Foreign Direct Investment, Economic Growth, Trade and Domestic Investment Relationship: An Econometric Analysis of Selected South Asian Countries

Transcription

1 JANUARY 01 VOL, NO 9 Foreign Direct Investment, Economic Growth, Trade and Domestic Investment Relationship: An Econometric Analysis of Selected South Asian Countries Rehmat Ullah Awan 8 Department of Economics, University of Sargodha, Pakistan Khalid Javed Graduate Student, Department of Economics, University of Sargodha, Pakistan Abstract Falak sher Department of Economics, University of Sargodha, Pakistan The present study analyses relationship among Foreign Direct Investment (FDI), Exports, Imports, Domestic Investment and Economic Growth in selected South Asian countries namely Bangladesh, India, Pakistan and Sri Lanka using annual time series data from 197 to 010. Through Granger Causality, relations are found among variables in the model. The main finding of the study is that the causality test supports export-led growth more as compared to FDI-led growth in all selected South Asian countries. The causality analysis shows that imports are caused by Gross Domestic Product (GDP) at different lag periods in all countries but no evidence of causality from imports to GDP is found. Causality test also does not support the causality from trade openness to GDP but the other way round. Moreover, two-way causality between FDI and Trade Openness also exists. Key Words: FDI, GDP, Exports, Imports, Granger Causality, Unit Roots Introduction: In the 1990 s, (FDI) got the status of major way of financing for investments in developing countries. It goes beyond all other forms of foreign capital that supplement domestic investment. FDI has long term and more productive effects on the economy of the host country. To accelerate economic growth, a more liberal policy towards FDI was adopted by many developing countries since the mid 1980,s. In the study a relationship is established to seek the causal link between FDI and economic growth that can provide basis for useful policy suggestions based on findings to accelerate growth. Causality from FDI to productivity growth may be considered as the evidence for holding FDI-led growth hypothesis and the opposite implies that economic growth is a major determinant of FDI. In either case, the impact of FDI inflow depends on the ability to absorb it in a nation. If two way causal relationship is observed, then growth and FDI are mutually dependent. However, to test the relationship between growth and exports, a comparison is made between FDI-led growth and export-led growth in selected South Asian countries, using Bivariate Granger Causality as the same used to investigate the causation among the important variables. Four countries namely Bangladesh, Pakistan, Sri Lanka and India have been selected for analysis. These four countries are also part of South Asian Association for Regional 8 Corresponding Author COPY RIGHT 01 Institute of Interdisciplinary Business Research 95

2 JANUARY 01 VOL, NO 9 Cooperation (SAARC) agreement and promotion of regional trade with lessened barriers to promote welfare of the people of the region is on their agenda. Tables1,, &4 show summary statistics for GDP, FDI, Exports, Imports and Domestic Investment in selected South Asian countries. (Insert Table 1,, & 4 here) The trends of Exports and Imports as ratio of GDP have decreased in Bangladesh from 19.% to 18.4% and 6.6% to 5%, respectively while in India Exports to GDP ratio increased from 19.8 % to 1.5% and Import to GDP ratio declined from 5.4 % to 4.9 from 009 to 010. In Pakistan Exports to GDP ratio increased from 1.9 % to 1.6% and Import to GDP ratio declined from 0.4 % to 18.8% from 009 to 010. In Sri Lanka Exports to GDP ratio increased from 1. % to 1.7% and Import to GDP ratio increased from 7.8 % to 0.8% from 009 to 010. The trends as shown in Table5 indicate that net inflows of FDI decline in the last four years in these South Asian Countries. As far as FDI is concerned, its share to GDP has declined from.6% to 1.4% and 1.4% to 1.1% in two main south Asian countries i.e. India and Pakistan from 009 to 010, respectively. In Bangladesh and Sri Lanka, share of FDI to GDP increased as well as remained stable from 0.79% to 0.96% and 1% to 1% in the said period. These are presented in Tables.5, 6, 7, 8 &9. (Insert Table 5, 6, 7, 8 &9here) The Growth rates of selected countries are presented in Figure1. (Insert Figure.1 here) The organization of remaining part of study is as follows: Section gives literature review. Section explains methodology and data. Results are described in section 4 and last section presents conclusion and policy suggestions.. Literature Review: Theory provides conflicting predictions concerning the growth impact of FDI. Foreign investment is a source of sharing technology and knowledge to deprived countries (Romer 199) and the same may advance the productivity in all the sectors (Rappaport 000). FDI is a composite multiple bunch of capital and knowledge which boosts the prevailing level of technology in recipient country (Balasubramanyam et al 1996; DE Mello (1999). Capital keeps on moving between two countries until its reward is identical in both the counties (Heckcher-Ohlen 1967; MacDougal 1960). Using a panel of 4 developing countries over 5 years from , FDI is found to have a significant impact on growth and positively related with levels of openness (Nair-Reichart 001). (Chakraborty and Parantap 00) found that FDI is related positively to GDP and inversely to import duty using the whole Indian sample from 1974 to1996 by divided into three phases and also found that GDP is not Granger caused by FDI but the reverse is true. Causation runs from growth to export in different sub samples of Asian and African countries and an inverse relationship exists between export and size of the country (Panayiots R. et al 005). COPY RIGHT 01 Institute of Interdisciplinary Business Research 96

3 JANUARY 01 VOL, NO 9 Similarly, weak causality from growth to exports exists and there is no support for export-led growth hypothesis (Sharma and Theodore 005). Evidence shows that export-led growth relationship is stronger as compared to FDI-led growth and trade openness is also helpful to boost growth in Thailand (Tanna and Kitja 005). (Chowdhury and Mavrotas 005) found strong two way causality in Thailand and Malaysia and it is also found that causality runs from GDP to FDI for Chilian economy but not the reverse is true. Duasa (007) found weak causality between FDI and growth that shows growth is not caused by FDI but the other way is correct in Malaysia. This study analyzes relationship among Growth, FDI, and Trade for the economies of the selected South Asian countries (Bangladesh, India, Pakistan and Sri Lanka) in the South Asian region. How have the paces of FDI, economic growth and Trade been changed during last four decades, the noticeable period for debt crisis, financial reforms, economic restructuring and economic recession? The above objectives are addressed using Granger causality test between different pairs of key variables among GDP, FDI, exports, Imports and Trade openness.. Data and Methodology:.1 Granger Causality Test The dependence of one variable on other variables is analyzed by the regression analysis that does not necessarily imply causation. Tests of causality include Granger (1969) and Sims (197) among others. The present study attempts to test the direction of causality between two given variables and also checks the stationary among the key variables by Philips Perron (1988). In a bivariate case where Yt and X t are main variables, while others in a VAR systems can be represented by the following equations: k k i a1 yt i + a j 1 xt j + ε t i= 1 j = 1 k k i j xt = c1 + a1xt i + a yt j + ε t i= 1 j= 1 y t = c 1 + (1) () j Coefficients a 1 need to be jointly significant for the presence of Granger causality from x to y. The acceptance of hypothesis H 0 : a j 1 = 0 implies that x does not Granger cause y and vice versa. F-statistics is used for testing the joint significance of the null hypotheses, as given below: ( RSSr RSSur) / m F = RSSur /( n k) The study uses the annual time series data in real terms based on prices of the year 000, from 197 to 010 for the variables GDP, Exports (X), Imports (M), FDI and Fixed capital formation as the proxy for Domestic Investment, with values in million US dollars. Additionally, Trade Openness is defined as: (X+M)/ GDP). Some missing values are filled by taking average of the previous two values. All the data are extracted from World Development Indicator (WDI). Variables and the data sources are presented in table 10. COPY RIGHT 01 Institute of Interdisciplinary Business Research 97

4 JANUARY 01 VOL, NO 9 (Insert Table 10 here) 4. Results and Discussion: Stationary of the included series have been checked using Philips Perron (1988) and all the series are found to be integrated of I (1). The results are presented in tables 11 to14. (Insert Table 11, 1, 1 & 14 here) The Granger Causality results show the lag relationship among the set of variables, as reported in table 15. Real output is caused by FDI in Pakistan on two and three lags period, and by exports on two and three lag period in Bangladesh and not caused by imports and trade openness in any one of the sample countries. FDI is being caused by real output on one lag period in India, on one, two and three lag periods in Pakistan and one lag period in Sri Lanka. FDI is being caused by exports on all three lag periods in Bangladesh, India and Sri Lanka, while on only two-lag periods in Pakistan. FDI is also being caused by imports on one and three lag periods in Pakistan and on one lag period in Sri Lanka. FDI is also being caused by trade openness in Pakistan on one and three lag periods. Exports are being caused by real output on one lag period in Bangladesh while in India, Pakistan and Sri Lanka on one, two and three lag periods. Exports are being caused by FDI on one lag period in India, while on one and two-lag period in Pakistan. Exports are being caused by imports on two and three lag period in Bangladesh and on one and three-lag period in Sri Lanka. Exports are being caused by trade openness in India on two and three lag periods. Imports are being caused by real output on one lag period in all four countries Bangladesh, India, Pakistan and Sri Lanka, on two lag period in Bangladesh, Pakistan and Sri Lanka, while on three lag periods in Bangladesh. Imports are being caused by FDI on one lag period in India and Pakistan, on two-lag periods in India, Pakistan and Sri Lanka while on three-lag periods in Pakistan. Imports are being caused by Exports on one lag period in Bangladesh, India and Pakistan, on two-lag periods in Bangladesh and Pakistan, while on three-lag period in Bangladesh only. Imports are being caused by trade openness on two-lag periods in Pakistan and on three-lag period in Bangladesh. Trade is being caused by real output on one lag period in India and Pakistan, on two-lag period in Sri Lanka and on three lag periods in Bangladesh. Trade openness is being caused by FDI on one lag period in India and Sri Lanka, while on two-lag periods in India, Pakistan and Sri Lanka, and on three-lag periods in Pakistan and Sri Lanka. Trade is being caused by exports on one lag period in India and Sri Lanka, on two and three lag periods in Sri Lanka. Trade openness is being caused by imports on one lag period in India and Bangladesh and on two-lag periods in Sri Lanka, while on three-lag periods in Bangladesh and Sri Lanka. The results are presented in Table Conclusion and Policy Implications: (Insert Table 15 here) Growth led Exports, FDI-led Growth, Export-led Growth, Growth-led FDI hypotheses are analyzed, using bi-variate Granger Causality methodological framework in selected South Asian countries. Main findings from causality test support Export-led Growth as compared to FDI-led Growth in these countries. The results show that economic growth is also influenced COPY RIGHT 01 Institute of Interdisciplinary Business Research 98

5 JANUARY 01 VOL, NO 9 by domestic investment positively. But causality test does not support the causality from trade openness to GDP but the other way is correct. Two way Causality between FDI and Trade Openness also confirms the results. In short run, FDI affects Openness significantly by investment environment improving factors. It indicates that a country should adopt more liberal policies for increase in investment. As a policy measure it is suggested that as FDI is a major determinant to economic activity and growth, the same should be attracted through necessary measures and incentives to realize its spillover effects in the recipient country. A country benefits from these features only if it has a friendly atmosphere in different socio-economic aspects. As supported by results, Exports are found beneficial for economic growth; it is recommended that the countries in region should increase their exports. COPY RIGHT 01 Institute of Interdisciplinary Business Research 99

6 JANUARY 01 VOL, NO 9 References: Balasubramanyan, V. et al (Jan, 1996). FDI and Growth in EP and IS a country. The Economic Journal. 106(4), Biswas, R. (00). Determinants of foreign direct investment. Review of Development Economics, 6 (), Borensztein, E., Gregorio, J. & J. Lee (1995). How does foreign direct investment affect economic growth? Journal of International Economics, 45 (1), Bosworth, B., P. & S., Collins, M. (1999). Capital flows to developing economies: Implications for saving and investment. Brookings Papers on Economic Activity, 1, Chakraborty, C., and Parantap, B. (00). FDI and Growth in India: a co-integration approach, Applied Economics: 4, Chowdhury, A. Mavrotas, G.(005). FDI and Growth: A Causal Relationship. WIDER Research Paper. C. W.J Granger, Investigating Causal Relations by Econometric models and Cross-Spectral Methods, Econometrica, July 1969, pp Duasa, J.(007), Malaysian Foreign Direct Investment and Growth: Does Stability Matter?, The journal of Economic Cooperation, 8,(007):8-98. Demello, L.R (1999), Foreign Domestic Investment-Led Growth: Evidence from Time Series and Panel data, Oxford Economic Papers, 51: Durham, J, B. (004). Absorptive Capacity and the effects of Foreign Direct Investment and equity foreign Portfolio investment on Eco Growth. European Economic Review; 48, Encarnation D. J. & Wells, L. T., (1986). Evaluating foreign investment. In T. H. Moran et al. Investing in development: new roles for foreign capital? Washington, DC: Overseas Development Council. Ericsson, J. & Irandoust. M. (000). On the causality between foreign direct investment and output: A comparative study. International Trade Journal, 15, 1-6. Green, W.H. (004). Econometric Analysis Fourth Edition, New York: Macmillan. Grosse, R. & Trevino, L., J. (1996). Foreign direct investment in the United States: An analysis by country of origin. Journal of International Business Studies, 7, Hassan, M., K. (005). FDI, Information Technology and Economic Growth in the MENA Region. 10th ERF paper University of New Orleans. Holtz-Eakin et al (1990). Estimating VAR with Panel Data. Econometrica. 56, Hsiao, C. (001). Efficient estimation of dynamic panel data models with an application to the analysis of foreign direct investment in developing countries. Paper presented at 001 Far Eastern Econometric Society Meeting, Kobe, Japan. Lee, M., H. & Ataullah, A. (006). Foreign Capital and Economic Performance of Pakistan. The Lahore Journal of Economics. 7(1), 1. Li, X., & Xiaming, I. (005). FDI and Economic Growth: An increasing Endogenous growth Relationship. World Development, (), MacDougal (1960), The Benefit and Cost s of Private inflows from abroad: A Theoretical Approach, Economic Record, 6: 1-5. Nair-Reichert, U. and Dianna (001), Causality Tests for Cross-Country Panels: A New Look at FDI and Economic Growth in Developed Countries, Oxford Bulletin of Economics and Statistics, 6:. Nelson, R. & Phelps, E. (1966). Investment in Humans, Technological Diffusion and Economic Growth. American economic Review, 51, COPY RIGHT 01 Institute of Interdisciplinary Business Research 90

7 JANUARY 01 VOL, NO 9 Ohlin, Bertil (1967). Interregional and International Trade. Harvard Economic Studies. 9. Cambridge, MA: Harvard University Press. Panayiots, R.and Dimitris, K. (005), The Export-Output Nexus: Evidence from African and Asian Countries Journal of Policy Modeling: 7, pp Phillips, P. & Perron, P. (1988). Testing for a unit root in time series regression. Biometrika, 75, Rapparot, J.(000), How does openness to Capital Flows Affect growth? mimeo, Federal Reserve Bank of Kansas Cities, (June). Romer, P., (199), Idea Gaps and object Gaps in Economic Development. Journal of Monetary Economicst,, No.. December. Sharma, A. and Theodore.P (005), An Analysis of Export and Growth in India: A Co integration and Causality Evidence ( ), Review of Development Economics, 9:, pp.-48 Sim, C.A. (197), Money Income and Causality American Economic Review, 6, pp Tanna, S. and Kitja, T. (005), Human Capital, trade, FDI and Economic Growth in Thailand; what Causes what? Coventry Business School, Coventry University UK. Internet downloaded. Trevino, L., J. & Upadhyaya, K., P. (00). Foreign aid, FDI and economic growth: Evidence from Asian countries. Transnational Corporations, 1 (), Veugelers, R. (1991). Locational determinants and rankings of host countries: An empirical assessment. Kyklos, 44 (), 6-8. World Bank (011). World Development Indicator. Washington D.C (USA) COPY RIGHT 01 Institute of Interdisciplinary Business Research 91

8 JANUARY 01 VOL, NO 9 Annexure Table.1 Summary Statistics for Bangladesh GDP FDI Exports Imports DI Mean Median Maximum Minimum Std.Dev Skewness Kurtosis Jarque- Bera Probability.080 (Authors calculation) Table. Summary Statistics for India GDP FDI Exports Imports DI Mean Median Maximum Minimum Std.Dev Skewness Kurtosis Jarque- Bera Probability (Authors calculation) COPY RIGHT 01 Institute of Interdisciplinary Business Research 9

9 JANUARY 01 VOL, NO 9 Table. Summary Statistics for Pakistan GDP FDI Exports Imports DI Mean Median Maximum Minimum Std.Dev Skewness Kurtosis Jarque- Bera Probability (Authors calculation ) Table.4 Summary Statistics for Sri Lanka GDP FDI Exports Imports DI Mean Median Maximum Minimum Std.Dev Skewness Kurtosis Jarque- Bera Probability (Authors calculation ) COPY RIGHT 01 Institute of Interdisciplinary Business Research 9

10 JANUARY 01 VOL, NO 9 Table.5 FDI Net Inflows in Selected SAARC Countries (BoP, Current US$) Year Bangladesh India Pakistan Sri Lanka (Source WDI 011) COPY RIGHT 01 Institute of Interdisciplinary Business Research 94

11 JANUARY 01 VOL, NO 9 Table.6 Exports, Imports, FDI and Domestic Investment % of GDP Sri Lanka Year Exports Imports FDI DI L (Source WDI 011) COPY RIGHT 01 Institute of Interdisciplinary Business Research 95

12 JANUARY 01 VOL, NO 9 Table.7 Exports, Imports, FDI and Domestic Investment % of GDP Pakistan Year Exports Imports FDI DI (Source WDI 011) COPY RIGHT 01 Institute of Interdisciplinary Business Research 96

13 JANUARY 01 VOL, NO 9 Table.8 Exports, Imports, FDI and Domestic Investment % of GDP India Year Exports Imports FDI DI (Source WDI 011) COPY RIGHT 01 Institute of Interdisciplinary Business Research 97

14 JANUARY 01 VOL, NO 9 Table.9 Exports, Imports, FDI and Domestic Investment % of GDP Bangladesh Year Exports Imports FDI DI (Source WDI 011) COPY RIGHT 01 Institute of Interdisciplinary Business Research 98

15 JANUARY 01 VOL, NO 9 Table.10 Variables, Definitions and Data Sources Variable Definition Data Source World GDP Real GDP Development indicator(wdi) Foreign Direct Investment Trade openness It is the sum of equity capital, reinvestment of earnings, other long term capital, and short term capital as shown in Balance of Payments Sum of exports and imports as ratio of GDP. WDI WDI Domestic Investment Fixed capital formation WDI Exports Real Exports of Services and goods WDI Imports Real Imports of Services and goods WDI Table.11 Results for unit root at level & 1st difference Bangladesh Variables PP at level (intercept & linear trend) Order of Integratio n PP at 1st difference (intercept & linear trend) Order of Integration LEXP I(0) I(1) LFDI I(0) I(1) LGDP I(0) I(1) LIMP I(0) I(1) LDI I(0) I(1) Critical value is 4.4, and at 1%, 5% and 10% respectively level of significance. Variables Table.1 Results for unit root at level & 1st difference India PP at level (intercept & linear trend) Order of Integratio n PP at 1st difference (intercept & linear trend) LEXP I(0) I(1) LFDI I(0) I(1) Order of Integration LGDP.547 I(0) I(1) LIMP I(0) I(1) LDI I(0) I(1) Critical value is 4.4, and at 1%, 5% and 10% respectively level of significance COPY RIGHT 01 Institute of Interdisciplinary Business Research 99

16 JANUARY 01 VOL, NO 9 Table.1 Results for unit root at level & 1st difference Pakistan Variables PP at level (intercept & linear trend) Order of Integrati on PP at 1st difference (intercept & linear trend) Order of Integration LEXP I(0) I(1) LFDI I(0) I(1) LGDP I(0) I(1) LIMP I(0) I(1) LDI I(0) I(1) Critical value is 4.4, and at 1%, 5% and 10% respectively level of significance Table.14 Results for unit root at level & 1st difference Sri Lanka Variables PP at level (intercept & linear trend) Order of Integratio n PP at 1st difference (intercept & linear trend) LEXP I(0) I(1) LFDI I(0) I(1) LGDP I(0) I(1) LIMP I(0) I(1) LDI I(0) I(1) Critical value is 4.4, and at 1%, 5% and 10% respectively level of significance. Order of Integration Table.15 Results for Granger causality Test South Asian Region Bangladesh India Pakistan Sri Lanka Null hypothesis Lag Remarks Remarks Remarks Remarks FDI does not granger cause GDP. 1 GDP does not granger cause FDI. 1 GDP does not granger cause Exports. 1 Exports do not granger cause GDP. 1 GDP does not granger cause Import 1 Imports do not granger cause GDP. 1 COPY RIGHT 01 Institute of Interdisciplinary Business Research 940

17 JANUARY 01 VOL, NO 9 GDP does not granger cause Trade 1 Trade does not granger cause GDP. 1 FDI does not granger cause Exports 1 Exports do not granger cause FDI 1 FDI does not granger cause Import 1 Imports do not granger cause FDI 1 FDI does not granger cause Trade. 1 Trade does not granger cause FDI. 1 Exports do not granger cause Imports 1 Imports do not granger cause Exports 1 Exports do not granger cause Trade 1 Trade does not granger cause Export 1 Imports do not granger cause Trade 1 Trade does not granger cause Imports. 1 COPY RIGHT 01 Institute of Interdisciplinary Business Research 941

18 JANUARY 01 VOL, NO 9 Figure.1 GDP Growth Rates of South Asian Countries in Sri Lanka Ban PAK IND SRI COPY RIGHT 01 Institute of Interdisciplinary Business Research 94