jiang zihan
Post on 05-Apr-2018
230 Views
Preview:
TRANSCRIPT
-
8/2/2019 Jiang Zihan
1/70
Foreign Direct Investment and Its impacts on Economic
Growth: An Empirical study on China
PROGRAMME: Msc in International Banking and Finance
Jiang Zihan
DATE: 01/09/10
WORD COUNT: 14060
-
8/2/2019 Jiang Zihan
2/70
Abstract
Since 1980s, foreign direct investment (FDI) has experienced a dramatically increase in
the world. Compared to developed countries, the importance of FDI in developing
countries is even higher, although the total amount is less. China, as a leading country in
developing world, even experienced a more significant increase in FDI. Coming from the
planned economy, China now has become the largest FDI recipient country in the
developing world. Among numerous literatures, whether FDI could affect Chinese
economy in a positive or negative method continue to be debated. While theoretical
research tends to support that there is a positive correlation between FDI and economic
growth, empirical evidences appear to have different results. This dissertation extends the
previous study, adopting an econometric method based on data from Chinese provincial
level. It tends to support that although FDI indeed could be regarded as a crucial factor in
Chinese economic growth, its importance is not significant. In particular, when divide FDI
into different categories, manufacturing FDI appear to have significant positive impacts on
economic growth. Primary sector and service sector, however, have the negative effects.
Finally, it suggests that human capital could be regarded as an important factor in
economic growth and FDI inflows.
-
8/2/2019 Jiang Zihan
3/70
Acknowledgement
First and foremost I would like to warmly thank my supervisor, Dr Cline Azmar. Her
detailed comments, constructive suggestions, great patience and sincere encouragement
helped me to write my dissertation in a more systematic and comprehensive way.
I would also like to thank the academic staff at the Economics Department, University of
Glasgow, for their help during the whole year of my master study. Particularly, I have
benefited a lot from lectures given by Dr Luis Angeles, Dr Joe Byrne, and Dr Mario
Cerrato. Also, my gratitude extends to administrative staff in the department, particularly
to Christine Athorne, for her sincere help and support.
Finally, I would like to thank my parents, providing me this opportunity to study in this
great university. Thank all my friends and relatives, who have given me support.
-
8/2/2019 Jiang Zihan
4/70
Table of contents
Chapter 1. Introduction1
Chapter 2. Literature review4
2.1. Theoretical relationship4
2.1.1 Exogenous and endogenous economic growth theory4
2.1.2 Potential Channels5
2.2. Empirical evidence11
2.2.1 Empirical evidence in the world11
2.2.2 Empirical evidence in China15
2.2.3 Reasons for the debate21
Chapter 3. The role of FDI in Chinese economy 23
3.1. FDI inflows into China
23
3.2 Sectoral Distribution of FDI in China27
3.3. Economic growth in China30
-
8/2/2019 Jiang Zihan
5/70
Chapter 4. Methodology34
4.1. Model description34
4.2. Data description38
Chapter 5. Empirical Results and discussion41
Chapter 6. Conclusion47
Bibliography51
Appendix62
-
8/2/2019 Jiang Zihan
6/70
List of tables
Table 1. FDI to GDP ratio, 1970s 2000s, (%)32
Table 2. OLS panel data results estimations: 1998-200741
Table 3. OLS panel data results estimations: 1998-2007 (with interaction term)44
Table 4. Economic growth and FDI by sector: OLS results45
-
8/2/2019 Jiang Zihan
7/70
List of figures
Figure 1. Inward FDI inflows and cumulative FDI in 1992-200525
Figure 2. Percentage of total amount of cumulative FDI, 198527
Figure 3. Percentage of total amount of cumulative FDI, 200729
Figure 4. Real GDP and growth rate of China, 1992-200531
-
8/2/2019 Jiang Zihan
8/70
Abbreviations
EP Export Promoting
FDI Foreign Direct Investment
GDP Gross Domestic Product
HFDI Horizontal Foreign Direct Investment
IMF International Monetary Fund
IS Import Substituting
JV Joint Venture
MNEs Multinational Enterprises
OLS Ordinary Least Squares
UNCTAD United Nations Conference on Trade and Development
VAR Vector Auto Regression
VFDI Vertical Foreign Direct Investment
-
8/2/2019 Jiang Zihan
9/70
1
Chapter 1: Introduction
Foreign Direct Investment (FDI) can be defined as a category of international investment,
which reflects the objective of a resident in one economy acquiring a lasting management
interest in an enterprise from another economy. Generally, the lasting interest indicates
that the relationship between the direct investor and direct investment enterprise should be
long-term, and normally direct investor should occupy at least 10% of the ordinary shares
or voting power of an enterprise abroad (Patterson et al, 2004).
Since 1980s, levels of FDI began to increase dramatically, and now it is regarded as a
crucial source of investment for many countries. According to the data of UNCTAD
(2008), during the period from 1970s to 2007, FDI has experienced a dramatically growth
across the globe. In 1970s, the annual FDI inflows across the world only had US $
23.97billion, then it increased to US$ 92.70 billion in the 1980s, almost grew as much as
four times. After that, it kept growing and in the 1990s, it reached an annual average of
US$ 402.05 billion. During the period from 2000 to 2007, the average annual FDI inflows
reached US $ 1041.2 billion in the world. In particular, the data from OECD separated the
country to developed countries and developing countries, and it shows that the total share
in developing countries grew slightly faster than FDI inflows into developed countries,
indicating that FDI play a more significant role in developing countries.
-
8/2/2019 Jiang Zihan
10/70
2
Among developing countries, China has become the largest FDI recipient country since
1992. In 2002, China even surpassed US with inflows of US $ 53 million. Its FDI-GDP
ratio, which measures the significance of FDI, is also much higher than average level. At
the same period, China also achieved an impressive economic growth with an average rate
over 9% since 1980s. According to Zhang (2006), the achievement can be attributed to
FDI inflows to a great extent.
Due to the importance of FDI, this issue attracts numerous research, both on developed
countries and developing countries. Although the amount of literatures in this field seems
to increase in recent years, research focuses on impacts of FDI inflows on Chinese
economy is still limited, which may be mainly because Chinese government initiated the
open-door policy relatively late. Among the literatures based on China, systematic
treatments of the role of FDI in Chinese economy are still limited (Zhang, 2006). In
particular, most of the research based on China is largely descriptive, and very few studies
have conducted in empirical analysis. In addition, based on the existing literatures,
whether FDI inflows into China could have positive impacts is still controversy. For
instance, Wei (1994) believes that FDI indeed plays a dominant role in accelerate the
economic growth. Similarly, Chen et al (1995) finds FDI have some obvious positive
impacts on Chinese economy in their research. However, other researchers, such as
Braunstein and Epstein (2002), suggest that FDI inflows could not cause real economic
growth in China.
This dissertation attempts to investigate the relationship between FDI inflows into China
and its economic growth. There are two features characterize in this dissertation. First, as
-
8/2/2019 Jiang Zihan
11/70
3
most of the research based on Chins is largely descriptive, this dissertation adopts
econometric methodology, attempts to fill the gap by providing evidence on impacts of
FDI inflows on Chinese economy through quantitative assessment. Second, based on the
former literatures, the dissertation collect data in recent decade, from 1998 -2007.
Additionally, the estimation is made based on panel data, which could include more
information and makes the results more reliable.
To achieve this objective, this dissertation mainly includes 5 parts. In Chapter 2, in order
to better understand the former research, it will outline the main literatures on this issue. In
particular, this chapter will review the literatures in both theoretical and empirical
perspectives. It will first provide a description of exogenous and endogenous economic
growth theory, and then potential channels that FDI inward can stimulate economic
growth will be provided. After that, empirical evidences will be represented, including
China and other countries. Since the issue continues to be debated, the reason for this
debate will be briefly analyzed. Then in Chapter 3, the role of FDI in Chinese economy is
presented. It mainly states the different stages of FDI inflows and Chinese economic
growth in China. The differences of FDI distribution will also be presented. In Chapter 4,
methodology will be provided. It will establish an economic growth model with possible
variables, mainly based on the model of Zhang (2006), in order to investigate the
correlations between economic growth and other explanatory variables. The measurement
of data and its sources will also be introduced. After that, in Chapter 5, results will be
presented and it will provide an analysis based on the results. Finally, Chapter 6 will
provide a conclusion.
-
8/2/2019 Jiang Zihan
12/70
4
Chapter 2: Literature Review
The issue of whether foreign direct investment can be helpful for spur economic growth
has been one of the fundamental questions and it attracts a great deal of research, both on
developed countries and developing countries. Some are largely descriptive, supported by
statistical data, and others based on econometric analyses. However, it appears that this
issue still has been debated. This chapter attempts to provide some main influential former
literatures, including both theoretical and empirical perspective.
2.1 Theoretical relationship
2.1.1Exogenous and endogenous economic growth theory
To investigate the reason for economic growth, most of the early research follow the
exogenous economic growth theory, proposed by Solow (1956). Basically, the
accumulation of productive factors and the existence of diminishing returns are included
in the exogenous theory, in the form of production function. The production function
indicates that the amount of output could be produced by the various combinations of
inputs, mainly by capital and labor. In other words, the model uses such production
function to investigate how output grows with the inputs increases (Mare, 2004). Although
the model has great contribution to the economic study, as it predicts, the model could not
hold in long run. In case of FDI investigation, since the diminishing returns to the physical
-
8/2/2019 Jiang Zihan
13/70
5
capital, the impact of FDI on economic growth is constrained. In other words, FDI could
only exert a level effect on the growth per capita, rather than a rate effect (Falki, 2007). In
addition, treating FDI as exogenous variable could be problematic because it is possible
that although FDI could have impacts on economic growth, conversely, such growth in
host countries can also affect FDI.
In the contrast, the endogenous growth theory, proposed in 1980s, could provide a
framework for investigate the correlation between FDI and economic growth. According
to Johnsons (2006), by adopting endogenous growth theory, characteristics of FDI can be
taken into account and therefore the chances of confirming the theoretical correlation by
empirical evidence can be increased. Research on this field has explained various channels
of FDI affect economic growth, mainly including capital formation, trade, and technology
transfer.
2.1.2 Potential Channels
According to Lim (2001), although there is no consensus on the relationship between FDI
and economic growth, an increasingly number of recent literatures appear to support that
the correlation between them is positive, especially in theoretical perspective.
Theoretically, FDI inward can have positive effects on domestic economic growth via
several channels, mainly including capital formation, trade and technology transfer.
-
8/2/2019 Jiang Zihan
14/70
6
Firstly, it is argued that FDI inward could raise capital formation, and it can also create
more employment opportunities, which could be considered as the most direct effect
(Zhang, 2006). Since the inflows of investment into host country, capital will be generated
and industrial output can be increased. According to De Long and Summer (1991),capital
formation can be regarded as an essential economic input, which can increase the level of
economic growth in the long run. Balasubramanyam et al (1999) also claim that a low
level of capital formation could lead to low rate of growth and even become a barrier. In
case of China, Zhang (2006) suggest FDI inflows increase the investment at a negligible
level. The ratio of FDI inflows to gross domestic investment grew from 7% in 1992 to
17% in 1996. Moreover, the contribution of foreign invested enterprises to the industrial
output increased from 7% in 1992 to 36% in 2004, more than five times as much as
before.
In addition, since it is unlikely to bring a large number of labors from home country, it is
expected that more jobs will be created. In addition, the inflows of capital could also
generate tax revenue, which could alleviate the deficit pressure. Recently, based on the
research of Fiji, Singh and Jayaraman (2007) obtain similar results as Zhang (2006). They
argue that FDI indeed added domestic savings to Fiji, and cushioned them against current
account deficits. Moreover, it also creates more jobs, helped the domestic government to
reduce unemployment pressure. However, Johnson (2006) holds different view by
claiming that if foreign investment takes the form of brownfield FDI, it is common that
multinational corporations might reduce a substantial incumbent labour force as usually
done during privatisations. Therefore, he argues that FDI is not supposed to stimulate
economic growth through these aspects.
-
8/2/2019 Jiang Zihan
15/70
7
Furthermore, it is claimed that FDI inflows could stimulate economic growth through
promoting manufacturing exports. The most debated issue in this field might be whether
the relationship between FDI and international trade is substitution or complementary. To
discuss the relationship, it is necessary to classify the two types of FDI. According to the
motivation of firms for affiliate operations abroad, FDI can be classified as two types,
horizontal FDI (HFDI) and vertical FDI (VFDI). VFDI refers to the case where a firm
attempts to pursue FDI in order to take advantages of international differences, often by
locating their labor-intensive process abroad and keeping capital-intensive input
production and knowledge-intensive designing in home country. In other words, firms try
to locate different stages of production in different countries, which could probably reduce
the costs and provide more benefits. On the other hand, HFDI arises when a firm can
reduce their trade costs by establishing foreign affiliates abroad. Unlike VFDI, firms often
almost duplicate roughly the same activities as parent firm when conducting HFDI (Lee et
al, 2005). Therefore, it can be argued that the trade costs and the access to local markets
are the main motivation for firms to choose HFDI.
Since the different types of FDI, the relationship between FDI and trade can also be
different. Based on the assumption of similar condition between the home country and
host country, Brainard (1993) claims that whether to choose HFDI or trade depends on the
tradeoff between proximity and concentration. If countries differ in conditions, such as
market size, or technology level, and if disadvantaged countries develop, advantaged
countries tend to establish subsidiaries. As the development of host and home countries,
they could become more similar. It is possible that multinational production will substitute
-
8/2/2019 Jiang Zihan
16/70
8
for trade when the countries become similar (Brainard, 1997). Moreover, Blonigen (2001)
argues that if a firm has intangible assets, such as advanced technology or managerial
skills, which are impossible to export, the relationship between FDI and trade can be
considered as substitution. Because it is unlikely to properly appropriates rents from such
assets through contracts with a third-party, which leads the corporations to establish their
own facilities abroad. In addition, when there are sufficient transaction costs on exporting
or licensing, FDI also could replace international trade (Blonigen in Lee et al, 2005).
While traditional trade theory seems to support substitution relationship, more literature
appears to suggest a complementary correlation between FDI and international trade (Lee
et al, 2005). For instance, when a firms production presence in a foreign market with one
product can increase total demands for all products, the relationship between them can be
considered as complementary. In other words, it is possible that the presence itself could
help the firm to know more about the market, and then can tilt customer preferences.
Therefore, it could be concluded that the linkages between FDI and trade are still complex
and unpredictable. Blonigen (2001) argues that both relationships could make sense.
Dunning (1998) suggests that the relationship between them is conditional on both type
and place. Petri (1994) classifies investments into three types, which are market-oriented
investments, production-oriented investments, and trade-facilitating investment. Since
production-oriented investments are attracted to low cost sites and trade-facilitating
investment are motivated by the need to provided services to exporting activities, they
tend to increase trade. Market-oriented investments, however, tend to substitute trade.
-
8/2/2019 Jiang Zihan
17/70
9
In case of China, Zhang (2006) argues that the most prominent contribution of FDI is the
expansion of Chinas manufacturing exports. What is more, he claims that FDI inflows not
only increase the volume of exports, but also upgrade its export structure. Zhang (2006)
argues that in 1980, Chinas exports ranked as the 26th in the world, with the volume of
US $ 18 billion and 47% of them are manufactured goods. With the development of FDI
inflows, in 2005, the volume increased to US $ 762 billion and 93% as manufactured
goods, ranked in the 3rd place in the world.
Among all the channels that FDI inflows could possibly stimulate economic growth,
technology transfer and spillover effects may be considered as the most influential
channel, especially for developing countries and transition economies. According to
Stanisic (2008), technology transfer and the so-called spillover effects, which refer to FDI
inflows bring a technological boost and then spread through the whole economy, play an
important role in economic growth. He argues that this knowledge diffusion can lead to
improvements in local through several ways. For instance, local firms could copy
advanced technology from multinational corporations directly. Additionally, this
technology from foreign firms could increase the competition pressure in host countries,
which could force the local firms use the existing technology and resources in a more
efficient way, or they might also be forced to innovate. Multinational enterprises (MNEs)
could also bring new know-how and managerial skills to host countries, and this could
also have spillover effects. As people leave the corporations, they leave with the know-
how and knowledge they accumulated, which could also benefit domestic industry and
increase the productivity. This is consistent with the argument of Johnson (2006), who
-
8/2/2019 Jiang Zihan
18/70
10
claims that technology spillovers from MNEs to domestic markets provide the most
significant and positive relationship between FDI inflows and economic growth. In case of
China, Huang (1995) claims that FDI has induced Chinese economic growth and
introduced advanced operation and management experiences, especially the advanced
technologies.
However, some researchers seem to hold the opposite view, they argue that rather than
promote technology level in host countries, it could have crowding out effects on host
countries. For instance, it occurs when domestic corporations are not able to compete with
these foreign firms, which with more advanced technology and managerial skills.
Additionally, since foreign corporations usually have higher wage levels for their
employees, this might force domestic firms to increase their wage in order to attract
capable employees. However, it is possible that domestic firms cannot cover the wage
increase with the growth of productivity, which may lead to the reduction of their
competitiveness. As a result, foreign enterprises might possess the monopoly position in
the market and domestic firms could be crowded out of the market. In case of China,
Zhang (2006) have similar results, and he claims that since foreign enterprises might
possess the dominance position in the market, their management know-how and advanced
technology might in fact inhibit developing local resources.
-
8/2/2019 Jiang Zihan
19/70
11
2.2 Empirical evidence
2.2.1 Empirical evidence in the world
Existing empirical studies attempt to examine whether FDI inward could affect economic
growth on host countries and the extent of the impacts adopt different estimation methods
and data, and therefore it is not surprising that results are still controversy. Based on a
sample of 46 developing countries, Balasubramanyam et al (1996) examine the
relationship between trade strategy, FDI and economic growth in developing countries in
the context of new growth theory. Following the hypothesis proposed by Bhagwati (1978),
which claims that the volume and efficacy of FDI inward could be vary according to
different trade strategies. Balasubramanyam et al (1996) classify trade strategies as two
types. Export promoting strategy (EP) could be defined as one that average effective
exchange rate on exports and imports are roughly equated. In other words, EP strategy
could be considered as trade neutral or bias free. In contrast, import substituting strategy
(IS) is the one that effective exchange rate on imports exceeds effective exchange rate on
exports, which means it is biased on import substitution activities. By characterising
different trade policy regimes and adopting cross-section data and OLS regression,
Balasubramanyam et al (1996) concludes that for those countries adopts EP strategy, FDI
has a positive effects on economic growth. However, for countries adopt IS strategy, the
relationship between FDI and economic growth is weaker.
-
8/2/2019 Jiang Zihan
20/70
12
Similarly, research conducted by Agrawal (2000) focuses on five Asia countries: India,
Pakistan, Bangladesh, Sri Lanka, and Nepal. By undertaking time-series cross-section
analysis, He finds that the impact of FDI inflows is negatively related to GDP growth rate
before 1980. Then the relationship is positive for early 1980s and becomes increasingly
positive in late 1980s and early 1990s. He also proposes some possible explanation for the
change. In 1960s and 1970s, most South Asian countries followed the IS policies and had
a high import tariffs. Then in the following decade, most countries began to largely
abandon these IS policies in favor of more international trade. This is consistent with the
result obtained by Balasubramanyam et al (1996). Besides, Kohpaiboon (2004) conducts
his research based on the data from Thailand during the period from 1970-1990 and
obtains similar results. He suggests that impacts of FDI on economic growth in EP trade
regime appear to be greater than import substitution regime.
Borensztien et al (1998) also make the research based on developing economies, utilizing
data from 69 developing countries in a cross-country regression framework. Compared
with above research, they emphasize the role of technology transfer on economic growth
rather than the different trade strategy. Based on the data, they suggest that compare to
domestic investment, FDI is a significant vehicle for technology transfer, contributing
more to the economic growth. In addition, the most robust finding of their research is that
the extent of effect of FDI on economic growth relies on the amount of human capital
available in the host countries. They find a strong positive interaction between FDI and the
level of educational attainment, which is not significant in domestic investment. In other
words, FDI could only have positive effects on economic growth if there is sufficient
human capital available in host countries. This result is consistent with the research
conducted by Olofsdotter (1998). His regression results suggests that the positive effects
-
8/2/2019 Jiang Zihan
21/70
13
of inward FDI are stronger in countries with a higher level of institutional capacity, as
measured by the degree of property rights and bureaucratic efficiency in host countries.
Moreover, both Blomstrom (1986) and Kokko (1994) adopt econometric method and find
positive correlation between FDI and economic growth in Mexico. In addition, Sjoholmn
(1999) suggest similar results based on the data from Indonesia. Bengos et al (2003)
analyse a sample of 18 Latin American countries from 1970-1999 and their result also
show a positive relationship between FDI and economic growth, as long as the host
country has adequate human capital, economic stability and liberalized markets.
More research appears to emphasize the importance of human capital. According to
Borensztein et al (1995), host countries receiving FDI have to achieve a certain level of
human capital. Since if the level is relatively low, it is difficult for countries to initiate and
operate advanced technologies, and new managerial skills could also be restricted, which
means that low level of human capital can become the barrier for the economic
development in host countries. Nelson and Phelps (1966) explain that education could
enhance ones ability to receive and understand information, which is important for the
performance in the job. As a result, knowledge transfer and diffusion can spread to the
whole economy, and therefore enhance the economic development. Furthermore,
Balasubramanyam et al (1999) claim that FDI can be beneficial to the economic growth in
host countries if appropriate supplementary measure are adopted, rather than entirely
relying on the positive spillover effects of FDI.
-
8/2/2019 Jiang Zihan
22/70
14
Empirically, Borensztein et al (1995) find that FDI can have significantly positive impacts
on economic growth if the human capital level in host countries is above a certain level.
Similarly, Keller (1996) also suggests that economic growth rates could not be increased if
the level of human capital remains unchanged. His model shows that host countries with
low level of human capital could constrain the ability to take advantages of advanced
technologies from foreign enterprises. Research conducted by Glass and Saggi (1998)
have similar results. By constructing study in a cross-country level, they suggest that areas
with higher quality of educated labors are more likely to take advantages from positive
spillovers effects from FDI. Therefore, it could be concluded that human capital plays an
important role in economic growth.
Although there are numerous literatures arguing that FDI inflows can have positive effects
on host counties economic growth, it still cannot be concluded that there is universe
relationship between FDI and economic growth (Lipsey, 2003). An early literature doubts
the positive correlation might be the research conducted by Brecher and Alejandro (1977),
they provide evidences and argue that foreign capital can lower the economic growth
because a country will earn excessive profits with severe trade distortions, such as high
tariffs. Similarly, Aitken and Harrison (1991) can only find a limited correlation between
FDI and economic growth in Venezuela. Additionally, based on the data from 32
developed and developing countries during 1970 to 1990, De Mello (1999) utilizes time
series, but he can only find weak relationship between FDI and economic growth.
In addition, Zhang (2001) uses data from 11 developing countries in Latin America and
East Asia, and he finds 5 out of 11countries in the sample has positive relationship
-
8/2/2019 Jiang Zihan
23/70
15
between FDI and economic growth, however, they are conditioned by trade regimes and
macroeconomics stability. Furthermore, Choe (2003) finds little evidence to prove FDI
can cause host country economic growth.
Furthermore, another important research in this field is conducted by Cakovic and Levine
(2002), they collect the data covering 72 developed and developing countries.
Methodologically, they adopt both OLS regression and dynamic panel procedure with data
averaged over five year periods during the period from 1960 to 1995. After the analysis,
they cannot find any robust linkage between inward FDI and host countries economic
growth.
2.2.2Empirical evidence in China
Since China operated its open-door policy relatively late, literatures on this field is limited,
especially for the empirical analysis. Wei (1994) might be the first researcher attempt to
analyses this issue by econometric measures. Since China has only experienced 12-year
reform, it is difficult to do the statistical analysis based on limited aggregate observations.
In order to make the results more reliable, Wei (1994) employs the city level data, 434 and
74 cities in two data sets respectively, covering the period from 1980 to 1990. He claims
that there is clear evidence that more exports are positively correlated with the higher
growth rate across Chinese cities during 1980 to 1990. In particular, in the late 1980s, the
contribution to Chinese economic growth mainly comes from foreign investment, mainly
-
8/2/2019 Jiang Zihan
24/70
16
in the form of technological and managerial spillover effects, as opposed to infusion of
new capital. In addition, he also explains the reason for the faster growth rate in coastal
cities than national average. He suggests that the extra growth rate comes almost entirely
from their ability to attract more foreign direct investment and effectively utilization of
those investments. In other word, after taking into account of the growth rate of labour,
physical capital and human capital, Wei (1994) believes that FDI indeed plays a dominant
role in accelerate the economic growth.
In the same period, there are also other literatures focus on the association between FDI
and economic growth in China. For instance, Mody and Wang (1997) adopts data on 23
industrial sectors in seven coastal regions over the period from 1985 to 1989, attempting
to investigate the correlation between FDI and economic growth. Overall, they find that
industry-specific features, which measure the degree of specification and competition,
could only explain a limited portion of variance in economic growth. Compared to this,
much of the growth comes from regional specific influences and regional spillover effects.
They explain that regional influences mainly contain the open door policies and specific
economic zones that successfully attracted investment. In particular, they emphases that
existing regional strengths, especially the high-quality human capital can play an
important role in economic growth. Even a higher percentage of secondary school
enrollment rates have a significant contribution to the economic growth.
In addition, Chen et al (1995) argue that FDI has some obvious positive impacts on
Chinese economy. For instance, it contributed to economic growth through augmenting
resources available for capital formation. In addition, FDI also expand Chinese exporting
-
8/2/2019 Jiang Zihan
25/70
17
volume, and advanced technology and managerial skills from foreign enterprises also have
contribution to domestic economy. Although FDI may entail some political risks in China,
its overall impacts should still be viewed as beneficial. Moreover, by using the traditional
regression model and panel data, Sun (1998) argues that there is a significantly positive
relationship between FDI and domestic investment. This indicates that FDI can increase
the exports demand from host countries, which could attract more investment in the export
industries. This result is consistent with the research by Shan (2002). He uses a Vector
Auto Regression (VAR) technique of innovation accounting to analyses the various
interrelationships between FDI, industrial output growth, and other economic variables in
China. He suggests that there is a significant positive impact of FDI on Chinese economy
when ratio of FDI to industrial output increases.
Most early literatures tend to support that FDI could be beneficial to Chinese economy
through several different ways. However, some doubts have generated about their research
in the following years. According to Wei and Balasubramanyam (2004), there is a
common problem in most early studies in China, including Wei (1994), Chen et al (1995),
Mody and Wang (1997), and Sun (1998). They treat FDI as an exogenous variable in the
regression models. Demurger and Berthelemy (2000) have the same doubts. They argue
that most of the former research based on the hypothesis, which is fundamental in
statistical terms, that the explanatory variables are exogenous. In particular, they fail to
propose the possible existence of reciprocal correlation between FDI and economic
growth. However, it is possible that although FDI could have impacts on economic
growth, conversely, such growth in host countries can also affect FDI. According to Wang
and Swain (1995), the principle determinants shaping FDI in China during the 1980s is its
economic conditions and characteristics of labour markets. Zhang (1995) has consistent
-
8/2/2019 Jiang Zihan
26/70
18
results as Wang and Swain (1995), and therefore, it can be concluded that the size of
China, including its land area, population, GDP level, makes itself an attractive market.
As discussed above, FDI could have positive impacts on Chinese economic growth, at the
same time, China in turn becomes an attractive environment to foreign enterprises. Zhang
(1999) and Shan et al (1999) all find a bi-directional correlation between FDI and
economic growth. (Zhang (1999) and Shan et al (1999) in Wei and Balasubramanyam,
2004). In addition, to avoid an ad hoc specification of the intermediate-sector function,
Demurger and Berthelemy (2000) estimate a simultaneous equation model, taking into
account the dynamics between FDI and economic growth. By colleting the data from 24
Chinese provinces covering the period from 1985 to 1996, they confirm that FDI indeed
has played a fundamental role in Chinese economic growth, although the magnitude of
FDI is small, and they also emphasis the importance of potential for future growth in
foreign investment decisions. Furthermore, a new important evidence is found in their
research. By using an original variable reflecting the stock of primary and secondary
educated people, they suggest that human capital may contribute to economic growth
when it adopts foreign technologies. Finally, they find that when both exports and foreign
investment are introduced in the growth regression, direct impacts of exports tend to
disappear. This is contrast with the work of Prime and Park (1995), who find support
evidence that exports growth contributes income growth in China (Prime and Park (1995)
in Demurger and Berthelemy, 2000).
Husain and Anuradha (2000) adopt a different method to measure the correlation between
FDI and economic growth. They separate the data set into three sub-periods, and then
-
8/2/2019 Jiang Zihan
27/70
19
conduct the panel study, attempting to identify possible structural variations over time.
They separate the period into 1978-1997, 1983-1997, and 1988-1997. They conclude that
during the period from 1993 to 1997, the relationship between FDI and economic growth
appears to be positive and the result tends to be more significant than other periods. From
1988 to 1992, the correlation is not significant. Similarly, Zhang (2001) uses the same
method. In his research, over the periods of 1984-1988, 1989-1993, and 1994-1998, with
the increase in FDI, the impact of FDI on economic growth in China tends to increase in
response.
Despite the proponents, who tend to support that FDI could have positive impacts on
Chinese economic growth, there are also some opponents of FDI, who believe FDI can be
detrimental to Chinese economy. A representative research in this view can be considered
as Braunstein and Epstein (2002). To test the correlation between FDI and economic
growth, they choose four variables, which are wages, job creation, investment and tax
generation. They collect the data from 1986 to 1999, running a panel regression model
analysis on provincial level data. They argue that contrary to the former conventional
supportive evidence, they find that FDI inwards could crowd out domestic investment in
China. Rather than providing significant positive relationship between FDI and economic
growth, they find that FDI has relatively small positive impacts on wage levels and
employment opportunities. However, inward FDI is negatively correlated with domestic
investment and total tax revenue.
Furthermore, Huang (2003) analyse this issue through the legislative and regulatory
perspective. After his research, he believes that the legislative development for foreign and
-
8/2/2019 Jiang Zihan
28/70
20
domestic firms occurs at a very different pace. He argues that in many significant aspects,
the legislative and regulatory framework developed for foreign enterprise appears to be
superior for domestic firms, especially for domestic private firms. In other words, Huang
(2003) believes that Chinese investment policies are more friendly to foreign enterprises
than to domestic firms, and therefore foreign enterprises has a better business
circumstance. As a result, Chinese partners are more eager to organize firms with foreign
investors, and these types of firms can exploit preferential policies and even possess
privileges in competing for local scarce resources. Consequently, in this perspective, it is
possible that FDI will crowds out domestic firms (Selvanathan et al, 2008).
Recent influential literatures include Zhang (2006), Selvanathan et al (2008), Hu (2008)
and Mah (2010). Zhang (2006) develops a growth model, collecting provincial data
covering the period from 1992 to 2004. Similar as Husain and Anuradha (2000), he also
separates data sets into three sub-periods. He finds a favorable impact of FDI on Chinese
economy growth rate, measured by Chinese real GDP growth rate in all three sub-periods.
Furthermore, he points out that FDI inward appears to positively affect Chinese economic
growth through direct effects, such as expanding export volumes and promoting domestic
productivity. Other positive externality effects, including facilitating transition and
technology transfer also play an important role in economic growth. During the period he
has researched, impacts of FDI have increased and the effects on costal regions seem to be
greater than inland area.
Moreover, Selvanathan et al (2008) attempt to investigate the causal linkage between FDI,
domestic investment and economic growth. By adopting the data from China from 1988 to
-
8/2/2019 Jiang Zihan
29/70
21
2003, they use the VAR system with error correction model and innovation accounting
technique. Rather than the crowding out effects proposed by Braunstein and Epstein
(2002) and Huang (2003), they find FDI has a complementary relationship with domestic
investment. Therefore, they argue that FDI can have positive effects on Chinese economic
growth, not only through overcoming the shortage of capital, but also through
complementing domestic investment in China. Based on the results they have found, they
suggest that less-developed countries should encourage and promote FDI inflows, and at
the same time, appropriate policies and regulations are also required.
A more recent research conducted by Mah (2010) seems to have opposite results as Zhang
(2006) and Selvanathan et al (2008). Their empirical results suggest that FDI inflows
could not cause real economic growth in China, while in turn Chinese economic growth
appear to have positive effects on FDI. He claims that compared by FDI, other reasons,
such as export, private property rights, and smooth transition tend to have more important
effects on economic growth in China.
2.2.3 Reasons for the debate
Because of the adoption of different methodologies and analysis approaches, empirical
evidences have shown that the debate on the impacts of FDI on economic growth is far
from being conclusive, and FDI inflows can have positive, insignificant, or even negative
impacts on economic growth in host countries. According to Ali (2010), a possible
explanation of the mixed results is that not all types of foreign investment can provide
-
8/2/2019 Jiang Zihan
30/70
22
positive impacts on host country economic growth. One important research in this field
can be considered as Alfaro (2003).
By adopting cross-country data covering the period from 1981-1999, she conducts her
study on FDI inflows into different sectors, including primary sector, manufacturing sector
and services sectors, and she finds different results for each sector. She argues that FDI
inflows into the manufacturing sector tend to have a positive effect on economic growth,
while FDI inflows into primary sector appear to have negative impact. Evidences of FDI
inflows into services sector tend to be ambiguous. Therefore, it is concluded by Alfaro
(2003) that benefits of FDI varies greatly across different sectors.
Another important explanation for the mixed results is the absorptive capacity. In other
words, not all host countries have the ability to fully reaping positive externalities offered
by FDI (Ali, 2010). The term absorptive capacity contains several factors, such as
human capital, degree of financial management, level of economic development. Teece
(1977) argues that due to the high absorptive capacity in well established firms, they are
more likely to benefit from the positive impacts from FDI inflows. However, there also
exist some doubts about this explanation. For instance, Carkovic and Levine (2005) argues
in their research that even taking into account the role of the absorptive capacity, it cannot
be helpful for reduce the inconclusiveness of the correlation between FDI inflows and
economic growth.
-
8/2/2019 Jiang Zihan
31/70
23
Chapter 3: The role of FDI in Chinese economy
3.1 FDI inflows into ChinaIt is claimed that China plays a leading role in the developing countries. Coming from the
planned economy, China has experienced a series of changes in economy. For the FDI
development in China, it could be classified as four main stages: the experimental stage
(1979-1983); the growth stage (1984-1991); the peak stage (1992-1993) and the
adjustment stage (1994-present) (Wei and Liu, 2001).
During the early stage, China began to operate the reforms and formulated the open-up
policy in 1979, aimed at attracting foreign capital, advanced technologies and
management skills to upgrade the industry structure and stimulate economy. However, it
enacted and promulgated a series of regulations and laws governing FDI (Wei and Liu,
2001). Moreover, due to both the ideological reasons and lack of experiences, FDI inflows
into China were fairly low at the beginning, with only a total of US $ 1.8 billion in three
years from 1979-1982. In 1983, the total volume of FDI inward was only US $ 0.9 billion.
What is more, at this period, the FDI inflow into China had large limitation in both
geographical and industry. For instance, it only concentrated in four specific economic
zones such as Guangdong and Fujian Provinces, and only joint venture (JVs) type and
export-oriented industry can be focused by foreign investors (Wei and Balasubramanyam,
2004). For the provinces in other regions, however, FDI inflows are still at limited level.
According to Coughlin and Segev (2000), the non-convertibility of Chinese currency,
-
8/2/2019 Jiang Zihan
32/70
24
difficulties in accessing Chinese market become the barrier in deterring the foreigners
investing in Chinese market.
After the experimental stage, after recognizing the potential benefits of FDI, Chinese
government operated a number of measures and established a series of laws and
regulations to improve the business environment and attract foreign investment, which
pushed China into the growth stage. In 1984, rather than focusing on four specific
economic zones, the Central Committee of the Communist Party and the State Council
decided to open 14 more costal port cities, including Dalian, Qinhuangdao, Tianjin,
Yantai, Qingdao, Lianyungang, Nantong, Shanghai, Ningbo, Wenzhou, Fuzhou,
Guangzhou, Zhanjiang and Beihai. They are chosen because at that period, these 14 cities
are the more prosperous areas in China. The main purpose to open these cities is to
attracting foreign funds, improving the markets, updating the existing technologies, and
strength the competitive abilities of domestic firms (Wei and Liu, 2001). As a result,
during this period, China has experienced a steady increase. The total volume of FDI
inflows grew from US $ 1.4 billion in 1984 to US $ 4.4 billion in 1991, with an average
annual growth of 20% (Wei and Balasubramanyam, 2004).
Between 1992 and 1993, due to Deng Xiaopings tour of southern provinces and the
openness of new sectors and areas for FDI, China stepped into the peak period,
experienced a surge of FDI inflows. Figure 1 below represents the FDI inflows and
cumulative FDI of China, covering the period from 1992 to 2005. It can be seen from the
table, in 1992, 132,201 enterprises with foreign investment were approved by Chinese
government and the total volume of realised FDI inflows attained US $ 11 billion, which
-
8/2/2019 Jiang Zihan
33/70
was nearly three times as much as the previous year (Wei and Liu, 2001). In 1993, the
figures for contracted FDI and realised FDI even exceeded the total number of previous 13
years, with a 150% growth rate.
Figure 1. Inward FDI flows and Cumulative FDI in 1992-2005
Sources: Zhang, (2006)
From 1994 onwards, the growth rate FDI inflows began to decline. The total number of
new projects decreased around 40%, from 83, 437 in 1993 to 47, 594 in 1994. (Wei and
Balasubramanyam, 2004). Wei and Liu (2001) try to explain the reasons for the decrease.
They argue that the first reason for the decline might be the increasing competition from
other countries. For instance, Vietnam, Laos, India, Pakistan, and other central and eastern
European transition economies all provided attractive business environment to absorb FDI
(Jiao, 1998 in Wei and Liu, 2001). Second, the State Council announced in 1995 that for
25
-
8/2/2019 Jiang Zihan
34/70
26
imported machinery, equipment, and other materials from foreign enterprises, it would be
re-imposed the duties. Zhang (1998) argues that such changes in taxes system inevitably
discouraged new foreign investors into Chinese market, and the reinvestment of existing
enterprises would also decline due to the increase of taxes. What is more, in order to
change the structure of FDI inflows into China, government classified FDI into three
categories, including encouraged FDI, restricted FDI and forbidden FDI (Wei and Liu,
2001). This classification would also discourage foreign investors from entering into
Chinese markets.
Although the growth rate seemed to fell since 1994 to 1999, its total volume still kept
growing, and it reached US $ 46.9 billion in 2001. Nowadays, China has become the
largest recipient in developing countries and the second largest in the world. Particularly,
in 2002, it even surpassed US, and by the end of 2005, the accumulated FDI inflows in
China have reached US $ 622 billion (Zhang, 2006). The most recent report from Ministry
of Commerce of China shows that by the end of April, 2004, 7506 more foreign
enterprises establish investment in China, and the volume of FDI inflows increased
11.28% as compared with the same period in last year (Ministry of Commerce of China,
2010).
-
8/2/2019 Jiang Zihan
35/70
3.2 Sectoral Distribution of FDI in China
Although the volume of FDI inflows in China keeps increasing since China have
conducted the open-door policy, the structure of FDI seems to be problematic. Figure 2
below shows the sectoral distribution of FDI in the first two periods.
Figure 2. Percentage of total amount of cumulative FDI in 1985
Percentage of total amount of cumulative FDI in 1985
48%
36%
14% 2%
Energy exploration, transport service, metallurgy, manufacture of machinery,
electronics, chemicals, telecommunication equipment, construction materials
Light industries, textiles, foodstuffs, pharmaceuticals
Tourism and service industry
Agriculture, animal husbandry, fishery, forestry
Source: Chu (1987), in Wei and Liu (2001)
27
-
8/2/2019 Jiang Zihan
36/70
28
It can be seem from the figure 2 that the investment into the hotels and buildings in
tourism and service sector possesses the leading position, with nearly half amount of the
total volume of investment. Compared to the large portion of FDI in service sector, FDI
into other sectors tend to be small. Energy explorations, manufactory of machinery,
electronics, and raw materials industry were the industries that Chinese government most
encouraged. However, FDI inflows into those sectors only possessed 36% of the total
amount. What is worse, the primary sector, including agriculture, animal husbandry,
fishery and forestry industry, accounting the smallest portion of total FDI inflows, which
is only 2%.
According to Wei and Liu (2004), the reasons for the dominance position of tourism
service industry can be attributed to the encouragement of Chinese government. Since
China just opening up to the outside world, there is a significant shortage of suitable hotels
and apartments. In order to attract more foreigners for business, Chinese government made
more efforts in this industry to accommodate the potential investors. As a result, surplus
high level hotels and apartments were built in Beijing and Shanghai, and even more in
Shenzhen and Guangzhou.
After realizing this problem, Chinese government readjusted the structure of FDI in China.
Rather than encouraging tourism service industry, they made more efforts to attract
foreigners to the technically advanced enterprises and export-oriented industries (Wei and
Liu, 2004). Due to the new policies and encouragements, the structure of FDI inflows
changed in the following periods. For instance, the total amount of FDI inward into
-
8/2/2019 Jiang Zihan
37/70
manufacturing sectors increased from less than 50% in 1985 to 60%, 75%, 85% in the
following three years, respectively (Wang, 1990).
During the last decade, the distribution of FDI inflows into China has become more
reasonable. Figure 3 below shows the distribution of FDI inflows into China in 2007. It
can be seen from the figure 3 that manufacturing sector, including construction, gas and
electricity and other manufactory industry still in the leading position, accounting for more
than half of the total amount of FDI. Service Sector is in the second place, including
transportation service, education, financial sectors, and other main service sectors. The
total amount of FDI inflows into this sector is around US $ 300 billion in 2007, possesses
about 40% of the total amount. Finally, FDI inflows into the primary sector are still low.
Only 2% of the total FDI amount inflows into this sector (National Bureau of Statistics of
China, 2008).
Figure 3. Percentage of total amount of cumulative FDI, 2007
Percentage of total amount of cumulative FDI, 2007
58%
40%
2%
Service sector
Primary sector
Manufacturing sector
Source: China Statistical Yearbook, (2009)
29
-
8/2/2019 Jiang Zihan
38/70
30
3.3 Economic Growth in China
Since the open-up to the outside world policy, China has achieved an impressive economic
growth. Measuring the economic size, china is surpassed today only by US, Japan,
Germany and France. It is estimated that its share in global growth during 1995 to 2002 is
around 25% (Holz, 2005). Additionally, China is also the nation with the largest exporter
and the second importer of goods. Considered the GDP growth rate, the statistics seem to
be more pervasive. Figure 2 shows the Chinese real GDP and its growth rate from the
period 1992 to 2005. According to IMF (2009), in 1980, the beginning of Chinas
economic reform, its GDP only has US $ 309. In that period, China has even experienced
several times of decrease of GDP. Then in the following years, it can be seen from the
figure that GDP grew steady, with an average growth rate of 9.37% every year. According
to the latest statistics from National Bureau of statistics of China, GDP of China in 2009
attained US $ 4757.743 billion, with a growth rate of over 9%. Now, China has become
the worlds fastest growing major economy. Based on the data of last few decades, it is
forecasted that Chinese economy will keep growing in the following years and it might
surpasses US in purchasing power terms between 2012 and 2015. It is also predicted that
by 2025, China is likely to be the largest economic power by almost any measure in the
world (Holz, 2005).
-
8/2/2019 Jiang Zihan
39/70
Figure 4: Real GDP and growth rate of China, 1992-2005
(Source: Zhang, 2006)
According to Zhang (2006), the achievements in Chinas economy growth could be
attributed to the adoption of the encouragement of inward FDI to a great extent. One
method to illustrate the significance of FDI is to measure the FDI to GDP ratio. Table 1
below demonstrates FDI to GDP ratio in the world, developed countries, developing
countries, and China, covering the period from 1970s to 2000s. It can be seen that in
1970s, globally, increased from 0.46% in the 1970s to 2.57% in the 2000s. In particular,
the data also shows that the ratio of developing countries is slightly higher than the ratio of
developed countries in all the periods, which implies that although developing countries
have lower total volume than developed countries, its significance of FDI inflows to their
local economies is higher. The last column shows the data of China. Since China operated
open-door policy in last 1970s, the first data cannot be accounted. In 1980s, although the
ratio is still below the average ratio in developing countries, it already surpasses the
31
-
8/2/2019 Jiang Zihan
40/70
32
average ratio of developed countries. Then in 1990s, the peak period, the ratio grew to
3.77%, almost six times as much as the last decade. Compared to other countries, its ratio
is significantly higher. In 2000s, although the ratio is slightly lower than 1990s, it is still
higher than other countries, in the leading position.
Table1. FDI to GDP ratio, 1970s-2000s, (%)
World Developed
Countries
Developing
Countries
China
1970s 0.46 0.43 0.61
1980s 0.64 0.62 0.72 0.63
1990s 1.4 1.25 2.08 3.77
2000s 2.57 2.38 3.12 3.52
Source: UNCATD World Investment Report (2008), China Statistical Yearbook (2009)
In response to the issue of whether FDI can affect economy growth and how deeply the
impacts are, an increasing number of literatures have appeared to developing and testing
the theories. Although there is a great deal number of literature concerning about FDI and
its impacts on economic growth on host countries, literatures focused on FDI inflows into
China and its effects are still limited, which might be mainly because China started its
opening-up policy is relatively late. In particular, very few of these literatures attempt to
test the issue empirically (Zhang, 2006). Moreover, based on the existing research, the
results of this issue are still debated. Although most literatures seem to support that FDI
have positive effects on economic growth, there are still some research find negative
-
8/2/2019 Jiang Zihan
41/70
33
relationship between them, and some researchers cannot find significant correlation.
Therefore, more research needed to be made to examine the role of FDI on Chinese
economy, especially in a quantitative method.
-
8/2/2019 Jiang Zihan
42/70
34
Chapter 4: Methodology
This chapter attempts to establish a model based on the former research, to investigate the
relationship between FDI inflows and economic growth in China. It also provides a brief
description about the collection of data.
4.1 Model description
In order to investigate the contribution of FDI inflows to the Chinese economic growth, a
growth model is established to analyse. It mainly base on the work conducted by zhang
(1996). Following the standard procedure of former literatures, the data is taken by natural
logarithm form. By including the constant term 1 and an error term , the benchmark
model specification is obtained in the following form, which describes the main basic
determinants of the economic growth rate:
Growth =1 + 2L+ 3 Inv + 4 FDI + (1)
In this model, Growth is the dependent variable, denotes the average economic growth,
measured by the average of GDP per capita growth. L denotes the labor input, which is
claimed to be helpful for promote the total productivity and therefore boost the economic
growth. Its coefficient2 represents the labor output elasticity.
-
8/2/2019 Jiang Zihan
43/70
35
Inv denotes the domestic investment, which is measured by the share of gross fixed
capital formation in GDP. It is taken into account since it is a key determinant of
economic growth (De Long and Summer, 1991). They suggest that capital could be
considered as an essential economic input, and it is also a crucial factor for achieving
increasing levels of long-run economic growth. This is confirmed by Klenow and Clare
(1997), and they claim that capital can combine other factors of production and therefore
argument total output levels and boost economic growth. Many influential empirical
research have included capital formation as an important factor in economic growth
model. For instance, based on their sensitive analysis of cross country growth regressions,
Levine and renelt (1992) find a positive and robust correlation between the share of
investment in GDP and economic growth. More recently research conducted by Ali (2010)
also confirm this robust correlation between investment share in GDP and economic
growth. Another reason for including this variable is that it can be helpful for make
comparison between domestic investment and foreign direct investment, whether the
contribution of FDI is greater or smaller than domestic investment. Moreover, FDI denotes
the foreign investment inflows, in the form of FDI to GDP ratio. Then the coefficient 3
and 4 reflects the marginal products of domestic investment and foreign investment,
respectively.
More recently, the work of Barro (1991) and Mankiw (1992) have become more
influential in economic growth theory, which derives a model including initial income
level to control the conditional convergence hypothesis. It is argued that countries per
capita growth rate tends to be inversely correlated with its starting level of economic. In
-
8/2/2019 Jiang Zihan
44/70
36
particular, if two countries have similar level of structural parameters for preferences and
technology, then the poorer country tends to have a faster growth rate than the richer
country (Barro, 1991). In addition, Ali (2010) also includes this variable when building his
model on FDI and economic growth, and similarly, he also finds a negative relationship
between economic growth and its initial level. Therefore, this variable, expressed by Y0, is
included in the growth model.
Another important variable suggested in recent literatures is human capital. An influential
research in proposing the importance of human capital is Barro (1991). He argues that
human capital plays a special role in endogenous economic growth model. Barro and Lee
(1994) included this variable in their growth model and they find a direct relationship, and
they conclude that since human capital may generate ideas and promote productivity, they
can always have significant impacts on economic growth. From that period, many
researchers have taken this variable into account. For instance, Mody and Wang (1997)
emphasize that highly quality human capital, as an existing regional strengths, can play a
significant role in economic growth. Similarly, Demurger and Berthelemy (2000) also
suggest that educated people can have positive impacts on economic growth. Moreover,
Borensztein et al (1995) find a complementary relationship between FDI and human
capital and they suggest that FDI inflows can have significant impacts on economic
growth when human capital is above a certain level. Therefore,another variableHCis also
suggested in the model, denotes human capital.
-
8/2/2019 Jiang Zihan
45/70
37
In order to investigate the potential linkage between FDI and human capital, an interaction
term of FDI and human capital is added in the model. Then the final version of the model
becomes the following form:
Growth =1 + 2L+ 3 Inv + 4 FDI +5 Y0 +6HC+7(FDI * HC) + (2)
Through this model, it is able to find the relationship between each variables and
economic growth in China. In particular, correlation between FDI and human capital can
also be investigated. There are three possible results in the model. Firstly, if4 and 7 are
both positive, then FDI has an unambiguous impact on economic growth, and human
capital could enhance this impact. Conversely, if they both are negative, then FDI could
have adverse impacts on economic growth and human capital could enhance this impact.
Secondly, if4 is positive and 7is negative, then FDI inflows still have positive impacts
on economic growth. However, with the increase in human capital, the extent of the
impact will diminish. Finally, if the 4 is negative and 7is positive, then the results could
be more ambiguous and complex.
In particular, according to Alfaro (2003), FDI inflows into different sectors can have
completely different impacts on economic growth. By establishing the model, he finds that
while FDI inflows into manufacturing sector is positively related to economic growth, the
correlation between FDI inflows into primary sector and economic growth appear to be
negative. What is more, FDI inflows into service sector are ambiguous. More recently, Ali
(2010) also confirms the results by Alfaro (2003), based on the data including both
developed countries and developing countries. In case of China, FDI inflows distribution
is significantly different. While manufacturing sector account for more than half of the
-
8/2/2019 Jiang Zihan
46/70
38
total amount, the primary sector only has 2% (National Bureau of Statistics of China,
2009). Therefore, to make the model more accurate and more reliable, it attempts to divide
the FDI into different sectors. As a result, it is possible for investigate the correlation
between economic growth in China and FDI inflows into different sectors.
The model is analyzed by ordinary last square method (OLS) in Eviews software,
attempting to investigate the coefficient of each variable. Particularly, in order to make
comparison, two variants are estimated, one is without FDI and the other one is with FDI.
In this way, it is able to find whether FDI can be considered as an important factor in
economic growth.
4.2 Data description
The equation (2) above provides the basis for cross-sectional and panel data analysis for
the correlation between FDI inflows and economic growth. The data is on the provincial
level, which is shown in appendix I. It includes four provinces from eastern region
(Jiangsu, Fujian, Shandong, and Zhejiang), two provinces from central region (Henan and
Hunan), and two provinces from western region (Sichuan and Shanxi). In addition, three
municipalities, including Beijing, Tianjin and Shanghai are also taken into account,
because they have provincial status and they all attract a large portion of FDI inflows in
the past decades. Other provinces, such as Qinghai, and the autonomous region of Tibet
are dropped from the sample since FDI inflows into those areas are scarce and the data is
unavailable.
-
8/2/2019 Jiang Zihan
47/70
39
Data are mainly collected from China Statistical Yearbook, covering the period from 1998
to 2007. Growth is measured by the real GDP growth rate in China. According to Zhang
(2006), due to the inter-province floating population, the growth rate of population is
collected as the measurement ofL. Moreover, Human capital (HC) is measured by the
ratio of secondary school enrollment in total population, and the secondary schools
include both the regular schools and the technical schools.
Inv is attempted to measure the ratio of domestic investment, and therefore it is computed
by the nominal gross fixed capital formation divided by the total nominal GDP. Since the
data in this aspect cannot be found in China Statistical Yearbook, the data are collected
from each Provincial Statistical Yearbook, published by each provincial government.
Similarly, FDIratio is computed as the ratio of nominal realized FDI inflows to nominal
GDP. In particular, because the FDI inflows are always reported by US $, and the nominal
GDP is in Chinese Yuan, they are converted into the same currency by the average
exchange rate of each year. Furthermore, Y0is measured by the initial level of economic
development, which is the per capita GDP in 1998.
For the data of FDI inflows into different sectors, the categories of sector follow the
research of Alfaro (2003). Primary sector includes agriculture, fishery and forestry
industry. Manufacturing sector includes the construction, gas and electricity industry and
other manufacturing industry. Finally, service sector contains industries that related to the
service, such as real estate, hotel and catering service, public transportation service,
-
8/2/2019 Jiang Zihan
48/70
40
education and financial sectors. The data in this part is collected from Statistical Yearbook
of each provinces and Statistical report from Ministry of Commerce of China. They are
also measured by the ratio to GDP.
Based on the former research, it is predicted that FDI inflows can have positive impacts on
China economic growth. What is more, the human capital could be an important variable
in the correlation and it is estimated that human capital can enhance the impacts. In
addition, the initial level of development Y0 is predicted to be inversely correlated with
economic growth due to the results provided by the former research. Furthermore,both theInv and L are expected to be positively related to the economic growth. Finally, while
manufacturing FDI is expected to be positively related to economic growth, service FDI
and primary FDI are predicted to have a negative correlation according to the former
research. In particular, the significance of manufacturing FDI is expected to be higher than
total FDI.
-
8/2/2019 Jiang Zihan
49/70
Chapter 5: Empirical Results and Discussion
The ordinary last square (OLS) method is adopted to analyze the model. The coefficient
results and T-statistic are shown in following tables.
Table 2 : OLS panel data results estimations: 1998-2007
(Dependent variable: average of GDP per capita growth rate)
Model without FDI Model with FDIIndependent
Variables Coefficients t-Statistics Coefficients t-Statistics
L 1.167** 1.853 1.064* 1.68
INV 0.13*** 2.3 0.12*** 2.89
HC 1.43*** 3.94 1.412*** 3.94
Y0 -0.202** -4.41 -0.197** -4.63
FDI 0.13** 1.22
Adjusted R2 0.5379 0.62
Notes: The asterisks ***, **, and * denotes the levels of significance at 1%, 5%, and 10%,
respectively.
Table 2 shows the comparison between model with FDI and model without FDI. It can be
seen from Table 2, the adjusted R2 is 0.5379 without FDI, and after taking into account of
FDI, the adjust R square increase to 0.62, which is around 15% higher than the results
without FDI. This means that FDI should be considered as an important factor in Chinese
economy and it indeed has positive impacts on economic growth.
41
-
8/2/2019 Jiang Zihan
50/70
42
Although the results confirm the positive correlation between FDI and economic growth,
the coefficient of FDI is not significant. This is inconsistent with the research conducted
by Zhang (2006), who find significant correlation on both cross-section data and panel
data analysis based on 28 provinces in China. However, Mansfield and Romeo (1980)
argues that although theoretical literatures tend to believe FDI inflows can be beneficial to
host countries, empirical evidence seems to be less pervasive. Moreover, this result is
similar with Aitken and Harrison (1991), who can only find a limited relationship between
FDI and economic growth. Similarly, De Mello (1999) also confirms this result because
the correlation in his research is also weak. This insignificance of correlation might due to
the inflows to different sectors of the economy. According to Alfaro (2003), FDI inflows
to different sectors can have different effects on economic growth. In his research, he finds
that FDI inflows into the manufacturing sector tend to have positive impacts on economic
growth, however, FDI inflows into primary sector appear to have the opposite effects.
What is more, for the service sector, the effects of FDI inflows tend to be ambiguous.
Therefore, it could be argued that the insignificance of the coefficient of FDI might be
because the different sectors.
Except for FDI, all other variables have the right sign as predicted, and they turn out to be
significant. For instance, the coefficient of human capital is 1.43, which indicates a
significant positive correlation with economic growth. This confirms the importance of
human capital. In addition, the initial level of economic development tends to be inversely
related to the economic growth, which is consistent with the research by Zhang (2006) and
Ali (2010). This indicates that countries with lower level of initial economic development
-
8/2/2019 Jiang Zihan
51/70
43
tend to have higher economic growth rate.
After the first estimation, the interaction term is included in the model, in order to
investigate the relationship between FDI and human capital. The results are presented in
Table 3. It can be seen that although the results are not significant, both the sign of FDI
and the interaction term are positive. This is consistent with the expected results. Although
the coefficient of interaction term is not significant, it still indicates that FDI indeed can
have positive impacts on economic growth, and human capital can enhance the impacts. In
other words, it could be argued that there might exist some complementary relationship
between human capital and FDI inflows.
This is highly consistent with the research conducted by Borensztein (1995), which
confirms this complementary correlation. In particular, they cannot find the similar
correlation between domestic investment and human capital. This might suggest that
compared to domestic investment, FDI have superior capacity in increasing the domestic
technology and then the subsequent economic growth. Similarly, Balasubramanyam et al
(1999) suggest even though FDI contains positive externalities, it can only be beneficial if
the country adopt complementary methods for economic development, rather than entirely
relying on the spillover effects of FDI. In other words, if human capital in a host country is
below a certain level, even though FDI inflows can possibly provide benefits, its low level
of human capital could become the barrier of economic development.
-
8/2/2019 Jiang Zihan
52/70
Table 3: OLS panel data results estimations: 1998-2007
(Dependent variable: average of GDP per capita growth rate)
Column 1 Column 2Independent
Variables Coefficients t-Statistics Coefficients t-Statistics
L 1.064* 1.68 1.04* 2.08
INV 0.12*** 2.89 0.104*** 1.96
HC 1.412*** 3.94 1.08*** 4.19
Y0 -0.197** -4.63 -0.17** -4.12
FDI 0.13** 1.22 0.117** 2.96
FDI*HC 0.07** 3.02
Adjusted R2 0.62 0.623
Notes: Notes: The asterisks ***, **, and * denotes the levels of significance at 1%, 5%,
and 10%, respectively.
Finally, in order to observe the different impacts of FDI inflows into different sectors, FDI
inflows are classified into the primary FDI, manufacturing FDI and service FDI. The
results based on different sectors are presented in table 4 in the below. It can be seen from
the table that all the coefficients have the right sign as predicted, with a positive sign in
manufacturing FDI and negative signs in primary FDI and service FDI. Coefficients of
other variables still remain unchanged. For primary FDI, although the sign is the same as
predicted, the coefficient is still not significant, with -0.066. However, Alfaro (2003) finds
a robust negative correlation, with a significant coefficient range from -0.28 to -0.13. For
service FDI, the coefficient shows in the table is -0.029. Similar with primary FDI, it
contains the right sign but without significant coefficient.
44
-
8/2/2019 Jiang Zihan
53/70
For manufacturing FDI, which accounts for the largest portion of total FDI inflows into
China, results tend to be more significant. Compared with the coefficient of total FDI in
Table 4, the coefficient increased almost twice as much as before, from 0.117 to 0.256.
This result is the same as expected. It indicates that compared to FDI inflows into other
sectors, FDI inward to manufacturing sector has the most contribution to the economic
growth. This is consistent with the results obtained by Alfaro (2003), which also finds a
robustness correlation and confirms the importance of FDI inflows into manufacturing
industry. What is more, Alfaro (2003) gives some possible explanation for this result. He
argues that the most mentioned benefits generated by FDI, such as technology transfers,
new managerial skills, and employee training tends to be more related to the
manufacturing sector. By comparison, the linkage between these potential benefits and
primary or service sector are relatively weak.
Table 4: Economic growth and FDI by sector: OLS results
(Dependent variable: Average of GDP per capita growth 1998-2007)
Column 1 Column 2 Column 3Independent
Variables Coefficient t-Statistics Coefficient t-Statistics Coefficient t-Statistics
L 0.987** 1.68 1.102** 1.79 1.02** 2.12
Inv 0.109*** 3.02 0.106** 2.64 0.094*** 2.86
HC 1.082** 2.94 1.121*** 3.12 1.098** 2.88
Y0 -0.168*** -4.54 -0.162*** -3.98 -0.212*** -4.64
Primary FDI -0.066* -1.94
ManufacturingFDI
0.256** 2.42
Service FDI -0.029 -1.14
Adjusted R2 0.569 0.607 0.537
Notes: The asterisks ***, **, and * denotes the levels of significance at 1%, 5%, and 10%,
respectively.
45
-
8/2/2019 Jiang Zihan
54/70
46
Therefore, it could be concluded that not all FDI inflows can be beneficial to economic
growth in China. While manufacturing FDI tends to have positive impacts on economic
development, FDI inflows into primary and service sectors appear to be negatively related
to the economic growth.
-
8/2/2019 Jiang Zihan
55/70
47
Chapter 6: Conclusion
Foreign direct investment has increased dramatically in the last several decades, and now
it is regarded as a crucial factor of economic growth. Due to the importance of FDI, it
attracts numerous research, attempting to investigate the relationship between FDI inflows
and domestic economic development. Since the different data and methodologies, it is not
surprising that the result of the correlation is still controversy. Many literatures are largely
descriptive and they tend to support that FDI inflows can be beneficial to the domestic
economic development. Theoretically, it is argued that FDI inflows can stimulate domestic
economy mainly through three channels. First, FDI could argument capital formation,
which could be regarded as an essential economic input, and subsequently increase the
economic growth level (De Long and Summer, 1991). What is more, since it is unlikely to
bring a large number of labors from home country, it is expected that more jobs will be
created. As a result, it could decrease the employment pressure in host countries. In
addition, the inflows of capital could also generate tax revenue, which could alleviate the
deficit pressure.
Second, it is claimed that FDI inflows can boost economy of host countries by
international trade. Whether the relationship between FDI inflows and international trade
is substitute or complementary is still controversy. On the one hand, the correlation can be
substitution if home countries establish their subsidiaries in countries, which have similar
condition (Brainard, 1997). Moreover, if firms contain intangible assets, such as advanced
technology or managerial skills, which is impossible for export, the relationship can also
be regarded as substitution. Finally, under the condition of high transaction costs on
-
8/2/2019 Jiang Zihan
56/70
exporting or licensing, FDI could also replace trade (Blonigen in Lee et al, 2005). While
traditional theories support substitution correlation, more research tends to suggest
complementary relationship. Dunning (1998) concludes that the relationship between them
is conditional on both type and place, and it is complex and unpredictable.
Third, it is believed that FDI inflows can increase economic growth of host countries by
advanced technology transfer, which is regarded as the most influential channel. It is
argued that technology diffusion can lead to improvement in host countries and
subsequently boost the whole economy. Furthermore, FDI inflows could also bring new
know-how and managerial skills to host countries. As the knowledge accumulated, it can
be beneficial to the whole industry and increase the productivity.
In case of China, since it conducted the open-door policy relatively late, research based on
China is still limited, especially in the quantitative method. This dissertation takes the
econometric method, attempting to find some empirical results of relationship between
FDI inflows and Chinese economic growth. The econometric model includes five
variables, labor, domestic capital formation, foreign investment, human capital, and initial
level of economic development, and an interaction term between human capital and FDI.
By adopting the ordinary least square method, the results shows that except for initial level
of economic development, all other variables are positively related to economic growth.
The adjusted R2 is 15% higher when including the FDI variable, which implies that FDI
indeed can be considered as a factor in economic growth. What is more, when including
48
-
8/2/2019 Jiang Zihan
57/70
49
the interaction term, both FDI and interaction term sign are positive. This indicates that
human capital can enhance the positive correlation between FDI and economic growth.
Finally, by dividing the FDI into three categories, which are primary sector,
manufacturing sector and service sector, results tend to be different. For both service
sector and primary sector, the coefficients are negative. Although results are not
significant, it still indicates that FDI inflows into these two sectors are more likely to have
negative impacts on economic growth. For manufacturing sector, results appear to be
opposite. The coefficient is not only positive, but also significant. Compared with the total
FDI inflows, the coefficient increased nearly twice times. This implies that FDI inflows
into manufacturing sectors can have positive impacts on economic development in China.
Alfaro (2003) explains that this is because the potential benefits of FDI are more related
with manufacturing industry rather than primary and service sector.
However, this dissertation still exist some limitation. First, data is not complete. The data
is collect in provincial level, however, several provinces, such as Tibet or Qinghai, are not
taken into account due to the unavailability. Second, since there is no accurate number of
inter-province floating population, the measurement of variable of L may be problematic.
Similarly, since the data on average schooling years is not available in provincial level, the
human capital is measured by the enrollment shares in total population, which is also less
accurate. Moreover, this model only narrowly focused on the impacts of FDI on economic
growth. Therefore, other variables, which are also considered to have contribution on
economic growth is not included in the model. For instance, the level of financial system
can be regarded as an important factor on growth, since a highly developed financial
system can provide an attracting business environment to foreign investment, which could
be beneficial to the whole economy. Other variables, such as inflation, exchange rate,
-
8/2/2019 Jiang Zihan
58/70
50
could also have impacts on economic growth, however, they are not taken into account in
this model.
Overall, this paper tends to support that FDI indeed is an important factor in economic
growth, with a positive correlation. While manufacturing FDI can have significant positive
impacts in Chinese economic growth, primary and service FDI tend to have the opposite
effects. In addition, human capital, as an essential factor, can enhance the positive impacts
of FDI on growth. Therefore, host countries could make more efforts to enhance the ratio
of human capital to total population ratio, making the environment more attractive and
more efficient. Further research might need to collect more accurate data, and more
variables should be included in the model, which could make it more complete.
-
8/2/2019 Jiang Zihan
59/70
51
Bibliography
Agrawal P. (2000), Economic impact of foreign direct investment in south Asia,Indira
Gandhi I
top related