FDI, Economic declineand recovery: lessons

fromthe Asian financial crisis

Based on a paper by :

Hwy-Chang Moon, Joseph L.C. Cheng,

Min-Young Kim, Jin-Uk Kim

• FDI Definition :An investment made by a company or

entity based in one country, into a company or entity based in another country is called Foreign Direct Investment(FDI).

• FDI Flow: Amount of FDI over a period of time (one year)

• FDI Stock: Total accumulated value of foreign owned assets

at a given point in time. FDI stock can happen in buying common stock, or joint venture of a foreign company and a local or like that.

• Note : investment by individuals or firms or public bodies in foreign financial instruments like foreign bonds and derivatives isnot called FDI.

U.S. is the largest receiver of FDI in the world with total amount of 194$ billion in 2010. About 84% of FDI in US. come from or through 8 countries : Switzerland, the United Kingdom, Japan, France, Germany, Luxembourg, the Netherlands and Canada. The FDI stocks in U.S. at the end of 2008 was about 16 percent of its GDP.

Flow of FDI inward /outward South East Asia

All Asian economies have been working towards trade agreements such as Free Trade Agreements (FTA) between countries. 10 South East Asian countries have trade agreement under the ASEAN. Under the ASEAN the countries have free flow of goods categorized under no import duty or reduced import duty.

ASEAN nations are attracting FDI so that each country has its competitive advantage. For example Thailand is attracting automobile sector, and is one of the industry with highest FDI in Thailand.

19921994

19961998

-200000

0

200000

400000

600000

800000

1000000

1200000

FDI StockThailand SingaporePhilippines MalaysiaSouth korea JapanIndia Hong KongChina AustraliaThailand South KoreaSingapore PhilippinesMalaysia JapanIndia Hong KongChina Australia

Mill

ion

US $

1992 1993 1994 1995 1996 1997 1998 1999-15

-10

-5

0

5

10

15

20

GDP %

AustraliaChinaHong KongIndiaJapanMalaysiaPhilippinesSingaporeSouth KoreaThailand

China and Australia didn’t get affected so much by the 1997 Asian Crisis and didn’t raise so much and rapid FDI.

The interesting part is in the 1998, while crisis had not recovered, the FDI increased sharply.

Historical data shows that Australia got affected later than the Southeast Asian countries (1999), as shown in the graph.

• Economic situation today (worldwide)– Subprime crisis, Euro zone crisis, fear of other regional crisis

• 3 possible senarios : – V shape drastical rebound– U shape gradual recovery– L shape stagnation

• Some solutions :– Monetary policy making– Fiscal policy making– Attracting more FDI

• Main Questions of the study paper:– Q1. Does FDI help reduce the negative impact of an externally induced crisis on a host

country’s economic growth? – Q2. Does it help speed up the country’s economic activities during the recovery period?

– Q3. Are these effects of FDI during economic decline and recovery the same for both inward and outward foreign direct investment?

• Why an MNC chooses FDI ?(1) Possesses ownership-specific advantages (O-advantage);(2) Finds location-specific resources (L-advantage) to complement its ownership-

specific advantages; (3) The ability to internalize markets through administrative fiat (I-advantage).

• Benefits to the Host country :– Increasing capital accumulation– Transfer of the non-financial and intangible ownership specific assets to the

location. Items like advanced production methods, marketing know-how,superior management skills, and new organizational form, which is the Main Benefit for the host country.

– Upgrading and introducing of new and higher standards, increase productivity, adopt new technology, and learn new ideas.

Host Country: Country receiving the FDI

• Major Economic effects of FDI Outflow :– balance of payments of the nation by bringing back the profit and earnings of

the company working in another country to the main country .– the presence of the company in another country may help the export of other

products of the main country. – increment of the employment and higher consumers’ spendings in the country

because of the growth in subsidiary demands from the home country resources.

– the country has to improve itself regularly and acquire more skills to be able to compete in the foreign markets and can transfer back these skills to the home country and spread the existing strategic assets.

Main Hypothesis and method of testing

H1. The higher the level of FDI prior to the crisis, the smaller the change (decline) in economic growth during the crisis period.

H2. The higher the level of FDI prior to the crisis, the smaller the change (increase or reduced decline) in economic growth during the recovery period.

Economic growth data for the 15 largest Asian economies in the affected region. however, full data were available from only ten of these economies: Australia, China, Hong Kong, India, Japan, Korea, Malaysia, Philippines,Singapore, and Thailand.

• Period :Asian Financial Crisis(AFC) lasted only in 1997-1998.it had astrong V shaped rebound in 1999.This region had a great steady economic growth for 5 years before the crisis.

Total period = 1992 – 1999

• Data collected and source of data:– United Nations Conference on Trade and Development (UNCTAD)– World Development Indicators (WDI) online database of the World Bank

Data and the collection method

Data collected from affected economies during the Asian financial crisis using a fixed-effect panel regression analysis.Panel (data) analysis is a statistical method, widely used in social science, epidemiology, and econometrics, which deals with two-dimensional panel data.

Panel data analysis has three more-or-less independent approaches:• Independently pooled panel;• Random effect model;• Fixed effect models or first differenced models;

In panel data analysis, the term fixed effects estimator (also known as the within estimator) is used to refer to an estimator for the coefficients in the regression model. If we assume fixed effects, we impose time independent effects for each entity that are possibly correlated with the regressors.

Data and the collection method

Variables• Dependent variable :

– Change in Economic Growth (CEG)

• Independent Variables :– GDP growth rate– GNP growth rate

• Control variables :– Inflation – Labor (as they both affect the economic growth.)

• Emperical Model :

AnalysisThe following model which is based on the first formula is tested for 4 types of FDI :

For the hypotheses to be supported, the results would need to show a negative coefficient for the FDI*Crisis and FDI*Recovery variables, indicating a reduction in the CEG variable (absolute CEG) during the crisis (1998) and recovery (1999) periods.

Results

Results

Results

Conclusion and recommendations

Different Reasons

Economic Crisis

Same Solutions

More economy integration

Good monitoring and policy making

More stable economic

growth

Main focus of policy making to attract more FDI stock .

• South East Asian countries might be the next region affected by crisis.• South East Asian countries is much dependent on Export to Western

countries.• The economic infrastructures in this area is not so strong.

• Paper concludes that traditionally trade was considered as a key tool to promote prosperity as it was export driven. But the Asian Financial Crisis has shown that FDI is a more reliable mechanism to promote national prosperity.

• Therefore ASEAN countries are trying to attract FDI to their own country and also promoting FDI and trade amongst ASEANcountries

Conclusion and recommendations

References :Multinational Business ReviewEmerald Article: FDI, economic decline and recovery: lessons from theAsian financial crisisHwy-Chang Moon, Joseph L.C. Cheng, Min-Young Kim, Jin-Uk Kim

U.S. Department of Commerce Economics and Statistics Administration 1401 Constitution Ave., NW Washington, DC 20230 www.esa.doc.gov

www.unctad.org united nation conference on trade and organization