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Fdi On Economic Growth In Developing Countries Economics Essay
(Shah, Qureshi & Bhutto, 2011) Pakistan has been performing poorly in terms of technological readiness and its inability to advance in innovation and the underlying factors are lower literacy rates and education systems having no focus on sustainable economic growth. A country which is only able to produce one full National Science and Technology Policy (1984) and one National Technology Policy (1993) had already lost much of its grounds for the development of its Nation more precisely on the ground of sustainable development. The factors responsible for the absence of regular introduction of policies in Pakistan are political instability, political will, bureaucrats’ motivation, leadership deficiencies and unavailability of S&T policy experts. In Pakistan majority of policies are formulated by politicians of ruling parties supported by bureaucrats holding key posts in government. Politicians and bureaucrats tend to avoid taking the burden taking do not want to adopt innovative thinking. This passive approach of policy makers results in unavailability of policies on regular basis responsible for deteriorating condition of science and technology in Pakistan.
(LeBel, 2008) the choice of institutional regime may have much to do with the positive effects of foreign direct investment. an increase in a region’s national saving rate and its level of trade dependence on real per capita GDP. Although increases in these variables do produce positive effects on the level of real per capita GDP, they are outweighed in most instances by reductions in aggregate country risk and in increases in creative innovation. Strengthened property rights are a necessary mechanism for this to take place, while a nurturing and open environment also has a role to play. Devising suitable policies built around credible models is an important step in raising per capita income.
(Kyriakou, 2002) adequate technical progress was able to guarantee Sustainable economic growth.
(WU, 2000) Since the initiative of economic reform in the late 1970s, the Chinese economy has sustained a continuously high rate of annual growth. This seemingly miraculous growth has attracted the attention of many economists in the world. However, most previous studies have focused only on the industrial or agricultural sectors, perhaps due to the limitation of statistics. However, the potential in efficiency improvement has been almost exhausted in the 1990s, and hence, economic growth in the future will mainly rely on innovation, i.e., technological progress which, in contrast, may continue indefinitely. Technological progress has now become an important factor propelling China's economic growth. This change is very favourable for sustained growth.
(Bazhanov, 2010) (Shah et al., 2011) Science and technology status of Pakistan after its independence in 1947 was not strong. It inherited very meager infrastructure of science and technology, which included one university, four research laboratories and a few industries with primitive technology [8]. Pakistan S&T status further suffered from the early loss of its founder and first Prime Minister. The early loss of its prime leadership further weakened the Pakistan’s vision for setting up its S&T priorities. The real work for S&T policy formulation in real terms was started very late after the
establishment of S&T cell in the Ministry of Science and Technology in 1975. The cell produced the first policy draft of National Science and Technology in 1976, which was approved in 1984.
A country which took almost 37 years to produce its first S&T policy had already lost much of its ground to accelerate in S&T. Still now National Science and Technology Policy (NSTP) of 1984 is the only full combined policy of S&T produced by Pakistan, whereas only one separate National Technology Policy (NTP) was launched in 1993. The NSTP-1984 touched all the aspects related to scientific and technological development of Pakistan. It defines and provides
outlines for the organization and structure of S&T to university research, technology development to S&T manpower, service condition and incentive for S&T manpower to the promotion of S&T, international liaison to financing of S&T. However, recently the new government also constituted a committee to formulate a new science and technology policy.
(Herzer, Klasen & Nowak-Lehmann, 2007) Cross-country studies
Cross-country studies generally suggest a positive role for FDI in generating economic growth. However, the growth impact seems to be conditional on a number of factors, such as the level of per capita income, human capital, trade openness, and financial market development. For instance, Blomstr?m et al. (1994), using cross-country data from 78 developing countries find that low-income developing countries do not enjoy substantial growth benefits from FDI, whereas high-income developing countries do. The authors conclude from this that a certain threshold level of development is necessary to absorb new technology from investment of foreign firms. Balasubramanyam et al. (1996), on the other hand — using cross-country data for a sample of 46 developing countries — find that trade openness is crucial for acquiring the potential growth impact of FDI. They argue that more open economies are likely to both attract a higher volume of FDI and promote more efficient utilisation thereof than closed economies. Moreover, their estimates indicate that FDI has stronger effects on growth than domestic investment, which may be viewed as a confirmation of the hypothesis that FDI acts as a vehicle of international technology transfer. Similarly, Borensztein et al. (1998) use cross-country analysis of 69 developing countries and find that the effect of FDI on growth depends on the level of human capital in the host country, where FDI has positive growth effects only if the level of education is higher than a given threshold.4 Finally, Alfaro et al. (2004) examine the links between FDI, financial markets and economic growth using cross-country data from 71 developing and developed countries. Their empirical evidence suggests that FDI plays an important role in contributing to economic growth, but the level of development of local financial markets is crucial for these positive effects to be realised.5 However, given the problems inherent to cross-country studies, these findings on FDI and growth should be viewed with skepticism. A well-known problem with cross-country studies is the assumption of identical production functions across countries. In fact, production technologies, institutions and policies differ substantially across countries, so that
the growth effects of FDI are also likely to differ. As a consequence of cross-country parameter heterogeneity, these regression results are generally not robust to the selection of countries (Ericsson et al., 2001). Moreover, unobserved heterogeneity due to omitted variables may lead to biased parameter estimates (see, e.g. Carkovic and Levine, 2005). Furthermore, a statistically significant coefficient of FDI in the growth equation does not necessarily need to be the result of an impact of FDI on economic growth. Given that rapid economic growth usually generates higher demand and better profit opportunities for FDI, a positive correlation can also be compatible with causality running from growth to FDI (Nair-Reichert and Weinhold, 2001). Accordingly, cross-country studies may suffer from serious endogeneity biases.
(Azman-Saini, Law & Ahmad, 2010) The provision of incentives (i.e., tax incentives and/or subsidies) and the adoption of FDI-stimulating policies stem from the expectation that FDI will bring tremendous benefits to the recipient countries. They have highlighted the adverse socioeconomic impacts of economic freedom (i.e., investment freedom) that include linkages,
asset bubbles, foreign dominance, economic instability, and massive inflows of foreign labors, among others. For instance, Krugman (2000) argues that foreign investors can take advantage of liquidity constrained domestic investors' fire sales of assets during financial crises. In this situation, foreign investors acquire local firms because of their superior cash position, and not because of technology advantage. Likewise, Hausmann and Fernández-Arias (2001) are doubtful about the benefits associated with FDI. They argue that a recent rise of FDI in Latin American countries is not a sign of good health, but instead a sign that local markets are not working properly. Domestic residents are selling their companies to foreigners because they do not have the markets and institutions that allow them to grow. Razin et al. (1999) in their article argue that foreign investors' asymmetric information advantage might lead to over-investment. With regard to this issue, Stiglitz (2000) warned that without an efficient regulatory framework, full capital account liberalization will bring instability to a developing economy due to free flows of short-term speculative capitals. However, the author recognized that FDI flows are not as disruptive as short-term flows that can rush into a country and, just as suddenly, rush out.
It has been pointed out in earlier studies that FDI spillovers do not appear automatically, but depend on the host countries' absorptive capacity that is largely determined by several factors. A number of papers have tested the absorptive capacity hypothesis. For instance, Blomstrom et al. (1994b) found that FDIs have a stronger positive growth effect in countries with a higher level of development (i.e., when the country is sufficiently rich in terms of per capita income).8
Balasubramanyam et al. (1996) tested the hypothesis of FDI efficiency given the trade policy of the recipient countries. They found that the effect of FDIs on growth was stronger in countries with export promotion policies than in countries that pursued import substitutions.
In fact, they found that the growth effect of FDIs in developing countries that followed import substitution policies could not be established. Balasubramanyam et al. (1996) argued that import substitution policies reduced the efficiency of FDIs by distorting the returns from social and private capitals. It has also been argued that the adoption of new technologies requires labor that is able to understand and work with the new technology. On this issue, Borensztein et al. (1998) found that FDI inflows only had a marginal direct effect on growth, but in countries where human capital was above a certain threshold it did positively contribute to growth (i.e., when FDI was interacted with the level of education of a country's labor force). The same interaction effect was not significant in the case of domestic investment, which may reflect the nature of technological differences between FDI and domestic investment. This finding implies that because developed countries have a higher level of human capital, they are more likely to gain from FDIs than developi
ng countries. This conjecture is further supported by Xu (2000) who found that technology transfer by U.S. MNCs contributed to the productivity growth in developed countries, but not in developing countries. The development of both banks and stock markets were found to be important pre-conditions for FDI spillovers. According to these authors, a more developed financial system positively contributed to the process of technology diffusion associated with FDI. Although empirical evidence on the link between FDI and growth is mixed, evidence on the role of institutions in the development process is more compelling. North (1990), perhaps today's bestknown economic ‘institutionalist,’ defines institutions as the humanly devised constraints or rules of the game that structure political, economic, and social interaction. As the structure evolves, it shapes the direction of economic change towards growth. In short, institutions affect security of property rights, prevalence of corruption, distorted or extractive policies, and thereby affect the incentive to invest in human and physical capital, and hence economic growth. A number of recent papers empirically confirm the importance of institutions for economic development. These institutional indicators include quality of bureaucracy, property rights, and the political stability of a country. Barro (2000) argues that secure property right improves growth performance by encouraging investments, and also by enhancing the productivity of investments. Meanwhile, Demetriades and Law (2006) find that stronger institutions are more important than financial developments in explaining output per capita in low-income countries. In short, empirical studies on FDI–growth relationship remain limited particularly with respect to the effects of EF on FDI spillovers. Arguably, countries that promote greater freedom of economic activities are more likely to gain from the presence of MNCs.
(Reiter & Steensma, 2010) The role of FDI in economic development from a neo-classical economic perspective, FDI from developed countries is deemed an integral ingredient to the economic growth of underdeveloped countries, and economic development is best served when the state plays a limited role in controlling the market (Caves, 1996; Hymer, 1976; Kindleberger
& Herrick, 1977; Todaro, 1989; Vernon, 1966). It is argued that developing countries benefit directly from FDI through an inflow of capital, tax revenues, and employment, and indirectly through spillover of the foreign investor’s technology and knowledge to local enterprises and workers, and through access to foreign markets. Domestic suppliers, competitors, distributors, customers, and employees learn from their interaction with foreign investors, and their ability to
compete globally is enhanced. It is also argued that the entry of competitive foreign enterprises takes the competitive structure of the industry to a new level. Local firms that survive in this increasingly competitive environment do so only by becoming more efficient and, thus, more competitive, raising the productivity of the local industry and, in turn, the economic
growth rate of the developing country. Hence, FDI can be an important vehicle for the transfer of technology to certain local firms and for increasing the overall competitiveness of the industry, which will have a positive effect on economic growth (Borensztein et al., 1998).
On the other hand, FDI may crowd out local enterprises and actually be detrimental to economic development. Foreign enterprises are often significantly superior to domestic enterprises and either buy out or drive out domestic firms, leading to a concentration of power in the industry (Agosin & Mayer, 2000; Aitken & Harrison, 1999; Blomstro¨m & Kokko, 1996).
The net effect is a decrease in competition and domination by foreign entities. Whether this occurs seems to depend on the level maturity of the local markets and the type of sectors
that FDI enters. Agosin and Mayer’s (2000) panel study found that the effect of FDI in Asia, and to a lesser extent in Africa, crowded in domestic investment, and, yet, in Latin America,
the study found that FDI crowded out domestic investment.
Agosin and Mayer (2000) conclude that the effects of FDI are not always positive and that FDI policy plays a role in determining the outcome. With regard to the theory that development occurs in an indirect way as a result of FDI spillovers, the results are mixed as well. Konings’s (2001) firm-level panel-data study of Bulgaria, Romania, and Poland found that there were no positive spillovers to domestic firms, and, in fact, on average, there were negative spillovers in Bulgaria and Romania. He surmises that this negative effect may be because the technology gap was too large in these less advanced countries and the dominant factor was the increased competition of the foreign firms. Glass and Saggi (1998) believe that the larger the technology gap between the host and home country, the lesser the chance of technological
transfer. This can occur for two reasons: one, the host country is unable to absorb the technology due to inadequacies in human capital and physical infrastructure or, two, the multinational
corporation may not invest in the latest technology in the host country because of its perception of the lack of absorptive capacity. In support of this hypothesis, the Kokko (1994) study of Mexico spillovers found no evidence of spillovers in industries where multinational firms used highly complex technologies. There are clear instances where FDI does contribute to economic growth, but, not always. This suggests that there are other factors that interact with FDI that determine
the outcome. Whether FDI has a positive or a negative effect on economic growth depends on such things as the sectors it operates in, the ability of locals to participate and learn for foreign investors, and the ability and willingness of host governments to use FDI with development in mind. Country policy can play a role in strategically positioning FDI for the benefit of the country in terms of economic development.
(b) FDI policy’s influence on the FDI-economic development relationship. When multinational corporations enter markets of developing countries, it is often market failures that attract FDI and give them the advantage in the market. Foreign investors anticipate that their superior technology and knowledge entering into a less efficient market with fewer and less capable competitors will give them the opportunity to capture a large percentage of the market.
Multinational corporations are interested in profit, not in local accumulation or local industrialization. It is up to the state to redirect multinational corporations’ rationality and oppose them, if necessary, to ensure that local objectives are met (Evans, 1979). The host government has a legitimate seat at the bargaining table with the foreign investor. It can strategically use FDI by controlling investors’ behavior through state policy. In this way, the state plays an important role in shaping the market and creating policy that ensures growth, development, and social equality and that the state is not beholden to foreign interests but can devise an economic strategy that leads to development. Thus, important variables for understanding growth and development in developing countries are the autonomy and strength of the state and the development policies and structure of the political processes (McMillan, 1999).
