on the determinants of direct foreign investment: evidence
TRANSCRIPT
World Development, Vol. 21, No. 3, pp. 391-406, 1993. 0305-750X/93 $6.00 + 0.00 Printed in Great Britain. fQ 1993 Pergamon Press Ltd
On the Determinants of Direct Foreign
Investment: Evidence from
Asia
East and Southeast
ROBERT E. B. LUCAS* Boston University
Summary. -A model of derived demand for foreign capital by a multiple product monopolist is estimated for seven Asian countries. Direct foreign investment (DFI) inflows are estimated to be less elastic with respect to the costs of capital (including taxes) than to wages, and to be more elastic with respect to aggregate demand in export markets than domestic demand. The output deterrent effect of higher wages is estimated to outweigh any substitution toward greater capital intensity. The estimates also suggest that: DFI rises with greater costs within the investors’ home countries; no similar effect occurs with respect to costs in rival host countries; and concerns for political stability have overlain economic determinants.
1. INTRODUCTION
During the 1970s and 198Os, the fraction of world direct foreign investment (DFI) hosted by the developing countries has declined, as foreign investment in the United States has increasingly dominated world capital inflows. Yet Asia (which in the International Monetary Fund regional scheme excludes the Middle East) has sustained and even slightly increased its world share. Thus during 1972-87 Asia received 8% of world DFI, amounting to 29% of DFI in the developing countries, and by 1987 this latter share reached 49%. For foreign investors as well as for the Asian region, the factors affecting these flows are clearly of major significance. In this paper some determinants of DFI inflows over the last three decades are examined in the context of seven economies in East and South- east Asia: Indonesia, South Korea, Malaysia, the Philippines, Singapore, Taiwan and Thailand.’
But this paper is not merely an application of a well-established framework to a specific region. Somewhat surprisingly, few prior empirical con- tributions on determinants of DFI are derived from any explicit model of firm behavior and, as a result, the literature has developed largely independently from the modern tradition of derived demand for domestic capital.’ Indeed from the substantial empirical literature on deter- minants of DFI it is difficult to discern a
conventional wisdom.’ One relatively consistent theme which does emerge is the attraction of a large domestic market in the host country, which is typically explained by the prevalence of protection-hopping DFI combined with scale economies.’ The newly industrialized countries of East Asia are dynamic exporters and a significant portion of DFI in this region has been to build an export platform. A priori, it therefore seems doubtful that one of the few elements in the conventional wisdom - that access to a large domestic market is important to foreign investors - will prove particularly helpful in this context.
In contrast there is no unanimity among the comparatively small number of studies which explore the role of labor costs in affecting DFI in various regional contexts; results range from higher, host country wages or unit labor costs discouraging inbound direct investment (Golds- brough, 1979; Saunders, 1983; Flamm, 1984; Culem, 1988), to having no significant effect or even a positive association, the latter being typically described as “perverse” or attributed to unmeasured labor quality (Caves, 1974; Nank- ani, 1979; Swedenborg, 1979; Kravis and Lipsey, 1982; Wheeler and Mody, 1990). In policy discussion within at least some of the newly industrialized economies of East Asia there is an explicit concern for the role of escalating labor
*Final revision accepted: March 30, 1992.
391
392 WORLD DEVELOPMENT
costs in deterring foreign investment, with an active tournament to attract seemingly footloose industries (Flamm, 1984). Consequently the role of labor costs, which has proved puzzling in prior literature, will be important to our story.
Section 2 sets out the theoretical approach adopted, namely a simple derived demand for foreign capital for a profit maximizing, multiple product monopolist. Extensions to this basic model, also oulined in section 2, include interde- pendence in location decisions, a potential role for market size, expectations formation, and consideration of political risk and the regulatory environment.’ Estimates of this model are pre- sented in section 3.
2. THEORY AND SPECIFICATION
(a) Basic theory
One of the simplest approaches to multiple plant production by a firm incorporates product differentiation across plants. Given some degree of monopoly in its product markets, and abstract- ing from product market interdependence and risks for now, a profit-maximizing firm chooses output in each host country (h) to satisfy:
Mux f Ph (qh) qh - ch ('?h) 9h
(1)
where qh = output in Country h ph = price of country h’s product C I, = total production cost in h.
More particularly, for empirical purposes, it will be convenient to adopt a constant elasticity of product demand and restricted, generalized Cobb-Douglas cost function with rising marginal costs?
p = qq-’ 0 < q < 1 (2)
c = wl-+ek-n 9 ‘+‘+I,4 O<@<l
x,y,t > 0 (3)
where w = cost of labor r = rental equivalent for foreign capital k = domestic capital stock and the subscript h is suppressed to ease notation.
Solving the first-order conditions from (1) subject to (2) and (3) provides an explicit form for the choice of output in any given location:
q = [(l+y)PL~w”P1rm”k”~] : (4)
From Shepard’s Lemma the derived demand for foreign capital (f) is:
f=ew l-QrQ-lk-Kql+./
After substituting for q from (4) into (5) and simplifyin
$> this derived demand may then be
rewritten:
(1 +Y) (l+Y) (e+y) H ~ _-
f=@r Y [:I Y [Ll-?ky P W
(l+Y) _-
where $ = Q( l+y) y (6)
Perhaps one reason for the ambiguity which has arisen with respect to the role of labor costs in much of the empirical literature on determinants of DFI is the dual role for win (6). As wages rise, ceteris paribus, production and hence foreign investment tend to be discouraged as may be seen from (4). On the other hand, as wages rise relative to the cost of capital there is a tendency to substitute DFI in place of labor, given output, which is shown in (5). When y is positive (the assumption of rising marginal costs in equation 3), the output effect dominates and while the exponents on both wlp and riw are negative in (6), that on the former is larger.
The exponent on domestic capital is positive in (6). At present, five of the countries under review impose some equity participation limits upon foreigners, usually depending upon the industry and export orientation of the investment.’ If some firms are constrained by a fixed equity-ratio requirement, while others behave according to (6), the aggregate would re- inforce the positive association between foreign and domestic capital present in (6). An alter- native formulation might specify the derived demand for a geometric composite of foreign and domestic capital. In this event, the rental cost of capital must refer to the composite, but the exponent on domestic capital in the equivalent of (6) would now presumably be negative. These opposing specifications, combined with the diffi- culty in measuring capital service costs, may offer a partial explanation for the mixed evidence as to whether foreign investment crowds out or com- plements domestic investment. (See Helleiner, 1989.)
DETERMINANTS OF DFI 393
(b) Extensions: Interdependence of locations and market size
(i) Interdependence of locations So far in this framework production costs in
other countries do not affect the demand for foreign capital in country h. It is not obvious that any such interdependence must occur. On the other hand, one mechanism which would allow for intercountry effects is to permit the elasticity of demand for h’s product to depend upon the output from alternative country a, as for instance if:9
where qa = output in country a. In other words, (7) permits the demand for h’s output to become less elastic, offering a greater potential for monopoly profits, as availability of alternative outputs diminishes. Substituting for n from (7) into (4) then yields an equation for qh in terms of
qa:
qh = [(l+vh)-‘wX”-‘rhe”k~p~] ih t: (8) 4u
A symmetrical equation may be written for qu as dependent upon qh and the two expressions solved simultaneously to eliminate qa. Substitut- ing for q/* in (5) then provides an extended form of (6):
cdl-r)-1 j&‘+r)
Yo(l+Yh) where F =
6h(l+Yh)
A=
Thus, provided 0 < F < 1 and A < 0, the exponents on the three terms in w&h, rrJwh, and kh keep the same signs as in (6) while the similar terms from country a have the opposite signs. “’
(ii) Size of markets The reason for juxtaposing this topic with
interdependence in location is because an ob- vious way to introduce a role for market size is again through the elasticity of demand term. Thus, if:
q=Q” a>0 (10)
where Q is some aggregate measure of market size (such as GDP in the relevant market), then substituting for n in (4) leaves Q with a positive exponent in the foreign capital equation.”
Two measures of market size are considered in section 3: one for the domestic market and one for the export market. The reason for making this distinction stems from the emphasis on protection and size of the home market in most of the prior literature (as noted in the introduc- tion), in contrast to the outward orientation and hence potential importance of size of the export markets for the East Asian countries under review.
(c) Expectations formation
To the extent that foreign investment commit- ments are non malleable and tend to be difficult to reverse, the anticipated time paths of future costs and returns shape today’s investments. Given the limited degrees of freedom available for estimation in the present context, it is necessary to envision a fairly circumscribed information set on which expectations are formed. In particular, four additional elements are incorporated. The first two are simply w/p and rlw lagged one period.” The remaining two elements require a few words of clarification.
In the empirical work to follow, labor costs (w) are measured by average earnings. But an addi- tional cost stems from the incidence of industrial disputes.” Certainly governments of some of the countries under review have been concerned to limit industrial disputes, and have restricted collective bargaining and the role of unions partly with this intent. Although not the sole reason for concern with respect to industrial disputes, the tournament to attract DFI has undoubtedly been a factor in affecting this policy stance. Toward considering whether this particular concern is well founded, a measure of workdays lost in industrial disputes, normalized on employment in manufacturing is examined in the empirical specification in section 3.
The role of the exchange rate in determining DFI flows has been the subject of some debate. (See, for instance, Froot and Stein, 1989; Lipsey, 1989). To the extent that the exchange rate affects wlp or rlw in an open economy it already plays a role in our model. There may, however, be a residual role with respect to exchange rate risk, for example, in determining the value of repatriated profits or in threatening restrictions on such remittances. To reflect this, a measure of
394 WORLD DEVELOPMENT
likelihood of currency depreciation, represented simply by months of imports covered by foreign exchange reserves, is included in the empirical formulation.‘”
(d) Political risk and the approvals process
Although “political risk” is commonly men- tioned as influential in foreigners’ decisions to invest, the concept actually embodies a variety of concerns, ranging from production disruption, to confiscation or damage to property, to threats to personnel, to a change in macroeconomic man- agement or the regulatory environment.
With regard to the last of these, special mention of one aspect in particular is warranted. Of the seven host countries under review, at least four currently require public authority approval for a substantial range of proposed foreign investments. l5 Clearly, if the approval process is ultimately binding in any situation, then one would not expect to find that realized DFI is responsive to the type of cost variables examined in section 2 (a). On the other hand, the mere existence of an approval process does not imply binding restrictions. Indeed, there has been increasing pressure within the region to acceler- ate decisions, to organize one-stop procedures, and to move toward automatic approvals in attempts to attract foreign capital. Nonetheless, such variations in ease of the approvals process through time and across countries may well play a significant role in determining observed DFI, and this will matter in the interpretation of our results.‘”
Measurement of changes in regulatory en- vironment and of political risk more generally are inherently difficult. No continuous representa- tions are available.” Instead, the estimates in section 3 incorporate dummy variables to repre- sent key episodes, though discussion of these time-specific dummies is postponed until presen- tation of the results.‘x
(e) Empirical specification
Given the confines of space it is not possible to itemize the extensive set of documents from which the data are compiled for this study, yet a few words on a number of issues with respect to measurement are essential.
The models already outlined are estimated using annual time-series data for 196tLS7, draw- ing upon the usual transformation from capital stock demand to investment decision. The mea- sure of DFI is net investment in the reporting
country, divided by that country’s deflator for fixed capital formation, where net DFI refers to net of depreciation but not net of any outgoing foreign investment abroad.‘” These capital flows are depicted in Figure 1, where it may be seen that in three contexts - Indonesia, South Korea and the Philippines - DFI has been negative or zero for some portion of the period. This presents a dilemma since a linear-in-parameters formulation of the model outlined above ex- presses DFI in logarithmic terms. Two strategies are adopted: to consider a logarithmic formula- tion for the dependent variable confined to the interval in which DFI is positive; or to explore a linear formulation over the entire period if non- positive DFI is observed.
The measurement of a rental equivalent cost for capital services is even more contentious in the context of foreign investment than for domes- tic capital. For present purposes this cost is measured by r = pk x ir/(l - tx) where pk is the fixed capital formation deflator in the host country, ir is a measure of the real interest rate and tx indicates the corporate profit tax rate. The marginal source of funds for foreign investors, and hence a relevant measure of the interest rate, is not apparent: retained profits, host country debt, or transfers from headquarters. Jun (1989) favors the last of these, and the measure adopted here reflects this view. In particular a weighted average of lending rates of interest in the United States, Japan and the United Kingdom is calcu- lated and the rate of inflation in host country wages deducted to leave a measure of real interest rate (ir).2” A reasonable measure of the corporate tax rate proves problematic. Not only are time series on the nominal rates not readily available, but various tax holidays and allowances - not to mention the incidence of evasion - considerably complicate the picture.” A proxy for the corporate tax rate is therefore constructed as the ratio of corporate tax revenue collected relative to value added in manufacturing. The absolute levels of these tax indices are based upon end period estimates of tax rates assessed on a roughly comparable basis across countries. (See Business International, 1990.) The resultant measure of r ranges from positive to negative in each of the seven econo- mies. In consequence, r/w is uniformly treated in linear rather than logarithmic form.
The wage rate (w) is measured by average monthly earnings in manufacturing. Given the export orientation of much of the DFI in the seven economies (partly the result of tax and equity-participation advantages tied to export performance), product price (p) is measured by the export price index. No consistent measures
DETERMINANTS OF DFI 395
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Figure 1. Direct foreign investment inflows
are available of domestic capital stock in joint contemplate examination of a multiple location
ventures with foreign residents. Instead, k is choice framework. Two alternatives for repre- represented by the rate of fixed capital formation sentation of the alternative location are therefore in the economy minus the rate of DFI. examined in section 3: a weighted average of the
Section 2 (b) (i) presented a theory of choice remaining six economies; and a weighted average between two locations. Reality is clearly more of the countries of origin of investment.22 complex, but the data are not rich enough to Traditionally the measure of domestic market
396 WORLD DEVELOPMENT
size has been GDP or its growth. Our model, however, already incorporates a role for domes- tic capital formation, and the issue of exports is to be examined separately. Consequently, domestic market size is measured here by private plus government consumption spending, deflated by the consumer price index, while size of export market is represented by a weighted average of GDP in the major export markets for the country in question.*’
3. RESULTS
The presentation of results is divided into two main sections: the first examines each of the seven countries separately; the second pools the time-series data across countries.
(a) Individual country results
Estimates of the basic model (6) for the individual countries are presented in Table 1. Whether the dependent variable is in logarithmic (LF) or linear (F, form is indicated in the heading of each column, and T-statistics for zero null hypotheses are shown in parentheses be- neath all coefficients throughout this paper.2J Estimation of results in Table 1 is by instrumental variables with the terms ln(wip), r/w, and In(k) endogenous.‘s
First, consider the effects of the continuous variables in the top portion of the table. To help in interpreting the estimated price terms (ln(w/p) and r/w) and their lags, Table 2 presents the estimated long-run elasticities for the three com- ponents - w, p and r - derived at the sample means from these equations.
In five out of the seven cases the joint test that all three elasticities are zero is rejected at a 95% confidence level or better, while for South Korea the significance level is approximately ll%.2h Thus DFI flows have indeed been responsive to prices and costs, though to this rule Taiwan seems to be an exception.27 With this exception, the elasticity of DFI with respect to host country wages proves negative with at least 90% confi- dence in Table 2. In other words, the output deterrent effect of higher wages is estimated to outweigh any substitution toward greater capital intensity. The elasticity with respect to export price is also positive in the same six countries, at a 90% confidence level or better.28 On the other hand, DFI flows generally prove somewhat less elastic with respect to the capital cost measures, though in the Philippines, Singapore and Thai-
land even this elasticity proves negative on a 2.5% significance level test.2”
The estimated association between domestic and foreign investment is mixed in Table 1: for South Korea, Malaysia and Singapore there is a statistically significant positive association on at least a 97.5% confidence level test; for the Philippines this positive association is statistically weaker; in Taiwan and Thailand no clear associa- tion emerges; while in Indonesia a strong nega- tive effect is found. The negative effect in Indonesia could arise from a derived demand for a composite domestic-foreign capital stock mod- el, as mentioned previously. On the other hand, the four positive values are consistent with the simple Cobb-Douglas framework in equation (6), though it was also noted earlier that such a positive association could readily result from binding foreign equity constraints on some joint ventures.“’
In order to discuss the meaning of the time- specific dummies, some country specific informa- tion must be introduced.
(i) fndonesia The DFI data for Indonesia in Figure 1 exhibit
a sharp discontinuity in 1974-75, and responses to the continuous variables already discussed are indeed significantly different in the years prior to this. There are a number of reasons why DFI may not have responded according to our simple model in this earlier period: during the Sukarno years, and prior to the banning of the Communist Party in 1966, perceived political risk was high (some foreign property was seized and part of this expropriated in 1963-6.5); following Suhar- to’s takeover, and a decline from the hyperinfla- tion of 1966, restoration of stability and confi- dence was gradual and a steady build up of DFI ensued until 1973, in which year a riot against the Chinese erupted, followed by widespread dis- turbances in 1974. The estimates reported for Indonesia in Table 1 consequently differ from those for the other countries in being confined to the period after 1974. A substantial portion of the DFI in Indonesia has been in petrochemicals and the period analyzed in Table 1 follows the first oil price shock. Yet, following the Iranian revolution and the second oil price shock in 1978, DFI in Indonesia actually fell sharply, as may be seen in Figure 1, which is reflected in the dummy for 1979-81 in Table 1. The Vietnamese invasion of Cambodia in 1979 certainly affected the immediate region adversely, but whether this is sufficient to explain the sharp drop in foreign investment in these years is unclear. In contrast, it might be mentioned that no such drop in DFI is observed in 1975-76 during the Pertamina (state
Tab
le
1.
Est
imat
es
of
basi
c m
odel
fo
r in
divi
dual
co
untr
ies
Indo
nes
ia
Kor
ea
Mal
aysi
a P
hil
ippi
nes
S
inga
pore
T
aiw
an
Th
aila
nd
Sam
ple
7587
61
-87
70-8
7 61
-87
61-8
7 61
-87
61-8
7 61
-87
Dep
V
ar
LF
F
L
F
LF
F
L
F
LF
L
F
Inte
rcep
t
Ln
( W/P
)
Ln
(W/P
)_,
R/W
(WW
)-1
Ln
(K)
Yea
r
Du
mm
y 1
-487
.3
(5.1
1)
-1.8
41
(5.4
9)
1.05
5 (2
.81)
0.00
1 (0
.37)
-0.0
03
(1.9
2)
-3.2
32
(5.8
9)
0.26
5 (5
.21)
79-8
1 -0
.759
(6
.51)
2 3 4
DW
S
tat
2.23
A
dj
R2
0.82
F
-Sta
t 8.
92
No.
O
bs.
13
5206
2.0
- 14
7.8
(3.5
4)
(0.7
8)
-347
.5
-9.5
46
(3.3
0)
(2.7
6)
304.
7 1.
539
(2.7
5)
(0.9
6)
-1.1
00
-0.0
15
(3.0
1)
(3.0
4)
0.56
3 0.
003
(2.8
2)
(0.7
4)
171.
0 6.
303
(2.5
0)
(2.5
8)
-27.
06
0.04
9 (3
.49)
(0
.55)
61-6
9 70
-72
-226
.8
2.40
0 (9
.15)
(2
.45)
79-8
0 79
-1
35.6
-1
.602
(4
.46)
(8
.89)
84-8
5 80
12
3.0
-2.8
17
(6.3
0)
(7.8
2)
86-8
7 86
-87
523.
6 0.
756
(26.
6)
(1.3
9)
2.59
0.
98
27
2.23
1.
92
2.40
1.
65
1.15
2.
27
0.83
0.
90
0.71
0.
92
0.59
0.
82
8.96
39
.17
7.30
49
.83
7.06
14
.24
18
27
27
27
27
27
-14.
94
2283
5 .O
(0
.20)
(2
.27)
-1.0
06
-391
.6
(1.9
2)
(3.8
9)
0.04
3 20
1.1
(0.0
9)
(3.0
7)
-0.0
01
-1.9
18
(0.2
1)
(4.0
0)
-0.0
06
-0.4
22
(1.1
1)
(1.0
1)
0.84
4 11
9.7
(2.4
8)
(1.6
6)
0.00
8 -1
2.09
(0
.19)
(2
.25)
7>85
15
4.0
(4.2
9)
74
-346
.8
(5.2
4)
79-8
0 -2
88.9
(5
.88)
8687
44
4.5
(6.0
0)
-143
.3
-263
.3
-509
.6
(2.1
0)
(0.9
5)
(3.5
6)
-3.0
22
-3.0
77
-4.5
84
(2.1
6)
(1.8
8)
(4.5
6)
1.23
2 2.
941
2.80
9 (1
.14)
(2
.44)
(5
.02)
-0.0
30
-0.0
47
-0.0
30
(2.4
8)
(3.2
3)
(4.8
6)
0.00
3 0.
036
-0.0
09
(0.2
1)
(2.5
2)
(2.7
9)
0.96
6 -0
.438
-0
.109
(3
.10)
(0
.92)
(0
.22)
0.07
3 0.
138
0.26
1 (2
.03)
(0
.97)
(3
.51)
61-7
2*Y
R
0.00
1 (4
.08)
65-6
9 0.
299
(2.3
2)
79-8
0 -1
.347
(5
.90)
398 WORLD DEVELOPMENT
Indonesia South Korea Malaysia Philippines Singapore Taiwan Thailand
Wage (~1 -0.773 -8.033 (1.73) (2.44)
Price (p) 0.786 8.00X (1.82) (2.44)
Capital cost (r) -0.013 0.025 (0.57) (0.98)
CHI’ Wald Test 7.956 6.004 P-Value 0.047 0.1 11
-0.9.57 ~2.461 (2.48) (2.02)
0.963 4.021 (2.55) (2.X7)
-0.006 - 1.560 (0.55) (3.06)
22.06 II.66 0.000 0.009
~ I .S81 (3.35)
1.618 (3.51)
-0.037 (2.45)
55.19 0.000
-0.176 (0.13)
0. 136 (0.11)
0.040 (0.49)
0.316 O.YS7
-1.6X7 (2.87)
1.77s (2.9X)
-0.080 (5.04)
2s .x0 0,000
oil company) scandal, despite defaults on some international payments at the time.31
(ii) South Korea Of the seven countries, South Korea presents
perhaps the most complex pattern. As may be seen from Figure 1, during 1960-69 DFI entering South Korea was positive in only five years and two equations are therefore reported: one linear in DFI for the entire period and a logarithmic specification from 1970 onward.“’ A likelihood ratio test for equal effects from the six con- tinuous variables before and after 1970, in the linear equation, fails to reject the null- hypothesis. and so the earlier period is repre- sented solely by a dummy shift in the intercept. Even during the period when a steadier flow of DFI was permitted, after 1970, six subperiods may usefully be considered: from 197@72 at the end of which Park imposed martial law; the period from 1973-78, prior to Park’s assassina- tion; 1979-80, the year of the assassination and its aftermath; a gradual political liberalization from 1981-87; the major liberalization of invest- ment codes after 1984; then the Asian and Olympic games in 1986 and 1987 respectively. In the linear variant, a likelihood ratio test fails to reject a null hypothesis that the 197CL-72, 1973-78 and 1981-83 episodes differ, and these are therefore combined as the reference period in the intercept; in the second variant only the latter two are indistinguishable. DFI in the year of Park’s assassination and the year following drop- ped sharply, ceteris puribus, according to both specifications.“’ The linear model suggests a significant rise in DFI with the revision to the investment codes in 1984, though no such result is found if included in the logarithmic version. But there is clear agreement with the regard to the substantial expansion in DFI in 198687, some of which was in hotel capacity for the
games. But 1987 was also a year of massive labor disruption, and to this later results will return.
(iii) Maluysiu The major disturbance in Malaysia during the
last three decades was the race riots in 1969, but no significant drop in DFI resulted either then or in the following year, and indeed a dummy for these years proves significantly positive if added to the reported equation. These riots ushered in the New Economic Policy in 1971, incorporating restrictions on ethnic composition of corporate equity capital as well as affirmative action in employment. Yet, despite the sweeping reforms involved from the inception of NEP until its conclusion in 1990, a dummy for this episode has no significant effect if appended to the reported equati0n.s” Since inclusion of either of these dummies also has no appreciable effect upon the reported coefficients these estimates are not shown.
(iv) Philippines In September 1972 Marcos declared martial
law in the Philippines. A dummy variable repre- senting the balance of the Marcos years, through 1985, is included in Table 1 and has a positive coefficient. In contrast, the honeymoon years following Marcos’ initial election in 1965 (marred by mounting protests in 197@71), brought no significantly greater DFI than in previous years. Even during the period of martial law, two episodes of violent domestic unrest erupted in 1974 and again in 1979-80, both represented by dummies with negative coefficients in Table 1. Following the Acquino election, DFI surged in 198687, again reflected in the reported results, though a part of this surge resulted from debt- equity swaps and hence reported DFI.
DETERMINANTS OF DFI 399
(v) Singapore The modern history of Singapore has been one
of remarkable stability under the continuing premiership of Lee Kuan Yew throughout the period of analysis. To what extent this stability has aided Singapore in attracting nearly a third of all DFI in the region during these years is difficult to ascertain.
(vi) Taiwan Undoubtedly the major international news for
Taiwan over the last three decades has been its deteriorating diplomatic status. In 1971, the United States normalized relations with Beijing and in October of that year Taiwan lost its seat in the UN; then in 1978 the United States severed diplomatic ties with Taiwan. If dummy variables are included for the periods after 1971 and after 1978 their coefficients prove negative - perhaps suggesting increased concern for stability - but statistical confidence in these findings is weak (especially after 1978, see also Flamm, 1984) and since no appreciable change is observed in other parameters these are excluded from the results in Table 1. It remains possible that the development of Western economic relations with the Peoples’ Republic might have detracted from DFI in Taiwan, but this proves not to be the case. In particular, if DFI on the mainland (which rose sharply after its inception in 1982) is included in the estimated equation for Taiwan it actually proves to have a strong positive association.‘5 On balance it therefore seems that the rotation of diplomatic recognition from Taipei to Beijing has not significantly discouraged foreign investment in Taiwan.
(vii) Thailand Political events in Thailand during the 1960s
were dominated by the burgeoning civil war in neighboring Laos and by the Vietnam war. From 1965-69, in particular, the United States built up
its military presence in Thailand and this attracted associated DFI as reflected in the positive coefficient on the dummy variable for this period. Indeed, an additional trend term for the period until 1972 also proves small but significantly positive in Table l.jh Since 1973 three major episodes may be distinguished: 1973-77 was a period of quite continuous domes- tic disturbances; in 1979 Vietnam invaded Cam- bodia resulting in an exodus of refugees into Thailand, and in June 1980 Vietnamese troops crossed the Thai border; but from 1982-87 both the domestic and international scene became relatively stable. It is clear from Figure 1 that DFI rose during the 1980s. Much of this acceler- ated investment, however, is consistent with the positive underlying trend - a dummy variable for the more stable years after 1982 proves insignificantly different from one for the dis- turbed years from 1973-77. On the other hand during 1979-80. with the heightened Vietnamese threat, DFI was significantly lower, as reflected by the dummy for these years in Table 1.
(b) Pooled estimates The degrees of freedom are too small to permit
meaningful exploration of extensions to the basic model for individual countries. Before proceed- ing, however, to pool the data from all seven countries it is worth asking if such a step is inappropriate. Table 3 reports F-statistics for the joint null hypothesis of equal effects from the six continuous variables, in pair-wise country com- parisons, based upon the logarithmic specifica- tions in Table I:’
Pooling all seven countries is clearly rejected. Two country groupings, however, are formed, though inclusion of Indonesia in the first pool requires some interaction terms.jx The pooled estimates, comparable to Table 1, are reported in the first column under both group headings in Table 4?’
Table 3. Pooling nests on coutltry pin
South Korea Malaysia Philippines Singapore Taiwan Thailand
Indonesia Korea Malaysia Philippines Singapore Taiwan
(6,12) 2.18 (6,25) 9.92** (6,‘)) 0.69 (6,25) X.74’* (6.2.5) 1.90 (6.22) 9.50-* (6,27) 1.64 (6,ll) 0.56 (6.27) 0.61 (6,27) 2.00 (6.21) 3.10*
(6.24) 1.22 (6,40) 6.43**- (6.40) 4.21” (6.37) 6.06”” (6,24) 1.42 (6,24) 1.79 (6.21) 1.61
(6,40) 2.01 (6.37) 1 .SS (6.37) 1.77
*Exceeds critical value at 5% confidence level. **Exceeds critical value at 1% confidence level. Degrees of freedom in parentheses followed by F-Statistic
Tab
le
4.
Est
imat
es f
rom
po
oled
sa
mpl
es
Poo
l de
fin
ed
Indo
nes
ia
75-8
7 S
outh
K
orea
7&
X7
Mal
aysi
a P
hil
ippi
nes
S
inga
pore
T
aiw
an
Th
aila
nd
61-8
7 73
-79
81-8
7 61
-87
61-8
7 61
-87
Inte
rcep
t In
don
esia
S
outh
K
orea
P
hil
ippi
nes
1
169.
1 (2
.66)
48
7.6
(1.6
6)
-435
.4
(1.6
6)
-3.3
19
(5.2
2)
-2.7
76
(3.2
9)
Ln
(W/P
) L
n(W
/P)
,
$1
Yea
r
-729
.6
(4.2
3)
-3.5
44
(9.7
4)
-2.6
37
(4.5
4)
-1.8
77
(2.3
3)
1.32
5 (2
.00)
-0
.013
(2
.70)
-0
.006
(2
.16)
1.
559
(5.5
3)
-0.0
89
(2.6
6)
0.01
4 (2
.14)
-5
.244
(6
.65)
0.
393
(4.3
3)
192.
4 (2
.20)
-6
02.7
(3
.72)
-3
.083
(4
.88)
-2
.106
(2
.93)
-1.4
11
(1.8
3)
1.13
0 (1
.89)
-0
.009
(1
.70)
-0
.004
(1
.52)
1.
423
(3.9
5)
-0.1
05
(2.2
3)
-1.4
62
(2.1
1)
0.67
0 (1
.30)
-0
.014
(2
.78)
-0
.005
(2
.09)
1.
353
(3.7
3)
-0.2
52
(1.6
7)
Indo
n*
(R/W
) In
don
* L
n
(K)
Indo
n*
Yea
r
0.00
9 (1
.45)
-3
.839
(3
.97)
0.
322
(3.7
5)
0.01
7 (2
.80)
-4
.206
(4
.43)
0.
239
(1.7
5)
Hom
e C
oun
try
Ln
( W/P
) L
n(W
/P)_
,
@;
I
4.68
8 (0
.87)
-1
.333
(0
.25)
-0
.012
(1
.46)
0.
001
(0.0
8)
-0.9
93
(0.9
9)
Con
sum
ptio
n
0.00
6 (0
.29)
F
orei
gn
GD
P
0.05
7 (1
.35)
M
ths.
R
eser
v.
0.07
3 (1
.18)
S
trik
es/E
mpl
-0
.013
(0
.99)
Du
mm
ies
Ind
79-8
1 K
or
70-7
2 79
80
8&
87
Ph
l 74
7%
30
86-8
7
DW
S
tat
Adj
R
Z
F-S
tat
No.
O
bs.
-0.5
84
(2.4
0)
0.73
9 (2
.14)
-1
.760
(1
0.6)
-3
.043
(1
5.2)
1.
389
(6.3
6)
-3.5
68
(9.9
4)
-3.2
27
(10.
4)
3.16
9 (5
.92)
2.00
0.
81
16.3
72
-0.4
64
(2.4
3)
0.94
3 (2
.05)
-1
.654
(9
.74)
-2
.797
(1
0.7)
1.
479
(5.6
8)
-3.6
47
(12.
6)
-2.9
45
(9.3
1)
3.15
2 (6
.94)
2.20
0.
82
14.2
72
-0.8
17
(2.7
4)
0.52
5 (1
.46)
-1
.788
(9
.13)
-2
.891
(1
6.7)
1.
416
(3.5
2)
-3.5
67
(12.
4)
-3.3
46
(14.
6)
2.71
8 (5
.92)
2.25
0.
82
14.8
72
2 3
Tai
wan
T
hai
lan
d
Th
l 61
-72*
yr
65-6
9 79
-80
Rh
o A
dj
R2
Log
L
ike.
N
o.
Obs
.
1
-413
.0
(4.0
8)
-1.5
06
(3.6
2)
-2.2
12
(6.0
9)
-4.2
63
(4.4
3)
2.82
9 (3
.30)
-0
.025
(3
.33)
-0
.001
(0
.19)
-0
.137
(0
.35)
0.
213
(4.0
4)
0.00
1 (3
.46)
0.
261
(0.8
4)
-1.1
37
(2.8
2)
0.32
(2
.86)
0.
71
-37.
6 81
2
-488
.0
(3.4
2)
-1.6
07
(3.6
0)
-2.4
13
(5.2
9)
-6.8
32
(3.2
6)
5.23
0 (2
.69)
-0
.042
(3
.00)
-0
.005
(0
.71)
-0
.124
(0
.30)
0.
252
(3.4
1)
21.3
4 (1
.86)
-2
0.59
(2
.10)
0.
037
(1.5
2)
-0.0
06
(0.3
7)
-0.8
02
(0.4
8)
0.00
1 (2
.41)
0.
265
(0.8
0)
-1.2
93
(2.7
0)
0.10
(0
.84)
0.
77
-46.
7 81
3
-81.
06
(0.4
2)
-2.5
83
(3.9
2)
-3.2
83
(4.4
1)
-3.3
54
(4.3
0)
1.41
4 (1
.90)
-0
.020
(2
.88)
-0
.003
(0
.67)
0.
105
(0.3
1)
0.04
3 (0
.43)
0.04
3 (1
.43)
0.
034
(1.0
8)
0.01
9 (0
.92)
-0
.080
(1
.35)
0.00
1 (2
.94)
0.
231
(0.8
3)
-1.1
08
(3.0
7)
0.25
(2
.02)
0.
79
-29.
5 81
DETERMINANTS OF DFI 40 1
On the basis of these pooled estimates three extensions are considered. The first two deal with production costs in alternative locations, as outlined in equation (9). No meaningful result is obtained, and none is shown, if the alternative country (a) in that equation is interpreted to be a weighted average of the remaining six countries. This may reflect the paucity of our weighting scheme, though it is also quite plausible that the products from these seven economies have not acted as imperfect substitutes on world markets such as to render location decisions interdepen- dent as assumed in (9). Estimates for the case when the alternative location is interpreted to be the foreign investor’s (weighted average) country of residence are shown in the second columns in Table 4. In the Singapore-Taiwan-Thailand pooled sample the estimated directions of effect are consistent with the theory leading to equation (9); thus the coefficients on ln(w/p), ln(wlp)_, and r/w for the home country differ from zero on a 10% significance level, and are of opposite sign from those on the host country variables. But for the other pool the evidence is somewhat mixed, for although the coefficients on ln(w/p) and Ln(k) are weakly consistent with equation (9) that on rlw is not.
The other extension considered incorporates two measures of domestic and export market size - domestic consumption (in billion US$) and an index of foreign GDP (1980 = 100) - and two measures associated with risk - months of imports covered by foreign exchange reserves and person-days lost in industrial disputes per employee. The first three are strongly intercorre- lated which has two implications: (i) prior studies which include measures of domestic market size alone may overstate the magnitude of effect; (ii) although these four variables prove jointly signi- ficant in both equations - passing likelihood ratio tests with more than 90% confidence levels - and bare signs consistent with the hypotheses advanced in section 2, statistical confidence in the separate effects is not great. A diminished risk of currency depreciation with greater foreign exchange coverage is associated with enhanced DFI, though the significance level on this finding is only approximately 12 and 18% in the two estimates. A greater incidence of industrial disputes has tended to deter foreign investment, and in the second pool confidence in this finding exceeds 90% .“’
Both enhanced size of the domestic market and of the export market are associated with more rapid DFI. with significance levels in excess of 14% except for domestic consumption in the first sample pool.” In light of the emphasis, however, on the role of size of domestic market
in many prior studies, as discussed in the introduction, it is interesting to note that the elasticity of response, measured at the sample means, is greater with respect to foreign GDP than with respect to domestic spending - a difference which is significant at the 10% level in the first pool though somewhat weaker in the second.
Finally, it may be noted that none of the reported equations includes a lagged endogenous variable though it is quite common to include one in capital equations. If such a term is appended to the reported equations in Table 4, the coefficient on this lagged dependent variable proves statisti- cally indistinguishable from zero and leaves other terms essentially unaffected. In this sense, it seems that DFI in this region has been ergodic rather than dictated by any agglomeration effects of prior investment patterns. (See Arthur, 1986; Wheeler and Mody, 1990.)
CONCLUSIONS
Using a simple model of derived demand for foreign capital by a multiple product monopolist, this paper explores the sensitivity of direct investment flows to production costs in seven Asian countries which are major hosts to direct investments. Various governments administering to these seven have been concerned to restrain wage escalation and to limit the role of organized labor, partially in order to attract foreign invest- ments. The output deterrent effect of higher wages is estimated here to outweigh any substitu- tion toward greater capital intensity, resulting in a combined negative effect of greater pay upon foreign direct capital inflows. Moreover, although any deterrent effect of industrial dis- putes upon foreign investors is less clear cut, some partial evidence is advanced to support a negative impact. Whether the policy concerns to restrain union activity and to limit pay incre- ments can consequently be justified by their inducement to foreign investors is, however, a larger question.
Foreign direct investment inflows are esti- mated to be less elastic with respect to the costs of capital (including taxes) than to wages, though as always this may reflect inherent difficulties in measuring capital costs. The results as to whether domestic capital complements foreign capital are mixed, though in the majority of country cases a positive association prevails, perhaps rccnforced by foreign equity restraints.
Given host country costs, some weak evidence is also isolated for more rapid foreign investment inflows as costs rise within the investors’ home
402 WORLD DEVELOPMENT
countries. On the other hand, no systematic evidence is obtained that higher costs in rival host countries, within the region, enhance inbound foreign investments. This may simply reflect a paucity in the data. Yet it is not obvious that competitor costs should matter: in our model this is a matter of crosselasticities in product de- mands. If this lack of relevance in competitor costs is correct, then any tournament among these nations to compete for DFI on the basis of lower relative costs may be misconceived.
Most prior empirical studies of DFI determi- nants, in various regions of the globe, consistently find size of domestic market to be important. This is typically ascribed to protection-hopping investments, which may or may not serve to help the host country in a second-best environment. But the results in the present paper depart to some extent from this conventional wisdom. A weak positive association is found between size of domestic consumption spending and rate of inbound DFI. But other elements in the macro- economic environment also appear to matter: thus there is at least a weak positive association between DFI and higher foreign exchange re- serves coverage (and hence diminished prospects
of currency depreciation); moreover DFI is found to be somewhat responsive to incomes in major export markets. Most studies omit con- sideration of these latter factors and, given the high levels of interaction found among these aggregate measures in the present context, it is conceivable that prior estimates bias upward the role of domestic spending. Seen in the context of debates over alternative development strategies (and of Europe after 1992), this is an important issue: inward orientation is not a necessary
1. During 1972-87, these seven absorbed 80% of total DFI in the Asian region. Of the remaining DFI in
NO1
Asia significant portions apparently also entered Hong Kong. though Hong Kong does not keep balance of payments accounts and consequently is excluded from the present study.
2. See. however. Kwack (1972), Goldsbrough (lY7Y), Swedenborg (lY7Y) and Flamm (19X4). In addition, while eschewing explicit treatment of factor costs, a number of recent studies of DFI in the United States. focusing upon tax policy, have adopted models incorporating reported returns (Hartman, 1984; Young, 1988; Slemrod. 1989).
3. For surveys of some of the earlier material see Stevens (1974), Hood and Young (1979) and Caves (1982).
condition for attracting DFI. Indeed, in the present context, DFI is estimated to be some- what more elastic with respect to aggregate demand in export markets than with respect to domestic demand. To what extent East Asia differs from the rest of the world in this regard cannot be discerned; but it is interesting to note how this region of outward orientation has come to dominate as a host to DFI at least within the Third World.
Although one can never be certain precisely what is represented by episodic dummies, a suggestive picture nonetheless emerges of in- fluential good and bad “news” superimposed upon the foregoing role for explicit economic costs: the Games in South Korea, Acquino’s succession, and the US build up in Thailand were accompanied by significantly greater DFI, while Sukarno’s rule in Indonesia, Park’s assassination in South Korea. disturbances despite Marcos’ martial law, and the Vietnamese threat to Thai- land in the late 1970s were each associated with diminished DFI. Direct foreign investment has been responsive to underlying economic factors, and in three of the seven economies examined - Malaysia, Singapore and Taiwan - no dummy variable representing domestic or international traumas is incorporated in the results. For these three the basic model stands alone without qualification. But for the remaining four coun- tries consideration of ‘*economic” costs alone does not suffice; certain periods depart from the pattern attributable to our simple economic model. In these intervals concerns for political stability have apparently overlain the economic determinants.
‘ES
4. A series of papers examine proxies for the role of European Economic Community (EEC) protectionism in promoting US DFI: (Scaperlanda. 1967; D’Arge, 1969; Scaperlanda and Mauer, 1969; Schmitz, 1970: Schmitz and Bieri, 1972; Lunn. 1980; Scaperlanda and Balough, 1983). The results on protectionism are mixed. but most find a positive role for size of host country market. In this same regional context, other studies also note the importance of either current host market size or its growth: (Balassa, 1966; Mikesell, 1967; Bandera and White. 1968; Goldberg. 1972; Boatwright and Renton. 1975; Goldsbrough, 1979; Culem, 1988). Swedenborg (1979) similarly finds a positive role for size of host market in explaining proportion of Swedish firms’ production abroad. Inter- industry studies for Canada find mixed results using effective protection measures (Caves, 1974; Saunders, 1983). La11 (1978, p. 219) notes, “The vast bulk of
DETERMINANTS OF DFI 403
foreign manufacturing investment in LDCs has gone into protected import-substituting activities.” though Nankani (1979), in a comprehensive cross-sectional study of DFI stocks in developing countries, finds no statistically significant support for either a high tariff or a non-tariff protection dummy. Nankani again finds, however, that size of LDC host market proves signifi- cantly positive in attracting DFI. a finding supported by Wheeler and Mody (1990).
S. On interdependence in regional investment deci- sions see Faini and Schiantarelli (1985). On risk and international diversification of investments see Rug- man (1977), Flamm (1984). Wheeler and Mody (1990).
6. While recognizing that the Cobb-Douglas specifi- cation is quite restrictive, an equivalent derivation from a CES formulation proves highly nonlinear. The notion of foreign capital as a distinct factor of produc- tion has a long tradition in the development literature, an approach consistent with different technologies (or management) resulting from alternative sources of capital financing. See, for instance, the two gap-model of Chencry and Bruno (1962). The issue of technology transfer as an alternative to direct foreign investment is not taken up in the present context, in part because good empirical measures of the former are generally not available for the countries under review.
7. For brevity the cost functions considered here make no provision for disembodied technical progress, but this is corrected in the empirical estimates by including a time trend in the empirical counterpart to
(6).
8. At the time of writing, neither Singapore nor Taiwan imposes such restrictions. See Business Interna- rional(l990). An explicit model of joint ventures is not developed here. See, however. Svejnar and Smith (1984).
9. Other mechanisms might also be considered such as risk pooling across countries, increasing marginal transport costs, or the role of noncollusive oligopoly. (See Flamm, 1984; Faini and Schiantarelli. 1985.) A few studies have included measures of production costs in alternative locations in DFI equations though normally without presenting an explicit theory and with mixed results. (See, for instance, Caves, 1974 and Culem, 1988.)
10. Given y > 0, a necessary condition for I > 0 is that y,y, > S,S,. For A < 0 then requires 6 < 0 as imposed in (7). Note, however, that more generally a “perverse” case cannot be ruled out if 6 > 0, meaning that price elasticity of demand for h’s product falls with greater availability of a’s product.
11. Note that such a role for market size is quite separate from the more common interpretation of scale economies; a test of whether the exponent on 4 in (5) differs from unity would indeed test for scale econo- mies. But the measure incorporated for market size in most studies is GDP in the host country, not a measure
of output by foreign investors. For a critique of related issues. see Goldberg (1972). On the inclusion of aggregate demand measures in derived demand for capital equations, see Nickel1 (1979) and Faini and Schiantarelli (1985).
12. The simplest interpretation of these is as adaptive expectations formation on w/p and r/w respectively. In a putty-clay context, once a given amount of domestic capital (k) is committed to production its proportions cannot be varied, and hence expectations on future k are not directly relevant. In a rational expectations model, however, lagged values of k may also affect expectations with respect to other terms; an issue to which section 3 returns.
13. No consistent data on other components of labor costs, such as social security contributions or severance pay, are available.
14. A complete series on foreign debt is not available.
15. In Singapore. most manufacturing projects do not require approval unless certain tax incentives are sought. In Thailand also no special permit is required of foreign investors, though all companies require an operating permit. In addition. in the Philippines, foreigners typically can invest up to 40% equity in most businesses without undergoing an approval process. See Business In~errralional (1990).
16. Although an approvals process is common. at least throughout most of the developing world. its role has passed largely ignored in empirical studies. An alternative approach to that adopted here might envision a mixture of two regimes - something along the lines of equation (6) mixed with a regime restricted by approvals, the proportion of mixture varying over time with the policy environment. Initial experiments in this direction did not prove fruitful in the present context, however. owing to the highly nonlinear functions and limited degrees of freedom. (See Quandt, 1972; Swamy and Mehta, 1975; Quandt and Ramsey, 1978.)
17. See, however, Wheeler and Mody (1990) who offer an imaginative use of the Business Infernafionul indices of political risk. These indices are not, however, available for the entire period examined here.
18. A number of DFI studies have also interpreted time specific dummies or dummies for country charac- teristics as representations of political risk. See, for instance, Nankani (1979) and Flamm (19X4).
19. South Korea, Singapore and Taiwan have been substantial investors abroad in recent years. The principal source for the data on net DFI in the reporting country is the IMF, Balance of Payments Srutlstics; for definitions see IMF (1977).
20. Weights are the portions of foreign capital stock originating in these three base countries toward the end of our period of observation, since annual source data
404 WORLD DEVELOPMENT
are generally not available to offer a Divisia index. The three nominal interest rates are expressed in a common currency by adjusting for any depreciation in the base country exchange rate. On the adjustment for expected wage inflation see Nickel1 (1979).
21. Even in the US context an appropriate measure for corporate tax incidence on multinationals is quite complex. See Horst (1977), Hartman (198.5) and Swenson (1989). In the Southeast Asian context see Age11 (1986) and Shome (1986).
22. In the latter case fixed weights are deployed, as in measuring the cost of financing. In this context, p. is represented by the consumer price index in the country of origin, essentially assuming that the alternative to foreign production is production for the home consum- er market. The weights used in averaging data across the six alternative countries are the annual rates of DFI in these economies. This presumes that industrial structure of DFI is irrelevant. To a certain extent this is correct; it is potential competitors who matter not merely those who actually host DFI in similar indus- tries. On the other hand, particularly where natural resource extraction is involved, these simple weights may be misleading: countries with no oil are not direct competitors for DFI in oil economies.
23. The measure of domestic market size includes imports, on the presumption that it is the potential for spending on goods to be produced in the host country which presumably should matter, if anything, and not merely the current domestic production for the home market. The dominant export markets for this region are the United States and Japan. An index is therefore formed from the weighted average of GDP in these two, with fixed export shares to the United States and Japan from the specific economy as weights.
24. Standard errors for parameter estimates in Table 1 are derived using White’s heteroskedasticity robust method. (See White, 1980.)
25. The instrumental variables are principal compo- nents of: export price, days lost in industrial disputes and the corporate tax index, plus lagged values of exports, the exchange rate, GDP and foreign exchange reserves for each of the seven countries; the lending rate, wage rate, consumer prices, GDP and the exchange rate for the United States, Japan and the United Kingdom; and time.
26. This is based on the Chi’ statistic for a Wald test which is shown in Table 2. The reported P-value refers to the marginal significance level of this test. The elasticities for South Korea refer to the second equa- tion reported in Table I.
27. Although the estimated current price terms for Taiwan in Table 1 are strongly negative they are only slightly larger in absolute value than the positive coefficients on the lagged terms. Yet even these small differences can matter in times of rapid change. For instance, the sharp rise in DFI after 1985 (as seen in
Figure 1). was accompanied by a substantial drop in the cost of capital relative to wages.
28. For the case of rising marginal costs (y > 0) the elasticity with respect to price should exceed one. In the cases of South Korea, the Philippines and Singa- pore this condition is met with 90% confidence or better. while in Thailand the confidence level is just slightly below 90%. For Indonesia. Malaysia and Taiwan the point estimates lie below one, but the upper limit of the 95% confidence interval lies well above one, even for the case of Taiwan.
29. One reason for the smaller estimated responsive- ness with respect to capital costs may well be inadequa- cy of the proxy measures developed. Note that in the case of Korea and of Taiwan. the reported point estimate of elasticity with respect to capital cost is slightly positive. This is a consequence of a negative mean value for capital cost in these cases. Certainly the point estimate of long-run marginal response of DFI to capital costs is negative in all seven countries:
Esfimated long-run marginal effect (hf/hr)
Indonesia Korea Malaysia Philippines -0.016 -0.011 -0.034 -0.052
(1.06) (1.9X) (0.82) (3.05)
Singapore Taiwan Thailand -0.162 -0.007 -0.093
(2.52) (0.33) (5.04)
30. An alternative explanation for a measured posi- tive association might be from any unobserved effects of investor optimism stimulating both sources of invest- ment. As noted in section 2, a case may be made for including lagged values of domestic investment as shaping rational expectations. For brevity, the results of including a one year lag on In(K) are excluded from Table 1 since the reported results remain broadly unaffected, though the coefficient on this lagged term proves negative for Indonesia and positive for South Korea’s linear variant with at least 90% confidence.
31. If a dummy for these two years is appended. the associated coefficient actually proves significantly posi- tive though the equation is otherwise essentially un- affected.
32. The linear specification is corrected for first order serial correlation with an estimated coefficient of -0.79 (T = 5.47) obtained by the Beach-MacKinnon maxi- mum likelihood procedure.
33. In the linear model a null hypothesis of equal decline in the two years cannot be rejected but this is untrue in the logarithmic version: hence the difference in’ treatment.
34. The obvious rise and decline in Malaysian DFI during the 1980s (as seen in Figure 1) is largely associated with a very similar pattern in domestic investments, in part associated with the capital inten-
DETERMINANTS OF DFI 405
sive, HICOM strategy of Dr. Mahatir’s government. Capital costs rose sharply in the mid-1980s as the Ringgit appreciated, but the estimated elasticity of response to this effect is low, as seen in Table 2.
35. For the purpose of this test, DFI in the Peoples’ Republic is deflated by the Taiwan capital formation deflator. Again it is found that the inclusion of this measure proves largely orthogonal to the results already reported.
36. Interestingly, no evidence is found of a significant downturn in this trend during 1971-72 despite the Nixon doctrine of diminished US involvement in Asia and resultant Thai overtures both to the Peoples’ Republic of China and the Soviet Union.
37. No separate estimate of a logarithmic formulation is reported in Table 1 for the Philippines owing to the very small number of observations.
38. In the results in Table 4, an interaction is included between the country dummy for Indonesia and r/w, In(k) and time. The coefficients on these three terms for Indonesia differ significantly from their counter- parts in the first pooled sample. Once these interactions
are included, however, incorporating Indonesia into the first pool cannot be rejected.
39. The result in Table 4 for the Singapore-Taiwan- Thailand pool exhibits significant first order serial correlation and is accordingly estimated using the Beach-MacKinnon maximum likelihood estimator.
40. Inclusion of reserves or industrial disputes lagged one year does not add significantly to either equation. The industrial disputes in South Korea in 1987 are a clear outlier, as already mentioned. The fact that DFI was sustained in South Korea despite this (partly as a result of the Games in 198687) contributes to the diminished significance of any deterrent effect in the first pool.
41. A few authors have argued in favor of growth in market size as the more important explanatory vari- able. (See Hymer and Rowthorn, 1970; Lunn, 1980; Scaperlanda and Balough, 1983; and Culem, 1988.) If domestic consumption and foreign GDP levels are replaced by their growth rates in Table 4, both measures are indistinguishable from zero in the first pooled sample and both are positive on a 17% significance level test in the second pool, leaving other terms essentially unaffected as reported in Table 4.
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