The Impact of FDI on Economic Growth - Research Paper Example

The impact of foreign direct investment on economic growth of less developed countries Outline: Introduction: Aims and objectives: Motivation: Development Economics and its usefulness in this study: A Brief Review of Literature: Methodology: Discussion: Introduction: Foreign direct investment (FDI) has been one of the important characteristics of the global economy for the past twenty years. It has developed at an unparalleled pace for over a decade. Liberalization of overseas investment regime is an essential part of expansion of FDI. FDI as a growth-augmenting constituent has received great interest from developed nations in general and less developed nations in particular in current decade. It has been an issue of great concern for several economists regarding how FDI influences economic growth of the host nation. In a closed economy, investment is financed exclusively by domestic savings since there has been no access to foreign saving. However, in open economy investment is funded both through household savings and foreign capital flows, incorporating FDI. FDI facilitates investment-receiving (host) nations to attain investment levels ahead of their capability to save (Atique, Ahmad and Azhar, 2004, p. 1). Aims and objectives: The study aims to discuss about the underlying effect of foreign direct investment on economic growth of the less developed or the developing nations. The study seeks to analyze whether the inflow of foreign direct investment is really leading to economic growth and capital formation within the less developed countries. Motivation: The topic “The impact of foreign direct investment on economic growth of less developed countries” seems to be interesting and relevant. Through this topic, the study seeks to find whether these inflows of foreign capital can be sustained within the less developed economies. Whether the transnational players in the international economy could contribute to the modernization of the economies of developing countries is also the point of concern in this study. Development Economics and its usefulness in this study: Development Economics is a topic that studies the economics of the developing nations. It has made exceptional use of economic hypothesis, econometric methods, sociology, anthropology, political science, ecology and demography and has mushroomed into one of the liveliest parts of study in all the social sciences. It is reasonable to say that the model of economic growth initiated by Robert Solow in 1956 has had an elementary impact on development economics. An addition to the capital stock will have a larger effect on per-capita income. It implies that by means of controlling parameters (for example, savings rates and population growth rates), poorer nations will tend to develop faster and hence will come up to reach the levels of comfort enjoyed by their affluent counterparts (Ray, 2007, pp. 1-2). A Brief Review of Literature: Leonard (2006) talks about the effect of FDI on wages and labor values in developing nations. Whilst wages for skilled labor often augment due to higher FDI, the disparity between skilled and unskilled labor income has broadened (Leonard, 2006, p. 671). Arestis, Baddeley and McCombie (2007) describe the current trend in foreign direct investment in developing nations from an endogenous growth hypothesis perspective. The aim is to emphasize the significance of enabling policy structure to help make the most of the opportunities that the innovative drifts contain. The stress is on FDI in research and development (Arestis, Baddeley and McCombie, 2007, p. 238). Levy-Livermore (1998) assessed the contribution of FDI to economic growth in chosen developing nations in South East Asia, Latin America and Sub-Saharan Africa during the period of 1963-1992. The study observes the role of human capital and the interface of overseas investment with other determinants of economic enlargement (Levy-Livermore, 1998, p. 87). Yang (2005) presented a methodical analysis of Chinas external FDI in the last quarter of a century. In his book, “Chinas offshore investments: a network approach”, he explored the underlying principle behind FDI’s materialization and development. Chinas external FDI displays unique characteristics regarding timing, speed and geographical allocation that challenge the existing conventional theories of FDI. Chinas offshore investment applies to the structure of a network model of FDI. This model is developed by applying economic norms to thoughts of networks in business evaluation. This network model has been structured purposely by Dexin Yang for the intention of theorizing the altering pattern of FDI in the period of globalization and inferring Chinas FDI. Cypher and Dietz (2008) portrayed that in neo-classical economic theory (as typified by Solow), developing countries are viewed as lacking in substantial capital investment. Accordingly, it would seem that the inflows of FDI could only have an optimistic impact on the growth rate of a poorer country. The higher level attained in 1990s proposed that FDI could make a contribution to the general investment level in a lot of developing countries (Cypher and Dietz, 2008, p. 461). Lee, B-H, Organization for Economic Co-operation and Development (2002) revealed about Koreas experience with external FDI. The study reveals that the ancillary advantages of such investment - knowledge and management relocation; market attainment and skills improvement can be considerable for individual companies. Furthermore, the resulting improved robustness of these companies contributes to the strength and permanence of the economy all together. While it is evident that inward FDI carries similar advantages, external FDI driven by the privileges of the domestic firm, is incorporated into existing business plans and polices. Thus it comprises of a more dynamic policy. The Korean case study depicts that there is a large possibility for other rising economies to achieve from FDI flows and that the primary costs from lost domestic investment are largely overshadowed by the medium-term advantages. Lovei and Gentry (2002) talked about FDI’s noteworthy role in privatization. FDI augments the pool of possible bidders and make the extra financial resources available. In 1998, FDI was the key source of foreign proceeds increased through privatization action. Whilst the total portfolio flows to the developing nations fell by nearly 50 percent between 1997 and 1998, overall FDI flows continued to be the same (Lovei and Gentry, 2002, p. 10). The proposed study will discuss the causal relation between stock price indices of the five developing nations and FDI. The project will analyze important studies and then will conduct an investigation that centers on foreign investment and the stock indices of the companies that reveal correlations between them. Methodology: In the final study, we are going to carry out qualitative as well as quantitative research. In case of qualitative study, types of data which will be collected generally involve the opinions and beliefs of the researcher and the subjects who will be studied, through the application of various instruments.  Instruments which will be used to collect the primary data will include questionnaires and conducted through telephones and internet as the mediums of communication. Interview is considered to be very useful and powerful for conducting qualitative researches. During a research, interviews of some selected people are conducted to find out what an individual actually thinks regarding a particular issue. Interviews enable researchers to access the opinion of the people who are being interviewed and in this case it will point out the trend in preferences. Through interviews it is possible to find out certain important things relevant to the studies that cannot be obtained or observed directly. Interviews also help in discovering and exploring the implications of certain things related to people’s behavior, feelings, habits, routines etc. Through interviews researchers get an access to a wide range of experiences, different kinds of circumstances and a range of knowledge that could otherwise not be obtained. We will be analyzing the causality between foreign direct investment and the stock prices of 5 developing nations. The questionnaire will comprise of 10 questions. Fifty individuals from the developing nations such as, India, Korea, Sri Lanka, Hong Kong and China are thought to be interviewed for the proposed research. The sample that will be chosen will be through random sampling. Some of the questions will be close-ended and the rest will be open-ended. The basic idea is to find out how the incorporation of FDI into the economy of these developing nations have changed their mode of living and these have either helped or hindered their business in particular and economic growth as a whole. The interviews will be taken through face-to-face meetings, telephones and e-mail.   In case of secondary research, the time period considered is of 10 years for a period of 1999 to 2008. Variables which will be taken into consideration are the stock price indices of these five developing nations and FDI. Due to time constraint, the other determinants such as, Gross Domestic Product (GDP), Personal Savings, etc. which could have influenced FDI, are not taken into account. The proposed study aims to consider three regression equations to test the causality between the stock price indices of the developing nations and FDI. The first hypothesis seeks to regress FDI on time, in the second case stock price indices will be regressed on time. Finally, the residual of FDI will be regressed on the residual of stock price indices. Monthly data on FDI and the value of stock price indices will be considered. SPSS statistical package will be used to run the regressions. The main aim is to check whether foreign direct investment in the economies of the developing nations is due to the phenomenal rise in the share prices of the companies. For further details the Johansen co-integration tests along with Granger Causality tests will be performed to check the causality between stock price indices and FDI. For this purpose, E-Views software package will be used in the proposed study. To check the goodness of a model specification, Akaike Information Criteria and Schwarz Criteria will also be used. The data for quantitative research will be collected from the official websites of the stock price indices of the respective developing nations. FDI data maybe collected from World Bank and IMF database of statistics. In case of quantitative research, the data collected will be of secondary type. In case of the qualitative study, the primary data sources will comprise of the businessmen who are into share trading business or into the export-import business. Few economists have also been incorporated into the process of interview. Discussion: In short, it can be said that foreign direct investment basically depends on time-fluctuation and location-specific aspects. The positive correlation between FDI and economic expansion, and which of the variables leads or insulates the other are the issues to be discussed in the research. For instance, opening up to untimely FDI inflows, united with close incorporation into world trade, appears to have reinforced the FDI or the growth nexus. The good news is that in case of the small and less developed economies, they can take advantage of positive development outcomes of FDI which is equivalent to the outcomes generated in more developed nations (Nunnenkamp, 2002, p. 31). A basic factor accounting for the effect of FDI to be severely positive or negative depends upon the level of competition in the markets in which the FDI is implanted. It has to be taken into consideration whether or not the host nations are suffering or benefiting from the presence and the existence of the foreign firms (FDI in developing countries and economies in transition: opportunities, dangers and new challenges, n.d., p. 25). References: 1. Arestis, P, Baddeley, M, McCombie, J.S.L. (2007). Economic growth: new directions in theory and policy (edition Illustrated). Gloucestershire: Edward Elgar Publishing. 2. Atique, Z, Ahmad, M.H, Azhar, U. (2004). ‘The Impact of FDI on Economic Growth under Foreign Trade Regimes: A Case Study of Pakistan’. The Pakistan Development Review. Volume 43. No. 4 Part II. Available at: http://www.pide.org.pk/pdf/psde20AGM/THE%20IMPACT%20OF%20FDI%20ON%20ECONOMIC%20GROWTH%20UNDER%20FOREIGN%20TRADE%20REGIMES%20A%20CASE%20STUDY%20OF%20PAKISTAN.pdf (Accessed on Nov. 20, 2009). 3. Cypher, J.M, Dietz, J.L. (2008). The process of economic development (edition 2, illustrated). London: Taylor & Francis. 4. “FDI in developing countries and economies in transition: opportunities, dangers and new challenges”. (n.d.). Peterson Institute for International Economics. Available at: http://www.piie.com/publications/chapters_preview/53/1iie258x.pdf (Accessed on Nov. 20, 2009). 5. Lee, B-H, Organization for Economic Co-operation and Development. Development Centre. (2002). FDI from developing countries: a vector for trade and development, Part 489 (edition Illustrated). Washington: OECD Publishing. 6. Leonard, T.M. (2006). Encyclopedia of the developing world, Volume 1 (edition Illustrated). London: Taylor & Francis. 7. Levy-Livermore, A. (1998). Handbook on the globalization of the world economy (edition Illustrated).Gloucestershire: Edward Elgar Publishing. 8. Lovei, M, Gentry, B.S. (2002). The environmental implications of privatization: lessons for developing countries, Part 63; & nbsp; Part 426. Washington: World Bank Publications. 9. Nunnenkamp, P. (2002). “Foreign Direct Investment in Developing Countries: What Economists (Don’t) know and what policy makers should (not) do!” Monographs on Investment and Competition Policy #11. CUTS. 1984 to 2003. Available at: http://www.cuts-international.org/FDI%20in%20Developing%20Countries-NP.pdf (Accessed on Nov. 20, 2009). 10. Ray, D. (March, 2007). “Development Economics” (edited by Lawrence Blume and Steven Durlauf). New Palgrave Dictionary of Economics. Available at: http://www.nyu.edu/econ/user/debraj/Papers/RayPalgrave.pdf (Accessed on Nov. 20, 2009). 11. Yang, D. (2005). Chinas offshore investments: a network approach (edition Illustrated). Gloucestershire: Edward Elgar Publishing. Read More