Last Updated 10 Aug 2020

FDI and Economic Growth in the Export-Oriented Economy

Category Economic Growth
Essay type Process
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The objective was to attract foreign direct investors in the various manufacturing industries and then export the finished manufactured products to Australia, New Zealand, European and North American markets. The study analyzes how the spillover and linkage effects between FED, productivity, domestic investment, and exports impacted economic growth. The results indicate that FED stock did not lead to the growth success in Fiji due to military coups as it experienced a substantial reduction in FED over time.

However, it was the FED-driven export sector which was the driving force of economic growth. The study also highlights the challenges that Fiji faced during its development path, lessons that emerging countries can learn from and policy recommendations on how to reposition of the economy going forward. Keywords: Foreign Direct Investment, Economic Growth Modeling, Country Study Seminar paper, School of Economics and Finance, Massey University, Palmettos North, 20 March, 2013. Preliminary Draft - Do Not Quote.

Introduction Both the governments of Fiji and Mauritius turned these island economies into an Export Processing Zone. The importance of FED in the various sectors is to stimulate Roth through capital formulation, employment creation, and technology transfer. The objective was to attract foreign direct investors in the various manufacturing industries and then export the finished manufactured products to European and North American markets in the case of Mauritius, and Australia, New Zealand, European and North American markets in the case of Fiji. Read about the impact of globalization on Ghana's economy

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This study analyzes how the spillover and linkage effects between FED, productivity, domestic investment, and Mauritius and Fiji faced during its development path, lessons that emerging countries can learn from and policy recommendations on how to reposition of these woo economies going forward. As a catalyst in the growth of developing countries FED brings additional sources of capital investment or foreign savings (Lucas, 1988; Roomer, 1986).

Fid's role in domestic capital formation also brings productive benefits, it includes employment creation; technology transfers and associated spill over effects; skill development; trade and competitiveness; and access to foreign markets (Khaki, 2004). It increases the profitability of domestic investment; transform the host country's ownership structure of total investment; and it supplements funding for mommies investment (Bowwow's, Collins and Reinhardt, 1999, Galahad, 2010).

Analysis of FED contribution to economic growth has been described as the FED-led growth hypothesis. Many studies on the other hand note some potential drawbacks of FED effects on economic growth (Aitkin and Harrison, 1999; Panel, 1973; Parry, 1988, Salaam and Fen, 2009); Visas and Rolland, 2005). This is associated with deterioration of a nation's balance of payments, via transfer pricing, capital/profit repatriation and increasing imports than exports which consequently increases trade deficits (Salaam and Fen, 2009).

Other weaknesses include over-exploitation of resources, poor generation of linkages, under-utilization of local inputs that reduces the impact on domestic investment, raising wage and local supply input prices thereby hampering growth and reducing employment, and crowding out of domestic investors. Based on country-specific experiences the differential views remain, however, the consensus appears that the relationship between FED and growth can be positive if the host country has the absorptive capacity and the correct level of human capital development (Bernstein et al. 1998), technological and infrastructure development Hansen and Rand, 2007), and domestic firms and financial systems (Unguent et al. , 2009) in addition to trade and a degree of openness (Flamboyancy's et al. , 1996). The volume and magnitude of FED flows differ from country to country given its level of development or absorptive capacity to realize the potential benefits of FED. The endogenous growth model incorporates FED inflows as an additional input in the production process and its spill-over effects that can influence growth-enhancing factors directly and/or indirectly.

We incorporate the effects of FED inflows on a home amounts specific macroeconomic variables and further include the causal link of FED inflows on key economic variables. Recent empirical studies on the direction of the causal link between FED inflows and economic growth have considered the traditional assumption of a one-way causal link from FED to growth and the possibility of a Ottawa (bi-directional) or non-existent causality among variables of interest. The paper is structured as follows: in the next section provides a brief analysis undertaken in the context of existing FED-led growth literature, incorporating insights ran from recent empirical studies. The specifications and the choice of variables are noted followed by methodology and empirical analysis. The results indicate that it was FED stock lead to the growth success for Mauritius but in the case of Fiji military coups have a significant adverse effect on growth and reduction on FED to the island inflows to economic growth.

The established bi-directional evidence indicates the causality between economic growth and FED, and in turn, they Granger cause domestic investment. The bi-direction causality implies that foreign direct investment For China, Tang et al. (2008) find a bi-directional causality between domestic investment and economic growth and a nun-directional causality from FED to domestic investment and economic growth. They affirm that FED inflows complement domestic investment and together their effects boost gross domestic product (GAP).

Fid's growth enhancing effect has been noted for India (Sacristans, 2006), Nigeria (Days, 2008) and East Asia and Latin America (Ghana (2001), Pakistan (Galahad, 2010) that stimulates domestic capacity and that FED inflow is complementary to domestic investment. Is the mechanism through which economic growth causes domestic investment. Final section presents the conclusion. Models, Variables and Methodology The effects of FED are based on two models, I. . Measuring the FED-economic growth nexus and the causality linkages that identify the direction of causation between the variables of interest, namely FED, GAP, DINT and Exports. These variables separately indicate the domestic and foreign investment components' contribution to economic growth, which is crucial for policy- makers in small island economies. The models estimated follow the tradition of the work by Flamboyancy's et al. (1996) in the model specification introduces FED as an additional input, which directly contributes to output production, via new technologies and other inputs and indirectly through improving human capital or labor and trade openness. Variables included reflect these effects for labor productivity (proxies by industry value added) and how the spillover and linkage effects between FED, productivity, domestic investment, and exports impact economic growth. The impact of military coups and civil unrest and political strife note that coups had a negative effect on economic growth and investment (see Sounder, 1999, 2002 in the case of Fiji).

The FED-growth enhancing factors in the production function framework take the following form: Get = ay + al Lollop + leadenly + alfalfa + lepton + subcompacts + Et (1) where GUY is growth in gross domestic product, Loped represents labor productivity, LADING is log of domestic investment to GAP ratio, FED is foreign direct investment to GAP share, LOPED is log of trade openness (sum of export and imports to GAP ratio), Coupons is dummy variable for military coups, O for the pre-1987 coups period and 1 for post-coups period.

Whilst a positive link between FED and economic growth is ideal supported, the direction of causation remains highly questionable. The causality models can be tested using the error correctional model (ECMA) in the VARY no causality between the variables. The causation between GAP, FED inflows, DINT and openness based on the autoregressive framework can be specified as follows: Light = opt Kept-t + Fit- J +2 Dint-k + I Open (2) where LAGS responds to LADING and LIFE in a lag period. The coefficient of signifies the impact due to change in the mean value of LAGS relative to the per unit change in LADING and LIFE, within the same time period.

Light-I denotes the distributed-lag and p represents the error term. The model includes other dynamic variables. In addition, it shows the time trend of the dependent variable with regards to its past values. A prior', it is expected that or depending on the direction that exists between LIFE and LAGS and LADING and Openness. Data source for annual data on GAP; labor productivity; domestic investment; FED; and trade openness (exports) are from the World Bank (2012) and Fiji Islands Bureau of Statistics (various).

The Autoregressive Distributed Lag (RADAR) approach to congregation techniques are used o estimate the model. 2 Augmented Dickey-Fuller (UDF) and Kowtowing, Phillips, Schmidt, and Shin (KBPS) are used for the stationary of the variables. The Bounds F test indicates the existence of a long run relationship between the variables. A pair wise Granger Causality test is employed to identify the direction of causality between the variables. Empirical Results The estimated results for FED-growth nexus, bounds tests and causality estimates are reported in Tables 1, 2 and 3.

The UDF and KBPS unit root tests (Appendix Table AY) show the stationary of the variables in either the level or iris difference forms. The Bounds test in the RADAR technique establishes the existence of a long-run relationship (Table 3). The calculated F-statistic exceeds the upper bound value of 3. 99 indicating the existence of the long run relationship between the variables. Table 1 Bounds F-Test Results for FED-Growth Nexus Model K- degrees of freedom 6 90% Critical value bounds '(1) 2. 88 3. 99 Estimated F test value 4. 0 Pass/Fail Equation 1 Pass Note: The critical value is from Pesaro, Shin and Smith (2001). K is the number of 2 This technique has the advantage of testing the long-run relationship amongst the rabbles when the sample size is small and can correct for possible endogenous of the explanatory variables (Pesaro, Shin and Smith, 2001). FED-Growth Nexus: Results The estimated RADAR coefficients, based on the Swartz Information Criterion, are presented in Table 2 for long-run and short-run error correction representation.

The equations have a relatively high explanatory power and the model diagnostics indicate no concern. The labor productivity (Loped) coefficient is positive and significant providing support to the view that labor productivity increases growth significantly. This estimated effect is also seen in the short-run that has a potentially influence on growth. Significance in the long-run impact is due to higher skilled labor that adds to the productive sectors and has a spill-over effect to other sectors of the economy.

The estimated negative domestic investment shows an immediate adverse impact and it did not increase substantially over time. The computed long run effect shows a positive coefficient but it is not significant. The effects of coups since 1987 have affected the domestic investor confidence, particularly after the coups in 2000 and 2006. Low domestic investment levels in Fiji suggest that the economy requires a substantial boost in investment and improve investor confidence. The estimated FED impact though positive is not significant and has a very small magnitude.

DO is Durbin Watson, SC is serial correlation, IF is Functional Form, N is Normality of residuals, H is Heterosexuality. Critical values for =6. 67 and (2) = 9. 97. Positive impact on economic growth in both the long-run and the short-run periods. The long run impact implies that a 1% increase in trade openness raises economic growth by 8. 48%. This suggests that openness of the economy complements foreign investment; trade liberation's and tax incentives; and opening up of various sectors f the economy, which support exports, imports and growth.

Given that most investment projects are directed towards the treatable sector, the degree of openness to international trade exerts a major influence on economic growth in Fiji. The Coups have adversely affected economic growth in Fiji since 1987 that caused risk and uncertainty in various sectors of the economy. While a new Constitution was implemented in 1997 and a democratic election held in 1999 the level of stability did not persist. The 2000 coup destabilize the economy while the 5 year period since hen has not been long enough to return investor confidence and other activities to enhance growth.

Moreover, the 2006 military coup led to prolonged political and economic instability. The estimated negative coup coefficient shows an immediate short run adverse impact while the long run coefficient indicates that the adverse effect continues in the long run. The adverse effects since 1987 led to an outflow of skilled labor and decline in domestic investment, FED flows and export levels. The ECMA result indicates that the economy returns to long run equilibrium after the shorter disturbances. The results reflect the importance of domestic sectors (labor productivity, trade openness, domestic investment).

Fiji government has undertaken liberation of FED and trade policies, however any increased investment opportunities and trade requires political stability to take advantage of the nation's comparative advantage in the export sector. This supports the view of Flamboyancy's et al. , (1996) that a more open trade policy framework promotes efficient allocation of investment to productive sectors that have comparative advantage in trade, thereby complements growth. Causality Results The Granger causality results between FED, DINT, Exports and GAP are presented in Table 5.

In Column 1 (LIFE is the dependent variable), both LADING and LAGS are not significant, thus the causality test accepts the null hypotheses that "LADING does not Granger cause LAGS" and vice versa that "LAGS does not Granger cause LADING". This suggests no causality between LADING and LAGS and in turn, they do not Granger cause LIFE. The result provides no evidence that both domestic investment and economic growth promote FED inflows and builds up the absorptive capacity of Fiji to enhance the benefits of FED inflows.

The bi-direction causality implies that foreign direct investment is the mechanism through which economic growth causes domestic investment. This supports the view by Demoded (1999) that Fid's growth enhancing effect is possible only when it stimulates domestic capacity of the host economy and that FED inflow is complementary to domestic investment. Thus, FED inflows provide more investment opportunities to increase domestic investment. Results support the view that fast growing economies attract significant FED inflow (Dada, 2008; Sacristans, 2006; Ghent, 2009).

The results in Column 3 LOPED as the dependent variable), indicates that both LIFE and LAGS are not significant, thus both we accept the null hypotheses that "LIFE does not Granger cause LAGS" and vice versa that "LAGS does not Granger cause LIFE". This result provides no evidence that both foreign investment and economic growth promote openness. As most of the exports are mainly by domestic investment the result indicates low foreign investment levels in the export sector. In the 10 percent significance level while the causality test accepts the null hypothesis that "LADING Granger does not cause LIFE" as it is not significant.

This means the direction of causality is from LADING to FED inflows, than in the opposite direct. The evidence suggests that domestic investment causes FED inflows which in turn Granger causes economic growth. The nun-direction causality implies that domestic investment is the mechanism through which foreign investment causes economic growth. This indicates that domestic investment is one of the most crucial factors or channels for driving FED flows. It also act as a catalyst for economic growth which means that higher capital accumulation causes higher economic growth and paves the path of resource availability (e. . Deter infrastructure, labor, markets) for FED. It lends some supports to the theoretical viewpoint that FED inflows have a complementary effect on domestic investment, and that both have complementary effects on economic growth (Tang et al. , 2008). The estimated long-run lagged error correction term in Columns 2 and 4 are significant at the 10 percent level. This re- affirms the results from the bounds test for co-integration and the short-run results and indicates that in the both LADING and LAGS Granger cause LIFE.

This suggests that the linkage runs interactively through the error correction term from domestic investment and economic growth to FED inflows. The coefficient of the lagged error term for in columns 2 and 3 are also negative and significant which imply that the linkage runs interactively through the error correctional term from economic growth to FED inflows to domestic investment. Conclusion The study presents an understanding of the role of foreign direct investment to enhance growth in the export-oriented economies of Fiji and Mauritius.

The empirical findings for Fiji show that FED and the main growth-enhancing national factors like domestic investment, labor productivity and trade openness have a costive and significant impact on economic growth with a much stronger influence from trade openness. This suggest that a highly open economy and domestic investment is vital during the early stages of economic development as it stimulates growth in trade and FED inflows, thus leading to higher economic growth. The results also affirm that civil unrest and political strife adversely affect economic growth in Fiji.

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