New Trends and Patterns of US FDI in Asia

New Trends and Patterns of US FDI in Asia

Shandre Mugan Thangavelu1 Department of Economics

National University of Singapore

Ramkrishnen Rajan George Mason University

And

Rasyad A. Parinduri

University of Nottingham

Preliminary Draft

Paper prepared for Global Development Network (GDN)

Ninth Global Development Network Conference Brisbane, Australia, 2008

Research Workshop Program

Emerging Trends and Patterns of

Trade and Investment in Asia

Organized by The Division of Economics

Research School of Pacific and Asian Studies College of Asia and Pacific

The Australian National University

1 Corresponding author: Shandre M. Thangavelu, Department of economics, National University of Singapore, Singapore (119750), email: [email protected]

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1. Introduction

Several studies have highlighted the importance of FDI for economic growth,

where FDI activities contributes to recipient countries through the channels of higher

exports, global networks, transfers of technology, increased government revenues and

improved job opportunities. At the aggregate level, these channels create strong and

positive externalities for domestic economic growth. For a considerable number of

developing countries, which includes those in Asia, the acceleration of output growth

has been driven by high levels of domestic and foreign investment, notwithstanding the

high savings levels of these countries (Yussof et. al 2002). For these developing

countries, the lack of indigenous technology as well as participation in global networks

has led to much dependence on foreign investments. As such, governments of these

developing countries have found it necessary to design policies to improve the

attractiveness of the economy to foreign investors, especially towards specific critical

economic sectors.

In the absence of strong domestic enterprises and technology levels sufficient to

drive economic growth entirely, developing countries in Asia have been generally

active in promoting themselves as choice destinations of FDI, with the aim of reaping

the benefits from FDI to boost growth in the domestic economy. These foreign

investments will be able to provide developing host countries with much-needed

technological know-how through knowledge transfers, such that domestic productivity

can increase. Foreign investments will also lead to more job opportunities which will in

turn increase the domestic economy�s output. In addition, foreign enterprises may invest

in the physical infrastructure in their activities, therefore improving the overall

infrastructure in the host countries.

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On the other hand, FDI has been viewed in certain situations as encroaching on

the sovereignty of a host country through a foreign control over resources, and also as a

possible danger to the promotion of domestic investment. Besides being questioned as a

threat to national security and accused of undermining national industries, FDI has also

been viewed as �good cholesterol� that promotes long-term economic development

(Kumar 2003).

This paper seeks to add on to the existing literature by examining the trends and

flow of United States foreign direct investment in Asia and in particular on the East

Asian and South Asian countries. The paper undertakes an empirical analysis of the key

determinants of U.S. foreign direct investment flows in the Asian region in a panel

gravity framework. The paper also identifies key implications for promoting FDI from

the changing decomposition of the United States FDI in Asia.

The paper is organized as follows. The next section provides a brief overview of

the recent literature on the importance of FDI for economic growth. Section 3 discusses

the trends and the changing patterns of the US foreign direct investments in Asia. We

provide the empirical model and discuss the panel gravity model in section 4. Section 5

provides the concluding remarks.

2. Literature Review: Importance of FDI and Growth

In view of the recent surge in foreign direct investments across the globe and

substantial liberalization of government policies towards FDI, a debate about the impact

and significance of FDI and transnational corporations (TNCs) on economic growth has

again rekindled in the recent years, albeit with conflicting viewpoints. There are a vast

number of empirical literatures on the impact of FDI on economic growth, with little

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conclusive empirical evidence. Recent paper by Choe (2003) asserts strong positive

relationships between FDI and economic growth, however the paper does not

sufficiently establish a causal relationship from FDI to growth.

Carkovic and Levine (2002) suggests that at the firm-level, studies generally

show that economic growth is not enhanced by FDI, and that positive spillovers do not

occur from foreign-owned firms to domestically owned ones. The firm-level study will

be able to control for firm specific and simultaneity issues much better than aggregate

level study.

Foreign affiliates� direct contribution to OECD countries� labor productivity

growth is examined by Criscuolo (2005) using the growth accounting approach. The

study decomposes the contribution to labor productivity growth by the within effect

(contribution from existing foreign affiliates to labor productivity growth) and the

between or compositional effect (contribution from the increase in foreign affiliates�

employment share in the host economy). The study highlighted that the labor

productivity differential between domestic and foreign firms is generally significant in

manufacturing industries where foreign affiliates are more labor productive, whereas

the service sector does not exhibit a similar differential. Through a sectoral analysis for

services, a negative correlation is confirmed between the size of the labor productivity

differential and the sector�s knowledge intensity level. Further analysis showed that

foreign affiliates� contribution mainly stems from the between effect, while evidence at

the sectoral level suggests that within effects determines the contribution in the high and

medium-high technology manufacturing sectors.

Borensztein et. al (1998) studied the role of FDI in the process of technology

diffusion and economic growth on developing countries. Based on a cross-sectional

5

framework, their results show that FDI�s contribution to growth is more than that of

domestic investment, suggesting that FDI is important for the transfer of technology.

The empirical results from this study also suggest that FDI is more productive than

domestic investment only in instances where the host country has a minimum threshold

human capital stock. The complementary effects between human capital and FDI

suggested by the results are consistent with the idea that the ability of the flow of

advanced technology to enhance economic growth is dependent on a country�s

absorptive capability.

In Carkovic�s and Levine�s (2002) study, after joint determination of growth and

foreign capital flows are controlled for, as well as other growth determinants and

country-specific effects, results show that FDI, as an exogenous component, has no

positive, robust causal impact on economic growth. The interaction term (the product of

FDI and average schooling years of the working age population) and FDI are generally

not significant. However when they both appear significant, the FDI term is significant

while the interaction term coefficient is negative. These results thus apparently suggest

that FDI only enhances growth in countries with low education levels, and these results

may be caused by the simultaneous inclusion of FDI, schooling and the interaction

term. Their panel regressions do not support the claim that FDI flows to financially

developed economies to have a strong positive impact on growth. The results also, do

not find a robust relationship between growth and FDI when dependence on trade

openness is allowed. The interaction between economic success and FDI are also seen

as not exerting any strong independent effect on growth. As such, the authors do not

uncover any independent impact of FDI inflows on economic growth in their study.

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Ram and Zhang (2002) conducted a study of FDI�s role in host countries�

economic growth with a focus on the 1990s and a use of a large cross-country sample.

The main part of their study uses three different proxies for the FDI variable, which are

growth rate of the ratio of FDI flows to GDP, growth rate of absolute FDI inflow and

the ratio of FDI inflows to GDP. Generally, the three proxies of the FDI variable result

in generally similar implications and empirical results point to a positive nexus between

FDI and host countries� economic growth.

Nair-Reichert and Weinhold (2001) examined the possible heterogeneous

pattern of the effect of FDI on growth using a panel of 24 developing countries over a

period of 25 years. To be able to estimate across the panel a distribution of causality,

they suggest a variation of the Mixed Fixed and Random (MFR) model. Growth rates of

all variables (apart from inflation) are used in the analysis, and an examination of

contemporaneous correlation of FDI and growth of GDP, as well as a test for Granger

causality, are conducted. Using a non-dynamic fixed effects panel in a test for simple

contemporaneous correlation, FDI growth was statistically insignificant to GDP growth.

In examining a causal relationship between growths of FDI and GDP, a dynamic panel

model is used where GDP growth becomes a function of the lags of itself and other

explanatory variables. The traditional Holtz-Eakin et al. (1988) panel causality test and

the MFR causality model are then used estimate the models. Hotlz-Eakin causality test

results show that FDI growth has a strong positive effect on GDP growth, while

domestic investment and export growths are not statistically significant. In using the

MFR causality approach, the evidence provides strong support for significant

heterogeneity in the sample of 24 developing countries. Results for the MFR estimation

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and traditional panel data causality tests differ greatly, but there exists, generally, a

causal relationship from FDI to GDP growth.

The two-way relationship between growth and FDI in India is examined in

Chakraborty and Basu (2002) through a structural cointegration and vector error

correction mechanism. They found positive impact of FDI on GDP growth in India.

3. United States Trade and Foreign Direct Investment in Asia The United States adopts an open market approach to trade and investment. It pursues

both a multilateral trading and concurrently the bilateral and regional trading

agreements to achieve the free and open trading environment. Due to its open trade

policy, the overall trade in the United States has increased in 2006 and has contributed

significantly to its economic growth. The U.S. economy is also experiencing a healthy

foreign investment activity in recent years. The United States is a major investor in the

global economy and its foreign activities have increased in 2006 (see Figure 1). It

nearly accounts for around 20 to 30 percent of the total World outwards FDI flows. In

2006, the U.S. multinational corporations have increased their investment in Europe and

Asia Pacific, and in fact the United States has doubled its foreign investments in Europe

and Asia Pacific. The Unites States is also the largest host to foreign investment in the

world. In 2005, the United States attracted nearly 13 percent of the total foreign direct

investments inflows in the World (World Investment Report, 2006). The FDI inflows to

U.S. economy increased from US$53,146 million in 2003 to nearly US$99,443 million

in 2006 (World Investment Report, 2006).

8

Source: Bureau of Economic Analysis, United States

9

Since 1994, United States has more than doubled its investment in the Asia-Pacific

region and it is the second largest investment region after Europe in 2006. Although the

overall investment in the Asia-Pacific region might have increased, the Asian crisis was

expected to have strong impact on the relocation of its foreign investment activities to

East-Asia from South-East Asia. Thus a more disaggregated analysis of the United

States outward FDI in the region will shed more light on the changing patterns within

the Asian region. Further, we might also expect changing patterns at the industry.

Another important component for the rising global share of FDI is the number of

bilateral and multilateral trading agreements undertaken by the United States. The

United States pursues open trade and investment strategy using both the multilateral and

bilateral tracks. The United States exports and imports with its FTA completed

countries and these countries account for more than 40 percent of the total exports of

United States. Out of the total of nine bilateral and regional trade agreements completed

in 2007, most of the agreements were completed in early 2000, except for only NAFTA

that was completed in 1994. The positive complementary effects of FTA on the exports

and investment of United States is clearly indicated in the increasing trend of exports

and investment to FTA-completed countries.

Asia Pacific is becoming an important trade region for the United States as it is

the largest export destination for U.S. goods. In fact, the average share of exports to

Asia Pacific to total United States exports is nearly 27 percent in 2000-2006. The trends

indicate that United States is relying on the Asia Pacific region for its imports over the

years. The average share of imports from the Asia Pacific region is nearly 37 percent of

the total imports into United States from 2000-2006.

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It is also important to highlight that trade in services is becoming an important

component of overall trade in the United States. The share of export of services has

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increased from 27 percent in 2000 to nearly 30 percent of the total export in 2006. The

travel and other private services account for the large proportion of the exports of

services by United States in 2006 (see Figure 9). The import of services accounts for

nearly 17 percent of the total imports of United States. The importance of services in the

overall trade indicates the importance of services trade in strategic trade areas of free

trade agreements and regional trade agreements.


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The United States FDI in Asia-Pacific region is given in Figure 7. There are several

interesting trends emerging from the United States investment in the region since 1994.

The FDI investment by the United States to Australia and Japan has surged strongly in

2006. It surged from 4 percent in 1994 to nearly 14 percent of the total FDI flow into

the Asia-Pacific region in 2006 for Australia. We also notice a similar trend for Japan,

where the United States investment increased from 14 percent in 1994 to nearly 30

percent of the total FDI flow in 2006. Although there is a slight increase in United

States foreign investment in China in 2006, it only marginally increased to 10 percent in

2006 from 8 percent in 2000. This might indicate that the United States investment in

China might be reaching a "steady state" or a plateau that we might not see much

increase in foreign investment by United States in the future. One possible reason for

the declining United States FDI might be the depreciating US dollar to the Chinese

Yuan, thereby making United States investment to China more costly. Further, recent

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evidence suggests that the cost of production including the labour cost is rising rapidly

in China that the profitability of foreign activities might be falling over the years. Other

than Australia and Japan, we also observed some increase in United States FDI in India

rising from 0.4 percent in 2000 to 5 percent in 2006. Most of East-Asian countries of

Korea, Hong Kong, Taiwan and Singapore are experiencing falling shares of United

States FDI over the years. Hong Kong and Korea seems to have experience very drastic

fall in the share of United States FDI, where the United States to Hong Kong has

declined from 22 percent in 2000 to nearly 10 percent in 2006 and Korea has

experienced a decline to 5.3 percent in 2006 from 10 percent in 2000. The United States

foreign investment in Singapore has fallen from 16 percent in 2000 to nearly 12 percent

in 2006.

The emerging Asian countries are also experiencing falling share of United

States foreign direct investment. The most drastic fall in United States investment is by

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Indonesia where the investment has declined from 15 percent in 1994 to nearly 3

percent in 2006. Malaysia (Mal) and Thailand (Thai) have also experienced significant

decline in United States FDI.

The breakdown of the United States FDI by country and industry is given in

Tables 1 to 3. The industrial analysis indicates that the United States is shifting its

investment into services sector away from the manufacturing sector in Asia-Pacific

region. The share of services in the total United States FDI was only 41 percent in 1994,

but it has shifted to nearly 72 percent in 2006.

Table 1: United States FDI by Region and Key Sectors (1994-2006)

1994 2000 2006

Manu Services

Manu (with

Mining) Manu Services

Manu (with

Mining) Manu ServicesAsia 59.0 41.0 51.7 43.3 56.7 33.3 27.9 72.1

Australia 58.2 41.8 60.9 43.1 56.9 22.9 14.2 85.8 China 73.0 27.0 86.6 74.0 26.0 62.8 55.9 44.1 Hong Kong 22.8 77.2 7.4 7.4 92.6 15.8 15.8 84.2 India 37.7 62.3 49.2 63.6 36.4 20.0 20.3 79.7

Indonesia 62.9 37.1 86.0 5.0 95.0 77.8 13.3 86.7 Japan 60.4 39.6 26.9 26.8 73.2 28.6 28.6 71.4 Korea 44.0 56.0 49.4 49.4 50.6 53.0 53.0 47.0

Malaysia 75.5 24.5 64.7 64.7 35.3 62.4 44.3 55.7 New

Zealand 20.0 80.0 4.9 2.5 97.5 20.1 13.5 86.5

Philippines 56.2 43.8 46.5 46.5 53.5 59.7 59.3 40.7

Singapore 53.5 46.5 65.5 65.4 34.6 26.6 26.3 73.7 Taiwan 58.4 41.6 38.6 38.6 61.4 28.8 28.8 71.2

Thailand 62.0 38.0 61.0 41.9 58.1 68.5 67.4 32.6 Other 3.6 96.4 26.5 6.4 93.6 31.6 2.2 97.8

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It is interesting to observe that Australia and Japan have been attracting United

States FDI into the manufacturing sector in 1990s, but the share of the United States

investment in manufacturing sector declined drastically and share of services

investment has increased to nearly 85 percent for Australia and nearly 70 percent for

Japan in 2006. Although United States was investing in the manufacturing sector in

China in 1990s and the share in 2006 is till nearly 60 percent, services sector share is

also increasing in 2006 to 40 percent from 27 percent in 1994.

Since the India economy was liberalized in 1985, we can observe gradual

increase in United States investment in India. In 2000, the foreign direct investment

from United States was mainly invested in the manufacturing sector, where it acconts

for nearly 60 percent of the investment. In 2006, the share of United States investment

in the manufacturing sector has drastically dropped to nearly 20 percent and more than

80 percent of United States investment in India is in the services sector.

The East Asia countries of Hong Kong, Singapore and Taiwan are also

experiencing a shift in the United States investment away from the manufacturing sector

to the services sector over years. The most drastic shift is in Singapore, where the share

of United States investment in the services sector increased from 35 percent in 1994 to

nearly 72 percent in 2006. One possible explanation for the falling share of the United

States investment in the manufacturing sector might be due to the US-Singapore FTA

which basically emphasised the trade in services. We also observe similar trend with

Malaysia, with the share of United States investment in the manufacturing declining

over the years.

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Table 2: United States Foreign Direct Investment by Country and Manufacturing Industies: 1994-2006

Food Chemicals Fab. Metals Machinery Electrical

&Electronics Transport Others

Asia

1994 2.75 7.17 1.13 6.23 8.13 2.74 30.9

2000 1.23 5.27 1.83 1.38 14.58 2.45 16.5

2006 0.90 4.55 0.52 1.14 7.13 1.94 11.7

Australia

1994 4.87 13.22 1.32 2.08 1.01 2.35 33.4

2000 3.81 4.12 6.70 1.09 0.96 2.74 23.6

2006 0.92 3.51 0.62 0.77 0.72 1.20 6.5

China

1994 5.12 8.60 4.07 0.00 6.65 0.00 48.6

2000 2.57 10.07 1.41 1.96 35.53 5.85 16.6

2006 3.39 11.66 2.08 2.88 11.07 7.74 17.1

India

1994 4.66 13.50 1.46 7.67 4.08 0.58 5.7

2000 2.56 10.76 3.28 13.03 1.47 2.40 30.1

2006 0.54 5.23 0.97 5.61 3.13 0.80 4.0

Indonesia

1994 0.28 2.27 0.13 0.09 0.46 0.06 33.8

2000 0.15 4.05 0.20 0.28 0.30 0.00 0.00

2006 0.00 3.10 0.26 0.00 -0.43 -0.09 10.4

Japan

1994 2.20 6.89 1.03 13.02 5.16 6.36 25.7

2000 0.40 5.87 0.54 1.86 6.92 3.33 7.9

2006 0.18 5.09 0.19 0.56 5.17 1.22 16.2 Korea

1994 5.38 9.09 0.76 2.12 10.38 2.22 14.1

2000 3.93 8.51 0.79 2.26 21.49 5.08 7.3

2006 4.07 7.80 0.68 0.57 14.11 3.95 21.8

Malaysia

1994 0.16 4.73 0.44 2.26 53.24 0.00 14.7

2000 -0.10 3.16 0.19 0.66 55.44 0.00 5.4

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2006 0.31 6.06 0.41 1.19 26.36 0.00 10.0

New Zealand

1994 0.00 2.08 0.00 0.28 0.49 0.00 17.2

2000 -0.26 1.57 0.00 0.14 0.77 0.21 0.1

2006 0.00 1.54 0.24 0.12 2.01 0.05 9.6

Philippines

1994 11.55 12.96 0.81 0.20 13.81 0.00 16.9

2000 4.67 8.05 0.47 1.62 23.17 0.00 8.5

2006 5.67 5.66 0.37 0.00 22.87 0.00 24.8

Singapore

1994 0.23 1.83 1.34 8.02 20.05 0.70 21.3

2000 0.04 2.30 0.94 1.10 44.11 2.35 14.6

2006 0.03 2.67 0.22 1.81 16.14 3.79 1.7

Taiwan

1994 1.88 18.78 0.00 6.30 26.07 0.00 5.4

2000 0.59 15.53 0.73 1.30 15.42 0.66 4.3

2006 0.33 6.27 0.92 0.63 10.68 0.86 9.1

Thailand

1994 3.32 7.39 2.06 0.00 7.56 -0.03 41.6

2000 0.67 17.02 1.49 0.89 19.81 2.04 0.0

2006 0.44 16.67 1.48 2.73 12.11 6.02 28.0

Others

1994 0.00 3.33 0.10 0.00 0.20 0.00 0.0

2000 1.20 2.11 0.00 0.11 0.25 1.64 21.2

2006 0.00 0.92 0.19 0.06 1.07 0.00 0.0

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Table 3: United States Foreign Investment in Services Sector in Asia: 1994-2006

Trading Information Banking

Finance(other than Banking),

Insurance Other

Services

Asia

1994 0.0 6.6 15.6 4.4 0.0

2000 2.9 4.5 20.4 4.0 0.0

2006 2.4 4.1 19.3 3.6 30.3

Australia

1994 10.5 0.0 9.4 15.5 6.4

2000 3.7 3.9 12.8 2.1 0.0

2006 0.8 1.6 6.5 2.5 63.6

China

1994 0.0 2.3 10.4 2.9 0.0

2000 0.7 0.6 0.4 2.2 0.0

2006 4.6 5.5 7.0 0.6 9.0

India

1994 0.0 43.8 13.6 1.9 0.0

2000 -6.1 14.6 12.0 6.6 0.0

2006 27.3 16.1 11.7 10.9 3.8

Indonesia

1994 0.0 0.0 6.0 0.7 0.0

2000 -0.7 2.4 0.0 1.6 0.0

2006 -0.7 6.4 2.1 0.4 8.0

Japan

1994 0.0 0.9 18.1 2.8 0.0

2000 4.4 0.9 40.2 9.4 0.0

2006 2.5 0.7 48.8 8.1 2.2

Korea

1994 0.0 29.0 0.0 4.0 0.0

2000 2.8 18.8 3.0 3.1 0.0

2006 1.0 22.0 12.5 5.4 0.0

Malaysia

1994 0.0 0.0 9.2 2.4 0.0

2000 1.0 0.0 3.6 2.6 0.0

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2006 0.3 0.0 3.6 1.7 0.0

New Zealand

1994 0.0 0.0 22.2 1.5 0.0

2000 0.0 0.0 25.6 -1.9 0.0

2006 3.4 0.0 19.7 4.6 0.0

Philippines

1994 0.0 13.0 17.1 0.0 0.0

2000 0.5 5.1 0.0 0.4 0.0

2006 0.7 0.0 13.7 -0.7 0.0

Singapore

1994 0.0 3.3 15.6 12.9 0.0

2000 2.7 2.9 10.6 2.1 0.0

2006 2.3 3.4 8.5 2.2 0.0

Taiwan

1994 0.0 11.7 6.2 2.4 0.0

2000 3.9 8.2 29.7 1.4 0.0

2006 1.1 5.8 48.5 0.7 0.8

Thailand

1994 0.0 7.7 4.2 2.8 0.0

2000 0.0 7.0 7.7 0.9 0.0

2006 0.1 8.9 10.2 2.8 1.5

Hong Kong

1994 0.0 10.3 27.2 5.3 0.0

2000 2.3 8.6 24.3 2.1 0.0

2006 4.4 4.4 22.8 1.0 30.9

Among the Asia-Pacific countries, the most affected country is Indonesia by the

changing pattern of United States foreign investment. It tends to enjoy nearly 63 percent

share of the United States investment in the manufacturing sector in 1994. However,

this share has fallen to less than 5 percent and 13 percent in 2000 and 2006 respectively.

In fact, if we add the share of the United States investment in natural resources (mining

industries), the share of United States investment in both the manufacturing and mining

sector accounts for nearly 80 percent of United States investment in 2000s. This clearly

indicates that United States is basically investing in the natural resources in Indonesia.

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The sectoral investment by United States in Asia is given in Tables 2 and 3. The trend

of foreign investment by United States in China in is declining in the electrical and electronics

industry over the years and in contrast the share in the chemical, transport equipments and

machinery is increasing in recent years. In fact, the share of United States investment in the

electronics & electrical industries has drastically declined from nearly 35 percent in 2000 to

around 11 percent in 2006. We also observed that the United States investment in electronics &

electrical products is also falling for the leading electronics & electrical exporting countries

such as Korea, Taiwan, Singapore, and Malaysia. However, United States foreign investment in

the chemical and transport equipments has increased across these countries in 2006 as their

share in the electrical and electronics sector declines.

The United States foreign investment in the services sector in Asia is showing an

interesting trend for Asia. As indicated previously that the share of United States foreign

investment in services sector is rising over the years. It seems United States is investing heavily

in the services sector in India and particularly the trading, information, banking and financial

services. We also observed an increase in the share of United States investment in the trading

and banking sector for China. The share of United States investment in the financial sector for

Japan, Korea and Taiwan shows a rising trend over the years. In particular, the share of

investment by United States in the financial services sector in Japan has significantly increased

from 21 percent in 1994 to nearly 57 percent in 2006. The share of investment in the financial

sector in Taiwan also increased from 8 percent in 1994 to nearly 49 percent in 2006. We also

noticed that the share of financial and information services has increased for Korea in 2006,

where the United States foreign investment in financial sector increased to 18 percent in 2006

from only 6 percent in 2000.

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4. Empirical Analysis

To understand the dynamic trends of United States FDI in Asia-Pacific, we adopted a

standard gravity model and examined the determinants of United States foreign direct

investment in Asia-Pacific countries compared to that in the rest of the world. We

estimated a standard gravity model as follows:

+++= −− )ln()ln()ln()ln( 31211 jjtitjt AreaYYFDI βββ ∑

kkk Regionϕ

jtjtl

ljk Distance εηλδ ++++∑ (1)

where FDIjt is the value of US� FDI in country j at time t; Yit and Yjt are US� and host

country j�s GDP at time t respectively; Areaj is the land mass of country j; Distancels

are some measures of distance between US and host countries such as their

geographical distance as well as their legal system and language. Regionks are regional

dummies for Asia, South America, Africa as well as Europe and Canada; the excluded

regional dummy is Europe and Canada; λ t and η j are time-effects and country-effects

respectively; εjt is the error terms. The coefficients of interest are the coefficients of the

gravity variables and the ϕks, the coefficients of the regional dummies.

Because we want to obtain the estimates for the coefficients of the time-

invariant regional dummies, we cannot estimate the model using fixed-effect or

dynamic panel data models. Random effect model may not suitable either because the

explanatory variables are likely to be correlated with the country effect ηj, which makes

that the random-effects biased.

We decided to estimate the model using correlated-random-effects model. We

adopted the Mundlak (1978)�s specification, which allows the country-effects η j to be

modelled using the means of the time-varying explanatory variables, i.e.

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jm

mmj X ϑπη +=∑

where mX s are time-varying explanatory variables and ϕ j is iid.

4.1 Data

The sample consists of 55 countries that are major destinations of United States FDI and

the data is obtained from the Bureau of Economic Analysis (BEA), United States. The

full details of the variables and their sources are given in Appendix. We also list the

countries in our study in the Appendix. The key summary statistics of the sample is

given in Table 4.

Table 4: Summary Statistics

Variables Units Obs Mean Std. Dev.

Gravity variablesFDI Constant 2000 US$, billlion 1355 16 33GDP US Constant 2000 US$, billlion 1566 7850 1910GDP Host Constant 2000 US$, billlion 1521 294 622Land Area Host Sq. Km, thousand 1566 1068 2176Distance Km 1566 7658 4104Contiguity (=1) 1566 0.03 0.18English (=1) 1566 0.29 0.46Anglo-American Law (=1) 1566 0.43 0.50

Regional dummiesEurope 1566 0.31 0.46South America 1566 0.31 0.46Africa 1566 0.09 0.28Asia Pacific 1566 0.28 0.45

Asian-Pacific dummiesSouth-east Asia 1566 0.09 0.28South Asia 1566 0.02 0.13East Asia 1566 0.09 0.28Middle-East 1566 0.05 0.22Australia and New Zealand 1566 0.03 0.18

Developed (=1) 1566 0.38 0.49

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4.2. Empirical Results The empirical results of our model are given in Tables 5 to 9. The results by OLS,

Random Effects (RE) and Correlated Random Effects (CRE) are given below. The key

results for our study are given in column (5) and (6). The results in Table 5 support the

specification of a gravity model to examine the determinants of United States foreign

investment across the countries. The flow of foreign investments to the region is

directly affected by the output growth in the US economy and also the respective host

countries in Asia. The coefficients of GDP of United States and also the host country

are positive and also statistically significant. The RE and CRE estimation reveals that it

is not statistically significant. The regulatory framework as given by the Anglo-

American Law is positive and statistically significant at 5 percent level. Hence, a

similar and transparent regulatory framework has a positive influence on the flow of

foreign investment.

The results of the Asia-Pacific region are given in Table 6. The coefficient of

host country GDP is the only key variable that is statistically significant and tends to

have positive impact on the flow of United States foreign investment. The results of

controlling for the September 11, 2001 terrorist attack and the Asian crisis are given in

Table 7. The results indicate that host country GDP is an important component to attract

foreign investment and both the Asian crisis and September 11, 2001 terrorist attack has

little impact on the long-term flow of United States foreign investment in the region.

24

Table 5: Determinants of US� FDI (All Countries) Dependent variable: ln(FDI)

RE CRE(1) (2) (3) (4) (5) (6)

Regional dummiesAsia (=1) -0.79 -0.78 0.38 0.43 0.23 0.16

(0.45)* (0.45)* (0.82) (0.61) (0.63) (0.64)South America (=1) -1.29 -1.24 0.12 1.12 0.88 0.87

(0.52)** (0.53)** (0.88) (0.64)* (0.76) (0.76)Africa (=1) -1.80 -1.80 -0.44 -0.13 0.22 0.07

(0.50)*** (0.51)*** (0.87) (0.75) (0.74) (0.76)Australia & New Zealand (=1) -0.06 -0.04 -0.12 0.15 1.90 1.86

(0.88) (0.89) (0.89) (1.05) (1.26) (1.26)Developed (=1) 1.44 0.96 -0.30 -0.29

(0.79)* (0.57)* (0.78) (0.78)Gravity variables

Lagged ln(GDP) US 1.46 0.84 0.84(0.26)*** (0.34)** (0.33)**

Lagged ln(GDP) Host 0.57 1.11 1.10(0.14)*** (0.26)*** (0.26)***

ln(Land Area) Host -0.19 -0.46 -0.45(0.08)** (0.14)*** (0.14)***

ln(Distance) 0.25 -0.38 -0.35(0.41) (0.53) (0.54)

Contiguity (=1) 2.32 1.44 1.35(0.77)*** (1.08) (1.08)

English (=1) 1.21 0.93 0.96(0.44)*** (0.54)* (0.54)*

Anglo-American Law (=1) -0.69 -0.62 -0.63(0.40)* (0.23)*** (0.23)***

Constant 4.51 5.28 3.91 -54.68 -40.21 -53.32(0.37)*** (0.39)*** (0.81)*** (7.88)*** (8.88)*** (19.66)***

Time effect No Yes Yes Yes Yes YesMeans of time-variant No No No No No YesObservations 1355 1355 1355 1330 1330 1330Number of countries 55 55R-squared 0.13 0.24 0.28 0.58 0.52 0.53

OLS

Notes: The sample includes all countries; robust standard errors in parentheses; the excluded regional dummy is Europe & Canada; RE stands for random-effect model, while CRE correlated-random-effect model; * significant at 10%; ** significant at 5%; *** significant at 1%.

25

Table 6: Determinants of US� FDI (Includes only Asia-Pacific Countries)

Dependent variable: ln(FDI)RE CRE

(1) (2) (3) (4) (5) (6)Regional dummies

South-east Asia (=1) 0.94 0.96 1.36 -1.69 -0.27 -0.38(0.39)** (0.41)** (0.54)** (0.84)* (1.58) (1.51)

South Asia (=1) -0.34 -0.36 0.03 -1.69 0.54 0.86(0.31) (0.32) (0.47) (0.77)** (2.26) (2.20)

East Asia (=1) 1.30 1.31 1.46 0.26 -0.004 -0.08(0.56)** (0.58)** (0.55)** (0.55) (1.30) (1.29)

Australia & New Zealand (=1) 1.50 1.52 0.73 -3.25 2.06 2.22(0.87) (0.91) (1.02) (1.12)** (2.64) (2.43)

Developed (=1) 1.19 1.76 -0.09 -0.17(0.58)* (0.44)*** (1.13) (0.95)

Gravity variablesLagged ln(GDP) US 2.09 0.62 0.69

(0.37)*** (0.62) (0.60)Lagged ln(GDP) Host 0.26 1.29 1.24

(0.09)** (0.43)*** (0.42)***ln(Land Area) Host -0.01 -0.55 -0.58

(0.07) (0.29)* (0.28)**ln(Distance) 8.80 6.01 6.03

(1.82)*** (4.07) (3.91)English (=1) 0.40 -0.86 -1.33

(0.34) (1.40) (1.39)Anglo-American Law (=1) 0.06 -1.34 -1.22

(0.34) (1.01) (0.83)Constant 2.95 3.77 3.36 -147.28 -96.43 -65.10

(0.31)*** (0.33)*** (0.44)*** (23.44)*** (41.48)** (49.53)Time effect No Yes Yes Yes Yes YesMeans of time-variant No No No No No YesObservations 394 394 394 394 394 394Number of countries 16 16R-squared 0.22 0.48 0.56 0.79 0.51 0.51

OLS

Notes: The sample includes Asia-Pacific countries only; robust standard errors in parentheses; the excluded regional dummy is Middle-Eastern countries; RE stands for random-effect model, while CRE correlated-random-effect model; * significant at 10%; ** significant at 5%; *** significant at 1%.

26

Table 7: The Effect of Asian Financial Crisis and the September 11

Dependent variable: ln(FDI)

A. Allow the periods of Asian Financial Crisis and the year of September 11 to have different intercepts

Asian Financial Crisis (=1) -0.08(0.09)

September 11 (=1) -0.05(0.06)

B. Allow the periods of Asian Financial Crisis and the year of September 11 to have different slopes of GDP variables

Lagged ln(GDP) US 0.83(0.34)**

Lagged ln(GDP) Host 1.12(0.26)***

Asian Financial Crisis * Lagged ln(GDP) US 0.005(0.03)

Asian Financial Crisis * Lagged ln(GDP) Host -0.01(0.03)

September 11 * Lagged ln(GDP) US 0.003(0.04)

September 11 * Lagged ln(GDP) Host -0.01(0.05)

C. Allow Asian countries to have different slopes of GDP variables

Lagged ln(GDP) US 0.83(0.34)**


Asia * Lagged ln(GDP) Host -0.03(0.28)

D. Allow Asian countries to have different slopes of GDP variables before and after the crisis


Asia * Lagged ln(GDP) Host -0.06(0.32)

Post-Asian Financial Crisis * Asia * Lagged ln(GDP)Host 0.001(0.01)

Notes: The sample includes all countries; the regressions are estimated using correlated-random-effect models; all variables in column (6) of Table 2 are included; the number of observations is 1330; because of collinearity, Specifications A and B does not include time-effects; robust standard errors in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.

27

We also undertake some robustness checks on our results. First, we use the share of US�

FDI in country j instead of ln(FDI) as the dependent variable. Tables A4 and A5 in the

Appendix present the results. The estimates of the coefficients of the regional dummies

of the random-effect and correlated-random-effect models do not seem to differ much

from those in Tables 5 and 6. We also add ln(Y/Pop)i and ln(Y/Pop)j as additional

explanatory variables, introduce indicators for ease of doing business and a proxy for

financial development. The estimates of the coefficients of the regional dummies does

not change much either.

5. Policy Conclusions

The paper examined the trends and patterns of United States foreign investment

in Asia. The trends indicate that the share of United States foreign investment in the

region is shifting towards the services sector. In particular, we observed this trend in

large economies such as Australia, China, India and Japan. Within the manufacturing

sector, United States is reducing its share of investment in electrical & electronics sector

in most Asian countries. In particular, we observed that the share of United States

investment in the electronics & electrical sector in China has declined, but there is an

increase in the share of the chemical and transport sectors. We also observe this trend in

the United States foreign investment in Thailand and Malaysia. Within the services

sector, we observed that the share of United States foreign investment is increasing in

the financial sector in the key Asian countries. In particular, both Japan and Australia

were the major recipients of United States foreign investment in the services sector and

this share is increasing over the years. The empirical results also indicate that the host

28

country GDP and the regulatory framework are the key factors to attract foreign

investment in the region. The empirical results also indicate that terrorist attack in

September 11, 2001 and the Asian crisis did not fundamentally change the flow of

United States foreign investment in the region.

With evidence of the benefits of FDI to host countries, the heightened global

race for FDI has led the governments to liberalize the domestic economy to attract FDI

and to maximize the benefits derived from it. There is agreement that there is no �one-

size-fits-all� strategy for governments to attract and benefit from FDI, but a general

direction for host countries, besides giving out fiscal incentives to foreign investors, is

to increase the absorptive capacities of the domestic economy in terms of human

capital, improving its institutions and the physical infrastructure.

One of the important components of the domestic absorptive capacity is the

importance of domestic companies. Thus to fully benefit from foreign direct

investment, the host country needs to increase the complementary effects between the

local and foreign companies. Governments� reliance on foreign affiliates to �solve�

competitiveness issues tend to neglect the importance of the development of domestic

companies. As such, policymakers tend to subsidize inward FDI heavily, leading to

high opportunity costs as compared to subsidies for growth industries domestically.

Besides policy to attract foreign investment, the government should also seek to

promote synergy between foreign and domestic investments, through the

encouragement of cooperative efforts, and creating and deepening linkages between

TNCs and local firms.

Our results also show that regulatory framework has a positive impact on

foreign investment in the region (Lall, 2002; Kumar, 2003). The successful

29

development of a FDI strategy that aims to attract (and keep) FDI, while benefiting host

countries, is a challenge for governments. The interventionist role of a government is

required in the presence of market failures in the process of investment and deviations

between national interests and those of TNCs. The FDI policies must also counter

coordination and information failures in the investment process, as well as the

divergence between national interests and TNCs� private interests.

Furthermore, governments hoping to attract FDI should also hold the task of

creating skilled technical manpower that is tailored to the activities that are nationally

desirable, as well as encouraging the vibrancy and technological dynamism of the

domestic enterprise sector, such that benefits from FDI can be maximized.

There are several policy implications for ASEAN countries. Generally, among

the ASEAN countries the fiscal incentives for foreign investors in terms of tax breaks

and other incentives are a major feature in the FDI promotion policies of host countries.

Such incentives are, undoubtedly, successful in attracting overseas investments as cost-

competitiveness is a large consideration for foreign investors. For example, tax breaks

and other incentives from the Malaysian government has drawn RM20 billion to the

south Johor economic zone. However, given the dynamic nature of TNCs and also to

increase the spillover of technology to the host countries, policy other than tax

incentives have to be adopted to attract foreign investment.

In general, there are four major tenets that should be addressed in FDI-

promoting policies of host countries, as well as policies to maximize the benefits

derived from FDI � firstly, that there should be a stable political regime and dependable

administration; secondly, that policies be formed in building, maintaining and

upgrading physical infrastructure available in the host country; third, that policies be

30

geared towards maintaining and upgrading human capital such that there is a ready pool

of human resource in terms of skilled professionals and managerial capacity. Combined

with high levels of physical infrastructure, the absorptive capabilities of such a

workforce will be enhanced. Lastly, that synergy between foreign investors and

domestic enterprises be fostered as a part of the promotion of FDI.

As China continues on its economic blaze, it could pose as a serious competitor

to Asian front-runners and other ASEAN members in terms of attracting inward FDI.

The Chinese government figures have shown that actual FDI to China stands at

US$5.18 billion as of January 2007, a 13.9% jump from the previous year. In addition,

India is an up-and-coming economy as well, and is also actively promoting the country

as a choice for technology-related FDI, as can be seen by the various incentives given

out to foreign investors like Intel to set up local wafer fabrication plants. As such,

ASEAN member countries need to put in serious and consistent efforts in growing their

attractive potential and aggressively promoting themselves as choice destinations for

FDI (Athukorla, 2006).

Ng (2006) mentions in his paper that China has often been likened to a vacuum-

cleaner, sucking away most of foreign direct investments at the expense of the region

whereby China�s low labor costs and abundant supply of labor competes head-on with

Southeast Asia in third country markets such as the European Union and the United

States. Wong and Chan (2002) state that, in comparison to ASEAN economies, China�s

route of export diversification, in terms of FDI, resembles that of the ASEAN

economies. However, China has a larger domestic market which allows greater

economies-of-scale advantages, and certainly a larger pool of labor, both skilled and

31

non-skilled. As such, China has a natural cost advantage over ASEAN economies and

other smaller developing countries.

On the other hand, the rise of China can be seen in a positive light.

Notwithstanding the accusation of China as a threat, its huge domestic market and large

external reserves offer plenty of opportunities for Southeast Asia to exploit. Moreover,

several studies have also produced evidence that FDI receipts in China are positively

correlated with other Asian countries� receipts. Complementarities between the region�s

countries have allowed them all to be part of the same global interconnected production

network. In addition, China�s on-going liberalization in the services sectors bodes well

for Southeast Asia, in particular for the region�s ethnic Chinese businesses in terms of

investment opportunities. Apart from that, Southeast Asian countries are now

candidates to attract Chinese investment in the region, considering that China has

become one of the largest investors globally (Wong and Chan, 2002).

As such, there is a need for ASEAN to take measures in a bid for survival and

sustained performance in attracting FDI in view of the Chinese �vacuum cleaner�. As

observed in empirical results, regional impact on economic growth is significant. To

match up better to China�s economic size, there should be a greater integrated ASEAN.

In addition, ASEAN should take a more liberal approach towards FDI from within and

without the region. Lastly, there should be consideration of information and

communications technology (ICT) in the pursuit of FDI.

Firstly, individual countries have to increase and speed up economic integration

within the region. A resulting ASEAN economy will offer a market of half a billion

people, which is close to half of China�s population; and an equivalent GDP to China�s.

Thus, in terms of economic size, ASEAN would have a better footing as a competitor

32

against China, in comparison to the individual countries. In addition, with a greater

range of resources across all member countries, an integrated ASEAN of governments

would be able to increase their bargaining power in negotiations with large TNCs, as

suggested by Lall (2002).

To facilitate economic integration, ASEAN member countries would need to

ensure commitment to designing domestic policies and regional agreements that

harmonize all member countries. Differential policy regimes may reduce the

effectiveness of a unified ASEAN representation, whereby individual member countries

or groups within the region engage in mutually-destructive competition for FDI.

Although joint-promotion of member countries such as the ASEAN-4 could be effective

in a way that all member countries are similar and thus easier to promote as a single

entity, it would be more enticing to promote ASEAN to foreign investors as a dynamic

region with the ability to house different levels of the production chain in ASEAN

locations with close geographical and cultural proximities. Thomsen (1999) had

suggested that FDI promotion should be for activities that build on the existing

comparative advantage of the host country. For the region, this would then imply the

need to highlight the comparative advantage that each member country possesses and

attract the corresponding investment activity which can build on those characteristics.

As Severino (2001) puts it, with an ASEAN of all ten countries of the region, it builds a

stronger base for stability in the region, and gives investors more choices in deciding

locations for their operations, for export production elsewhere or for the ASEAN

market that is increasingly integrated.

In addition, ASEAN should increase the region�s openness to FDI while

balancing and maintaining internal relationships between member countries. As

33

mentioned by Thomsen (1999), the incomplete openness towards FDI of the ASEAN-4

does not promote sustainable development, whereby FDI�s role in the domestic

economy is very limited and full beneficial transfers are hindered. As such, the region

as a whole should take a more liberal approach to FDI inflows, so as to benefit from a

wider impact from foreign transfers across the domestic economy. While external

relationships established with source countries of outward FDI should be pursued to

gain transfers of new and more advanced technology from the developed regions, intra-

regional cooperative measures can be undertaken based on the complementarities of

member countries� resources and niche knowledge. This is done to increase the

competitive edge of the region, as well as to build up the indigenous capabilities of each

individual country. As ASEAN countries grow as a region and improve their

capabilities in terms of human capital and infrastructure, coupled with the increasingly

outward-oriented FDI regime, their attractiveness as FDI destinations increases,

especially to FDI activities which are higher on the value chain of production.

As such, it is imperative that individual ASEAN countries be committed in

building up the absorptive capacities of the domestic economy in terms of infrastructure

and human capital. In addition, synergy between foreign and domestic sectors within

the domestic economy should be encouraged, amidst a sound political environment.

Combined with regional openness and incorporation of ICT, an integrated ASEAN can

be promoted as a region for FDI.

34

Appendix Table A1 United States: Demand, Output, External Indicators 2005 2006 2007 2008 Change from the previous year (%) Real GDP 3.1 2.9 2.2 2.0 Private consumption 3.2 3.1 2.9 1.8 Government consumption 0.8 1.4 2.0 2.4 Gross fixed investment 5.8 2.6 -2.1 -1.2 Public 0.6 3.7 2.5 2.9 Residential 6.6 -4.6 -17.2 -15.4 Non-residential 7.1 6.6 4.7 3.7 Final domestic demand 3.3 2.7 1.8 1.4 Stock building -0.2 0.1 -0.3 0.1 Total domestic demand 3.1 2.8 1.6 1.5 Exports of goods and services 6.9 8.4 8.1 8.6 Imports of goods and services 5.9 5.9 2.1 3.4 External indicators (US$ billion) Exports of goods and services 1309.4 1467.6 1642.6 1838.0 Imports of goods and services 2024.0 2229.6 2350.8 2539.0 Foreign balance -714.6 -762.0 -708.2 -701.0 Invisible, net -40.3 -49.5 -60.5 -74.0 Current account balance -754.8 -811.5 -768.7 -775.0 Source: OECD(2007)

Table A2: The Variables and Their Sources

35

Table A3: List of Countries in the Sample

1 Argentina 21 Guatemala 41 Philippines2 Australia 22 Honduras 42 Portugal3 Austria 23 Hong Kong, China 43 Saudi Arabia4 Bahamas 24 India 44 Singapore5 Barbados 25 Indonesia 45 South Africa6 Belgium 26 Ireland 46 Spain7 Brazil 27 Israel 47 Sweden8 Canada 28 Italy 48 Switzerland9 Chile 29 Jamaica 49 Taiwan

10 China 30 Japan 50 Thailand11 Colombia 31 Korea, Rep. 51 Trinidad and Tobago12 Costa Rica 32 Luxembourg 52 Turkey13 Denmark 33 Malaysia 53 United Arab Emirates14 Dominican Republic 34 Mexico 54 United Kingdom15 Ecuador 35 Netherlands 55 Venezuela16 Egypt 36 New Zealand17 Finland 37 Nigeria18 France 38 Norway19 Germany 39 Panama20 Greece 40 Peru

Table A4: Determinants of The Share of US� FDI (All Countries)

Dependent variable: Share of FDIRE CRE


Asia (=1) -2.46 -2.46 -0.65 0.38 0.21 0.16(1.08)** (1.09)** (1.29) (1.08) (0.81) (0.88)

South America (=1) -2.33 -2.33 -0.18 -0.50 -0.76 -0.77(1.10)** (1.11)** (1.26) (0.86) (0.97) (0.97)

Africa (=1) -3.08 -3.09 -0.93 -1.01 -0.04 -0.12(1.05)*** (1.06)*** (1.22) (1.57) (1.25) (1.42)

Australia & New Zealand (=1) -1.40 -1.41 -1.53 -1.04 0.22 0.22(1.54) (1.55) (1.56) (2.43) (2.70) (2.72)

Developed (=1) Yes Yes Yes YesGravity variables Yes Yes YesTime effect No Yes Yes Yes Yes YesMeans of time-variant No No No No No YesObservations 1451 1451 1451 1377 1377 1377Number of countries 57 57R-squared 0.14 0.14 0.16 0.53 0.51 0.51

OLS

Notes: The sample includes all countries; robust standard errors in parentheses; the excluded regional dummy is Europe & Canada; RE stands for random-effect model, while CRE correlated-random-effect model; * significant at 10%; ** significant at 5%; *** significant at 1%.

36

Table A5: Determinants of the Share of US� FDI (Includes only Asia-Pacific Countries)

Dependent variable: Share of FDIRE CRE


South-east Asia (=1) 0.46 0.47 1.15 -2.51 -2.04 -2.65(0.23)* (0.24)* (0.61)* (0.89)** (0.95)** (0.74)***

South Asia (=1) -0.12 -0.11 0.57 -1.81 -1.06 -2.94(0.08) (0.08) (0.57) (0.72)** (1.07) (0.59)***

East Asia (=1) 1.21 1.22 1.50 0.05 -0.06 0.24(0.70) (0.72) (0.70)** (0.43) (0.61) (0.26)

Australia & New Zealand (=1) 1.65 1.66 0.42 -4.69 -2.80 -6.22(1.16) (1.20) (1.57) (1.48)*** (1.74) (1.27)***

Developed (=1) Yes Yes Yes YesGravity variables Yes Yes YesTime effect No Yes Yes Yes Yes YesMeans of time-variant No No No No No YesObservations 420 420 420 407 407 407Number of countries 16 16R-squared 0.22 0.22 0.44 0.80 0.74 0.86

OLS

Notes: The sample includes Asia-Pacific countries only; robust standard errors in parentheses; the excluded regional dummy is Middle-Eastern countries; RE stands for random-effect model, while CRE correlated-random-effect model; * significant at 10%; ** significant at 5%; *** significant at 1%.

37

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Documents

New Trends and Patterns of US FDI in Asia