Foreign direct investment, financial development and economic growth in asian developing countries

UNIVERSITY OF ECONOMICS INSTUTION OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM- NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS FOREIGN DIRECT INVESTMENT, FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH IN ASIAN DEVELOPING COUNTRIES A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By NGUYEN THUC DUY ANH Academic Supervisor: DR NGUYEN VAN PHUC HO CHI MINH CITY, DECEMBER 2011 CERTIFICATION I hereby certify that the substance of the thesis has not already been submitted for any degree and is not being currently submitted for any other degree I also certify that, to the best of my knowledge, and help received in preparing the thesis and all sources used have been acknowledged in the thesis Signature Nguyen Thuc Duy Anh Date: ACKNOWLEDGMENTS I would like to express my gratitude to all those who gave me the possibility to complete this thesis I am deeply grateful to my supervisor Dr Nguyen Van Phuc from Ho Chi Minh City Open University whose support, stimulating suggestions and encouragement • helped me in all the time of research for and writing of this thesis I am also very grateful to all lecturers of the Vietnam-Netherlands Programme for giving me knowledge and guidance to fulfill the M.A Programme I would like to thank all the members of the Vietnam-Netherlands Program, especially, VNP Library for helping me to have necessary documents and research papers during my completion of the thesis Finally, I am indebted to my parents and my dear husband whose love, sympathy and encouragement enabled me to complete this thesis I am also thankful to my classmates for their warm encouragement ; 11 ACRONYMS AND ABBREVIATIONS • FDI Foreign Direct Investment FINANCE Financial Development WDI World Development Indicators WGI Worldwide Governance Indicators UNCTAD United Nations Conference on Trade and Development OECD Organization for Economic Cooperation and Development MNCs • Multinational Enterprises M&A Mergers and Acquisitions R&D Research and Development POOLED Pooled Regression Model FEM Fixed Effects Regression Model REM Random Effects Regression Model OLS Ordinary Least Square • 111 ABSTRACT This research investigates the role of domestic financial development plays in enhancing FDI's positive effects on economic growth in Asian developing countries In other words, we examine whether countries with better domestic financial system can utilize FDI more efficiently The empirical analysis uses balanced panel data of24 Asian developing countries in the period 1995-2009 This research applies the various models and techniques in panel data regression Linear static models for panel data named constant coefficients model or pooled regression model (POOLED), fixed effects regression model (FEM) and random effects regression model (REM) are employed We analyze all models and employ many kinds of test including poolability test, Hausman test, LM test, fixed effects tests and Wald tests to select the most appropriated estimated model The research findings show that FDI alone does not have directly effect on economic growth but does have when combined with financial development Well-developed domestic financial markets promote the process of technological diffusion associated with FDI in Asian developing countries Therefore, FDI and domestic financial development are complementary in increasing the rate of economic growth in the region There is a threshold level of domestic financial development above which FDI starts to have positive impacts on economic growth • lV TABLE OF CONTENTS - I CHAPTER INTRODUCTION 1.1 Problem statement 1.2 R 1.3 R 1.4 Research scope and data 1.5 Organization ofthe thesis CHAPTER LITERATURE REVIEW 2.1 The impact ofFDI on economic growth 2.2 FDI, financial development and economic growth: theoretical framework and • empirical studies 10 2.2.1 Theoretical framework 10 2.2.1.1 Neoclassical growth model 10 2.2.1.2 Endogenous growth model 11 2.2.1.3 Technological change model 11 2.2.2 Empirical studies about the role of financial development in FDIGrowth nexus 15 2.3 The measures of financial development 21 2.4 The determinants of economic growth 23 Chapter remark CHAPTER RESEARCH METHODOLOGY 27 • 3.1 Variables measurements 27 3.1.1 Dependent variable: Economic growth (GROWTH) 27 v 1.2 Independent variables 3.1.3 Control variables (CONTROLS) 31 3.2 Data collection 33 3.3 The estimation strategy 34 3.3 Panel regression models 3.3.1.1 Constant coefficients model (POOLED) 35 3.3 1.2 Fixed effects regression model (FEM) 3.3.1.3 Random effects regression model (REM) 37 3.3.2 Choice of panel regression model (Testing panel models) 38 3.3.2.1 The F-Test for individual and time effects in FEM models: 38 3.3.2.2 The Chow Test for the POOLED against the FEM (Test for poolability): 39 3.3.2.3 The Hausman Specification Test for the FEM against the REM 39 3.3.2.4 The Breusch-Pagan (1980)- Lagrange Multiplier (LM) Test for the POOLED against the REM 40 3.3.3 Testing assumptions of the error term 41 3.3.4 Model specification 41 3.4 Summary of the analytical methods 43 3.5 Hypothesis statements 43 CHAPTER RESEARCH RESULTS 45 4.1 The descriptive statistics of the sample 45 4.2 Empirical results 46 4.2.1 Examining the impact ofFDI, on its own, on economic growth .46 4.2.1.1 Choosing the appropriate model 47 Vl 4.2.1.2 Test for heteroskedasticity 48 4.2.1.3 Results discussion 50 4.2.2 Examining the role of financial development in FDI-Growth nexus 51 4.2.2.1 Choosing the appropriate model 52 4.2.2.2 Test for heteroskedasticity 53 4.2.2.3 Results discussion 55 4.3 Chapter remark 62 CHAPTER CONCLUSION AND RECOMMENDATION 64 5.1 Conclusion 64 5.2 Recommendation 66 5.3 Research limitation and suggestion for further study 68 REFERENCES 70 APPENDIX A LIST OF ASIAN DEVELOPING COUNTRIES A-1 APPENDIX B DATA SOURCES AND DESCRIPTIVE STATISTICS B-2 APPENDIX C PANEL MODEL TESTS C-1 APPENDIX D REGRESSION MODEL RESULTS D-11 Vll LIST OF TABLES Table 3.5-1: Summary of expected signs of all variables 44 Table 4.2-1: Summary of testing panel model results for model (4.1) 47 Table 4.2-2: Summary the result of Testing Heteroskedasticity for Model ( 4.1) 48 Table 4.2-3: REM regression model (4.1) result 49 Table 4.2-4: Summary of testing panel model results for model ( 2) 52 Table 4.2-5: Summary the results of Testing Heteroskedasticity 53 Table 4.2-6: Two-way FEM regression model results 54 Table 4.2-7: The Wald Test on joint significance ofPOP 55 Table 4.2-8: The Wald Test on joint significance ofEDUC 56 Table 4.2-9: Final two-way FEM regression model results 57 Table 4.2-10: Asian developing countries have financial system reaching a sufficient level of development so that FDI has positive effect on economic growth 62 Table A-1: List of 24 Asian developing countries in data sample A-1 Table B-1: Variables definitions and Data sources B-2 Table B-2: Summary statistics of GROWTH B-3 Table B-3: Summary statistics ofFDI B-3 Table B-4: Summary statistics of Financial Development Indicators B-4 Table B-5: Summary Statistics ofFDixFINANCE B-4 Table B-6: Summary statistics of control variables B-5 Table B-7: Correlation matrix of the explanatory variables for GROWTH B-5 vm LIST OF FIGURES Figure 3.4-1: Steps ofthe analytical methods Figure C-1: The POOLED model1 Figure C-2: The FEM model1 Figure C-3: The REM model1 Figure C-4: The POOLED model 2a with LL Y used as financial development indicator Figure C-5: The POOLED model 2b with PRIVATECREDIT used as financial development indicator Figure C-6: The FEM model2a with LL Y used as financial development indicator C-3 Figure C-7: The FEM model 2b with PRIVATECREDIT used as financial development indicator Figure C-8: The REM model2a with LL Y used as financial development indicator C-4 Figure C-9: The REM model 2b with PRVATECREDIT used as financial development indicator Figure C-1 0: Hausman Test for FEM and REM of model Figure C-11: Hausman Test for FEM and REM ofmodel2a- using LLY Figure C-12: Hausman Test for FEM and REM of model 2b with - PRIVATECREDIT Figure C-13: Test for cross-section fixed effects in the FEM model 2b PRIVATECREDIT Figure C-14: Test for cross-section fixed effects in the FEM model2a- using LL Y C-9 Figure C-15: Test for time fixed effects in the FEM model2a- using LLY C-10 IX HO: sigma(i)A2 all = sigmaA2 for i chi (24) P r'ob>chi = C10 APPENDIX D REGRESSION MODEL RESULTS Figure D-1: The REM mode/1 with Robust Standard Errors " Random-effects Group R-sq: corr(u_i, X) , D-11 Figure D-2: The Two-way FEM Regression Model 2a with Robust Standard Errors- using LLY _Iyear_1996 _Iyear_1997 _Iyear_1998 _Iyear·_1999 _Iyear_2000 _Iyear_2001 _Iyear_2002 _Iyear_2003 _Iyear·_2004 _Iyear_2005 _Iyeal'_2006 _Iyear_2007 _Iyear_2008 _Iyear_2009 _cons Figure D-3: The Wald Test on joint significance of POP in the Two-way FEM Model 2a -using LL Y • D-12 Figure D-4: The Two-way FEM Regression Madella with Robust Standard Errors- using LLY GROWTH _Iyear·_l996 _Iyear_l997 _Iyear_l998 _Iyear_1999 _Iyear_2000 _Iyear_2001 _Iyear_2002 _Iyear_2003 _Iyear_2004 _Iyear_2005 _Iyear_2006 , _Iyear_2007 _Iyear_2008 _Iyear_2009 Figure D-5: The Wald Test on joint significance of EDUC in the Two-way FEM Model 2a -using LL Y • D-13 Figure D-6: The Two-way FEM Regression Model 2b with Robust Standard Errors-using PRIVATECREDIT Linear regression, absorbing indicators PRIVATECRE~T FDixPRIVAT-T _Iyear_l996 _Iyear_l997 _Iyear_l998 _Iyear_l999 _Iyear_2000 _Iyeat'_2001 _Iyear_2002 _Iyear·_2003 _Iyear_2004 _Iyear·_2005 _Iyear_2006 _Iyear·_2007 _Iyear_2008 _Iyear·_2009 Figure D-7: The Wold Test on joint significance of POP in the Two-way FEM Model2b- using PRIVATECREDIT • D-14 Figure D-8: The Two-way FEM Regression Model 2b with Robust Standard Errors-using PRIVATECREDIT after eliminating POP • GROWTH _ryear_l996 _Iyear_l997 _Iyear_l998 _Iyear_l999 _Iyear_2000 _Iyear_2001 _Iyear_2002 _Iyear_2003 _Iyear_2004 _Iyear_2005 _Iyear'_2006 _ryear_2007 _Iyear·_2008 _Iyear_2009 Figure D-9: The Wald Test on joint significance of EDUC in the Two-way FEM Mode/2b- using PRIVATECREDIT fl D-15 Final regression models: Figure D-10: The final Two-way FEM Regression Modella -using LL Y ~ GROWTH • "' _Iyear_1996 _Iyear_1997 _Iyear·_l998 _Iyear_l999 _Iyear·_2000 _Iyear_2001 _Iyear_2002 _Iyear·_2003 _Iyear_2004 _Iyear·_2005 _Iyear_2006 _Iyear·_2007 _Iyear_2008 _Iyear·_2009 ~ D-16 Figure D-11: The final Two-way FEM Regression Mode/2b- using PRIVATECREDIT GROWTH _Iyear_l996 _Iyear_l997 _Iyear_l998 _Iyear_l999 _Iyear_2000 _Iyear·_2001 _Iyear_2002 _Iyear·_2003 _Iyear_2004 _IyeaP_2005 _IyeaP_2006 _Iyear_2007 _Iyear_2008 _Iyear_2009 _cons D-17 ... Examine the impact of FDI on economic growth in Asian developing countries (2) Investigate the role of financial development in FDI -Growth nexus m Asian developing countries The research findings... few studies examining the role of financial development in enhancing the contributions of FDI on economic growth in Asian developing countries Vietnam is one of Asian developing countries where... one of developing economy in Asia Finally, there are still few studies examine the role of financial development in enhancing the contributions of FDI on economic growth in Asian developing countries