.69 billion Baht from expansion projects and 19.71 billion Baht from new projects (Thailand Business News, 2010). Table 6, below, shows the current net flow of foreign direct investment classified by sector.
In a study conducted in Africa, instability, corruption and political instability vis-à-vis FDI were assessed. Data on 22 countries for the period 1984-2000 was used. The study found that natural resources and large markets promote FDI, but a similar effect resulted from a good infrastructure, lessened corruption and political stability had equal effects (Asiedu, 2006, pp. 63-77).
In conclusion, FDI-has spread rapidly through the world economy in the past two decades. More countries and more sectors have come become part of the international FDI network. The high level and diverse forms of FDI represent an important force generating greater global economic integration. Outward FDI generally improves the economy of developed countries, while inward FDI improves the economies of developing countries, but does not necessarily do so in developed countries.
Words count: 2319 (exclude Tables and References)
