The Role of FDI in Nurturing Competition Environment - Dissertation Example

? The Role of FDI in Nurturing Competition Environment This paper investigates the fundamentals of Foreign Direct Investment (FDI) in developing countries like China. Moreover, it examines how FDI aids in fashioning domestic competition environment in China. The drive for writing the paper comes from the inability of the academic world to establish a rich and strong view for the role of FDI in fashioning domestic competition for economic growth. First, the paper lays down a short vivid overview of the chief determinants for FDI. Second, the typical Solow growth model is offered aiming at simplifying the main drives for economic growth. Moreover, a comprehensive analysis of the actions of the MNEs is included. As a result, this method provides a multi-dimensional approach which puts emphasis on the modifications in efficiency, labour and possible spillover effects arising from the MNEs’ actions in China. Table of Content Contents Abstract 2 Table of Content 3 Contents 3 Introduction 3 Literature Review 5 Theoretical Framework 6 The Model 6 Conceptual Framework 11 Unconditional Approach 13 Conditional Approach 14 Total Factor Productivity Approach 16 Methodology 18 Research Methods 18 Data Sources 19 References 20 Introduction One of the greatest sensitive zones in international economics currently is Foreign Direct Investment (FDI). Developing countries like China dread misuse on one hand, and insufficient access to foreign capital, expertise, marketing, and administration skills on the other. FDI comprises a course of financial capital and impalpable assets like technology, professional capabilities, promotion skills and other possessions (Blonigen, 2005). It is worth noting that direct investment, in most cases, it begins with a minute or no net flow of financial capital. Occasionally, the parent company only adds its trademark name, managerial principles pegged with other assets of the less tangible variety (Moosa, 2002). A good prevarication strategy for a parent company that has foreign currency possessions in its partners is to take on foreign currency obligations as well (Ruane, & Ugur, 2005). This is made available by appropriating in foreign moneys that are used to fund the affiliate. In the current years, the portion of the developing nations as a basis of FDI significantly intensifies. However, the lion’s part is reserved to the EU nations, USA and Japan which make up for 80-90 percent of the entire FDI outflows. In situations where FDI is measured as a proportion of GDP, the developed nations still account for the inordinate majority of FDI outflows (Kneller & Pisu, 2005). The role of FDI unavoidably increases in a quickly globalizing world. Bill Gates once said: “No one gets to vote on whether technology is going to change our lives”. By utilizing this quote as a representation, comparable parallels can be made in respect to FDI. No doubt, FDI has developed into an evitable part of the current globalized world and no person has the authority to stop this development. Therefore, it is vital that the consequences of FDI to the host economies be carefully and independently assessed. It is worth declaring that this is not an easy task, bearing in mind the schism of the bulk of opinions (Simpson, 2010). GDP, Export and FDI flows* *(Constant 1995 US$ index numbers, 1970=100, log scale) Source: Navaretti & Venables, 2004 Literature Review Theoretical Framework This chapter targets to provide the dissertation with a resilient theoretical framework in association with economic growth pegged with its determinants. By understanding and appreciating what motivates the development in the short and long-run, it will be much tranquil to identify the influence that FDI has on the domestic competition environment. The beginning point of this investigation is the structure of a production function. Bestowing Alfaro, Kalemli-Ozcan and Sayek, (2009), we will use Solow’s neo-classical model of economic growth as a foundation of the discussion. This model was a choice of the discussion because of its extensive applicability, simplicity, and capability to stand the test of time. However, it is worth noting that the neo-classical growth model, just like any other model, has its noteworthy shortcomings. The most significant is the deliberation that the long-term growth can only be as a consequence of changes in technological growth coupled with labour or demographic force growth, which are mutually measured as exogenous. FDI can affect production growth only temporarily. In the long-term, according to Gottschalk & Hall (2008), the beneficiary economy would always join to its steady-state development level. As a result, the only means for growth-enhancing FDI would be as a result of permanent technological upgrading. Moreover, the neo-classical growth model proposes that government strategies have a consequence only in the short-term. Therefore, the outcomes of FDI-promoting strategies would be short lived (de Mello Jr., 1997). The Model Firstly, it should be noted that growth will be demarcated as “the stable increase of collective output over a given period” through this paper (Blanchard, 2006). According to Alfaro, Kalemli-Ozcan & Sayek (2009), it is presumed that output is demarcated by two aspects of production, which are capital and labour. Therefore, their relation can be described by the production function: …….. {1} In the above calculation, Y stands for cumulative output, K for capital and L for labour. Solow (1956) reason that in the theory of growth, it is normal to assume continuous returns to scale. As a result, it can be concluded in the production function above (Solow, 1956). L, or the quantity of labours in the economy, has a direct consequence on output. So, other things being constant, a rise in labour translates to an increase in productivity. However, Smarzynska and Wei (2000) think it is vital to comment that in this model, increasing returns to scale are actual only if both elements grow by the same multiplier. Therefore, in the instance of an increasing L, given K, the earnings to scale will be decreasing (Blanchard, 2006; Solow, 1956). In Solow’s model of economic development, the supposition of equality among output and income is upheld to facilitate interchangeability (denoted by Y). As a result, it can be invented that at any given moment, a portion of this income is spent and the rest of it is set aside and invested (Yan, 2008). Thus, sY indicates the part of production that is saved, supposing a constant inclination to save specified by the factor s. Symbolizing the stock of capital which is accrued over time by K, the disposable investment can be demarcated as the rate of growth of K over a given time or dK/dt = Ќ. This point to the following calculation: ……………. {2} Merging equations [1] and [2] offers: …………. {3} Supposing that labour develops (or shrinks) by a constant number n, the model can be developed by replacing L(t) with L0ent . As a result, the equation [3] is rephrased as: …………… {4} By creating these changes, one should know that the circumstances of total employment are continuously kept constant. Thus, in [4] L represents the total existing labour supply. The equation discloses the variations in capital stock growth in time. Hence, by introducing the variable K(t) and regulating for the above given expectations and limitations, the time track of capital stock can be constructed. Shared by the time track of labour force, it can be noted that the production function in equation [1] can be able to be used in order to calculate the time path of production. Essentially, in relation to Markusen and Venables (1997), it is vital to evaluate growth, previously defined as “the stable increase of collective output over a given period”. The quantity of savings can be dignified by the tendency to save a fraction of the output for the time in question. It is vital to state that the model is very candid. As a result, it does not comprise the technological progress. This is because growth originates only from the stagnant increase of labour supply coupled with the accumulation of capital stock. With the preliminary moment of time when the existing capital stock is K(0) and t=0, the present labour supply sums up to L(0). It is worth noting that L(0)= L0ent. With these contributions, the production function equation will look like Y(0)=F(K(0), with K(0) at t=0 is L(0). Therefore, the current output Y(0) is attained. Multiplying with one’s ability to save constant s, it obtains Ќ(0), which is the percentage of growth of the capital stock for the recent period of time. In conclusion, summing up the opening capital K(0) with the disposable accumulated capital for the present period, Ќ(0) provides the existing capital stock for the succeeding period which is K(t+1) = K(1). Thus, the process can be initiated all over (Solow, 1956). A novel variable called r represents the ratio of capital to labour, r = K/L. As a result, r can be presented as the difference between the virtual fluctuations of K and L, or: ……. {5} Nevertheless, the ratio of K (capital) was previously defined in equation [3] as per Ќ = sF(K, L). Moreover, the ratio of L (labour) is equivalent to the amount of labour force growth n, or L/L = n. Substituting with the above equation and making r the subject results to: ………….. {6} Simplifying the above equation using K/K = 1 and L/K = 1/r gives: ………… {7} Isoquant map of the total product curve Source: Solow, Robert M. (1956) In situations where F(r, 1) is a subject of calculating the entire productivity as capital per worker, r fluctuates and labour is equivalent to constant 1. Equation [5] can be interpreted to mean that the degree of variation of the capital to labour ratio r is equivalent to the difference among the capital growth function sF(r, 1) coupled with the labour growth function (nr). This is further explained in the graph above. In situations where the degree of modification of the capital to labour ratio is equivalent to zero (r = 0), the ratio is constant (r star). Therefore, the proportions of capital coupled with labour growth ought to equate to n (Solow, 1956). Effects of an improvement in the state of technology Source: Blanchard, Olivier (2006) The above stated neo-classical growth model offers the paper with an appreciated and valid theoretical framework for appreciating the factors for economic development, that is labour and capital. In order to label the position of FDI on output, it will be essential to focus on the influences FDI has on every one of the growth determinants. These are technological advancement, capital and labor. The succeeding chapter generally discusses this matter. Conceptual Framework The query addressed in this sector is whether FDI nurtures domestic competitive environment in the host country, China. Under Helpman (2006), numerous different tactics can be utilized when gauging the variance in production between foreign and domestic-possessed firms in China. Unconditional effects exist as the first variance. Its main practice is to simply measure means. Experimental evidence displays that, when functional, the unconditional tactic often highlights higher production levels on average between the multinational companies compared to their local opponents. This can be for the reason that MNE hold certain benefits, such as large economies of scale, product image, better R&D among others (Navaretti & Venables, 2004). It is worth noting that the unconditional approach entails certain disadvantages. This is because it is incapable to communicate to the onlooker, if the foreign-owned companies are actually more resourceful than the domestically-owned companies. On the other hand, the conditional effects approach targets at evaluating the difference in effectiveness by ignoring all the elements that can have an impact on performance and are connected with foreign rights (size, technology, R&D). When functional, the conditional approach wheels for all the above stated factors. Scientific proof proposes that foreign-owned companies are still more industrious than the domestically-owned ones. However, but the gap in performance between the foreign-owned and domestically-owned companies is smaller, and in some instances statistically irrelevant (Navaretti & Venables, 2004). To some extent the unconditional and conditional tactics deliver us with appreciated tools in laying down the variance in efficiency amongst the local and multinational-owned companies. In pursuing objectivity, nonetheless, it must be specified that the domestic companies often profit from the presence of foreign competitors. Bequeathing Javorcik (2002), it is essential to address the latent spillover effects in relation of yield that occur from the actions of the multinational subsidiaries which translate to developed productivity between the local firms (Navaretti & Venables, 2004). Unconditional Approach Unfortunately, it is virtually impossible to analyse how FDI affects production on a macro level. Consequently, the most applicable way to address this problem is by concentrating on firm-level datasets, uniting foreign- and domestically-owned companies. Numerous case studies are present, primarily in India, Pakistan, China and some other developing nations (Khaliq, & Noy, 2007). In this section, the discussion will be facilitated grounded on some case studies that have happened in China. The projected case studies utilize the Annual Census of Production (ACOP) respondents’ data base. This data base encompasses very detailed evidences on foreign and local firms working in China since 1970 (Navaretti & Venables, 2004). Comparing foreign-owned and national China based plants (Average 1996-2000, in thousand pounds sterling)   Foreign owned National Number of observations 3499 161,234 Value added/employee 44.61 27.98 Output/employee 151.98 76.52 Employment 485.05 142.09 Capital/employee 98.82 38.23 Intermediate inputs/employees 107.81 50.52 Source: Navaretti & Venables, 2004 The figure above lays a contrast between the foreign-owned and national companies found in China for the 1996-2000 period. It is noted that two diverse measures of labour fabrication are described in output per employee and the table-value added. On both accounts, it can be stated that MNE tend to be approximately twice more industrious than their local contestants. However, the two groups of companies differ in all other structures. MNE s are superior in terms of production, employment and value added. As a result, they capitalize more and use more transitional inputs per worker. All the above mentioned aspects (economies of scale pegged with rigorous use of capital) are more or less associated with labour productivity. Under the applied unconditional approach, it is noted that MNEs are per se more productive when compared to their local competitors. As a result, the FDIs in terms of MNEs causes the local competition to increase between the local companies. This is because a majority of the market share is taken up by the MNEs leaving a less portion of the local companies to work with (Navaretti & Venables, 2004). Conditional Approach Granting Haskel, Slaughter and Pereira (2002), the second approach utilizes the conditional effects by monitoring for all factors linked with labour productivity. The consequences from relating the conditional approach are summarized in the figure below. The difference in actual value added per worker between MNEs and local firms Dependent variable: ln (real value added per) 0.018 (0.003) 0.0003 (0.0001) ln () -0.034 (0.006) ln [^2] 0.001 (0.0002) -0.094 (0.022) Year Dummy Yes Within groups fixed effects Yes Observations 131,097 Dependent variable  North American 0.517 -0.042 European Union 0.424 -0.086 Other European 0.351 -0.052 Japanese 0.496 -0.132 Other foreign 0.572 -0.146 Observations 13,909 Source: Navaretti & Venables, 2004 Note: Standard errors in brackets. Year indicates full set of year dummies. Industry indicates full set of 4-digit industry dummies. Exit is a dummy which takes the value 1in year r when industry k shuts down in year t. It can be noticed that a set of control variables are fashioned. In this instance, the size and age are utilized, pegged with an extra variable. This shows that if the firm ceases to exist or not. Furthermore, a dummy variable presenting the nationality of the MNEs is utilized in order to accurately capture the consequence of foreign ownership (Navaretti & Venables, 2004). The recital superiority of the foreign-owned companies can be understood from the factors of the dummy variables described in the table. According to Borensztein, Gregorio and Lee, (1995), foreign firms from all groups have a habit of to be more productive than the local ones. North American institutions are with 68 percent more productive, European ones by 53 percent, other European plants by 42 percent, the Japanese ones by 42 percent and finally, the plants from the rest of the world are worth 77 percent more productive when compared to the local Chinese enterprises (Navaretti & Venables, 2004). Total Factor Productivity Approach Bestowing Barrios and Strobl (2002), both unconditional and conditional tactics show that MNEs show a higher industrious when compared to domestically-owned competitors. The estimations, though, are grounded on the fractional measure of productivity. The circumstance lies on the fact that labour productivity does not entail some other elements of production that exist. This may influence the value added per employee. Taking into account several other factors of production, it is crucial to approximate the total factor productivity (TFP) as an alternative of just concentrating on labour productivity (Navaretti & Venables, 2004). Two independent studies exist conducted by Deng & Jefferson, (2011). These studies aid to measure the difference in TFP among MNEs and the local firms. The principal study examines the car industry in China. The subsequent is based on the manufacturing in the US. It is worth noting that both works use identical approach, considering the Cobb-Douglas production function:  In situations where Y is output, A remains as Hicks neutral productivity shift parameter, K exists as capital, L is labour and M measures other transitional inputs. The subsequent equation can be assessed in its log-linear system as follows: In this instance, TFP is dignified by the residual  which encompasses all the factors affecting output. Moreover, TFP are not comprised in the independent variables. To examine the effect of foreign ownership two different strategies were used by Lu & Beamish, (2001). First, it can be assessed by failing to control ownership ( = 0) pegged with retreating the time-averaged on the possession status of the company. Second, numerous dummies can be involved in order to quantify the foreign ownership, supposing that ( (Navaretti & Venables, 2004). It can be resolved that MNEs are considerably more productive when compared to domestically-owned companies. According to Driffield and Love, (2007), the first unconditional approach highlighted that the MNEs are more industrious. In addition, the conditional approach was smeared in order to scrutinize the efficiency levels of the corporations and disregard all the potential influences, such as size, R&D, etc. that can be valuable for the MNEs. Finally, the TFP methodology was of particular worth in comprising not only the labour efficiency, but also all probable factors of production (Billington, 1999). Methodology Scruggs and Mastropieri (2006) stated “in the widest sense of the word, the meaning of research includes any collection of data, information and evidences for the development of knowledge." Moreover, a research poses a question, gathers data that will aid in the answering of the question, and present an answer to the question. Research Methods Qualitative research is a category of social scientific research method used to investigate the why and how decision making. This aids in getting a deep understanding of the research question or problem. Conferring Jha (2008), qualitative research tends to be exploratory and flexible. Case studies exist as one of the rudimentary designs in qualitative research methods. It is aimed at precisely to describe or rebuild a case. With the case analysis lead, this paper tries to find out the impact FDIs have on the competitive environment of China (Loewenthal & Bryan, 2007). Data Sources Most researchers gather observed data for research projects and use several types of data collection means. It is worth noting that the data source could be either one or a mixture of different sources. Empirical data gathered by researchers are called primary data. Secondary data, on the other hand, are those empirical data that somewhere already contain both textual data (documents, diaries, memos) and graphic materials (video recordings, programs, movies)( Welman, Kruger, Mitchell, & Huysamen., 2005). Whether to practice primary or secondary source be governed by on the topic. Moreover, they can be appropriate to certain topics better than others. The information revealed in this paper relies on secondary data from several ways. Secondary data bases can be categorized into internal record pegged with external sources. Rendering Paivi and Kovalainen (2008), the best way to progress is to start with general evidence and continue with additional information. In this paper, I will put emphasis on external data that include media texts, digital materials among many others. References Alfaro, L., Kalemli-Ozcan, S., & Sayek, S., 2009. FDI, Productivity and Financial Development. World Economy, 32(3), pp 111-135. Barrios, S., & Strobl, E., 2002. 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