FDI -- key to sustained growth

      By Jeffrey I. Kim

 
The entire world was shocked by the breaking news that the U.K. voted for an exit from the EU. As a result, European economies are now facing great uncertainties and high economic risk. Emerging market economies including China, Russia, India, and other countries in South America are likely to experience slower GDP growth and exports.

To stop the spreading adverse effects of the Brexit to neighboring regions of the world, some measures must be done properly and quickly. Not only will individual governments have to undertake necessary action but also global organizations such as the IMF and the World Bank should make concerted efforts to prevent an international economic disaster from happening.

Last week I attended the 91st Annual Conference of Western Economic Association International held in Portland Oregon with a group of about 20 Korean scholars. The conference was attended by more than 1,200 economists from around the world. I was invited to chair a session on the Asian economy. Also I presented a paper on macroeconomic policies including exchange rate policy for emerging market economies, and discussed other papers presented.

I was particularly interested in one paper coauthored by Agbola and Liu. The purpose of the paper was to investigate the relationship between foreign direct investment (FDI) and trade. The authors tried to figure out whether FDI was a substitution for or complementary to exports.  If the correlation is statistically positive, it means that FDI and exports move in the same direction. In other words, FDI is complementary to exports. They examined China’s FDI flows and exports for 2003 to 2013 and found evidence that FDI had a positive influence on China’s exports. This is an interesting finding. According to existing economic literature, FDI can be either complementary to or a substitution for exports depending on the type.
Economists in the early period argued that trade and factor movements were perfect substitutes in the long run. This argument is based on the premise that the international movement of production factors such as capital and labor would lead to an abatement of the differences in resource endowment. This then leads to the identical endowment ratio factor for the two countries, which means that there will be little trade. But this is a very hypothetical statement.

In a real sense, FDI is one example of international movement factors. FDI is a controlling ownership in a business enterprise in the host country by an entity based in the home country. In a broad sense, FDI includes (1) building new factories and facilities; (2) reinvesting profits earned from overseas operations; (3) merger and acquisitions (M&A); and (4) loans from the mother company in the home country to affiliated companies in the host country. FDI involves participation in management, joint-ventures, transfer of technology and expertise. It also provides on-the-job training for workers.

Actually the relationship between FDI and exports depends on the type of FDI. If the foreign-invested companies produce the same product they used to export to the host country, then the home country’s exports fall. So the relationship is negative. If they produce intermediate goods in the host country and send them back to their home country for production of export products, then the home country’s outbound FDI contributes to export expansion.

From the standpoint of the host country, it does not matter if the foreign-invested companies produce the final product or the intermediate goods. It can be argued that if whatever the foreign companies produce in the host country is exported back to the home country or to a third country, inbound FDI expands the export volume of the host country. This argument certainly applies to Korea.

For Korea, its exports have slowed these years although it has been running a moderate trade surplus. Fortunately, however, Korea is doing well in FDI attraction. As of end of June this year, Korea’s inbound FDI hit a record high of $10.5 billion. This figure is almost the half the annual FDI target for 2016. Furthermore, FDI brings with it non-economic benefits as well. Foreign investors while living in the host country can exert a positive influence on cultural, diplomatic, and security relationships. FDI is the key to sustained exports and growth.

Link : http://www.koreatimes.co.kr/www/news/opinon/2016/07/197_209101.html