Determinants of Foreign Direct Investment Inflow to China - Case Study Example

EMPIRICAL RESULTS AND ANALYSIS By Student’s Name Course code + name Professor’s name University name City, State Date of Submission Empirical Results and Discussion Introduction The chapter discusses the empirical studies based on the data analyzed from chapter 3. The main focus will be on discussion of study findings, highlight these findings as compared to the previous studies on the subject matter and make a comparison of empirical findings with the existing literature taking into account the consistencies or inconsistencies thereof. Descriptive statistics. Figure 1. Description of the foreign direct investment, Exchange rate volatility, Growth rate of GDP, per capital wage level and Consumer price index, during 1986‐2016 periods Table 2 shows the performance of foreign direct investment, exchange rate volatility, GDP growth rate, per capita wage level and household consumption price index during the period 1986 to 2016. According to the Table 2, during this period, the amount of foreign direct investment reached the highest value 12626555 in 2015, while the lowest value 224400 appeared in 1986 and its average was 175946193.The exchange rate volatility data shows that the average value of it during this period is 97.469, the highest value 49.581 appears in 1994, and the lowest value is -8.665 in 2008.The average of the growth rate of GDP is 479.983 shown from the table, it reaching the peak point with 36.342 in 1994, and the lowest value is 6.302 in 1999.The average per capita wage level in the period is 605003 with the highest value 67569 in 2016 and the lowest value 1329 in 1986.Among the period, the consumer price index in 1994 has reached the highest value 124.1, and the lowest value is 98.6 in 1999, its average value is 3266.36. The above data description shows that, in addition to the trend of per capita wage level is to move forward, there are fluctuations in the other variables' change trends in the 30 years, the further evidences as shown in the following picture. Figure 2. Change trends of the FDI, Exchange rate volatility, Growth rate of GDP and Consumer price index Aggregated average mean values for FDI, ER, GGDP, Average wage and Consumer Price Index Average Consumer Price index between 1986 and 2000 was the highest in 30 years at between 110%-113%and was relatively stable at between 101%-102% from 2001-2016. There average FDI has been on an upward trend from 1986-2016 with the highest percentage mean for the five years in the years1991-1995 with a 680%. Stationarity of time series To obtain consistent non erroneous results, variables were tested for stationarity using ADF test. Empirical results showed that the variables were stable after the first difference level and thus, first difference series. The variable co-integration testsJohansen, (1988)carried out suggested that there is long-term co-integration relationship between dependent variable and independent variables thus having a stochastic trend. The Multivariate model selected for the study had a goodness of fit with a low R-square value of 0.877 and a 46.31 under F-statistic which was statistically significant giving the model a lease of life fit the variable for the impact of foreign direct investment. Discussion of study findings. Foreign direct investment (actual inflow of FDI) The study findings from Multiple regression analysis shows that FDI is dependent on GDP growth rate and per capita wage level which have positive correlation with foreign direct investment which is consistent with study by Swain and Wang (1995) which established that there exist a relationship between low labour cost and FDI in China. These findings also agrees with those of Liu et al (1997) and Zhang (2000) which highlights the cheap labour cost as one of the main contributors of China’s FDI. Similarly, the findings was also supported by Liu et al (1997) which asserted that GDP growth is an important factor for China’s FDI. While these literature greatly supports the relationship between FDI and GDP growth and Per capita wage level; further study needs to be undertaken to establish how the GDP growth is affected by the existing business environment in terms of taxes and political risk. Exchange rate volatility The empirical result from Granger causality test suggests that Exchange rate volatility has a two was causal relationship with FDI. This means that higher volatility in exchange rate has a direct effect on inflow of foreign direct investment and vice versa. Theoretically, volatility in exchange rate is said to impede FDI in the sense that it affects the price of exports in the home country (Chou 2000).The assertion is supported by various studies on this area for instance;Dharmendra et al (2010) which suggested that exchange rate volatility has a favorable effect on foreign direct investment a view which seems different for private investment. Serven (2003) intimates that private investment is negatively affected by exchange rate volatility in that highervolatility in exchange rate indicates an unstable economy in the host country and multinational investors tend to shy away from investing in that kind of setup. Although literature in a sense points to the effect of exchange rate uncertainty, the effect may be either positive or negative on the flow of FDI and more research needs to be done on specific markets as this varies greatly from one to another. Growth rate of GDP Empirical data shows that China’s GDP has been growing since 1983 with the highest growth percentage in 1994 at 36% and an average of 15.48% from 1986-2016. The study suggest that there is a positive correlation between FDI and GDP based on Johansen co-integration test. The Granger Causality Test further indicated two way directional relationship between FDI and GDP. Theassertion is supported by various literature based on the subject as advanced by Sandalcilar and Altiner(2000) for instance, using Granger Causality Test on error correction model which suggest that there is positive causality from FDI to GDP and a slightly less positive causality from GDP to FDI. The positive relationship between growth rate of GDP and FDI inflow is true in theory since investors tend to invest in a country which has a positive economic growth in the future. The background backing to these empirical evidence suggests that FDI is a front runner in creating the necessary components for incremental GDP of host country. China has a vast endowment in market which is a key attraction to investors. China’s population which is unparalleled by any other economy globally plays out by having a huge market for local and foreign products. The increased growth rate in GDP arguably stems from the economies of scale and huge resource bestowment which attracts investments and thus inflow in terms of FDI. The resultant inflow in FDI means that the host country will have a larger capital base which accelerates business in terms of production of goods and services as well as many people being employed which increases their purchasing power and eventual growth in economy. The result of this study is complimentary to those of Martinez-Zarzoso (2003) that proposed that investor confidence is built by a growing GDP in the home country, a few supported as well by Nowak-Lehmann (2004). Therefore, the growth of GDP is a true measure of the country’s increasing production as well as consumption of the locally produced commodities. China in this sense has been consistent since early 80’s as its GDP trend has been on the upward trend surpassing established European economies to be a power house in 21st century. Per capita wage level. Per capita wage level plays a role in foreign domestic investment inflow from the study. The study established that there was significant positive relationship between per capita wage level and FDI. The major explanation to this is that high wage rate is associated with high level of skill which is usually a characteristic of techno-oriented Chinese industries. This therefore imply that high FDI inflow is associated with high wage rate through this relationship is unidirectional as espoused by the Granger causality test in this study which indicated that there is a one-way causal relationship between the FDI and per capita wage level, the increase in the level of staff wages can promote the growth of foreign direct investment, but FDI changes does not affect the per capita wage level. High wages are usually presumed to be an indicator of productive capacity of techno-driven industries but the major attraction of FDI to china is presumably the industrial labor wage, Wen-Hsien (2010). Taking this view means that the relationship between wage rate and outward FDI to host country China will be positive. The study is consistent to that of Na & Lightfoot, 2006, who established that investors pay high wage in order to attract skilled manpower. Generally speaking, OECD (2000) suggests that cheap labour costs is no longer a key driver of investment in China and that higher FDI in some areas in China provinces may be linked to higher wage rates (Sun et al., 2002; Na & Lightfoot, 2006).Contrary to this study, many scholars have found divergent views. Many have found a negative relationship between FDI and per capita wage rate, for instance Yu C. and Sylvie D. (2002) on the effect of wage rate on FDI stock which showed that an incremental 1% in labour wage in China would result to a lower FDI by close to 1% a negative correlation. Wage level impact on inflow of FDI is not uniform since its dependent on the level of skills. The more the skilled the workforce is, the more the inflow in terms of FDI. Consumer Price Index The study sought to find out the correlation between macroeconomic indicator Consumer Price Index CPI and FDI, which is a proxy measure of inflation. In this study it was established that there was a weak negative relationship between FDI and CPI in the regression model with a coefficient of -0.0243 which was not significant at 0.05 level of significance. This negative relationship is deemed to be as a result of rising cost of production of products which in turn results to high prices of commodities. The increase in production costs is due to increase in cost of raw materials, labour costs capital outlay and input prices. The high cost of these products as result, led to a ripple effect in the sense that the demand for them will plummet in both domestic and foreign markets. The decrease in demand means that the business environment becomes unfavourable for the investors because of falling profits and ultimately decreased foreign direct investment. This observation from this study analysis allows us to conclude that consumer price index and foreign direct investment have an inverse (adverse) relationship and an increase in consumer prices leads to a decreased foreign direct inverse and the converse holds true. Nevertheless; despite the above observation, it was evident from the study that GGDP and CPI have similar characteristics in that it reflects on the standard of living of the people of a country and high growth in GDP means there is high purchasing power of the local consumers as shown: Figure 3.Superimposed line graph showing relationship between GGDP and CPI Data Source: Statistics Bureau of China The GGDP and CPI graph above shows similar behavior which is consistent with the result of the regression analysis. Wherever the rate of economic growth is high it’s usually accompanied by a higher consumer price index. The CPI being a comprehensive measure of price of commodities at any given duration is used in this case to highlight the effect it has on the inflow of FDI to China. Conclusion The study sought to establish the major contributing factors to China’s ever increasing inflow of FDI. Using multiple linear regression model, where FDI (actual inflow of FDI) being dependent variable was regressed against the variables under study; exchange rate volatility, growth rate in GDP,Per capita wage level and Consumer price index (inflation rate). China’s FDI inflow is the presumably the greatest in the past decade globally. This has been growing steadily since the early 1980’s (Figure 4). The growth has been attributed to many factors among them, cheap readily available skilled labour, ready and expanded domestic market for locally produced products, favorable internal business environment which has been changing for the better and the country’s integration with outside economies Yu C. and Sylvie D. (2002). Figure 4. Average FDI in ($0000) Source: Statistics Bureau of China The graph shows an upward trend in FDI to China from 1986-2016 The study sufficiently concluded that Foreign Direct Investment is a factor of Exchange rate uncertainty, wage level and consumer price index. The direction of interrelationship is varied depending on the variable at hand some highly unidirectional for instance Exchange rate volatility while others were bi-directional as gross domestic product. The macroeconomic indicators of FDI inflow captured in this study circulated around GDP and exchange rate. There are other determinants of interest which may play a role in FDI inflow among these are; economic risk of the host country, legal policy and framework and infrastructural development. While these are major player variables in any economy of interest, China’s economic development through FDI has largely due to the changing business landscape that favors both local and international investors while the business environment has been opened up to suit integration with other international economies. The technology and a solid capital base has played a role nevertheless, though this study was only limited to the variables that influence Foreign Domestic Investment in China. The inflow in FDI resulting from afore mentioned determinants and other factors has had a tremendous effect on China’s economy. China; in order to make this success sustainable in the long run, has reworked its market and economic policy to improved management systems and technologies which has revolutionized the business environment to make vibrant and more accommodating to new entrants. The improved business environment has synergized infrastructural development, capital inflows and skilled man power improvement which in overall contributes to China’s economic development, Muhammad et al (2015). The study is significant as it may contribute to existing literature in looking closely at how variables discussed have impacted on Chinas FDI inflow. The adoption of the model and use of Granger Causality Test expands direction of the variable relationships. Despite the detailed discussion on the impacts of these variables; the study made no study on other factors which are relevant to inflow in FDI. These factors includes political and legal framework and ease of doing business, taxation and interest rates. Therefore; the study recommends a further research on these to build a more robust view of contributing factors to inflow of FDI to China’s economy. References Swain, N.J. and Wang, Z(1997). Determinants of inflow of foreign direct investment in Hungary and China: time-series approach. Journal of International Development, 9(5), pp.695-726. Liu, X.M.; Romilly, P; Song, H.Y. and Wei, Y.Q. (1997). Country characteristics and foreign direct investment in China: A panel data analysis”, Weltwirschaftliches Archiv, 133(2) pp313-29 Zhang, K.H. (2000). Why is U.S. Direct Investment in China so Small? Contemporary Economic Policy, 18(1), 82-94 Johansen, S. “Statistical Analysis of Cointegrating Vectors.” Journal of Economic Dynamics and Control, 12 (1988), 231-54 Dharmendra, D., Raja, N., Gyan, P. and Kamal P. (2010). Exchange Rate Volatility and Foreign Direct Investment: Evidence from East Asian Countries. Serven, L. 2003. ―Real-Exchange Rate Uncertainty and Private Investment in LDCs,‖ Review of Economics and Statistics, vol. 85, pp. 212-218 Sandalcilar A. R., Altiner A. (2000). Foreign Direct Investment and Gross Domestic Product: An Application on ECO Region (1995–2011). International Journal of Business and Social Science, 3(22), 189–198. Yu C. and Sylvie D. (2002).Foreign Direct Investment and Manufacturing Productivity in China: “The Competitiveness of China’s Economy”. Martinez-Zarzoso, I. (2003). The log of gravity revisited. Applied Economics, 45(3), 311-327. http://dx.doi.org/10.1080/00036846.2011.599786 Martanez-Zarzoso, I., & Nowak-Lehmann, F. D. (2004). Economic and geographical distance: Explaining MercosurSectoral Exports to the EU. Open Economies Review, 15(3), 314.http://dx.doi.org/10.1023/B:OPEN.0000037702.33704.20291 CHOU, W.L., 2000. Exchange Rate Variability and China's Exports. Journal of Comparative Economics, 28(1), pp. 61-79. Muhammad W.B., Kaleem A. Muhammad I., Sadique H., & Sayed F. A (2015)Factors Determining Foreign Direct Investment in China. Research Journal of Finance and Accounting.Vol.6, No.11, 2015,www.iiste.org/Journals/index.php/RJFA/article/viewFile/23351/24177 Wen-Hsien L. (2010). Determinants of FDI Inflows to China: An Empirical Analysis of Source Country Characteristics: http://proj3.sinica.edu.tw/~econ/2010GTD/18/18-1.pdf. Sun, Tong and Yu (2002),” Determinants of foreign direct investment across China”, Journal of International Money and Finance, Vol. 21, Issue 1, pp. 79-113 OECD (2000), “Main determinants and impacts of foreign direct investment on China’s economy”, Working papers on international investment, Number 2000/4 Na, Lv and Lightfoot, W.S. (2006),”Determinants of foreign direct investment at the regional Level in China”, Journal of Technology Management in China, Vol. 1, No 3, pp. 262-278 Read More