Foreign Direct Investment Essay

Foreign Direct Investment (FDI) is a key component of the global capital flow that entails world economic growth through investment opportunities. As an investment tool FDI also affect the aggregated growth of the host country. FDI as a share of GDP has become the largest source of capital moving from developed nations to developing ones. FDI inflow usually involves starting new production facilities namely Greenfield investments or purchase of existing business through mergers and acquisitions. In developing nations, equity investments as a percentage of gross national income have been growing in recent years. In spite of FDI’s potential to impact on know-how, output and investment, development economists have unexpectedly not interested in finding a strong causal link to economic growth. However, some studies have identified a positive impact, but only if the country has human capital and infrastructural support. Literature Review The Gross Domestic Product (GDP) is a measure of a country’s aggregated economic output. It is the final market value of all goods and services finally produced within the territory of a country in a particular year. GDP can be estimated in different ways and in different measurements which would give results with different implication. According to Sullivan and Steven (2003) GDP can be measured in three ways such as the product (or output) approach, the income approach, and the expenditure approach. The expenditure approach measures that all of the product must be bought by somebody and thus the value of the total product must be equal to total expenditures for purchase. Product approach aggregates the outputs of every business to get the total. The income approach measures the sum of all producers’ incomes based on the principal that the incomes of the productive factors must be equal to the value of their product. Foreign direct investment (FDI) is the long term capital investment by a country into another country. It usually involves participation in a business entity by means of management, joint-venture, technological know-how and expertise. There are three types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow. Whereas, foreign direct investment stock or FDI Stock is the cumulative number for a given period. FDI and Economic Growth Agrawal (2000) examined the impact of FDI inflows on GDP and found negative impact prior to 1980, mildly positive for early eighties and strongly positive over the late eighties and early nineties. This supported the view that FDI is more likely to be beneficial in more open economies. His study was based on both time-series and cross- section analysis of data from five South Asian countries i.e. India, Pakistan, Bangladesh, Sri Lanka and Nepal. Athukorala (2003) argued that there is no such extreme link between FDI and economic growth in Sri Lanka. However, the study did not imply that FDI is insignificant; rather, the study concluded that the direction of causal relation was not towards from FDI to GDP growth but GDP growth to FDI. Lan (2006) stated that FDI and economic growth are important determinants of each other in Vietnam over the period of 1996-2003. Thus the study concluded that economic growth in Vietnam was viewed as an important factor to attract FDI inflows into Vietnam. Feridun (2004) used Granger test to examine the causality between FDI and GDP in the economy of Cyprus and found that GDP in Cyprus was caused only by the FDI. Further the study suggested that the economic development will depend on the performance in attracting foreign investment in Cyprus. Borensztein, Gregorio and Lee (1998) argued that FDI had a positive growth effect when the country had human capital that allowed it to disseminate FDI spillovers. However, Alfaro et al (2003) argued that FDI promotes economic growth in countries having developed and liberalized financial markets. Methodology and Data GDP data has been obtained from World Bank website (World Development Indicators). Values are based upon GDP in national currency and the exchange rate projections provided by country economists for the group of other emerging market and developing countries. Exchanges rates for different economies are established in the WEO assumptions for each WEO exercise. UNCTAD has the most complete FDI database and it compiles data on bilateral FDI flows – both inflows and outflows. The main sources for UNCTAD’s FDI flows are national authorities (central banks or statistical office). These data are further complemented by data obtained from other international organizations such as the IMF, the World Bank (World Development Indicators), the Organisation for Economic Co-operation and Development (OECD), and UNCTADÂ ´s own estimates. Both Remittance and Official Development Assistance (ODA) data are retrieved from the website that compiled from IMF balance of payments data. Empirical Analysis & Interpretations of the Results This section presents the result of regressions of the previously defined measure of GDP using 20 years data of Bangladesh. Table 1 presents descriptive statistics for the variables used in the estimates. Summary statistics in table 3 include the mean and the standard deviation for time period of 1986-2005.