Essays on the Perspective of Foreign Direct Investment in South and South-East Asian Economies: Beyond its Growth Effects

Abstract

Foreign Direct Investment (FDI) is the process that enables the residents of one country to acquire ownership of assets in another country thereby controlling the production, distribution, and other activities in a firm of that country. The period of globalization in the 1990s marked the flow of private investment from developed countries to developing countries, mostly in the form of FDI. The developing countries are left behind in the process of economic growth due to lack of capital accumulation, poor infrastructural facilities, technological backwardness, low investment and paucity of research and development. FDI from the developed countries helps in boosting their economy by increasing investment and efficiency, leading to economic growth. It provides capital for financing new industries and enhancing the existing ones, boosts the infrastructure, creates new employment opportunities and increases productivity. It has been considered as a source of employment generation and modernization through transferring technical know-how and enhancement of technology. It helps in increasing the efficiency of resource use as well as total factor productivity in the host economy. As a result, it aids in increasing the production capacity and capital accumulation. Thus, it acts as a catalyst to economic growth. Prior to the 1990s, South Asia and Southeast Asia were only partially open to FDI; however, after realizing the importance of FDI in determining investment, economic growth, and employment, the governments of these regions began to act as 'facilitators' to draw FDI. South Asia and Southeast Asia have recently been favored recipients of FDI inflows due to their strong economic growth in services and exports, their sizable domestic market, and the favorable opinions of international investors. The World Bank anticipates that these regions will be crucial to the global development narrative in the Asian century. Although South Asia and Southeast Asia were only partially open to FDI before the 1990s, their governments came to understand that FDI is a key factor in determining investment, economic growth, and employment during this time and began acting as "facilitators" to draw FDI. Due to this, FDI inflows rose, making South Asia and Southeast Asia a more desirable location for foreign investors, albeit not as desirable as China or Brazil. This is due to the unfavorable business environment, which includes subpar infrastructure, stringent labour laws, a lack of coordination between government departments on policy, a policy for special economic zones (SEZs) that is dormant, a lack of institutional reforms, corruption, and cost and time overruns in infrastructure projects as a result of contractual and institutional failures, which are frequently brought on by a lack of coordination between central and state government departments on land acquisition and environmental clearance. The present study broadly examines the determinants and impact of FDI inflows in South Asian and Southeast Asian countries. The first objective of the study is to investigate the determinants of FDI inflows in South Asian and Southeast Asian countries. We have used data from WDI over the period 1980-2019 for this study. Six explanatory variables (market size, trade openness, infrastructure, inflation, exchange rate and human capital) were considered for the study. We used the Hausman test to determine which of the two models (fixed effect model and random effect model) fits our data the best. We found the fixed effect model to be the best fit and the results indicate that market size and human capital yield significant coefficients in relation to FDI inflow for the panel of 18 countries under consideration. The findings also reveal that the influence of inflation on FDI was negative and significant. This implies that with a decrease in the rate of inflation, FDI inflows increase in the South Asian and Southeast Asian countries. The second objective is to examine the role of foreign aid on FDI inflows and economic growth in South Asian and Southeast Asian countries. We examine the interrelationship among foreign aid, FDI and economic growth during 1980–2019. For unit root tests, we have applied LLC, IPS and PP-Fisher tests. After testing the stationarity of the variables, we run the Johansen-Fisher Co-integration test to establish the long run relationship among the variables during the concerned time period. Further we proceed with OLS, quantile regression and system GMM. Our empirical results from alternate empirical estimations suggest that FDI flows positively impact economic growth in the region. Whereas GDP growth attracts FDI only when entire in South Asian and Southeast Asian region as a whole is considered; underlying the importance of trade integration to benefit from foreign capital. In this regard, our findings also suggest that being a member of WTO have shown mixed impact on FDI and economic growth in the region. This clearly indicates that mere compliance of WTO norms might not work well for most of these economies due to their macroeconomic constraints and structural bottlenecks. We find that foreign aid flows have contemporaneous negative relation with FDI flows. The results indicate that foreign aid crowds out FDI. The third objective examines the effect of institutional quality on FDI inflows in South Asian and Southeast Asian countries by controlling the effects of macroeconomic instabilities during the period 2002-2019. We have used six governance indicators as a measure of institutional quality by the use of Principal Component Analysis. The governance indicators have been extracted from the WGI database. In this study, we have applied Iterated-GLS (IGLS) model for estimation of the results. We find that institutional quality affects FDI inflows in this region positively. Furthermore, we have investigated the impact of each of the six variables separately on FDI inflows and found that except for the 2 variables, that is, rule of law and voice and accountability, all the other institutional variables have a positive impact on FDI inflows. The fourth objective investigates the impact of FDI inflows on domestic investment in South Asian and Southeast Asian countries over the period 1990-2019. We have used various panel methods such as Westerlund co-integration, pooled OLS, fixed effect, GMM system, and FMOLS. We found the existence of long run stable relationship among the variables from the cointegration test. Further, the results showed that, in the South Asian and Southeast countries, a one unit increase in FDI led to increase in domestic investment by more than one unit in the long run. This implies that an increase in FDI will lead to improvement in the domestic investment in the South Asian and Southeast Asian countries. In other words, FDI crowds in domestic investment in these regions. Lastly, the fifth objective examines the effect of ICT and FDI on environmental pollution in South Asia and Southeast Asia during the year 1990–2019. We use Pooled Mean Group (PMG) and Dumitrescu-Hurlin Panel Causality for the estimation of the results. Our results suggest that ICT and FDI affect the carbon emissions or environmental pollution negatively. This implies that with the rise in ICT infrastructure and FDI inflows, environmental pollution decreases significantly in the long run. The Dumitrescu-Hurlin causality results suggest the existence of bidirectional causality among ICT and FDI which implies that increase in foreign investment leads to increase in ICT infrastructure and also, with increasing ICT infrastructure, the foreign investment increases in the South Asian and Southeast Asian countries.