A study on the impact of foreign direct investment on economic development of Lao P.D.R.

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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.

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Nội dung Text: A study on the impact of foreign direct investment on economic development of Lao P.D.R.

MINISTRY OF EDUCATION MINISTRY OF EDUCATION AND TRAINING LAOS NATIONAL UNIVERSITY NATIONAL ECONOMICS UNIVERSITY 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 A dissertation summary submitted to the National Economics University in fulfillment of requirements for the degree of Doctor of Philosophy in Economics
Hanoi, 2014 2
3 CHAPTER 1: INTRODUCTION 1.1 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. 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
4 direct impact on national income as well as GDP growth. 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 do 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. This research tried to answer the questions: 1) What are the relevant literature and the theoretical background on FDI and its impact on
5 economic development? and 2) Does FDI have a significant contribution to economic development of Laos? With regard to the impact of FDI on economic development, the research aims to answer the following specific questions: 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 19902012. The analyses of correlations were used to serve the objectives of this research. 1.5 Contributions of the Study
6 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. 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.
7 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
8 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 Definition and Indicators of Economic Development 2.1.1 Definition of Economic Development 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 selfesteem 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). 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.
9 Economic growth on the other hand refers to the general increase in the country products and services output (source: whatiseconomics.org). 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 Human Capital Energy and Natural resources Transportation and Communication 2.1.3 Theoretical Economic Overview This section review several economic models such as Lewis' Dual Economy model (1954), Solow's model (1956), the HarrodDomar 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
10 2.2.1.1 Definition of FDI and reasons for FDI inflows to developing countries FDI is defined as crossborder 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 longterm relationship between the direct investor and the enterprise and a significant degree of influence by the direct investor on the management of the enterprise. Ownership of at least 10% of the voting power, representing the influence by the investor, is the basic criterion used (OECD, 2012). 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) countryspecific 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
11 Complement Theory of FDI The ResourceBased 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 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. 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
12 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. 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 FiveYear Plan target (the plan target was 7.5%). In FY 20092010, the value of GDP was 54,282 billion Kip which was 1.89 times higher than FY 20042005. The growth in share of agriculture in GDP was 4%, of industry was 12.6%, and of services was 8.4%. 3.1.2 Economic structural changes The economic structure has changed as an economy transforms from a subsistence agriculture economy based on raw materials to a market oriented economy based on processing. 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 20092010. An increase in the money supply or M2 was
13 contributed by the increasing numbers of foreign investors. 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 FiveYear 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 3.1.8 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 3.2 Foreign Direct Investment in Laos 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. 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
14 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 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 nonresource sectors. However, the FDI inflow to Laos has quickly recovered at around US$300 million in 2009 2011 period. The majority of FDI goes to natural resource sectors. Major FDI to Lao PDR in recent years comes from the region, mainly from Thailand, China, Vietnam, Australia, India, Japan, and Korea. Vietnam now has become the Laos' biggest foreign investor during the period since the Lao Government first adopted foreign investment incentive policies (19892012). The most popular fields for foreign investors are the mining industry (accounting for 27 percent), electricity production (25 percent), agriculture, services, processing, hotels, restaurants, telecommunications, construction, industry, and banking.
15 CHAPTER 4: RESEARCH METHODOLOGY This chapter describes research methodology used in this study. First, research questions are briefly presented and the statistical method used to test the impact of FDI on economic development in Laos. Next, variables and their measures are provided. Finally, the author presents a detailed description of data employed for this study. 4.1 Research Questions In addition to reviewing the relevant literature, the research tried to answer the question: Does the FDI have a significant contribution to economic development for Laos? In particular, the research answers the six specific questions regarding the relationships between FDI and six aspects of economic development. 4.2 Variables and measures In this section, the author presents key variables used in this study and the indicators measuring them. These indicators are adopted from World Bank. FDI inflows: measured by BoP (current US$) Economic developemnt: A. GNI per capita: constant 2005 US$ B. Financial Capital: Financial Capital is measured by the five following indicators. Gross capital formation (% of GDP) Total debt service (% of exports of goods, services and primary income)
16 Debt service on external debt, longterm (TDS, current US$) Debt service on external debt, total (TDS, current US$) 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) Mortality rate, under5 (per 1,000 live births) School enrollment, secondary (% gross) School enrollment, secondary (% net) School enrollment, tertiary (% gross) E. Energy and Natural resources: Energy and Natural resources is measured by the following indicator. Oil consumption per capita (bbl/day per 1000 people) F. Transportation and Communication: Transportation and Communication is measured by the six following indicators. 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)
17 4.3 Data Description This study employed the secondary data which were collected from the World DataBank (2013) queries from 19902012 and Index Mundi website (2013).
18 CHAPTER 5: RESEARCH FINDINGS This chapter presents the research findings. Specifically, the correlations results regarding the relationships between FDI inflows and economic development indicators in Laos are provided. 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. Figure Graph of Correlation between FDI and GNI per capita
19 Table 17. FDI and GNI per capita Coefficient of Correlation GNI per capita (constant 2005 US$) FDI, net inflows (BoP, Pearson Correlation .881** current US$) Sig. (2tailed) .000 N 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. 5.2 FDI and Financial Capital Table 18. FDI and Financial Capital Coefficient of Correlation Financi Total debt Debt al service service on Debt Capital Gross Gross (% of service on external capital capital exports of external debt, Inflation, GDP formation formation goods, debt, total longterm deflator (annual %) (% of (annual % services (TDS, (TDS, GDP) growth) and current current primary US$) US$) income) FDI, Pearson .819** .167 .173 .820** .812** .267 net Correlation inflows Sig. (2 .001 .623 .453 .000 .000 .229 (BoP, tailed) current N 12 11 21 22 22 22 US$) As indicated in Table 18, the results show that FDI inflows was significantly correlated with the Gross capital formation (% GDP), Debt service on external debt, longterm (TDS, current US$), and Debt service on external debt, total (TDS, current US$). Figure 11 presents the graph of correlation between FDI and long term debt service on external debt.
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