The Influence of FDI on Export Performance: The Case of Kyrgyzstan

 

American University of Central Asia 
 
 
 
 
 
 
 
 
 
 
 
 

  “Influence of Foreign Direct Investments on Export Performance: The Case of Kyrgyzstan” 
 
 
 
 

Student: Ruslan kyzy Meerim

ID: 3941 
 
 
 
 
 
 
 

Bishkek 2011 
 

Content: 
 

Data description                                                                                                     18

Conclusion                                                                                                          18-20

Bibliography                                                                                                       21-22 
 
 
 
 
 
 
 
 
 
 
 
 

Glossary:

Foreign Direct Investment (FDI) – is international capital flows in which a firm in one country creates or expands a subsidiary in another country.  The distinctive feature of FDI is that it involves not only a transfer of resources but also acquisition of control (Krugman, Obstfeld 169).  

Heckscher  -  Ohlin  -  Samuelson (HOS) -  model  suggests that  international  trade  can  substitute  FDI  by  moving  freely  factors  of  production  (labour  and  capital)  between countries. Based on the assumptions of the neoclassical HOS framework, where the flows of FDI depend on the differences in factor prices and factor endowments between countries (Pham, Nguyen 2). 

Horizontal Integration – means that multinational enterprises produce the same product in multiple plants located in more than one country. Horizontally integrated firms often arise because of trade barriers in the form of tariffs or high transport costs (Vuksic 10). 

Vertical Integration – separate segments of production process are carried out in different countries. The production process is likely to be geographically fragmented depending on the countries different factor- prices and stages of production with different factor intensities. So, there is a trade of intermediary products (Vuksic 10). 
 
 
 
 
 
 
 
 
 
 
 
 
 

Introduction

      During recent decades foreign direct investments (FDI) became a significant factor for increasing of export performance of the host country. Nowadays China is a second largest economy in the world after USA. Export growth has continued to be a major component supporting China's rapid economic growth. In 2010 China’s exports were $1’578 billions, that comprise 10.3 percent of world exports and 39.7 percent of Chinese GDP¹.  During 30 years China became a leading exporter that supplies the entire world. How this country achieved rapid economic growth and succeeds in export performance? What factors influenced on such results? Can small Kyrgyzstan from Central Asia achieve sustainable economic growth through large exports like Chinese economy? 

      Many economists affirm that developing and underdeveloped countries wallowed in poverty. There are a lot of theoretical explanations for such situation one of them is vicious circle of poorness. For instance, according to Nurkse, it is about capital deficiency. The concept explains that capital scarcity is one of the reasons of low level of productivity, which results in low income level. Consequently, there is weak purchasing power which results in insufficient incentives for the investment (Nureev 141).

Picture 1. R. Nurkses “Vicious circle” of capital deficiency

      Influence of foreign direct investment on exports has been actual issue in the past and it is still important for modern economists. According to economists- Harrod and Domar “Big Push” theory, investments stimulate the development of the economy, long run economic growth and getting out from vicious cycle of underdevelopment. Authors of the model stated that injection of large investments to the economy results in the beginning of self sustained growth. However, monetary and credit policy and tax policy of the government can not provide necessary amount of capital. Scarcity of investments in the country can be compensated by importation of capital. The amount of injection has to be sufficient, in other case there is a risk that all investments will be spent for the support of current demand, but not for support of entrepreneurs and production capacity in the economy. According to Leibenstein, minimal amount of injection – investments have to be 12-15% of GDP. Such push increases average income rate per capita and amount of entrepreneurs, who will support further growth of GDP and exports respectively (Nureev 149-150). 

      The economy of Kyrgyzstan during latest years declines. One of the reasons is political instability, revolutions in 2005 and 2010. Frequent reelection of government officials, high level of corruption and bureaucracy, all of these are reasons of macroeconomic instability. Year by year we observe increasing of inflation rates, decreasing of population living standards and worsening of infrastructure. Young generation move abroad for higher earnings, do not seeing future of the country. At this moment in time government officials should approve huge projects for economic development. One of them is injection of huge investments to the economy (Big Push Theory) for increasing of production rates and then increasing of exports. Because of the fact that there is a huge budget deficit in the economy, and there are not enough resources for huge investments, government should attract more foreign capital.

      As it was mentioned before, foreign direct investments according to empirical assessment play an important role on the export performance of the host country. And exports, in its turn, are considered to be as an engine of economic growth. For implementation of international projects, government should figure out all advantages and disadvantages from FDI and specifically the influence of FDI on export performance of the economy in percentages. Whether the influence of this variable will be positive and significant or it will be just time and money wasting. So the purpose of this paper is to investigate the influence of foreign direct investments on exports in Kyrgyzstan during the period from 2000 till 2010.

      Therefore the hypothesis would be an increase in the amount of FDI inflows to Kyrgyzstan leads to an increase of export volumes.

      For achieving an objective of this research, first we should analyze works that were done on this issue before, then investigate theory on the relationship between FDI and exports. After that we should establish methodology that will be used for the estimation of dependent variable, and then collect relevant data. 

      There are many previous researches on this topic, and influence of FDI on exports in various countries differs from each other. There are no identical economies, so in one country the influence can be huge, while in the other typical country can be no correlation between FDI and exports. The hugest influence of FDI is found in Cameroon by an economist Njong in his research conducted for the period between 1980- 2003. According to his empirical results 1% increase in FDI stock leads to 9% increase of exports. In the other research by Vuksic, 1% increase in FDI stock led to a 0.09% increase of exports in Croatian manufacturing industry was revealed. In the North European Union (NEU) economies 1% increase in FDI stock led to 0.16% increase of exports in short run and 0.42% increase in long run (Kutan and Vuksic 2005). In the case of Taiwan, the author found positive but not significant influence of FDI on export growth (Lee 2007). Also there are other researches conducted on 49 developing countries, 9 CIS economies, which will be analyzed in detail further in research. Now let’s briefly observe theory on FDI and exports in the following paragraph.

      One theoretical model- theory on multinational enterprises (MNE) is used for the explanation of the reason why corporations become MNEs. And three theoretical models such as the flying geese model, Vernon’s product life cycle theory and new growth theory are applied to explain the phenomenon of FDI inflows and its influence on export volumes of the country will be investigated in the theoretical part of the research.

      For the estimation of the impact of FDI on exports time series approach will be applied as methodology of the research.  
 

Literature review

   The purpose of this section as was mentioned above to analyze the works with the hypothesis that increase in the amount of FDI inflows leads to an increase of export volumes in the country, and to find the factors which influenced on the obtained results. 

      Authors of the collected literature for the investigation of the impact of FDI on exports employed different time spans- long run and short run, studied countries with different levels of development – developed and advanced economies or developing economies. Also for the obtaining of reliable results researchers used various explanatory variables that play major role on the estimation of the effects of independent variables on estimated one.  

     First, let’s analyze collected literature on the employed time span. Here are authors that employed short run period for the observation, less than 15 years- Vuksic, Kutan and Vuksic, Awokuse and Gu, Ibrahimova. And researchers with observations more than 15 years- long run period- Njong, Zhang, Majeed and Ahmad, Lee, Johnson, Pham and Nguyen.

      Comparing the empirical results of all collected researches by time span, there was found that all of the researches had positive and significant impact of FDI on exports, except the work of Ibrahimova. The study on nine CIS countries during the period of 13 years (1995-2008) resulted in significant negative effects of FDI on exports. One of the reasons of having such result is in the shortage of data. The author used data on aggregate level, not distinguishing them into sectors. And including shorter time span- 13 years might also had an impact on the received results. But in other researches with also short- run period, even shorter period than in this research, all of the authors obtained positive results. However, employing longer time span, anyway, allows for researcher to observe the influence of FDI on exports in more detail. How fast the impact of FDI on exports will be seen, depends on the initial situation of the host country. According to Kutan and Vuksic (11) foreign companies purchase domestic firms and further results of its influence depends on its initial productivity. If the plant had higher average productivity, so the impact of FDI on production will be seen immediately. In other case, if the plant had lower productivity before, then for observing more clear influence of FDI on production will be seen after 2 years of acquisition of a firm by a foreign company. Necessity of time, for transition of more developed technology, learning market behavior, managerial skills and other business skills from multinationals, take place here. So, for obtaining of more clear results, researchers should employ longer time span, but still it depends on the level of development of the observed economy. 

      In the further paragraphs we will discuss the influence of FDI on exports in countries with different development levels. Let’s start from the researches on developed and transition economies.  

      Kutan and Vuksic in their research over 12 Central and Eastern European economies (one developing country, six economies in transition and five developed economies) found out positive and significant influence of FDI on export performance. For North European Union (NEU) countries a 1 percent increase in FDI stock lead to 0.16 percent increasing of exports in short run and 0.42 percent in long run, through FDI – specific effect only (spillover effects). According to the estimation, in NEU countries FDI created higher level of competitive advantage which spread to the domestic producers. The reason for having more significant impact of FDI on NEU economies is that NEU countries are more developed than the Southeast European economies. They have relatively more productive companies, which allow for multinationals increase production. So, as it was mentioned before in plants with higher average productivity the impact of FDI on production will be seen immediately. Also, another factor of no small importance of having more significant impact of FDI on exports to NEU economies is that these countries accumulated more FDI inflows comparing to SEU countries (Kutan and Vuksic 11-12).

      In the other research by Vuksic, 1 percent increase in FDI stock led to a 0.09 percent increase of exports in Croatian manufacturing industry was revealed. During a previous decade there was weak development of manufacturing exports and relatively high FDI inflows to Croatia. The reasons of a small export performance according to the author are (1) war conditions in the country, (2) loss of important export markets in some other former republics of Yugoslavia, (3) slow and inefficient privatization and (4) low export competitiveness (Vuksic 5).

      In two researches conducted on Chinese economy: first on six manufacturing industries (Awokuse and Gu 2007), second on 186 industries (Zhang 2005), was found out positive influence of FDI on exports. More concretely, on the first research the most significant influence was on Machinery and transport equipment (MACH) sector with coefficient of 0.64, on the other sectors: food, textile, mineral fuels and chemical industries FDI promotes their exports as well. However, exports in beverages and tobacco industry decrease as FDI flows in. This might be due to the intensiveness of the competition in beverage world markets (Awokuse and Gu 17). In the second research the author revealed that export boom was mostly by well organized FDI strategy and comparative advantages, such as, large country size and lower relative wage costs. The effect of FDI on exports was clearly larger in labor- intensive industries than in capital- intensive industries (Zhang 9).

      Observing the influence of FDI on exports in developed economies we see that in all works authors obtained positive impact of FDI on exports. Of course, the significance and coefficients in all countries differ from each other depending on the type of a market, or on a development, comparative advantages and other factors. In the further paragraphs we will observe studies that were conducted in developing economies.

      The hugest influence of FDI is found in Cameroon by an economist Njnog. According to his empirical results 1 percent increase in FDI stock leads to 9 percent increase of exports (Njong 17).  There are a lot of reasons for increasing of exports: devaluation of country’s currency in 1994, market liberalization and investment policy liberalization. Government adopted series of reforms on the attraction of foreign investments, the structure of a National Industrial Free Trade Zone.  Due to all these changes adopted by government, increased investments, exports have grown rapidly over 11 percent per year while GDP growth was about 4.5 percent over the period 1994-2003 (Njong 2). 

      In the other researches by Lee, Pham and Ngyuen, Majeed and Ahmad, Johnson, conducted in Taiwan, Vietnam and other 49 developing countries, authors found positive influences of FDI on export growth. Three out of five researches found positive and significant impact.

      In the United Nations Conference on Trade and Development was noted that owing to multinationals domestic firms have an opportunity for expanding of their export performance. During the process of taking integration strategies between parent MNE and its subsidiaries, local firms obtain an access to the international market by linking themselves to MNE subsidiaries through different agreements (qtd in Lee 16). Competition between MNEs subsidiaries and domestic firms provoke domestic firms’ incentives to increase their exports. Zhang (4) notes that because of competition domestic firms’ learn by watching to protect their market share and earnings (Mom 2008, Zhang 2005, Vuksic 2006, Lee 2007, Majee and Eatzaz 2007, Awokuse and Gu 2007, Kutan and Vuksic 2005, Jayachandran and Seilan 2010, Pham and Nguyen 2007). Thereby, MNEs improve production capacity and export performance of host countries.

      Comparing collected researches by the level of development of countries, all of the researches obtained positive results, except the one, that was conducted in CIS countries. Here, the Product Life Cycle theory, which will be discussed in the theoretical part, can explain the reason of having positive influence of FDI on exports not depending on the development of the country. Having analyzed collected literature on used time span and the level of development of the host countries, let’s continue our analysis with used explanatory variables on the estimation of the influence of FDI on exports. 

      All of the researchers used various explanatory variables that influence on exports, but the most used are FDI, GDP and REER. Six out of ten works used these variables and also other ones, but different form each other in their models. For example, Vuksic added to this package of independent variables also wage rate, Kutan and Vuksic- trade liberalization index, Njong added also trade liberalization index, external market access indicator and lagged exports, and Ibrahimova added trade openness index. Other researches, for instance, Zhang used FDI, domestic investments, wage rate, scale economies and industrial dummy based on factor intensity. Lee used only two variables - lagged exports and FDI. Johnson also used two variables FDI inflows and outflows. Awokuse and Gu used the biggest quantity of variables, they are lagged exports, REER, imports, domestic investment, research and development level, firm size for economies of scale, wage rate and FDI. And finally, Majeed and Ahmad, used FDI, GDP, national savings, indirect taxes and REER.           

      Comparing research results on used explanatory variables, it is found that research results do not depend on the amount of used variables. There are two works that used only two variables (Lee and Johnson), and it is seen that they both obtained positive impact of FDI on exports. However, omitting relevant explanatory variables on the model may result in the biasedness of obtained estimator.

      Why all of the researches not depending on the period of observations, level of countries’ development and used explanatory variables obtained positive influence of FDI on exports, but in the case of CIS countries, there was found negative significant impact? Is it that CIS countries should not attract foreign investments to their economies and stimulate other factors that increase exports?

      In this research, the author for obtaining reliable results used three different methods: testing of pooled OLS, Fixed Effects and First-Difference estimation. So for further estimation may be researchers should use another methodology. The other reason might be that not all factors affecting FDI – export relationship have been taken into account. Also, the author did not divide influence of FDI on exports to direct and indirect spillover effects that might affect positively domestic production. Other reasons of having negative results are in the shortage of data in CIS countries and that the data were taken on aggregate level, not distinguishing among sectors. But still the author had 126 observations on each of the variables, that were obtained from reliable sources- UNCTAD and IMF databases.

      Analyzing this research and reasons of having such result, I came to the conclusion that for further research on CIS countries, researchers should find more data, including longer time span, introduce more variables and use another methodology. In my opinion, the development of CIS countries also influenced on obtained results. There is possibility that FDI influenced on production level, but not as much as that country supplied all domestic demand and the rest for exports. Or there is corruption rate that is too high, and most of foreign investments were directed to the specific interest group of people. However, there is a research that claims that high FDI inflows to the host country deter its corruption rate.

      Flow of investments to the country not only improve production capacity but also multinationals show domestic firms how to work better with less corruption and bureaucracy level. Tavares and Larrain (2004) in their research conducted for the period of 24 years and broad cross- section of countries (Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Iran, Italy, Japan, South Korea, Mexico, Netherlands, Poland, Spain, Turkey, the United Kingdom and the United States) proved that higher the FDI inflows to the country results in decreasing of corruption rate of the economy. Authors revealed that 1 percent increase in FDI leads to decrease of corruption rate by 0.3 percents. With such results, for the development of the economy, countries should attract more investments to the country, by switching from centrally planned economic system to the one that is based on market forces, open economy.