Management Science and Engineering

 

The Impact of Foreign Capital on the Country Economy

 

Sofia L. Eremina[1]

 

 

Abstract:  An influence effect of penetration of foreign direct investments (FDI) is not clear for economy of a home country. There are quantitative and qualitative indicators measuring the role of foreign direct investments: macro economical indicator characterizes an ability of a country to attract FDI; and micro economical indicator characterizes how transnational the country is. The effects for countries exporters and importers of capital are being discovered through the effects of issues (employment, competition), surplus and rent payments. To measure out the investment effect is possible within portfolio theory.

It is offered to modify the criteria accepted for factories to measure out macro economical effectiveness of foreign investment. Figuring out the macro economical effects assumes an analysis of foreign capital inflow on the size of GDP, level of export / import and employment. Due to help of Pierson��s correlation coefficient it was found out that there is a connection between these indicators without a temporal log at first and then with a temporal log in Russia, Hungary and China.

We chose Hungary as it was the first country of Eastern Europe to attract the foreign capital; China as a country attracting the largest volume of FDI among the emerging markets countries. On a base of statistical materials of central banks in Russia, Hungary and China tables arranged and graphs were imaged. They help to make a conclusion that the inflow of foreign capital in home country is not absolutely positive. It leads to another conclusion: the national investors must be stimulated.

Keywords: foreign direct investments; home countries; investment policy; correlation coefficient; effect valuation; temporal log

 

 

Investment statistics of several countries, international organizations reports as well as a number of scientific publications analysis enables us to single out some showings which measure the impact of foreign direct investment (FDI). Namely, there are the total volume of attracted foreign direct investment; the volume of attracted foreign direct investment per head; FDI/national investment ratio; annual (average annual) growth; the share of foreign direct investment in GDP; the share of foreign direct investment (companies) in production, total profits, importing country tax revenue; project average cost; minimum amount of investment (in China).

During the period from 1995 to 2003 most of FDI, of both exporters and importers, accounted for developed countries. Companies from EC countries turned into major FDI owners (about $ 3.4 trillion in 2002) what is more than twice as much as USA ($1,5 trillion). In 2003 the global FDI was declining (three years running) and came to $ 560 billion owing to 25 % slump in FDI influx in developed countries as compared to 2002 ($367 billion). 111 countries saw FDI flow growth while the decrease took place in 82 nations. Especially sharp drop (by 53 %) in FDI influx was seen by USA and the figure made up $30 billion �C the lowest value of late 12 years. In CEEC countries FDI influx fell from $31 to 21 billion. Developing countries saw 9 % FDI growth and came to  $172 billion a year while accumulated FDI volume ran up to about 30 % of GDP, having increased from 13 % in 1980.

Operating with international statistics we can calculate FDI volume indexes. (FDI �C development policy; national and international issues, 2003)

a) Macroeconomic �C the ability of country to attract FDI, that is revelation of compliance of country��s share in global FDI with its economic state, in particular, expressed with three ratios of country��s share in global FDI to its share in:

GDP,

employment,

export.

b) Microeconomic �C transnational ratio �C average value of three figures:

the ratio of foreign assets to the total assets volume,

abroad sales to the total sales volume,

staff number abroad to the total employed number.

Modern Scandinavian economic school representatives distinguish three types of effects for both capital exporting and capital importing countries: (Hoekman B., Saggi ��., 2001)

Output,

employment,

competition.

Surplus.

Rent.

1. For the exporting countries the problem of loss of jobs caused by FDI influx is extremely controversial meaning that the capital is being exported but the labor force remains. FDI export can lead to native employment pattern change: the employment rate of low-skilled workers will fall while concerning high-skilled workers this figure will increase as in the homeland scientific activities are being carried out and there is a possibility to create office, managerial and engineering jobs. It��s highly likely that new jobs wouldn��t be created at all because of the competition with foreign companies. The transfer of the part of the production process abroad increases company��s gross yield and competitiveness and even strengthens the parent company.

For the importing countries the total effect of FDI on their employment rate is also vague. On the one hand, imported workforce contributes to net domestic employment rate growth; and if there is unemployment in the country-recipient, such situation becomes beneficial for its economy. However, firstly, employment rate growth caused by FDI can put pressure upon native labor-market through wages growth effect. No doubt, this effect is favorable for employees of companies that attract FDI, yet cost escalation in labor remuneration causes decrease in purchasing capacity of another part of population. Secondly, FDI influx in the form of mergers and takeovers is often accompanied with employed number reduction in the country-recipient. Thus, for output effect to ensure country development and its common wealth growth, two terms should be met: firstly, additional employment shouldn��t induce the reduction in real income of population; secondly, FDI influx should provide the most favorable workforce use.

With foreign companies emerging the competition becomes more severe what can lead to deterioration of national producers on the domestic market of the country-recipient.

2. For the exporting countries the surplus effect is expressed with steady concentration on R&D, new knowledge acquisition, methods and directions of work organization and other skills that spur the production process intensification.

The positive impact of FDI on the importing country is relative surplus of work and cash flows; new acquired foreign technologies, management strategies or knowledge of higher quality can enable local companies to modernize their technologies. The surplus can be both direct (from firm to firm) and indirect (through other markets: labor, etc.). FDI can reduce the technological gap. Buying of half-finished products by foreign firm from local suppliers is likely to spur the rise in make quantity, higher productivity and national industry modernization. If a foreign company supplies new or more quality productions, both national producers and consumers will benefit from this situation. Thus, both countries will be developing.

3. For the exporting countries the rent effect concerns the profit share that will be left in the home country. This effect is also not always positive. It��s well known that companies of some countries transfer their property to other countries, so the bulk of tax proceeds come to the foreign country.

For the FDI importing countries the presence of foreign ownership can lead to capital outflow in the form of rent and other outgoings. As rent is the investment income of foreigners its outflow should be taken into consideration. On the other hand, if foreign investors have special benefits (understated rent) the rent transfer lowers the benefits of the recipient country and violates mutually beneficial nature of the transaction.

Investment effect evaluation can also be carried out within the framework of the portfolio theory where two competing approaches were distinguished in the second half of the last century:

eastern (the Russian school), based on operating economies and

western (European and American approaches) based on investment effect evaluation from certain project realization. Nevertheless, the correlation of the two approaches is clear: operating economies always increase the profit margin and profit earning doesn��t exclude its augmentation owing to operating economies.

World experience (UNIDO standards, World bank) testifies the fact that during project design commercial, technical, financial, institutional and economical feasibility analysis is necessary.

In short, project commercial feasibility analysis envisages competition environment analysis. Technical analysis of the investment project sets task to find out the most appropriate technologies, resources availability and cost. Project financial analysis is a calculation and interpretation of liquidity and solvency ratios, company profitability and management efficiency. Project financial analysis is the calculation and interpretation of the liquidity and solvency ratios, company profitability and management efficiency. Institutional analysis evaluates the whole of internal and external factors: organizational, legal, political and administrative situation. Finally, economical analysis (what, in fact, is our interest) includes the evaluation of project contribution to the country development, realization of its objectives.

As it is well known, for the project investment economical efficiency evaluation on the microeconomic level international and Russian experts mostly use the following interrelated criteria: net present value (NPV), profitability index (PI), Benefits to Costs Ratio, Internal Rate of Return.

For the macroeconomic efficiency evaluation of FDI we suggest the same criteria that are customary for a company. We just need to make some modification. From the direction of society the growth of production volume (GDP), reduction of production unit costs, decrease in delivery and storing costs and product improving could be their real benefit.[2] Here we should take into consideration the fact that for the society, which is considered to be the country resources owner and the recipient of all the benefits from project realization, the total growth of benefits should exceed the growth of costs taking into account possible alternative resources involved into the project. The most significant effects when evaluating the investment are: the change in jobs number in a region; improvement of workers�� housing, cultural, living and working conditions; the change of operative personnel structure (the number of employed holding positions demanding higher or special education), standards of education (the number of workers subject to training, retraining and skill level raising), other development showings.

Let��s calculate macroeconomic effects, i.e. analyze the impact of foreign capital influx on GDP value (country ��value�� criterion), export/import volume and employment rate. First, we will evaluate the impact without taking time gap into account, i.e. suppose that the impact of foreign investment attracting for the recipient country �C small open economy �C comes at once. However, since this situation is unlikely to take place we should conduct the evaluation with regard to the time gap between FDI influx and the result (the change in GDP value, export/import volume and employment rate) by the example of Russia, Hungary and China. In order to do so, let��s determine the type and closeness of correlation between foreign direct investment and

population mean income,

export/import volume,

unemployment rate and

GDP.

using Pirson's correlation coefficient (formula 1) and the data of the Federal state statistics service (table 1, 2) about the volume of foreign investment attracted to Russia, population mean income, export/import volume and unemployment rate.

 

,

Formula 1. Pirson's correlation coefficient

where ��_i-  the volume of attracted foreign direct investment,

y_{i -}  dependent variables, in our case mean income value, export/import volume, unemployment rate and GDP value, where:

FDI �C foreign direct investment (FDI) volume, in terms of $ billion

GDP�C gross domestic product, in terms of $ billion

XP �C export, in terms of $ billion

IM �C import, in terms of $ billion

 UNP �C unemployment rate, (%)

 

Interdependence correlation coefficient between foreign direct investment and:

Average per capita population income equals �C 0,0438,

Unemployment rate equals �C 0,0999,

GDP equals �C 0,0291.

 «�C» sign indicates the inverse negative relationship between analyzed characteristics while «+» sign indicates the direct relation. As in all the cases correlation coefficient tends to zero (<0,1) we could draw a conclusion that there is no linear dependence between present showings and foreign direct investment.

The absence of interdependence between the volume of investment attracted to Russia and calculated showings is indicated visually in the following figures (1-4).

It��s possible that the absence of interdependence between FDI influx and analyzed national measures is the result of negligibly small amount of FDI attracted to Russia.  In our opinion, to test this assumption we should follow the experience of the countries-small open economies, which were leading in FDI attraction. And it��s desirable to take non-developed countries. As we know that at that time Hungary took the first place in investment attraction among CEEC countries (tab.3) and China �C among South-East Asia nations (tab.4) let��s make detailed calculations and graphs for these countries. Since we didn't manage to find the information about population mean income for the period of 1992-2002 in these countries we would use export/import showings what corresponds to UNCTAD practice.

Correlation coefficient between foreign direct investment in Hungary and:

export volume equals 0.0840,

import volume equals �C 0.0422,

Unemployment rate equals �C 0.0481,

GDP equals �C 0.0594.

Correlation coefficient between foreign direct investment in Hungary and:

export volume equals 0.3661,

import volume equals �C 0.3650,

Unemployment rate equals �C 0.4938,

GDP equals �C 0.3746.

Let��s also make a graphical interpretation of the information on Chinese economy.

 

According to regression and correlation analysis theory we can only talk about the interdependence when the coefficient value lies in the range from 0.7 to 1.0. If the range is from 0.4 to 0.7 the dependence is small and if the coefficient value is less than 0.4 �C there is no dependence at all. In our calculations only in China the dependence slightly exceeded the threshold of 0.4.

In accordance with the adopted approach which consists in using the project investment analysis method for the evaluation of FDI impact on the small economy development we should take time gap into account. It��s clear that we can��t obtain a result at once, i.e. in 1992 we can��t gain effect from the investment put up in the same year. Therefore, we have calculated the dependence of GDP, export/import volume and unemployment rate on FDI taking the time gap into account. The purpose of the research was to find out whether the time gap corresponded to a seven-year grace period given by the legislation of most of the world countries to investment projects. In Russia the correlation with the time gap was discovered in 2 and 3 years only concerning export; all other showings were below 0.7. And since the 4-th year almost all the showings have demonstrated negative correlation coefficient. In Hungary, the correlation by GDP was seen in the 7-th and 9-th years (in 8-th there wasn��t), by export/import �C in the 8-th year.  There was no correlation between FDI and unemployment rate.  In China since the 6-th year the correlation was seen only by GDP (Appendix 1).

Nevertheless, we think that foregoing calculations don��t give the ground to draw a conclusion about the total lack of FDI impact on the economy of the recipient country. But we can undoubtedly talk about the lack of the dependency between the volume of the attracted foreign direct investment and the examined national measures. The conducted research proves that for the elaboration of foreign direct investment attraction policy we need to make the predesign of the FDI effect (quantitative and qualitative).  Our calculations also have revealed that seven-year grace period adopted in many countries is not always warranted. 

There are small counties which are heavily dependant on FDI. Belgium and Ireland belonging to the European Community (EC); Argentina, Chile, Venezuela (MERCOSUR); Malaysia, Singapore (ASEAN) depend heavily on the foreign direct investment. At the end of the nineties, Hungary, Bolivia and Sweden were the most dependent on the foreign investment. In these countries an economic progress was up to the foreign direct investment almost to the same extent as to the national investment.

Why do attracted FDI volumes differ from country to country? Why do the effects of FDI differ? What are the reasons for such differences? Why do some countries succeed in this activity and others don��t?

Perhaps the answers to these questions are as follows:

countries have different objectives and use different strategies,

the objectives of the recipient country and transnational corporations as FDI bearers don��t concur,

it��s necessary to take into account ethnic and cultural business traditions,

recipient countries entered the international capital market in different times (some were earlier, others-later).

As for FDI impact on other showings and activities of the recipient country �C small open economy, in general there are both positive and negative effects of FDI. The completion phase of the research should be the evaluation of the positive and negative effects of FDI attraction for the small open economy development.

Certainly, there are many examples of both positive and negative FDI impact on small countries development.

 

Appendix 1

National measures correlation

(with the time gap)

 

References

FDI �C development policy; national and international issues. (2003).  Another turn in irregular FDI sinking. International investment report �C 2003. �C www. unctad.org.

Hoekman B.Saggi ��. (2001). Multilateral Discipline for Investment - Related Policies. Paper presented at the conference Global Regionalism. Rome. Turrini A., Urban D. A theoretical perspective on multilateral agreements on investments. Discussion paper. �C London. �C 2001. - ��. 2774.Center for Economic Policy Research.

 

 

Tables  and  Figures

Table 1:   National measures of the Russian economy (1994-2003)

 

 

 

Table 2:   National measures of the Russian economy (1994-2002)[3]

 

 

 

Table 3: Main national measures of Hungary, 1992-2003[4]

 

 

Table 4: Main national measures of China (1990 �C 2003)

 

 

 

Figure 1:  The dependence of GDP value on the volume of foreign investment attracted to Russia

 

 

 

Figure 2:  The dependence of unemployment rate on the volume of attracted foreign investment.

 

 

Figure 3:  The dependence of export/import volume on the volume of foreign investment attracted to Russia

 

 

 

Figure 4: The dependence of population mean income on the volume of foreign investment attracted to Russia.

 

 

Figure 5: The dependence of GDP value on the volume of foreign direct investment in Hungary

 

Figure 6: The dependence of export/import volume on the volume of foreign direct investment in Hungary

 

Figure 7: The dependence of unemployment rate on the volume of foreign direct investment in Hungary

 

Figure 8: The dependence of GDP value on the volume of foreign direct investment in China

 

 

Figure 9: The dependence of export/import volume on the volume of foreign direct investment in China

 

 

Figure 10:  The dependence of unemployment rate on the volume of foreign direct investment in China

 

 

Figure 11:  The correlation between the foreign direct investment and export volume in Russia

 

Figure 12:  The correlation between the foreign direct investment and GDP value in Hungary (year 7)

 

 

Figure 13:  The correlation between the foreign direct investment and export volume in Hungary (8 year)

 

Figure 14. The correlation between the foreign direct investment and GDP value in China (years 6-8)

 

Appendix 1

National measures correlation (with the time gap)

 

Russia

 

 

 

 

 

 

 

 

 

Hungary

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

China