FDI in Examination of China and India

RONI BHOWMIK

Roni Bhowmik
Master’’s Program
Master
International Business

Shenyang Aerospace University

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Contents
ABBREVIATIONS............................................................................................................3
Abstract.........................................................................................................................4
Chapter1: Introduction..................................................................................................6
1.2. Motivation and Purpose of the Study....................................................................6
1.3. Objectives...............................................................................................................7
1.4. Brief Outline of the Study.......................................................................................7
Chapter 2: Review of Literature....................................................................................8
2.1. Existing
Literature...................................................................................................8
2.2. Definition of FDI...................................................................................................11
2.3. General Theories and Concepts of FDI.................................................................11
2.3.1. Ownership Specific Advantage or OSA..............................................................12
2.3.2. Location Specific Advantage..............................................................................13
2.3.3. Internalization Specific Advantage....................................................................14
2.4. Types of FDI..........................................................................................................13
2.4.1. Horizontal Foreign Direct Investments..............................................................14
2.4.2. Vertical Foreign Direct Investment....................................................................14
2.4.3. Greenfield
Investment.......................................................................................14
2.4.4. Mergers and Acquisition...................................................................................14
2.5. Determinants of FDI.............................................................................................15
2.5.1 Economic Factors...............................................................................................15
2.5.2 Government policies..........................................................................................16
Privatization and Macroeconomic
policies..................................................................16
Policies supporting private sector...............................................................................17
2.5.3. Strategy of MNE’s ……………………………………………….……………………..…………………17
Country Risks …………………………………………………………….……………………………………………17
2.6. Impact of FDI in Host Country
Development........................................................17
2.6.1. Impacts of Foreign Direct Investment...............................................................18
Chapter 3: Foreign Direct Investment in China and India...........................................19
3.1. FDI Inflows in China..............................................................................................19
3.1.1. The impact of FDI in Chinese Economy.............................................................20
3.2.1. Impact on 51% FDI on India…………………………………………………………………………..22
Chapter 4: ………………………………………………………………………………………………………………24


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4.1 Methodology and Data Collection.........................................................................24
4.2. Graphical Analyses...............................................................................................24
4.3. Regression Analysis..............................................................................................26
4.3.1. Regression Analysis of China.............................................................................28
4.2.2 Regression Analysis of India...............................................................................28
Chapter 5: Findings and Conclusion............................................................................29
5.1. Author’s Conclusion.............................................................................................29
Appendix.....................................................................................................................30
References...................................................................................................................3
2

ABBREVIATIONS

FDI – Foreign Direct Investment
GDP – Gross Domestic Product
LPG – Liberalization, Privatization and Globalization
MNC’s – Multinational Corporations
OECD – Organization for Economic C0-operation and Development
UNCTAD- United Nations Conference on Trade and Development
OSA – Ownership Specific Advantage
LSA – Location Specific Advantage
ISA – Internalization Specific Advantage
TNC’s – Transnational Corporations
MNE’s – Multinational Enterprises
SPSS – Statistical package for social sciences
FERA – Foreign Exchange Regulation ACT


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Abstract

The purpose of the dissertation project is to empirically determine if Foreign Direct
Investment (FDI) influences economic growth in rapidly growing economies? With
emphasis placed upon China and India – both economies have seen exponential
economic growth over the past decade. Both China and India have seen an abnormally
high inflow of capital in several forms during the past few decades. Why such an
inflow and what had inculcated the investors to adopt such a project in these
countries? This dissertation focuses in brief, the reason for such a massive
undertaking by the multinationals. The dissertation undertaken also investigates the
significant role of FDI among the other determinants of economic growth in these
countries. For the purpose data’s for the last 39 years are taken into consideration.
Methodology used consists of graphical representation and regression analysis.
Graphical analysis is used to show the relationship between FDI and economic
growth in INDIA and China. From the graph it is clear that there is a positive
relationship between FDI and GDP in China and they move in the same direction,
while it is opposite in the case of India. To prove this a linear regression method is
used with the help of SPSS. The results so obtained suggest that FDI has a positive
impact on China and a less, but a positive impact on India’s economic growth.


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Chapter 1: Introduction
The recent studies conducted on FDI shows that the relevance of FDI inflows for the
economic growth is very important and the policy makers adopted more liberalized
approach to gain the benefit out of it. It is argued that FDI inflow has got so many
effects on a growing economy. The role of FDI in creating employment, transferring
technology, creating spillover effects and other activities that can act as a fuel for
economic growth is quite worth noticing.
Studies done by Alfero (2003), Blomstrom et.al (1994) and Borenstein (1998)
suggests that a country in order to attract FDI inflows should possess some relevant
factors like better labor market, balance of payment, technology and infrastructure,
stable policies etc. These factors act as a determinant to the flow of FDI in the host
country. The dissertation explicitly covers the theory relating to the importance of
FDI, the factors determining its growth and FDI impact on host country development.
The countries of concern in the dissertation are India and China. China opened its
economy during 1979 by adopting open door policy. The growth since then was so
remarkable and astonishing. The relationship between FDI inflow and GDP growth
was so uniform and upward after 1980 indicating the major role of FDI inflows on
GDP growth rate of China. Many researchers argued that this inflow of FDI was
mainly due to the liberalized approach made by the Chinese economy. The recent
economic reforms that it had made, indulged several multinational giants to invest in
the host country. The introduction of open door policy and China’s WTO entry are
such reforms that can be highlighted while discussing about FDI. The paper thus
examines the role of FDI, which it had played during this significant time period in
CHINA for this massive growth.
India’s economic growth after the introduction of the famous ‘LPG’ (Liberalization,
Privatization and Globalization) concept was remarkable. The paper therefore
explores the irregular start up of FDI in INDIA and also evaluates the development
that it had brought about in the economy.
This dissertation project does not provide a comparative analysis, but it shows the
relevant role of FDI on economic growth in both the countries. The role of other
determinants with regard to FDI is also discussed and analysed briefly. The data’s


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from the periods 1970 to 2009 is taken for the analysis to check the rate of FDI
inflows. For the purpose regression analysis is employed to calculate the relevance of
FDI in China and India. The analysis showed a positive effect on China and a less
positive effect on India, thus indicating that FDI has a major role in China’s growth
and a minor role on India’s growth rate.

1.2. Motivation and Purpose of the Study
Indian and Chinese economies were partially closed and were under the control of
stringent rules and regulations during 1970’s and 80’s. The growth that had happened
in these geographical areas was astonishing during 1990’s. There are several factors
that had contributed for such an economic outburst. The role of FDI as such a factor is
significant. Many researchers say that it is due to the various economic strategies of
each country for e.g., ‘open door policy’ of China and opening of Indian economy by
introducing the ‘Liberalization, privatization and globalization’ or the ‘LPG’ concept
that attracted such a huge investment, which was actually true. Even during the
recession time both the economy had performed well and even attracted more
investment and capital. The level of inflow in both the countries was astonishing and
varying, which is quiet exciting to study. The main frame of the study is to analyse
the economic strategies of each countries and to find the factors which are lacking on
the part of the straggler. The purpose of the study is to create a model of both the
countries and to analyze the pros and cons that exist in both economies and to find
ways to overcome the problem of laggards through an effective empirical analysis.
The study also intends to reveal a path for the less developed and other developing
economy’s, which might emerge in the next few decades.
There are only few research works that are from the Indian point of view. This study
is also aimed to fill those gaps.

1.3. Objectives
1. To evaluate the contribution of FDI in economic growth (in INDIA and CHINA)
2. To find the nature of contribution made by these investment.
3. To evaluate the rate of inflow of these investment in INDIA and CHINA
4. To study the significance of FDI with other economic growth indicators.

1.4. Brief Outline of the Study
The dissertation project is divided into four chapters. The first part covers the
introduction, motivation and purpose of the study. The second chapter covers the
review of literature and the theoretical aspects of FDI – including its definitions,
types, determinants and impacts of FDI. The third chapter covers the FDI trends and
related strategies adopted in China and India to attract FDI inflows. The fourth
chapter deals with the methodology and empirical analysis of the study of concern. It
includes graphical representation and regression analysis to find the inflow of FDI and
also to discover the relationship between both FDI and GDP in China and India. After
doing the graphical analysis, a regression equation is formulated. The equation
consists of some variables that exert direct impact on GDP growth. The main purpose
of the equation is to find the contribution of FDI, the primary variable of concern and


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also to analyze the impact of other variables on GDP growth rate in India and China.
The last chapter covers the findings and conclusion.

Chapter 2: Review of Literature

2.1. Existing Literature
Caves (1996), suggests that the underlying principle to attract heavy foreign
investment starts from the belief that FDI brings numerous positive effects. This
include employee training, productivity gains, technology transfer, improved
managerial skills, improved international production networks, introduction of
innovative ideas to the host countries, employment opportunities etc. Ndikumana and
Verick (2008), Andreas (2006) and Lumbila (2005), suggests that FDI has significant
positive effect on economic growth. Romer (1993), argues there exist a wide “Idea
Gaps” between poor and rich countries. He believes foreign investment can facilitate
technological transfer and business expertise to less-developed or poorer countries
and, as a consequence, FDI might boost host countries firms productivity and hence
increases economic growth. A relative study done by Blomstrom (1986) concludes
that Mexican sectors with a high degree of foreign investment show high productivity
growth. FDI is also characterized by immense positive spillovers. As per the study of
Lipsey and Sjoholm (2005), FDI has positive spillover effects. Some economists
found that FDI exerts varying effects. For instance the study conducted by Theodore,
Edward and Magnus (2005) suggests that FDI can have varying effects – that is both
positive and negative effect. Some economists were of the opinion that it has got more
positive effect, but FDI inflow depends on several factors in the host countries. Alfero
(2003) admits that FDI inflow to certain sectors induces economic growth – according
to him the economy achieves more growth when, FDI inflows to the manufacturing
sector is high when compared to that of primary sector. Many factors in the host
countries such as labor market, capital market, technology, balance of payment etc
also are adversely affected through FDI inflow which in turn acts as a fuel for
economic growth, Lall (2002). Another study done by Blomstrom et. al (1994) states
that, those countries that have a certain level of income can take up new technologies
and enjoy its benefits through FDI. However some research works had proved the
importance of human capital in attracting the FDI. The studies conducted had


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revealed that an educated workforce or human capital can only understand the
importance of innovation and technology diffusion and thus supports the inflow of
FDI to their economy. Borenstein (1998), in his study found out the relative
importance of FDI and human capital in economic growth. He also suggests that an
economy may need a minimum stock of human capital to understand the positive
effects of FDI. For instance, another study done by Borenztein, De-Gregorio and Lee
(1998), states that FDI has a positive effect in the host country when the economy has
a highly educated workforce who welcomes FDI spillover effects. Carkovic and
Levine (2002), also argues about the importance of educated workforce in attracting
FDI and hence increasing growth.
The significant role of FDI, in bringing foreign technology towards the host country is
indispensable. Borenstein et.al (1998) postulates that, FDI plays a vital role when it
comes to technological transfer, which in turn might contribute to larger economic
growth than domestic investment. Findlay (1978) in his studies sees that the rate of
technical progress in the host country can be increased by the inflow of FDI through a
“contagron” effect. In a debate regarding to the importance of FDI, De Gregorio
(2003) contributes that FDI brings in knowledge expertise and technologies that are
not available in the host country; thereby increasing productivity growth through out
the economy. In his study on Latin American economy, he found out that FDI is
thrice more efficient than domestic investment, when it comes to economic growth. A
similar study conducted by De Mello (1997) suggests that there is a positive
correlation and it boosts investment levels, thereby creating a space for economic
growth.
Explanations regarding FDI and its relative importance on long- term and short-term
economic growth is quite importance at this juncture. Neo-classical economists
postulate that FDI persuades economic growth by increasing the amount of capital per
person. However, this may not influence long- run growth due to diminishing returns
to capital. Sauchez-Robles and Bengos (2003) emphasizes that, even though the
correlation between FDI and economic growth is positive, a host country in order to
benefit from long term FDI inflows must require economic stability minimum human
capital and liberalized markets. The other interesting study done by Bende- Nabende
et.al (2002) found that long term impact of FDI on productivity is more positive for
less economically advanced countries and negative for economically advanced
countries. Rome (1986) and Lucas (1988) claims that FDI also influences long- run
variables such as Human capital and Research and development. FDI when analyzed
in short- term aspect, it is more beneficial than long-term (Andeolu B Ajamoaler,
2007). Durham (2004) contributes that FDI effects are more conditional on the
“absorptive” capability of host countries. Obwana (2001) quotes in his study relating
to the determinants of FDI and growth on Uganda, that parameters like political
stability, macro economic and policy consistency are so important in attracting FDI
inflows. To add to this, the study done by Bhasin et al. 1994, Love and Lage-
Hidalgo, 2000 and Lipsey 2000) is more important, they found that determinates like
factor prices, market size of the host country and balance of payments are significant
in attracting FDI inflows. In the case of India and China the economic growth which
they achieved is largely due to the post liberalization periods of each country. The
factors like political stability, policy consistency and other factors like better labor
force etc also had played a vital role in attracting such a huge inflow, hence making
them the most desirable place for investment. A study done by Pradeep Agarwal
(2000) on five South Asian countries relating to foreign direct investment, argues that
the role of FDI on GDP growth rate was negative during Pre- 1980’s and slightly


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positive during 1980’s and strongly positive during 1990’s. He found out that this
high inflow of FDI is largely due to a strong market oriented policies and open
international trade strategies of these countries. According to a study done by Zhang
(2006) on FDI and economic growth in China, states that FDI promotes economic and
this positive growth is achieved overtime. Xiaobuo Dang (2008) asserts that FDI has
got significant role in increasing economic growth and determinants like
infrastructure and political environment plays a crucial role in exerting a pull on FDI
inflows.

Table: 2.1.1. The table below shows some relevant studies done on FDI and
economic growth.
AUTHOR YEAR OF STUDY METHODOLOGY USED FINDINGS
Agrawal.P 2000 Time series cross sectional Prior 1980’s period-FDI inflow on
analysis of panel data from GDP growth rate was negative. Early
five south Asian countries 1980’s- mildly Positive.
Andres.J 2005 Panel data analysis FDI enhances economic growth
in
developing economies when
compared to that of the developed
economies.
Alfaro.et.al 2004 Panel data cross country FDI has got a significant role in
eco-
regression nomic growth. He also pinpoints the
importance of local financial
market in achieving this economic
growth through.
Balasubramanyam 1997 Pnael data cross country FDI promotes growth and is
more
Regression efficient in export promoting
regimes rather than import
substituting ones.
Sauchez-Robles and 2002 Panel data analysis FDI has got positive
correlation
Bengos with economic growth in the host
country.
Borensztein et.al 1998 Panel data cross country He argued about the
sufficient
Regression. Instrumental absorptive capability of the host
variable regression country and found out that FDI
contributes to economic growth
He argued that the sufficient human
capital is necessary in the host
country to achieve this growth.
Carkovic and Levine 2002 Generalized method of FDI exerts a positive impact
on
moment’s panel growth, that is independent of other
estimator. growth determinants (educated
workforce infrastructure, markets,
and liberalization policies)
Nair-Reichert and 2001 Panel data analysis. They found out that there
exists a
Weinhold mixed, fixed and random heterogeneity across developing
coefficient approach economies regarding the impact of


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FDI and other variables on
economic growth
Obwona 2001 Two stage least square Foreign investment has got
major
estimation method role in enhancing economic
development in Uganda.
Ram and Zhang 2002 Panel data cross country FDI has got positive effect on
the
regression host country’s economic growth.
S.Adewumi 2006 Graphical analysis, FDI has got positive impact on
regression and granger GDP growth rate in Africa.
causality
Xiaohong Ma 2009 Regression analysis FDI has significant role in
Economic growth in China

2.2. Definition of FDI

A clear cut definition of FDI is very difficult (Haluk sezer (Piggot and Cook, 2006)).
Definitions of FDI were formulated depending on its international characteristics and
MNC’s activities in host countries and some authors even contrast it with portfolio
investment. The definition thus evolved and recognized, often has two common
elements such as, involvement of two countries – which quite often described as the
multinational FDI character, and the other elements which is basically related to the
issue of ownership and management – which makes it entirely different from portfolio
investment. FDI is therefore considered as the ownership and management of
production activities abroad, whereas foreign portfolio investment is the transfer of
financial capital, loan or equity from one country to another.
FDI stand aside due to its complexity, because it involves transfer of managerial and
organizational ability and technical know-how. The definition of FDI is not isolated.
The FDI being a part of MNC’s activities, a single and isolated definition is not
possible. Therefore the definition of MNC’s is some what similar to that of MNC’s
(Haluk sezer (Piggot and Cook, 2006)).
Despite of its difficulty many definitions have evolved. According to the IMF balance
of payment manual defines FDI “as an investment that is made to acquire a lasting
interest in an enterprise operating in an economy other than that of the investor, the
investor’s purpose being to have an effective voice in the management of the
enterprise” Imada Moosa (2002).
(Haluk sezer (Piggot and Cook, 2006)) defines FDI “as the acquisition, establishment
or increase in production facilities by a firm in a foreign country. These definitions
cover all three elements of FDI such as mergers and acquisitions, ‘Greenfield
Investment’ and reinvestment. Robert E. Lipsey (1999) defined, FDI ‘as the
investment that involves some degree of control of the acquired or created firm which
is in any other country apart from investors country’ (S. Adewumi, 2006)
OECD has provided an extensive definition of FDI (“OECD Benchmark Definition of
Foreign Direct Investment, 2008, 4th edition) “Foreign Direct Investment occurs when
a business located in one country (the direct investors) invests in a business located in
another country (the direct investment enterprise) with the objective of creating a


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strategic and a lasting relationship. Within an effective policy framework FDI can
assist host countries in developing local businesses, promoting trade and contributing
to technology transfer. Similarly, it can provide greater market access to businesses in
home countries. Governments, businesses and other stakeholders need reliable FDI
statistics to inform and support their decisions for investments worldwide.”
By keeping in mind all the above said definitions, we can define FDI as the
investment made by a firm (MNC’s) in another country to utilize the resources
available in that country so as to expand internationally and to gain long-term profits.

2.3. General Theories and Concepts of FDI

A specific and a neat theory for FDI is difficult, because of the complexity it has.
Economist had even struggled to give an exact definition for FDI. The theories thus
formed are considered as the theories of MNC’s and therefore it is inseparable from
the firm’s theory. Another difficulty involved is its multidimensional aspects, it
involves capital theory, international finance theory, firm’s theory, distribution theory,
trade theory and also it covers some aspects of politics and sociology. Due to these
characteristics it is impossible to recognize a single neat theory of FDI (Haluk sezer
(Piggot and Cook, 2006))

The rising importance of FDI in this global scenario over the last few decades, made
the economists and the researchers to identify and generate some important
explanations for FDI. These explanations thus generated, is considered as the
conclusion of several findings. Because of the existence of substantial overlap in these
explanations, we can group them into three genuine categories, traditional, modern
and radical theories. For the purpose of the case study, it is however important to go
through the types of FDI and the factors that determine the flow of such FDI’s in the
host country. To understand these general theories of FDI mentioned above, it is
useful to discuss the OLI paradigm by Dunning (1977, 1981). MNC’s while taking up
foreign investment projects will go through some advantages that the host country
possess. Dunning explained these advantage variables as; Ownership advantage (O),
Location advantage (L) and Internalization specific advantage. ‘L’- type advantage is
the external factor of the firm, while ‘O’- type and ‘I’- type advantage are internal
aspects of the firm. Of these advantages, ‘L’- type is considered as the most relevant
one for FDI flows from developed to developing economies in common and mainly to
transition countries. (Marco.Neuhaus, 2006).

2.3.1. Ownership Specific Advantage or OSA (H.Sezer (Piggot and Cook, 2006),
M.Neuhaus, 2006)

Ownership specific advantages are the knowledge based and firm specific assets that
the firm possesses, but which are not available to its competitors. These advantages
constitute cost benefits and lead to market power. They mainly arise due to
imperfections that exist in factor and commodity markets. Imperfections in factor
market include management expertise, patents, trade secrets, difference in the
accessibility to capital market, trade marks and brands, while in the commodity
markets appear in the form of promotional skills, collusion and product
differentiation. Imperfect market situation arise due to several factors such as;
economies of scale and government policies regarding interest rates, taxes etc. these


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imperfections in the market gives rise to several OSA’s which can be categorized as
follows:
 Monetary and financial advantage – these include access to capital market to get
Cheaper capital.
 Industrial organization – advantages arising from Research and development and
Economies of scale in an oligopolistic market.
 Technical advantage – advantages in holding patent rights, management expertise
etc.
 Access to raw materials.

2.3.2. Location Specific Advantage or (LSA) (Haluk sezer (Piggot and Cook,
2006))
These are those advantages that the company possesses, when it locates it production
facilities or activities in a particular geographical region. Such advantages can be
categorized as follows:
 Imperfections in foreign labor market - MNC’s shift their product activities to
areas, were they can get cheap work force.
 Access to minerals and raw materials in host regions.
 Trade barriers – these induces MNC’s to start or set up production or business in
certain areas. For example, Japanese companies interest in Europe to avoid Common
External Tariff.
 Government economic policies – government may in turn change economic
policies to attract FDI flows. The case study undertaken proves the same fact that the
liberalized policies of China and India have opened the economy and as a
consequence it increased FDI inflows.

2.3.3. Internalization Specific Advantage or ISA

It refers to the capability of the firms to utilize the ownership advantage internally
rather than through markets (Nagesh Kumar, (Dunning and Narula,1996). It happens
when the imperfection in the foreign markets make market solutions too costly (Haluk
sezer (Piggot and Cook, 2006))
The benefits of internalization can be classified as follows:
 Vertical integration advantage such as price discrimination and transfer pricing
 Relevance of intermediate products for research activities.
 Benefits of training due to internalization of human skills.
These above said OLI paradigm acts as a base for general theories of FDI. Now lets
discuss about the major types of FDI and important factors that determines the FDI
inflows.


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2.4. Types of FDI
Researchers, based on the business activities of MNC’s had formulated several types
of FDI’s. They are horizontal foreign direct investment, vertical foreign direct
investment, Greenfield investment, mergers and acquisitions and benefit seeking
FDI’s.

2.4.1. Horizontal Foreign Direct Investments (J. Paul, 2008)

It refers to MNC’s regional (host country) diversification of established domestic
products or services. Horizontal FDI occurs when MNC’s goes to host countries to
produce their existing products at their home country. Japanese MNC’s for example
adopt the same kind of investments with the belief to avoid risks by sharing their
resources, knowledge and experiences.

Horizontal FDI takes place when:

 A firm achieve monopolistic characteristics in a spotted region.
 A firm competes in an infant industry
 Economies of scale supply numerous competitive advantages.
 A firm has enough human resources and capital to look after the diversified
organization.
 A firm has the advantage of management expertise when compared to that of their
competitors.

2.4.2. Vertical Foreign Direct Investment (J. Paul, 2008)

Vertical foreign direct investment refers to investments made by a company in a
particular industry abroad. In this the company will be responsible for the control of
entire activities starting from raw materials to finished goods and distribution.
Vertical FDI can be again divided into two such as, Forward vertical FDIK and
Backward vertical FDI.

2.4.3. Greenfield Investment


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It refers to firm’s investment in new facilities abroad or widening up of existing
facilities
(www.slideshare.net). It can also be defined as the starting up of a completely new
operation in foreign country. This sort of investment is considered as the host nation’s
primary target of promotional efforts, because it generates job opportunities, new
production units and technology transfer. It also has got the advantage of integrating
host country with the global market (www.slideshare.net)

2.4.4. Mergers and Acquisition (Banerjee, Nair, Agarwal, 2009)

Mergers and Acquisition is considered as the primary source of FDI. In an
Acquisition strategy, a firm joins with another established firm working in the host
country to overcome the barriers of trade and business and makes the acquired firm a
subsidiary business. For example Tata motors India acquired Jaguar a company in
Britain, by doing so Tata had the advantage of supplying its home product abroad and
also got the advantage of technological know-how from Jaguar for its home products.

Apart from Greenfield investment, Merger and Acquisition generates cash flow
within a short span of period, because by definition a firm does not have to start from
base process by engaging in Merger and Acquisition. Another advantage of Mergers
and Acquisition with that of Greenfield Investment is that it gets instant access to host
country firm’s resources. FDI can again be classified into three based on the
motivational factors and benefits of investing firm’s. They are as follows:
Resource Seeking FDI – in this the MNC’s eye’s on the resources available in the
host countries (which some times that are not available in the home country) such as
cheap labor, raw materials etc.
Market Seeking FDI – these are investments that are intended to penetrate a new
market.

Efficiency seeking FDI – this strategy is adopted by the firms with an intension to
increase their efficiency by utilizing the gains of economies of scale and scope. This
is considered as the third step by the firms, after resource seeking and market seeking
FDI. This strategy is adopted by the firm’s to gain more profits and can be mostly
seen among the developing economies. For example; investments among EU nations
(www.slideshare.net)

2.5. Determinants of FDI (Sanjay Lall, 1997)

The determinants of FDI can be broadly divided into three set of factors, such as
economic, government policies and MNC’s strategies.

2.5.1 Economic Factors

Market size – globalization and trade liberalization had enhanced growth of world
markets as well as the domestic markets. Evidence from various studies indicates that
the size of the market plays a major role in attracting FDI flows. For instance the size
of the domestic markets in China and India acts as a catalyst to attract huge FDI in
these geographical regions. Similarly the growth of intra-regional trade and the
prospective regional markets in south East Asian fuelled the growth of investments in


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these regions. Factors like skilled human capital, advance infrastructure, liberalized
FDI policies and stable government policies acts as a magnet in attracting FDI’s. This
is more evident in the small states of Singapore and Hong Kong, were the above said
factors prevails, thereby indicating that small economies can generate large amount of
FDI.
The available resources in the host country are another factor that the MNC’s eye’s
for investment. The resources like petroleum and minerals are now the powerful
determinants of FDI in some regions. The location as a part resource also has got
upper hand in promoting FDI inflows. The fortunate regions that are closer to
developed economy markets and the potential growing regions also enhance the
inflow of FDI.
Competitiveness and efficiency of the host country plays a significant role in drawing
FDI. In this changing scenario, the role of skilled labors, better management and
financial skills are very important. The MNE’s have proficiency to bring along with
them the skilled labors, but in practical it generates high costs for them. In order to
avoid that, the MNC’s look for those countries that can supply these sort of skilled
employees.

Apart from skilled workforce, the factors like better suppliers and good infrastructure
also plays a vital role in directing the route for FDI inflows. Existence of a strong
supplier’s base enables the host countries to capture more spillover effects from
TNC’s and this in turn also lower the initial cost to the foreign entrepreneurs’ to set
up facilities in that region. Taiwan for example has this advantage and it is able to
attract more technological and high value added FDI’s. Like strong supplier base,
infrastructure also has its own role in drawing more FDI’s. China for example has the
capability to attract huge FDI because of their advanced infrastructure facilities when
compared to that of India. A countries financial system also has got some relevance in
this competing scenario for capturing FDI. An efficient national financial system is
actually of less importance to TNC’s, but it is of great importance for the domestic
firms. Though it will be less important for MNC’s in host country, but it is vital to
create a better image in global market. Companies do often invest, in those place,
were there is less risk and sound economy.

2.5.2 Government policies

Political stability is the most crucial factors that the investors look for. Political
environment characterized by minimum level of predictability and stability is
necessary for the MNC’s to set up facilities that can yield long term returns. Investors
more often pay attention to the long term economic situation, were they can earn huge
profits in the future when compared to that of short term policies like tax concessions.
An efficient policy framework is very important for an host country to signal the
foreign investors to invest, as a consequence it promote dynamic spillover effects,
more employment opportunity, technological transfer and diffusion of better
managerial skills to the host country. These contributions from FDI, therefore brings
better economic growth.

Privatization and Macro economic policies

Privatization and FDI are considered as the two sides of the same coin. Evidence from
Latin America, Africa and some of the Asian countries shows that privatization


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regime’s are successful in capturing investment flows to these areas. Privatization also
had enhanced MNE’s to diversify in those sectors (such as telecommunication and
aviation) which they never had significant role.
In many parts privatization is included in their policy agenda’s. Africa thus can be
taken as an example for the same. Studies show that privatization policies in the
developing countries during 1988-92 had stimulated about $49 billion in sales. During
this period the privatization had accounted for about 7% of the total FDI inflows. The
privatization is therefore becoming more relevant at this present scenario. Even the
developing economy is concentrating on privatizing the infrastructure in order to
increase the related FDI inflows. Like privatization another determinant of FDI is a
well executed macro economic policies. A relatively well managed economy,
characterized by realistic interest and exchange rates, low inflationary rates and well
managed external debt, gives more confidence for the entrepreneurs to invest in that
country. Countries which lack such a stable macro economic policies which are
mentioned above suffers from recession and balance of payment problems, this
relatively diverge foreign investment.

Policies supporting private sector

Policies such as openness to market forces and the private sector and well
implemented accounting and legal framework encourages foreign investment. An
environment which is basically liberal in nature, transparent, stable and better suitable
for private sector sends positive impulse to MNE’s to invest. Totally, a policy that has
a ‘business like’ attitude enhances better investment scenarios in the host country.

2.5.3. Strategy of MNE’s

Strategies adopted by MNE’s often acts as a vital determinant of FDI’s in developing
countries. There are several factors that determine this sort of MNE’s strategies. The
mostly discussed among them are the host country risk factors and corporate level
approaches to various international operations.

Country Risks

While going for an investment project, the MNE’s analyze the host country
environment. The results of such analysis are very confidential and circulated on a
limited basis. Factors like macro management, labor market, stable policy and other
political factors are considered as a benchmark for studying the country risk, before
committing for an investment project.

2.6. Impact of FDI in Host Country Development

Most of the economies in the world try to attract FDI with the hope that it will have a
significant positive effect on the economy. Based on this paradigm, many research
works and case studies have been done to explore the contribution of FDI on
economic growth. Many had come with a mixture of conclusion, stating that it has


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both positive and negative effect. For instance the study conducted by Theodore,
Edward and Magnus (2005) suggest that FDI can have varying effects – that is both
positive and negative effect. Some say economist were of the opinion it has got more
positive impact, but depends on several factors in the host country such as sectors of
the economy – the economy achieves more growth when FDI inflows to the
manufacturing sector is high when compared to that of primary sector Alfaro (2003).

Many factors in the host countries such as labor market, capital market, technology,
balance of payment etc also are adversely affected through FDI inflow which in turn
acts as a fuel for economic growth Lall (2002). The arguments relating to the
causality of growth and FDI inflow and vice versa are the focal point for several
researchers. The study of Chowdhary and Mavrotas (2003) indicates that when an
economy experience high growth it tends to attract more FDI inflows than the
countries with weaker growth. All the above mentioned assumptions and findings
however brought into light some major effects (both positive and negative) of Foreign
Direct Investment. As we have seen earlier in the literature studies, it is clear that
Foreign Direct Investment is associated with activities like transfer of technology,
capital, managerial skills, promotional skills, organizational reengineering etc. this
process in turn generates both costs and benefits for both (investing as well as for host
country) the countries which are involved. To measure these costs and benefits is a
difficult task, apart from this, the most widespread and common explanation for FDI
is that, it has a positive impact. This section covers most significant globally
discussed issues that are associated with FDI. These include FDI impact on capital
market, labor market, management techniques, balance of payments and technological
change or overhauling.

2.6.1. Impacts of Foreign Direct Investment Technological Transfer
(Haluk sezer (Piggot and Cook, 2006))

The recent exploration in the developing countries reveals that FDI is seen as a way to
encourage technological change. MNC’s while opting for a foreign investment, would
more likely to bring along with them their own technologies instead of depending on
the local facilities. There are two sided effects for technology when it follows FDI,
such as direct – when associated with technology spillovers. However both the
aspects mentioned above is considered as a positive contribution of FDI to economic
growth.
Recent empirical analysis based on this context supports the following conclusions:
(OECD,2002)
Diffusion of technology in an FDI undertaking occurs through four channels such as
vertical and horizontal linkages, switching of skilled labour from MNC’s to local
firms and also through Research and Development. Empirical evidence shows that
more positive impact is seen in vertical linkages, especially in the backward linkages,
because the local suppliers get adequate training and technological assistance from
MNC’s in order to raise the quality of supplier products and services. MNE’s even
assist them in the purchase of raw materials and intermediary goods and also helps
them to establish a most modern production facility in the host countries. This will
ensure better business environment and economic growth. Evidence relating to
horizontal spillovers with regard to FDI is less. But some available evidence suggests
that horizontal spillovers are more effective when organizational functions in totally
different sectors.


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Apart from the above two channels, labor migration and Research and Development
also plays a major role in technological transfer. Employees who are affiliated with a
foreign company acquire superior technological know-how and managerial skills.
Bende Nabende (2002) suggests in his study that there is a wide scope for the spread
of technological knowhow, especially when the employees switch to domestic firm
from an MNC. MNE’s therefore avoid these spillovers by giving high ransoms to
skilled staffs. The other method which they commonly follow is the consideration of
expatriate staffs in the host country instead of local ones.

Chapter 3: Foreign Direct Investment in China and India

3.1. FDI Inflows in China

China being isolated for 30 years, decided to open its economy again in the late
1970’s. The period between 1980’s – 1990’s witnessed an increase in the level of FDI
inflows, through varied economic reforms. Major types of FDI that are prevailing in
China according to Yuan (2005) are: 1) contractual joint ventures 2) Equity joint
ventures 3) joint exploration 4) wholly foreign – owned enterprises5) share company
with foreign investment. All the above mentioned FDI’s are considered as the fruits of
well implemented economic reforms. The analysis of the Chinese history reveals the
actual facts to the readers.
The first stage of the reforms kick-started in 1979, with the establishment of joint
venture law and the formation of Special Economic Zones. The main aim of the
policy was to attract foreign capital or investment through incentives and low tax
regimes. During this period, the number of Contractual joint ventures was more in
comparison to the Equity Joint Ventures, which accounted 86% to the total number of
FDI projects. At the end of this period about 1399 investment projects was approved
with an accrued contract capital of 4958 million dollars (Dunning and Narula,1996).
In 1984 – 89 the concept of SEZ’s was again recalled and upgraded, thereby
formulating tax advantaged economic development zone and open coastal economic
zones respectively. The newly improved business environment triggered an increase
in FDI by 50% and 120% in 1984 and 85 respectively (Dunning and Narula,1996).
Meanwhile during this period the FDI inflow to manufacturing sector and service
sector was worth noticing. The inflow to the manufacturing sector rose by 33% from
14%, but the considerable flow to the service sector got decreased. The magnificent
growth of FDI inflow that was visible during 1984 – 85 came to an in 1986, because
of the changes involved in both general business scenario and market situation. In


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order to improve investment environment, the state council executed another reform
called ’22 regulations’ or the so called ‘provisions for the encouragement of foreign
investment.’ The new economic policy had given the investors more confidence, and
resulted in a increase inward FDI more than
36% during 1987 – 1988. The FDI inflow to manufacturing sector again rose to 56%
from 33% (in 1984- 88) during this period. The service sector again experienced a 5%
decline in FDI, because of Chinese selective FDI policies. These reforms and the
growth were again hindered during the period between 1988 – 91, because of a
political crisis that took place between student activists and the government military
officials in Tiananmen Square (Margaret M. Price, 1994). In order to accelerate
investment activities, overall economic restructuring was made. The 1979 joint
venture was renewed and rules regarding the elimination of contract duration in some
Joint Ventures were made. The period of 1990’s and 2000’s can be considered as the
golden era of Chinese economic growth, several reformation such as opening of
inland cities, liberalization of service sector and infrastructural development was
made. The early 1990’s recorded a negligible ratio of increase in the flow of FDI to
the total domestic investment, which was 7% in 1992. The FDI inflow steadily
increased after this period, thus projecting a figure of 17% in 1996(Zhang, 2006).The
overall FDI projects during 1996 also rose to 70%, 90% and 134% respectively,
which was more when compared to that of 1992 (Dunning and Narula,1996). After a
long 15 years of negotiation, China on 11th of November 2001, became an official
member of WTO. This had given china the opportunity again to restructure the
economic reforms. This in turn had improved business environment a lot. According
to Yuan (2006), china during the post WTO period had made significant changes in
the economic policies; one among such policies was the reduction of tariff rate and
establishment of direct trading rights for foreign firms. This along with Chinese
membership in WTO had given more confidence for the investors which as a
consequence lead to better FDI inflows (Xiaobao Dang, 2008).
On the whole from the above analysis, Chinese FDI history can be divided into 5
stages. 1) 1979- 1983 – experiment stage 2) 1984 – 1991 – growth stage 3) 1992 –
1993 – peak stage 4) 1994- 200 – adjustment stage 5) 2001 – present – post WTO
stage. The reform undergone during these stages was the critical factors that led to
such a huge productivity boom in China (Xiaobao Dang, 2008).

3.1.1. The impact of FDI in Chinese Economy

China’s run to the second most desirable investment places in the world was begun in
from the year 1978, through various economic reforms, since then the economy had
attained a steady growth. One of the main agenda behind these economic reforms was
the attraction of FDI. This case study of china explicitly projects the significant role
of FDI in economic growth. “Foreign capital has played a largely positive role in
china’s economic development during the reform “ (Machanna, August 15 2010).
According to Zuliu and Mohsins Khan (IMF report, 1997) capital investment plays a
vital role in economic growth and it becomes more important when accompanied by
economic reforms or market oriented reforms. The most prominent advantage of FDI
in china was the sudden increase in export and import trade. The Chinese market
share in the international trade increased to 6.1% from 1.6% during the period 1985 to
2000.
The other prominent impact of FDI on Chinese economy was the creation of job
opportunities, technological spillovers and capital contribution.


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The FDI also facilitated the transition towards a market system from a centrally
controlled system. This in turn had given few valuable benefits to china, which
includes the formation of a market mechanism, production restructuring, up-gradation
in the domestic enterprises competitiveness and Chinese economic integration with
the global economy (Zhang, 2006).

3.2. FDI Inflows in India

The importance of FDI India’s economic growth is indispensable. The economic
survey of 2001-2002 by the Indian government had pinpointed several benefits of FDI
on Indian economy, which are as follows: it encourages domestic investment for
achieving higher economic growth; FDI is beneficial for both consumers and
domestic industries in many ways; FDI brings along with it the benefits of
technological up-gradation; fuller utilization of resources; and access to better
managerial skills, which in turn helps the Indian industries to become highly
competitive in the global market. FDI also helps in opening export markets, which
enables access towards better goods and services (Swapna s. Sinha, 2007). To study
the impact of FDI in Indian economy, it is necessary to analyse the period before
liberalization and period after liberalization of 1991. The governmental policies
towards FDI have been changing from the post independence period. To study these
variations, we can divide the period into four distinct faces. The period of gradual
liberalization of attitude – which was from independence to 1960’s; the period of
most selective stance from 1960’s to 1970’s; the period of less or limited
liberalization of policies, which was from 1980’s to 1990’s. The period after 1991, the
economy was opened and the concept ‘LPG’ (Liberalization, Privatization and
Globalization) was introduced (Dunning and Narula, 1996). After independence,
India adopted several developmental plans – of them the strategy of import
substituting industrialization was the first. The aim of the strategy was to improve the
productivity and capability of the heavy industries (Shujiro and Fukunari, 2006).
During this period the FDI inflow was increasingly receptive. The Foreign Investment
policy issued by the Prime Minister in 1949 considered FDI is necessary to
accumulate capital and also needed to secure more technical, scientific and industrial
knowledge. To do this, foreign investors were given the assurance of fair
reimbursement in the event of acquisition and no restriction on the payment of profits
and dividends (Shujiro and Fukunari, 2006). The FDI policies in India was again
liberalized during 1957 – 58 followed by the foreign exchange crisis, the policy
included more incentives and concessions. In the late 1960’s government focused on
several industries, which include drugs, aluminum, heavy electrical equipments
textiles etc and opened the economy for them in order to increase FDI inflows. In
order to promote FDI in India, the government even started Indian investor centers
with offices in various investor countries. The result for these amendments as a
measure to attract FDI was overwhelming. A large number of foreign enterprises
including foreign drug companies showed interest in establishing branches in the
country. The inflow of FDI during this period was better when compared to that of
early 1950’s. The FDI accumulation in the country during 1948 – 1964 was multiplied
from Rs2560 million to Rs5655million (Dunning and Narula, 1996).
The attitude towards FDI during the late 1960’s by the government was more of a
restrictive one. FDI proposals which accompanied technological transfer and
investment, which is more 40% foreign ownership was only accepted. Different items
were specified by the government to the foreign collaborators for the royalty


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payments and for the duration of technology transfer agreements. The government
also had put forth to the foreign investors, to use Indian consultancy services
wherever it is available. The year 1973 was characterized by with the establishment of
new FERA and limitations in the activities of foreign companies was made – which
concentrated only on selected high priority industries. According to new FERA, the
foreign companies having 40% had to register with Indian corporate legislation,
exceptions from the 40% limit was given only for high- priority sectors, which was
concentrating on exports (Shujiro and Fukunari, 2006). This restrictive environment
had stagnated the FDI inflows. The FDI inflow recorded during 1974- 1980 was only
Rs163 million. Liquidation of FDI stock in non-manufacturing sector due to
government takeover of several companies and fresh inflows to the manufacturing
sector were worth noticing during this period. The share of manufacturing sector in
the FDI stock increased to 86.9% in 1980 from 40.5% in 1964 (Dunning and Narula,
1996). As a part of modernization, India’s FDI perspectives began to change in
the1990’s. There was overall freedom in the import of capital goods and technological
transfer, this in turn exposed Indian industry to have competition with foreign
investors or companies. The other changes adopted during this period include;
numerous incentives, exemption from foreign equity restrictions under FERA to
100% export oriented units – for the purpose new export processing Zones were
established and also brought the liberalization rules for the approval of industrial
licensing. The rules regarding lump sum technical fees and royalties were released
and taxes were also decreased. India’s growth rate during 1980’s was far better than
that of previous decade, which projected an average growth of nearly 6% (Shujiro and
Fukunari, 2006). The stock of FDI also got tripled during this period to 27 billion.
The share of services, plantations and manufacturing sectors to the total FDI stock
increased, while the share of chemicals and metal products got declined. Besides UK,
US and Germany, Japan also started their investment in India during this period
(Dunning and Narula, 1996). Indian scholars pointed out that the economic policies of
1970’s – 1980’s in some way or the other was responsible for the crisis of 1990- 91.
The economic environment of pre liberalization period was more or less closed in
nature. Policies during this period were mainly for the protection of the domestic
firms. Inward orientation and import substitution was the main backbone of
development strategy during this period. Because of the above said unfavorable
economic reforms, FDI inflow was less and dint had much role to play with up
liftmen of Indian Economy. The share of FDI during 1970- 80 to India’s GDP was on
.033% (K R Gupta, 2000). 1991 till date is considered as India’s post liberalization
period. It started of with the liberalization of investment and trade policies under the
short form ‘LPG’ (Liberalization, Privatization and Globalization). The government
reduced most of the products tariff rates. The recorded average tariff rate on import
during 1990-91, 1994-95 and 1997-98 was 87, 25 and 20% respectively. They also
had made reforms in old policies like discontinuation in technological requirements
for FDI in India. A wide variety of sectors mostly consumer goods sectors were
opened for the foreign investment. Previous FDI requirements (except for 24
consumer goods industries), like export earnings balance the dividend payment for
over the first 7 years from the date of commercial production was dropped and profit
repatriation by the foreign- managed firms were eased. In the mid 1990’s India
became the member of Multilateral Investment Guarantee Agencies, as a
consequence, all the government improvements were insured against nationalization.
The government also allowed 100% equity in high technology and export oriented
industries. In order to deal with large investment proposals, a Foreign Investment


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Promotion Board was set up. It deals with foreign investments which exceeds foreign
equity of 51%. During this period Reserve Bank of India was also authorized to give
approvals to projects in the high priority areas, where foreign equity did not exceed
50% in mining sector and 51% in other sectors. This open attitude by the government
enabled FDI inflow to get tripled and it recorded US$ 10 billion per year (A Mattoo
and R M Stern, 2003).

3.2.1. Impact on 51% FDI on India

The decision to hold back FDI in multi-brand retail will have a strong impact on the
domestic and foreign investor sentiment, another chamber, the Confederation of
Indian Industry (CII), said in a release. “We firmly hope that this would not be a
rollback and a quick consensus is reached,” CII Director General Chandrajit Banerjee
said. Describing the volte face as a case of “missed opportunity”, Assocham Secretary
General D S Rawat said, “It will send a very negative message to foreign investors.”
Rawat said FDI in multi-brand retail could have created over 10 million jobs in three
years, curbed wastage of farm products and benefited farmers through better prices
for their produce.
FICCI urged the government to move ahead with this progressive reform and
proposed solutions like considering a maximum of 49 per cent FDI in multi-brand
retail and increasing the percentage of sourcing from the small scale sector, which
was proposed to be fixed at a minimum 30 per cent. The government was forced to
put its decision to allow FDI in multi-brand retail on hold in view of stiff opposition
from UPA ally Trinamool Congress and other political parties.


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Chapter 4: Empirical Analysis
4.1 Methodology and Data Collection
In the previous section, we discovered that what fraction of FDI flows to India and
China. The strategies and policies they have adopted also played an immense role in
attracting such an inflow. The current section examines the contribution of FDI on
Chinese and Indian economy. The data for FDI inflows and other variables are from
the data base of UNSTAD. The data undertaken for the study covers a period of 39
years starting from 1970 to 2009. The section for the purpose is divided into two. The
first section deals with graphical representation. This method is adopted to explain the
relationship between the growth rates of the primary variable of concern, FDI and
GDP for India and China as a whole. The second section presents the regression
analysis for the aggregate for India and China as a whole.

4.2. Graphical Analyses

The purpose of the analysis is to show the affiliation between the growth rate of GDP
and FDI. If the GDP growth rate is related to that of FDI, then it might be due to FDI
determining of GDP, the growth rate of FDI at any time t is calculated as (FDIt
FDIt-i) / FDIt-1. Similar method is employed to calculate GDP growth rate. The
analysis also shows the recent trends in FDI inflows in INDIA and CHINA.
Figure: 4.2.1. FDI and GDP growth rate in China


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The figure 4.2.1for china shows that the FDI inflow during the time period from 1970
to 1982 was some what zero and it might be due to the closed nature of economic
activity during those days (Zhang 2006). The trend started to change since 1980
onwards and this might largely due to the liberalization policies which they adopted
during those days. An important point to be noted during the period 1982 to 1990 was
that both FDI and GDP was going at the same rate and was almost parallel. After
1990 there witnessed a sudden increase in the rates of FDI but the GDP growth rate
during those period was less, but positive. The period from 1998 to 2000 is also worth
noticing because FDI growth rate plunged to almost 4% from 5% and it was almost
constant till the year 2001. This sudden slow down in the FDI inflow during this time
was largely due to the Asian crisis of 1997. However the directions of both the lines
were moving in the same direction from the period 1980 onwards. After 2000 the FDI
inflow again started to rise, but experienced little fall back during 2002 and 2005
respectively. The GDP line shows that the economic growth rate was enormous from
2000 to 2009 respectively, but FDI experienced a steep fall during the period 2007 to
2008 and this is, might be as a consequence of global financial crisis. On the whole
the relationship between FDI flow and GDP growth rate was positive and the graph
shows both the lines were, somewhat moving in the same direction.

Figure: 4.2.2 FDI and GDP growth rate in INDIA


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The figure 4.2.2 for India shows that, the variable FDI and GDP growth is not moving
at the same proportion, which might indicate that FDI does not play a relevant role in
economic growth. The period ranging from 1970 to 1993 suggest that the inflow of
FDI was minute and during the period 1978 to 79 it went to negative, but the GDP
growth was less but was positive. The FDI growth during 1994 to 1999 was positive
and went to a maximum of 3%. It again declined during 1999 to 2002, this might be
as consequences of Asian financial crisis.
The important point to be noted that at any point till 2006 both FDI and GDP growth
rate was not more than 5%. There witnessed sharp rise in FDI inflows during 2006 to
07 and it rose almost to 12% which was actually double the growth of the previous
periods, but the relationship of FDI and GDP during that period shows, that FDI has
got only less importance in the economic growth of India. After experiencing a small
fall back during 2007 it again went upward to a maximum of 24% in 2008, which was
enormous when compared to that of 2007, but at the same time GDP also increased
but not at significant level compared to that of FDI. The graph shows that in the
beginning of 2009 the FDI inflows went down very sharp to 21% from 24% while the
GDP growth decreased and became constant. However the period from 2006 to 2008
can be considered as a golden period for FDI inflows in India.

Both graphs give us an insight into the flow of FDI in these countries and the
relevance of FDI on economic growth. Most significant thing to be noted is that the
graphs do not explain the impact of FDI on economic growth of these countries but
only shows the relationship between these variables. Another important fact is that,
these investment inflows became more strong and positive after the adoption of
liberalization policies in these countries.
Therefore the graph supports the findings of Agarwal (2000), Zhang (2006) and Dang
(2008), that growth in these countries were periodical and it largely occurred as a
result of more liberalized policies. It is astonishing to see how the growth rate went
upward after opening up their economy (especially the early1990 period and the post
1990 period is worth noticeable in both the countries – China and India respectively).

4.3. Regression Analysis


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The method used for the empirical analysis on this dissertation involves linear
regression analysis. The variables concern for the study involves GDP, which is
considered as the dependent variable, while FDI inflow is taken as the independent
variable of interest. The study also covers the relevance of other variables that
contribute to the total GDP. The analysis is done in two different parts, one part
predominantly for China and the other for India. For the purpose two equations are
formulated by including independent variables like FDI, exports and labor force for
China along with the dependent variable GDP. Meanwhile in the equation for India
independent variable like FDI, Labor force and workers remittance receipts from
abroad are also included. This is done with an intention to study the impact of these
variables along with FDI on economic growth of these countries respectively.
Labor and employment plays major role in the economy. Often large entrepreneurs
are largely directed towards to those countries where they avail skilled labor at a
cheap rate for their business. Besides labor also contribute a major portion in the total
GDP. The study, therefore analysis their contribution in accordance with FDI.
Workers remittance level is another important factor that contributes to GDP growth
rate. The importance of the same is increasing day by day in India and China. The
number of people who are working in another country remits a part of their wages or
business activities to their country of origin in a way of savings. The exchange rate
and the conversion procedure also play a major role which again adds to the total
GDP. The study therefore analysis their contribution as well, to the total GDP in
India.
Net export is another most important variable considered for the dissertation. Net
export is the difference between total import and export. It is also referred to as
balance of trade of a country. It is also considered as a major part of national account
(current) in the balance of payment of a country. The correlation of net exports and
national asset position is immense, that an increase or decrease in net exports will
have a direct impact on the later, causing it to change.
As mentioned earlier, for the purpose of the dissertation, a linear regression model is
used. The results are so obtained with the use of SPSS (statistics package for the
social sciences), a software similar to E-views. This is commonly used by the
management students and corporate official all around the world to determine a
precise analysis of the problem. The study done by Adewumi (2006) and Xiaohong
Ma (2009) had used similar analysis to find the impact of FDI on economic growth in
Africa and China respectively. Adewumi (2006) had used three methods such as
graphical, regression and granger causality, while Xiaohong Ma (2009) employed
only regression model to do the analysis. The finding so obtained from both studies
was some what positive in nature. The correct precision and the compatibility of
regression method used in both the studies can be taken as a base to formulate a
multiple regression model to analyze the problem concerned for the dissertation.
Multiple linear regression models are used to determine the impact of one or more
independent variable on a dependent one. It allows analysts to examine the effect of
more than one independent variable on dependent variable (Xinyan, Xinogang Su,
2009).
The equation for the model for China is formulated as follows:
GDP= α + β1 FDI + β2 LBR + β3Nx+ εt………………………………. (1)
Were GDP = Average annual growth rate of real per capita
FDI = Measured as a percentage of GDP, in US dollar millions,
LBR = Annual average of the labor force, given in percentage,
Nx = Measured as a percentage of GDP, in US dollar Millions


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Here the variable GDP is the gross domestic product, while FDI is the foreign direct
inflows, while Nx and LBR represent net exports and labour force of China
respectively.
The equation for the model for India is formulated below:
GDP = α + β1FDI + β2LBR + β3WR……………………… (2)
Were GDP = Average annual growth rate of real per capita.
FDI = Measured as a percentage of GDP, in US dollar millions,
LBR = Annual average of the labor force, given in percentage,
WR = Measured as a percentage of GDP, in US dollar millions.
Here the variable GDP is the gross domestic product, while FDI is the foreign direct
inflows, while LBR and WR represents labor force and worker’s remittance receipts
of India respectively.
The hypothesis for the empirical analysis is that the impact of FDI on economic
growth of
India and China is positive. The confirmation of the above hypothesis can be made
according to the estimated value of β1 in the regression models. The hypothesis for the
model is:
Ho: β1 = 0 (FDI inflow do not have any impact on economic growth), while
H1: β2  0
The result of the model for India and China is represented in the tables 4.2.1.2 and
4.2.2.2.
(Appendix Section) The Durbin Watson test is also included in the analysis to find the
autocorrelation in the error term. If the DW value is near to zero, the autocorrelation
will be positive, and if it is near to 2, then no autocorrelation. The‘t’ value is shown in
the model to test the significance level of the co-efficient estimates. There are 39
observations in each analysis for China and India. The FDI inflow data’s for China for
the year’s between 1970 to 1980 is not available because China has opened its
economy after a long period of the late 1970’s encouraged more FDI inflows during
1980 onwards (Dunning and Narula, 1996). The labor force data for India and China
and workers remittance receipts data for India is only available from 1980 onwards.
These limitations might have an impact on the regression results.

4.3.1. Regression Analysis of China

GDP = -253.901 + .564FDI + 3.747LBR + .086Nx
(-.998) (1.353) (1.023) (1.350)
R square = .140, DW = 1.023
1) From the analysis for the sample (see table 4.2.1.1 in appendix), β1 = .564  0, in
other words FDI has an independent variable has got a positive effect on the economic
growth of China. In other words a unit increase in FDI causes the GDP to increase by
.564 percent in China. The coefficient value for β2 is 3.744, it indicates that labor
contribution to economic growth is worth noticing and positive in China. Besides, β3
= .086  0 means net exports in China also has got a positive impact, thereby
indicating that a unit increase in exports causes the GDP to increase by .49 percent in


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China. By comparing all the variables, we find that FDI, LBR and Nx has got positive
impact on China’s economic growth.
2) From the equation the t-value for FDI, LBR and Nx are 1.353, 1.025 and 1.350
which are all positive and significant- but not that significant when compared to that
5% significance level. Of the entire variable, again FDI has got more positive effect,
indicating that FDI’s contribution is more significant than the other variable.

4.2.2 Regression Analysis of India

GDP = -7.562 + .536FDI + .165LBR + .212WR
(-.084) (.581) (.144) (.267)
R square = .086 DW = 1.836
1) The analysis (see tables 4.2.2.1 and 4.2.2.2 in appendix) shows that β1 = .536 0,
indicating that co-efficient estimates of FDI is positive with the GDP growth rate of
India.
The equation suggests that a unit increase in the FDI cause GDP to grow by .581
percent for India. Besides the value of β2 and β3 are .144 and .267 respectively,
showing that the natures of contribution made by labor force and workers remittance
are almost positive in nature. Of all the variables the coefficient estimates of FDI is
more positive, whereby indicating that role of FDI in economic growth is quite
significant.
2) The t-value for FDI, LBR and WR are .581. .144 And .267 respectively, which are
all positive but not significant at 5% significance level. Of the entire variables
computed, FDI has got highest effect on the GDP, even though it’s not significant.
The study thus reveals FDI has got relevance in the GDP growth of India, hence
supporting our theory of concern for the study.

Chapter 5: Findings and Conclusion

5.1. Author’s Conclusion

FDI inflows in India and China was periodical, and the relevance of the same is
increasing year by year. China being isolated for more than 30 years opened its
economy on the late 1970’s, since then the flow was astonishing. China at present is
the main FDI attracting zone in entire Asia and India is in second place according to
the recent studies. India on the other hand opened its economy in 1991 with the
introduction of Liberalization, Privatization and globalization policies, since then the
inflow was quite good. The pre- liberalization period of both the countries were of a


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closed nature, giving due importance to domestic firms. After realizing opportunities
and possible benefits the policy makers in both the countries decided to open the
economy. The main aim of this research is to examine the role of FDI in economic
growth in CHINA and INDIA. The study is so aligned that, it gives due importance to
both empirical and theoretical aspects to give the readers an insight into the strategies,
intervention, role of FDI and partially the role of other factors of growth that are
prevailing in INDIA and CHINA, which enabled them to achieve such a rapid
economic growth. The graphical analysis of China as a whole shows that the
relationship between FDI and GDP growth rate was remarkable and both the variables
are going at the same upward direction, indicating that FDI might have a significant
effect on GDP growth rate in China, The graphical analysis of India shows that there
is only very minute relationship between FDI and GDP growth rate. The direction of
flow of both the variable are not equal and vary at certain periods, FDI as a variable
might not have a significant role in the in the economic growth of India.
The main point to be noted is that the graphs do not explain the impact of FDI on
economic growth of these countries but only shows the recent trend in FDI inflow and
the affiliation between these variables.
Regression equation is formulated after doing the graphical analysis. For the purpose
linear regression method is used to calculate the impact and the role of FDI on GDP
growth of China and India. There are 39 observations in each analysis for China and
India. The FDI inflow data’s for China for the year’s between 1970 to 1980 is not
available because China has opened its economy after a long period of the late 1970’s
encouraged more FDI inflows during 1980 onwards (Dunning and Narula, 1996). The
labor force data for India and China and workers remittance receipts data for India is
only available from 1980 onwards. These limitations might have an impact on the
regression results. Empirical results for China suggests that FDI as an independent
variable has a favorable impact on the GDP growth rate of China. The other variable
such as labor force and exports also has got positive relation with GDP, thereby
indicating that all the variables contributes positive to economic growth in CHINA.
Empirical results for India suggests that FDI as a primary variable has got a positive
relation between GDP growth rate, indicating that FDI is relevant in contributing to
the growth of GDP growth rate in India. Of all the variables computed FDI is more
positive but not that significant at 5% significance level.
Recent statistical figures shows that FDI inflows are increasing yearly and it might
have a major role in the contribution of GDP growth rate of both the countries in the
nearing future.

Appendix
A1.1. Regression analysis for China
Table: 4.2.1.1 Model summary (b)

Model R R square Adjust R Std. error of Durbin-
Square the estimate Watson

1 .347(a) 0.140 0.40 2.83087 1.023


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a predictors: (constant), nx, fdi, lbr

b Dependent variable: gdp

Table: 4.2.12 coefficients (a)

Unstandardized Standardized
Coefficients Coefficients

Model B Std. Error Beta t sig.

1 (constant) -253.091 254.464 -.0998 .328

fdi .654 .417 .335 1.353 .188

lbr 3.747 3.657 .289 1.025 .315

nx .086 .064 .308 1.350 .189

a Dependent Variable: gdp

A1.2 Regression analysis for India
Table: 4.2.21 Model summary (b)

Model R R Square Adjusted R Std. Error of Durbin-
Square the Estimate Watson


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1 .293 (a) .086 -.020 2.15592 1.836

a predictors: (constant), wr, lbr, fdi
b Dependent Variable: gdp

Coefficients (a)
Table: 4.2.2.2
Unstandardized Standardized
Coefficients Coefficients

Model B Std. Error Beta t Sig

1 (constant) -7.562 90.431 -.084 .934

fdi .536 .923 .218 .581 .566

lbr .165 1.145 .031 .144 .886

wr .212 .795 .099 .267 .792

a Dependent variable: gdp

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