Convergence and FDI in the Mediterranean basin: an empirical evidence June 8-9, 2006 Giuseppe...

Convergence and FDI in the Mediterranean basin:

an empirical evidence

June 8-9, 2006

Giuseppe Notarstefano - Raffaele Scuderi

Dipartimento di Contabilità Nazionale ed Analisi dei Processi SocialiUniversità degli Studi di Palermo, Italy

Bridging the Gap:the Role of Trade and

FDI in the Mediterranean

1 – Purpose

Structure

4 – Conclusions

2 – Statistical approaches to test convergence hypothesis

i. Review of literature: choice of the methodology

ii. Methodology: the Stochastic Kernel

iii. Empirical findings

3 – Relationship between FDI and growth

i. Review of literature

ii. Methodology: the Stochastic Kernel in a deterministic conditioning scheme

iii. Empirical findings

1. Purpose

Per capita income convergence test

To assess growth dynamics of countries agreeing

to the Euro-Mediterranean Partnership (EMP)

Role of Foreign Direct Investments (FDI) for economic growth

In particular:

2.i – Convergence: Review (1)

Implication of neoclassical theory of growth: long term reduction of per capita income gaps (Solow, 1956; Cass, 1965; Koopmans, 1965)

CONVERGENCE HYPOTHESIS (CH)

Decreasing marginal productivity of capital

Per capita incomes of a given set of countries converge to the unique steady state

Absolute convergence

Conditional convergence

Each economy converges towards its own steady state, proxied by variables

Durlauf and Quah (1998) - the choice of steady state’s proxies depends on the interest of the researcher


CONVERGENCE HYPOTHESIS TESTS

No strong empirical evidence is found about factors influencing economic growth

Test the influence of proxy variables to economic growth (endogenous growth theory)

Contributions are classified into two categories

Per capita income needs to be conditioned to a set of proxies





“[…] there are reasons other than the testing of economic growth theories for the empirical study of economic convergence. We, as economists, are interested in knowing whether the distribution of income changes over time” (Sala-i-Martin, 1996)

“[…] the new research no longer makes production function accounting a central part of the analysis. Instead, attention shifts more directly to questions like, Why do some countries grow faster than others? It is this changed focus that, in our view, has motivated going beyond the neoclassical growth model” (Durlauf and Quah, 1998)

Classification of the approaches, according to the methodology employed

Cross-section Panel data Time series

Cross-section approach

Sigma convergence: variability of per capita income, as measured by the coefficient of variation, reduces over time

Beta convergence:

, , , i,t , , -= - log + +i t t T i t i t t Ty ψX

country i’s per capita income at time t , , , ,logi t t T i t T i ty y T

absolute: no Xi,t

conditional


→ reject CH on a set of world countries

Baumol (1986)

→ accept CH on a set of world countries

Barro and Sala-i-Martin (1992) Mankiw et al. (1992)

Cross-section approach

Sigma convergence: variability of per capita income, as measured by the coefficient of variation, reduces over time

Beta convergence:

, , , i,t , , -= - log + +i t t T i t i t t Ty ψX

country i’s per capita income at time t , , , ,logi t t T i t T i ty y T

absolute: no Xi,t

conditional

Quah’s criticisms:

- parametric tests generally refer to the behaviour of a representative unit, and they are then unsuitable to catch the more real situations of polarization and club convergence

- sigma and beta convergence approaches are shown to be uninformative about convergence in some cases

- beta convergence approach does not properly consider dynamics


→ reject CH on a set of world countries

Baumol (1986)


Barro and Sala-i-Martin (1992) Mankiw et al. (1992)

Panel data approach

Time series approach

Islam (1995): each steady state is better proxied by employing a fixed effects panel estimator, otherwise convergence effect would be underestimated.

Quah’s criticism:“individual heterogeneities“ conditioned out by panel data regression contain those characteristics which are treated as something not consistently estimable (Quah, 1999)

Bernard and Durlauf (1995) test the presence of common long-run trends between per capita GDP seriesHobjin and Franses (2000) propose an algorithm to detect clubs of converging countries

Quah’s criticism:these tests do not put in account cross-sectional information



→ reject CH

Evans and Karras (1996) perform a unit root test on panel data → accept CH

2.ii – Convergence: Methodology (0)

“parametric tests generally refer to the behaviour of a representative unit, and they are then unsuitable to catch the more real situations of polarization and club convergence”

1971 1982 1993 All (1960-2003)

Univariate density estimates of per capita income

26 countries: Algeria, Austria, Belgium, Cyprus, Denmark, Egypt, Finland, France, Germany, Greece, Ireland, Israel, Italy, Jordan, Lebanon, Luxembourg, Malta, Morocco, Netherlands, Portugal, Spain, Sweden, Syria, Tunisia, Turkey, United Kingdom


“parametric tests generally refer to the behaviour of a representative unit, and they are then unsuitable to catch the more real situations of polarization and club convergence”

Quah’s distribution dynamics approach: the stochastic kernel (SK)

- Time series methodology which also considers sectional information

- Each period’s observation is not a scalar or a finite-dimensional vector, but a distribution

- Nonparametric estimate of the law of motion of the evolving income distribution; based on some properties of Markov chains

SK is a transition probability matrix in the continuum. It tracks income distribution’s evolution over time


Quah’s distribution dynamics approach: the stochastic kernel (SK)

- Time series methodology which also considers sectional information

- Each period’s observation is not a scalar or a finite-dimensional vector, but a distribution

- Nonparametric estimate of the law of motion of the evolving income distribution; based on some properties of Markov chains

SK is a transition probability matrix in the continuum. It tracks income distribution’s evolution over time

is a measure corresponding to Ft (the cross-country distribution of per capita income at time t)

M maps then how yt evolves at t+1; it also contains information about distribution dynamics and shape.

λt+1= M * λt

Iteration of (1) estimates future density distribution:

λt+s= (M * M * … * M) * λt = Ms * λt

the relation that links λt+1 with λt is analogous to a standard time-series

first-order vector autoregression

λt

(1)



Silverman’s criterion is employed for the choice of the bandwidth h

We consider relative to the mean income

- Epanechnikov kernel nonparametrically estimates the joint density of relative income at dates t and t+5:

1

1ˆn

i

i

x Xf x K

nh h

- The current-period marginal density, implied by that estimated joint density, is calculated by integration

- Stochastic kernel is obtained by dividing the joint density by the marginal

, , , 1ˆ

i t i tf Y Y

,ˆi tf Y

, , , 1

, 1 ,

,

ˆˆ |

ˆi t i t

i t i t

i t

f Y Yf Y Y

f Y

Stochastic kernel: estimation (Quah, 1995; 1997)

Ft =

λt

Ft+1 =

λt+1

then M | λt+1= M * λt


PROBABILITY MASS

- Located along the 45-degree diagonal: persistence in the economies’ relative position

- Concentrated along the perpendicular line to the 45-degree diagonal: overtaking of economies in their rankings.

- Parallel to t+k axis: the probability of being in any state at period t+k is independent of economies’ position at t

- Parallel to the t axis: convergence

Stochastic kernel: output and interpretation

26 countries: Algeria, Austria, Belgium, Cyprus, Denmark, Egypt, Finland, France, Germany, Greece, Ireland, Israel, Italy, Jordan, Lebanon, Luxembourg, Malta, Morocco, Netherlands, Portugal, Spain, Sweden, Syria, Tunisia, Turkey, United Kingdom

Convergence analysis of relative per capita GDP over 1960-2003, 5 years transition (EMP)

2.iii – Convergence: Results

Data source: The World Bank (2005)

3.i – FDI-growth: Review (1)

Foreign debt crisis of developing countries (Eighties)

Attention to no debt creating flows like FDI

Many countries offered tax incentives and subsidies to attract foreign capital

FDI nowadays accounts for over 60 percent of private capital flows

Increase of FDI towards Mediterranean developing countries (DCs) has been considerably smaller than the one shown by all the DCs

0

0.5

1

1.5

2

2.5

3

3.5

1987

1989

1991

1993

1995

1997

1999

2001

2003

MPC

LMIC

FDI/GDP ratio

LMIC = Low and Middle Income Countries

MPC = Mediterranean Partner Countries


Theoretical FDI spillover effects:

- stock of human capital

- propension to invest

- per capita income

Carkovic and Levine (2002): “While there are sound conceptual reasons for believing that FDI can ignite economic growth, the empirical evidence is divided”

… but …

Macroeconomic analyses

Borensztein et al. (1995) – set of 69 developing countries receiving flows from industrialized countries

Balasubramanyam et al. (1999) – Asian and South American countries

Alfaro et al. (2000) – three samples of countries, ranging from developing to advanced

Berthélemy and Démurger (2000) – Chinese provinces

Nair-Reichert and Weinhold (2001) – sample of 24 developing countries

Notarstefano and Scuderi (2004) – EMP countries

Prevailing literature: positive relationship between FDI and growth

They criticise methodologies employed by macroeconomic approaches, which often do not control for simultaneity distortions and specific country effects.

Carkovic and Levine (2002)

Dynamic panel estimation on a set of countries, ranging from developing to advanced. FDI are found to be not related with growth


Microeconomic analyses at firm level

Liu (2002), – 29 manufacturing Chinese industries

Branstetter (2006) – Japanese firms investing to the US

Positive spillover effects of FDI

Absence of spillover effects

Aitken and Harrison (1999) – firms in Venezuela

see also Germidis (1977), Haddad and Harrison (1993), Mansfield and Romeo (1980)


Nonparametric analysis of original distribution compared to its

conditioned version

The approach aims to catch how a conditioning factor “alters” the

original distribution

Stochastic Kernel: deterministic conditioning scheme (Quah, 1997)

Regression-like rationale

3.ii – FDI-growth: Methodology (1)

Nonparametric analysis of original distribution compared to its

conditioned version

The approach aims to catch how a conditioning factor “alters” the

original distribution

Stochastic Kernel: deterministic conditioning scheme (Quah, 1997)

Regression-like rationale


lY t

lY t

value of the original distribution Y at time t in region i

conditioned version of

Conditioning scheme G – collection of the triple

def

in

ˆ

l

l j j lj C t

Y t t Y t t

def

ˆ,l l lY t Y t Y t lY t

l t

lC t

l t

an integer indicating the lag in time

a subset of countries from the set I

a set of probability weights, which sum to 1

Our estimation

ˆ j ij ij ii iy t d d y

ijd is the absolute distance of FDI value in region i from the value in region j.

Following Quah (1995, 1997):

mean-relative per capita GDP

Silverman’s criterion for the choice of the bandwidth h

Epanechnikov kernel

is the ratio


3.iii – FDI-growth: Results (1)

Original and conditioned-to-FDI-inflows per capita GDP, over 1990-2003 EMP countries

32 countries: Algeria, Austria, Belgium, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Israel, Italy, Jordan, Latvia, Lebanon, Lithuania, Morocco, Netherlands, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Syria, Tunisia, Turkey, United Kindgom


Original and conditioned-to-FDI-inflows per capita GDP, over 1990-2003 non-EU-in-1992 EMP countries

10 countries: Algeria, Cyprus, Egypt, Israel, Jordan, Lebanon, Morocco, Syria, Tunisia, Turkey



Original and conditioned-to-Italian-FDI-inflows per capita GDP, over 2000-2003 EMP countries

34 economies: Algeria, Austria, Belgium, Cyprus, Czech Republic, Denmark, Egypt, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Israel, Jordan, Latvia, Lebanon, Lithuania, Luxembourg, Malta, Morocco, Netherlands, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Syria, Tunisia, Turkey, United Kindgom, West Bank and Gaza


Data source: The World Bank (2005) and Italian Exchange Office (Ufficio Italiano Cambi, 2006)

Original and conditioned-to-Italian-FDI-inflows per capita GDP, over 2000-2003 non-EU-in-1992 EMP

12 economies: Algeria, Cyprus, Egypt, Israel, Jordan, Lebanon, Malta, Morocco, Syria, Tunisia, Turkey, West Bank and Gaza.


Data source: The World Bank (2005) and Italian Exchange Office (Ufficio Italiano Cambi, 2006)

4 – Conclusions

- Literature on convergence hypothesis tests has been divided about the methods to employ, and the presence of convergence in real data

- The choice of the methodology has been driven by statistical consideration about methodologies previously applied and by characteristics of per capita income density estimate

- SK analysis suggests that no convergence has occurred between countries agreeing to the Euro-Mediterranean Partnership, as expected. Income gaps have then persisted over 1960-2003.

- A regression-like rationale has been applied to SK as done in Quah (1997). Evidence indicates that FDI have a positive influence on income distribution. This confirms the evidence of the prevailing macroeconomic empirical analyses.

- Cluster persistence within EMP countries, as well as the influence of FDI for growth, have also been shown in a previous contribution (Notarstefano and Scuderi, 2004)

- Future research may be based on the concept of growth as multidimensional phenomenon, as pointed out by recent literature on living standards, and as also done in our previous work

Convergence and FDI in the Mediterranean basin: an empirical evidence June 8-9, 2006 Giuseppe...

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