A study on the impact of foreign direct investment on economic development of lao p d r (sum)

2 MINISTRY OF EDUCATION LAOS NATIONAL UNIVERSITY MINISTRY OF EDUCATION AND TRAINING NATIONAL ECONOMICS UNIVERSITY CHAPTER 1: INTRODUCTION 1.1 KHAMSEN SISAVONG A STUDY ON THE IMPACT OF FOREIGN DIRECT INVESTMENT ON ECONOMIC DEVELOPMENT OF LAO P.D.R (Development Economics) Code: 62.31.01.05 Research Background Laos is a small landlocked country with an area of 236,800 square kilometers It shares its borders with Vietnam in the East, China in the North, and Cambodia in the South, Thailand and Myanmar in the west Two third of the country is mountainous (northern part) thus its geographic circumstances constrain both the quality and quantity of agriculture and cause difficulties to the development of trade, social infrastructure and transportation and communication links However, the country has transformed from a landlocked to a land link and cross road to other parts of the world In 1986, the Lao government implemented the New Economic Mechanism (NEM) to open the country and provided incentives for developers and investors and moved from a centrally planned economy to a market oriented economic model A dissertation summary submitted to the National Economics University in fulfillment of requirements for the degree of Doctor of Philosophy in Economics FDI inflows in Laos have grown dramatically over the past decade and have played an important role in the growth of the world economy as well as the ASEAN Nations In the developing world, FDI has become the most stable and largest component of capital flows As a result, FDI has become an important alternative in the development finance process (Global Development Finance, 2005.) Laos is a small and still poor country Therefore, the investment from foreign countries in terms of FDI is needed because FDI plays an important role in job creation, economic growth, capital inflow, technology transfer, human resource development, and wealth in the host country Thanks to the economic reform, the number of FDI projects and the income on international trade have increased significantly and have had a direct impact on national income as well as GDP growth Hanoi, 2014 1.2 Rationale for the Research It has been suggested that Foreign Direct Investment (FDI) inflows have played an important role in promoting economic growth in developing countries, especially in the Southeast Asian countries (Nguyen, 2008) Given the importance of FDI especially in developing countries like Laos, theoretically as well as practically, there are however still inconclusive arguments for and against the role of FDI inflows in enhancing economic development in a country (cf., Nguyen, 2008) It has still been debate about whether FDI inflows are beneficial or not to economic development, and what governments should to attract and use FDI inflows effectively (Kokko et al., 2003; Longani & Razin, 2001; Masina, 2002; Nguyen, 2008) In addition, it has been suggested that the relationship between FDI and economic growth may be country and period specific (cf., Adegbite & Ayadi, 2010) Therefore, this study aims to explore the impact of FDI inflows on some indicators of economic development in the context of Laos, a developing country in Asia 1.3 Research Objectives and Research Questions This study seeks to analyse FDI inflows into Laos and to investigate their impact on the economic development of Laos The desired outcome of this research aims at confirming the linkage between FDI inflows in Laos and the economic development indicators including GNI per capita, financial capital, level of technology, human capital, energy and natural resources, transportation and communication • Does FDI have a significant role on the GNI per capita? • Does FDI have a significant role on the Financial Capital? • Does FDI have a significant role on the country's level of technology of Laos? • Does FDI have a significant role on Human Capital of Laos? • Does FDI have a significant role on the Energy and Natural Resources availability of Laos? • Does FDI have a significant role on the Transportation and Telecommunication infrastructure of Laos? 1.4 Scope of the Study This study focuses on the role of FDI on some indicators of economic development in the context of Laos Other aspects of development such as social and environmental issues (i.e., poverty ratios of different sectors, education and health care, environment pollution and damage) are not addressed in this dissertation This study mainly employed the data to analyse the relationships between FDI and Laos’ economic development indicators during the period 1990-2012 The analyses of correlations were used to serve the objectives of this research 1.5 Contributions of the Study This research tried to answer the questions: 1) What are the relevant literature and the theoretical background on FDI and its impact on economic development? and 2) Does FDI have a significant contribution to economic development of Laos? This study aims to examine the impact of FDI on several economic development indicators in the context of Laos The study is important to help Laos enjoy further economic development as well as contributes to the literature of FDI and economic growth in the context of developing countries With regard to the impact of FDI on economic development, the research aims to answer the following specific questions: FDI has been suggested as a determinant of economic development in both developed and developing countries Its important role in promoting economic growth and bringing many benefits to the economy is especially emphasized in the context of developing countries However, the literature also provides mix findings pertaining to the effects of FDI, and there has been suggested that the link between FDI and economic development may be country and period specific Therefore, it is important and meaningful to examine the impact of FDI inflows on economic development in Laos, a developing country which has received very modest research attention to date By focusing on six main research questions pertaining to the relationships between FDI inflows and various indicators of economic development, the research has contributed to both theoretical and practical sides From theoretical perspective, the research helps to enrich the knowledge about the important topic pertaining to FDI’s impacts on economic development in general and in the context of a developing country in particular From practical perspective, the research findings provide significant implications to policy makers in Laos The issue of FDI and its important role is more important for developing countries and the countries in transition like Laos because they lack capital, know how, and managerial skills Understanding the role of FDI would help making good policies to attract more FDI for the purpose of economic development 1.6 Dissertation Structure This dissertation includes six main chapters as follows Chapter 1: Introduction Chapter 2: Literature review on the impact of FDI on economic development Chapter 3: Overview of economic development and FDI in Laos Chapter 4: Research methodology Chapter 5: Research findings Chapter 6: Conclusions and discussion CHAPTER 2: LITERATURE REVIEW ON THE IMPACT OF FDI ON ECONOMIC DEVELOPMENT This chapter reviews the literature on IJVs’ performance and the factors influencing it In the first section of the chapter, the literature on the five common measures of IJV performance were reviewed, followed by the review of the key determinants of IJV performance Finally, the proposed conceptual framework is presented 2.1.2 Indicators of Economic Development In literature, previous studies have examined various aspects of economic development In this study, the author examines the impact of FDI on economic development in Laos, focusing on some economic development indicators including: - Gross National Income (GNI) per capita - Financial Capital - Level of technology 2.1 Definition and Indicators of Economic Development - Human Capital 2.1.1 Definition of Economic Development - Energy and Natural resources Economic development is a normative concept It means that it applies in the context of people's sense of morality (right and wrong, good and bad) The definition of economic development given by Todaro (1994) is an increase in living standards, improvement in self-esteem needs and freedom from oppression as well as a greater choice The most accurate method of measuring development is the Human Development Index which takes into account the literacy rates and life expectancy which affect productivity and could lead to economic growth It also leads to the creation of more opportunities in the sectors of education, healthcare, employment and the conservation of the environment It implies an increase in the per capita income of every citizen (Todaro, 1994) - Transportation and Communication The terms economic development and economic growth are used interchangeably but there is a big difference between the two Economic growth can be viewed as a sub category of economic development Economic development refers to government policy to increase the economic, social welfare and ensure a stable political environment Economic growth on the other hand refers to the general increase in the country products and services output (source: whatiseconomics.org) 2.1.3 Theoretical Economic Overview This section review several economic models such as Lewis' Dual Economy model (1954), Solow's model (1956), the Harrod-Domar growth model, and Dependency theory (Pool & Stamos, 1990) 2.2 FDI and its Impact on Economic Development 2.2.1 Definition and Determinants of FDI 2.2.1.1 Definition of FDI and reasons for FDI inflows to developing countries FDI is defined as cross-border investment by a resident entity in one economy with the objective of obtaining a lasting interest in an enterprise resident in another economy The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence by the direct investor on the management of 10 the enterprise Ownership of at least 10% of the voting power, representing the influence by the investor, is the basic criterion used (OECD, 2012) development, mainly in the context of developing countries After that, a review of the studies on the impact of FDI on economic development through human capital and technology is provided Finally, the author presents FDI and its spillover effects In the same line, according to investopedia.com, FDI refers to an investment made by a company or entity based in one country, into a company or entity based in another country Yoonbai (2000) examined the reasons behind the flow of FDI in countries like Korea, Malaysia, Chile, and Mexico The research found that this flow was influenced by two factors on a global level: recessions faced by many industrialized economies and the global interest rate drop Internal factors like (a) country-specific productivity shocks, (b) demand shocks, (c) inflation shocks,(d) monetary shocks, (e) credit worthiness because of macroeconomic stabilization, (f) widespread liberalization of financial market, and (g) a successful resolution of debt problems were found relatively less important 2.2.1.2 Determinants of FDI There have been a number of theories and approaches that help explain the motivations of FDI and identify FDI’s determinants - Internalization - Eclectic paradigm - Complement Theory of FDI - The Resource-Based Theory - The Theory of New Economic Geography - Diversified FDI and risk diversified model - Policy determinants of FDI 2.2.2 Impact of FDI on economic development In this section, first the author review previous studies on the impact of FDI on economic growth and some other aspects of economic 2.2.2.1 Impact of FDI on economic growth and other economic development aspects 2.2.2.2 Impact of FDI on Economic Development through Human Capital 2.2.2.3 Impact of FDI on Economic Development through Technology 2.2.2.4 Foreign Direct Investment and Spillovers 11 CHAPTER 3: OVERVIEW OF ECONOMIC DEVELOPMENT AND FDI IN LAOS 3.1 Overview of Laos’ Economy This section presents various aspects of Laos’s economy, inclusing economic growth, economic structural changes, etc 12 3.1.4 Banking sector development The banking sector is one of the sectors that grew rapidly and distinctly during the period of the Sixth Five-Year Plan 3.1.5 Inflation has been effectively managed 3.1.6 The appreciation of the Kip currency 3.1.7 Workforce and employment balance 3.1.1 Economic growth On average, the Gross Domestic Product (GDP) during the Sixth Plan period was 219,853 billion kip, approximately 43,970 billion kip per year GDP grew at an annual rate of 7.9%, which was higher than the Sixth Five-Year Plan target (the plan target was 7.5%) In FY 2009-2010, the value of GDP was 54,282 billion Kip which was 1.89 times higher than FY 2004-2005 The growth in share of agriculture in GDP was 4%, of industry was 12.6%, and of services was 8.4% 3.1.8 Balancing the sources of funds for development 3.1.9 Balancing the State budget 3.1.10 Balancing imports and exports 3.1.11 Sectoral development, regional and international economic integration 3.1.12 Infrastructure 3.1.2 Economic structural changes 3.2 Foreign Direct Investment in Laos The economic structure has changed as an economy transforms from a subsistence agriculture economy based on raw materials to a marketoriented economy based on processing FDI plays very important role in many developing countries in generating capital, job employment and technology transferring As a trend of FDI moves forward to country which rich in natural resources and have advantage in cheap labor, in the case of Lao PDR it is also no exception 3.1.3 Financial sector growth During the past years, the banking sector has contributed to financial stability, and the foreign exchange rate has remained stable This is reflected in the money supply growth at 23% per year which contributed to19.6% of GDP Foreign exchange grew and contributed to approximately 35% of GDP in 2009-2010 An increase in the money supply or M2 was contributed by the increasing numbers of foreign investors Before 1985, there was not any FDI inflow to Lao PDR With the Investment Law in 1994 onward the government of Laos PDR has paid attention in attracting FDI by improving business environment, political stability and macroeconomic policy, its commitment to be member of WTO and AFTA which giving foreign investors in flavor of investment incentive especially in tax policy and land policy However with the implementation of Investment Law in 2004 which given huge investment incentive to foreign investors especially tax incentive, as the resulted in 13 2005 onward the FDI inflow has been significantly increased especially in mining sectors and hydropower sectors In 2006 the FDI inflow soared to US$187 million and reached a peak at US$323.5 million in 2007 FDI inflows to Lao PDR fell considerably in 2008 due to the impact of the global economic crisis The nominal FDI inflow value was decline from about US$323.5 million in 2007 to US$227.7 million in 2008 (or by about 30 percent) due to recent delays of new hydropower and mining projects, as well as slow growth in the non-resource sectors However, the FDI inflow to Laos has quickly recovered at around US$300 million in 2009- 2011 period The majority of FDI goes to natural resource sectors Major FDI to Lao PDR in recent years comes from the region, mainly from Thailand, China, Vietnam, Australia, India, Japan, and Korea Vietnam now has become the Laos' biggest foreign investor during the period since the Lao Government first adopted foreign investment incentive policies (1989-2012) The most popular fields for foreign investors are the mining industry (accounting for 27 percent), electricity production (25 percent), agriculture, services, processing, hotels, restaurants, telecommunications, construction, industry, and banking 14 CHAPTER 4: RESEARCH METHODOLOGY This chapter describes research methodology used in this study First, research questions are briefly presented and the statistical method used to test the impact of FDI on economic development in Laos Next, variables and their measures are provided Finally, the author presents a detailed description of data employed for this study 4.1 Research Questions In addition to reviewing the relevant literature, the research tried to answer the question: Does the FDI have a significant contribution to economic development for Laos? In particular, the research answers the six specific questions regarding the relationships between FDI and six aspects of economic development 4.2 Variables and measures In this section, the author presents key variables used in this study and the indicators measuring them These indicators are adopted from World Bank FDI inflows: measured by BoP (current US$) Economic developemnt: A GNI per capita: constant 2005 US$ B Financial Capital: Financial Capital is measured following indicators by the five • Gross capital formation (% of GDP) • Total debt service (% of exports of goods, services and primary income) • Debt service on external debt, long-term (TDS, current US$) 15 16 • Debt service on external debt, total (TDS, current US$) CHAPTER 5: RESEARCH FINDINGS • Inflation, GDP deflator (annual %) C Level of technology: Level of technology is measured by the following indicator • Industry, value added (% of GDP) D Human Capital: Human Capital is measured by the five following indicators • Life expectancy at birth, total (years) 5.1 FDI and GNI per capita Figure 10 presents the graph of correlation between FDI and GNI per capita and Table 17 presents coefficient of correlation between FDI and GNI per capita • Mortality rate, under-5 (per 1,000 live births) • School enrollment, secondary (% gross) • School enrollment, secondary (% net) • School enrollment, tertiary (% gross) Figure Graph of Correlation between FDI and GNI per capita • Oil consumption per capita (bbl/day per 1000 people) and • Air transport - passengers carried • Air transport - registered carrier departures worldwide • Mobile cellular subscriptions (per 100 people) • Fixed broadband Internet subscribers (per 100 people) • Internet users (per 100 people) • Roads, total network (km) 4.3 Data Description This study employed the secondary data which were collected from the World DataBank (2013) queries from 1990-2012 and Index Mundi website (2013) 700 GNI per capita (constant 2005 US$) E Energy and Natural resources: Energy and Natural resources is measured by the following indicator F Transportation and Communication: Transportation Communication is measured by the six following indicators This chapter presents the research findings Specifically, the correlations results regarding the relationships between FDI inflows and economic development indicators in Laos are provided 600 500 400 300 200 100 0 50 100 150 200 250 FDI (BoP, current US$mn.) 300 350 17 18 FDI, net inflows (BoP, current US$) Pearson Correlation Sig (2-tailed) N GNI per capita (constant 2005 US$) 881** 000 14 As indicated in Table 17, Pearson correlation of FDI inflows and GNI per capita is 0.881 (p < 0.05), that confirms a strong correlation between FDI inflows and GNI per capita It implies the significant and important role of growth of FDI inflows on the growth of GNI per capita Figure Graph of Correlation between FDI and long-term debt service on external debt 350 Long-term debt service (TDS, current US$mn.) Table 17 FDI and GNI per capita Coefficient of Correlation 300 250 200 150 100 50 0 5.2 FDI and Financial Capital 50 100 150 200 250 300 350 FDI, net inflows (BoP, current US$mn.) Table 18 FDI and Financial Capital Coefficient of Correlation Financial Capital Gross capital formatio n (% of GDP) FDI, net inflows (BoP, current US$) Pearson Correlation Sig (2tailed) N Gross capital formation (annual % growth) Total debt service (% of exports of goods, services and primary income) Debt service on external debt, long-term (TDS, current US$) Debt service on external debt, total (TDS, current US$) Inflation, GDP deflator (annual %) 5.3 FDI and Level of Technology 819** -.167 173 820** 812** -.267 001 623 453 000 000 11 21 22 22 22 Techonology FDI, net inflows (BoP, current US$) Industry, value added (% of GDP) Pearson Correlation Sig (2-tailed) N 838** 000 22 229 12 Table 19 FDI and Level of Technology Coefficient of Correlation As indicated in Table 18, the results show that FDI inflows was As indicated in Table 19, the correlation of FDI inflows and Industry value added (% of GDP) is 0.838 (> 0.5) that confirms a strong correlation between these measures significantly correlated with the Gross capital formation (% GDP), Debt 5.4 FDI and Human Capital service on external debt, long-term (TDS, current US$), and Debt service As indicated in Table 20, in the 1990-2012 period, the FDI inflows of Laos had strongly positive relationship with the indicators of Human Capital on external debt, total (TDS, current US$) Figure 11 presents the graph of correlation between FDI and longterm debt service on external debt 19 20 Table 20 FDI and Human Capital Coefficient of Correlation Human Capital FDI, net inflows (BoP, current US$) Life expectancy at birth, total (years) Pearson 665** Correlation Sig (2- 001 tailed) N 22 Mortality rate, under-5 (per 1,000 live births) -.705** Table 22 FDI and Transportation and Communication Coefficient of Correlation School enrollment, secondary (% gross) School enrollment, secondary (% net) School enrollment, tertiary (% gross) 538* 621** 856** 000 012 006 000 22 21 18 20 5.5 FDI and Energy and Natural Resources The correlation results indicates a weak correlation between FDI and Energy and natural resources Table 21 FDI and Energy and Natural Resources Coefficient of Correlation Energy and Natural Resources FDI, net inflows (BoP, current US$) Pearson Correlation Sig (2-tailed) N Oil consumption per capita (bbl/day per 1000 people) -.271 481 5.6 FDI and Transportation and Communication As indicated in Table 22, in general, the FDI inflows of Laos had strongly positive relationship with indicators of the Transportation and Communication Transportation and Communication FDI, net inflows (BoP, current US$) Pearson Correlation Sig (2tailed) N Air Fixed Mobile transport, broadband Internet Roads, Air cellular users registered Internet total transport, subscriptions subscribers (per carrier network passengers departures (per 100 100 (per 100 (km) carried people) people) worldwide people) 721** 707** 833** 593 815** 896** 000 000 000 055 000 006 22 22 22 11 15 In summary, in this study the author employed the method of correlation analysis to test the relationship between FDI inflows and various indicators measuring six aspects of economic development in the context of Laos over the period 1990-2012 The research findings in general provide empirical evidence to support the important and positive role of FDI inflows on economic development 21 CHAPTER 6: CONCLUSIONS AND DISCUSION 6.1 Conclusions This research aims to explore the role of FDI inflows on economic development in Laos, a developing country which has received very mosdest research attention to date The correlation analysis method was employed to serve this purpose The research results show that in general, FDI plays a significant role on economic development Specifically, FDI inflows were found to be positively correlated with almost all indicators measuring six aspects of economic developent The research findings are summarized in the following • FDI and GNI per capita: The findings suggest an important role of FDI inflows on GNI per capita by showing a strongly positive correlation between the two measures • FDI and Financial Capital: The findings show that FDI inflows are significantly and positively correlated with some indicators of financial capital including the Gross capital formation (% of GDP), the Debt service on external debt, long-term (TDS, current US$), and the Debt service on external debt, total (TDS, current US$) • FDI and Level of Techonology: The findings show that FDI inflows has a positive and important role on level of techonology, based on a strong and positive correlation between FDI and the Industry value added (% of GDP) • FDI and Human Capital: The findings show that FDI inflows are significantly correlated with all five indicators of human capital All correlation coefficients are positive, except the one between FDI and Mortality rate, under-5 (per 1,000 live births) This results may need to have further study for clarify the relationship between the two measures The strongest correlation is the one between FDI and School enrollment, tertiary (% gross) 22 • FDI and Energy and Natural Resources: The findings failed to provide empirical evidence for the significant role of FDI inflows on Energy and Natural Resources Perhaps, it is partly due to the measure limittaion of Energy and Natural Resources with only one indicator - the oil consumption per capita This may need further exploration with more comprehensive measure • FDI and Transportation and Communication: The findings suggest that in general FDI inflows have an important and positive role on the Transportation and Communication, by showing significantly positive correlations between FDI and five indicators of Transportation and Communication including Air transport, passengers carried, Air transport, registered carrier departures worldwide, Mobile cellular subscriptions (per 100 people), Internet users (per 100 people), and Roads (total network - km) The strongest correlations are those between FDI and Roads (total network - km), Mobile cellular subscriptions, and Internet users 6.2 Implications of the Study Theoretical implications From theoretical perspective, this study is important because it contributes to better understanding the relationship between FDI inflows and economic development in the context of a developing country This is especially interstesing and important since the research context in this study is Lao P.D.R., a country that has received very little research attention from scholars up to date Therefore, the findings from this study help to enrich the literature on FDI and its role on economic development in general and in developing countries, in particular In addition, in this study the author empirically examined the relationship between FDI inflows with a number of aspects of economic 23 24 development, rather than just focusing on one aspect as in many previous studies Developing an effective mechanism affecting foreign direct investors to ensure mutual benefits of the foreign investors and the host country’s development Implications for policy makers On the basis of the findings, this study is also expected to provide a number of implications for policy makers in Laos with the purpose of making effective use of FDI for enhancing economic development in this country Some implications and suggestions are presented in the following Promoting and attracting FDI inflows: it is important for policy makers to develop appropriate policies to create favorable environment to attract FDI inflows Maximizing the effective impact of FDI on economic development: Laos government may need to put sufficient investment into upgrading infrastructure and developing human capital so that the country can maximize the techonological spillovers and other benefits associated with FDI inflows Policy makers in Laos also need to work on the necessary activities and developing relevant policies to promote favorable environment for FDI and enhance the government’s capability to maximize the benefits of FDI inflows Enhancing capabilities of controlling and regulating FDI for better economic development: Laos government needs to develop its capabilities of controlling and regulating FDI for better economic development FDI should be directed to the right sectors and areas so that the economy can have sustainable development The government also needs to have ability to select the appropriate FDI projects, develop relevant policies toward different types of FDI projects, and have ability to make decision of rejecting some inappropriate projects 6.3 Limitations of the Study and Future Research Direction • First, regardless of the long period of the data collected (1990-2012), some variables had limited and small number of observations, like the Energy and Natural Resources data which gave mixed results of the unavailability of that data • Second, with regard to measurement issue, there is some limitation in terms of a limited number of indicators measuring some variables in this study For example, Level of Techonology and Energy and Natural resources each was measured by only one indicator Future research should use more comprehensive scales with multiple items to increase the validity of the results • Third, many other aspects of economic developemnt could be affected by FDI inflows other than the ones selected in this study The future research could explore the impact of FDI on more aspects of economic developemnt • Fourth, in this study the author just explored the role of FDI on economic development by empirically examined the correlations between FDI inflows and various indicators of economic development in Laos It would be desirable for future research to test the impact of FDI on economic development employing more advanced technique such as regression • Another suggestion for future research would be having a micro level analysis for Laos to come up with a reform strategy for improving their GNI per capita following the path in accomplishing that goal Future research could also examine the factors influwncing the attraction of FDI inflow to Laos  ... (bbl/day per 1000 people) and • Air transport - passengers carried • Air transport - registered carrier departures worldwide • Mobile cellular subscriptions (per 100 people) • Fixed broadband Internet... correlations between FDI and five indicators of Transportation and Communication including Air transport, passengers carried, Air transport, registered carrier departures worldwide, Mobile cellular... this research 1.5 Contributions of the Study This research tried to answer the questions: 1) What are the relevant literature and the theoretical background on FDI and its impact on economic development?