ESLSCA BUSINESS SCHOOL Summer 2016

Correlation between FDI and

Trade vs. Economic Growth in
Turkey
A comparative Study

Prepared By :

Hossam Adel Dalia Mohamed

Bassem Dyab Heba Tullah Azzam

Ahmed Mohye

Proffesor : Dr. Ahmed Mabrouk

 Contents
1- Introduction 2

2- Research Question 2

3- Literature review 3

3.1 FDI and Economy ..3

3.2 Trade and Economy3

3.3 Trade and FDI.4

3.4 Turkey..6

4- Data interpretation of Turkey.8

5- Conclusion 17

References .18

1
1-Introduction
FDI and Trade are viewed through many economic studies and theories are the important key
players affecting the economic growth of developing nations.

Some theories tend to prove that FDI is more suitable for growing economies as it sees these
economies eager for capital, yet FDI is seen as the water that quenches this thirst.

On the other hand, some other theories look to FDI as temporary effectors on economic growth
as it may destroy domestic capital investments as FDI has the power of capital, developed
technology, knowledge and market access which may negatively reflected on the long run of
economic growth.

Most developing countries take trade as an engine for economic growth. They depend on
export as a development strategy that put industrial companies into competition and hence
creates industrial development and push the economic growth.

While the import substitution schools believe that trade protection and industrial policies are
constrains on ability to conduct microeconomic policy.

Debates about trade and FDI and the linkage to economic growth are still a subject of many
studies and theories specially after the big change happened by the BRICS (Brazil, Russia, India,
China and South Africa) which prove a growth lead by developing countries against the G 7
economies (the United States, Canada, France, Germany, Italy, Japan, and the United Kingdom).

Our study in taking Turkey as a model for economic growth changes as FDI & Trade had the
great effect on this development in the recent 2 decades that was subject to many studies in
this regard.

2-Research Questions:
1- The Effect of FDI on economic Growth
2- The Effect of Trade (export and import and net trade)
3- The relation between FDI and Trade Elements Individually and collectively and their
effect on economic growth

2
3-Literature review
3-1 FDI ECONEMY

The neoclassical and endogenous growth models can be considered as a theoretical foundation for FDI
led economic growth hypothesis of a country. The neoclassical growth theories assume that FDI can
channel required funds to the productive sectors of a capital shortage economy which, in turn, help
increase the economic growth rate by increasing the marginal productivity of capital. In other words, the
neoclassical perspective is based on a basic principle in economics that outlines economic growth
demands capital investment in the form of long-term commitment [1]. The neoclassical economists also
view FDI as more reliable and less volatile sources of capital for the developing economies that can
augment economic growth [2], [3], [4], [5], [6], [7]).On the other hand, the endogenous growth theories
state that the long-run growth of a country is not only influenced by the volume of physical investment
but also depends on the efficiency of utilizing investment. Therefore, endogenous growth model focuses
on incorporating organizational, managerial, technical and human skills, innovation and technological
progress, and accumulation of knowledge endogenously in the growth theories that are often brought
by FDI ([8], [9], [10], [11] ). Precisely, in the endogenous growth model, the long-run economic growth is
viewed as a function of technological progress deriving from technology transfers and knowledge
spillovers ([12], [13], [14]).

Despite this positive link between FDI and economic growth, empirical evidence also reveals negative
association between them. the underlying assumption behind the dependency theory is that an
economy controlled by foreigners does not develop organically rather grows in a disarticulated manner
[15]. The dependency theories also argue that foreign gigantic players may create negative effect on the
growth and development of domestic firms of a host country in the long-run as they have large volume
of capital, superior technologies, higher market access, advanced marketing networks and better
managerial and human relation skills ( [16], [17], [18]). This situation could be even dismal for the
limited capital young growing firms as they may be unable to compete with the Multinational
Corporations (MNCs).

This confounding theoretical and empirical evidence on FDI and economic growth leads us to conclude
that FDI is country specific, and can be positive, negative or insignificant, depending on the economic,
technological and institutional conditions of a host country.

3-2 TRADE ECONEMY

Several studies, including [19][20][21]; have analyzed the export-led economic growth hypothesis. They
argue that exports increase factor productivity because of better utilization of capacity and economies
of scale. They also argue that exports are likely to alleviate foreign-exchange constraints and thereby
facilitate importation of better technologies and production methods. Grossman and Helpman [12]
argue that open trade regimes go hand-in-hand with good investment climates, technology
externalities, and learning effects. Theoretical literature on the relationship between trade and
economic growth reveals that international trade may have long run impact on economic growth. For

3
instance, Grossman and Helpman [28], Rivera-Batiz and Romer [29], Barro and Sala-i-Martin [30]
discussed that in the long run, trade openness may encourage to economic growth by diffusing technical
knowledge by importing high-tech items and from the spillover effects of foreign direct investment (FDI)
for instance, financial openness, from the collaboration with the sources of innovations. Sachs and Rajan
and Zingales [31] recommended that trade liberalization pushes the governments to launch a reforms
program to face the competition in international market. Empirical studies by [22] [23] [24] generally
support the view that open economies grow faster.

There are other studies, however, that question the wisdom of trade openness. Rodriguez and Rodrik
[25], for example, present a critical view of the link between open-trade policy and economic growth.
They argue that past studies fail to account for institutional differences among countries resulting in an
upwardly-biased estimate of trade and other policy liberalizations. Their analysis shows that the
relationship between average tariff rates and economic growth is only slightly negative and nowhere
near statistical significance. Redding [32] pointed out that trade openness impedes economic growth
through comparative disadvantage in the growth of productivity in specialized sectors of an economy. In
such scenario, protection policies may stimulate technological advancements and leads to economic
growth. In Bangladesh [34], the negative association between the trade openness and economic growth
rates perhaps due to the exchange rate depreciation, large volume of imported materials and negative
trade balance position.

Greenaway et al. [33] investigated short and long run impacts of trade liberalization on economic
growth by using panel data approach, they documented that there is j-curve relationship between trade
liberalization and economic growth; they also illustrated that trade increases economic growth at
certain levels of trade liberalization and then declines it.

According to Srinivasan and Bhagwati [35], in-depth studies of individual countries are the best
approaches for understanding the relationship between trade openness and long-term rate of growth.

The question of whether FDI and trade trigger economic growth or the economic development brings
FDI and trade is an unresolved issue. Past studies either analyzed the impact of trade and FDI on
economic growth (Borensztein[26] and Balasubramanyam [4]) or analyzed the effects of economic
growth on FDI (Barrel and Pain[27]; Lipsey [23]). A positive effect of FDI and trade on economic growth
may simply reflect the fact that FDI is attracted to countries that are expected to grow faster and follow
open-trade policies. It is, therefore, important to understand the interrelationships among FDI, trade,
and economic growth.

3-3 FDI TRADE

Since the apparent vehicle of capital mobility is Multinational corporations (MNCs) the link between the
FDI and trade is underscored in the following principle. If the operations of MNCs can be vertically linked
with the host nations, an increase in MNCs activities will generate demand for intermediate goods and
capital goods from the home nation (see Lu and Graham, 1998 [36] ). This presupposes that FDI could
be complementary or substitute and it depends on the nature of FDI. If it is a substitute for imports it

4
improves the host country's balance of payment position indicating that FDI is used for exports.
However, if it is complementary the balance of payment is adversely affected.

The early attempts to reconcile the activities of the MNCs with trade theory appear in Markusen[37]and
Helpman[38]. Markusen [37] focused on horizontal investments in which a firm sets up abroad to
produce the same products that it produces at home, while Helpman [38] focused on the vertical
investments in which the production process is decomposed by stages according to factor intensities in
different countries. This gives MNCs segmented structure either horizontal or vertical, justifying both
complementarity and substitutability of relationship between FDI and trade (Camarero and Tamarit
[39]). Theories of horizontal MNCs suggest they are substitutes (see Markusen 1984 [37], Alguacil and
Orts [40]). Firms decide whether to serve a foreign market by exporting goods or by setting up a plant
overseas. When the firm decides to set up a foreign plant, it reduces its exports of goods to that market.
As a result, an increase in affiliate sales is associated with a fail in exports of goods to that market.
Market access rather than cost consideration influences the location decisions of FDI. However, Neary
[41] shows that even when MNC activity is purely horizontal, costs are still crucial in determining where
in the union a new plant will be located.

In contrast, theories of vertical MNCs suggest that FDI and trade are complements. Here, firms
geographically separate different production stages across countries to take advantage of lower factor
prices (see Helpman [38]). For instance, the unskilled intensive stages of the production process are
located in a low-wage country and the final goods re-exported back to the source country. The source
country exports services and intermediate inputs and imports final goods. Hence, an increase in MNC
affiliate sales is associated with an increase in trade. As the geographical dispersion of the production
process increases we would expect intra-firm trade to increase correspondingly. These theories typically
assume there are zero trade costs throughout; hence there is no motivation for horizontal MNCs i.e.
horizontal FDI is ruled out by this assumption.

A recent study by Pacheco-Lopez [42] shows bi-directional causality between imports and FDI. This
suggests that imports and FDI are endogenous; and as FDI increases, import content increases too and
vice versa.

Past studies either analyzed the impact of trade and FDI on economic growth [3],[4], or analyzed the
effects of economic growth on FDI (Barrel and Pain[27]; Lipsey [23]). A positive effect of FDI and trade
on economic growth may simply reflect the fact that FDI is attracted to countries that are expected to
grow faster and follow open-trade policies. It is, therefore, important to understand the
interrelationships among FDI, trade, and economic growth. Since theory is unclear, this issue has been
the subject of empirical studies.

This paper (Makki [43]) analyzes the role FDI and trade in economic growth of developing countries
within the endogenous growth-theory framework. Using cross-section data relating to a sample of 66
developing counties over three decades, we show that FDI and trade contribute toward advancing
economic growth in developing countries. There is a strong, positive interaction between FDI and trade.

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 3-4 TURKEY

(Ylmaz Bayar [44]) study investigated the effects of FDI inflows and domestic investments on the
economic growth in Turkey during the period 19802012 by using co-integration test based on ARDL
bound test approach. Study findings demonstrated that there was a long run relationship among the
economic growth, FDI inflows and DI. The empirical findings demonstrated that FDI inflows had negative
effect on economic growth, while gross domestic investments had positive impact on economic growth.

This paper (Kevin o [45]) examines the relatonship between foreign direct investments (FDI) and import
growth in Turkey over the period 1950 to 2004. test reveals that in the long run FDI, GDP, and domestic
price affect import demand; while in the short run only GDP, domestic price and relative exchange rate
have influence on the import demand.

(Asl Akg [46]) work aims at demonstrating the effect of Turkeys liberalization process on economic
growth by investigating a Granger causal relationship running from exports to economic growth in
Turkey from 1987-I to 2002-IV. Additionally, causality tests among trade, FDI and output for the same
period are performed to show the inter-relatedness of trade, FDI and growth. Results are in line with the
ELG hypothesis, but do not confirm the existence of FDI-growth nexus, in other words the study did not
find significant positive spillovers from FDI to output. Furthermore, the findings do not suggest a kind of
FDI-led export growth linkage, hence only with more foreign capital investments flowing to Turkey FDI
may have a powerful effect over output.

The aim of this study (BIRGL CAMBAZOLU [47]) is to analyze the causal link between the inward
foreign direct investments (FDI), import service sector, and export service sector over a period of time
beginning with 1980 which lasts till 2012 According to the test results, an increase in the export service
sector level shows that it promotes imports. Since an expansion of the export sector depends on the
imported inputs in Turkey, the results of this study justify the structural current account of the deficit
problem. And also the results of the study show that an increase in the export service sector level
stimulates inward FDI.

This study (MASOUD ALI KHALID [48]) is analyzing the impact of trade openness on economic growth in
the case of Turkey. The study has applied the ARDL model to examine for a short and long run
relationship between trade openness and economic growth over the sample period 1960 - 2014. Results
confirm co-integration among the series. Moreover, in the short run, trade openness promotes
economic growth; while in the long run this relationship does not exist. Furthermore, the results refer
that in the long run this relationship is positive and statistically insignificant. The findings suggest that
economic growth gets boosted from gross capital formation and trade index which help sustained
economic growth in the short and long run.

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4-Data interpretation
4-1 FDI vs economic growth

7
 2001 to 2007
Seems to be a correlation in pattern though momentum seems to vary that suggests presence of
other factors involving in GDP performance.
2009 2010
Sharp decline in both GDP and FDI might suggest a direct causal effect
2011 to 2016
Almost complete mismatch between the two factors in terms of performance pattern and
magnitude. the reason could be attributed to other more powerful factors intervenes the GDP
performance.

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4-2 Trade VS GDP

4-2-1 Exports vs GDP

9
 There seems to be a significantly strong resemblance between the two factors performance
curves. That emphasizes the role of exports as a determinant of GDP performance.

4-2-2 Imports Vs GDP

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 Surprisingly there is a semi complete matching between both imports and GDP magnitudes.
There are many reasons for that requires investigation but may be attributed to importing
production goods or just imports due to improvement in economic conditions.

4-3 Trade balance VS GDP

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12
 2001 t0 2007
Increase in the negative gap between exports and imports accompanied by increase in the GDP.
2008-2009
Sharp improvement in trade balance accompanied by sharp decline in GDP
2010 to 2014 deficit in trade balance increases and then decreases from 2014 to 2016. on the
GDP side we find the same pattern inversely applied.
We can conclude a negative correlation between trade balance and GDP. A finding that is
contrary to the classical equation of GDP = c+I+g+(E-M)

13
14
 We can find a direct matching between imports and both GDP from construction and
manufacturing. this matching is lost completely when comparing these variables to the GDP
from agriculture.

4-4 FDI, EXPORTS, IMPORTS

15
 There is a perfect match between exports and FDI. that suggests a strong positive correlation
between the two measures and implies a positive impact of FDI on exports.
Matching between imports and FDI is almost perfect in pattern that might be attributed to the
need to production goods that are not available domestically.

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5-Conclusion
GDP= C+ I + G + (Ex-Im)
C= spending by consumer

I= investment

G= government expenditure

Ex= exports

Im= imports

This study was conducted on the Turkish model. it studied the past 16 years.
We found a direct correlation between FDI and GDP performance in terms of pattern and
magnitude.
We could find direct correlation between exports and GDP which implies a strong role of exports
in GDP performance improvement.
Surprisingly we could find an identical positive correlation between imports and GDP
We could find an identical positive correlation that links increase in trade deficit and increase in
GDP. this is totally contrary to the mathematical equation.
A very meaningful reason for the previous finding would be the nature of imported goods. these
would be production goods that tremendously enhanced both construction and manufacturing
sectors.
The governmental expenditure would have been increased especially in construction and infra
structure and that has led to both increase in FDI and GDP according to the equation.

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