Group 10 - The impact of FDI on economic growth of 9 SEA countries - Thao Luong PDF

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FOREIGN TRADE UNIVERSITYSCHOOL OF INTERNATIONAL BUSINESS ECONOMICSMIDTERM PROJECTTHE IMPACT OF FDI ON ECONOMIC GROWTH OFNINE SOUTH-EAST ASIAN COUNTRIESCourse: Development Economics Lecturer: Nguyễn Thị Hải Yến Class: CTTTKT K Group: 10Hanoi, May 2021Member list Nguyen Thi Tuong Van Name Student ID N...

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FOREIGN TRADE UNIVERSITY SCHOOL OF INTERNATIONAL BUSINESS ECONOMICS

MIDTERM PROJECT THE IMPACT OF FDI ON ECONOMIC GROWTH OF NINE SOUTH-EAST ASIAN COUNTRIES

Course:

Development Economics

Lecturer:

Nguyễn Thị Hải Yến

Class:

CTTTKT K57

Group:

10

Hanoi, May 2021

Member list

Name

Student ID

Nguyen Thi Tuong Van

1811140106

Nguyen Kim Huong

1810140027

Nguyen Thi Quynh Hoa

1811140080

Nguyen Truc Quynh

1810140057

Nguyen Thu Huyen

1810140030

Luong Thu Hien

1811140077

Nguyen Thi Thanh Huyen

1810140029

Luong Thu Thao

1810140061

Nguyen Hien Thao Chi

1811140071

Nguyen Duy Anh

1810140003

Table of Contents Chapter 1: Introduction

1

Chapter 2: Theoretical framework

5

2.1. Theories explain FDI under the framework of international trade theories

5

2.1.1. Product life cycle theory (Vernon, 1966, 1971; Wells, 1968)

5

2.1.2. Macroeconomic approach (Kojima, 1973)

5

2.2. Theories explain FDI under the framework of firm and industrial organization (IO) literature theories 2.2.1. Market imperfections theory (Hymer, 1970)

6 6

2.2.2. The Internalization Theory (Buckley and Casson, 1976; Swedenborg, 1980)6 2.2.3. The Eclectic theory of FDI (Dunning 1977, 1988, Dunning and McQueen, 1981). Chapter 3: Literature review 3.1. Literature review of factors affecting economic growth worldwide

7 8 8

3.2. Literature review of factors’ effects on South East Asia’s economic growth 11 3.3. Gap in the literature

14

3.4. Research question

14

3.5. Hypothesis

15

Chapter 4: Methodology 4.1. Variables description

16 16

4.1.1. Dependent variables

16

4.1.2. Independent variables

16

4.2. Research design

18

4.3. Data collection

18

5.1. Empirical results

19

5.1.1. Hausman test

19

5.1.2. Fixed effects model

20

5.2. Discussion

22

5.2.1. Meaning of the empirical results

22

5.2.2. Suggestions to boost economic growth rate in southeast asian countries

24

5.2.3. Vietnam: how to increase the growth rate and strategies to apply in the context of Covid-19 pandemic Chapter 6: Conclusion and recommendations

25 28

6.1. Conclusion

28

6.2. Recommendations

28

References

31

Lists of figures Figure 1. Hausman test

19

Figure 2. Fixed effects model

21 Chapter 1: Introduction

Foreign direct investment (FDI) is generally recognized as a powerful catalyst to stimulate economic growth, especially in developing countries. Thanks to FDI, capital-poor countries can possess employment opportunities and build up physical capital. It provides local labor forces the chance to enhance their working skills through transfer of technology from developed countries (Makki and Somwaru, 2004). Most importantly, economic restructuring and export-market expansion can also be supplemented by FDI, thus domestic economies could be further integrated in the global economy. However, numerous researches have shown mixed results about the relationship between FDI and economic growth. Following recent critiques of the conventional presumption of a one-way causal relation between FDI and growth (Kholdy, 1995), new studies have looked into the probability of a two-way (bidirectional) or non-existent causality between variables of interest. To put it another way, not only can FDI influence GDP growth (both positively and negatively), but GDP growth may also influence FDI inflows, or there could be no causal correlation at all. Some have seen the positive linkage between FDI and economic growth in Southeast Asia. For instance, Zhao and Jiang (2007) stated that the economic growth in China accelerated rapidly, along with the presence of foreign investment ever since the introduction of new trade policy. In Malaysia, FDI is believed to have contributed 17% of the country’s economic growth (Mun et al., 2008). On the contrary, when reviewing literature which included 880 regression estimates of the impact of FDI on economic growth, Iamsiraroj and Ulubaşoğlu (2015) found out that roughly 17% of 108

published papers reported a negative relationship between FDI and economic growth. Bruno, Campos, and Estrin (2017), on investigating 175 studies conducted on Eastern European, Asian, Latin American, and African data over the period 1940 to 2008, also concluded that 11% of 1100 macro (economy wide) estimates on the economic growth – FDI association were negative. Many factors, such as level of human capital and local productivity, domestic investment, infrastructure, or macroeconomic stability, lead to such heterogeneous results. Therefore, it is challenging to isolate and assess the impact of FDI on its own. In many cases, because of those factors, results even show no existence of FDI-led economic growth. Since the Association of Southeast Asian Nations (ASEAN) was born on August 8, 1967, it has been developing and growing. Starting with 5 nations, ASEAN is now consists of 10 members: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. In 1992, The ASEAN Free Trade Area (AFTA) was signed to increase ASEAN’s competitive edge by eliminating tariffs and non-tariff barriers within ASEAN members. The full regional economic integration was set on December 31, 2015, to establish the ASEAN Economic Community (AEC). One of the primary goals of AFTA is to attract more multinational enterprises (MNEs) to have foreign direct investment (FDI) in the ASEAN area. Normally, among ASEAN countries, Singapore always received the highest amount of FDI net inflows, with more than 50 percent of the total. The FDI net inflows into Singapore increased from $53,547.0 million to $72,098.3 million in 2014. The main destination of those FDI net inflows is the financial sector, which is quite different from other countries, such as ASEAN 5 countries, where the main use of FDI inflows is manufacturing. Further, Brunei, Cambodia, Laos, and Myanmar attracted only a small percentage of total FDI net inflows.

However, Singapore's leading FDI decline was gentler than the global contraction of 42 per cent to US$859 billion, from US$1.5 trillion in 2019. The collapse left FDI flows more than 30 per cent beneath the trough that followed the global financial crisis in 2009. Within Asean, Malaysia experienced the steepest decline, with FDI plunging by 68 per cent to US$2.5 billion. FDI fell in Thailand by 50 per cent to US$1.5 billion, in Indonesia by 24 per cent to US$18 billion, and in Vietnam by 10 per cent to US$14 billion. The Philippines bucked the trend; its FDI flows rose by 29 per cent to US$6.4 billion. Nevertheless, the report said the strength of South-east Asia as an FDI engine remained evident. South-East Asia registered over US$70 billion in new greenfield investment projects last year, the largest volume among developing regions. This was a more moderate contraction in announced greenfield investments (-14 per cent) than in other developing regions. Especially in the case of Vietnam, since the global economic recession in 2008, FDI net inflows % of GDP sank to a low for the following three years. The rate still declined during the 2011-2014 period, albeit more slowly than during the previous three years. Specifically, in 2014, the figure fell back to its 1992 level at 4.8%. Accordingly, GDP growth rate fluctuated around 5.8% for the 2008-2014 period. As the recession is over, from 2014 to 2018, a recovery in FDI net inflow % of GDP (from 4.8% to 6.3%) has resulted in a recovery in GDP growth rate (from 5.9% to 6.8%) (World Bank, 2018). Generally speaking, thanks to the 1987 Law on Foreign Investment, Vietnamese investment environment has gained more interest from foreign investors. FDI inflows arrived from over 100 nations and territories and contributed 19% to the GDP, 19% to domestic budget revenue, over 55% to industrial output value, and 70% to total export turnover in 2017 (Huong, 2017). Thus, it is widely believed that FDI is one of the crucial factors in stimulating Vietnam’s economic growth.

This research will investigate the causality between FDI and economic growth in 9 South-East Asian countries, using ordinary least squares regression. The dependent variable is GDP growth rate, representing economic growth. The independent variables are FDI net inflows, FDI net inflows % of GDP, market size, gross capital formation and openness to trade. Multiple tests were conducted, including the ADF Fisher Unit Root test, Johansen test, OLS test, Heteroscedasticity test, Normality test, and Granger causality test. After selected theories of FDI are presented, other researches on the same topic would be considered. The methodology would present the variables used, hypothesis, research design and how data is collected. Test outcomes and analysis are in the empirical results and discussion part. Given the current world situation being heavily affected by the COVID-19 pandemic, the results were applied to assess the current situation regarding FDI and give predictions. The conclusion is presented last, which includes limitations, suggestions for further research on the topic and policy recommendations.

Chapter 2: Theoretical framework 2.1. Theories explain FDI under the framework of international trade theories 2.1.1. Product life cycle theory (Vernon, 1966, 1971; Wells, 1968) i. Theoretical emphasis: a country’s export strength builds; foreign production starts; foreign production becomes competitive in export markets; import competition emerges in the country’s home market (Vernon, 1966, 1971; Wells, 1968) ii. FDI linkage: This theory provided a linkage between FDI and international trade. One of the key issues regarding FDI is the reasons why firms prefer investing abroad over exporting. As the theory suggested, if the costs of exporting and foreign-market catering are more than those of locating and producing overseas, FDI is justified. It also mentioned the significance of specific host-country factors, such as cheap labor, in determining FDI. iii. Limitations: It could not explain the sources of ownership advantages for foreign firms. Additionally, Buckley and Casson (1976) argued that the theory cannot account for non-export substituting FDI and the tendency of producing non-standardized products aboard. 2.1.2. Macroeconomic approach (Kojima, 1973) i. Theoretical emphasis: FDI’s flow could be attributed to the comparative disadvantages of the home countries and the potential advantages of the host countries, respectively. This theory places FDI in changing economic contexts and points out its future trends. ii. FDI linkage: The theory emphasized that FDI should be trade-oriented and be subordinate to the free trade policy, not reversely. When assessing FDI, it is essential to look at the present technology in the receiving country, consider the monopolistic element, and the internationalization of production and marketing to make use of

economies of scale. Kojima (1973) criticized the usage of trade barriers and stressed on agreed international specialization. 2.2. Theories explain FDI under the framework of firm and industrial organization (IO) literature theories 2.2.1. Market imperfections theory (Hymer, 1970) i. Theoretical emphasis: Firms’ strategy to seek market opportunities is designed on the ground that investing overseas is ideal since they possess certain capabilities that foreigner competitors don’t. (Hymer, 1970). Thus, firms have proprietary control in the international markets to enjoy oligopolistic market power. ii. FDI linkage: Considering FDI as an outcome of international market imperfections, the theory pointed out the obtainable benefits of exploiting oligopolistic advantages as the driving forces behind FDI. The Multinational Enterprises (MNE) appears due to the market imperfections that led to a divergence from perfect competition in the final product market. FDI is a firm-level strategy decision rather than a capital-market financial decision. iii. Limitations: The market imperfection theory lacked justification for the reasons behind firms’ decision to produce overseas, as against options like producing at home and exporting, or licensing production to local agents in foreign countries. 2.2.2. The Internalization Theory (Buckley and Casson, 1976; Swedenborg, 1980) i. Theoretical emphasis: Since the transaction costs involved in trading through external markets are too much to bear, firms are better off to take ownership advantages through internal networks by establishing local production facilities. This theory suggested that firms will exploit their advantages through FDI, rather than through alternative market-based arrangements.

ii. FDI linkage: The theory provided explanations for FDI by identifying circumstances in which internalizing operations are preferable to external arm's-length arrangements like licensing. Given the imperfect market’s advantages, internalizing production across national borders by undertaking FDI appears to be a logical strategy for multinational corporations (MNE) 2.2.3. The Eclectic theory of FDI (Dunning 1977, 1988, Dunning and McQueen, 1981). i. Theoretical emphasis: This theory is a mix of three different theories of FDI (O-L-I). O (Ownership): Firms with exclusive possession of intangible assets have chances to surpass local firms in doing business abroad. L (Location): Foreign markets should offer some location advantages, which make foreign production more profitable than producing at home and exporting abroad. I (Internalization): There must be some internalization advantages that encourage firms to transact their intangible assets through internal organizational networks, rather than through the market. ii. FDI linkage: This theory suggested that determinants of FDI can be grouped into supply-side factors (O and I advantages) and demand-side factors (L advantages). Thus, attractiveness to FDI varies considerably between nations.

Chapter 3: Literature review 3.1. Literature review of factors affecting economic growth worldwide Foreign Direct Investment (FDI) has been considered a crucial factor in economic growth across countries. However, the existing research has generated mixed results. This inconsistency has been seen in numerous studies using both large cross-country samples and small single-country samples over the last decades. Makki and Somwaru (2004) looked at 66 developing countries over three decades and found out that FDI and trade accounted for economic growth in all those countries. They suggested that governments of those countries should implement policies that further promote FDI and trade. With a model based on endogenous growth theory, they assessed empirically the effects of FDI and trade on economic growth using FDI, trade, human capital, domestic investments, initial GDP per capita, inflation rate, tax rate, and government consumption as IVs. Meanwhile, Wang's research (2009) has come up with ambiguous results about the use of total FDI, which was attributed to the differences in sector-level FDI inflows. Nevertheless, he believed that analyzing the FDI of different sectors (manufacturing and nonmanufacturing) provided a better assessment of FDI's impact on economic growth. To study 12 Asian economies from 1987 to 1997, Wang used an endogenous growth model with five IVs, namely FDI, domestic investment, human capital, labor force, and initial GDP. He concluded that manufacturing FDI was the most influential in increasing the country's economic growth. Herzer (2012) presented contradictory results to those above. With data from 44 developing countries from 1970 to 2005, Herzer found that the effect of FDI is negative on average. It was his use of panel cointegration with four main variables (general level of development, trade openness, human capital, and development of local financial markets) that showed such different results compared to others.

However, it’s important to note that the differences between each country in the study were substantial. To analyze FDI's impact on economic growth in specific countries, many studies used regression models. In Malaysia's case, Omer and Yao (2011) used data over a period of 39 years from 1970 to 2008 and proved that, in the long term, inward FDI and economic cycles could be Granger Causally related. With further studies from VAR model, they concluded that it has a fast effect on the Malaysian economy. Shaari, Hong & Shukeri (2012) used VAR model with cointegration technique to examine the relationship of FDI on real GDP and thus concluded FDI's substantial impact on economic growth. In Anwar’s and Nguyen’s study (2010) of Vietnam's case, the chosen determinants of FDI were market size, infrastructure development, labor market, and level of openness. Like Omer and Yao (2011), they found out that GDP has a granger cause to FDI, and vice versa using annual data from 1971 to 2010. A similar conclusion was drawn from the case of Romania during the 1990-2011 period. Nistor (2014) used foreign direct investment inflows (FDI), government expenditure (GE), and gross fixed capital formation as the central IVs and found out that FDI inflows positively impacted GDP, and thus, economic growth. On the other hand, as mentioned above, Herzer (2012) reported a negative correlation between FDI and growth, but the result varies widely among countries studied. Dinh et al. (2019) also were cynical about the results of other studies in which FDI is reported to have a positive impact on GDP growth rate. They studied that relationship in 30 developing countries over the 2000–2014 period. They believed that foreign capital flows, endogenous financial development, domestic financial development, domestic capital reserve, and human capital are the ideal independent variables to examine the impact of FDI on economic growth. After studying numerous panel data sets, they concluded that FDI had no statistically significant long-run effect on GDP. The sample provided no long-run positive and unidirectional impact of FDI on GDP anywhere.

This result is explained by the long-run FDI-GDP relationship depending on characteristics of the investment resulting from FDI, such as type, sector, scope, duration, and the proportion of domestic businesses in the industry. For some countries, there was even strong evidence of FDI limiting growth in the long and short term. Moreover, the differences in the effect of FDI cross-country could not be explained by geography, which suggests further research on each country's particular case. It is necessary to look at the linkage between FDI-related variables and GDP growth rate before further research is conducted. Urgaia (2017) studied the panel data of FDI and GDP growth rates in seven East African countries, then concluded that there existed bi-directional inter-temporal causal relationships between them in the short, medium, and long terms. Employing the time scaling wavelet decomposition in the framework of dynamic panel ARDL, he concluded that factors affecting the domestic economic sector are mainly FDI net inflow, index of openness, terms of trade, and official exchange rates. In general, the combined mean coefficients also witnessed an increase over time scaling horizons. Basu and Guariglia (2007) also found out that FDI facilitates GDP growth. Furthermore, their empirical results ...