Does Foreign Direct Investment (FDI) Benefit

Host Countries: Uncovering the Relationship

between FDI, GDP and Capital Formation in
Host Countries

Prashant Kulkarni
Asst. Professor, Indian Business Academy, Bangalore

Anantha Murthy N.K.

Asst. Professor, Indian Business Academy, Bangalore

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Foreign Direct Investment
 Net inflows of investment to acquire a lasting
management interest (10 percent or more of
voting stock) in an enterprise operating in an
economy other than that of the investor (World
Bank)
 Critical element in the flow of international
capital.
 Less volatile
 Shift towards services sector

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Objectives

 To examine the trends and directions of FDI

flows and stock
 To understand the implication of FDI on host
countries.
 To examine the relation between FDI stock
and the GDP growth rate of the country.
 To gauge the extent of FDI flows in gross
fixed capital formation of the country

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Literature Survey
 Hymer (1960)
 eclectic paradigm of FDI theory by focusing on firm specific
advantages
 Vernon (1966)
 concept of product life cycle into theories international trade
to explain the existence of international trade, production
and consequently capital flows
 Dunning (1981, 1986)
 Extended the framework of the OLI paradigm to develop the
investment development path (IDP) theory.

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Contd..
 Gastanaga, Nugent, and Pashamova (1998)
 Countries with relatively liberalized capital accounts tend to
attract more foreign direct investment flows.
 Feldstein (2000)
 Case of risk reduction through free flows in the international
capital by allowing the owners of the capital to diversify their
lending and investment
 Bosworth and Collins (1999) and Mody and Murshid
(2001)
 Near unitary correlation between FDI and domestic
investment.

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Methodology
 We define Growth as a function of
GROWTH= f(LABOUR, OPENNESS, EXCHANGE, CAPITAL,
GOVERNMENT, FDI)
Where
 GROWTH- Real GDP per capita
 LABOUR- Labour force in the economy
 OPENNESS- Export + Imports of the economy / 2
 EXCHANGE- Exchange rate
 CAPITAL- GCF as % of GDP
 GOVERNMENT- Government expenditure as % of GDP
 FDI- FDI inflows as % of Gross Capital Formation
International Conference on
Recent Developments in
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Delhi, Sep 8-12, 2008
 The regression equation is
GROWTH= α +β0 LABOUR+ β1OPENNESS+ β2
EXCHANGE + β3CAPITAL + β4GOVERNMENT +
β5FDI + Error

International Conference on
Recent Developments in
Economics, Hotel Hans New
Delhi, Sep 8-12, 2008
  Our analysis used the T-statistic to test our
hypothesis.
 We also used the co-relation study to
understand the relation between GDP and
FDI inward stock and also the relation
between FDI inflows and Gross Fixed Capital
Formation.
 We also made use of bar charts and
diagrams apart from the normal tools and
mean and standard deviation

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Proposition

 H0: There is no Impact of FDI on economic

growth

 H1: There is an Impact of FDI on economic

growth.

We further test it for developed and developing

countries separately

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
Data Description

 World Investment Reports of 2004 and 2005.

(published by United Nations Commission on
Trade and Development. )
 World Development Indicators
 World Resources Institute
(earthtrends.wri.org).

International Conference on
Recent Developments in
Economics, Hotel Hans New
Delhi, Sep 8-12, 2008
  Classified the countries into developed and
developing countries as per the classification
adopted by WDI databases.
 The time period of the data is between 1980-
2005.
 Our sample was initially 85 countries (25
developed and 60 developing). However in
some cases, the missing data resulted in a
final sample size of 76 countries (25
developed and 51 developing countries).

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Results of Analysis

10.000

8.000
Real gdp per capita

6.000

4.000 Fitted Values

Residuals
2.000 Real gdp pc
0.000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49
-2.000

-4.000
Developing countries

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 5.000

4.000
Real gdp per capita

3.000

2.000 Fitted Values

Residuals
1.000 Real gdp pc
0.000
1 3 5 7 9 11 13 15 17 19 21 23 25
-1.000

-2.000
developed countries

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Correlation Table
Developing countries
Labou Opennes Exchange Capital Govt FDI
r s
Labour 1.000
Openness -0.246 1.000

Exchange 0.002 -0.046 1.000

Capital 0.379 0.189 0.023 1.000

Govt -0.092 0.301 -0.218 -0.234 1.000

FDI -0.010 -0.086 -0.1000 0.157 0.005 1.000

 Correlation Table
Developed countries
Labou Opennes Exchange Capital Govt FDI
r s
Labour 1.000
Openness -0.060 1.000

Exchange 0.201 0.610 1.000

Capital -0.157 0.347 0.555 1.000

Govt 0.189 -0.093 -0.384 -0.576 1.000

FDI -0.101 0.278 -0.132 -0.058 -0.072 1.000

 Correlation Table
Real GDP &FDI as %of GCF
Developed countries Developing countries

Real FDI Real FDI

GDP per GDP per
capita capita
Real 1.000 Real 1.000
GDP per GDP per
capita capita

FDI 0.624 1.000 FDI 0.163 1.000

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Multiple correlation and
coefficient of Determination

R R2 Adj R2 S.E

0.6626 0.4390 0.3902 1.4332

Multiple correlation and
coefficient of Determination

Developed countries Developing countries

R R2 Adj S.E R R2 Adj S.E

R2 R2

0.754 0.569 0.510 1.480 0.667 0.444 0.259 0.660

6 4 7 7 0 9 8 5
 Multiple Regression Results
Samples Overall Constant Labour Openness Exchange Capital Govt FDI

(F-Value) (t-Value) (t-value) (t-Value) (t-Value) (t-Value) (t- (t-Value)

Value)

76 Significant Significant Significant at Significant Significant at

at at 10% los at 5% los
1% los 1% los 1% los

51 Significant Significant Significant at Signific Significant at

(Developin at at 10% los ant at 10% los
g) 1% los 1% los 1% los

25(Develo Significant Significant at

ped) at 5% los
10% los

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008
 Inferences and Scope for Future
Work
 The results of regression on growth provide
indicators of FDI influencing the growth.
 The influence however seems weak in case of
developing countries.
 Correlation between FDI and growth is stronger in
developed world as compared to developing world
 Capital formation does not show any significant
relationship with economic growth

International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008