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(ii)
Over Lapping Generations Model:
The overlapping Generations (OG) model is a long run growth model
and it gives a different perspective of the effects of foreign direct
investment on the home and host countries. The summary of the
finding is that this model gives is that when a country takes up the
foreign investment it makes the future generations of the country
which imports capital(host country) better off and the future
generations of the country that Exports capital(home country)
worse-off (Bhalla, 1994).
When a foreign investment takes place anywhere in the world, the
rate of interest increases in the home country and it tends to fall in
the host country. The capital stock of the previous generation
determines the wage levels of the present generation. It therefore
directly affects the savings made by the present and future
generations. The wage rate is assumed not to change. Therefore,
since foreign investment reduces the rate of interest in the host
country, according to the O.G. Model the present generation suffers
the effect of low interest rates. The rate of Interest increase in the
home country which exports capital, therefore, the present
generation of that country enjoys the fruits of high interest rates
(Roy, 1979).
(iii) OLI Paradigm:
The most recent of them all, is the one given by Dunning popularly
known as Eclectic or OLI paradigm. It discusses about ownership
(O), location (L), internalization (I) advantages of a countrys firms
differentiates along the countrys course of economic development
(Dunning, 1994), According to this theory, three conditions have to
be fulfilled in order for a firm to become a multinational: the
ownership (O) advantages must be such as to make it profitable for
the firm to relocate abroad its own production (or at least part of it);
there must be some localization (L) advantage, typically linked to
the host countrys specific characteristics; it must be more
convenient the firm to manage its advantages internally (I) rather
than trade them through the market. This appeared to be a very
useful paradigm in explaining the different characteristics that
needs to be fulfilled for a firm to be called a Multi-national and also
helped in developing further empirical workings on this topic. (Soci,
2002)
Review of Earlier Works:
+ +
+ + -
+
+
+
+
+
+
+
+
Where,
FDI = Outward/inward flows of FDI.
Y = Real GDP.
I = Interest rate.
ER = Real Effective Exchange Rate (REER) Index.
T = Technology variable. This variable is reflected through the number
of patents issued in the home country.
HC = Human capital variable. It is approximated by number of
education students.
O = Openness of the economy. This variable is reflected by the level of
exports plus imports.
D = Dummy variable for measuring the impact of liberalization process
started in 1991 in the Indian economy: it takes the value 0 for the
years between 1980 and 1991 and the value 1 for the years between
1991 and 2005.
The signs given below the variables indicate the expected relation
(negative or positive) between the independent variables and FDI
outflows. The linear regression analysis is done using the OLS for the
period between 1980 and 2005.
The Model: Variables used and Explanations:
The dependent variable in the model is FDI of the given economy for
the period specified above.
There are several independent variables in the model namely Income,
exchange rate, technology, human capital and openness in the
economy. A brief explanation as to why these are considered as
variables in the model and why they are regarded as independent
variables supposed to have an influence on FDI is explained below.
1. Income: The first independent variable is GDP of the economy.
It is generally observed that the pattern of International Trade in
terms of the composition and direction changes with
development of an economy. There are changes observed in the
internal sectors also such as increasing share of industry and
service sectors, the capital intensity of production increases,
demand patterns move towards the consumption of
differentiated products and markets grow. The latter improves
the realization of economies of scale through specialization, the
introduction of new technology and greater volumes of output
(Chenery et al., 1986).
As the income of the nation increases there is always a
possibility that firms start accumulating advantages which are
5
expected that if the interest rate of the home country is low, then
there would be high propensity for FDI inflows and vice versa
(Clegg, 1987; Prugel, 1981; Lall, 1980; Grubaugh, 1987).
4. Technology: This factor is widely recognized as one factor that
does have a sure and great impact on FDI, infact the FDI
sometimes may be the cause for increasing technological
progress as it also gets influenced by the level of technological
progress of the economy. Every firm across different countries
has its own ability to organize and produce technological inputs.
This depends on several parameters like the legal systems and
patent processes, the availability of technological inputs and the
requisite skills to handle it, the market structure, the policy of the
government related to education and the incentives that these
policies offer to encourage education, scientific research, etc. ,
(Krykilis, 2003). The ability of firms to generate technological
inputs of a country is approximated by the number of patents
issued. Thus higher the patents issued higher would be the
outward FDI propensity of the country. Researchers across the
globe have proved theoretically as well as empirically that
technological capability is positively related with FDI (Lall, 1980;
Prugel, 1981; Grubaugh, 1987; Clegg, 1987; Cantwell, 1981;
Cantwell, 1987; Pearce, 1989; Kogut and Chang, 1991; Dunning,
1993, Krykilis, 2003).
5. Human Capital: Some researchers proved that the skill
intensive sectors are more prone to attract the foreign direct
investment than the rest (Juhl, 1979; Lall, 1980; Prugel, 1981;
Clegg, 1987). The availability of the human resources is one
factor that plays an important role in determining the FDI;
however the sheer number does not affect the inflow as the
quality of the human resource does. The size of labour force may
be instrumental in determining the price of the factor, as low
labour cost may increase the cost competitiveness of the firm.
But in an skill intensive industry, the quality of the labour force
determined by the number of people who are educated and the
number of science and technology professionals that exist
matters. The human capital supply varies depends largely on the
education systems and also the government policies.
The
number of students both male and female who are taking up
higher level of education is taken as a variable to measure this
factor, as the data of R&D professionals in the Indian economy is
not available for continuous years for the period of study. Many
researchers showed that the higher the number of graduates, the
higher would be the expected skill content in the employment.
Thus, there is a positive relation that is suggested between
human capital and FDI (Krykilis, 2003).
(Edward, 1992).
In those manufacturing sectors which enjoy
comparative advantage, the inflow of FDI would give rise to economies
of scale and higher productivity and create linkage effects (Edward,
1992) with FDI, profitability and outward remittance of profits and
dividends move in close tandem with the performance of the economy
and the balance of payments (Siow, 1993).
Coming to the scenario in Asia, few economies in this region are
attracting heavy inflows and others remain a low player. As can be
seen in the Table II, Asia contributes around one-fifth of the worlds FDI.
South, East and South-east Asia contributing almost four-fifth of the
total inflows destined in this region. However, there is a huge skewness
in favour of some economies in East Asia, with China dominating the
scene among all the economies. The internal policy framework and the
conducive environment for the foreign investors have been very fruitful
over the period for China. South Asia is among a deprived region in
entire Asia, with India contributing only around 3 percent to the regions
inflow in the year 2005. Singapore and Thailand are among other
economies in this region that attract a large inflow of Direct
Investments.
Take in Table I
Table I
Inward FDI Stock as a Percentage of Gross Domestic Product, by Host Region and
Economy, 1985 - 2005
199
7
11.7
6
10.3
6
15.2
2
19.0
7
199
8
14.0
1
12.4
7
19.0
7
23.7
3
North America
9.21
9.91
United States
Other developed
countries
Developing
economies
8.26
2.34 2.91
12.2
8.93
2
10.4 16.7
5
2
11.0
9.26
5
12.1
8.31
5
3.45
17.5
3
17.5
6
15.4
7
18.6
7
Region/economy
World
Developed
economies
Europe
United Kingdom
Africa
Latin America and
the Caribbean
Asia and Oceania
198
5
199
5
199
6
10.2
6.95 9.40
6
3.53
13.2
8
16.4
3
12.6
8
13.1
4
8.95
199
9
15.9
5
13.5
4
20.6
4
26.3
6
11.4
6
10.3
7
200
0
18.3
5
16.2
3
26.3
8
30.5
0
14.0
2
12.8
7
200
1
19.8
0
17.5
7
28.4
4
35.4
0
14.4
5
13.3
4
200
2
20.9
2
19.3
6
31.8
3
33.4
4
14.0
7
12.8
9
200
3
22.5
0
21.0
9
33.8
9
33.7
2
14.3
4
12.8
8
200
4
2005
23.3 22.6
0
7
22.0 21.4
5
0
34.9 33.4
4
8
33.3 37.1
2
0
14.5 14.5
1
6
13.0 13.0
3
2
3.93
20.5
7
19.3
2
18.6
6
21.9
5
4.35
25.9
1
26.9
8
24.2
9
26.5
6
3.94
26.2
6
25.9
9
25.8
4
26.5
1
4.40
28.0
7
26.5
6
31.8
2
26.3
7
6.02
26.7
4
29.8
2
33.9
9
23.3
0
7.29
27.7
7
30.4
0
36.7
8
23.8
8
8.15
27.9
3
29.9
4
37.6
4
23.8
8
7.32
27.0
0
28.2
0
36.6
5
23.1
5
Asia
West Asia
East Asia
China
Hong Kong,
China
Korea,
Democratic People's
Republic of
Korea, Republic
of
South Asia
India
Pakistan
12.1
8.26
2
11.3
2 8.02
12.2
8.24
6
14.4
2.04
4
75.2 50.0
4
7
..
13.1
1
18.6
6
21.9
5
26.5
7
26.5
1
26.3
7
23.2
9
7.80
13.1
9
15.6
9
51.5
2
8.31
23.2
7
17.1
4
143.
59
8.99
25.4
7
18.5
1
136.
21
8.88
34.0
4
18.7
8
252.
29
8.52
33.9
8
17.8
9
275.
44
9.66
33.3
4
17.2
8
257.
53
9.22
27.6
4
17.0
4
210.
25
9.80
10.3
1
9.98
9.83
9.45
2.74
4.14
2.54
12.7
4
12.2
4
27.4
7
14.5
7
42.2
8
10.2
3
78.3
5.56
4.70
3.33
11.7
9
12.7
3
47.2
2
32.6
8
62.4
4
14.2
8
105.
6.47
4.53
3.43
10.1
8
14.0
9
45.9
8
20.9
5
61.8
6
14.9
8
124.
7.32
4.66
3.77
13.3
6 6.57
Malaysia
Philippines
Singapore
Sri Lanka
South-East Asia
Indonesia
23.8
8
11.8
2
28.0
9
16.1
2
243.
39
23.8
9
11.3
8
28.3
4
14.8
8
275.
21
23.1
5
11.8
8
26.9
9
14.2
9
299.
88
8.58
9.17
10.0
9
10.7
0
8.58
4.78
4.20
8.11
5.45
5.00
7.94
5.62
5.18
8.24
6.04
5.68
7.97
6.23
5.84
9.78
8.25
9.80
45.4
2
16.5
0
58.4
0
16.8
7
121.
9.71
44.6
3
10.6
3
38.6
0
14.9
5
139.
8.29
10.4
4
43.6
5
8.48
10.7
2
43.8
4
8.77
11.3
1
44.1
6
8.78
10.4
1
43.2
0
4.11
39.4
5
15.6
8
153.
4.96
39.7
0
14.8
7
157.
7.05
37.1
9
14.9
2
156.
7.65
36.5
2
14.3
7
158.
Thailand
1
1
10.5 10.8
5.14
3
3
30.5 34.4 40.8
5
8
2
9
8.84
49.4
8
Viet Nam
South-East Europe
and the
Commonwealth of
Independent States
(CIS)
0.00 1.31 1.97 3.24
Source: World Investment Report 2006
83
22.7
8
57.5
1
23
25.3
7
63.3
9
67
24.3
7
66.0
7
95
28.7
9
70.4
3
20
30.0
9
74.3
1
55
33.9
6
70.4
4
19
32.9
5
63.5
4
57
33.5
0
61.1
7
5.40
8.64
15.8
7
19.4
9
22.1
5
24.4
5
23.8
0
21.2
2
Take in Table II
Table II
Inward FDI Flows, by Host Region and Economy, 1985 - 2005 (in US $ Million)
Asia
% of
World
West
Asia
% of
Asia
South,
East and
Southeast
1985
5421.
41
1990
22642.
36
1991
24154.
07
1995
79918.
01
1999
111285.
32
2000
147992.
76
2001
112044.
89
2002
96124.
85
2003
110136.
74
2004
156622.
32
2005
199553.
64
9.35
681.5
6
11.23
23.48
2495.2
1
10.12
10.50
13.46
455.69
15.60
2145.3
3
1799.49
3518.27
7219.71
15.56
6018.7
7
19.74
12313.5
3
22.04
18580.9
6
21.78
34460.7
5
12.57
4739.
85
2.01
22186.
67
8.88
22008.
74
3.12
77422.
80
1.62
109485.
82
2.38
144474.
49
6.44
104825.
18
6.26
90106.
08
11.18
97823.2
1
11.86
138041.
36
17.27
165092.
89
Asia
% of
Asia
East
Asia
% of
Asia
China
% of
Asia
Hong
Kong,
China
Korea,
Republic
of
Taiwan
Province
of China
South
Asia
% of
Asia
Banglade
sh
India
% of
Asia
87.43
2248.
30
97.99
8791.0
7
91.12
7944.1
1
96.88
46551.
57
98.38
77478.4
4
97.62
116275.
40
93.56
78828.5
9
93.74
67350.
24
88.82
72173.9
8
88.14
105074.
18
82.73
118192.
28
41.47
1956.
00
38.83
3487.1
1
32.89
4366.3
4
58.25
37520.
53
69.62
40318.7
1
78.57
40714.8
1
70.35
46877.5
9
70.07
52742.
86
65.53
53505.0
0
67.09
60630.0
0
59.23
72406.0
0
36.08
267.2
2
15.40
18.08
46.95
36.23
27.51
41.84
54.87
48.58
38.71
36.28
3275.0
7
1020.8
6
6213.3
6
24578.0
9
61924.0
6
23776.5
3
9681.8
8
13623.5
8
34031.7
0
35897.4
6
759.20
1130.3
0
1246.7
0
3042.8
0
3891.90
7726.90
7198.00
342.0
0
173.1
3
1330.0
0
1271.0
0
574.75
424.35
1559.0
0
2717.1
8
3.19
2.54
1.76
-6.66
106.0
9
3.24
236.6
9
1.39
1.96
1.05
217.9
0
9630.70
8650.60
3866.30
2926.00
4928.00
4109.00
3241.83
4658.30
3.40
2.91
75.00
1.90
2151.
00
0.31
2.69
453.00
1898.00
1625.00
6414.86
1445.0
0
6982.1
3
5729.27
7301.26
9765.05
3.15
5.73
7.26
5.20
4.66
4.89
309.12
2168.0
0
578.70
3585.0
0
354.50
5472.0
0
328.30
5627.
00
350.20
4585.0
0
460.40
5474.0
0
692.00
6598.0
0
1.95
2.42
4.88
5.85
4.16
3.50
3.31
Pakistan
Sri Lanka
SouthEast
Asia
% of
Asia
Indonesia
Malaysia
Philippine
s
Singapore
% of
Asia
47.44
24.40
278.33
43.35
271.92
67.00
492.10
65.00
532.00
201.00
309.00
172.95
383.00
171.79
823.00
196.50
534.00
228.72
1118.00
233.00
2183.00
272.00
2318.
42
12820.
85
13640.
28
28154.
05
28765.5
5
23540.7
9
19581.7
2
15773.
71
19919.9
6
25665.9
3
37135.5
6
42.76
310.0
0
694.7
1
105.0
0
1046.
75
56.62
1092.0
0
2611.0
0
56.47
1482.0
0
4043.0
0
25.85
1865.00
15.91
4550.00
17.48
2978.43
16.41
18.09
16.39
18.61
1896.00
5260.00
3895.26
3787.63
553.95
2473.16
4624.21
3967.12
556.00
4887.0
9
1247.00
16577.9
1
2240.00
16484.4
9
195.00
15648.8
7
145.09
3203.4
2
1542.0
0
7338.0
8
-596.92
550.00
5574.7
5
35.23
4346.0
0
5815.0
0
1459.0
0
11535.
31
491.00
10376.3
7
688.00
14820.1
1
1132.00
20082.7
3
9.42
9.46
10.06
1952.00
1414.00
3687.48
Since the data used is time series and for over two and half decades, it
was checked for its stationarity and there was no stationarity observed.
The descriptive statistics of the data set is given in Table III, as it can
be observed that in India the Inflows of foreign direct investment in all
years have been much higher than the outflows, this aspect owes itself
to the liberalization policies which were put in place quite late in the
economy only after 1991 when they were initiated. The process of
integrating the domestic economy with the global economy though has
advanced over a period; it still remains partial in many cases.
Take in Table III
Table III
Descriptive Statistics
Mean
FDI In
Std. Deviation
9731.2081
12784.42419
57.8788
20.20889
361970.5485
152980.33055
ER
80.4319
16.60447
10.2885
1.89696
1774.1538
434.72876
6630645.1923
2982656.33152
58961.3462
42828.08604
FDI Out
GDP
Correlations
REE
R
FDII FDIO
GDP
1.000
.969 -.033
.969
-.71
6
.963
1.00
-.62
-.213
0
5
ER
-.033 -.175
-.21
-.38
1.000
3
1
.272
-.716 -.613
-.62
1.00
-.381
5
0
-.233
-.010 -.052
.012
.272
-.23
3
1.000
FDII
Y
HC
.946
.977
.944 -.257
-.55
8
-.065
.978
.951
.983 -.123
-.62
9
-.051 .921
.638
.683
.708 -.637
-.10
5
1.00
.687
0
1.00
0
The regression results are shown in Table V, here the FDI inflows are
taken as dependent variable and other variables as independent. It can
be observed that the constant in the model is significant. It can be
seen that all variables except the exchange rate, interest rate and
technological factor is seen to have values as expected in the model.
However, this factor also shows no significance in the model. Though
the overall goodness of fit is very high and the Durbin-Watson statistics
does not show any signs of autocorrelation among the data variables,
surprisingly the exchange rate is not related to the inflows of FDI in the
Indian scenario possibly because it was controlled for a major part of
years in the period of study. The process of liberalization also shows a
positive and significant impact on the FDI flows, as seen by the results
of dummy variable, which should be a factor that the policy makers
should note and go ahead with further fastening of the pace of
relaxations of norms for FDI inflows in the economy.
Thus, it can be said that that Indian FDI inflows are mainly dependent
on the levels of openness and sectors of available for inflows rather
than major macro economic considerations such as exchange rates
16
Table V
OLS estimates of all variables in the model 1980-2005
Variabl
es
FDI In
Y
ER
I
T
HC
O
D
.009
117.898
-787.356
-.159
.002
.123
2388.20
0
13680.0
44
.996
671.048
Consta
nt
R2
F
statistic
DW
tstatistic
s
.740
4.758
-4.294
-.279
7.855
3.346
2.827
-2.941
1.768
The FDI outflow of the Indian economy has been largely restricted by
policies almost till the turn of the millennium. The regression results of
FDI outflows as a dependent variable can be seen in Table VI. As can be
observed that none of the variables are significant except the human
capital and most of the variables are showing reverse correlations as
against the expected signs in the model. Thus, the model can be
discarded as not relevant in Indian context as Indian liberalization of
FDI outflows has still a long way to go. This need to be tested further
when the liberalization process takes off in true sense and in a
complete manner.
Take in Table VI
17
Table VI
OLS estimates of all variables in the model 1980-2005
Variabl
es
FDI Out
3.73E005
.060
.003
-.002
4.46E006
4.74E005
-1.602
10.733
ER
I
T
HC
O
D
Consta
nt
R2
F
statistic
DW
tstatistic
s
.775
.608
.004
-.676
5.484
.323
-.474
.576
.976
102.471
1.584
Conclusions:
The exchange rate and economic growth seem to show least impact on
the FDI inflows in Indian economy and human capital and openness of
the economy plays a significant role as far as attracting inflows are
concerned. These results are exactly opposite to the findings related to
developed countries FDI determinants, where exchange rate and GDP
play a more positive and important role (Krykilis, 2003). This shows
that the liberalization process of the economy needs to be fastened
and more and more sectors should be thrown open for inward flows.
Similarly the model does not work for outward flows as in many cases
the flow is restricted by policy. Thus, it can be said that human capital
plays a significant role, which can be related to the abundance of
human resources at a competitive cost. Finally, national endowment
resulting in natural competitiveness does determine the FDI of Indian
economy.
References:
1. Aliber, R.Z. (1970), A theory of foreign direct investment, in
Kindleberger, C.P. (Ed.), The International Corporation, MIT Press,
Cambridge, MA.
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29.
Prugel, T.A. (1981), The determinants of foreign direct
investment: an analysis of US manufacturing industries,
Managerial and Decision Economics, Vol. 2, pp. 220-8.
30.
Prugel, T.A. (1981), The determinants of foreign direct
investment: an analysis of US manufacturing industries,
Managerial and Decision Economics, Vol. 2, pp. 220-8.
31.
Ranis Gustav, Schive Chi, (1985 ), Direct Foreign
Investment in Taiwans Development in Galenson Walter (ed)
Foreign Trade and Investment, The University of Wisconsin Press,
Madeson.
32.
Reddaway W.B., (1968), Effects of U.K. Direct Investment
Overseas, Cambridge University Press, Cambridge.
33.
Roy J. Ruffin, (1979), Growth and Long-rune theory of
International Capital Movements, American Economic Review,
Vol. 69, No. 5, December, pp. 832-842.
34.
Scaperlanda, A. (1992), Direct investment controls and
international equilibrium: the US experience, Eastern Economic
Journal, Vol. 18, pp. 157-70.
35.
Scaperlanda, A. and Balough, R. (1983), Determinants of
US direct investment in the EEC revisited, European Economic
Review, Vol. 21, pp. 381-90.
36.
Scaperlanda, A. and Mauer, L.J. (1973), The impact of
controls on US direct foreign investment in the EEC, Southern
Economic Journal, Vol. 39, pp. 419-23.
37.
United Nations, (2005) World Investment Report, New York.
38.
United Nations,( 1997), World Investment Report, New
York.
39.
Yue Chia Siow, (1993), Foreign Direct Investment in ASEAN
Economies, Asian Development Review, Vol. 11, No. 1, P. 75
Further Readings:
i)
ii)
iii)
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