FDI in Examination of China and India

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Does Foreign Direct Investment Influence Economic Growth in Rapidly Growing Economies? An Examination of China and India

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FDI in Examination of China and India

  1. 1. RONI BHOWMIKRoni BhowmikMaster’’s ProgramMasterInternational Business Shenyang Aerospace University
  2. 2. RONI BHOWMIK ContentsABBREVIATIONS............................................................................................................3Abstract.........................................................................................................................4Chapter1: Introduction..................................................................................................61.2. Motivation and Purpose of the Study....................................................................61.3. Objectives...............................................................................................................71.4. Brief Outline of the Study.......................................................................................7Chapter 2: Review of Literature....................................................................................82.1. ExistingLiterature...................................................................................................82.2. Definition of FDI...................................................................................................112.3. General Theories and Concepts of FDI.................................................................112.3.1. Ownership Specific Advantage or OSA..............................................................122.3.2. Location Specific Advantage..............................................................................132.3.3. Internalization Specific Advantage....................................................................142.4. Types of FDI..........................................................................................................132.4.1. Horizontal Foreign Direct Investments..............................................................142.4.2. Vertical Foreign Direct Investment....................................................................142.4.3. GreenfieldInvestment.......................................................................................142.4.4. Mergers and Acquisition...................................................................................142.5. Determinants of FDI.............................................................................................152.5.1 Economic Factors...............................................................................................152.5.2 Government policies..........................................................................................16Privatization and Macroeconomicpolicies..................................................................16Policies supporting private sector...............................................................................172.5.3. Strategy of MNE’s ……………………………………………….……………………..…………………17Country Risks …………………………………………………………….……………………………………………172.6. Impact of FDI in Host CountryDevelopment........................................................172.6.1. Impacts of Foreign Direct Investment...............................................................18Chapter 3: Foreign Direct Investment in China and India...........................................193.1. FDI Inflows in China..............................................................................................193.1.1. The impact of FDI in Chinese Economy.............................................................203.2.1. Impact on 51% FDI on India…………………………………………………………………………..22Chapter 4: ………………………………………………………………………………………………………………24 Shenyang Aerospace University
  3. 3. RONI BHOWMIK4.1 Methodology and Data Collection.........................................................................244.2. Graphical Analyses...............................................................................................244.3. Regression Analysis..............................................................................................264.3.1. Regression Analysis of China.............................................................................284.2.2 Regression Analysis of India...............................................................................28Chapter 5: Findings and Conclusion............................................................................295.1. Author’s Conclusion.............................................................................................29Appendix.....................................................................................................................30References...................................................................................................................32 ABBREVIATIONSFDI – Foreign Direct InvestmentGDP – Gross Domestic ProductLPG – Liberalization, Privatization and GlobalizationMNC’s – Multinational CorporationsOECD – Organization for Economic C0-operation and DevelopmentUNCTAD- United Nations Conference on Trade and DevelopmentOSA – Ownership Specific AdvantageLSA – Location Specific AdvantageISA – Internalization Specific AdvantageTNC’s – Transnational CorporationsMNE’s – Multinational EnterprisesSPSS – Statistical package for social sciencesFERA – Foreign Exchange Regulation ACT Shenyang Aerospace University
  4. 4. RONI BHOWMIK AbstractThe purpose of the dissertation project is to empirically determine if Foreign DirectInvestment (FDI) influences economic growth in rapidly growing economies? Withemphasis placed upon China and India – both economies have seen exponentialeconomic growth over the past decade. Both China and India have seen an abnormallyhigh inflow of capital in several forms during the past few decades. Why such aninflow and what had inculcated the investors to adopt such a project in thesecountries? This dissertation focuses in brief, the reason for such a massiveundertaking by the multinationals. The dissertation undertaken also investigates thesignificant role of FDI among the other determinants of economic growth in thesecountries. For the purpose data’s for the last 39 years are taken into consideration.Methodology used consists of graphical representation and regression analysis.Graphical analysis is used to show the relationship between FDI and economicgrowth in INDIA and China. From the graph it is clear that there is a positiverelationship between FDI and GDP in China and they move in the same direction,while it is opposite in the case of India. To prove this a linear regression method isused with the help of SPSS. The results so obtained suggest that FDI has a positiveimpact on China and a less, but a positive impact on India’s economic growth. Shenyang Aerospace University
  5. 5. RONI BHOWMIK Chapter 1: IntroductionThe recent studies conducted on FDI shows that the relevance of FDI inflows for theeconomic growth is very important and the policy makers adopted more liberalizedapproach to gain the benefit out of it. It is argued that FDI inflow has got so manyeffects on a growing economy. The role of FDI in creating employment, transferringtechnology, creating spillover effects and other activities that can act as a fuel foreconomic growth is quite worth noticing.Studies done by Alfero (2003), Blomstrom et.al (1994) and Borenstein (1998)suggests that a country in order to attract FDI inflows should possess some relevantfactors like better labor market, balance of payment, technology and infrastructure,stable policies etc. These factors act as a determinant to the flow of FDI in the hostcountry. The dissertation explicitly covers the theory relating to the importance ofFDI, the factors determining its growth and FDI impact on host country development.The countries of concern in the dissertation are India and China. China opened itseconomy during 1979 by adopting open door policy. The growth since then was soremarkable and astonishing. The relationship between FDI inflow and GDP growthwas so uniform and upward after 1980 indicating the major role of FDI inflows onGDP growth rate of China. Many researchers argued that this inflow of FDI wasmainly due to the liberalized approach made by the Chinese economy. The recenteconomic reforms that it had made, indulged several multinational giants to invest inthe host country. The introduction of open door policy and China’s WTO entry aresuch reforms that can be highlighted while discussing about FDI. The paper thusexamines the role of FDI, which it had played during this significant time period inCHINA for this massive growth.India’s economic growth after the introduction of the famous ‘LPG’ (Liberalization,Privatization and Globalization) concept was remarkable. The paper thereforeexplores the irregular start up of FDI in INDIA and also evaluates the developmentthat it had brought about in the economy.This dissertation project does not provide a comparative analysis, but it shows therelevant role of FDI on economic growth in both the countries. The role of otherdeterminants with regard to FDI is also discussed and analysed briefly. The data’s Shenyang Aerospace University
  6. 6. RONI BHOWMIKfrom the periods 1970 to 2009 is taken for the analysis to check the rate of FDIinflows. For the purpose regression analysis is employed to calculate the relevance ofFDI in China and India. The analysis showed a positive effect on China and a lesspositive effect on India, thus indicating that FDI has a major role in China’s growthand a minor role on India’s growth rate.1.2. Motivation and Purpose of the StudyIndian and Chinese economies were partially closed and were under the control ofstringent rules and regulations during 1970’s and 80’s. The growth that had happenedin these geographical areas was astonishing during 1990’s. There are several factorsthat had contributed for such an economic outburst. The role of FDI as such a factor issignificant. Many researchers say that it is due to the various economic strategies ofeach country for e.g., ‘open door policy’ of China and opening of Indian economy byintroducing the ‘Liberalization, privatization and globalization’ or the ‘LPG’ conceptthat attracted such a huge investment, which was actually true. Even during therecession time both the economy had performed well and even attracted moreinvestment and capital. The level of inflow in both the countries was astonishing andvarying, which is quiet exciting to study. The main frame of the study is to analysethe economic strategies of each countries and to find the factors which are lacking onthe part of the straggler. The purpose of the study is to create a model of both thecountries and to analyze the pros and cons that exist in both economies and to findways to overcome the problem of laggards through an effective empirical analysis.The study also intends to reveal a path for the less developed and other developingeconomy’s, which might emerge in the next few decades.There are only few research works that are from the Indian point of view. This studyis also aimed to fill those gaps.1.3. Objectives1. To evaluate the contribution of FDI in economic growth (in INDIA and CHINA)2. To find the nature of contribution made by these investment.3. To evaluate the rate of inflow of these investment in INDIA and CHINA4. To study the significance of FDI with other economic growth indicators.1.4. Brief Outline of the StudyThe dissertation project is divided into four chapters. The first part covers theintroduction, motivation and purpose of the study. The second chapter covers thereview of literature and the theoretical aspects of FDI – including its definitions,types, determinants and impacts of FDI. The third chapter covers the FDI trends andrelated strategies adopted in China and India to attract FDI inflows. The fourthchapter deals with the methodology and empirical analysis of the study of concern. Itincludes graphical representation and regression analysis to find the inflow of FDI andalso to discover the relationship between both FDI and GDP in China and India. Afterdoing the graphical analysis, a regression equation is formulated. The equationconsists of some variables that exert direct impact on GDP growth. The main purposeof the equation is to find the contribution of FDI, the primary variable of concern and Shenyang Aerospace University
  7. 7. RONI BHOWMIKalso to analyze the impact of other variables on GDP growth rate in India and China.The last chapter covers the findings and conclusion. Chapter 2: Review of Literature2.1. Existing LiteratureCaves (1996), suggests that the underlying principle to attract heavy foreigninvestment starts from the belief that FDI brings numerous positive effects. Thisinclude employee training, productivity gains, technology transfer, improvedmanagerial skills, improved international production networks, introduction ofinnovative ideas to the host countries, employment opportunities etc. Ndikumana andVerick (2008), Andreas (2006) and Lumbila (2005), suggests that FDI has significantpositive effect on economic growth. Romer (1993), argues there exist a wide “IdeaGaps” between poor and rich countries. He believes foreign investment can facilitatetechnological transfer and business expertise to less-developed or poorer countriesand, as a consequence, FDI might boost host countries firms productivity and henceincreases economic growth. A relative study done by Blomstrom (1986) concludesthat Mexican sectors with a high degree of foreign investment show high productivitygrowth. FDI is also characterized by immense positive spillovers. As per the study ofLipsey and Sjoholm (2005), FDI has positive spillover effects. Some economistsfound that FDI exerts varying effects. For instance the study conducted by Theodore,Edward and Magnus (2005) suggests that FDI can have varying effects – that is bothpositive and negative effect. Some economists were of the opinion that it has got morepositive effect, but FDI inflow depends on several factors in the host countries. Alfero(2003) admits that FDI inflow to certain sectors induces economic growth – accordingto him the economy achieves more growth when, FDI inflows to the manufacturingsector is high when compared to that of primary sector. Many factors in the hostcountries such as labor market, capital market, technology, balance of payment etcalso are adversely affected through FDI inflow which in turn acts as a fuel foreconomic growth, Lall (2002). Another study done by Blomstrom et. al (1994) statesthat, those countries that have a certain level of income can take up new technologiesand enjoy its benefits through FDI. However some research works had proved theimportance of human capital in attracting the FDI. The studies conducted had Shenyang Aerospace University
  8. 8. RONI BHOWMIKrevealed that an educated workforce or human capital can only understand theimportance of innovation and technology diffusion and thus supports the inflow ofFDI to their economy. Borenstein (1998), in his study found out the relativeimportance of FDI and human capital in economic growth. He also suggests that aneconomy may need a minimum stock of human capital to understand the positiveeffects of FDI. For instance, another study done by Borenztein, De-Gregorio and Lee(1998), states that FDI has a positive effect in the host country when the economy hasa highly educated workforce who welcomes FDI spillover effects. Carkovic andLevine (2002), also argues about the importance of educated workforce in attractingFDI and hence increasing growth.The significant role of FDI, in bringing foreign technology towards the host country isindispensable. Borenstein et.al (1998) postulates that, FDI plays a vital role when itcomes to technological transfer, which in turn might contribute to larger economicgrowth than domestic investment. Findlay (1978) in his studies sees that the rate oftechnical progress in the host country can be increased by the inflow of FDI through a“contagron” effect. In a debate regarding to the importance of FDI, De Gregorio(2003) contributes that FDI brings in knowledge expertise and technologies that arenot available in the host country; thereby increasing productivity growth through outthe economy. In his study on Latin American economy, he found out that FDI isthrice more efficient than domestic investment, when it comes to economic growth. Asimilar study conducted by De Mello (1997) suggests that there is a positivecorrelation and it boosts investment levels, thereby creating a space for economicgrowth.Explanations regarding FDI and its relative importance on long- term and short-termeconomic growth is quite importance at this juncture. Neo-classical economistspostulate that FDI persuades economic growth by increasing the amount of capital perperson. However, this may not influence long- run growth due to diminishing returnsto capital. Sauchez-Robles and Bengos (2003) emphasizes that, even though thecorrelation between FDI and economic growth is positive, a host country in order tobenefit from long term FDI inflows must require economic stability minimum humancapital and liberalized markets. The other interesting study done by Bende- Nabendeet.al (2002) found that long term impact of FDI on productivity is more positive forless economically advanced countries and negative for economically advancedcountries. Rome (1986) and Lucas (1988) claims that FDI also influences long- runvariables such as Human capital and Research and development. FDI when analyzedin short- term aspect, it is more beneficial than long-term (Andeolu B Ajamoaler,2007). Durham (2004) contributes that FDI effects are more conditional on the“absorptive” capability of host countries. Obwana (2001) quotes in his study relatingto the determinants of FDI and growth on Uganda, that parameters like politicalstability, macro economic and policy consistency are so important in attracting FDIinflows. To add to this, the study done by Bhasin et al. 1994, Love and Lage-Hidalgo, 2000 and Lipsey 2000) is more important, they found that determinates likefactor prices, market size of the host country and balance of payments are significantin attracting FDI inflows. In the case of India and China the economic growth whichthey achieved is largely due to the post liberalization periods of each country. Thefactors like political stability, policy consistency and other factors like better laborforce etc also had played a vital role in attracting such a huge inflow, hence makingthem the most desirable place for investment. A study done by Pradeep Agarwal(2000) on five South Asian countries relating to foreign direct investment, argues thatthe role of FDI on GDP growth rate was negative during Pre- 1980’s and slightly Shenyang Aerospace University
  9. 9. RONI BHOWMIK positive during 1980’s and strongly positive during 1990’s. He found out that this high inflow of FDI is largely due to a strong market oriented policies and open international trade strategies of these countries. According to a study done by Zhang (2006) on FDI and economic growth in China, states that FDI promotes economic and this positive growth is achieved overtime. Xiaobuo Dang (2008) asserts that FDI has got significant role in increasing economic growth and determinants like infrastructure and political environment plays a crucial role in exerting a pull on FDI inflows. Table: 2.1.1. The table below shows some relevant studies done on FDI and economic growth.AUTHOR YEAR OF STUDY METHODOLOGY USED FINDINGSAgrawal.P 2000 Time series cross sectional Prior 1980’s period-FDI inflow on analysis of panel data from GDP growth rate was negative. Early five south Asian countries 1980’s- mildly Positive.Andres.J 2005 Panel data analysis FDI enhances economic growthin developing economies when compared to that of the developed economies.Alfaro.et.al 2004 Panel data cross country FDI has got a significant role ineco- regression nomic growth. He also pinpoints the importance of local financial market in achieving this economic growth through.Balasubramanyam 1997 Pnael data cross country FDI promotes growth and ismore Regression efficient in export promoting regimes rather than import substituting ones.Sauchez-Robles and 2002 Panel data analysis FDI has got positivecorrelationBengos with economic growth in the host country.Borensztein et.al 1998 Panel data cross country He argued about thesufficient Regression. Instrumental absorptive capability of the host variable regression country and found out that FDI contributes to economic growth He argued that the sufficient human capital is necessary in the host country to achieve this growth.Carkovic and Levine 2002 Generalized method of FDI exerts a positive impacton moment’s panel growth, that is independent of other estimator. growth determinants (educated workforce infrastructure, markets, and liberalization policies)Nair-Reichert and 2001 Panel data analysis. They found out that thereexists aWeinhold mixed, fixed and random heterogeneity across developing coefficient approach economies regarding the impact of Shenyang Aerospace University
  10. 10. RONI BHOWMIK FDI and other variables on economic growthObwona 2001 Two stage least square Foreign investment has gotmajor estimation method role in enhancing economic development in Uganda.Ram and Zhang 2002 Panel data cross country FDI has got positive effect onthe regression host country’s economic growth.S.Adewumi 2006 Graphical analysis, FDI has got positive impact on regression and granger GDP growth rate in Africa. causalityXiaohong Ma 2009 Regression analysis FDI has significant role in Economic growth in China 2.2. Definition of FDI A clear cut definition of FDI is very difficult (Haluk sezer (Piggot and Cook, 2006)). Definitions of FDI were formulated depending on its international characteristics and MNC’s activities in host countries and some authors even contrast it with portfolio investment. The definition thus evolved and recognized, often has two common elements such as, involvement of two countries – which quite often described as the multinational FDI character, and the other elements which is basically related to the issue of ownership and management – which makes it entirely different from portfolio investment. FDI is therefore considered as the ownership and management of production activities abroad, whereas foreign portfolio investment is the transfer of financial capital, loan or equity from one country to another. FDI stand aside due to its complexity, because it involves transfer of managerial and organizational ability and technical know-how. The definition of FDI is not isolated. The FDI being a part of MNC’s activities, a single and isolated definition is not possible. Therefore the definition of MNC’s is some what similar to that of MNC’s (Haluk sezer (Piggot and Cook, 2006)). Despite of its difficulty many definitions have evolved. According to the IMF balance of payment manual defines FDI “as an investment that is made to acquire a lasting interest in an enterprise operating in an economy other than that of the investor, the investor’s purpose being to have an effective voice in the management of the enterprise” Imada Moosa (2002). (Haluk sezer (Piggot and Cook, 2006)) defines FDI “as the acquisition, establishment or increase in production facilities by a firm in a foreign country. These definitions cover all three elements of FDI such as mergers and acquisitions, ‘Greenfield Investment’ and reinvestment. Robert E. Lipsey (1999) defined, FDI ‘as the investment that involves some degree of control of the acquired or created firm which is in any other country apart from investors country’ (S. Adewumi, 2006) OECD has provided an extensive definition of FDI (“OECD Benchmark Definition of Foreign Direct Investment, 2008, 4th edition) “Foreign Direct Investment occurs when a business located in one country (the direct investors) invests in a business located in another country (the direct investment enterprise) with the objective of creating a Shenyang Aerospace University
  11. 11. RONI BHOWMIKstrategic and a lasting relationship. Within an effective policy framework FDI canassist host countries in developing local businesses, promoting trade and contributingto technology transfer. Similarly, it can provide greater market access to businesses inhome countries. Governments, businesses and other stakeholders need reliable FDIstatistics to inform and support their decisions for investments worldwide.”By keeping in mind all the above said definitions, we can define FDI as theinvestment made by a firm (MNC’s) in another country to utilize the resourcesavailable in that country so as to expand internationally and to gain long-term profits.2.3. General Theories and Concepts of FDIA specific and a neat theory for FDI is difficult, because of the complexity it has.Economist had even struggled to give an exact definition for FDI. The theories thusformed are considered as the theories of MNC’s and therefore it is inseparable fromthe firm’s theory. Another difficulty involved is its multidimensional aspects, itinvolves capital theory, international finance theory, firm’s theory, distribution theory,trade theory and also it covers some aspects of politics and sociology. Due to thesecharacteristics it is impossible to recognize a single neat theory of FDI (Haluk sezer(Piggot and Cook, 2006))The rising importance of FDI in this global scenario over the last few decades, madethe economists and the researchers to identify and generate some importantexplanations for FDI. These explanations thus generated, is considered as theconclusion of several findings. Because of the existence of substantial overlap in theseexplanations, we can group them into three genuine categories, traditional, modernand radical theories. For the purpose of the case study, it is however important to gothrough the types of FDI and the factors that determine the flow of such FDI’s in thehost country. To understand these general theories of FDI mentioned above, it isuseful to discuss the OLI paradigm by Dunning (1977, 1981). MNC’s while taking upforeign investment projects will go through some advantages that the host countrypossess. Dunning explained these advantage variables as; Ownership advantage (O),Location advantage (L) and Internalization specific advantage. ‘L’- type advantage isthe external factor of the firm, while ‘O’- type and ‘I’- type advantage are internalaspects of the firm. Of these advantages, ‘L’- type is considered as the most relevantone for FDI flows from developed to developing economies in common and mainly totransition countries. (Marco.Neuhaus, 2006).2.3.1. Ownership Specific Advantage or OSA (H.Sezer (Piggot and Cook, 2006),M.Neuhaus, 2006)Ownership specific advantages are the knowledge based and firm specific assets thatthe firm possesses, but which are not available to its competitors. These advantagesconstitute cost benefits and lead to market power. They mainly arise due toimperfections that exist in factor and commodity markets. Imperfections in factormarket include management expertise, patents, trade secrets, difference in theaccessibility to capital market, trade marks and brands, while in the commoditymarkets appear in the form of promotional skills, collusion and productdifferentiation. Imperfect market situation arise due to several factors such as;economies of scale and government policies regarding interest rates, taxes etc. these Shenyang Aerospace University
  12. 12. RONI BHOWMIKimperfections in the market gives rise to several OSA’s which can be categorized asfollows: Monetary and financial advantage – these include access to capital market to get Cheaper capital. Industrial organization – advantages arising from Research and development and Economies of scale in an oligopolistic market. Technical advantage – advantages in holding patent rights, management expertiseetc. Access to raw materials.2.3.2. Location Specific Advantage or (LSA) (Haluk sezer (Piggot and Cook,2006))These are those advantages that the company possesses, when it locates it productionfacilities or activities in a particular geographical region. Such advantages can becategorized as follows: Imperfections in foreign labor market - MNC’s shift their product activities toareas, were they can get cheap work force. Access to minerals and raw materials in host regions. Trade barriers – these induces MNC’s to start or set up production or business incertain areas. For example, Japanese companies interest in Europe to avoid CommonExternal Tariff. Government economic policies – government may in turn change economicpolicies to attract FDI flows. The case study undertaken proves the same fact that theliberalized policies of China and India have opened the economy and as aconsequence it increased FDI inflows.2.3.3. Internalization Specific Advantage or ISAIt refers to the capability of the firms to utilize the ownership advantage internallyrather than through markets (Nagesh Kumar, (Dunning and Narula,1996). It happenswhen the imperfection in the foreign markets make market solutions too costly (Haluksezer (Piggot and Cook, 2006))The benefits of internalization can be classified as follows: Vertical integration advantage such as price discrimination and transfer pricing Relevance of intermediate products for research activities. Benefits of training due to internalization of human skills.These above said OLI paradigm acts as a base for general theories of FDI. Now letsdiscuss about the major types of FDI and important factors that determines the FDIinflows. Shenyang Aerospace University
  13. 13. RONI BHOWMIK2.4. Types of FDIResearchers, based on the business activities of MNC’s had formulated several typesof FDI’s. They are horizontal foreign direct investment, vertical foreign directinvestment, Greenfield investment, mergers and acquisitions and benefit seekingFDI’s.2.4.1. Horizontal Foreign Direct Investments (J. Paul, 2008)It refers to MNC’s regional (host country) diversification of established domesticproducts or services. Horizontal FDI occurs when MNC’s goes to host countries toproduce their existing products at their home country. Japanese MNC’s for exampleadopt the same kind of investments with the belief to avoid risks by sharing theirresources, knowledge and experiences.Horizontal FDI takes place when: A firm achieve monopolistic characteristics in a spotted region. A firm competes in an infant industry Economies of scale supply numerous competitive advantages. A firm has enough human resources and capital to look after the diversifiedorganization. A firm has the advantage of management expertise when compared to that of theircompetitors.2.4.2. Vertical Foreign Direct Investment (J. Paul, 2008)Vertical foreign direct investment refers to investments made by a company in aparticular industry abroad. In this the company will be responsible for the control ofentire activities starting from raw materials to finished goods and distribution.Vertical FDI can be again divided into two such as, Forward vertical FDIK andBackward vertical FDI.2.4.3. Greenfield Investment Shenyang Aerospace University
  14. 14. RONI BHOWMIKIt refers to firm’s investment in new facilities abroad or widening up of existingfacilities(www.slideshare.net). It can also be defined as the starting up of a completely newoperation in foreign country. This sort of investment is considered as the host nation’sprimary target of promotional efforts, because it generates job opportunities, newproduction units and technology transfer. It also has got the advantage of integratinghost country with the global market (www.slideshare.net)2.4.4. Mergers and Acquisition (Banerjee, Nair, Agarwal, 2009)Mergers and Acquisition is considered as the primary source of FDI. In anAcquisition strategy, a firm joins with another established firm working in the hostcountry to overcome the barriers of trade and business and makes the acquired firm asubsidiary business. For example Tata motors India acquired Jaguar a company inBritain, by doing so Tata had the advantage of supplying its home product abroad andalso got the advantage of technological know-how from Jaguar for its home products.Apart from Greenfield investment, Merger and Acquisition generates cash flowwithin a short span of period, because by definition a firm does not have to start frombase process by engaging in Merger and Acquisition. Another advantage of Mergersand Acquisition with that of Greenfield Investment is that it gets instant access to hostcountry firm’s resources. FDI can again be classified into three based on themotivational factors and benefits of investing firm’s. They are as follows:Resource Seeking FDI – in this the MNC’s eye’s on the resources available in thehost countries (which some times that are not available in the home country) such ascheap labor, raw materials etc.Market Seeking FDI – these are investments that are intended to penetrate a newmarket.Efficiency seeking FDI – this strategy is adopted by the firms with an intension toincrease their efficiency by utilizing the gains of economies of scale and scope. Thisis considered as the third step by the firms, after resource seeking and market seekingFDI. This strategy is adopted by the firm’s to gain more profits and can be mostlyseen among the developing economies. For example; investments among EU nations(www.slideshare.net)2.5. Determinants of FDI (Sanjay Lall, 1997)The determinants of FDI can be broadly divided into three set of factors, such aseconomic, government policies and MNC’s strategies.2.5.1 Economic FactorsMarket size – globalization and trade liberalization had enhanced growth of worldmarkets as well as the domestic markets. Evidence from various studies indicates thatthe size of the market plays a major role in attracting FDI flows. For instance the sizeof the domestic markets in China and India acts as a catalyst to attract huge FDI inthese geographical regions. Similarly the growth of intra-regional trade and theprospective regional markets in south East Asian fuelled the growth of investments in Shenyang Aerospace University
  15. 15. RONI BHOWMIKthese regions. Factors like skilled human capital, advance infrastructure, liberalizedFDI policies and stable government policies acts as a magnet in attracting FDI’s. Thisis more evident in the small states of Singapore and Hong Kong, were the above saidfactors prevails, thereby indicating that small economies can generate large amount ofFDI.The available resources in the host country are another factor that the MNC’s eye’sfor investment. The resources like petroleum and minerals are now the powerfuldeterminants of FDI in some regions. The location as a part resource also has gotupper hand in promoting FDI inflows. The fortunate regions that are closer todeveloped economy markets and the potential growing regions also enhance theinflow of FDI.Competitiveness and efficiency of the host country plays a significant role in drawingFDI. In this changing scenario, the role of skilled labors, better management andfinancial skills are very important. The MNE’s have proficiency to bring along withthem the skilled labors, but in practical it generates high costs for them. In order toavoid that, the MNC’s look for those countries that can supply these sort of skilledemployees.Apart from skilled workforce, the factors like better suppliers and good infrastructurealso plays a vital role in directing the route for FDI inflows. Existence of a strongsupplier’s base enables the host countries to capture more spillover effects fromTNC’s and this in turn also lower the initial cost to the foreign entrepreneurs’ to setup facilities in that region. Taiwan for example has this advantage and it is able toattract more technological and high value added FDI’s. Like strong supplier base,infrastructure also has its own role in drawing more FDI’s. China for example has thecapability to attract huge FDI because of their advanced infrastructure facilities whencompared to that of India. A countries financial system also has got some relevance inthis competing scenario for capturing FDI. An efficient national financial system isactually of less importance to TNC’s, but it is of great importance for the domesticfirms. Though it will be less important for MNC’s in host country, but it is vital tocreate a better image in global market. Companies do often invest, in those place,were there is less risk and sound economy.2.5.2 Government policiesPolitical stability is the most crucial factors that the investors look for. Politicalenvironment characterized by minimum level of predictability and stability isnecessary for the MNC’s to set up facilities that can yield long term returns. Investorsmore often pay attention to the long term economic situation, were they can earn hugeprofits in the future when compared to that of short term policies like tax concessions.An efficient policy framework is very important for an host country to signal theforeign investors to invest, as a consequence it promote dynamic spillover effects,more employment opportunity, technological transfer and diffusion of bettermanagerial skills to the host country. These contributions from FDI, therefore bringsbetter economic growth.Privatization and Macro economic policiesPrivatization and FDI are considered as the two sides of the same coin. Evidence fromLatin America, Africa and some of the Asian countries shows that privatization Shenyang Aerospace University
  16. 16. RONI BHOWMIKregime’s are successful in capturing investment flows to these areas. Privatization alsohad enhanced MNE’s to diversify in those sectors (such as telecommunication andaviation) which they never had significant role.In many parts privatization is included in their policy agenda’s. Africa thus can betaken as an example for the same. Studies show that privatization policies in thedeveloping countries during 1988-92 had stimulated about $49 billion in sales. Duringthis period the privatization had accounted for about 7% of the total FDI inflows. Theprivatization is therefore becoming more relevant at this present scenario. Even thedeveloping economy is concentrating on privatizing the infrastructure in order toincrease the related FDI inflows. Like privatization another determinant of FDI is awell executed macro economic policies. A relatively well managed economy,characterized by realistic interest and exchange rates, low inflationary rates and wellmanaged external debt, gives more confidence for the entrepreneurs to invest in thatcountry. Countries which lack such a stable macro economic policies which arementioned above suffers from recession and balance of payment problems, thisrelatively diverge foreign investment.Policies supporting private sectorPolicies such as openness to market forces and the private sector and wellimplemented accounting and legal framework encourages foreign investment. Anenvironment which is basically liberal in nature, transparent, stable and better suitablefor private sector sends positive impulse to MNE’s to invest. Totally, a policy that hasa ‘business like’ attitude enhances better investment scenarios in the host country.2.5.3. Strategy of MNE’sStrategies adopted by MNE’s often acts as a vital determinant of FDI’s in developingcountries. There are several factors that determine this sort of MNE’s strategies. Themostly discussed among them are the host country risk factors and corporate levelapproaches to various international operations.Country RisksWhile going for an investment project, the MNE’s analyze the host countryenvironment. The results of such analysis are very confidential and circulated on alimited basis. Factors like macro management, labor market, stable policy and otherpolitical factors are considered as a benchmark for studying the country risk, beforecommitting for an investment project.2.6. Impact of FDI in Host Country DevelopmentMost of the economies in the world try to attract FDI with the hope that it will have asignificant positive effect on the economy. Based on this paradigm, many researchworks and case studies have been done to explore the contribution of FDI oneconomic growth. Many had come with a mixture of conclusion, stating that it has Shenyang Aerospace University
  17. 17. RONI BHOWMIKboth positive and negative effect. For instance the study conducted by Theodore,Edward and Magnus (2005) suggest that FDI can have varying effects – that is bothpositive and negative effect. Some say economist were of the opinion it has got morepositive impact, but depends on several factors in the host country such as sectors ofthe economy – the economy achieves more growth when FDI inflows to themanufacturing sector is high when compared to that of primary sector Alfaro (2003).Many factors in the host countries such as labor market, capital market, technology,balance of payment etc also are adversely affected through FDI inflow which in turnacts as a fuel for economic growth Lall (2002). The arguments relating to thecausality of growth and FDI inflow and vice versa are the focal point for severalresearchers. The study of Chowdhary and Mavrotas (2003) indicates that when aneconomy experience high growth it tends to attract more FDI inflows than thecountries with weaker growth. All the above mentioned assumptions and findingshowever brought into light some major effects (both positive and negative) of ForeignDirect Investment. As we have seen earlier in the literature studies, it is clear thatForeign Direct Investment is associated with activities like transfer of technology,capital, managerial skills, promotional skills, organizational reengineering etc. thisprocess in turn generates both costs and benefits for both (investing as well as for hostcountry) the countries which are involved. To measure these costs and benefits is adifficult task, apart from this, the most widespread and common explanation for FDIis that, it has a positive impact. This section covers most significant globallydiscussed issues that are associated with FDI. These include FDI impact on capitalmarket, labor market, management techniques, balance of payments and technologicalchange or overhauling.2.6.1. Impacts of Foreign Direct Investment Technological Transfer(Haluk sezer (Piggot and Cook, 2006))The recent exploration in the developing countries reveals that FDI is seen as a way toencourage technological change. MNC’s while opting for a foreign investment, wouldmore likely to bring along with them their own technologies instead of depending onthe local facilities. There are two sided effects for technology when it follows FDI,such as direct – when associated with technology spillovers. However both theaspects mentioned above is considered as a positive contribution of FDI to economicgrowth.Recent empirical analysis based on this context supports the following conclusions:(OECD,2002)Diffusion of technology in an FDI undertaking occurs through four channels such asvertical and horizontal linkages, switching of skilled labour from MNC’s to localfirms and also through Research and Development. Empirical evidence shows thatmore positive impact is seen in vertical linkages, especially in the backward linkages,because the local suppliers get adequate training and technological assistance fromMNC’s in order to raise the quality of supplier products and services. MNE’s evenassist them in the purchase of raw materials and intermediary goods and also helpsthem to establish a most modern production facility in the host countries. This willensure better business environment and economic growth. Evidence relating tohorizontal spillovers with regard to FDI is less. But some available evidence suggeststhat horizontal spillovers are more effective when organizational functions in totallydifferent sectors. Shenyang Aerospace University
  18. 18. RONI BHOWMIKApart from the above two channels, labor migration and Research and Developmentalso plays a major role in technological transfer. Employees who are affiliated with aforeign company acquire superior technological know-how and managerial skills.Bende Nabende (2002) suggests in his study that there is a wide scope for the spreadof technological knowhow, especially when the employees switch to domestic firmfrom an MNC. MNE’s therefore avoid these spillovers by giving high ransoms toskilled staffs. The other method which they commonly follow is the consideration ofexpatriate staffs in the host country instead of local ones.Chapter 3: Foreign Direct Investment in China and India3.1. FDI Inflows in ChinaChina being isolated for 30 years, decided to open its economy again in the late1970’s. The period between 1980’s – 1990’s witnessed an increase in the level of FDIinflows, through varied economic reforms. Major types of FDI that are prevailing inChina according to Yuan (2005) are: 1) contractual joint ventures 2) Equity jointventures 3) joint exploration 4) wholly foreign – owned enterprises5) share companywith foreign investment. All the above mentioned FDI’s are considered as the fruits ofwell implemented economic reforms. The analysis of the Chinese history reveals theactual facts to the readers.The first stage of the reforms kick-started in 1979, with the establishment of jointventure law and the formation of Special Economic Zones. The main aim of thepolicy was to attract foreign capital or investment through incentives and low taxregimes. During this period, the number of Contractual joint ventures was more incomparison to the Equity Joint Ventures, which accounted 86% to the total number ofFDI projects. At the end of this period about 1399 investment projects was approvedwith an accrued contract capital of 4958 million dollars (Dunning and Narula,1996).In 1984 – 89 the concept of SEZ’s was again recalled and upgraded, therebyformulating tax advantaged economic development zone and open coastal economiczones respectively. The newly improved business environment triggered an increasein FDI by 50% and 120% in 1984 and 85 respectively (Dunning and Narula,1996).Meanwhile during this period the FDI inflow to manufacturing sector and servicesector was worth noticing. The inflow to the manufacturing sector rose by 33% from14%, but the considerable flow to the service sector got decreased. The magnificentgrowth of FDI inflow that was visible during 1984 – 85 came to an in 1986, becauseof the changes involved in both general business scenario and market situation. In Shenyang Aerospace University
  19. 19. RONI BHOWMIKorder to improve investment environment, the state council executed another reformcalled ’22 regulations’ or the so called ‘provisions for the encouragement of foreigninvestment.’ The new economic policy had given the investors more confidence, andresulted in a increase inward FDI more than36% during 1987 – 1988. The FDI inflow to manufacturing sector again rose to 56%from 33% (in 1984- 88) during this period. The service sector again experienced a 5%decline in FDI, because of Chinese selective FDI policies. These reforms and thegrowth were again hindered during the period between 1988 – 91, because of apolitical crisis that took place between student activists and the government militaryofficials in Tiananmen Square (Margaret M. Price, 1994). In order to accelerateinvestment activities, overall economic restructuring was made. The 1979 jointventure was renewed and rules regarding the elimination of contract duration in someJoint Ventures were made. The period of 1990’s and 2000’s can be considered as thegolden era of Chinese economic growth, several reformation such as opening ofinland cities, liberalization of service sector and infrastructural development wasmade. The early 1990’s recorded a negligible ratio of increase in the flow of FDI tothe total domestic investment, which was 7% in 1992. The FDI inflow steadilyincreased after this period, thus projecting a figure of 17% in 1996(Zhang, 2006).Theoverall FDI projects during 1996 also rose to 70%, 90% and 134% respectively,which was more when compared to that of 1992 (Dunning and Narula,1996). After along 15 years of negotiation, China on 11th of November 2001, became an officialmember of WTO. This had given china the opportunity again to restructure theeconomic reforms. This in turn had improved business environment a lot. Accordingto Yuan (2006), china during the post WTO period had made significant changes inthe economic policies; one among such policies was the reduction of tariff rate andestablishment of direct trading rights for foreign firms. This along with Chinesemembership in WTO had given more confidence for the investors which as aconsequence lead to better FDI inflows (Xiaobao Dang, 2008).On the whole from the above analysis, Chinese FDI history can be divided into 5stages. 1) 1979- 1983 – experiment stage 2) 1984 – 1991 – growth stage 3) 1992 –1993 – peak stage 4) 1994- 200 – adjustment stage 5) 2001 – present – post WTOstage. The reform undergone during these stages was the critical factors that led tosuch a huge productivity boom in China (Xiaobao Dang, 2008).3.1.1. The impact of FDI in Chinese EconomyChina’s run to the second most desirable investment places in the world was begun infrom the year 1978, through various economic reforms, since then the economy hadattained a steady growth. One of the main agenda behind these economic reforms wasthe attraction of FDI. This case study of china explicitly projects the significant roleof FDI in economic growth. “Foreign capital has played a largely positive role inchina’s economic development during the reform “ (Machanna, August 15 2010).According to Zuliu and Mohsins Khan (IMF report, 1997) capital investment plays avital role in economic growth and it becomes more important when accompanied byeconomic reforms or market oriented reforms. The most prominent advantage of FDIin china was the sudden increase in export and import trade. The Chinese marketshare in the international trade increased to 6.1% from 1.6% during the period 1985 to2000.The other prominent impact of FDI on Chinese economy was the creation of jobopportunities, technological spillovers and capital contribution. Shenyang Aerospace University
  20. 20. RONI BHOWMIKThe FDI also facilitated the transition towards a market system from a centrallycontrolled system. This in turn had given few valuable benefits to china, whichincludes the formation of a market mechanism, production restructuring, up-gradationin the domestic enterprises competitiveness and Chinese economic integration withthe global economy (Zhang, 2006).3.2. FDI Inflows in IndiaThe importance of FDI India’s economic growth is indispensable. The economicsurvey of 2001-2002 by the Indian government had pinpointed several benefits of FDIon Indian economy, which are as follows: it encourages domestic investment forachieving higher economic growth; FDI is beneficial for both consumers anddomestic industries in many ways; FDI brings along with it the benefits oftechnological up-gradation; fuller utilization of resources; and access to bettermanagerial skills, which in turn helps the Indian industries to become highlycompetitive in the global market. FDI also helps in opening export markets, whichenables access towards better goods and services (Swapna s. Sinha, 2007). To studythe impact of FDI in Indian economy, it is necessary to analyse the period beforeliberalization and period after liberalization of 1991. The governmental policiestowards FDI have been changing from the post independence period. To study thesevariations, we can divide the period into four distinct faces. The period of gradualliberalization of attitude – which was from independence to 1960’s; the period ofmost selective stance from 1960’s to 1970’s; the period of less or limitedliberalization of policies, which was from 1980’s to 1990’s. The period after 1991, theeconomy was opened and the concept ‘LPG’ (Liberalization, Privatization and Globalization) was introduced (Dunning and Narula, 1996). After independence,India adopted several developmental plans – of them the strategy of importsubstituting industrialization was the first. The aim of the strategy was to improve theproductivity and capability of the heavy industries (Shujiro and Fukunari, 2006).During this period the FDI inflow was increasingly receptive. The Foreign Investmentpolicy issued by the Prime Minister in 1949 considered FDI is necessary toaccumulate capital and also needed to secure more technical, scientific and industrialknowledge. To do this, foreign investors were given the assurance of fairreimbursement in the event of acquisition and no restriction on the payment of profitsand dividends (Shujiro and Fukunari, 2006). The FDI policies in India was againliberalized during 1957 – 58 followed by the foreign exchange crisis, the policyincluded more incentives and concessions. In the late 1960’s government focused onseveral industries, which include drugs, aluminum, heavy electrical equipmentstextiles etc and opened the economy for them in order to increase FDI inflows. Inorder to promote FDI in India, the government even started Indian investor centerswith offices in various investor countries. The result for these amendments as ameasure to attract FDI was overwhelming. A large number of foreign enterprisesincluding foreign drug companies showed interest in establishing branches in thecountry. The inflow of FDI during this period was better when compared to that ofearly 1950’s. The FDI accumulation in the country during 1948 – 1964 was multipliedfrom Rs2560 million to Rs5655million (Dunning and Narula, 1996).The attitude towards FDI during the late 1960’s by the government was more of arestrictive one. FDI proposals which accompanied technological transfer andinvestment, which is more 40% foreign ownership was only accepted. Different itemswere specified by the government to the foreign collaborators for the royalty Shenyang Aerospace University
  21. 21. RONI BHOWMIKpayments and for the duration of technology transfer agreements. The governmentalso had put forth to the foreign investors, to use Indian consultancy serviceswherever it is available. The year 1973 was characterized by with the establishment ofnew FERA and limitations in the activities of foreign companies was made – whichconcentrated only on selected high priority industries. According to new FERA, theforeign companies having 40% had to register with Indian corporate legislation,exceptions from the 40% limit was given only for high- priority sectors, which wasconcentrating on exports (Shujiro and Fukunari, 2006). This restrictive environmenthad stagnated the FDI inflows. The FDI inflow recorded during 1974- 1980 was onlyRs163 million. Liquidation of FDI stock in non-manufacturing sector due togovernment takeover of several companies and fresh inflows to the manufacturingsector were worth noticing during this period. The share of manufacturing sector inthe FDI stock increased to 86.9% in 1980 from 40.5% in 1964 (Dunning and Narula,1996). As a part of modernization, India’s FDI perspectives began to change inthe1990’s. There was overall freedom in the import of capital goods and technologicaltransfer, this in turn exposed Indian industry to have competition with foreigninvestors or companies. The other changes adopted during this period include;numerous incentives, exemption from foreign equity restrictions under FERA to100% export oriented units – for the purpose new export processing Zones wereestablished and also brought the liberalization rules for the approval of industriallicensing. The rules regarding lump sum technical fees and royalties were releasedand taxes were also decreased. India’s growth rate during 1980’s was far better thanthat of previous decade, which projected an average growth of nearly 6% (Shujiro andFukunari, 2006). The stock of FDI also got tripled during this period to 27 billion.The share of services, plantations and manufacturing sectors to the total FDI stockincreased, while the share of chemicals and metal products got declined. Besides UK,US and Germany, Japan also started their investment in India during this period(Dunning and Narula, 1996). Indian scholars pointed out that the economic policies of1970’s – 1980’s in some way or the other was responsible for the crisis of 1990- 91.The economic environment of pre liberalization period was more or less closed innature. Policies during this period were mainly for the protection of the domesticfirms. Inward orientation and import substitution was the main backbone ofdevelopment strategy during this period. Because of the above said unfavorableeconomic reforms, FDI inflow was less and dint had much role to play with upliftmen of Indian Economy. The share of FDI during 1970- 80 to India’s GDP was on.033% (K R Gupta, 2000). 1991 till date is considered as India’s post liberalizationperiod. It started of with the liberalization of investment and trade policies under theshort form ‘LPG’ (Liberalization, Privatization and Globalization). The governmentreduced most of the products tariff rates. The recorded average tariff rate on importduring 1990-91, 1994-95 and 1997-98 was 87, 25 and 20% respectively. They alsohad made reforms in old policies like discontinuation in technological requirementsfor FDI in India. A wide variety of sectors mostly consumer goods sectors wereopened for the foreign investment. Previous FDI requirements (except for 24consumer goods industries), like export earnings balance the dividend payment forover the first 7 years from the date of commercial production was dropped and profitrepatriation by the foreign- managed firms were eased. In the mid 1990’s Indiabecame the member of Multilateral Investment Guarantee Agencies, as aconsequence, all the government improvements were insured against nationalization.The government also allowed 100% equity in high technology and export orientedindustries. In order to deal with large investment proposals, a Foreign Investment Shenyang Aerospace University
  22. 22. RONI BHOWMIKPromotion Board was set up. It deals with foreign investments which exceeds foreignequity of 51%. During this period Reserve Bank of India was also authorized to giveapprovals to projects in the high priority areas, where foreign equity did not exceed50% in mining sector and 51% in other sectors. This open attitude by the governmentenabled FDI inflow to get tripled and it recorded US$ 10 billion per year (A Mattooand R M Stern, 2003).3.2.1. Impact on 51% FDI on IndiaThe decision to hold back FDI in multi-brand retail will have a strong impact on thedomestic and foreign investor sentiment, another chamber, the Confederation ofIndian Industry (CII), said in a release. “We firmly hope that this would not be arollback and a quick consensus is reached,” CII Director General Chandrajit Banerjeesaid. Describing the volte face as a case of “missed opportunity”, Assocham SecretaryGeneral D S Rawat said, “It will send a very negative message to foreign investors.”Rawat said FDI in multi-brand retail could have created over 10 million jobs in threeyears, curbed wastage of farm products and benefited farmers through better pricesfor their produce.FICCI urged the government to move ahead with this progressive reform andproposed solutions like considering a maximum of 49 per cent FDI in multi-brandretail and increasing the percentage of sourcing from the small scale sector, whichwas proposed to be fixed at a minimum 30 per cent. The government was forced toput its decision to allow FDI in multi-brand retail on hold in view of stiff oppositionfrom UPA ally Trinamool Congress and other political parties. Shenyang Aerospace University
  23. 23. RONI BHOWMIK Chapter 4: Empirical Analysis4.1 Methodology and Data CollectionIn the previous section, we discovered that what fraction of FDI flows to India andChina. The strategies and policies they have adopted also played an immense role inattracting such an inflow. The current section examines the contribution of FDI onChinese and Indian economy. The data for FDI inflows and other variables are fromthe data base of UNSTAD. The data undertaken for the study covers a period of 39years starting from 1970 to 2009. The section for the purpose is divided into two. Thefirst section deals with graphical representation. This method is adopted to explain therelationship between the growth rates of the primary variable of concern, FDI andGDP for India and China as a whole. The second section presents the regressionanalysis for the aggregate for India and China as a whole.4.2. Graphical AnalysesThe purpose of the analysis is to show the affiliation between the growth rate of GDPand FDI. If the GDP growth rate is related to that of FDI, then it might be due to FDIdetermining of GDP, the growth rate of FDI at any time t is calculated as (FDItFDIt-i) / FDIt-1. Similar method is employed to calculate GDP growth rate. Theanalysis also shows the recent trends in FDI inflows in INDIA and CHINA.Figure: 4.2.1. FDI and GDP growth rate in China Shenyang Aerospace University
  24. 24. RONI BHOWMIKThe figure 4.2.1for china shows that the FDI inflow during the time period from 1970to 1982 was some what zero and it might be due to the closed nature of economicactivity during those days (Zhang 2006). The trend started to change since 1980onwards and this might largely due to the liberalization policies which they adoptedduring those days. An important point to be noted during the period 1982 to 1990 wasthat both FDI and GDP was going at the same rate and was almost parallel. After1990 there witnessed a sudden increase in the rates of FDI but the GDP growth rateduring those period was less, but positive. The period from 1998 to 2000 is also worthnoticing because FDI growth rate plunged to almost 4% from 5% and it was almostconstant till the year 2001. This sudden slow down in the FDI inflow during this timewas largely due to the Asian crisis of 1997. However the directions of both the lineswere moving in the same direction from the period 1980 onwards. After 2000 the FDIinflow again started to rise, but experienced little fall back during 2002 and 2005respectively. The GDP line shows that the economic growth rate was enormous from2000 to 2009 respectively, but FDI experienced a steep fall during the period 2007 to2008 and this is, might be as a consequence of global financial crisis. On the wholethe relationship between FDI flow and GDP growth rate was positive and the graphshows both the lines were, somewhat moving in the same direction.Figure: 4.2.2 FDI and GDP growth rate in INDIA Shenyang Aerospace University
  25. 25. RONI BHOWMIKThe figure 4.2.2 for India shows that, the variable FDI and GDP growth is not movingat the same proportion, which might indicate that FDI does not play a relevant role ineconomic growth. The period ranging from 1970 to 1993 suggest that the inflow ofFDI was minute and during the period 1978 to 79 it went to negative, but the GDPgrowth was less but was positive. The FDI growth during 1994 to 1999 was positiveand went to a maximum of 3%. It again declined during 1999 to 2002, this might beas consequences of Asian financial crisis.The important point to be noted that at any point till 2006 both FDI and GDP growthrate was not more than 5%. There witnessed sharp rise in FDI inflows during 2006 to07 and it rose almost to 12% which was actually double the growth of the previousperiods, but the relationship of FDI and GDP during that period shows, that FDI hasgot only less importance in the economic growth of India. After experiencing a smallfall back during 2007 it again went upward to a maximum of 24% in 2008, which wasenormous when compared to that of 2007, but at the same time GDP also increasedbut not at significant level compared to that of FDI. The graph shows that in thebeginning of 2009 the FDI inflows went down very sharp to 21% from 24% while theGDP growth decreased and became constant. However the period from 2006 to 2008can be considered as a golden period for FDI inflows in India.Both graphs give us an insight into the flow of FDI in these countries and therelevance of FDI on economic growth. Most significant thing to be noted is that thegraphs do not explain the impact of FDI on economic growth of these countries butonly shows the relationship between these variables. Another important fact is that,these investment inflows became more strong and positive after the adoption ofliberalization policies in these countries.Therefore the graph supports the findings of Agarwal (2000), Zhang (2006) and Dang(2008), that growth in these countries were periodical and it largely occurred as aresult of more liberalized policies. It is astonishing to see how the growth rate wentupward after opening up their economy (especially the early1990 period and the post1990 period is worth noticeable in both the countries – China and India respectively).4.3. Regression Analysis Shenyang Aerospace University
  26. 26. RONI BHOWMIKThe method used for the empirical analysis on this dissertation involves linearregression analysis. The variables concern for the study involves GDP, which isconsidered as the dependent variable, while FDI inflow is taken as the independentvariable of interest. The study also covers the relevance of other variables thatcontribute to the total GDP. The analysis is done in two different parts, one partpredominantly for China and the other for India. For the purpose two equations areformulated by including independent variables like FDI, exports and labor force forChina along with the dependent variable GDP. Meanwhile in the equation for Indiaindependent variable like FDI, Labor force and workers remittance receipts fromabroad are also included. This is done with an intention to study the impact of thesevariables along with FDI on economic growth of these countries respectively.Labor and employment plays major role in the economy. Often large entrepreneursare largely directed towards to those countries where they avail skilled labor at acheap rate for their business. Besides labor also contribute a major portion in the totalGDP. The study, therefore analysis their contribution in accordance with FDI.Workers remittance level is another important factor that contributes to GDP growthrate. The importance of the same is increasing day by day in India and China. Thenumber of people who are working in another country remits a part of their wages orbusiness activities to their country of origin in a way of savings. The exchange rateand the conversion procedure also play a major role which again adds to the totalGDP. The study therefore analysis their contribution as well, to the total GDP inIndia.Net export is another most important variable considered for the dissertation. Netexport is the difference between total import and export. It is also referred to asbalance of trade of a country. It is also considered as a major part of national account(current) in the balance of payment of a country. The correlation of net exports andnational asset position is immense, that an increase or decrease in net exports willhave a direct impact on the later, causing it to change.As mentioned earlier, for the purpose of the dissertation, a linear regression model isused. The results are so obtained with the use of SPSS (statistics package for thesocial sciences), a software similar to E-views. This is commonly used by themanagement students and corporate official all around the world to determine aprecise analysis of the problem. The study done by Adewumi (2006) and XiaohongMa (2009) had used similar analysis to find the impact of FDI on economic growth inAfrica and China respectively. Adewumi (2006) had used three methods such asgraphical, regression and granger causality, while Xiaohong Ma (2009) employedonly regression model to do the analysis. The finding so obtained from both studieswas some what positive in nature. The correct precision and the compatibility ofregression method used in both the studies can be taken as a base to formulate amultiple regression model to analyze the problem concerned for the dissertation.Multiple linear regression models are used to determine the impact of one or moreindependent variable on a dependent one. It allows analysts to examine the effect ofmore than one independent variable on dependent variable (Xinyan, Xinogang Su,2009).The equation for the model for China is formulated as follows:GDP= α + β1 FDI + β2 LBR + β3Nx+ εt………………………………. (1)Were GDP = Average annual growth rate of real per capitaFDI = Measured as a percentage of GDP, in US dollar millions,LBR = Annual average of the labor force, given in percentage,Nx = Measured as a percentage of GDP, in US dollar Millions Shenyang Aerospace University
  27. 27. RONI BHOWMIKHere the variable GDP is the gross domestic product, while FDI is the foreign directinflows, while Nx and LBR represent net exports and labour force of Chinarespectively.The equation for the model for India is formulated below:GDP = α + β1FDI + β2LBR + β3WR……………………… (2)Were GDP = Average annual growth rate of real per capita.FDI = Measured as a percentage of GDP, in US dollar millions,LBR = Annual average of the labor force, given in percentage,WR = Measured as a percentage of GDP, in US dollar millions.Here the variable GDP is the gross domestic product, while FDI is the foreign directinflows, while LBR and WR represents labor force and worker’s remittance receiptsof India respectively.The hypothesis for the empirical analysis is that the impact of FDI on economicgrowth ofIndia and China is positive. The confirmation of the above hypothesis can be madeaccording to the estimated value of β1 in the regression models. The hypothesis for themodel is:Ho: β1 = 0 (FDI inflow do not have any impact on economic growth), whileH1: β2  0The result of the model for India and China is represented in the tables 4.2.1.2 and4.2.2.2.(Appendix Section) The Durbin Watson test is also included in the analysis to find theautocorrelation in the error term. If the DW value is near to zero, the autocorrelationwill be positive, and if it is near to 2, then no autocorrelation. The‘t’ value is shown inthe model to test the significance level of the co-efficient estimates. There are 39observations in each analysis for China and India. The FDI inflow data’s for China forthe year’s between 1970 to 1980 is not available because China has opened itseconomy after a long period of the late 1970’s encouraged more FDI inflows during1980 onwards (Dunning and Narula, 1996). The labor force data for India and Chinaand workers remittance receipts data for India is only available from 1980 onwards.These limitations might have an impact on the regression results.4.3.1. Regression Analysis of ChinaGDP = -253.901 + .564FDI + 3.747LBR + .086Nx(-.998) (1.353) (1.023) (1.350)R square = .140, DW = 1.0231) From the analysis for the sample (see table 4.2.1.1 in appendix), β1 = .564  0, inother words FDI has an independent variable has got a positive effect on the economicgrowth of China. In other words a unit increase in FDI causes the GDP to increase by.564 percent in China. The coefficient value for β2 is 3.744, it indicates that laborcontribution to economic growth is worth noticing and positive in China. Besides, β3= .086  0 means net exports in China also has got a positive impact, therebyindicating that a unit increase in exports causes the GDP to increase by .49 percent in Shenyang Aerospace University
  28. 28. RONI BHOWMIKChina. By comparing all the variables, we find that FDI, LBR and Nx has got positiveimpact on China’s economic growth.2) From the equation the t-value for FDI, LBR and Nx are 1.353, 1.025 and 1.350which are all positive and significant- but not that significant when compared to that5% significance level. Of the entire variable, again FDI has got more positive effect,indicating that FDI’s contribution is more significant than the other variable.4.2.2 Regression Analysis of IndiaGDP = -7.562 + .536FDI + .165LBR + .212WR(-.084) (.581) (.144) (.267)R square = .086 DW = 1.8361) The analysis (see tables 4.2.2.1 and 4.2.2.2 in appendix) shows that β1 = .536 0,indicating that co-efficient estimates of FDI is positive with the GDP growth rate ofIndia.The equation suggests that a unit increase in the FDI cause GDP to grow by .581percent for India. Besides the value of β2 and β3 are .144 and .267 respectively,showing that the natures of contribution made by labor force and workers remittanceare almost positive in nature. Of all the variables the coefficient estimates of FDI ismore positive, whereby indicating that role of FDI in economic growth is quitesignificant.2) The t-value for FDI, LBR and WR are .581. .144 And .267 respectively, which areall positive but not significant at 5% significance level. Of the entire variablescomputed, FDI has got highest effect on the GDP, even though it’s not significant.The study thus reveals FDI has got relevance in the GDP growth of India, hencesupporting our theory of concern for the study. Chapter 5: Findings and Conclusion5.1. Author’s ConclusionFDI inflows in India and China was periodical, and the relevance of the same isincreasing year by year. China being isolated for more than 30 years opened itseconomy on the late 1970’s, since then the flow was astonishing. China at present isthe main FDI attracting zone in entire Asia and India is in second place according tothe recent studies. India on the other hand opened its economy in 1991 with theintroduction of Liberalization, Privatization and globalization policies, since then theinflow was quite good. The pre- liberalization period of both the countries were of a Shenyang Aerospace University
  29. 29. RONI BHOWMIKclosed nature, giving due importance to domestic firms. After realizing opportunitiesand possible benefits the policy makers in both the countries decided to open theeconomy. The main aim of this research is to examine the role of FDI in economicgrowth in CHINA and INDIA. The study is so aligned that, it gives due importance toboth empirical and theoretical aspects to give the readers an insight into the strategies,intervention, role of FDI and partially the role of other factors of growth that areprevailing in INDIA and CHINA, which enabled them to achieve such a rapideconomic growth. The graphical analysis of China as a whole shows that therelationship between FDI and GDP growth rate was remarkable and both the variablesare going at the same upward direction, indicating that FDI might have a significanteffect on GDP growth rate in China, The graphical analysis of India shows that thereis only very minute relationship between FDI and GDP growth rate. The direction offlow of both the variable are not equal and vary at certain periods, FDI as a variablemight not have a significant role in the in the economic growth of India.The main point to be noted is that the graphs do not explain the impact of FDI oneconomic growth of these countries but only shows the recent trend in FDI inflow andthe affiliation between these variables.Regression equation is formulated after doing the graphical analysis. For the purposelinear regression method is used to calculate the impact and the role of FDI on GDPgrowth of China and India. There are 39 observations in each analysis for China andIndia. The FDI inflow data’s for China for the year’s between 1970 to 1980 is notavailable because China has opened its economy after a long period of the late 1970’sencouraged more FDI inflows during 1980 onwards (Dunning and Narula, 1996). Thelabor force data for India and China and workers remittance receipts data for India isonly available from 1980 onwards. These limitations might have an impact on theregression results. Empirical results for China suggests that FDI as an independentvariable has a favorable impact on the GDP growth rate of China. The other variablesuch as labor force and exports also has got positive relation with GDP, therebyindicating that all the variables contributes positive to economic growth in CHINA.Empirical results for India suggests that FDI as a primary variable has got a positiverelation between GDP growth rate, indicating that FDI is relevant in contributing tothe growth of GDP growth rate in India. Of all the variables computed FDI is morepositive but not that significant at 5% significance level.Recent statistical figures shows that FDI inflows are increasing yearly and it mighthave a major role in the contribution of GDP growth rate of both the countries in thenearing future.Appendix A1.1. Regression analysis for China Table: 4.2.1.1 Model summary (b) Model R R square Adjust R Std. error of Durbin- Square the estimate Watson 1 .347(a) 0.140 0.40 2.83087 1.023 Shenyang Aerospace University
  30. 30. RONI BHOWMIKa predictors: (constant), nx, fdi, lbr b Dependent variable: gdpTable: 4.2.12 coefficients (a) Unstandardized Standardized Coefficients Coefficients Model B Std. Error Beta t sig. 1 (constant) -253.091 254.464 -.0998 .328 fdi .654 .417 .335 1.353 .188 lbr 3.747 3.657 .289 1.025 .315 nx .086 .064 .308 1.350 .189a Dependent Variable: gdpA1.2 Regression analysis for India Table: 4.2.21 Model summary (b)Model R R Square Adjusted R Std. Error of Durbin- Square the Estimate Watson Shenyang Aerospace University
  31. 31. RONI BHOWMIK 1 .293 (a) .086 -.020 2.15592 1.836a predictors: (constant), wr, lbr, fdib Dependent Variable: gdp Coefficients (a) Table: 4.2.2.2 Unstandardized Standardized Coefficients Coefficients Model B Std. Error Beta t Sig 1 (constant) -7.562 90.431 -.084 .934 fdi .536 .923 .218 .581 .566 lbr .165 1.145 .031 .144 .886 wr .212 .795 .099 .267 .792a Dependent variable: gdpReferencesAgarwal P.( 2000) Economic impact of foreign direct investment in south Asia IndiraGandhi Institute of Development Research, Gen. A.K. Bombay; India.Agarwal, Banerjee and Nair. 2009.” Business policy and strategic management”.Pragati prakashan. Meerut. India.Alfero. 2003. “foreign direct investment and growth: does the sector matter?”,Harvard Business School. Shenyang Aerospace University
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