53248243 What Affects the Relationship Between Foreign Direct Investments and GDP Growth Evidence...

8/3/2019 53248243 What Affects the Relationship Between Foreign Direct Investments and GDP Growth Evidence From East

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Endrit Avdullari

What affects the relationship between Foreign Direct Investments and GDP growth:Evidence from Eastern Europe

WHAT AFFECTS THE RELATIONSHIP BETWEEN FOREIGN DIRECT INVESTMENTS AND GDP GROWTH:EVIDENCE FROM EASTERN EUROPE

by

E Avdullari(Student Number: 10299447)

A dissertation submitted for the MSc International Management Programme

School of Business & Social Sciences Roehampton University 2011


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Acknowledgements

I would like to thank Debbie Pearson, Cindy Ferguson, Paul Bemand and Sarah Gartland for their valuable contribution in this study.

This dissertation is dedicated to my family who have supported me immensely throughout this process.


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List of Abbreviations and AcronymsABF ALB B&H CEFTA CIA Corr. CRO CZE EC EEC EU FDI FYR GDP HUN INSTAT IMF MAC MNC

N NATO POL Rep. ROM R&D Sig. SLO Std. SVK UK UN UNCTAD UNESCO U.S. USD WDI WB WGI Associated British Food Albania Bosnia and Herzegovina The Central European Free Trade Agreement Central Intelligence Agency (of the United States) Correlation Croatia Czech Republic European Commission Eastern European Countries European Union Foreign Direct Investments Former Yugoslav Republic Gross Domestic Product Hungary (Albanian) Institute of Statistics International Monetary Fund Macedonia Multinational Companies Number of values The North Atlantic Treaty Organization Poland Republic Romania Research and Development Significance Slovenia Standard Slovak Republic United Kingdom United Nations The United Nations Conferenceon Trade and Development The United Nations Educational, Scientific and CulturalOrganization United States United States Dollar World Development Indicators World Bank World Governance Indicators


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1. Introduction, organisational context and research objectivesThe relationship between the economic growth and the level of FDI has always been a matter of discussion between economists. The theoretical framework explaining the relationship between FDI and GDP growth derives from two major models. Theneoclassical growth model states that FDI cause an increase in investments andtheir efficiency leading to increases in growth. In the long-run, according to the endogenous growth model, FDI promote growth, which is considered a function of technological progress, originating from diffusion and spillover effects (Nair-Reichert and Weinhold 2001; Jones 2002). Nevertheless, a number of studies haveproved that FDI are not always correlated with GDP growth and recent research has concentrated more in identifying the reasons behind these results stressing the importance of economic and political economy of the countries under considera

tion.

This study determines which variables are most often correlated to FDI in our sample of 11 EEC such establishing which ones are most influential and as a resultdeserve particular attention from policy makers and entrepreneurs. A linear regression model will be built, whenever possible, for each country in order to identify the variables that best explain the variance of FDI. The study will also investigate whether there is any significant pattern or difference between the countries where the relationship between GDP growth and FDI is strong and the countries where it is not. The research tests whether each of the variables is correlated with FDI and than a model that best explains the variance of FDI as a function of these factors is constructed. The results are expected to provide a setof common features of the countries that are able to absorb the advantages comin

g from FDI which as a result would then be reflected in the economic growth. Thefindings will offer advice to policy makers on which issues need to be addressed with priority. The conclusion will also be helpful to executives of MNC on which countries offer a more positive environment to host their investments and will provide information on the markets with future potential.

The selected determinants are GDP growth, human capital, market size, economic freedom, political freedom, openness to trade, tax rate, GDP per capita, R&D, government spending, real interest rate, accessibility to credit, infrastructure, inflation and unemployment. The countries under investigation are Albania, Bosniaand Herzegovina, Bulgaria, Croatia, Czech Republic, FYR of Macedonia1, Hungary,Romania, Poland, Slovenia and Slovak Republic.1

Now on will be referred to simply as Macedonia.

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Macroeconomic data series were collected from highly reputable international bodies. the research is mostly based on the WDI dataset from the WB but data from U

NESCO, The World Factbook from CIA, The Wall Street Journal and The Heritage Foundation publication on freedom, The UN, The EC for Economic and Financial Affairs as well as other national statistical institutes are also used for an eleven-year time frame from 1998 to 2008.

After testing the relationship between GDP growth and FDI for each country individually, the results were confronted to other possible factors that have been suggested by the literature to be influencing FDI. A regression model collecting all influential determinants was then created to prioritize the impact of each determinant on FDI and check whether there was any general pattern that explainedthe difference between the countries where the correlation between FDI and GDP growth was significant and the countries where it was not.

This study tested the importance and prioritized previously researched settingsaffecting the efficiency of FDI in regard to economic growth. Prior research hasoften concentrated on testing or finding one or few individual influencing variables and aimed to either build a model for the whole region or alternatively for a single country. This research does not concentrate on one or few but includes a wide range of determinants. The countries are divided into two groups. The first group includes those countries where FDI is correlated with GDP growth andthe second group includes those where this relationship is not significant. Thesecond group is further divided into subgroups according to their common characteristics identified by the study. The main findings were collected from researchin different regions and/or temporal horizons and were tested in the selected time and region. The results helped creating both a national and a regional frame

work that describe why some countries are more successful than others in attracting FDI and where can each of the countries under consideration focus in order to be more attractive to investors. In this paper, the model will be statistically tested among 11 countries of CEE, in order to subsequently be compared with the conclusions reached by the literature review. Previously offered factors thatare believed to determine the significance of the relationship between the GDP growth and FDI will be tested in order to identify those more relevant to the countries under investigation. The region has been chosen because CEE is one of themost dynamic regions of the world due to the many political developments that have occurred there in a short span of time and although close geographically there are significant differences between individual countries such offering to this research a very diverse sample. All these countries experienced a quick transition from being planned economies to adopting a free market economic system withdifferent approaches and inevitably, different results. The contribution of this paper on the overall knowledge relays on the fact that there seem to be no previous 2


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studies that covered all the allegedly influential factors together, especiallynot in so many EEC countries altogether. In addition, to the author`s best knowl

edge, there is no other study offering both a national and regional insight in this context. The second part of this paper will cover the literature available up to date which includes findings of important studies and the evidence that they presented to support their theses. Starting by offering a general background on how the theory has evolved, this paper continues by presenting some of the most influential suggestions, results and methodology from previously published works. Different views and the arguments on where they are based are included in this section. In part three, details on how this research was carried out and a closer view to the variables and the sample taken into investigations are presented. Reasons on why this particular approach, data set, data sources and researchdesign were used are also explained in this section together with a closer lookto the tests used. Main findings are included in part four together with a selec

tion of illustrating graphs and tables to support the analysis. In part five main conclusions and recommendations are drawn adding a note regarding this study`slimitations and other implications for future research. Other relevant information such as the bibliography, full statistical results, the data and the variables is attached at the end of this paper.

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2. The Literature ReviewMultinational enterprises expanding their influence in foreign countries in orde

r to have control on local assets and production activities has been a growing trend of the world economy (Mallampally and Sauvant 1999). Starting from the late1980`s a rapid increase of FDI was experienced almost anywhere in the world. This new striking economic feature revitalised the debate on the net resulting effect of the costs and benefits that FDI inflows produce on the economy of host country and/or vice-versa (Hansen and Rand 2006). 2.1 The relationship between FDIand GDP growth Developing countries, rightly, do not appear to show as much interest in foreign bank lending and portfolio investment as they do in FDI. The reason behind this preference is related to the fact that countries are not very motivated by short-term profits (e.g. portfolio investments) which are volatile and do not guarantee a steady income for the economy (Mallampally and Sauvant 1999). Hence, since the 1990`s, FDI has become the leading source of external finan

ce. Long-term prospects for making profits in production activities which are not as flexible and hence reflect stability motivates this choice. Many countriesare inclined to liberalise their policies toward MNC in order to benefit from the positive influence that the investments are thought to have on a countrys tradeand industry. Policy makers have been so eager to attract these investments that they even offered special incentives to foreign enterprises like lower or short-term brakes in income taxes, import duty exemptions, lowering of entry barriers, subsidies for infrastructure etc., sometimes even to the point of damaging the free competition (Aitken and Harrison 1999; Blomstrm and Kokko 2003). Thomas (2007) has collected many examples where EEC have been competing fiercely using the above-mentioned incentives as well as providing free or discounted price on land or opening agencies to help new foreign businesses reduce bureaucracy, time and costs and provide all required information to them. Some countries have even

offered free funds coming from newly introduced schemes and investment-supporting legislation, all to attract as much FDI as possible. The competition has become so fierce that some of these schemes are being subject to abuse. Recently, ABF, the British manufacturer of Twining, obtained a fund of 15 million USD comingfrom the European Regional Development Fund granted to the Polish authorities toattract new investments. The move has drawn criticism from the EC which is reviewing the situation since ABF is closing its factory in the UK such suggesting that is in fact simply relocating its operations to Poland and not expanding itsactivity as the scheme requires (OMurchu and Cienski 2010). All these efforts have leaded to the unavoidable fact that the largest amount of investments from abroad in developing countries has originated from FDI (Lipsey 1999). 4


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Casson (1990) sees the theory of FDI as a mixture of other existing theories. Heargues that it intersects with the theory of international capital markets whic

h illustrates the risk-sharing and financing agreements, the theory of the firmwhich specifies the location, management and utilization of the output and the trade theory which indicates the location of production and the destination of sales.

MNC are believed to bring new advanced technologies in developing countries suchplaying an important role in their growth (Borensztein, Gregorio and Lee 1998).Since in developing countries there exists a low efficiency of the capital, FDIinflows can help these economies to increase their capital-worker ratio by introducing more productive technologies (Bosworth, Collins and Reinhart 1999). Theinflow of FDI was seen as crucial in resolving the issues of EEC related to their scarcity of capital and low productivity (Sergi 2004). Investors, especially r

isk seeking ones, are interested to expand in developing countries since investments in capital-scarce countries are expected to yield a higher return (Asiedu 2002). There is a general belief that FDI can give valuable help in transformingformer communist countries by adding significantly to the low amount of domesticsavings directed to investments. In contradiction to the Solow growth model1 where technology is assumed exogenous, the growth literature supports the hypothesis that economic growth depends on the level of domestic technology and its ability to adopt and adapt new advanced technologies used by leading countries (Moosa 2002). Enterprises that are part of transnational systems which consist of parents and affiliates, achieve important advantages being linked to these channelsthrough non-equity arrangements. If the environment is conducive, these features can be harnessed successfully by domestic firms of the host country (Mallampally and Sauvant 1999). Productivity gains, transfer of advanced technology and pr

ocesses, managerial skills, employee training, augmentation of domestic savingsand investments, profits from foreign exchange that originate from exports to other countries, creation of new markets, capital flows, networks and channels areall positive effects that originate from FDI and support the rationale for theefforts that are made to attract FDI (Alfaro et al. 2004; Ram and Zhang 2002). Many studies (e.g Hansen and Rand 2006; Carkovic and Levine 2005; De Mello 1997)have been conducted to test the relationship between FDI and GDP growth in different contexts. The results have proven to be rather extreme. Some of these studies (e.g. Bengoa and Sanchez-Robles 2003; Alfaro et al. 2004) have found a considerably strong relationship while others (e.g. Borensztein, Gregorio and Lee 1998) found no evidence of a significant correlation between the two variables. Theviews can be grouped into two main categories.1

The Solow model of growth: Y= AK L-1 where Y= tot l output, A = technology, K= C pit l nd L=L bour. (Solow 1956).

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Wh t ffects the rel tionship between Foreign Direct Investments nd GDP growth:Evidence from E stern Europe

The first group rgues th t FDI ssist in the tr nsfer of technologic l nd business skills nd underst nding to the host country. In contr st, the second group

believes th

t FDI will hurt resource

lloc

tion

nd slow growth (C

rkovic

nd Levine 2005). The effects of FDI on the level, composition nd growth of the output of the host country lso depend to l rge extent on the m croeconomic policyin oper tion in th t country. In gener l, it seems th t FDI c n exert n imp cton the output of the host country if it is possible to bsorb surplus resources nd/or improve efficiency through ltern tive lloc tions (Moos 2002). In order to benefit from technologic l tr nsfer, Xu (2000) h s found th t minimum threshold level of hum n c pit l needs to be re ched. As M nsfield nd Romeo (1980), h ve found in their r ther d ted study, multin tion l comp nies tend to protect their technologies s long s they c n from domestic firms to strengthen theirposition in the loc l m rket. Neither they nor Germidis (1977) found ny signific nt evidence of technology tr nsfer to loc l competitors. However, recent evid

ence suggests th

t the technologic

l environment h

s ch

nged completely in the l st three dec des. In the long term, technology diffusion might occur from l bour turnover by le rning-by-observing or le rning-by-doing s domestic employees move from foreign to domestic firms (Alf ro et l. 2004). Altern tively, domesticfirms might benefit just from observing the products of these foreign firms (Blomstrm nd Kokko 1997). B l subr m n y m, S lisu nd S psford (1996) stress th tthis process still depends on the bility of the hum n c pit l to dopt nd implement these pr ctices. In trying to determine whether FDI c uses n incre se onGDP or vice-vers , H nsen nd R nd (2006) found th t is FDI which c uses growthwhile GDP h s no l sting imp ct on FDI. This finding is import nt in th t supports the hypothesis th t by tr nsferring know-how skills nd d pting new technologies FDI c n signific ntly ffect economic growth. The view contr dicts two e rlier studies one by De Mello (1997) nd the other by C rkovic nd Levine (2005) who

concluded th

t there w

s no positive long-run imp

ct to growth c

used by FDI. Moos (2002) expl ins the effect of FDI on output by using the multiplier model of Keynes (1936) which predicts th t most of the income is spent for consumption

nd only wh t is left fter this is s ved. This is cyclic l process where e chtime th t the income incre ses, the spending incre ses too by gener ting more income for the businesses which in turn c n hire more people dding further moreto the tot l spending. The theory pplies in closed economy so rightly Moos (2002) recognises its limit tions in qu ntifying the multiplier in the re l economy where domestic investment is highly ffected by other f ctors such s importsor t xes. This comes from the f ct th t in ddition to the le k ges coming fromdomestic investments, FDI h s other le k ges on its own (e.g. remitt nces) which dd to the foreign cl ims on the domestic output. To complic te m tters further, FDI m y not gener te extr 6


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income but inste d be just substitution for imports such expl ining the different findings from rese rchers in this subject.

On one h nd, one could rgue th t given ppropri te policies nd b sic level of development, FDI c n pl y key role in the process of cre ting better economic environment. On the other h nd potenti l dr wb cks do exist, including deterior tion of the b l nce of p yments, s profits re rep tri ted h ving neg tive imp cts on competition in n tion l m rkets. As in m ny other fields of development economics, there is not univers l greement bout the positive ssoci tionbetween FDI inflows nd economic growth (H nsen nd R nd 2006). Different developing countries h ve been ble to t ke dv nt ge of the presence of FDI in theireconomies but on ver ge they h ve not been s successful s middle or high-income countries which h ve shown notice bly higher r te of success in this process (Singh nd Jun 1995). From the m cro point of view FDI m y le d to rise in o

utput

nd income for the economy. This is p

rticul

rly true for developing countries when there is usu lly high r te of unemployment nd the c pit l is sc rce. Being considered s foreign borrowing but which does not h ve to be p id b ck, FDI will h ve positive imp ct on the b l nce of p yments. The net effect on tr

de however, will depend on whether FDI substitutes the current imports or whether its imp ct f lls on exports. From the micro point of view, new tr nsn tion lcomp ny entering the domestic m rket might upset the m rket powers. It might incre se the competition but it might lso le d the m rket to monopolistic or oligopolistic environment (Moos 2002). Unfortun tely, n import nt re son why MNCchoose to invest in country is often rel ted to wh t is known s the t riff jumping hypothesis which rgues th t if it is difficult to ccess loc l m rket through tr de, firms m y set up loc l ctivities with the simple go l of voidingthis restr int (Asiedu 2002) nd not to exp nd their ffili te so th t they c n

export to other countries from there (R

m

nd Zh

ng 2002). Another concern withMNC entering the domestic m rket is th t it m y not le d to rise in c pit l ccumul tion since gener ted profits might be rep tri ted in the form of dividends, roy lties etc. inste d of being reinvested in loc l ctivity. When very powerful, MNC c n we ken government control over cert in economic policies le ding tounw nted pr ctices like c rtels or pricing tr nsfer such c using dverse effectson the m rket m king it less competitive (L ll nd Streeten 1977). Obviously, by ffecting c pit l ccumul tion, FDI is seen s m jor pl yer in economic development nd this f ct is cknowledged by convention l theories of economic growth. Nevertheless, not ll FDI re founded by c pit l from their home country. They m y s well borrow from fin nci l institutions of the host country which wouldneutr lise the positive effect of c pit l ccumul tion (Moos 2002). Undesir ble effects of FDI th t d m ge domestic tr de nd industry include use of technologies th t misuse the host countrys f ctor proportions, d m ging loc l businesses7


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through intense competition, concentr ting only in the loc l m rket nd not iming to export, s well s d pting nd promoting in ppropri te soci l nd cultur

l norms which d

m

ge the host countrys tr

ditions

nd inherit

nce (R

m

nd Zh

ng2002). 2.2 The Determin nts Blomstrm, Lipsey nd Zej n (1994) st te th t when country becomes rel tively rich, FDI h ve positive effect on economic growth. They me sure the we lth in terms of GDP per c pit . Lower income countries find it difficult to ttr ct FDI m inly bec use they l ck infr structure f cilities especi lly in cruci l re s such s tr nsport, communic tions nd inform tion technologies (Obwon 2001). The view is lso supported by Binici, Hutchison nd Schindler (2010) who suggest th t income levels ffect c pit l flows nd cross-border sset holdings. Agreed on principle, the m tter is seen from different perspective by L ne nd Milesi-Ferretti (2003). They ssoci te country with higherincome per c pit with lower risk nd conclude th t since intern tion l investments re more risky th n domestic ones, higher level of GDP per c pit le ds to

n incre

se in intern

tion

l

ssets tr

de. In

ddition to the import

nce of GDPper c pit , rese rch of UNCTAD (1999) h s found th t the GDP growth-FDI rel tionship depends lso on the levels of other v ri bles including politic l nd fin nci l environment, educ tion nd tr de of the country under consider tion. Schneider nd Fry (1985) support the view on politic l environment, h ving found ninverse rel tionship between FDI flows nd politic l risk1 while J spersen, Anthony nd Knox (2000) nd H usm nn nd Fern ndez-Ari s (2000) did not find ny import nt evidence on the imp ct of politic l freedom on FDI. When it comes to economic freedom, there is gener l greement th t it f cilit tes FDI (Bengo nd S

nchez-Robles 2003). For ex mple, Lipsey (1999) found th t mong ten Asi n countries th t he studied, the ones who h d the highest r nked economic indices were

lso the ones who h d ttr cted more investments from Americ n firms. Borensztein, Gregorio nd Lee (1998) suggest th t the growth effects of FDI c n be expl ine

d by the differences in the

bility to

bsorb technology hence hum

n c

pit

l

ndR&D re cruci l in this process. H nsen nd R nd (2006) bring the point forw rdst ting th t the le st dv nced is the technology, the sm ller is the FDI imp ct on growth. They reject the effects of GDP per c pit , hum n c pit l, tr de nd ccessibility to credit, recognising however the import nce of the economic ndtechnologic l environment. The uthors further suggest th t once cert in level of development s whole is re ched, the country c n h rness the benefits origin ting from FDI. Bengo nd S nchez-Robles (2003) h ve found1

Politic l risk nd politic l inst bility re the opposite of politic l freedom.High politic l freedom me ns low politic l risk nd low politic l inst bility.

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simil r results dding to the discussion the import nce of m rket liber lis tion. Their findings contr dict with those of Blomstrm, Lipsey nd Zej n (1994) who d

id not find evidence th

t hum

n c

pit

l is critic

l

nd with the findings of Bruno, Crin nd F lzoni (2004) who st ted th t FDI tend to h ve more positive effect on countries th t h ve bund nt unskilled l bour. B l subr m n y m, S lisu nd S psford (1996) point out th t developing countries h ve rel tively less tr ined hum n c pit l nd s result technologic l progress does not ccount for big p rt of growth. Bec use of notice ble g p in levels of hum n c pit l between developed nd developing countries, it becomes very ch llenging for developingcountries to undert ke investments in R&D since they would r rely be ble to gener te new signific ntly useful knowledge h ving less tr ined hum n c pit l. Beck, Levine nd Lo yz , (2000) support the ide th t developed fin nci l system stimul tes growth. M rtin nd Rey (2003) h ve found th t fin nci l integr tiondecre ses the cost of c pit l. Borensztein, Gregorio nd Lee (1998) go further

st

ting th

t it is

two w

y rel

tionship: c

pit

l gener

tes FDI

nd FDI gener

te per se more c pit l. A very import nt point reg rding the fin nci l environment nd the doption of best technologic l pr ctices is m de by Alf ro et l. (2004) who st te th t if ccess to credit is restricted, FDI c nnot be fully efficient since loc l entrepreneurs would not be ble to cquire these new technologiescoming from FDI, even if they h ve cquired the know-how, due to fin nci l restr

ints. In this kind of environment the m rket would limit the positive extern lities of FDI s result pushing investors to move to countries where ccessibility to credit is higher. Moore (2010) gives p rticul r ttention to the fin nci ldevelopment bec use he considers it s essenti l in deregul ting c pit l m rketsrestriction s well s developing fin nci l innov tions which le ds to widerc pit l m rket nd investment opportunities. Furthermore, this cre tes positive incentive for foreign b nks which in turn gener tes even more liquidity for th

e m

rket. Kind

(2010) indic

tes th

t the studies th

t h

ve investig

ted this rel tionship h ve found FDI to be encour ged by fin nci l development. The level of ddition l t x revenue e rned by the government from MNC nd the mount of funds going b ck from the ffili te to the mother comp ny t the home country re two import nt counter cting f ctors identified by Feldstein (1994). He believes th t their influence is decisive on the over ll effect on growth nd finds th t the t x r te imposed to MNC ffects their decision to invest or not in foreigncountry only when this r te exceeds or f lls below the existing t x r te on theorigin ting country. Wei (2000) gener lises furthermore st ting th t the rel tionship between FDI nd the t x r te is lw ys neg tive. A wide number of studiesh ve investig ted this rel tionship but very few of them h ve found ny evidenceshowing th t investors re signific ntly influenced by the t x policy. The 9


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gener l greement seems to be th t t x r te ffects the volume of FDI only whenm rket nd politic l f ctors re seldom equ l. Still, the t x r te effect seems

to v

ry

ccording to the firm

nd the loc

l ch

r

cteristics of the country (Morisset nd Pirni 2000). For ex mple, export-oriented comp nies (Gusinger 1986) nd comp nies fin nced by ret ined e rnings re more sensitive to t x dv nt ges (Feldstein 1994). St rt-up comp nies highly ppreci te incentives th t help them

void or postpone initi l expenses (Rolfe et l. 1993). Sm ll countries tend toh ve sm ll corpor te t x r te in order to ttr ct big comp nies (Morisset ndPirni 2000) etc. Nevertheless, policy m kers still feel th t signific nt differences mong neighbours or other countries with which they believe to be competing with in ttr cting FDI re to be voided whenever possible. The EU is n ex mple of how countries c n incre se pressure on different members to incre se r tesof cert in t xes which re rel tively lower s for ex mple income t x nd t xeson the self-employed in the c se of Greece (IMF 2009) or the corpor te t x in t

he c

se of Irel

nd (B

rber 2010). T

x

tion policy is decided unil

ter

lly by n

tion l governments under EU l w but the union pressured these two countries in return of b il-out p ck ge when they were experiencing fin nci l difficulties. Other c ses include pressure on the UK crown dependencies of Isle of M n, Guernsey nd Jersey which h ve been sked to incre se their corpor te t x r te since some members of the EU h ve expressed concerns th t the policy does not coincide with the spirit of the union (Sherwood 2010).

B rthel, Busse nd Neum yer (2010) believe th t openness to tr de not only improves FDI by incre sing the bility of goods nd services to flow freely but lsoreflects positive ttitude tow rd foreigners nd glob lis tion which investors ppreci te. Nevertheless, their rese rch found th t the rel tionship, lthoughpositive w s not strong. However, on her Afric -b sed study, Asiedu (2002) did f

ind th

t openness to tr

de w

s cruci

l to every country th

t

ims to benefit from FDI. She lso found th t big m rket size lso promotes FDI while infr structure h s n import nt effect only on some countries. Kind (2010) lso supports theview th t infr structure problems discour ge FDI especi lly in developing countries considering its v il bility critic l in running n efficient business. Them rket size is considered s determin nt lso by Bengo nd S nchez-Robles (2003) bec use in l rge m rkets MNC c n exploit economies of sc le. The view is putin doubt by Endres, Fuest nd Spengel (2010) who rgue th t growing simply in m

rket size c n even le d to neg tive effects if the growth comes simply from strong popul tion growth nd is not reflected in re l per c pit terms. On the other h nd, both glob l nd region l m rkets re in continuous integr tion. This h

s le d to gre ter tr de liber lis tion which h s reduced the import nce of the m rket size which is still import nt but worth mentioning th t now even sm ll countries,

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given the right incentives re provided, c n compete to ttr ct FDI (Blomstrm ndKokko 2003).

Anch r z (2002) offers helpful review of the most import nt studies th t h vetested the import nce of government spending. He h s found th t foreign investors p y p rticul r ttention to the mount th t the government spends in the hostcountry nd believe th t the size of the government reflects the ttitude of thecountry tow rds foreign investments. The gener l consensus is th t l rge mount of spending by the government is perceived s h rmful to m rkets nd free competition when it goes beyond cert in optim l level. This conclusion is often rel ted to the f ct th t n investor might h ve to go through long line of bure

ucr cy le ding to extr costs nd potenti l inefficiencies including corruption. On this line of logic, l rge government spending is considered s neg tive toFDI. The ltern tive view is th t l rge mount of expenditure by the governmen

t m

y

lso be considered

s

sign of development

nd investment to productive sectors such s infr structure or tr nsport to provide businesses positive environment to invest efficiently.

Levy-Yey ti, P nizz nd Stein (2007) found n inverse rel tionship between interest r te cycles nd FDI inflows suggesting th t FDI inflows re expected to incre se during recession. Moore (2010) t kes more c utious ppro ch st ting th tthe imp ct of interest r tes m y v ry ccording to the level of GDP per c pit ,technology, l bour qu lity, institution l c p bility nd their bure ucr tic efficiency of the host country. His econometric results indic te th t in the s mpleof 108 countries the rel tionship is neg tive but it loses signific nce when the m rket re ches cert in st ge of fin l development.

The effects of infl

tion on FDI

re

lso

m

tter of discussion. On one h

nd, infl tion m y be sign of n unst ble m croeconomic environment. Different studies (Mehl nd Winkler, 2003; V ldovinos, 2003) h ve found th t in countries in tr

nsition, infl tion h s neg tive imp ct on growth. It does not stimul te long-term contr cts forcing credit institutions to keep liquid portfolios such incre sing their costs nd decre sing efficiency (Bordo nd Rousse u 2006; Rousse u ndW chtel, 2001; De Mello 1997). It lso h s neg tive imp ct on investors sinceit reflects irresponsible policies which m y le d to unst ble exch nge r te regimes, excessive money supply nd poor economic conditions. However, n interesting point is m de by C mpos nd Kinoshit (2003) who believe th t in the initi lst ges of tr nsition, positive rel tionship between infl tion nd FDI c n le dto growth (e.g by encour ging investments r ther th n s vings).

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B rros nd C br l (2000) h ve found th t country which h s high unemploymentr te is expected to be more ttr ctive to investors. Billington (1999) found th

e s

me results. He suggests th

t unemployment encour

ges FDI since the situ

tionimplies to the investor th t the required l bour will be v il ble in the hostcountry. However, Jones nd Wren (2010) stress th t while unemployment ttr ctsFDI, very high r te will m ke the region un ttr ctive suggesting to entrepreneurs th t it is depressed.

The study will t ke ll of these f ctors into consider tion nd will investig tetheir imp ct in order to est blish whether there is ny rel tionship between these determin nts nd FDI for the countries of the selected s mple. The study will lso prioritize these f ctors ccording to their imp ct nd will check for p tterns between the countries where FDI is positively ssoci ted to GDP growth ndthe presence or not of signific nt correl tions between cert in v ri bles with

FDI in these countries.12


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3. Rese rch Design nd MethodsIn their efforts to expl in why FDI re ssoci ted with economic growth in some

countries

nd not in others, previous studies h

ve b

sed their rese

rch on one or few expl n tory v ri bles nd h ve tested their st tistic l signific nce (Levine nd Renelt 1992). This p per t kes n ltern tive ppro ch offering wide view of the v il ble knowledge on the subject so f r nd then tests ll the v ri

bles collected in e ch country sep r tely. M croeconomic d t series were collected from reput ble intern tion l bodies such s the WB, The WSJ nd The Herit geFound tion, CIA The World F ctbook, The UN, EC for Economic nd Fin nci l Aff irs nd other n tion l st tistic l institutes for n eleven-ye r time fr me from1999 to 2008.

The study tested the influence of the following v ri bles on FDI: GDP growth, hum n c pit l, m rket size, economic freedom, politic l freedom, openness to tr de

, t

x r

te, GDP per c

pit

, R&D, government spending, re

l interest r

te,

ccessibility to credit, infr structure, infl tion nd unemployment. Det ils on the v

ri bles c n be found in Appendix I. To test the FDI-GDP rel tionship the net FDIinflows nd the GDP growth r te v ri bles h ve been used respectively s suggested by Borensztein, Gregorio nd Lee (1998). All the p pers reviewed in this rese rch th t h ve found signific nt rel tionship between the two v ri bles, h ve lso found it to be positive. Both GDP growth nd FDI c n t ke neg tive v lues.GDP growth c n be neg tive when the economy contr cts in ny p rticul r ye r nd FDI c n be less th n zero when the mount of investments le ving the country (FDI outflows) is gre ter th n the mount of the new investments entering the country (FDI inflows). The net FDI inflows me sures the net inflows of investment to cquire l sting m n gement interest (10 percent or more of voting stock) in

n enterprise oper ting in n economy other th n th t of the investor. It is the

sum of equity c

pit

l, reinvestment of e

rnings, other long-term c

pit

l,

nd short-term c pit l s shown in the b l nce of p yments (Alf ro et l. 2004: 94-95).To me sure the hum n c pit l, the number of ye rs spent by m le on second ry schooling h s been dopted s used by B rro nd Lee (1994), since they consider itto be the most signific ntly correl ted with growth. Although their methodologyh s been used by wide number of other studies with less or no v ri tion (Seefor ex mple C stell nd Domnech 2002), Liberto, Mur nd Pigli ru (2005) present

v lid point when they criticise it for not 13


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t king into consider tion the qu lity difference between educ tion l institutions. B rro nd Lee (1994) found this correl tion to be positive. B sed on the s me

study, to me

sure the government spending, the r

tio of government consumption(expenditure) to the GDP h s been used. B sed on their findings we will be expecting FDI to be positively rel ted to hum n c pit l nd to h ve neg tive rel tionship with the government spending. However, other studies (see for ex mple Anch r z 2002) h ve expressed ltern tive expl n tions on how the correl tion between FDI inflows nd government size c n lso be positive when investors see it s n effort to provide more positive economic environment so we c n expect bothresults.

The WGI d t on politic l freedom w s collected by different institutes on beh lf of nd published by the WB. It c ptures perceptions from enterprises, citizens nd expert survey respondents s reported by number of survey institutes, thi

nk t

nks, non-government

l org

niz

tions

nd intern

tion

l org

niz

tions on thepossibility th t the government is overthrown by ny me ns other th n those included in the constitution of the country. These include terrorism nd politic lly-motiv ted violence. The d t r nge within the (-2.5: 2.5) interv l where higherv lues represent more st ble environment (K ufm nn, Kr y nd M struzzi 2010;The World B nk Group 2010). If signific nt, the correl tion with FDI is expected to be positive (B rro nd Lee 1994). Thom s (2010) lists l rge number of studies nd policy m kers th t h ve used this d t set. In his critic l study on this d t set he lso list some of the concerns rel ted to it including the comp r

bility cross countries over time, bi s in expert polls, nd the question ble independence of the different sources used. K ufm nn, Kr y nd M struzzi cknowledge th t the govern nce estim tes is ssoci ted with l rge st nd rd errors butstill cl im th t the methodology m kes the WGI the most inform tive individu l d

t

source

nd c

lcul

tes estim

ted indic

tors

s well

s m

rgin errors. In ourc se, since the d t c n be either positive or neg tive we would expect positive coefficient if the index is gre ter th n zero nd vice-vers . To me sure theeconomic freedom d t collected by the WSJ nd The Herit ge Found tion were usedsince they offer n index which llows us to observe ch nges in the economic clim te over time. The economic freedom t kes into consider tion freedom to do business, to tr de nd to invest s well s fisc l, monet ry nd fin nci l freedom,level of government spending, property rights, l bour freedom nd freedom fromcorruption. A gr de is ssigned to e ch of these ten components for e ch countryusing sc le from 0 (no freedom) to 100 (m ximum freedom) nd then the ver geof the results is c lcul ted in order to find the over ll economic freedom index (The W ll Street Journ l nd The Herit ge Found tion 2010). Using the s me d t

set in different time-series for L tin Americ n countries, Bengo nd S nchez-Robles (2003) found positive rel tionship between FDI nd economic freedom.14


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We will be expecting simil r results for ll the countries in our s mple where the rel tionship is signific nt.

Although the d t sets of both politic l nd economic freedom re widely used, there is still much discussion bout their v lidity. Besides the concerns listedin the p r gr ph bove in reg rds to me suring politic l freedom, b sed on the work of Thom s (2010), the d t set of economic freedom might in ddition suffer

lso from high correl tion between the used indic tors for c lcul tion. As Thom

s (2010) st tes, soci l scientists h ve continuously developed qu ntit tive methods to me sure bstr ct concepts nd they h ve concerned with the issue of v lidity. He concludes th t bec use the WGI re n import nt step he d in ttemptingto qu ntify the d t , there relies the d nger of prem turely ccepting them sv lid. The d t sets on politic l nd on economic freedom will be used in this study being, to the uthor`s knowledge, the most ccur te yet, but since there is

still discussion

bout their v

lidity, p

rticul

r c

ution will be t

ken beforere ching ny conclusions in this subject. M rket size is me sured simply by GDPlevel nd l rge number of studies consider this v ri ble s cruci l in fostering FDI (see for ex mple Asiedu 2002 or Bengo nd S nchezRobles 2003). The rel tionship between the two v ri bles is expected to be positive. However, in our s

mple, ll countries re p rt of either CEFTA or the EU so ccording to Blomstrm

nd Kokko (2003) even sm ll countries c n be expected to h ve strong ssoci tion between FDI nd GDP growth since they c n e sily export within the tr de re which they re p rt of such benefiting from high level of openness to tr de tothe common m rket. Another condition is put in by Endres, Fuest nd Spengel (2010) who believe th t m rket size is import nt only if is supported by wide distribution of the we lth. Hence, we might expect more moder te effect of the m

rket size in EEC comp red to other countries where we lth is distributed more ev

enly or to more integr

ted (in terms of freedom to tr

de) regions of the world.Different uthors me sure openness to tr de using different ppro ches. It m y be c lcul ted s exports plus imports rel tive to GDP (C rkovic nd Levine 2005)or me sured by the r tio of exports to GDP (N ir-Reichert nd Weinhold 2001). The l tter method w s used for this study since we re interested to test whethersm ll countries th t h ve rel tively sm ll m rket size c n benefit from FDI reg rdless of their m rket size if they h ve high openness to tr de nd from this point of view we re interested only in the level of exports. B sed on the v

il ble evidence presented, openness to tr de is expected to be positively rel ted to FDI.

The development of fin nci l intermedi ries is me sured by the ccessibility toc pit l c lcul ted by the mount of domestic credit th t fin nci l intermedi ries supply to the priv te 15


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sector s sh re of the tot l output s used by Beck, Levine, nd Lo yz (2000). They find th t the imp ct of fin nci l intermedi ries is signific nt nd posit

ive. Other studies might h

ve not

lw

ys found the rel

tionship to be signific

nt (e.g. B rthel, Busse nd Neum yer 2010) but no ltern tive point of view reg rding the direction of the rel tionship w s found so it is f ir to ssume th t ny signific nt ssoci tion between ccessibility to c pit l nd FDI will be positive. The conditions of infr structure in the host country re very import nt toinvestors since they incre se the productivity of the investment nd s result ttr ct FDI. The liter ture uses the number of telephones per 1000 popul tion to me sure infr structure nd they re positively correl ted with FDI (Asiedu 2002). We h ve used d t collected by the WB which simplifies the figure by c lcul

ting the figure per 100 people. The ch nge is only for pr ctic l purposes nd implies no st tistic l difference. Kind (2010) h s lso found th t the infr structure is positively ssoci ted with FDI. There is still discussion mong rese rch

ers

bout which t

x r

tes need to be considered when trying to build

regression model. Sever l studies h ve used the nomin l t x r te which c n be misle dingsince it does not consider t x reb tes offered continuously to v rious MNC (Morisset nd Pirni 2000). Devereux nd Griffith (1998) h ve concluded th t the ver

ge ggreg te t x r te h s gre ter influence on the decision of investors to where to exp nd their ctivity. B sed on this conclusion we h ve dopted the tot

l ver ge t x r te in this study which ccounts for deductions nd exemptions. While different businesses re ttr cted to different t x systems, on n tion llevel t x r tes seem to ffect FDI either when there is notice ble differencebetween the countries th t compete in ttr cting the investment or when there islittle or no difference between other economic nd politic l conditions (Feldstein 1994; Morisset nd Pirni 2000). In these circumst nces its effect is expected to be neg tively correl ted to the level of FDI. GDP per c pit is me sured

s GDP divided by the popul

tion number in the middle of the ye

r1. A higher level of GDP per c pit is expected to ttr ct more FDI especi lly for middle nd higher income countries (Obwon 2001). R&D is c lcul ted s the mount of expenditure for R&D s sh re of the GDP. The more is spent in developing the technology the more likely it is to ttr ct FDI interested in the industry nd dopt theuse of these new technologies which in turn will help other domestic comp nies

nd will ultim tely incre se growth. As result the rel tion between the two v ri bles is believed to be positive. Re l interest r te is the r te of b nks lending to prime customers fter h ving been djusted for infl tion. Although previous studies indic te neg tive rel tionship with FDI, Moore (2010) suggests t king c utious ppro ch since the business environment of the host country1

All definitions on this p r gr ph re b sed on the WDI published by the WB.

16


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might highly influence the rel tionship. Infl tion represents gener l incre sein the consumer prices index. Most studies h ve found th t the rel tionship bet

ween infl

tion

nd FDI is neg

tive but

ccording to C

mpos

nd Kinoshit

(2003)it c n lso be positive when ssoci ted with growth during tr nsition period so we might expect to find positive rel tionship for countries th t h ve h d long tr nsition. Unemployment is the percent ge of the l bour force th t is v il ble nd looking for work to the tot l l bour force. Its rel tionship with FDIis lso mbiguous. On most c ses, unemployment h s positive rel tionship withFDI bec use it sign ls investors th t l bour is v il ble (B rros nd C br l 2000) but if cert in high level of unemployment is re ched, it c n reflect pooreconomic environment nd s result discour ge investors to enter the countryJones nd Wren (2010).

3.1 The Regression Model The multiple regression model will h ve the following l

ine

r form:(1) = bo+b1x1+ b2x2+b3x3+b4x4+b5x5-b6x6+b7x7+b8x8 b9x9-b10x10+b11x11+b12x12 b13x13+b14x14

b15x15

Where: = FDI, b0= const nt, b1-b15 the coefficients of the v ri bles. x1= M rketsize; x2= Hum n c pit l; x3=Economic freedom; x4=Politic l freedom x5=Opennessto tr de; x6= T x r te; x7= GDP per c pit ; x8=R&D; x9=Government spending; x10=Re l interest r te; x11=Accessibility to credit; x12= Infr structure; x13=Infl tion; x15=Unemployment.

To be noted th t mong ll the determin nts GDP growth, politic l freedom, re linterest r te nd infl tion re the only ones th t c n t ke neg tive v lues. As

result, we might expect their coefficients signs to be different from wh t it

h

s been shown in the

bove regression model (1)

s long

s the over

ll v

lue ofbnxn coincides with the expected sign in the model (i.e. bnxn is positive whenthe coefficient in the model is positive nd it is neg tive when the coefficientin the model is neg tive). Also, since FDI c n be neg tive too, we c n expect the s me for the const nt b0. 3.2 The S mple nd the Time Interv l This study isinvestig ting Alb ni , Bosni nd Herzegovin , Bulg ri , Cro ti , Czech Republic, M cedoni , Hung ry, Rom ni , Pol nd, Slov k Republic nd Sloveni from 1998 to2008. The time interv l h s been chosen ccording to the d t v il bility. Prior to 1989 ll of the countries in our s mple were centr lly pl nned economies

nd there were b rely ny st tistics reg rding FDI. Before 1995, FDI figures were lmost non existing nd very vol tile for this region (Bev n nd Estrin 2004).D t v il bility for the 1995 1998 time17


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fr me re still very limited especi lly for Alb ni , B&H nd M cedoni . Studiesth t h ve covered this period h d to exclude t le st these three countries. Nev

ertheless, the

dopted11-ye

r period with

s

mple of 11 countries still

llowsre ching signific nt conclusions. Other studies1 h ve m n ged to re ch robust results working with even shorter periods nd sm ller s mples. The re son why EECoffer useful study context to test FDI determin nts relies on the f ct th t lthough these countries h ve common st rting point, i.e. the time when the current economic systems w s dopted, they h ve signific nt differences in economic

nd institution l development s well s in size (World B nk 2002). Coming from communist b ckground, ll the countries under investig tion h ve tr nsited tom rket economy in the e rly 90`s f cing simil r ch llenges most of which unknownbefore. Yet, some were more successful th n others such offering rese rches theopportunity to comp re their individu l fe tures th t le d to these differences nd t ke import nt lessons from them for the future. 3.3 Exclusions nd Missing

D

t

The study

ttempted to include

ll the countries of the region in the s

mple. Unfortun tely, this w s not possible. Montenegro nd Kosovo decl red their independence respectively in 2006 nd 2008 from Serbi . H ving ll been p rt of St te Union of Serbi nd Montenegro since 1992, the d t used to be collected for ll three entities s one country. Since the sep r tion, e ch of them h s collected nd published its own d t thus m king it impossible to include them in the study since the period of the st tus quo would be too short nd s such insignific nt. As result, Kosovo, Montenegro nd Serbi were excluded from this rese

rch. The d t for our rem ining 11 countries w s not lw ys v il ble. Alb ni does not record the d t for R&D so w s excluded when c lcul ting this p rticul

r v ri ble. Also, d t on hum n c pit l for B&H could not be used for correl tion tests since it w s v il ble for two ye rs only. The d t on hum n c pit l re v il ble only from 1999 nd for t x r te only from 2005 for ll countries. For

Cro

ti

nd B&H, it w

s not possible to c

rry out

correl

tion test between the t x r te nd ny other v ri ble since the t x r te h s been const nt from 2005to 2008. D t on politic l freedom for 1999 nd 2001 were not v il ble for nycountry since t the time, the d t used to be collected bi nnu lly. Det ils onother missing d t c n be found in Appendix I. The correl tion between FDI nde ch of the other v ri bles w s c lcul ted on p irwise exclusion b sis to de lwith the missing d t .

1

See for ex mple Bruno, Crin nd F lzoni (2004) who b sed their study on 3 countries in 9-ye r time-fr me. Asiedu (2002) focused in the 1996-2003 interv l whileBev n nd Estrin (2004) collected d t from 1994 to 2000.

18


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3.4 Multicolline rity Multicolline rity mongst two predicting v ri bles is to be expected especi lly when using sm ll s mples nd time periods. For ex mple, ec

onomic freedom is by definition correl

ted with openness to tr

de, politic

l freedom nd government spending. M rket size is n tur lly correl ted with government spending, R&D, GDP per c pit nd openness to tr de since they ll re c lcul

ted s sh re of GDP. Accessibility to c pit l is highly ffected by the re l interest r te which is in turn ffected by infl tion etc. We will check whether multicolline rity h s c used ny problems in our correl tion tests by spotting ny odd results in our coefficients in section 4.2. 3.5 Tests The d t will be processed with PASW (former SPSS) St tistics 17TM . The ssoci tion of the determin nts with FDI will be tested st tistic lly in order to provide fr mework th t c

n expl in which f ctors re more strongly rel ted to FDI in e ch country. Initi

l hypotheses reg rding the expected sign of the coefficients of e ch signific ntf ctor h ve been constructed b sed on the liter ture review. The results will b

e p

rticul

rly import

nt for v

ri

bles th

t c

n be both positively

nd neg

tively rel ted to FDI (e.g government spending) ccording to their economic nd politic l settings such providing ddition l evidence to the over ll c demic discussion. The collected d t were in line with the origin l sources from the uthorsth t h ve suggested th t these v ri bles would ffect the FDI such m int ining the s me methodology th t they h ve used in their study. For ex mple the hum n c

pit l w s me sured in the s me w y s in the study of Borensztein, Gregorio ndLee (1998). 3.6 Procedures A correl tion test w s first run mongst FDI nd llthe other v ri bles for every singly country in order to observe which v ri bleswere most often correl ted with FDI. As result we were ble to build list of most import nt v ri bles which would then be used lso to construct the regression models. These models would determine which v ri bles re most import nt forevery country sep r tely. Although signific ntly ssoci ted with FDI, not ll o

f these v

ri

bles were included in the respective regression model simply bec

use there could be only one or few determin nts needed to expl in the FDI v ri ncebetter nd dding n ddition l determin nt would not necess rily improve the model, on the contr ry it might c use problems of multicolline rity (See for ex mple the c se of B&H in Appendix II). Nevertheless, this does not imply th t thev ri bles which re not included in the regression models re not import nt. Themodel simply prioritizes their import nce ccording to their bility to expl inthe v ri nce of FDI. The countries were fterw rds divided into groups 19


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ccording to the correl tion results between the GDP growth nd the level of FDI iming to observe potenti l differences between the models of the countries whe

re the rel

tionship w

s import

nt

nd those where it w

s not. This en

bled us todetermine p ttern of fe tures where countries th t h ve strong FDI - GDP growth rel tionship differenti te from the other countries under investig tion. Countries where the FDI- GDP growth rel tionship w s not import nt were further divided into subgroups ccording to the re sons identified by this study th t eventu lly le d to this rel tionship being insignific nt. As in most crosscountry studies on growth ccording to Kormendi nd Meguire (1985), the expl n tory v ri bles were entered independently nd line rly.

Among other objectives, this study lso imed to c lcul te the correl tion of e

ch determin nt with FDI nd build for e ch country regression model th t considered FDI the v ri ble which w s dependent from one or more determin nts collect

ed from the liter

ture with

t le

st

90% confidence interv

l. We did not choose lower signific nce level due to the limited number of v ri bles nd the short time period. However, signific nce h s been noted throughout the results if pr

ctitioners re interested in higher level (i.e. 0.05 or 0.01). The def ult method for this n lysis is Enter but this would me n th t we would force ll correl

ted v ri bles into the equ tion nd most possibly decre se the v ri nce expl ined by the model. Inste d the Stepwise method w s used in order to enter into the equ tion only those v ri bles which would signific ntly incre se the import nce of the model. This me ns th t n extr v ri ble w s dded to the model only if itimproved it signific ntly. The Enter method w s used only in the c se of Sloveni

nd Czech Rep. where only one v ri ble w s correl ted to FDI nd s result there w s only one v ri ble to be dded in the equ tion. The F-test tests our nullhypothesis th t there is no signific nt rel tionship between FDI nd the v ri b

le in our model. All the models h

ve the form: = b0 + b1x1 + b2x2+...+b15x15. The coefficients (b1-b15) represent the rel tive import nce of e ch independent v

ri ble. Our model form implies th t b0 equ ls the level of FDI which would be re ched independently from the level of the v ri bles included in the equ tion (i.e. if the v ri bles re equ l to 0), while bn shows the degree of ch nge of FDIwhen xn (the v ri ble included in the regression model) ch nges by one. N mely,

ch nge in xn (xn) by one unit will h ve n imp ct of bn xn on FDI. If v ri ble(xn) is not included in the fin l model, it would me n th t its coefficient (bn) is equ l to 0.

20


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4. Findings, n lysis nd ev lu tionThe existing liter ture offers number of v ri bles th t re believed to ffect

FDI. In our study we selected 15 v

ri

bles which were most often encountered inprevious nd most influenti l studies. The v ri bles t ken into consider tion for ll the countries were GDP growth, hum n c pit l, m rket size, economic freedom, politic l freedom, openness to tr de, t x r te, GDP per c pit , R&D, government spending, re l interest r te, ccessibility to credit, infr structure, infl

tion nd unemployment. 4.1 Correl tion nd Regression results Alb ni The correl tion w s signific nt between FDI nd the following v ri bles: m rket size, economic freedom, openness to tr de, GDP per c pit , ccessibility to credit, infr structure nd unemployment. The model for Alb ni FDI = 7249333.24 + 2.131E7 * ccessibility to credit R2 =0.9031

Bosni nd Herzegovin The correl tion w s signific nt between FDI nd the follo

wing v

ri

bles: m

rket size, economic freedom, openness to tr

de, GDP per c

pit

, R&D, ccessibility to credit, unemployment, re l interest r te# nd infr structure#.

The model for B&H FDI= -1.69E9 + 1.11E11* R&D R2 = 0.932 Bulg ri The correl tion w s signific nt between FDI nd the following v ri bles: GDP growth, hum n c pit l, m rket size, economic freedom, openness to tr de, GDP per c pit , ccessibility to credit nd unemployment#.

#

R2 (the coefficient of determin tion) shows how much of the v ri nce of FDI is expl ined by the equ tion. Determin nt w s signific nt t 0.1 signific nce leve

l.

21


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The model for Bulg ri FDI= -5.538 + 0.192*openness to tr de R2 = 0.797 Cro ti The correl tion w s signific nt between FDI nd the following v ri bles: hum n c

pit

l, m

rket size, GDP per c

pit

, re

l interest r

te,

ccessibility to credit, unemployment politic l freedom# nd economic freedom#.

The model for Cro ti FDI = - 7.047E9 + 0.365* m rket size R2= 0.682 Czech Republic The correl tion w s signific nt only between FDI nd R&D#.

The model for Czech Republic FDI= -6.145E9 + 1.011E10*R&D R2= 0.285

Hung ry No v ri bles were signific ntly correl ted to FDI nd s result no regression model could be built for the country. Hung ry is the only country in ours mple where the v ri nce of FDI could not be expl ined by ny of the 11 v ri bles. M cedoni The correl tion w s signific nt between FDI nd the following v r

i

bles: m

rket size, openness to tr

de, GDP per c

pit

, re

l interest r

te,

ccessibility to credit nd infl tion.

The model for M cedoni FDI = 1.370E8 + 4.680E7*infl tion R2=0.539

#

Determin nt w s signific nt t 0.1 signific nce level.

22


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Pol nd The correl tion w s signific nt between FDI nd the following v ri bles:GDP growth, m rket size, openness to tr de, GDP per c pit , ccessibility to cre

dit

nd unemployment#. The model for Pol

nd FDI= 8.275E8 + 1.839E9*GDP growth R2= 0.592 Rom ni The correl tion w s strong between FDI nd the following v ri bles: GDP growth, hum n c pit l, m rket size, economic freedom, GDP per c pit , government spending, ccessibility to credit, infr structure nd infl tion.

The model for Rom ni FDI= -1.887E10 + 0.527*m rket size R2=0.923 Slov k Republic The correl tion w s signific nt between FDI nd the following v ri bles: openness to tr de, government spending#, economic freedom# nd infl tion#.

The model for Slov k Rep. FDI= -4.976E9 + 9.793E7*openness to tr de R2=0.409 Sloveni The correl tion w s signific nt only between FDI nd the t x r te#.

The model for Sloveni

FDI= 1.17E10 - 2.95E8*t

x r

te R2= 0.839We c n notice th t in ll countries, only one determin nt h s been included in the model. In no c se, would dding second determin nt h ve improved the regression model signific ntly (by t le st 0.05). The result comes s surprise, especi lly in some of the countries were number of v ri bles were correl ted to FD, since tot l of 15 determin nts#

Determin nt w s signific nt t 0.1 signific nce level.

23


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were included in the n lysis. As mentioned previously (section 3.4) this m y h

ve resulted from the f ct th t m ny determin nts re correl ted to e ch other n

d they h

ve been excluded from the model due to multicolline

rity. Another potenti l re son is rel ted to our rel tively sm ll s mple. Adding extr v ri bles tothe model would h ve incre sed the prob bility th t the rel tionship is signifiic nt due to ch nce. For ex mple, in the c se of B&H, dding two ddition l v ri

bles would h ve incre sed the coefficient of determin tion, but two of the v ri bles h d to be excluded since the model would h ve become insignific nt h d wenot done so (See Appendix II). A summ ry of the correl tion results th t show which v ri bles re correl ted to FDI for e ch country c n be seen in T ble 1 ndT ble 1b.ALB GDP growth Hum n c pit l M rket size Economic freedom Politic l Freedom Openness to tr de T x r te GDP per c pit R&D Government spending Re l interest r teAccessibility to credit Infr structure Infl tion .898** .902** .815** .902**

**B&H

BUL .649* .822** .762** .803**

CRO .723* .826** .59# .637#

CZE

HUN

MAC

POL .77** -.764* .721* -.697* .687*

ROM .636* .949** .961** .847**

SVK

SLO

+/+ ++

.816** .712*

.653* .787* .610*

.623# ++ .640* -.916#

.798****

.893****

.670***

.893


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.823 .966*

.769**

.817

.655 .533#

*

.714* -.576#

.955

.946** -.652# .950** .690* .578# .734*** * #

-.697* -.579#

+ + ++--.705* .705* .811**

-.603# .671* .635* .948** .739** -.736** 7 -.577 10 9 + + -.589# 4 1 +-

Unemployment -.817 -.772 -.569 Tot l 7 9 8 **Sig. t 0.01 *Sig. t 0.05 #Sig. t0.1

-.651 8

*

1

0

T ble. 1 . Correl tion results of the v ri bles signific ntly correl ted to FDI.Determin nt^ GDP growth M rket size Countries where the determin nt w s includedin the regression model Pol nd Cro ti ; Rom ni

Openness to tr de Bulg ri ; Slov k Rep. T x r te Sloveni R&D B&H; Czech Rep. Accessibility to credit Alb ni Infl tion M cedoni ^The other determin nts were not included in ny of the regression models.

T ble 1b. Determin nts included in the regression models.

N tur lly, the v ri ble which w s most strongly correl ted with FDI w s lso theone th t best expl ined the v ri nce of FDI. All models re good represent tion of the v ri nce of FDI (more th n 50%) except for Czech Rep. (28.5%) nd Slov

k Rep. (40.9%).

24


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4.2 The coefficients T ble 1. offers det iled view on the direction of the signific nt rel tionships between FDI nd e ch determin nt. There re no surprises

in the

ssoci

tion of FDI with GDP growth, m

rket size, openness to tr

de,

ccessibility to credit nd infr structure which is positive in ll c ses s expected nd neither re there ny controversies with t x r te, re l interest r te nd unemployment which rel tionship with FDI is neg tive. We were expecting possible

mbiguous results on government size, politic l freedom nd infl tion. While neg tive rel tionship between FDI nd government size is more common, we c n notice th t Rom ni h s positive ssoci tion between the two v ri bles. The countrys government is not mong the highest spenders ( s sh re of the GDP) but it isthe one who h d incre sed the spending more th n two times from 1998 to 2008 (see Gr ph 1). This spending h s led30 Alb ni 25 20 15 10 5 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Bosni nd Herzegovin Bulg ri Cro ti Czech Republic Hung ry M cedoni Pol n

d Rom

ni

Slov

ki

Gr ph 1: Gener l government fin l consumption expenditure (% of GDP) 1998-2008.Source: WDI.

to better infr structure, better tr ined hum n c pit l, growth in GDP, decre sed unemployment, more st ble infl tion etc. (see Appendix I for the complete d

t set) which h s sent investors sign ls of positive economic environment. Asmentioned previously by Anch r z (2002), this situ tion cre tes the conditionsfor positive correl tion between government spending nd FDI which is lso wh

t we h ve found. The positive rel tionship between infl tion nd FDI for M cedoni is nother interesting finding. The country h s been the le st free politic lly in the region (see Gr ph 2) nd lthough positive steps h ve been m de since

2004, it still suffers from

very high r

te of unemployment, suggesting th

t its tr nsition period is not completely over yet. As described by C mpos nd Kinoshit (2003) these economic nd politic l settings c n le d to positive rel tionship between infl tion nd FDI, which coincides with our findings.

25


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1.5 Alb ni 1 0.5 0 1998 2000 2002 2003 2004 2005 2006 2007 2008 -0.5 -1 -1.5Gr ph 2. Politic l st bility nd bsence of violence index 1998-2008. Source: Th

e World B

nk Group.

Bosni nd Herzegovin Bulg ri Cro ti Czech Republic Hung ry M cedoni Pol ndRom ni Slov ki Sloveni

4.2.1 Wrong signs Since ccording to the theory, the rel tionship between politic

l freedom nd FDI is positive, we were expecting the coefficient of politic l freedom to be positive for ll countries (if signific nt) except for Alb ni , B&H

nd M cedoni for which the d t is neg tive. Hence, neg tive coefficient to indic te the positive rel tionship between politic l freedom nd FDI w s predicted in their c se. Surprisingly, the coefficient w s positive for both Alb ni ndM cedoni . The inverse rel tionship between the economic freedom, R&D nd hum n

c

pit

l with FDI in the c

se of Pol

nd

nd th

t of R&D with FDI for Slov

k Rep.do lso contr dict the theory nd come s surprise result. Since the predictions were b sed on the theory review the controversy h s to be investig ted in the methodology nd the econometric results. While there is no discussion bout the methodology used to me sure R&D, the concerns nd critics on the v lidity of the d t on hum n c pit l, economic freedom nd especi lly politic l freedom prove to be more serious th n nticip ted. The problem with hum n c pit l nd economic freedom rises only once, in the c se of Pol nd which le ds to the ssumptionth t for R&D, hum n c pit l nd economic freedom the problem results from the high correl tion between the v ri bles nd/or other econometric l problems. Sincec rrying out det iled n lysis of the qu lity of institutions in Pol nd comp

red to the other EEC nd on the d t of Pol nd in economic freedom in order to test this ssumption would go beyond the mbitions of this study, we will inste d

n

lyse the problem st

tistic

lly in se

rch of

n expl

n

tion. On the other h

nd, the problem with the politic l freedom indic tor h s been noticed in 2 out ofthe 4 times th t the indic tor w s correl ted to FDI. Hence, this study 26


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dds evidence to the concerns presented by different uthors (See Thom s 2010) on the v lidity of the used methodology in c lcul ting this indic tor. From the s

t

tistic

l point of view, the problem might be noticed when de

ling with

rel

tively sm ll s mple (in our c se 11 ye rs or even less when there re missing d t

) if the independent v ri ble h s l rge v ri nce nd the determin nts h ve minim l v ri tion especi lly when lso highly correl ted with e ch other (Kennedy 2005; C mpos nd Kinoshit 2003). T ble 2 shows th t in Pol nd, hum n c pit l,economic freedom, R&D nd GDP growth re highly correl ted with e ch other ( swell s with other v rious determin nts). A closer look t the descriptive st tistics of the v ri bles correl ted with FDI in the c se of Pol nd, Alb ni , M cedoni nd Slov k Rep. offers further expl n tions. We c n see th t FDI being rel tively high figure in ll four countries h s rel tively high v ri nce whilethe v ri nce of the determin nts under discussion is very sm ll le ding to the wrong coefficient sign, which s Kennedy (2005) notes, is indeed n indic tor of mu

lticolline

rity.Economic freedom R&D Hum n c pit l Pe rson Correl tion Sig. (2-t iled) N**. Correl tion is signific nt t the 0.01 level (2-t iled).

GDP growth .735*

.844

**

-.722** .028 9

.004 9

.024 9

*. Correl tion is signific nt t the 0.05 level (2-t iled). T ble 2. Results ofcorrel tion tests between hum n c pit l with economic freedom, R&D nd GDP growth in Pol nd.

In T ble 3 we c n see how sm ll is the v ri nce of the three v ri bles th t h vewrong coefficients. It is interesting how sm ll s mple of 9 v lid c ses for hum

n c pit l (two c ses h ve been excluded due to d t un v il bility) h s le d to sm ller v ri nce. Their correl tion to GDP growth, which lso h s sm ll v ri nce, expl ins the surprising result. Note th t politic l freedom h s very sm

ll v ri nce too but the f ct th t it is not correl ted with GDP growth h s protected it by being ffected from multicolline rity in Pol nd but th t is not the c

se for Alb ni nd M cedoni . Another re son th t m y h ve c used this issue with politic l freedom is g in linked with the methodology used. The d t r nge is(-2.5: 2.5), too sm ll comp red with the other determin nts nd implying sm ll v ri nce of the indic tor.

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N FDI GDP growth Hum n c pit l M rket size Economic freedom Politic l freedom Openness to tr de GDP per c pit R&D Accessibility to credit Unemployment 11 11 9

11 11 9 11 11 11 11 11

Std. devi tion 4.154E9 1.7388580333E0 .223763281 2.5930241E10 1.9305 .30494502706 6.427150259 697.8691521 .05419925758 7.713724738 4.44524

V ri nce 1.725E19 3.024 .050 6.724E20 3.727 .093 41.308 487021.353 .003 59.502 19.760

T ble 3. St nd rd devi tion nd v ri nce of FDI nd v ri bles signific ntly correl ted to FDI in Pol nd

N FDI Economic freedom R& D Government spending Openness to tr de Infl tion 10 1

1 11 11 11 11Std. devi tion 1.3393166E9 6.2176143 .1812070 1.500513746 8.7471856 3.1519163658E0

V ri nce 1.794E18 38.659 .033 2.252 76.513 9.935

T ble 4. St nd rd devi tion nd v ri nce of FDI nd v ri bles signific ntly correl ted to FDI in Slov k Rep.

The s me p ttern c n be noticed in the c se of Slov k Rep. The v ri nce of R&D in Slov k Rep. is much sm ller th n th t of ny of the other v ri bles th t re correl ted with FDI (T ble 4). As T ble 5. shows, the s me pplies in the c se of

Slov

k Rep. R&D is highly correl

ted with

ll the v

ri

bles th

t

re correl

tedwith FDI.Economic freedom R& DPe rson Correl tion Sig. (2-t iled) -.836** .001

Government spending.693* .018 11

Openness to tr de-.913** .000 11

Infl tion.658* .028 11

N 11 *. Correl tion is signific nt t the 0.05 level (2-t iled). **. Correl tionis signific nt t the 0.01 level (2-t iled).

T ble 5. Results of correl tion tests between v ri bles signific ntly correl tedto R&D in Slov k Rep.

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Politic l freedom in Alb ni nd M cedoni h s lso very sm ll v ri nce (T ble6). Missing d t for 1999 nd 2001 h s incre sed the ch nces of multicolline ri

ty

nd the results in both countries h

ve been

ffected. This h

d led to

wrongsign for this indic tor. For the bove re sons, since these correl tions re notgenuine but occur due to their ssoci tion with other dependent v ri bles, theywill be not considered s signific ntly correl ted with FDI in our n lysis. Ourfin l correl tion m trix will be s shown in T ble 7.T ble 6. St nd rd devi tion nd v ri nce of FDI nd v ri bles signific ntly correl ted to FDI.

.Alb ni b. M cedoni

N

Std. devi tion 249812059.9 800911154.6 3.079433242

V ri nce

N

Std. devi tion 175523719.8 368859150.9 0.304945027

V ri nce

FDI M rket size Economic freedom Politic l freedom Openness to tr de GDP per c pit

11 11 11

6.241E16 6.41459E17 9.482909091

FDI M rket size Politic l freedom Openness to tr de GDP per c pit Re l interestr te Accessibility to credit Infl tion

11 11 9

3.08086E16 1.36057E17 0.09299147

9

0.298306567

0.088986808

11

5.407232676

29.23816521

11

5.440651211

29.6006856


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11

170.3464452

29017.91138

11

246.3238948

60675.46116

11

5.812624718

33.78660612

Accessibility to credit Unemployment

11

11.14056133

124.1121068

11

8.909657377

79.38199457

11

1.793523703

3.216727273

11

2.753952449

7.58425409

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T ble 7. Correl tion coefficients nd signific nce (corrected).

ALB GDP growth Hum

n c

pit

l M

rket size Economic freedom Politic

l freedom Openness to tr de T x r te GDP per c pit R&D Government spending Re l interest r teAccessibility to credit Infr structure Infl tion Unemployment Tot l -.817 6**

B&H

BUL .649* .822**

CRO

CZE

HUN

MAC

POL .77**

ROM .636* .949**

SVK

SLO

Sign + + +

Tot l 3 3 7 6 2 6 1 7 2 2 3 7 2 3 5

.723*

*

.898 .902

**

.816 .712

**

.762** .803**

.826** .590~

**

.653

*


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.721*

.961 .847

**

**

*

**

.623

#

+ +

.637 .902

**#

.687* .610*

.798**

.893**

.670*

.640

*

+ -.916#

+ +

.893

**

.823 .966

**

.769**

.817**

**

.655 .534#

*

8/3/2019 53248243 What Affects the Relationship Between Foreign Direct In

53248243 What Affects the Relationship Between Foreign Direct Investments and GDP Growth Evidence...

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