Foreign Direct Investment and Economic Growth

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nAbstract

nFDI is an important factor in the economy because it contributes in the provision of employment, technology, capital inflows, and improvement of productivity. Most of the previous pieces of scholarly evidence highlight a beneficial effect of FDI on the transformation of the GDP of various countries. It promotes the free movement of services, goods, and capital as well as the formulation of a proper environment for business. The recipient state is able to make or amend economic policies, which are more accountable and friendly to both the foreign and domestic investors. However, other studies suggest that FDI does not necessarily leads to expansion of the economic status. The research paper used secondary data to determine the effects of FDI on the recovery of the economy. From the econometric tests, it is evident that FDI is vital for the advancement of the GDP because it improves employment rate, interest rate and inflation rate in a given country, which is crucial in the progress of key sectors in the economy. Nonetheless, other variables of GDP affect the magnitude of positive effects.

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nIntroduction

nForeign direct investment (FDI) is an essential determinant in the world economy and the globalization. Most of the FDI involves multinational companies (MNCs) who set up businesses in the emerging countries. Globalization has enhanced economic activities between countries as multinational enterprises (MNEs) establish business in the emerging world (Herzer, 2012). Most developing nations have benefited from FDI. The issue of FDI and the recovery of the gross domestic income (GDP) are important because they produce both advantageous and adverse effects on economic transformation particularly in the developing countries. Therefore, it is imperative to analyse the kind of benefits that it can produce in the host nation (Olayiwola & Okodua, 2013). Firstly, it is a key driver of technological growth, employment opportunities, improvement of productivity, and eventually economic development. It has significant contribution in filling gaps of tax revenue, investment, foreign exchange, and the development in the both receiving and target nations. FDI can enhance progress of the industries of the host state either directly or indirectly via the introduction of technology, productivity efficiency, capital accumulation, and the launch of new procedures and methods (Young, Hood & Hamill, 2017).

nOn the other hand, although FDI has numerous advantages, the quality or level of benefits it generates in the host country is questionable especially in a developing GDP (Büthe & Milner, 2014). For instance, the proceeds generated by the multinational company are transferred to the home state or other overseas economies; hence, it does not promote long-term economic recovery (Dunning, 2013). FDI should play a part in development and investment in the host nation via various networks not just advancement of workers skills and technology transfer. Foreign direct investment (FDI) is a strategic driver for modernization, poverty alleviation, employment opportunities, and income growth. For this reason, majority of countries have formulated a wide range of policies aiming to entice inward FDI particularly through eliminating barriers of foreign investment, encouraging the financial sector growth, strengthening local economic regulations and policies, and generating reassuring business conditions for foreign investment (Hassen & Anis, 2012). Although most of the nations that recorded positive impacts owing to FDI, some studies have not found any relationship between the two factors. In fact, some of the lower income nations do not register economic growth resulting from foreign investments (Adeniyi, Omisakin, Egwaikhide & Oyinlola, 2012).

nLiterature Review

nEconomic theories

nThere is no universal theory of FDI that can expansively describe the existence of transnational corporations, FDI, and global production. The existing explanation on FDI and economy states that it was initiated following the end of Second World War or after the emergence of globalization across the globe (Young, Hood & Hamill, 2017). The rising significance of foreign investment and MNEs during the mid-1900s gave incentive to most researchers to determine the theories of MNEs and their behaviours and the presence of global production. Based on the capital-market approach, the imperative cause for capital flows are differentials of interest rate. The strategy suggests that capital have a tendency of flowing in the area with highest returns (Tan & Tang, 2016). However, this approach does not integrate the crucial differences between direct and portfolio investment.

nSecondly, the idea of ownership advantage suggests that MNCs must have company-specific strengths such as superior economies of scale, managerial skills, brand name, and technology. Nevertheless, this tactic does not specifically explain the concept of FDI and economy (Büthe & Milner, 2014). Furthermore, the product life cycle theory states that companies establish new facilities of production for items that have been matured and standardized in their original or home markets. According to Saqib, Masnoon & Rafique, (2013) foreign investors are normally pursuing natural resource in these countries, in order to establish the strategic asset or markets (Saqib, Masnoon & Rafique, 2013).

nEmpirical studies

nVarious scholars have examined the impacts of FDI on the advancement of the GDP of various third world economies across the world. Most of them concur that FDI is a strategic determinant, which fuels the growth of economic parameters. Dunning, (2013) established that FDI is a fundamental source of employment opportunities for a wide range of individuals in the GDP. In fact, investors who have set up businesses in the overseas state help in the development of the country via the creation of direct job opportunities for the entire population (Dunning, 2013). Similarly, Alfaro & Charlton, (2013) confirmed this finding arguing the most evolving economies have a higher rate of unemployment hence FDI provides an avenue of reducing this rate, which spur improvement of an economy. The number of employment opportunities offered by FDI has been rising progressively in the past decade across the globe (Alfaro & Charlton, 2013).

nNonetheless, Holmes Jr. et al., (2013) noted that in the emerging nations, the kinds of jobs established by FDI are of low level hence the locals do not benefit from higher income. The scholars claimed that human capital is essential for the expansion process of any economy (Holmes Jr. et al., 2013). Therefore, if human capital receives lower wages as it happens in the emerging nations, then there is significant negative impact owing to FDI happening in the host countries. Likewise, Young, Hood & Hamill, (2017) argued that employment boost the peoples purchasing power which enables the advancement of the economy (Young, Hood & Hamill, 2017).

nA research by Gui-Diby, (2014), suggested that FDI is of beneficial effect during the time of extreme economic crisis. In this case, foreign investment acts as the most dependable and practical foundation of inflow for the growing GDP (Gui-Diby, 2014). Free movement of capital is preferred because of the idea that it permits capital flow in an economy to realize the highest rate of returns. Olayiwola & Okodua, (2013) agree with the results of this study as he argues that FDI promotes the establishment of new national and local markets, which implies that it incorporates and enhances policies that facilitate the elimination of trade barriers. Consequently, the researchers contended that it promotes the free movement of services, goods, and capital as well as the formulation of a proper environment for business (Olayiwola & Okodua, 2013).

nMoreover, a research by Büthe & Milner, (2014) highlighted that FDI allows and encourages transfer and flow of modern technology in the recipient land particularly in relation to capital inputs. Such technologies could not be accomplished by strengthening the trade or financial investment in services and goods (Büthe & Milner, 2014). Additionally, Saqib, Masnoon & Rafique, (2013) also confirms that FDI is a crucial factor in the rise of not only machines but also technical expertise and experience to manufacture and operate useful technology in the host nation. Similarly, it provides an opportunity for employees to acquire vital training in the course of operating new machines or running a business (Saqib, Masnoon & Rafique, 2013). In this regard, Jadhav, (2012) suggested employee training is useful in the GDP because it enables human capital development to the host land (Jadhav, 2012).

nFurthermore, Almfraji & Almsafir, (2014) asserted that FDI plays critical part in the local economy because it stimulates competition in the host input market. Notably, the government raises corporate revenue through taxes from FDI, which are used for economic activities (Almfraji & Almsafir, 2014). According to Tan & Tang, (2016), FDI is a way by which hostile terms of business can be reviewed and handled. The researchers emphasized that it also offers an opportunity for the recipient country acquire foreign exchange from the exported goods. For instance, a number of MNCs set up industrial companies in areas with cheaper cost of raw materials. In so doing, they improve the value of goods, which are exported hence fetching foreign exchange (Tan & Tang, 2016). Moreover, according to Alfaro & Charlton, (2013), FDI has a capacity to help in the improvement of the entire environment and the general public atmosphere of host nations. In this respect, the study established that the introduction of better and safer knowledge and tools in the economy is of significant importance. Additionally, the recipient country is able to make or amend economic policies, which are more accountable and friendly to both the foreign and domestic investors (Alfaro & Charlton, 2013). Therefore, pursuant to these arguments, most of the researchers have encouraged FDI in their home nations.

nNumerous pieces of scholarly evidence have revealed out that FDI is also an important source of long-lasting external financing instead of over-reliance of loans from global financial institutions. Dunning, (2013) argued that through foreign income, the FDI can minimize the gaps between costs and revenues; hence, host state can ensure that production costs are lower to improve its competitiveness (Dunning, 2013). A study by Acaravci & Ozturk, (2012) noted that foreign direct investment is economically viable to evolving economies because it boosts the opening of new domestic market. Therefore, it promotes and integrates regulations that generate the deletion of trade barriers thus encouraging free flow and exchange of services, goods, and capital (Acaravci & Ozturk, 2012). Moreover, Melnyk, Kubatko, & Pysarenko, (2014) argued it also becomes a driver for the formulation of appropriate domestic for trade in the local market. The study also found out that FDI emboldens the transfer and flow of modern technology in the developing nations particularly through capital inputs, which cannot be accomplished by strengthening trade or financial investment in services and goods (Melnyk, Kubatko, & Pysarenko, 2014).

nOn the contrary, some scholars have argued that FDI is associated with negative effects in the economy. The FDI comes with some effects, which are often overlooked. Sothan, (2017) noted that the benefits of FDI in the economy are not the same in all the nations but they differ depending on the societies and localities. The study also pointed out that most of the disadvantages associated with foreign direct investment occur in the third world states as opposed to the affluent countries (Sothan, 2017). For this reasons, the impacts tend to be disregarded.

nYoung, Hood & Hamill, (2017) revealed out that FDI is a big barrier to the type of investment which occur domestically since when a Multinational Company utilizes its own resources and capital in the host nation, the local firms are adversely affected. The researcher contended that most of the firms in the emerging economies are in their emerging stage and lacks the capacity to compete with the MNCs. Furthermore, the customers may have no or little attention because of the perception that foreign companies offer quality services or products (Young, Hood & Hamill, 2017). Consequently, the third world may in the long-term have little domestic or internal investment because FDI pays close attention to the external market as opposed to the internal ones.

nTan & Tang, (2016), claimed that FDI is associated with other hazardous circumstances like when in most cases, transnational companies are likely to be interested in engaging in the internal matters of the host nation especially if the country is struggling to protect the welfares of its people. The study implied that in most cases the transnational companies engage in politics of the host country in order to influence the decision-making process or policy formulation (Tan & Tang, 2016).

nAdditionally, the researchers noted that the MNCs attempts to campaign for persons who address their needs in the economic policies. In this respect, they contribute in the elimination of government officials who oppose their economic activities and fix persons who support their actions. Alfaro & Charlton, (2013) reasoned that a third world economy, which desires to take advantage of FDI, is required to initially elevate its economic condition into a lasting position of an emerging country. In this regard, they fear that the state may experience a misunderstanding with transnational corporation, which might claim that the country does not exhibit adequate compliance (Alfaro & Charlton, 2013). However, Olayiwola & Okodua, (2013) opine that MNCs and FDI are not a bad concept because they are likely to cooperate with their matches in regards to economic stability (Olayiwola & Okodua, 2013).

nMeanwhile, the majority of MNCs normally intends to work with countries that are experiencing less state of volatility in their capital markets. Additionally, Saqib, Masnoon & Rafique, (2013) noted FDI may not motivate improvement or growth of manufacturing industries in the host nation. In fact, the transnational firms introduce equipment and technologies, which operate at certain time without advancement or renewal (Saqib, Masnoon & Rafique, 2013). Moreover, Jadhav, (2012) highlighted that in emerging economies, FDI tends to focus on extractive sectors such as mining as opposed to productive industries, development, and expansion of the infrastructural and manufacturing segments. In so doing, the FDI may not guarantee adequate development that can offer sustainability of the economy in the emerging country (Jadhav, 2012).

nAccording to Büthe & Milner, (2014), the existence of the transnational corporations may have detrimental effects on the existing generative process in the host countries. Furthermore, most of the foreign investments tend to offer lower cadre jobs to the local people while the expatriates benefit from executive positions hence obtain better salaries (Büthe & Milner, 2014). In the meantime, Tan & Tang, (2016) reasoned that countries having monetary assets that are sold in global markets their domestic monetary markets are likely to be vulnerable to financial pollution (Tan & Tang, 2016).

nEconomic theory underlying the topic, the hypothesis, analytical/empirical/econometric methodology

nEconomic theory

nBased on the contemporary theories of FDI and improvement of the economy, which utilizes general equilibrium Version, imperfect competition, rising returns to scales, and MNEs company-specific strengths are fundamentally founded on capital-knowledge involving intangible assets such as brand name, trademarks, human capital, and patents (Sothan, 2017). Licensing raises the danger of the transnational company losing the company-specific benefits hence MNE selects internalize and pick foreign direct investment. The dependence of knowledge capital among the MNC offers powerful incentive for adopting ownership-precise benefits leading to huge numbers of FDI (Alfaro & Charlton, 2013). The theory of proximity-concentration trade-off suggests that transnational companies equate corporate cost to the expenses of producing at various regions across the globe. In case the trade cost is larger than the production cost, MNE venture in the FDI that sustain the Horizontal FDI. In this respect, the transnational companies utilize variations in factor costs in various geographical areas, which result to Vertical FDI. Platform-export FDI occurs when an international company produces goods in a recipient economy but they are sold in other markets and not in the host or parent markets (Tan & Tang, 2016).

nThe hypothesis

nEmerging countries are more likely to realize benefits of foreign direct investment in terms of GDP growth. Countries that have eliminated barriers to foreign investment and have strong local economic policies are in a better position to achieve higher economic development from foreign direct investment (Herzer, 2012). Furthermore, the third world nations that have generated attractive business conditions for foreign investment are expected to achieve positive impacts of FDI in the GDP in areas such as inflation rate, interest rate, and employment rate (Sothan, 2017).

nEconometric Methodology

nThe study adopted the analytical model, which played a major part in the analysis of data to generate the study findings. Precisely, the research used econometric model such as the multiple linear regression model. The model was important because it enabled analysis of various variables, which determine the effectiveness of FDI in realizing economic transformation across the group. It also enabled the determination of the relationship between independent variable and dependent variables. In this regard, the following formula was used

nY=α+β1X1 + β2X2 + β3X3 + β4X4+ε

nY refers to the random or response/dependent variable while X is an independent/fixed variable. In particular, Y represented the growth of the economy, which is assessed through the Gross Domestic Product (GDP). The FDI inflow was determined through the real interest rate, exchange rate, and inflation rate.

nX1 = Foreign Direct Investment = Log [short term capital + long term capital + equity capital]

nX2 = rate of inflation = ([old Consumer Price Index – current CPI) divided by old CPI]*100)

nX3 = Human capital (employment)

nX4 = rate of interest = (A/P) 1/t -1

nε = error term

nβ= independent variable coefficient

nα= constant

nThe multiple linear regression models were utilized to calculate the effect of independent variable in influencing the economic transformation of developing countries, which was assessed using GDP. In addition, the outcomes were also subjected to t-statistical analysis in order to assess whether they were statistically significant at 0.05 levels. The level of significance was measured through the t-value, which demonstrated how the standard error diverges from the tried value. The multiple linear regression models helped to assess the effects of FDI on the GDP of emerging economies.

nDetailed explanation of the data sources and data used

nThe research used secondary data acquired from the reputable international institution. Data were obtained from 50 emerging economies across the globe from 1986 to 2016. The study only used data whose viability has been verified through the World Bank (Sothan, 2017). In order to enhance the scope, this research incorporated FDI, investment, and manufacturing as the vehicles of growth in the economy. More importantly, the dependent variable of this study was economic growth, which is reflected by the real GDP per capita. The sources of data included UNCTAD. The agency issues most of the monetary reports annually (Tan & Tang, 2016). The data obtained from this agency are reliable since types of studies have utilized the reports issued by this institution. The GDP was assessed through variables such as interest rates, unemployment rate, inflation rates and FDI, which were obtained from UNCTAD and World Bank databases.

nPresentation of results

nAccording to Abbes et al., (2015), the transformation of the economy is an improvement of consumption and production of services and goods. In addition, it encompasses rise in per capita consumption and population (Abbes et al., 2015). The results of the study on employment rate, interest rate, inflation rate, FDI and GDP are presented in Table 1

nIn terms of the trend of GDP values over the 30-year period, the results of the study noted that lowest value was US $10.5 billion in the year 1993. However, the highest GDP value was US $55.3 billion in the year 2014. Therefore, in the given period, it demonstrated a positive change in the values of GDP of US $ 44.8 billion over the 30-year period. The stable rise in the values of GDP portrays a growth of the economy in the emerging countries, which has taken place in the past three decades.

nMoreover, the table also highlighted the inclination of FDI values over the similar period. The lowest FDI value was US $11.3 million in 2000 while the largest FDI value was US $975.0 million in the year 2014. The results represent falling and rising levels of FDI within the given period. On the other hand, the study noted high values of standard deviation, which suggest the variations in the annual values of FDI across the countries over the 30-year period. More importantly, most countries had higher values of FDI in the last decade (2007-2016) as compared to the first two decades (1986-2006).

nIn terms of the average inflation rate over the 30-year period, there was fluctuation of values. The lowest level of inflation was 3.97% in the year 1995. On the other hand, the highest rate of inflation was approximately 42% in 2008. Therefore, the results demonstrate the falling and rising inflation rates with substantial annual changes over the 30-year period.

nThe study also noted the trend of unemployment rate over the given period in the 50 emerging countries. The lowest level of interest rate was recorded in the year 1989, which was at 13.5% while the highest rate of interest rate was witnessed in 2008 at 34.7%. Importantly, the study results indicated that there was overall increase in the rate of unemployment in the countries over the 30 years period. Concerning unemployment, the lowest level was 6.42 % while the highest was 12.03%.

nInferential statistics

nThrough the multiple regression analysis, the relationship between growth of the economy and FDI was assessed as presented in Table 2

nThe dependent variable was the GDP, which represented the improvement of the economy while the constant variables include the interest rate, the unemployment rate, inflation rate, and FDI. The determination of coefficient describe the level to which variations in the dependent variable can be described by the alterations in the independent variables (GDP) which is described by all the four constants (independent variables).

nThe independent variables, which were examined, represented a variance of 63.84% in the improvement of the economy in the emerging countries as illustrated by the r2. Therefore, it implies that other aspects, which were not included in this study, contributed to 36.16% of variance, which may have affected the GDP.

nIn Table 3, the Analysis of variance was calculated to deliver information regarding the variability level within the regression analysis. It was used to determine the significance level. The “F” offered a value of hypothesis testing against the null hypothesis. Based on this analysis, 0.04 was the value of significance, which indicated that the model was statistically significant in forecasting how interest rate, exchange rate, inflation rate and FDI influence the GDP of different countries. The F value of this study was 8.52, which indicated that the model was statistically significant.

nY= α + β1X1 + β2X2 + β3X3 + ε

nY = 4.678+0.817X1+0.691X2+0.981X3+0.316X4+ε

nY=GDP while X1, X2, X3, and X4, are variables of FDI, rate of inflation, unemployment and interest rates.

nBased on the equation when all the constant of all the variables (interest rate, unemployment, inflation rate and FDI) the resultant product will be 4.678 (GDP). The results of the study demonstrated that a unit rise in FDI would contribute to an increase of 0.817 in GDP while that of inflation rate would help to an increase of 0.691in GDP. Similarly, a unit rise in the interest rate can assist in improvement of 0.316 in the economy. Furthermore, it helps reduce the rate of unemployment by 0.981 in the economy. At 95% confidence level and 5% significance level, the FDI, inflation rate, unemployment rate, and interest rate had a significance level of 0.09, 0.017, 0.019 and 0.031 respectively.

nDiscussion of results

nThe results of this study imply that FDI plays a great part in stimulating the lasting transformation of the economy of different nations. The findings of this study are consistent with various researches by (Long, Yang & Zhang, 2015; Abbes et al., 2015; Faruk, 2015; Jude & Levieuge, 2015). The study offers robust information on the causative effect of FDI on the rise of a GDP various countries. Nonetheless, some empirical results vary with the findings of this paper. For instance, a study by (Fadhil & Almsafir, 2015; Mohamed, Singh & Liew, 2017; Nwaogu & Ryan, 2015), suggest that the FDI does not necessarily lead to the development of the economy because of different factors. Therefore, it means that the results on the causal effects on foreign direct investment on the recovery of the GDP remain a controversial issue. A few studies utilize manufacturing as a variable to assess the effects of FDI on development of the economy. The findings of this study indicated that FDI has a causative outcome on the advancement of an interest rate and employment rate as well as reduction of inflation rate of a given country. The results are similar with Stanisic, (2015) study that noted that FDI focused on industrial sector leads to higher rate of advancement of the GDP. The study robustly validates the crucial part that FDI plays in the human capital development and employment of various economies. Other studies such as (Azam & Ahmed, 2015; Long, Yang & Zhang, 2015) support this view.

nConclusion

nA wide range of literature has scrutinized the effect of FDI on the transformation of the economy in different countries across the globe. A number of studies point out that there is a positive association between improvement of the GDP and FDI (Büthe & Milner, 2014). Nonetheless, some experimental researches do not concur with the association between the rise of economy and FDI. Therefore, the research paper was performed with trying to understand the causal relationship (Young, Hood & Hamill, 2017). According to the findings of this research, the FDI improves the advancement of the GDP of various economies across the globe by expanding the physical capital, which is required in the nation. Nevertheless,, the other variables in the GDP of the country seems to influence the level of advancement of the financial environment after FDI. Therefore, the findings provide a number of essential policy implications (Holmes Jr, Miller, Hitt & Salmador, 2013). For instance, states must initiate proper domestic policies to provide conducive atmosphere for FDI, which can stimulate a significant rise in the economic status in the country. Therefore, economic policies should be geared towards achieve proper conditions for FDI in the country (Almfraji & Almsafir, 2014). Finally, all developing nations should emphasize on the manufacturing FDI because it would raise the capital inflows, facilitate transfer of technology, and create employment.

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nReferences

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