An empirical analysis of determinants and trends of FDI in the selected high income countries since 1990.
Shahmoradi, Behrooz ; Thimmaiah, Navitha
Abstract
The marked rise of FDI flows to selected countries since the early
1990s has prompted substantial empirical research into the importance
determinants of FDI. This paper also has attempted to identify important
determinant of FDI inflow for the selected high-income countries (23
countries) since 1990. Based on the related review of literature six
variables (Outflow, GDP, BOP, Export, Import and labor) have been
selected. Employing adding-up / multiple regression models significant
determinants were identified.
Keywords: High Income Countries, Determinant of FDI, Inflow,
Outflow and Adding-up Model
INTRODUCTION
The marked rise of FDI flows to High Income (HI) countries since
the early 1990s has prompted substantial empirical research into the
underlying factors, for at least two reasons. First, FDI has become an
important part of the domestic economy. Second, foreign investments
played and still play a crucial role in the recipients' transition
from centrally planned economies to market economies, providing
substantial financial capital, technological know-how and managerial
expertise. Yet the patterns of absolute and relative FDI inflows have
been quite erratic, with respect to developed countries.
Therefore, an in-depth analysis of the factors determining FDI
inflows is needed not only to understand these aspects but also to
predict future patterns of FDI relating to HI countries and provide
policy makers with guidelines on how to improve FDI inflows.
The objectives of the current study are as follow:
* To analyze the determinants of FDI inflows in selected high
income countries
* To highlight the trends of FDI inflows in selected high income
countries
The study is an attempt to evaluate FDI behavior in selected HI
countries (1) in relation to important determinants of FDI, which have
been highlighted in previous studies.
To guide the analysis, the study starts with a summary of the major
trends in inflow of foreign direct investments in selected high-income
countries since 1990. A brief discussion on the main theories of FDI
determinants precedes the analysis of the empirical literature on the
same issue.
THEORETICAL AND EMPIRICAL BACKGROUND
Though there has been considerable theoretical work on foreign
direct investment (see e.g. Hymer (1960); Caves (1982); Buckley and
Casson (1976)), there is no agreed model providing the basis for
empirical work. Rather, Dunning's (1974, 1980) OLI (Ownership,
Locational and Internalization) paradigm has provided a taxonomic
framework for most estimating equations. Dunning proposes that FDI can
be explained by three categories of factors; ownership advantages (O)
for firms to operate overseas, such as intangible assets, locational
advantages to investment in the host rather than the home country (L),
and the benefits of internalization (I).
The literature indicates that the key locational factors
determining FDI are country's market size, input costs--notably of
natural resources and labor--and openness of an economy (see e.g. Singh
and Jun (1995); Culem (1988)). Market size, typically measured by host
country Gross Domestic Product (GDP) captures potential economies of
large-scale production. In the transition context, survey evidence
suggests that most firms invested in search of new market opportunities
(Lankes and Venables (1996)), which can also be related to absolute
market size.
Expected profitability will also be higher if inputs costs, most
notably labor, energy and raw materials costs, are lower than in the
donor economy. For most of the transition economies, the key resource is
labor, which is regarded as having relatively high levels of skills and
training (in comparison for example to regions with comparable per
capita income levels in South East Asia or Latin America) and a strong
scientific base (see EBRD (1999)). This aspect indicates the inclusion
of labor in the present analysis of FDI inflows in HI countries.
It is also widely argued that FDI and openness of the economy will
be positively related (see Caves (1996); Singh and Jun (1995)). This in
part proxies the liberality of the trade regime in the country and in
part the higher propensity for multinational firms to export and import.
Therefore the degree of openness of the country can be measured by its
export as well as its import. While, determinates of BOP can be the
country's exports and imports of goods, then we can conclude that
BOP can be correlated to FDI too.
Higher FDI outflow may also enhance the capability of the home
country in undertaking FDI inflow (Banga, 2007) with a lag, by enhancing
the flow of non-debt private capital and technological and managerial
skill, creating domestic employment through backward linkage effects and
also by building up the foreign exchange reserves of the country. Thus,
FDI inflows and outflows could be complementary. On the other hand, it
may be a plausible theoretical proposition to argue that entry of
foreign firms represented by FDI inflows increases competition in the
domestic market, which in turn forces domestic firms to seek additional
markets through exporting and FDI outflow. It is therefore topical to
get an insight into the effect of FDI outflows into corresponding
inflows.
Recent empirical works have tried to establish the determination of
FDI inflows by considering economic growth, export, import, labor
productivity or a combination of them. But, in the literature review,
relatively few published empirical works deal with determinant relations
among more than two variables simultaneously in a group of countries
(2).
TRENDS OF FDI FLOWS IN HIGH INCOME COUNTRIES
Developed countries are the main source of both inflow and outflow
of FDI and this can be clearly observed in the below diagrams. They show
the flows of FDI as a percentage of the world for the selected
high-income countries and for the different years (1990, 1995, 2000,
2005 and 2007).
[ILLUSTRATION OMITTED]
Chart 1 indicates that the share of FDI inflows in HI countries is
very high compared to the rest of the world. Their share has increased
from 60% to 64% and to 80% since 1990, 1995 and 2000 respectively. But
in 2005 it has decreased to 62% and again in 2007 it increased to 71%.
[ILLUSTRATION OMITTED]
The scenario is some thing different for the outflow of FDI as
indicated in the chart 2. It shows decrease in the share of high-income
countries in the world's total outflow from 93% in 1990 to 83% in
2007. It is quite clear that though the share of HI countries in total
outflows has decreased over time, still HI countries are the major
source of FDI outflow. It is observed that the share of inflow of FDI in
HI income countries since 1990 is increasing while their share in FDI
outflow is decreasing though only marginally.
METHODOLOGY
Multiple regression methodology has been employed to identify
significant variables in determining FDI inflows on HI countries. Data
on FDI inflow, outflow, GDP, BOP, Export, Import and labor once very
five year since 1990 to 2007 have been considered. (3)
To identify the impact of each variable on FDI inflows Adding Up
Model (4) was employed. Data on FDI inflows was first regressed on
outflow. In the next stage GDP was added to outflow. Other determinants
were added in subsequent stages. Hence, with 6 explanatory variables we
ended with 6 models for each year.
FDI inflows = [[beta].sub.0] + [[beta].sub.1] Outflow + [u.sub.1]
FDI inflows = [[beta].sub.0] + [[beta].sub.1] Outflow +
[[beta].sub.2] GDP + [u.sub.2]
FDI inflows = [[beta].sub.0] + [[beta].sub.1] Outflow +
[[beta].sub.2] GDP + [[beta].sub.3] BOP + [u.sub.3]
FDI inflows = [[beta].sub.0] + [[beta].sub.1] Outflow +
[[beta].sub.2] GDP + [[beta].sub.3] BOP + [[beta].sub.4] Export +
[[beta].sub.5]
FDI inflows = [[beta].sub.0] + [[beta].sub.1] Outflow +
[[beta].sub.2] GDP + [[beta].sub.3] BOP + [[beta].sub.4] Export +
[[beta].sub.5] Import + [u.sub.5]
FDI inflows = [[beta].sub.0] + [[beta].sub.1] Outflow +
[[beta].sub.2] GDP + [[beta].sub.3] BOP + [[beta].sub.4] Export +
[[beta].sub.5] Import + [[beta].sub.5] Labor + [u.sub.6]
Likely because of interrelatedness of certain explanatory variables
like BOP, Import and Export, and observing the results of adding up
model, the data was checked for multicollinearity problem at each stage
with the help of correlation analysis, partial correlations, Variance
Inflation Factor (V. I. F), Conditional Index (C. I) and Tolerance
(TOL). It was observed that multicollinearity problem existed in the
models, where import was included as an explanatory variable. Therefore,
import was excluded from the analysis. The variables were identified as
important determinants in explaining FDI inflows after checking for
multicollinearity problem, significance of the parameters and
[[??].sup.2] values. Subsequently the findings for all the considered
years have been discussed as follows:
In 1990, BOP and Outflow are the two important determinants of FDI
inflows with [[??].sup.2] value of 0.843. In the multiple regression
model where all the variables were considered, V.I.F indicated that
there was multicollinearity problem with export and import. Regarding
significance of variables GDP was insignificant and Labor though
significant had a negative sign. Hence at the next stage FDI inflows was
regressed On BOP, outflow and labor. In this model Labor turned out to
be insignificant where as V.I.F and C.I were good enough for BOP,
Outflow and labor. So As indicated in table 3 also regression model with
BOP and Outflow as explanatory variables was considered which yielded
[[??].sup.2] value of 0.843 and significant t values of -9.582 and 6.043
without any problem of multicollinearity and good TOL, VIF and CI
statistics.
FDI [inflows.sub.1990] = [[beta].sub.0] + [[beta].sub.1] BOP +
[[beta].sub.2] outflow + [u.sub.i]
FDI [inflows.sub.1990] = 1635.225 - 375.267 BOP + 0.433 outflow +
[u.sub.i]
In 1995, Outflow and BOP explain variations in FDI inflows to a
greater extent. In the adding up model the highest [[??].sup.2] value
was 0.818 when only Labor was absent as a explanatory variable. But the
model had the problem of multicollinearity as indicated by collinearity
statistics. GDP though not collinear with other variables was
insignificant where as Outflow, Export and imports were highly
collinear. Hence the regression with BOP and Outflow (6) was considered
which yielded [[??].sup.2] value of 0.781 and absence of multi
collinearity problem.
FDI [inflows.sub.1995] = 3638. 582 - 107. 711 BOP + 0.413 outflow+
[u.sub.i]
In the year 2000 the regression model with all explanatory
variables resulted a [[??].sup.2] value of 0.946. But there was severe
multicollinearity problem as per V. I. F with all variables except for
GDP and Outflow. And in the group of collinear variables C. I. indicated
favourable results toward BOP and export. So FDI inflow was regressed
considering these four variables. With a [[??].sup.2] value of 0.870 and
absence of multi collinearity problem GDP turned out to be
insignificant. So a model with only outflow, BOP and export as
regressors was run, which resulted in 0.814 of [[??].sup.2] value,
significance of all variables and obviously absence of multicollinearity
problem.
FDI [inflows.sub.2000] = - 1042. 765 - 390. 02 7 BOP + .185 Export
+ 0.166 Outflow + [u.sub.i]
For the year 2005, 0.545 was the highest [[??].sup.2] value
obtained wherein all regressors were included. As per V.I.F and TOI
statistics only outflow and GDP were free of multicollinearity problem
where as C.I was alright for all variables except for Labor. But
coefficient of GDP had a negative sign and was also insignificant with a
t value of 1.004. Hence a regression model with outflow and BOP (7) was
run. The model had [[??].sup.2] value of 0.514, variables were
significant and there was no multicollinearity problem.
FDI [inflows.sub.2005] = 699.61 + 0.74 Outflow-136.52BOP +
[u.sub.i]
In the year 2007 the simple regression model with only variable
Outflow yielded the highest [[??].sup.2] value of 0.779 as per the
results of adding up model. Even when all the variables were included
only outflow was significant and [[??].sup.2] value was 0.774. GDP and
Labor coefficients had negative sign, which would be theoretically
inconsistent. Among other three highly collinear variables BOP was
selected as per the criteria explained earlier and FDI was regressed on
Outflow and BOP and this resulted in a [[??].sup.2] value of 0.788 in
the significance of both Outflow and BOP with T values of 6.77 and
-1.393 respectively and absence of multicollinearity problem.
FDI [inflows.sub.2007] = 12943.16 + 0.596 Outflow - 60.45 BOP +
[u.sub.i]
CONCLUSION
As mentioned earlier most studies offer various determinants of FDI
inflows. The present study has demonstrated that all determinants do not
equally appeal FDI inflows in all the considered years. To be more
specific, the study found out that BOP and Outflow turn out to be the
two significant explanatory variables in all the years. But the
parameter of BOP was negative, indicating inverse relationship between
FDI inflows and BOP. We can say that outflow is emerging to be a major
component in determining FDI inflows especially in High Income
countries.
Furthermore, export was significant only in the year 2000. Another
important finding is insignificance of GDP in explaining FDI inflows,
while many empirical studies have shown significant relationship between
FDI inflows and GDP of an economy. The present study has a paradoxical
finding that GDP has insignificant relationship with FDI inflows. This
can be due to consideration of cross sectional data. Hence the
relationship between GDP and FDI inflows in HI Countries can be further
analyzed by considering time series data.
This analysis can serve both as a guide for a better comprehension
of FDI inflows into the region, and as a starting point for future
research areas.
FURTHER RESEARCH
* The findings of the present study can be further analyzed by
considering time series data of different HI countries.
* Same analysis can be employed to other group of countries.
* Causality relationships between FDI inflows and its determinants
can be analyzed with the help of time series data.
Appendix
Inflow: US Dollars at current prices in millions, Source UNCTAD
World Investment Report Database 2008.
Outflow: US Dollars at current prices in millions, Source: UNCTAD
World Investment Report Database 2008.
GDP: GDP per capita in U.S. dollars, Source: International Monetary
Fund, World Economic Outlook Database, October 2008.
BOP: Current account balance, Source: International Monetary Fund,
World Economic Outlook Database, October 2008.
Labor: Total labor force, Absolute Value in thousands, Source:
International Monetary Fund, World Economic Outlook Database, October
2008.
Export: Value and shares of merchandise exports, US Dollars at
current prices in millions, Source: International Monetary Fund, World
Economic Outlook Database, October 2008.
Import: Value and shares of merchandise import US Dollars at
current prices in millions, Source: International Monetary Fund, World
Economic Outlook Database, October 2008.
TABLES
Coeffiecient of Outflow of FDI and BOP for 1995
Coefficients(a)
Unstandardized Standardized
Coefficients Coefficients
Model B Std. Error Beta
1 (Constant) 3638.582 1590.410
OUT .413 .071 .688
BOP -107.711 40.856 -.312
Coefficients(a)
Collinearity
t Sig. Statistics
Model TOL VIF
1 (Constant) 2.288 .033
OUT 5.815 .000 .712 1.404
BOP -2.636 .016 .712 1.404
(a) Dependent Variable: IN
Coeffiecient of Outflow of FDI and BOP for 2000
Coefficients(a)
Unstandardized Standardized
Coefficients Coeffiecients
Model B Std. Error Beta
1 (Constant) -7831.253 14081.655
OUT .154 .112 .128
GDP .393 .627 .053
BOP -397.340 75.878 -.507
EXPORT .177 .042 .455
Coefficients(a)
Collinearity
t Sig. Statistics
Model Tolerance VIF
1 (Constant) -.556 .585
OUT 1.378 .185 .688 1.452
GDP .626 .539 .837 1.195
BOP -5.237 .000 .631 1.584
EXPORT 4.202 .001 .505 1.979
(a) Dependent Variable: IN
Coefficient of Outflow of FDI and BOP for 2005
Coefficients(a)
Unstandardized Standardized
Coefficients Coeffiecients
Model B Std. Error Beta
1 (Constant) 699.616 8695.591
OUT .740 .176 .631
BOP -136.523 40.764 -.503
Coefficients(a)
Collinearity
t Sig. Statistics
Model Tolerance VIF
1 (Constant) .080 .937
OUT 4.200 .000 .979 1.022
BOP -3.349 .003 .979 1.022
(a) Dependent Variable: IN
Coefficient of outflow of FDI and BOP for 2007
Coefficients(a)
Unstandardized Standardized
Coefficients Coeffiecients
Model B Std. Error Beta
1 (Constant) 12943.162 8772.745
OUT .596 .088 .797
BOP -60.456 43.390 -.164
Coefficients(a)
Collinearity
t Sig. Statistics
Model Tolerance VIF
1 (Constant) 1.475 .156
OUT 6.771 .000 .693 1.442
BOP -1.393 .179 .693 1.442
(a) Dependent Variable: IN
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BEHROOZ SHAHMORADI AND NAVITHA THIMMAIAH
Mysore University, Mysore, India
Notes
(1.) Australia, Austria, Canada, Denmark, Finland, France, Germany,
Hong Kong, Ireland, Italy, Japan, Korea, Mexico, Netherland, Norway,
Portugal, Saudi Arabia, Singapore, Spain, Sweden, Switzerland, U.K, U.S.
(2.) Aharoni (1966); Kobrin (1979); Davidson (1980); Buckley and
Mathew (1980); Root (1987); Young, Hamill, Wheeler, and Davies (1989);
Sabi (1988); Fuat Erdal and Ekrem Tatoglu (2002); Anjum Aqeel and
Mohammed Nishat (2005); emphasized that.GDP, export and import are most
important determinant of FDI. Liu et al. (2000); Vahter (2004); Girma
(2005) ;Thiam (2007) studied on labor. Meanwhile Fry (1993); Jansen, K.
(1995); Woodward (2001). Arslan Razmi (2007) on BOP.
(3.) See the appendix.
(4.) A linear regression model may be built up by adding new
independent variable to an existing model.
(5.) Coefficient tables for other years has been attached in
appendix.
(6.) Outflow was considered among the collinear variables as it had
lowest V. I. F.
(7.) Among BOP, Export and Import, BOP was selected as it had
lowest V. I. F
Table 1
Adding up Model of Determinant Variables of FDI Inflow in 1990
Constant Outflow GDP BOP
Coefficient 5219.990 0.653085
T 0.498409 3.075251
Sig 0.6234 0.0057
Coefficient 10973.88 0.682189 -0.204174
T 0.541392 2.917534 -0.334253
Sig 0.5942 0.0085 0.7417
Coefficient 12097.92 0.800515 -0.409312 -140.6493
T 0.737375 4.160616 -0.821915 -3.396936
Sig 0.4699 0.0005 0.4213 0.0030
Coefficient 7695.856 0.738312 -0.363076 -129.4816
T 0.404234 3.149855 -0.702085 -2.691773
Sig 0.6908 0.0055 0.4916 0.0149
Coefficient 9845.175 0.633297 -0.406176 219.7704
T 0.530657 2.649157 -0.807161 0.890531
Sig 0.6025 0.0169 0.4307 0.3856
Coefficient 12388.71 0.403288 -0.492897 429.1030
T 0.686517 1.441085 -1.004313 1.540529
Sig 0.5022 0.1688 0.3302 0.1430
Export Import Labour [R.sup.2]
Coefficient 0.310507
T
Sig
Coefficient 0.314337
T
Sig
Coefficient 0.573414
T
Sig
Coefficient 0.017100 0.578942
T 0.486138
Sig 0.6327
Coefficient -0.296727 0.313495 0.624790
T -1.346267 1.441271
Sig 0.1959 0.1677
Coefficient -0.490830 0.601896 -1.070160 0.669006
T -1.953032 2.085952 -1.461976
Sig 0.0685 0.0534 0.1631
[[??].sup.2]
Coefficient 0.277674
T
Sig
Coefficient 0.245771
T
Sig
Coefficient 0.506058
T
Sig
Coefficient 0.485374
T
Sig
Coefficient 0.514434
T
Sig
Coefficient 0.544883
T
Sig
Table 2
Coeffiecient of Outflow of FDI and BOP for 19905
Coefficients(a)
Unstandardized Standardized
Coefficients Coefficients
Model B Std. Error Beta
1 (Constant) 1635.225 1182.356
OUTFLOW .433 .072 .513
BOP -375.267 39.165 -.813
Coefficients(a)
Collinearity
t Sig. Statistics
Model Tolerance VIF
1 (Constant) 1.383 .182
OUTFLOW 6.043 .000 .994 1.006
BOP -9.582 .000 .994 1.006
(a) Dependent Variable: IN
