The Policy Studies Journal, Vol. 36, No.

3, 2008

U.S. and Japanese Foreign Direct Investment in East Asia: A Comparative Analysis
Sung Deuk Hahm and Uk Heo
East Asia has led the world in economic growth and export expansion in recent decades. The phenomenal rate of economic growth among the so-called four little tigersHong Kong, Singapore, South Korea, and Taiwanenabled them to achieve newly industrializing country (NIC) status in the 1980s, followed by Indonesia, Malaysia, and Thailand. Earlier studies explained the development from the government-led development paradigm, or the so-called the statist approach. Scholars also argue that foreign direct investment (FDI) played an important role in the economic development, thanks to technology transfers. Kojima and Ozawa and later Kohama, however, argue that Japanese FDI help East Asian economies while U.S. FDI do not because Japanese technology transfer practices are appropriate for East Asian countries but not the United States. Thus, we revisit the issue of East Asian economic development and test the economic effects of FDI from the United States and Japan. Using a Barro-type growth model, we test the effects of FDI from the United States and Japan on economic growth in East Asian NICs. We nd that FDI from both the United States and Japan helped economic growth in the four little tigers, but not in Indonesia, Malaysia, and Thailand.

Introduction The miraculous economic development of the four little tigers in the 1970s and 1980s (the rst generation of newly industrializing countries: Hong Kong, Singapore, South Korea, and Taiwan) has generated substantial research aimed at explaining the economic success of these countries.1 A number of factors have generally been considered crucial in the success: (i) the role of Confucian culture; (ii) relatively cheap quality labor based on high levels of education; (iii) high rates of savings and investment; and (iv) export-oriented industrialization policy under the governmentled development paradigm, the so-called the statist approach (Amsden, 1989; Clark & Lemco, 1988; Clark & Roy, 1997; Evans, Rueschemeyer, & Skocpol, 1985; Johnson, 1982; Wade, 1990). Although there have been some debates regarding the explanations mentioned above, discussions on this issue largely ended by the early 1990s, with most accepting these explanations. The emergence of the second generation of newly industrializing countries (NICs) with Indonesia, Malaysia, and Thailand signicantly developing their economies, however, has led to a need for better explanations. The reason is that these

385
0190-292X 2008 Policy Studies Organization Published by Wiley Periodicals, Inc., 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington Road, Oxford, OX4 2DQ.

386

Policy Studies Journal, 36:3

countries are much more diverse than the four little tigers, therefore, previous theories have limited explanatory power.2 For instance, the inuence of the Confucius culture on economic success in the second generation of NICs is rather limited given that Islam is dominant in Indonesia and Malaysia while Buddhism is the prime religion in Thailand. Although ethnic Chinese played an important role in the growth of Indonesia, Malaysia, and Thailand, dominating a signicant portion of local capital assets, the explanatory power of this theory for explaining national economic growth seems to be limited given that they constitute less than 10 percent of the population (see Chan, 1993). The theory of high-quality human capital that stems from the Confucius culture theory is also less applicable to the second generation of NICs than the four little tigers, because education levels in Indonesia, Malaysia, and Thailand are much lower than those in Hong Kong, Singapore, South Korea, and Taiwan. For instance, according to Barro and Lees (2001) education attainment data, the average years of schooling in the four little tigers were 9.3 in 2000, whereas it was only 6.1 for the second generation of NICs. The percentage of population over 15 years old with complete secondary educations for the four little tigers was 7.25 percent in 2000 while that for the second generation of NICs was merely 3.46 percent (http://www.cid.harvard.edu/ciddata/Appendix%20Data%20Tables.xls).3 Furthermore, Kohama (2003, 2004), Heo and Hahm (2007), and Urata (2005) report that foreign direct investment (FDI), particularly U.S. FDI, played an important role in recent economic success of South Korea, Taiwan, Indonesia, Malaysia, and Thailand. There is also considerable controversy about the role of the state in Thailands economic development, although the statist approach still provides good explanations for economic development in Indonesia and Malaysia, as well as in the four little tigers (see Neher, 1999). In addition, the four little tigers have continued to enjoy relatively good economic growth despite the signicant political and economic changes. For instance, Hong Kong was returned to China, and the third wave of democratization led to the weaker autonomy of the state in South Korea, Taiwan, and Indonesia. Yet the average annual growth rate between 1989 and 2005 for Hong Kong was approximately 5 percent according to Central Intelligence Agency (CIA) World Fact Book. The International Monetary Fund (IMF) reports in the International Financial Statistics Yearbook that South Korea enjoyed 5.39 percent of growth between 1996 and 2005. South Korea also experienced a nancial crisis in 1997, and had to be bailed out by the IMF. During the recovery period, South Korea experienced negative growth but recovered shortly and graduated from the IMF bailout program sooner than expected. The 1997 nancial crisis also affected Hong Kong, and an economic recession occurred in Taiwan in the early 2000s. The Severe Acute Respiratory Syndrome outbreak in 2003 also had an impact on the economies of Hong Kong, Taiwan, and other Southeast Asian countries. In light of these developments, the previous theories do not fully explain the economic success of the second generation of NICs and the continuing economic growth even after signicant political and economic changes in the four little

Hahm/Heo: U.S. and Japanese FDI in East Asia

387

tigers. A new theory and empirical studies are needed to better understand economic development in East Asia. In this paper, we develop and empirically test a theory based on previous research and the commonality of the East Asian economieshigh levels of domestic investment and FDI. Despite the fact that macroeconomists have developed a number of growth models, previous studies on this issue have often employed a qualitative analysis approach. To ll this gap in the literature, we adopt Barros endogenous growth model, a mainstream growth model in economics literature (Dunne, Smith, & Willenbockel, 2005), and quantitatively test the economic effects of labor, domestic, and foreign investment; human capital; and the role of government on growth in both generations of NICsHong Kong, Singapore, South Korea, Taiwan, Indonesia, Malaysia, and Thailandfrom 1966 to 2000.4 As the United States and Japan have led FDI in the region, we focus on FDI from the United States and Japan.5 Kojima (1978, 1985) and Ozawa (1979) and later Kohama (2003, 2004), however, argue that Japanese FDI helped East Asian economies better than U.S. FDI because Japanese technology transfer practices were more appropriate for East Asian countries than those of the United States. Therefore, by separately testing the economic effects of FDI from the United States and Japan, we also test if the two FDI produce different economic effects. The rest of the paper consists of four parts. First, we revisit the previous theories on economic success in the rst generation of East Asian NICs. The theories include cultural explanations, human capital theory, and the statist approach. We then discuss the economic effects of FDI on growth. We discuss both the general effects of FDI on economic growth and how the effects of direct investment from the United States and Japan may be different based on the argument by Kohama (2003, 2004), Kojima (1978, 1985), and Ozawa (1979). We then empirically test the existing theories and the effects of U.S. FDI and Japanese FDI using a Barro-type growth model. Finally we conclude by summarizing our research and discussing policy implications. Theory and Empirical Model Confucianism and Human Capital Theory Since the rst generation of NICs (Hong Kong, Singapore, South Korea, and Taiwan) was under the inuence of Confucianism, it has been argued that Confucianism played an important role in their economic success (Rowen, 1998). Confucianism is a secular ideology focusing on the proper behavior of social actors to maintain social order and hierarchy (Chan, 1993). According to Clark and Roy (1997, p. 62), the ideology promoted respect for authority, merit-based mobility, family entrepreneurship and . . . large-scale corporations and bureaucracies. The belief is that adherence to these principles contributed to the economic success of the rst generation NICsHong Kong, Singapore, South Korea, and Taiwan. Root (1998), however, argues that the role of Confucianism in the economic success of East Asian NICs is signicantly inated. The reason is that the emphasis

388

Policy Studies Journal, 36:3

of family values by Confucianism indirectly promoted nepotism, thus reducing economic productivity. Furthermore, while respecting authority for stability and maintaining hierarchy might have contributed to social stability, this also discouraged new ideas and creativity (see also Rowen, 1998). Despite the critiques, one element of Confucianism, encouraging education for upward mobility, is highly regarded in making contributions to economic development in East Asian NICs. The following story concisely represents how education was promoted by Confucianism (recited from Rowen, 1998, p. 20). When Confucius went to the state of Wei, Zan Yu acted as driver of his carriage. Confucius observed, How numerous are the people! Zan Yu asked, Since they are thus numerous, what more shall be done for them? Enrich them, was the reply. And when they have been enriched, what more shall be done? Confucius replied, Teach them. This story may well answer the question why education has been highly valued and economic growth has been the focus of government policies in the four little tigers that were all under Confucian culture. The value of high-quality human capital in economic growth is well established in the economics literature. According to Barro and Lee (2001, p. 541): A greater amount of educational attainment implies more skilled and productive workers, who in turn increase an economys output of goods and services. An abundance of well-educated human resources also helps to facilitate the absorption of advanced technologies from developed countries. In addition, the level and distribution of educational attainment has a strong impact on social outcomes, such as child mortality, fertility, education of children, and income distribution. In another article, Lee (2001) argues that one of the reasons for the signicant technology gap between developed and developing countries is the difference in technology readiness due to disparities in education. Considering that technology is one of the main reasons for the gap in economic wealth between the two groups of countries, education is critical in developing countries economic growth, which will in turn help to adapt advanced technologies (Abramovitz, 1979). Furthermore, previous studies (Bishop, 1989; Moll, 1998) have provided evidence of the correlation between school performance (test scores) and economic growth. There is also a vast volume of studies on the contribution of education to the economic success of the rst generation of East Asian NICs. Vogel (1991, p. 101) wrote: Four institutions and cultural practice rooted in the Confucian tradition but adapted to the needs of an industrial societya meritocratic elite, an entrance exam system, the importance of the group, and the goal of selfimprovementhave . . . ignited the greatest burst of sustained economic growth the world has yet seen.

Hahm/Heo: U.S. and Japanese FDI in East Asia

389

Following Vogel, Fry (1997) argues that meritocratic institutions created incentives for learning and education in East Asia, which led to abundant high-quality human capital. Stevenson (1998) notes that the value of education and hard work in East Asian cultures, along with healthy attitudes of students and family involvement, made education more effective in East Asia compared with other developing countries. Moreover, according to a report by World Bank (1993), rapid economic success in East Asia was possible because of consistent investments in human capital starting from primary education to secondary and vocational education as their economies developed. Thomas and Wang (1997) explain how education helps economic growth. They argue that investment in education leads to signicant increases in productivity growth, which leads to good economic performance. Clark and Roy (1997) also nd that education played a signicant role in East Asias economic success. Literacy levels in Hong Kong, Singapore, South Korea, and Taiwan have been much higher than those of South Asian countries, with the differences dating back to the 1950s and 1960s. Thus, they contend that given high levels of education and rapid economic growth in East Asia, the human-capital theory is valid. In a recent work, Guo (2005) asserts that Asias educational edge has not only contributed to the success of Asian economies but also will provide options for employment to foreign-born scientists and engineers in the United States, implying that Asian economies are likely to enjoy good performance considering the abundance of high-quality human capital. Based on the discussion above, we hypothesize that education helps economic growth. Since education levels in Indonesia, Malaysia, and Thailand have not been nearly as high as those in the four little tigers, we hypothesize that the positive effect of education is limited to the second generation of NICs. Thus, our hypotheses are: Hypothesis 1: Education levels are positively associated with economic growth. Hypothesis 1.1: Education levels in the four little tigers helps economic growth. Hypothesis 1.2: Education levels in the second generation of NICs are not correlated with economic growth.

The Statist Approach (Government-Led Development Paradigm) In a discussion of the statist approach, Clark and Roy (1997, p. 141) summarize the role of government in economic growth as follows: [A] government can mobilize and concentrate the necessary resources by providing subsidized capital from public revenues, obtaining foreign loans for development purposes, searching out information about business opportunities and foreign markets, using trade policy to extend infant-industry protection to new plants, licensing technology, recruiting and regulating foreign-invested corporations, building the basic infrastructure necessary for an industrializing society, getting the prices wrong in order to stimulate

390

Policy Studies Journal, 36:3

sunrise industries that can become internationally competitive in the future, establishing state corporations to develop industries for which private capital is not forthcoming. To play the role described above, a strong government is necessary. In most of the East Asian NICs except Thailand, strong governments have existed throughout the period of rapid growth. Governments in these countries often built leading but cooperative relationships with the dominant social economic forces, such as business companies and associations, in order to reinforce their autonomy from them. Regimes in South Korea, Taiwan, Indonesia, and, periodically, Thailand came to power by using force; accordingly, the regimes wanted to share benets with the dominant social economic forces to draw their support to compensate for their lack of political legitimacy (Haggard & Moon, 1990; Hahm & Plein, 1997; Jesse, Heo, & DeRouen, 2002). For the same reason, economic growth was emphasized because getting the people out of poverty was perceived as the solution to legitimize their political power (Pei, 1998). To this end, technocrats were employed to push economic growth, and the dominant political elite created space for bureaucratic rule in a cooperative politicalbusiness setting. As the bureaucrats focused on economic growth and were technically competent, they wanted to implement economic and industrial policies effectively. At the same time, the dominant social economic forces were interested in affecting economic policymaking to reect their interests. Thus, bureaucracies became partners with business in promoting economic growth (Root, 1998; see also Haggard, 1998; Haggard & Moon, 1990; Heo & Kim, 2000; Heo & Tan, 2001; Jesse et al., 2002).6 Turning to actual government policies, governments emphasized creating business-friendly environments. To this end, openness of the economy was emphasized to promote export. Although Indonesia, Malaysia, and Thailand had some natural resources, Hong Kong, Singapore, South Korea, and Taiwan had very little natural resources. Thus, export-oriented industrialization policies were adopted along with periodical utilization of import substitution. National resources heavily concentrated on the export sector, and preferential treatment in terms of tax and credit allocation was provided to them (Chu, 1987; Heo, 2001; Heo & Kim, 2000). Private property rights were highly protected, and few trade restrictions were adopted. Labor market freedom was also common except in Singapore and South Korea. As a result, economic freedom in most of the NICs was ranked in the top 20 out of 102 rated (Gwartney, Lawson & Block, 1996). In addition, governments reformed agriculture and developed labor-intensive manufacturing industries through import substitution to lay the groundwork for export. Realistic exchange rates were maintained by governments to provide an incentive to export and to sustain the price stability of imported materials. Tariff barriers were kept at minimum to obtain imported factor inputs at world prices (Clark & Roy, 1997). The quality of public nance was also excellent. According to Corden (1993), the balanced national and current accounts ensured macroeconomic stability in East

Hahm/Heo: U.S. and Japanese FDI in East Asia

391

Asia. For instance, budget and trade decits in East Asian NICs were less than half of the average of those in other developing countries. Prudent international loan practices before the 1997 nancial crisis also kept them away from debt crises while other developing countries were suffering in the 1980s (Leipziger & Thomas, 1997).7 The consistent macroeconomic stability led to high investment (Clark & Roy, 1997). Market-friendly interventions, such as drastic policy changes to maintain exchange rate stability and policies to improve business environments, also brought in high rates of investment. High rates of investment provided resources necessary for business expansion and export, which helped economic growth (Thomas & Wang, 1997). Moreover, public consumption in all East Asian NICs was lower than the average of other developing nations. They also performed well in controlling ination while maintaining high interest rates. This kind of nancial discipline through prudent reviews of government spending allowed the East Asian economies not to miss crucial investments. Overall, macroeconomic stability in East Asian NICs sent a positive signal to investors and businessmen by reducing investment risk.8 In addition, public investment has increased over time. According to World Bank (1993) data, public investment shares in East Asia rose between 1979 and 1982, when those in other countries declined, staying nearly 4 percent above the average in the 1970s. A large portion of the investment went into productive infrastructure and important industries. For instance, the World Bank rejected the loan request by the South Korean government for Pohang Steel in the late 1960s, but the company became efcient by the 1990s (Amsden, 1989; Wade, 1990). This kind of successful state entrepreneurship example can be also found in other East Asian NICs (Clark & Roy, 1997). Based on the discussion above, we hypothesize that the role of the government in the economic success of the East Asian NICs was positive. Hypothesis 2: Government programs promote economic success.9 Domestic Savings and Investment Macroeconomists have shown that the role of savings and investment is crucial in economic growth because it provides resources for industrialization. According to Hagen (1986), in order for an economy to experience meaningful growth, it is necessary to have domestic savings of at least 12 to 15 percent of gross national product (GNP) for nancing investment. East Asian NICs have maintained high rates of savings and investment. For instance, the domestic investment share of gross domestic produce (GDP) for Singapore between 1966 and 2000 was 44.23 percent, which is much higher than that of most other countries in the world. South Korea and Thailand also recorded their investment shares of GDP at 30.03 and 30.83 percent, respectively, for the same period. Hong Kong and Malaysia invested 24.75 and 21.28 percent of their GDP, respectively, while Taiwan and Indonesia showed gures of 18.54 and 13.47 percent, respectively. With the exception of Indonesia, all NIC countries have enjoyed high

392

Policy Studies Journal, 36:3

rates of domestic savings and investment. According to a report by World Bank (1993), investment levels in East Asia were about the same as those of Latin America in 1965, but they almost doubled the average for Latin America by 1990. This is why Krugman (1994) argues that East Asian development is primarily based on increases in investment. Three factors made signicant contributions to the high rates of investment. First, as discussed earlier, macroeconomic stability and export-oriented government policies provided investment-friendly environments. With the protection of private property rights, the business sector did not hesitate to reinvest their prots. Second, successful export performance and governments preferential treatment of credit allocation to export-oriented industries enabled high rates of investment (Heo, 2001; Heo & Kim, 2000). Third, a moderate repression of interest rates increased investment by transferring income from household to rms (World Bank, 1993). In summary, there existed a virtuous cycle in East Asian economies. Macroeconomic stability and business-friendly policies led to high rates of investment, providing resources for business and export expansion. With the success of exports, these economies grew rapidly, which in turn enabled the prots to be reinvested. Thus, we hypothesize as follows. Hypothesis 3: Investments help economic growth in East Asia. Foreign Direct Investment East Asian NICs have changed their attitude toward FDI over time. For instance, Hong Kong, Singapore, and Malaysia adopted FDI-led industrialization policies for economic growth. To this end, these nations upgraded their industrial structures and comparative advantages to encourage foreign transnational corporations (TNCs) to invest, particularly in high value-added industries (Fry, 1997; Jomo, 1997; Mardon, 1990; Urata, 2005). In contrast, Indonesia, South Korea, Taiwan, and Thailand were not FDI friendly until the mid-1980s. In fact, these countries only used TNCs as sources of advanced technology during the time (Sachwald, 2004). Since then, they aggressively attracted foreign capital (direct and portfolio) into their countries to continue to develop their economies. To this end, these nations have implemented vigorous reforms and improved their business climates, as well as policies. For instance, one-stop ofces for government permission for FDI were created in South Korea and Indonesia, and many barriers for industrial licensing have been removed in Malaysia. As a result, nearly 30 percent of FDI in developing countries went to Indonesia, Malaysia, South Korea, and Thailand in 1990 (Thomas & Wang, 1997). Overall, Hill (1990, p. 24) writes that a common trend in East Asia with respect to FDI is as follows: A key features of East Asia has been an increasingly open and receptive policy environment during the 1980s for a variety of reasons: the need to recycle trade surplus (in Korea and Taiwan); greater condence in the competitive capacities of domestic business groups (Korea, Taiwan and Thailand); economic imperatives, such as a deteriorating current account for all

Hahm/Heo: U.S. and Japanese FDI in East Asia

393

or part of the decade (Indonesia and Malaysia); and a perception that FDI may be preferable to local nonindigenous investment (as in Malaysia). Turning to the benets of FDI, Heo and Hahm (2007), based on a report by UNCTAD (1999), argue that FDI makes signicant contributions to economic growth. First, FDI provides valuable capital for investment, which can compensate domestic savings to increase nancial resources for economic expansion. Given that TNCs tend to invest in long-term projects, FDI through TNCs can be a stable source of capital. Second, FDI, particularly in the manufacturing sector, generates employment through new business or expanding existing business (see also Borensztein, De Gregorio, & Lee, 1998; Fieldhouse, 1999; UNCTAD, 1999). Third, through FDI from TNCs, host countries may receive technology transfers (Hahm & Plein, 1997; Hahm, Plein, & Florida, 1994). There are also likely to be skills and knowledge spillovers on business management and marketing through international production and international training by the foreign afliates of TNCs, although the benets of technology transfers would be greater if the technology readiness of the host country was high, illustrating the importance of education (Borensztein et al., 1998). This ultimately helps rms become more competitive (see also Fieldhouse, 1999; UNCTAD, 1999). Fourth and nally, FDI introduces foreign market access for goods and services via TNCs, which help industries to internationalize utilizing the host nations international comparative advantage. East Asia has also enjoyed the benets of FDI discussed above. According to Urata (2005, p. 204), FDI brought to East Asia made two signicant contributions. First, FDI provided nancial resources for xed investment, as well as technologies and managerial know-how. These skills and knowledge played crucial roles in East Asian economic growth. Second, FDI enabled East Asian countries to access networks of foreign rms for sales, procurement, and information, which signicantly improved production and marketing efciency. A number of empirical studies have provided evidence of the benets of FDI on economic growth in East Asia. Lee, Rana, and Iwasaki (1986), in their simultaneous equation analysis, nd that FDI has a positive and signicant effect on economic growth in East Asia. Fry (1997), using a simulation model, reports that FDI in East Asia is responsible for 1.4 percent growth for the period 198392. The positive effect of FDI in the same period for Singapore and South Korea was even greater at 2.6 percent. Based on the theoretical discussion and empirical studies reported above, we hypothesize that FDI makes signicant contribution to East Asian economic growth. Hypothesis 4: FDI helps economic growth in East Asia. Kojima (1978, 1985) and Ozawa (1979), and later, Kohama (2003, 2004), however, argue that Japanese FDI is better suited for East Asian economies than U.S. FDI, because Japanese technology transfer practices are more appropriate for East Asian countries than those of the United States. They argue that technologies transferred from Japan t the needs of East Asian developing countries better with respect to accessibility, standardization, and maturation (Kohama, 2004). In contrast, American

394

Policy Studies Journal, 36:3

technologies tend to be harmful because they require patent loyalty in addition to being too sophisticated (Hahm et al., 1994). To test the argument, we develop another hypothesis. Hypothesis 4.1. FDI from Japan helps East Asian economies while U.S. FDI hampers growth. Empirical Model In order to test the effects of FDI on economic growth, we may choose one of the following approaches: (i) develop a structural equation model, including a number of relevant independent variables based on extant literature but in an ad hoc manner; and (ii) adopt a mainstream economic growth model developed by macroeconomists. We choose the latter because various combinations of independent variables can generate different results due to the sensitivity of each variable included in the model to individual countries. The mathematically derived growth model is based on macroeconomic theory and commonly used in macroeconomics literature. We employ a Barro-type growth model for two reasons: (i) the model is widely used in macroeconomics literature to estimate economic growth (Dunne et al., 2005); (ii) the independent variables included in the model cover the existing literature on East Asian economic success. The model assumes that economic output is a function of the quality of human capital (education level of the population), the income share of investment (capital), the relative change in labor (employed population), and the role of government programs. To test the effects of FDI from the United States and Japan, we add the U.S. FDI and Japanese FDI as a share of GDP. Given that the data are time series and cross-section, we follow the common practice and add the starting value of GDP (GDPt-1) as a control variable (see Barro & Lee, 2001; Borensztein et al., 1998; Lee, 2001). The model is,

Economic Growth = Initial GDP + Domestic Investment + Labor + U.S. FDI + Japan FDI + Government Expenditures + Education

Data and Methods Data Data for GDP, labor, investment, and government expenditures were obtained from Heston and Summers Penn World Table 6.1 available online (http:// pwt.econ.upenn.edu, accessed March 24, 2006). Data for U.S. direct investment come from the U.S. Bureau of Economic Analysis U.S. Direct Investment Position Abroad on a Historical-Cost Basis, also available online (http://bea.gov/bea/di/home/ directinv.htm, accessed March 24, 2006). Data for Japans direct investment are from Japans Ofcial Development Assistance (ODA) 2004 CD-ROM Seifu Kaihatsu Enjo Hakusho (White Paper on Japans ODA), Japanese Ministry of Foreign Affairs. All the

Hahm/Heo: U.S. and Japanese FDI in East Asia

395

values are 1996 constant prices. Education attainment data are from Barro and Lee (2001). Following Barro and Lee, we use the years of schooling completed for people aged 15 and over. The empirical measures employed in the analysis are: Economic Growth: the log of GDP less the GDP in the previous year. Labor Growth: the log of population less the log of population in the previous year.10 Domestic Investment: the log of investment share of GDP less the log of investment share of GDP in the previous year. U.S. Direct Investment: the log of U.S. direct investment share of GDP less the log of US direct investment share of GDP in the previous year. Japans Direct Investment: the log of Japans direct investment share of GDP less the log of Japans direct investment share of GDP in the previous year. Government Expenditures: the log of government expenditures share of GDP less the log of government expenditures share of GDP in the previous year. Education: the log of education attainment less the education attainment in the previous year. Methods We use pooled time series analysis to test the effects of United States and Japans direct investment on economic growth in East Asian countries (Hong Kong, Singapore, South Korea, Taiwan, Indonesia, Malaysia, and Thailand) from 1966 to 2000. According to Baltagi (2002), pooling the time series and cross-sectional data provides three benets: (i) controls for heterogeneity across individual countries; (ii) more information with reduced collinearity; and (iii) improved detection capability compared with pure cross-sections or pure time series. The analysis of time series cross-section data inherently has problems of autocorrelation and heteroskedasticity due to the nature of the data. To address these issues, we employ ordinary least squares (OLS) with panel-corrected standard errors as recommended by Beck and Katz (1995). As panel-specic autocorrelation still can be an issue, we tested employing the Wooldridge test for autocorrelation in panel data. The Wooldridge test indicated an autocorrelation problem for the entire panel data set (signicant at 0.01 level) but not for the panel of the rst or second generation of NICs (F1,6 = 25.647; F1,2 = 10.599; F1,3 = 10.022 respectively). We addressed the issue by employing Prais-Winsten regression with correlated panels-corrected standard errors (PCSE). Findings The results of the empirical analysis on the effects of U.S. and Japanese direct investment on economic growth in East Asian NICs for 19662000 are reported in Table 1. As expected, domestic investment has a positive and statistically signicant

396

Policy Studies Journal, 36:3 Table 1. The Economic Effects of FDI on Growth in East Asia: Pooled Analysis for 19662000

Variable

All NICs in East Asia

Four Little Tigers -2.44e-08* (1.43e-08) 0.1660** (0.0258) 0.1873 (0.2697) -0.1751** (0.0371) 0.0393** (0.0155) 0.0152** (0.0035) 0.0939** (0.0288) 0.0596** (0.0070) N = 130 R2 = 0.50

Second Generation -2.29E-08 (1.58E-08) 0.1801** (0.0182) 0.3407 (0.3921) -0.0156 (0.0409) 0.0044 (0.0129) 0.0050 (0.0034) 0.0109 (0.0253) 0.0598** (0.0109) N = 97 R2 = 0.50

Dependent Variable: Economic Growth Initial GDP -4.04e-08 (1.15e-08) Domestic investment 0.1694** (0.0147) Labor 0.0147 (0.2442) Government expenditures -0.1158** (0.0270) U.S. direct investment 0.0197* (0.0094) Japanese direct investment 0.0084** (0.0024) Education 0.0186 (0.0176) Constant 0.0701 (0.0071) N = 227 R2 = 0.48

Notes: *signicant at 0.05 level, one-tailed; **signicant at 0.01 level, one-tailed. Standard errors in parenthesis. FDI, foreign direct investment; NIC, newly industrializing country; GDP, gross domestic product.

impact on growth in all East Asian NICs whether they are tested all together or separately. Both U.S. and Japanese direct investment show positive and statistically signicant effects on economic growth in the rst generation of the East Asian NICs and in the test with all the countries together. However, neither FDI shows a signicant effect on economic growth when the second generation of East Asian NICs is tested alone. Unlike the four little tigers, the effects of FDI on economic growth in Indonesia, Malaysia, and Thailand are not statistically signicant. Although Kohama (2003, 2004), Kojima (1978, 1985), and Ozawa (1979) argue that Japanese FDI is a better t for East Asian economies than U.S. FDI, the positive effect of U.S. FDI seems to be greater than that of Japanese FDI. A 1 percent increase of U.S. FDI as a share of GDP growth leads to an approximately 0.02 and 0.04 percent increase in economic growth in all East Asian NICs and the four little tigers, respectively, while the same increase in Japanese FDI results in only a 0.008 and 0.015 percent respective increase in economic growth. In contrast with Kohama (2003, 2004), Kojima (1978, 1985), and Ozawa (1979), but consistent with Roemer (1976) and Mason (1980), U.S. FDI is not detrimental to East Asian economies. In other words, regardless of the source, FDI helps economic growth in East Asian NICs. Turning to the effects of labor and education, labor shows no signicant effects on economic growth. The reason for the labor result may come from the fact that we used population growth as a proxy of employed labor because of the lack of data. Education shows positive and signicant effects on economic growth when the relationship between the variables was tested for the four little tigers alone. Since

Hahm/Heo: U.S. and Japanese FDI in East Asia

397

education levels in the second generation of NICs (Indonesia, Malaysia, and Thailand) are not nearly as high as in the four little tigers, the results are not surprising. An unexpected surprise is that government expenditures are negative and statistically signicant. Considering that government policies in these countries have been considered one of the reasons for their economic success, the result is surprising. Yet this result might have occurred because we used government expenditures as a proxy for the role of government. The results of the statistical analysis of the second generation of East Asian NICs alone are somewhat similar to the typical features of multicollinearity, a relatively high R2 (0.57) but a small number of (only two) statistically signicant independent variables. Thus, we tested for bivariate simple correlations of the independent variables. The results show no signicant bivariate correlations.

Conclusion The miraculous economic development of the four little tigers attracted a lot of scholarly attention in the 1970s and 1980s, leading to the conclusion that the economic success of these countries can be attributed to the role of Confucian culture, relatively cheap quality labor based on high levels of education, high rates of savings and investment, and export-oriented industrialization policies under the government-led development paradigm. However, scholars have argued that FDI also helps economic growth, and Kohama (2003, 2004), Heo and Hahm (2007), and Urata (2005) recently reported the positive effects of FDI on economic growth in the four little tigers. On the other hand, Kojima (1978, 1985) and Ozawa (1979), and later, Kohama (2003, 2004), argue that Japanese FDI helps East Asian economies but not U.S. FDI, because Japanese technology transfer practices were more appropriate for East Asian countries. In this paper, we revisited the issue of East Asian economic development and tested the economic effects of FDI from the United States and Japan on growth in East Asian NICs using a Barro-type growth model. Labor, domestic investment, and government expenditures were included as control variables as suggested by previous economic theories (see Barro, 1990; Barro & Lee, 2001; Ram, 1986). In contrast with the statist argument (Krugman, 1994) that government was critical in economic success of the East Asian NICs, we found that the role of government in the economic development of East Asian NICs was rather marginal during the period of high growth.11 We found that FDI from both the United States and Japan helps economic growth in the four little tigers, but not in Indonesia, Malaysia, and Thailand. In addition, FDI and education in the four little tigers showed signicant and positive effects on economic growth. This nding also reafrms that the negative effects of FDI on economic growth as posited by the dependency theory do not apply to East Asian NICs. The reason might be found in the benet of technology transfers and access to markets (UNCTAD, 1999).

398

Policy Studies Journal, 36:3

Moreover, regardless of the source and/or type of capital, the effects on growth seem to be positive, given that both domestic and foreign investment promotes economic growth. In other words, the recent trend toward the liberalization of foreign capital in East Asian NICs is likely to lead to continuing economic success in East Asian NICs. This nding is meaningful in shedding light on the scholarly debate concerning the effects of FDI on economic growth in the era of globalization. Sung Deuk Hahm is professor of political economy at Korea University. He is a co-editor of International Public Management Journal and an associate editor of Administration & Society. His research interests are in the areas of Korean presidency, international political economy, public budgeting and nance, and industrial policy. Uk Heo is professor of political science at the University of Wisconsin-Milwaukee. His research focuses on the political economy of defense, international conict, international political economy, and Asian politics.

Notes
The authors share equal authorship. The authors names are listed in alphabetical order. We thank the nancial support of the Korean Ministry of Commerce, Industry, and Energy. Sung Deuk Hahm also thanks the nancial support of Korea University (K0617021). 1. During the successful economic growth period, per capita incomes in these countries almost quadrupled (Leipziger & Thomas, 1997). The average annual growth rate between 1981 and 1990 in the Pacic Rim East Asian countries was approximately 9.4 percent (World Bank, 1993; see also Heo & Hahm, 2007; Kohama, 2003, 2004; Urata, 2005). 2. The second generation of NICs has been distinguished from the four little tigers with respect to the resource wealth of the former in contrast with the resource poverty of the latter (Jomo & Rock, 1998). Southeast Asian resource wealth made possible rapid economic growth on the basis of primary production and thus weakened the imperative to industrialize. As much of this primary production was for export, such resource wealth also weakened the imperative to manufacture for export. Therefore, resource wealth is seen by Sachs (1997) as a resource cures, weakening the imperative to industrialize, especially for export. 3. The calculation was done by the authors. 4. The reason for selecting the period of 19662000 is mainly because of data availability. U.S. FDI data start in 1966, and education attainment data by Barro and Lee (2001) end in 2000. 5. U.S. direct investment reached $60.5 billion in 1995 alone. 6. This relationship is often referred to as crony capitalism and became heavily criticized as a source of corruption and one of the causes of the 1997 Asian nancial crisis (see Heo, 2001; Heo & Tan, 2001; Jesse et al., 2002; Smith, 1999). 7. After the crisis, the governments in these countries aggressively attracted foreign direct investment to get out of the nancial trouble. 8. However, Shafer (1990) points out that the statist approach has a limited explanatory power because the key factor of the theory, state strength, is dened largely based on economic outcomes. This is why weak states move from weakness to weakness in a vicious circle, while strong states move from strength to strength along a path of self-reinforcing evolution (Shafer, 1990, p. 127). 9. We use government expenditures for a proxy of government activities. It is not a perfect measure, but commonly used in economic studies (Ram, 1986). 10. Because the lack of employment data, total population is commonly used as a proxy for labor in economic studies (see Barro & Lee, 2001; Ram, 1986).

Hahm/Heo: U.S. and Japanese FDI in East Asia

399

11. The results need to be interpreted with caution because a great portion of government expenditures in these countries was spent on improving economic infrastructure, which would indirectly help growth.

References
Abramovitz, Moses A. 1979. Rapid Growth Potential and its Realization: The Experience of Capitalist Economies in the Postwar Period. In Economic Growth And Resources, vol. 1, ed. Edmond Malinvaud. London: Macmillan, 1151. Amsden, Alice. 1989. Asias New Giant: South Korea and Late Industrialization. Oxford: Oxford University Press. Baltagi, Badi. 2002. Econometrics. New York: Springer-Verlag. Barro, Robert. 1990. Government Spending in a Simple Model of Endogenous Growth. Journal of Political Economy 98 (5): 10326. Barro, Robert, and Jong-Wha Lee. 2001. International Data on Educational Attainment: Updates and Implications. Oxford Economic Papers 3: 54163. Beck, Nathaniel, and Jonathan Katz. 1995. What to Do (and Not to Do) with Time-Series Cross-Section Data. American Political Science Review 89: 63447. Bishop, John. 1989. Is the Test Score Decline Responsible for the Productivity Growth Decline? American Economic Review 79: 17897. Borensztein, Eduardo, Jose De Grgorio, and Jong-Wha Lee. 1998. How Does Foreign Direct Investment Affect Economic Growth? Journal of International Economics 45 (1): 11535. Chan, Steve. 1993. East Asian Dynamism: Growth, Order and Security in the Pacic Region. Boulder, CO: Westview Press. Chu, Yun-Han. 1987. State Structure and Economic Adjustment of the East Asian Newly Industrializing Countries. International Organization 43: 4. Clark, Cal, and Jonathan Lemco. 1988. State and Development. New York: E.J. Brill. Clark, Cal, and K. C. Roy. 1997. Comparing Development Patterns in Asia. Boulder, CO: Lynn Rienner. Corden, W. Max. 1993. Seven Asian Miracle Economies: Overview of Macroeconomic Policies. The East Asian Miracle, Policy Research Department, World Bank, Washington, DC. Dunne, J. Paul, Ron Smith, and Dirk Willenbockel. 2005. Models of Military Expenditure and Growth. Defence and Peace Economics 16 (6): 44961. Evans, Peter, Dietrich Rueschemeyer, and Theda Skocpol. 1985. Bringing the State Back In. Cambridge, UK: Cambridge University Press. Fieldhouse, David K. 1999. The West and the Third World. Oxford: Blackwell Publishers. Fry, Maxwell. 1997. Foreign Direct Investment in East Asia. In Lessons from East Asia, ed. Danny M. Leipziger. Ann Arbor: University of Michigan Press, 51140. Guo, Yugui. 2005. Asias Educational Edge: Current Achievements in Japan, Korea, Taiwan, China, and India. Lanham, MA: Lexington Books. Gwartney, James, Robert Lawson, and Walter Block. 1996. Economic Freedom of the World: 19751995. Vancouver, Canada: Fraser Institute. Hagen, Everett E. 1986. The Economics of Development. 4th ed. Homewood, IL: Irwin. Haggard, Stephen, and Chung-In Moon. 1990. Institutions and Economic Policy: Theory and a Korean Case. World Politics 42 (2): 21037. Haggard, Stephen. 1998. Business, Politics, and Policy in East and Southeast Asia. In Behind East Asian Growth: The Political and Social Foundations of Prosperity, ed. Henry S. Bowen. London: Routledge, 78104. Hahm, Sung Deuk, and Chris Plein. 1997. After Development. Washington, DC: Georgetown University Press.

400

Policy Studies Journal, 36:3

Hahm, Sung Deuk, Chris Plein, and Richard Florida. 1994. The Politics of International Technology Transfer: Lessons from the Korean Experience, Policy Studies Journal 22: 31121. Heo, Uk. 2001. South Korea: Democratization, Financial Crisis, and the Decline of the Developmental State. In The Political Economy of International Financial Crisis: Interest Groups, Ideologies, and Institutions, ed. Shale Horowitz, and Uk Heo. Lanham, MA: Rowman and Littleeld, 15164. Heo, Uk, and Sung Deuk Hahm. 2007. The Political Economy of US Direct Investment in East Asian NICs. International Interactions 33 (2): 11933. Heo Uk, and Sunwoong Kim. 2000. Financial Crisis in South Korea: Failure of the Government-led Development Paradig. Asian Survey 40 (3): 492507. Heo, Uk, and Alexander C. Tan. 2001. Democracy and Economic Growth in Developing Countries: A Causal Analysis. Comparative Politics 33 (4): 46373. Hill, Hall. 1990. Foreign Investment and East Asian Economic Development. Asian Pacic Economic Literature 4 (September): 2158. Japanese Ministry of Foreign Affairs. 2004. Japans ODA 2004 CD-ROM-Seifu Kaihatsu Enjo Hakusho (White Paper on Japans ODA). Tokyo: National Printing Bureau. Jesse, Neal, Uk Heo, and Karl DeRouen Jr. 2002. A Nested Game Approach to Political and Economic Liberalization in Democratizing States: The Case of South Korea. International Studies Quarterly 46 (3): 40122. Johnson, Chalmers. 1982. MITI and the Japanese Miracle: The Growth of Industrial Policy. 192575. Stanford, CA: Stanford University Press. Jomo, K. S. 1997. Southeast Asia Misunderstood Miracle: Industrial Policy and Economic Development in Thailand, Malaysia, and Indonesia. Boulder, CO: Westview Press. Jomo, K. S., and Michael Rock 1998. Economic Diversication and Primary Commodity Processing in the Second-Tier South-East Asian Newly Industrializing Countries. UNCTAD Discussion Papers, Geneva, Switzerland. Kohama, Hirohisa. 2003. Japans Cooperation in East Asia. In External Factors for Asian Development, ed. Hirohisa Kohama. Singapore: Institute of Southeast Asian Studies, 3658. . 2004. Japans Development Cooperation in East Asia: A Historical Overview of Japans ODA and its Impact. International Conference on Economic Aid, FDI, and Trade in East Asia, Korea University Graduate School of International Studies. Kojima, Kiyoshi. 1978. Direct Foreign Investment: A Japanese Model of Multinational Business Operations. New York: Praeger. . 1985. Japanese and American Direct Investment in Asia: A Comparative Analysis. Hitotsubashi Journal of Economics 26: 135. Krugman, Paul. 1994. The Myth of Asias Miracle. Foreign Affairs 73 (6): 6278. Lee, Jong-Wha. 2001. Education for Technology Readiness: Prospects for Developing Countries. Journal of Human Development 2 (1): 11551. Lee, Jungsoo, Pradumna Rana, and Yoshihiro Iwasaki. 1986. Effects of Foreign Capital Inows on Developing Countries in Asia. Asian Development Back Economic Staff Papers, No. 30, Asian Development Bank, Manila, Philippines. Leipziger, Danny, and Vinod Thomas. 1997. An Overview of East Asian Experiences. In Lessons from East Asia, ed. Danny M. Leipziger. Ann Arbor: University of Michigan Press, 132. Mardon, Russel. 1990. The State and the Effective Control of Foreign Capital. World Politics 43 (1): 11138. Mason, R. Hal. 1980. A Comment on Professor Kojimas Japanese Type versus American Type of Technology Transfer. Hitotsubashi Journal of Economics 20: 4850. Moll, P. G. 1998. Primary Schooling, Cognitive Skills and Wages in South Africa. Economica 65: 26384. Neher, Clark. 1999. Southeast Asia in the New International Era. Denver, CO: Westview. Ozawa, Terutomo. 1979. Multinationalism, Japanese Style. Princeton, NJ: Princeton University Press.

Hahm/Heo: U.S. and Japanese FDI in East Asia

401

Pei, Minxin. 1998. Constructing the Political Foundations of an Economic Miracle. In Behind East Asian Growth: The Political and Social Foundations of Prosperity, ed. Henry S. Rowen. London: Routledge, 3959. Ram, Rati. 1986. Government Size and Economic Growth: A New Framework and Some Evidence from Cross-Section and Time-Series Data. American Economic Review 76: 191203. Roemer, John. 1976. Japanese Direct Foreign Investment in Manufactures: Some Comparison with US Pattern. Quarterly Review of Economics and Business 16, 98107. Root, Hilton. 1998. Distinctive Institutions in the Rise of Industrial Asia. In Behind East Asian Growth: The Political and Social Foundations of Prosperity, ed. Henry S. Rowen. London: Routledge, 6077. Rowen, Henry. 1998. The Political and Social Foundations of the Rise of East Asia: An Overview. In Behind East Asian Growth: The Political and Social Foundations of Prosperity, ed. Henry S. Rowen. London: Routledge, 138. Sachs, Jeffrey. 1997. The Emerging Asia, The Asian Development Bank, Manila, Philippines. Sachwald, Frederique. 2004. FDI and the Economic Status of Korea. Washington, DC: Korea Economic Institute. Shafer, D. Michael. 1990. Sectors, States, and Social Forces: Korea and Zambia Confront Economic Restructuring. Comparative Politics 22 (2): 12750. Smith, Heather. 1999. Korea. In East Asia in Crisis: From Being a Miracle to Needing One? ed. Ross H. McLeod, and Ross Garnaut. London: Routledge, 6684. Stevenson, Harold. 1998. Human Capital: How the East Excels. In Behind East Asian Growth: The Political and Social Foundations of Prosperity, ed. Henry S. Rowen. London: Routledge, 14764. Thomas, Vinod, and Yan Wang. 1997. Government Policies and Productivity Growth: Is East Asia an Exception? In Lessons from East Asia, ed. Danny M. Leipziger. Ann Arbor: University of Michigan Press, 483510. UNCTAD. 1999. World Investment Report. Geneva, Switzerland: UNCTAD. Urata, Shujiro. 2005. Foreign Direct Investment and Economic Growth in East Asia. In Working Together on Investment for Development, ed. APEC-OECD. Busan, South Korea: APEC-OECD, 20422. Vogel, Ezra. 1991. The Four Little Dragons: The Spread of Industrialization in East Asia. Cambridge, MA: Harvard University Press. Wade, Robert. 1990. Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization. Princeton, NJ: Princeton University Press. World Bank. 1993. The East Asian Miracle: Economic Growth and Public Policy. New York: Oxford University Press.