A study on the impact of foreign direct investment on economic development of lao p d r (sum)

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, huma

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

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 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

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 1990-2012 The analyses of correlations were used to serve the objectives

of this research

1.5 Contributions of the Study

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.

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

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 self-esteem 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

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 Harrod-Domar 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

2.2.1.1 Definition of FDI and reasons for FDI inflows to developing countries

FDI is defined as cross-border 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 long-term 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) country-specific 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

- Complement Theory of FDI

- The Resource-Based 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

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

Five-Year Plan target (the plan target was 7.5%) In FY 2009-2010, the

value of GDP was 54,282 billion Kip which was 1.89 times higher than FY

2004-2005 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 2009-2010 An increase in the money supply or M2 was

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 Five-Year 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 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 non-resource 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

(1989-2012) 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

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)

• Debt service on external debt, long-term (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, under-5 (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)

4.3 Data Description

This study employed the secondary data which were collected from

the World DataBank (2013) queries from 1990-2012 and Index Mundi

website (2013)

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 1 Graph of Correlation between FDI and GNI per capita

0 100 200 300 400 500 600 700

FDI (BoP, current US$mn.)

Table 17 FDI and GNI per capita Coefficient of Correlation

GNI per capita (constant

2005 US$) FDI, net inflows (BoP,

current US$)

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

Financial Capital

Gross capital formatio

n (% of GDP)

Gross capital formation (annual % growth)

Total debt service (% of exports of goods, services and primary income)

Debt service on external debt, long-term (TDS, current US$)

Debt service on external debt, total (TDS, current US$)

Inflation, GDP deflator (annual

%)

FDI,

net

inflows

(BoP,

current

US$)

Pearson

Correlation

Sig

(2-tailed)

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, long-term (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

Figure 2 Graph of Correlation between FDI and long-term debt service on external debt

5.3 FDI and Level of Technology

Table 19 FDI and Level of Technology Coefficient of Correlation

FDI, net inflows (BoP, current US$)

As indicated in Table 19, the correlation of FDI inflows and Industry value added (% of GDP) is 0.838 (> 0.5) that confirms a strong correlation

between these measures

5.4 FDI and Human Capital

As indicated in Table 20, in the 1990-2012 period, the FDI inflows

of Laos had strongly positive relationship with the indicators of Human Capital

0 50 100 150 200 250 300 350

FDI, net inflows (BoP, current US$mn.)

Table 20 FDI and Human Capital Coefficient of Correlation

Human Capital Life expectancy

at birth, total (years)

Mortality rate, under-5 (per 1,000 live births)

School enrollment, secondary (% gross)

School enrollment, secondary (% net)

School enrollment, tertiary (%

gross)

FDI, net

inflows

(BoP,

current

US$)

Pearson

Correlation 665** -.705** .538* .621** .856**

Sig

(2-tailed)

5.5 FDI and Energy and Natural Resources

The correlation results indicates a weak correlation between FDI and

Energy and natural resources

Table 21 FDI and Energy and Natural Resources Coefficient of Correlation

Energy and Natural Resources Oil consumption per capita

(bbl/day per 1000 people) FDI, net inflows

(BoP, current

US$)

5.6 FDI and Transportation and Communication

As indicated in Table 22, in general, the FDI inflows of Laos had

strongly positive relationship with indicators of the Transportation and

Communication

Table 22 FDI and Transportation and Communication Coefficient of

Correlation

Transportation and Communication transport, Air

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) FDI,

net inflows (BoP, current US$)

Pearson Correlation

Sig (2-tailed)

In summary, in this study the author employed the method of correlation analysis to test the relationship between FDI inflows and various indicators measuring six aspects of economic development in the context of Laos over the period 1990-2012 The research findings in general provide empirical evidence to support the important and positive

role of FDI inflows on economic development