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 economy 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 nation 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 economy. 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 essential for the advancement of the economy because it provides adequate capital, which is essential in the progress of key sectors in the economy. Nonetheless, the existing regulatory framework affects 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 developing countries. The issue of FDI and the recovery of the economy is important because it produces both advantageous and adverse effects on economic transformation particularly in the developing countries. Therefore, it is imperative to analyze 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 economy of the host nation 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 nation is questionable especially in a developing economy (Büthe & Milner, 2014). For instance, the proceeds generated by the multinational company are transferred to the home nation 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.

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 approach 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. However, this approach 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 investment are normally seeking or natural resource, the strategic asset, efficiency or markets (Saqib, Masnoon & Rafique, 2013).

nEmpirical studies

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

nHowever, Holmes Jr. et al., (2013) noted that in the developing nation, 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 development process of any economy (Holmes Jr. et al., 2013). Therefore, if human capital receives lower wages as it occur in the developing nations, and 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 economy (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 argued 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 nation particularly in relation to capital inputs. Such technologies could otherwise not be accomplished by strengthening the trade or financial investment in services and goods (Büthe & Milner, 2014). Additionally, Saqib, Masnoon & Rafique, (2013) study 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 economy because it enables human capital development to the host nation (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 manufacturing 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 nation 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 nation can ensure that production costs are lower to improve its competitiveness (Dunning, 2013).

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 developing world 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 developing countries 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 developing country 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, for 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 developing countries, 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 and whose 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 transnationals 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 case 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

nDeveloping countries with encouraging the financial sector growth are more likely to realize benefits of foreign direct investment. In addition, 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, developing nations that have generated attractive business conditions for foreign investment are expected to achieve positive impacts of FDI (Sothan, 2017).

nEconometric methodology

nThe study used econometric methods to test the hypothesis. Precisely, the Unit root test, Granger causality analysis, and Johansen co-integration test were used. The unit root test was utilized to assess the regression through the Augmented Dickey-Fuller test (Saqib, Masnoon & Rafique, 2013). In addition, the Johansen co-integration test was employed determine the long-term relationships in the study factors such as the logof GDP, TI, MAN, and FDI. Similarly, the granger causality analysis was used to determine the causality (Sothan, 2017). The Johansen co-integration framework used optimal lag length beginning with the vector autoregressive (VAR) model of the imperative.

nDetailed explanation of the data sources and data used

nThe research used secondary data acquired from the reputable international institution. In addition, data were obtained from 50 emerging economies across the globe from 1986 to 2016. In addition, the research 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 research 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 researches have utilized the reports issued by this institution.

nPresentation of results

nThe empirical results for the stationary assessment, the Granger causality trial, and the Johansen co-integration assessment founded on the VEC are provided. Most of the economic series was revealed to be non-stationary, while some were found to be stationary. In this regard, to evade unauthentic findings for strategy scrutiny, the stationary test of the factors was essential. The findings of typical ADF analysis are shown in Table 1. The outcomes of the test demonstrate that all the information is established to be non-stationary at the stage.. Following initial analysis, there is the rejection of the null hypothesis. The results approve that the Johansen co-integration process is a suitable mechanism utilized to assess whether the variables are co-integrated.

nTo execute the Johansen co-integration test, the decision on the optimum lag structure is made for the VEC process. The study utilized the AIC statistics to choose the suitable lag arrangement for the VEC process. Moreover, the volume of lag selected is founded on the optimal AIC data. Table 2 presents the findings of the Johansen co-integration test. Based on the three Versions, the experimental findings confirm that the maximum value test and those o trace trials are statistically significant and more than the crucial data. Therefore, it demonstrates the rejection of the H0 of no co-integration by both the trace and optimum eigenvalue in these Versions. In this regard, it suggests that the presence of a lasting relationship between GDP and FDI, GDP and asset, and GDP and manufacturing for the time under investigations.

nThe course of causation cannot be explained via the Johansen analysis. For this reason, the study employed the Granger causality test founded on the VEC Version. The research concentrated on the causation study to determine the underlying consequence of FDI on the financial transformation of different countries. The analysis used three versions to be assessed through the causality test (Granger causality analysis). Table 3 presented the results of the Granger causality test.

nMeanwhile, the variables are co-incorporated at similar order; causation can be categorized into two crucial fragments, the short-term and the long term. The long-term effects are assessed through the coefficient EC(t-1) while the temporary effects of FDI are examined via the LR test. In the long-term, the findings are statistically significant at 1% confidence level, which suggest the existence of an underlying association between GDP and FDI. On the contrary, the paper did not establish the underlying connection between GDP and FDI in the temporary nature.

nComparison of results with other 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), and (Jude & Levieuge, 2015). The study offers robust information on thecausative effect of FDI on the rise of an economy 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), and (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 economy 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 manufacturing has a causative effect on the advancement of an economy of a given country. The results are similar with Stanisic, (2015) study that noted that FDI focused on manufacturing sector leads to higher rate of advancement of the economy. The study robustly validates the crucial part that FDI plays in the manufacturing of various economies. Other studies such as (Azam & Ahmed, 2015) and (Long, Yang & Zhang, 2015) supports 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 economy and FDI. 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. According to the findings of this research, the FDI improves the advancement of the economy of various economies across the globe by expanding the physical capital which is required in the nation. However, the regulatory framework 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. For instance, countries must initiate proper regulatory framework to provide conducive atmosphere for FDI, which can stimulate a significant rise in the economic status in the country.

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nReferences

nAbbes, S. M., Mostéfa, B., Seghir, G., & Zakarya, G. Y. (2015). Causal interactions between FDI, and economic growth: evidence from dynamic panel co-integration. Procedia Economics and Finance, 23, 276-290.

nAlfaro, L., & Charlton, A. (2013). Growth and the Quality of Foreign Direct Investment. In The Industrial Policy Revolution I (pp. 162-204). Palgrave Macmillan UK.

nAlmfraji, M. A., & Almsafir, M. K. (2014). Foreign direct investment and economic growth literature review from 1994 to 2012. Procedia-Social and Behavioral Sciences, 129, 206-213.

nAzam, M., & Ahmed, A. M. (2015). Role of human capital and foreign direct investment in promoting economic growth: evidence from Commonwealth of Independent States. International Journal of Social Economics, 42(2), 98-111.

nBüthe, T., & Milner, H. V. (2014). Foreign direct investment and institutional diversity in trade agreements: Credibility, commitment, and economic flows in the developing world, 1971–2007. World Politics, 66(1), 88-122.

nDunning, J. H. (2013). The role of foreign direct investment in a globalising economy. PSL Quarterly Review, 48(193).

nFadhil, M. A., & Almsafir, M. K. (2015). The Role of FDI Inflows in Economic Growth in Malaysia (Time Series: 1975-2010). Procedia Economics and Finance, 23, 1558-1566.

nFaruk, M. O. (2015). The effect of FDI to accelerate the economic growth of Bangladesh and some problems & prospects of FDI. Asian Business Review, 2(2), 37-43.

nGui-Diby, S. L. (2014). Impact of foreign direct investments on economic growth in Africa: Evidence from three decades of panel data analyses. Research in economics, 68(3), 248-256.

nHolmes Jr, R. M., Miller, T., Hitt, M. A., & Salmador, M. P. (2013). The interrelationships among informal institutions, formal institutions, and inward foreign direct investment. Journal of Management, 39(2), 531-566.

nJadhav, P. (2012). Determinants of foreign direct investment in BRICS economies: Analysis of economic, institutional and political factor. Procedia-Social and Behavioral Sciences, 37, 5-14.

nJude, C., & Levieuge, G. (2015). Growth effect of FDI in developing economies: the role of institutional quality.

nLong, C., Yang, J., & Zhang, J. (2015). Institutional impact of foreign direct investment in China. World Development, 66, 31-48.

nMohamed, M. R., Singh, K. S. J., & Liew, C. Y. (2017). Impact of foreign direct investment & domestic investment on economic growth of Malaysia. Malaysian Journal of Economic Studies, 50(1), 21-35.

nNwaogu, U. G., & Ryan, M. J. (2015). FDI, foreign aid, remittance and economic growth in developing countries. Review of Development Economics, 19(1), 100-115.

nOlayiwola, K., & Okodua, H. (2013). Foreign direct investment, non-oil exports, and economic growth in Nigeria: a causality analysis. Asian Economic and financial review, 3(11), 1479.

nSaqib, D., Masnoon, M., & Rafique, N. (2013). Impact of foreign direct investment on economic growth of Pakistan.

nSothan, S. (2017). Causality between foreign direct investment and economic growth for Cambodia. Cogent Economics & Finance, 5(1), 1277860.

nStanisic, N. (2015). Do foreign direct investments increase the economic growth of Southeastern European transition economies?. South-Eastern Europe Journal of Economics, 6(1).

nTan, B. W., & Tang, C. F. (2016). Examining the causal linkages among domestic investment, FDI, trade, interest rate and economic growth in ASEAN-5 countries. International Journal of Economics and Financial Issues, 6(1).

nYoung, S., Hood, N., & Hamill, J. (2017). Foreign multinationals and the British economy: Impact and policy. Routledge.

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nAppendices

nTable SEQ Table * ARABIC 1 ADF test

nSequence (log) Level First Variance

nGDP 1.022 -3.801*

nFDI -0.321 -5.7203*

nMAN -0.860 -6.050*

nTI -0.603 -12.00*

n*Demonstrates that the H0 has been rejected at the 1% significant level

nTable SEQ Table * ARABIC 2 Johansens Co-integration test (1985-2016)

nNull (H0) Alternative (H1) λ trace 95% CV λmax 95% CV

nVersion One: y = [log(FDI), log(GDP)]

nt=0 t ≥1 35.27* 14.50 32.9* 14.30

nt ≤ 1 t ≥2 1.257 3.732 1.400 3.700

nVersion 2: y = [log(MAN), log(GDP)]

nt=0 t ≥1 46.950* 15.392 46.11* 14.115

nt ≤ 1 t ≥2 0.6191 3.751 0.6291 3.7420

nVersion 3: y = [log(GDP), log(TI)]

nt=0 t ≥1 54.80* 15.391 52.90* 14.165

nt ≤ 1 t ≥2 2.061 3.791 2.060 3.791

n*Represents the level of significance at 1%

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nTable SEQ Table * ARABIC 3 Analysis of causality

nDependent variables Temporary effects Lasting effects

nVersion 1: n=[log(FDI), log(GDP] GDP FDI EC(t-1)

nGDP _ 2.99 -2.11*

n FDI 6.4 – 3.5*

nVersion 2: n=[log(GDP), log(MAN)] GDP MAN EC(t-1)

n GDP _ 5.9 -2.9*

n MAN 6.0 _ 1.9

nVersion 3: n=[log TI, GDP] GDP TI (EC(t-1)

n GDP 71.1* -8.5*

nTI 8.0 _ -0.9

n*represents the significant level at 1%