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

     Having a significant and positive effect of FDI on exports also was because of a shift of economies from protectionist trade policy to an open and export oriented economy by lowering tariffs and entering to different free trade organizations. For example, World Trade Organization (WTO), National Industrial Free Trade Zone (NIFTZ), North American Free Trade Agreement (NAFTA) and many others. Movement to a more liberalized environment, improved policies for attraction of foreign investments, good governance, low rate of corruption and achievement of macroeconomic stability are appropriate environment for foreign investment inflows (Zhang 2004; Kutan and Vuksic 2004; Mom 2008; Lee 2007; Vuksic 2006; Awokuse and Gu 2007).  

Theoretical background of FDI and exports

This section of my research investigates economic theory on influence of FDI on exports. First, we will discuss theory on multinational enterprises, then Flying Geese model, Product Life Cycle theory and finally New Growth theory.

Theory of multinational enterprises (MNE)

      The theory of multinational enterprise investigates conditions under which firms can undertake foreign direct investment and become MNE.

      Companies become multinational enterprises because of having certain advantages comparing to other rival firms.  It is obvious, companies running business in foreign countries have higher costs than domestic firms, but still they are able to produce because of having other specific advantages that compensate expenses (Vuksic 9; Kutan and Viksic 3; Zhang 4; Majeed and Ahmad 736). Dunning in his OLI paradigm organized these advantages into three groups: 

1. Ownership advantage – O: multinational firm must have a monopoly power in the host country’s market;
2. Location advantage – L: reason to locate production abroad;
3. Internalization advantage – I: incentive to exploit its ownership advantage internally (qtd. in Vuksic 9; in Kutan and Vuksic 3).

Firms have different motives for becoming multinational corporations and according to these reasons they define type of foreign direct investment.

      In OLI paradigm, there are three types of foreign direct investment: market-seeking, resource-seeking and strategic asset- seeking. Most of foreign investments are market and resource- seeking. Resource-seeking means both natural resource and labor-seeking investments, while strategic asset-seeking investments mean the acquisition of local firms.

      Generally, theory of MNEs describes main reasons and conditions of companies for becoming MNEs. Having specific advantages such as ownership, location and internalization advantages firms undertake FDI and produce in abroad. Mostly foreigners invest their capital to increase their production, searching for new markets, and to produce with lower costs, searching for cheaper resources. Also, companies differentiate their FDI locations depending on the conditions of international trade, such as tariffs and transport costs. Having explored theory of multinational corporations lets move to the explanation of influence of FDI on exports in the further paragraphs.

Flying Geese Model

      The term “flying geese pattern of development” was invented by Japanese economist Akamatsu in the 1930s and introduced to the world in early 1960s (Njong 11; Lee 20). “The model was developed based on the observation of the Asian economies and FG model provides a migratory image where Japan is a leading country in industrialization in Asia, while other countries fly behind and emulate the Japanese model” (Lee 20). The essential factors in FG model are labor cost and openness. Corporations having high labor costs in their countries (for example, Japan), undertake FDI to the lower labor cost countries (other Asian economies). With the lapse of time, when these countries have developed, they become high labor cost host country. Become importers, being exporters. Thereby, corporations relocate production process from developed and advanced economies to developing countries (Njong 11; Lee 20).

      The model points out that MNE subsidiaries increase host countries export performance by using of a host country’s factor endowments to produce at lower costs. Increased export competitiveness stimulates local producers, there by increasing of export capacity. FDI inflows bring not only capital to the host country, but also it has spillover effects, through which production and export abilities are improved. Let’s observe the other explanation of moving FDI from developed economies to developing countries in the next paragraph. 

Product Life Cycle (PLC) Theory        

      Vernon’s Product Life Cycle theory was introduced in 1966 to provide a structure to explain the phenomenon of the increasing FDI from US MNEs and its influence on trade flows. There are four stages of production in the PLC theory: innovation, growth, maturity and decline. According to Vernon, at the first stage of production, US MNEs tend to produce new and innovative products in the US for mainly domestic consumption without any foreign direct investments. And the rest of the production they used for exporting purposes. As the products progress to the growth stage and become high in demand and productivity, the US corporations undertake FDI and set up production of the products in different newly industrialized countries. Consequently, US exports decline and American consumers import products from those foreign industrialized countries (Mom 11; Lee 21).

      In the maturity phase of the production process raises the problem of cost reduction for the producers. In this case MNEs move their production from advanced countries to the ones with lower production costs, developing countries. Part of the products supply host countries demand and the other is exported to the US consumption and other foreign markets. So during last decades, USA and other developed countries became importers from being exporters. At the last stage of PLC, the cost minimization becomes the first target for MNEs. They allocate their production to the countries with the cheapest costs, and to the countries which have comparative advantages of production (Mom 12; Lee 22).

      PLC theory describes four stages of production, in which MNEs move their production process from developed to developing economies. These movements depend on the stages of production; if it is innovation stage then US corporations develop and supply only domestic consumers. In the growth stage, US corporations undertake FDI and locate their production process in developed economies. In the next two stages, maturity and decline, searching for minimal costs, they relocate their production process to the developing countries. In the next paragraph, we will explore the importance of technological progress and knowledge skills from FDI for the development of host countries.     
 

New Growth Theory              

      Cortright (2001) notes, that new growth theory includes two important points. First, it views technological progress as a product of economic activity. Second, new growth theory suggests that knowledge and technology are characterized by increasing returns and these increasing returns drive the growth process (qtd. in Lee 23). Investment in knowledge capital contributes to increasing returns in production function and the more resources devoted to research and development, the faster the rate of innovations and the higher the rate of growth (Lee 24).

      According to Mom (12) and Lee (24) the capital accumulation FDI generates non- convex growth by combination of new inputs and foreign technologies in the production function of the MNE subsidiaries economies. The transfer of advanced technology develops knowledge through labor training, skill acquisition, introduction of alternative management practices and organizational structure. In the result, FDI improves productivity of the host country and also FDI can be a catalyst for domestic investment and technological progress (Lee 24; Mom 13).   

     Conclusion, in this section of my research, we investigated theoretical background on FDI and its influence on host countries exports. Theory of multinational enterprises aimed in description of main reasons and conditions of companies for becoming MNEs. Also there are, provided OLI paradigm, types of FDI and differentiation of the production location. Next, we observed Flying Geese model, and Product Life Cycle theory. Each of these models describes the relocation of the production process to developing economies for decreasing of production costs, but in different ways. Finally, there was a New Growth theory, which pointed out that the transfer of technological progress and knowledge by FDIs to developing countries stimulate their production, domestic investments and overall development.      
 
 

Methodology

      This section illustrates methodology for revealing potential effect of FDI on export performance in Kyrgyzstan.  Chosen model in this research is the model that was used by the researcher Njong, who investigated an impact of FDI on exports in Cameroon. This author got highest positive result among other collected works, so in my opinion chosen methodology plays important role in obtaining reliable and clear results. 

      This paper carries out time series estimation, using total exports as the dependent variable, and FDI, REER, GDP, Trade Liberalization Index (TLI) and External Market Access Indicator (MKT) as explanatory variables. This results in the following time series equation:

where subscript t denotes time and ε is the error term.

      Relative price level is important factor that explains country’s exports, according to macroeconomic theory. Including real effective exchange rate (REER) is a good measure that captures the competitiveness of Kyrgyz Republic economy. The indicator is constructed in a way that an increase in REER means a real appreciation of the national currency.  So, the coefficient α₁ is expected to be negative.

      Gross domestic product (GDP) variable is included to capture the effects of increased FDI inflows on increased supply capacity of the country. The coefficient α₂ is expected to be positive.

      Trade liberalization index (TLI) is calculated as import ratio on total international trade volume. And external market access indicator (MKT) which is approximated by the growth rate of export penetration index is calculated as the ratio of exports on total international trade (Njong 14). The reason of including these indicators is to observe the potential impact of the trade liberalization measures adopted by the government. Expected coefficients of α₃ and α₄ are positive.

      First equation is our benchmark equation. In the second model, FDI variable is added to track its direct and indirect effects on production and export performance of the host country. The coefficient α₅ therefore is expected to be positive.  

Data description

      In this research data is collected from primary and secondary sources. Exports, import and REER are taken from National Bank of Kyrgyz Republic (NBKR). FDI inflows and GDP are taken from National Statistics Committee of Kyrgyz Republic. Also some numbers were taken from United Nations Conference on Trade and Development (UNCTAD) and from International Monetary Fund (IMF) databases. An observed period in the research will be from 2000 till 2011, covering quarterly data on variables – 47 observations. Now let’s examine FDI and exports trends in Kyrgyzstan during 20 years.

Insert figure 1. FDI inflows and exports in Kyrgyzstan in million $, 1991-2010

      Looking at the graph we observe that changes in foreign investment inflows to the country influences on exports. During 1997-2001 was financial crisis in Russia that had impact on slow investment flows. Panic among Russian investors decreased growth of investments to Kyrgyzstan that influenced on export volumes.  Also macroeconomic instability in 2005 and 2010 was result of revolutions influenced on decreasing of FDI inflows. On the graph we see that World Financial Crisis also left its mark on the investment and exports levels in the country. There was a sharp increase and then immediately decrease of export volumes.     

Conclusion

      This research provided an analysis of the obtained results of existing literature on the influence of FDI on export performance of the host country.  Comparing all of the researches by employed time spans- long run and short run, the level of development of observed countries and used explanatory variables, it is found that in some cases using of whether short run or long run period may not influence on obtained results, but in other cases it influences on outcome. Here are the cases of the works by Ibrahimova on nine CIS countries, who obtained negative and significant impact using longer time span 13 years, Kutan and Vuksic on European countries and Vuksic on Croatian economy, who found positive results using shorter time spans 8 and 6 years respectively. On the research we investigated that rapidity of the impact of FDI on exports depends on the initial situation of the host country. 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.     

      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.

      Almost all of the researchers found positive results, 6 out of 10 works found positive and significant results and one found negative significant impact. For having such influence of FDI on exports can be explained by theoretical models- Flying Geese model, Product Life Cycle theory and New Growth theory. In the flying geese model, FDI is allocated to the country where the factor endowments would reduce production costs (developing countries). The location of FDI changes over time in line with the country’s level of development. With a lapse of time these developing countries with foreign investments develop through spillover effects of FDI and MNEs subsidiaries move to another developing country with lower production costs. As for the flow of FDI in the product life cycle theory, movement of FDI locations depend on the stage of production. At the beginning, FDI in the host country is mainly for local consumption. Then with increasing of the production and consumers demand, producers search for the minimal costs location for production process. Starting from developed and industrialized economies, FDI moves to developing countries. In terms of the role of FDI in new growth theory, FDI can be a catalyst for domestic investment and technology progress. There is not only direct effect of FDI but also spillover effects of FDI on export growth through MNEs and domestic firms.

      Also obtained results depend on economies trade policy and investment climate in the country. All of the observed economies moved from protectionist trade policy to an open and export oriented economies by lowering tariffs and entering to different free trade organizations. Movement to a more liberalized environment, improved policies for attraction of foreign investments, good governance, low rate of corruption and achievement of macroeconomic stability are appropriate environment for foreign investment inflows. 

 

    
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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