The impact of foreign direct investment and trade on economic. growth Taking China, Korea, Malaysia, Philippines & Thailand for.

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1 Dec. 2009, Volume 8, No.12 (Serial No.78) China-USA Business Review, ISSN , USA The impac of foreign direc invesmen and rade on economic growh Taking China, Korea, Malaysia, Philippines & Thailand for example Pourshahabi Farshid, Shirazi Ali, Safdarian Gholamhosein (Deparmen of Economics, Universiy of Sisan and Baluchesan, Zahedan 98177, Iran) Absrac: In his sudy he auhors make effors o survey he impac of foreign direc invesmen and rade on he economic growh of five Eas Asian counries, China, Korea, Malaysia, Philippines and Thailand. Using an augmened producion funcion (APF) growh model, he auhors apply panel daa Mehod and daa span is from1980 o The required daa are exraced from World Developmen Indicaor The resul shows ha a co-inegraion relaionship beween growh and is deerminans in he APF model is suppored. Firsly, he sudy shows ha wih he increasing he inflow of foreign direc invesmen, posiive impac on growh in Thailand, Korea and China is proved. However, his impac is negaive in Philippine and Malaysia. Also he impac of rade on economic growh has he same resul wih FDI impac in sign. Furher, he impac of labor force on growh is no significan in hese counries and he effec of gross fixed capial on growh is posiive and has a very high impac on seleced counries. Key words: rade; foreign direc invesmen (FDI); growh 1. Inroducion The relaionship among FDI, rade and growh is one of he mos imporan issues in inernaional economics. Policymakers in a large number of counries are engaged in creaing all kinds of incenives o arac FDI, because i is assumed o posiively affec economic developmen. Also, hey make effors o expand heir rade capaciies wih foreign counries o simulae heir growhs. Explosion of growh in FDI and rade over he 1990 s, especially in he developing counries, has inspired a sream of lieraure focusing on he impac of FDI and rade on he growh. The main simulus of economic growh and developmen is invesmen and he mos imporan source of he preparaion of his invesmen for various counries is naional saving, while mos of he developing counries encouner wih he shorage of invesmen because of some fundamenal economic difficulies, such as low naional income, inflaion, unemploymen and he deficiency of differen economic pars. For his reason, hese counries make consan endeavor o uilize foreign borrowing for realiaing his shorage. Bu, afer awhile hey face wih difficulies for repaying hem. Why? For his reason ha hese invesmens have been used in deficien Pourshahabi Farshid, M.Sc suden of economics, Deparmen of Economics, Universiy of Sisan and Baluchesan; research field: economics. Shirazi Ali, M.Sc of economics, Deparmen of Economics, Universiy of Sisan and Baluchesan; research field: economics. Safdarian Gholamhosein, M.Sc suden of economics, Deparmen of Economics, Universiy of Sisan and Baluchesan; research field: economics. 37

2 secions which are no profiable and hey are no able o repay heir debs. This problem causes he increase of foreign debs ha has bad and moral effec on he economic of hose counries. For hese causes, hese counries are encouraged o use foreign invesmen paricularly foreign direc invesmen (FDI). The need for aracing FDI causes hem o compare wih each oher. In his compeiion, he menioned counries increasingly relae wih he developed counries ha are he origin of he prior echnology and managemen. Because of he mos significance of his subjec, a grea number of researchers have a lo of sudies abou he effec of FDI on differen economic secions. Under his background, i is imperaive ha he impac of FDI and rade on economic growh needs o be assessed for each counry. The main objecive of his sudy is o survey he impac of FDI and rade in Eas Asia counries such as China, Korea, Malaysia, Philippines and Thailand. 2. Lieraure review In heory, here are several poenial ways in which FDI can promoe economic growh. For example Solow ype sandard neoclassical growh model suggess ha FDI increases he capial sock and hus growh in he hos counry by financing capial formaion (Brems, H., 1970). FDI by ransferring knowledge in he hos counry will increase he exising sock of knowledge hrough labor raining, ransferring of skills, and he ransfer of new managerial and organizaional pracice. Also i can promoe he use of advanced echnology by capial accumulaion in hos counries. Accordingly, FDI relaed o echnological spillovers offses he effecs of diminishing reurns o capial and keeps he economy on a long-run growh pah. Therefore, FDI from way of capial accumulaion and knowledge spillover may play an imporan role for economic growh (De Mello, L., 1999; De Mello, L., 1997). Also, FDI may allow a counry o develop in echnology and knowledge ha are no readily available o domesic invesors, and in his way increase produciviy growh hrough he economy (De Gregorio, Jose, 2003). Blomsrom, e al (1994) said ha FDI has a posiive effec on economic growh, bu here seems o be a hreshold level of income which above FDI has posiive effec on economic growh on above, and i does no in below. Counries ha have reached a cerain income level can absorb new echnologies and benefis of echnology ransfer, and hus reap he exra advanages of FDI. This is because i akes a well-educaed populaion (human capial) o undersand and spread he benefis of new innovaions o he whole economy. Borenszein, e al (1998) suggesed ha counries may need a minimum hreshold sock of human capial in order o experience posiive effecs of FDI. UNCTAD (1999) submied ha FDI has eiher a posiive or negaive impac on oupu depending on he variables ha are enered alongside i in he es equaion. These variables include he iniial per capia GDP, educaion aainmen, domesic invesmen raio, poliical insabiliy, erms of rade, black marke exchange rae premiums, and he sae of financial developmen. Bende-Nabende, e al (2002) found ha he level of economic developmen may no be he main enabling facor in FDI-growh nexus. In conras o he modernizaional perspecive, dependency heoriss argue ha dependence on foreign invesmen is expeced o have a negaive effec on growh and he disribuion of income. Bornschier and Chase-Dunn (1985) claimed ha foreign invesmen creaes an indusrial srucure in which monopoly is predominan, leading economy o be conrolled by foreigners ha would no develop organically, because he muliplier effec by which demand in one secor of a counry creaes demand in anoher is weak and herefore 38

3 leading o sagnan growh in he developing counries. This argumen can be imporan if mos of he FDI is in naural resources secors. The fac ha openness o rade is associaed wih higher growh is documened in numerous sudies. For example, we can menion o sudies of Edwards (1998), Dollar (1992) and Ben-David (1993). Ben-David (1993) demonsraed ha a sample of counries wih open rade regimes displays absolue convergence in per capia income, while a sample of closed counries does no. Also Sachs and Warner (1995) showed ha closed counries experienced annual growh rae a full 2 percenage poins below open counries in he period of They also confirmed Ben-David s resul ha open counries end o converge, no closed ones. There are many reasons ha could explain a posiive esimaed coefficien in a regression of rade openness (however measured) on growh or income levels. Such effecs could sem from beer checks on domesic policies, an improved funcioning of insiuions, echnological ransmissions ha are faciliaed by openness o rade, increased foreign direc invesmen and scale effecs. Wacziarg (2001) had argued ha rade openness exers a posiive and significan impac on economic growh due o he acceleraed accumulaion of physical capial, susained echnological ransfer and improvemen in macroeconomic policies. Therefore, rade and FDI have been recognized as he imporan facors in he economic growh process. Sudies boh cross counry and counry specific on rade and FDI ineracion on growh (Kohpaiboon, A., 2004), FDI-growh nexus and rade-growh nexus (Lipsey, R. E., 2000) and (Pahlavani, M., E. Wilson & A.C. Worhingon, 2005) have mosly concluded ha boh FDI and rade promoe economic growh. And Balasubramanyam (1996) had mosly concluded ha boh FDI and rade promoe economic growh neverheless, here are clear indicaions ha he growh-enhanced effecs from FDI and rade vary from counry o counry. For he same counry s FDI and rade can even negaively affec he growh process (Borenszein, E., J. D. Gregorio & J. W. Lee, 1998; De Mello, L. R., Jr., 1999; Xu, B., 2000). According o Bhagwai s hypohesis ha due o adjusmens for differences among counries for heir economic size, poliical aiudes owards FDI and sabiliy, boh he magniude of FDI and heir efficacy in promoing economic growh will be greaer over he long run in counries pursuing he expor promoion (EP) sraegy han in counries pursuing he impor subsiuion (IS) sraegy (Bhagwai, J. N., 1978; Bhagwai, J. N., 1985). Thus, he growh-enhanced effec of FDI and rade ineracion was no auomaic bu depends on various counry specific facors such as he rade openness. Similar conclusion is made by Asiedu, E. (2002). Observing heory abou he possible growh-promoed roles of boh FDI and rade, he used daa is modeled in an aggregae producion funcion (APF) framework. The APF assumes ha, along wih convenional inpus of labor and capial used in he neoclassical producion funcion, unconvenional inpu like FDI and rade may be included in he model o capure heir conribuion o economic growh. The APF model has been used in many aricles like Kohpaiboon (2004). Following (Herzer, D., D. F. Nowak-Lehmann & B. Siliversovs, 2006, p.3), he general APF model o be esimaed is: α β Y = A K L (1) Tha Y denoes he aggregae producion of he economy a ime and A, K, L are he oal facor produciviy, he capial sock and he sock of labor respecively. According o Lipsey (2001), he impac of FDI on economic growh possibly operaes hrough oal facor produciviy. In his sudy, he auhors wan o 39

4 invesigae he impac of FDI and rade on economic growh hrough changes in oal facor produciviy, assuming ha oal facor produciviy is a funcion of FDI and rade and oher exogenous facors ( C ), hus: α β φ δ Y = CK L FDI TR (2) In secion 3, he auhors will presen he used model and explain ha how we use APF framework for surveying he impac of FDI and rade on growh of seleced counries. 3. Daa and mehodology The enered variables in model are: Y is defined as real GDP per capia, FDI is real gross foreign direc invesmen flows, TR is he sum of expor and impor values o GDP raio, L is oal labor force and K is real value of gross fixed capial formaion ha is proxy of capial sock. For he benefis of using he linear logarihmic models, which conained he obained coefficiens hrough hese models showing elasiciy, all of he variables have been used as logarihmic o esimae he model. In his sudy, he auhors use he panel uni roo es proposed by Breiung (2000). The reason for using his panel uni roo es is ha a recen large-scale Mone Carlo simulaion sudied by Hlouskova and Wagner (2006) found ha he Breiung (2000) panel uni roo es generally had he highes power and smalles size disorion of any of he so called firs generaion panel uni roo ess. If he model conains a panel uni roo, he issue arises wheher here exiss a long run equilibrium relaionship among he variables. The auhors es for panel co-inegraion using Kao (1999) es (Engle-Granger based) mehod. 4. Model and resul The resuls of Breiung (2000) panel uni roo es suggesed ha here are panel uni roo variables in model (see Table 1). Therefore, he auhors use Kao (1999) co-inegraion es o es wheher here is a long-run relaionship among variables or no. The resul of co-inegraion es shows ha here is long-run relaion among variables (see Table 2). Table 1 Breiung uni roo es Null hypohesis: uni roo -saisic Probabiliy lny lnk lnl lnfdi lntr D (lny) D (lnk) D (lnl) D (lnfdi) Dln (TR) Noe: Null hypohesis is rejeced a 5% significan level. 40

5 Table 2 Kao residual co-inegraion es Null hypohesis: no co-inegraion -saisic Probabiliy ADF Noe: Null hypohes is rejeced a 5% significan level. The esimaed model is: ln Y = c + α 1 ln K + α 2 ln L + α 3 ln FDI + α 4 ln TR + ε (3) Those variables are presened in secion2. Seleced mehod for esimaed model is fixed effec, because here is srucural variaion in economy of seleced counries ha lead o expecing ha he effecs of foreign direc invesmen and rade on growh are various. In his mehod, researchers can see he srucural variaion in differen economies and also hey can explain hese effecs on exogenous variables. Wih noice of consan coefficiens of fixed effec model, i is obvious ha differences beween he srucures of seleced counries exis. Therefore, o achieve growh, here are very obvious srucural differences. The esimaed coefficiens in Table 3 show ha capial invesmen ha peroxided by real gross fixed capial formaion has a very high significan impac on per capia GDP (economic growh) in se of seleced counries. A 1% increase in capial invesmen leads o approximaely 0.6% increase in per capia GDP in se of seleced counries. We can see ha he capial invesmen is imporan for economic growh and developmen of seleced counries. Table 3 Esimae of fixed effec model 1 Variables Coefficien -saisic Probabiliy C lnk lnl lnfdi lntr R-squared: F-saisic: The labor force variable is negaive and insignifican saisical effecs on per capia GDP of seleced counries, which shows ha hese economies are based on echnology. Also resuls indicae ha he number of labor force is no imporan facor for growh in hese counries. Also resuls indicae he decrease in he share of acive labor force on GDP of seleced counries. The coefficien of rade openness for hese counries is posiive and significan. The coefficien of rade openness invesigaes ha a 1% increase in rade openness leads o a 0.16% increase in per capia GDP of seleced counries. This coefficien sign shows ha increase in rade volume leads o economic growh in hese counries. Also resul suppors he posiive relaion beween foreign direc invesmen and economic growh in sum of seleced counries, and is coefficien is equal o 0.03, herefore a 1% increase in FDI leads o a 0.03% increase in economic growh in se of seleced counries. To coninue, he auhors esimae wo oher panel regression wih assuming ha rade openness and foreign direc invesmen variables have a special coefficien on each counries. Resuls of his esimae show ha he coefficiens of rade in Thailand, Philippine, Malaysia, Korea and China are equal o: 0.26, -0.78, -0.63, 0.36 and This resul indicaes ha he effec of rade on economic growh in Philippine and Malaysia is negaive. 41

6 Special coefficiens of foreign direc invesmen in Thailand, Philippine, Malaysia, Korea and China are equal o: 0.12, , , 0.08 and 0.11 (see Table 4). This resul shows ha he effec of foreign direc invesmen on economic growh of Philippine and Malaysia are negaive bu oher counries are posiive. Table 4 Esimaes of fixed effec model 2 and model 3 Model 2 Trade coefficiens Model 3 FDI coefficiens Counries Coefficien -saisic Counries Coefficien -saisic China China Korea Korea Malaysia Malaysia Philippines Philippines Thailand Thailand Also we can invesigae ha in Malaysia and Korea, oher facors ha affec growh and aren included in model are more han in oher counries, such as managemen, social developmen, poliics, culural, personal freedom ec, which exer heir effecs on consan coefficiens. 5. Conclusion This sudy uses panel co-inegraion echniques o examine he exisence of long-run relaionship among foreign direc invesmen, rade and economic growh in China, Korea, Malaysia, Philippines and Thailand. Panel co-inegraion es shows ha he variables of ineres pu in an aggregae producion funcion model are co-inegraed. The resuls indicae ha capial invesmen has grea impac on economic growh in seleced counries. We can gaher from he sudy ha labor force does no have significan effec on economic growh in seleced counries. According o resuls, rade openness effecs on growh imply ha rade liberalizaion of he economy is posiive in China, Korea, Thailand bu negaive in Malaysia and Philippines. Also he effecs of foreign direc invesmen on economic growh of seleced counries see he same sign wih rade effec resuls. Also, from he sudy, we can invesigae ha he effec of FDI on economic growh in China and Thailand is near ogeher, insead, he effec of rade on economic growh in China and Korea is higher han in oher counries and near ogeher. From he effec of gross fixed capial on economic growh, we can obain ha his coefficien is higher in China and Korea han in oher counries. References: Asiedu, E.. (2002). On he deerminans of foreign direc invesmen o developing counries: Is Africa differen? World Developmen, 30(1), Balasubramanyam, V. N., M. A. Salisu & D. Sapsford. (1996). Foreign direc invesmen and growh in EP and IS counries. The Economic Journal, 106(434), Bende-Nabende, A. & J. L Ford. (1998). FDI, policy adjusmen and endogenous growh: Muliplier effecs from a small dynamic model for Taiwan World Developmen, 26(7), Bhagwai, J. N.. (1978). Anaomy and consequences of exchange conrol regimes. In: Sudies in inernaional economic relaions. New York: Naional Bureau of Economic Research. Bhagwai, J. N.. (1985). Invesing abroad. In: V. N. Balasubramanyam (Ed.), Wriings on inernaional economics. Delhi: Oxford Universiy Press. Blomsrom, M., R. Lipsey & M. Zegan. (1994). Wha explains developing counry growh? (NBER working paper No. 4132). Naional Bureau for Economic Research, Cambridge, Massachuses. 42

7 Borenszein, E., J. D. Gregorio & J. W. Lee. (1998). How does foreign direc invesmen affec economic growh? Journal of Inernaional Economics, 45(1), Bornschier, V., & Chase-Dunn, C.. (1985). Transnaional corporaions and underdevelopmen. New York: Praeger. Brems, H.. (1970). A growh model of inernaional direc invesmen. American Economic Review, 60(3), De Gregorio, Jose. (2003). The role of foreign direc invesmen and naural resources in economic developmen. (Working paper No 196). Cenral Bank of Chile, Saniago. De Mello, L.. (1999). Foreign direc invesmen led growh: Evidence from ime series and panel daa. Oxford Economic Papers, 51(1), De Mello, L. R., Jr.. (1997). Foreign direc invesmen in developing counries and growh: A selecive survey. The Journal of Developmen Sudies, 34(1), 124. Herzer, D., D.. Nowak-Lehmann & B. Siliversovs. (2006). Expor-led growh in Chile: Assessing he role of expor composiion in produciviy growh. Developing Economies, 44(3), Kohpaiboon, A.. (2004). Foreign rade regime and FDI-growh nexus: A case sudy of Thailand. (Working paper). Ausralian Naional Universiy. Lipsey, R. E.. (2001). Foreign direc invesmen and he operaions of mulinaional firms: Conceps, hisory and daa. (NBER working paper No. 8665). Cambridge, MA: Naional Bureau of Economic Research. Lipsey, R. E.. (2000). Inward FDI and economic growh in developing counries. Transnaional Corporaions, 9(1), Pahlavani, M., E. Wilson & A. C. Worhingon. (2005). Trade-GDP nexus in Iran: An applicaion of he auoregressive disribued lag (ARDL) model. American Journal of Applied Sciences, 2(7), UNCTAD. (1999). Foreign direc invesmen in Africa: Performance and poenial. In: Unied naions publicaions. UNCTAD/ITE/IIT/Misc. 15, New York and Geneva: Unied Naions. Wacziarg, R.. (2001). Measuring he dynamic gains from rade. The World Bank Economic Review, 15(3), Xu, B.. (2000). Mulinaional enerprises, echnology diffusion and hos counry produciviy growh. Journal of Developmen Economics, 62(2), (Edied by Emma and Chris) (coninued from Page 21) When he decision maker acs raionally, he normaive approach is ofen considered superior o he descripive approach, because i is based on formal heories of raional decision making (Beroggi, 1999, p.50). In he auhor s opinion, when raionaliy of he decision makers can be expeced, he normaive approach o decision making would be preferred. References: Anderson, D. R., Sweeney, D. J., Williams, T. A. & Marin, K.. (2008). Quaniaive mehods for business. Mason: Thomson. Beroggi, G. E. G.. (1999). Decision modeling in policy managemen: An inroducion o he analyic conceps. Norwell, Massachuses: Kluwer Academic Publishers. Brown, R.. (2005). Raional choice and judgmen: Decision analysis for he decider. New York: J. Wiley and Sons. Clemen, R. T. (1991). Making hard decisions: An inroducion o decision analysis. Boson: PWS-Ken. Clemen, R. T. & Reilly, T.. (2001). Making hard decisions wih decision ools. Pacific Grove: Duxbury Thomson Learning. Keeney, R. L. & Raiffa, H.. (1976). Decisions wih muliple objecives. New York: J. Wiley and Sons. Raiffa, H.. (1968). Decision analysis: Inroducory lecures on choices under uncerainy. Massachuses: Addison-Wesley, Reading. Terek, M.. (2007). Analýza rozhodovania (Decision analysis). Braislava: Iura Ediion. Vincke, Ph. (1992). Mulicrieria decision-aid. New York: Wiley and Sons. (Edied by Ruby and Chris) 43

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