Does the Worldwide Shift of FDI from Manufacturing to Services Accelerate Economic Growth- a GMM estimation study?

Nadia Doytch, University of New Haven

and

Merih Uctum, Graduate Center and Brooklyn College, City University of New York

FDI Net Inflows: The Current World View

Global FDI rose moderately to $1.24 trillion in 2010, but were still 15 per cent below their precrisis average (UNCTAD, WIR 2011). For first time, developing and transition economies together attracted more than half of global FDI flows (UNCTAD, WIR 2011).
2000 500 0 1000 1500

bln. USD

1980

1990 year

2000 World Developed economies Developing economies

2010

FDI Net Inflows in USD bln. data source: UNCTAD

FDI in South-East Asia

South-East Asia is among the regions experiencing the strongest growth in FDI inflows. SEA list of countries: Brunei Darussalam; Cambodia; Indonesia; Lao People's Dem. Rep.; Malaysia; Myanmar; Philippines; Singapore; Thailand; Timor-Leste; Viet Nam.
80

At $1.7 bln., Philippines experienced a slight decline in FDI from 2009 ($2 bln.), but up from 2008 levels ($1.5bln.). FDI peaked at $3 bln. In 2006-2007. Indonesia, Malaysia, Singapore, Vietnam have seen the fastest growth of FDI in the region.
3

60

bln. USD

bln. USD

40

20

1980

1990 year

2000

2010

1970

1980

1990 year

2000

2010

South-East Asia; FDI Net Inflows in USD bln.; data source: UNCTAD

Philippines; FDI Net Inflows in USD bln.; data source: UNCTAD

Why Study the FDI-Growth Relation?

FDI spillovers affect growth in host country.
FDI is a stable component of capital flows to emerging economies. FDI became a large component of capital flows to these economies.

Spillovers
Cost

A3 A1

AC0 A2 AC1 Q

A voluntary or involuntary transfer of MNEs intangible assets to domestically owned firms lower AC curve (positive spillover). Domestic firm imperfectly competitive. MNE competes in quantity and captures market. Firm spreads fixed costs over smaller market moves up AC curve (negative spillover) MNE drains resources away (e.g. labor) Costs go up (negative spillover)

Why Study the FDI-Growth Relation in Services?

Service FDI has been gradually supplanting manufacturing FDI

1990-2002: the share of service FDI rose from 44% to 55%, that of manufacturing FDI declined from 33% to 21%.

How does this switch affect growth?

Two Approaches to Study the Growth Effect of FDI

Macro approach Cross-country growth effects of total FDI (Borstein,
deGregorio, Lee, 1998, Blomstrom, Lipsey and Zejan, 1994, Alfaro et al., 2004)

FDI inflows benefit growth. But does not explain intersectoral differences.
Micro approach Plant-level productivity of firms in manufacturing industry (Haskel, Pereira and Slaughter, 2002, Blalock and Gertler, 2003, Aitken
and Harrison, 1999, Gorg and Stroble, 2001, Lipsey (2003, 2004)

Results ambiguous. Cross-country analysis not possible. Drawback: static analysis does not allow examination of a dynamic phenomenon of a shift from manufacturing to services FDI; emphasis on total or firm specific FDI.

Study objectives and Contribution

Disaggregates total FDI and examines the growth effects of four types of FDI flows- manufacturing, aggregate service, financial and non-financial service FDI, in addition to total FDI. Addresses the question what kinds of sectors are affected by FDI by examining in thirteen separate questions the growth of manufacturing and service sectors in addition to the growth of aggregate economy. Addresses the question what kind of countries are affected by FDI by studying a sixty country-sample from three perspectives: geographical region, level of development and size of their manufacturing and service shares, thus forming nine subsamples. Systematic analysis of sectoral spillover of disaggregated FDI, including analysis of the growth effect of a shift in sectoral FDI.

Rich data set combined with a dynamic panel estimation method.

Main Findings
The effect of the shift in composition of FDI towards services depends on whether the shift is towards financial or non-financial services FDI. Manufacturing FDI has predominantly positive spillovers through own sector growth. Services FDI produce mixed evidence of spillovers. Financial FDI has a positive effect in most country specifications; Non-financial services FDI has predominantly negative effects on manufacturing industries.

Empirical Model
g 0 1 log( y
k it
i ~ i.i.d (0, ) , it
i

k i ,t 1

) 2 f it 3 xit 4 D i it
j t

~ i.i.d.(0, ) , and E[i it ] 0

k g it = real per capita growth,

y ik,t 1 = lagged level of income per capita, in constant year 2000 prices.

f itj = FDI net inflows share of GDP

k= GDP, manufacturing value added, and services value added, j= manufacturing FDI, service FDI, financial FDI, and non-financial service FDI, i= 1,..,60 and t= 1,..,15 = the cross-sectional and time dimensions of the data

xit = investment share of GDP, real lending interest rate, gross secondary school
enrolment ratio, government consumption/GDP, government stability.
D t = 15 year-dummy variable

Empirical Methodology
Flaws with existing methodology of pooled OLS with fixed effects:
Dependent variable loses its long-run variation. Problem of endogeneity

Advantage of the dynamic panel GMM estimators Arellano-Bond (AB) and Blundell-Bond (BB)
Control for joint endogeneity while preserving the dynamic nature of the regression BB: Instruments=lagged level observations for differenced variables and lagged differenced observations for level variables.

Data
Annual 1990-2004, 60 countries: - Unbalanced (1990-2004), balanced (1998-2004) Sources: FDI net inflows: OECD, UNCTAD, government institutions and investment agencies web sites. Secondary school enrollment ratios: UNESCO and WDI. Government stability: ICRG All other: WDI, Economic Intelligence Unit Organization of the data according to geographic regions; income distribution; and relative share of industries High manufacturing (services) share if share of manufacturing (services)>sample average manufacturing (services) share and share of services (manufacturing) < sample average services share Mixed if neither.

Empirical results: Growth effects of total and manufacturing FDI

Total FDI GDP sampl growth e
All countries
1990-2004 1998-2004

Manufacturing FDI Manuf Service GDP growth growth growth

0.110 0.081 3.383** 7.294** 0.29** - 0.352 0.148 0.027 -0.409 [2.316**] 2.807** 2.822 0.126 -0.520 [2.662*] 2.155 0.093 -0.308 0.729 2.331** -0.025 0.238 0.359 [1.615**] 0.082 0.222 -0.368 0.117 0.787 4.161** 2.062** 2.073** -0.107 0.052 2.48** 3.150 -0.010 0.030 -0.519 -0.276 0.043 0.028 1.140 3.058** 0.059 -0.093 -0.247 0.207 -0.760 1.667* 2.118** 2.513** -0.045 0.084 2.264** 2.104* 0.045 -0.157 -0.456 -0.292

0.158** 0.129* 0.082 -0.468 0.102 0.122 0.131 0.173** 0.146 0.080 0.170 -0.529 0.141** 0.096 [0.268**] 0.220 0.229** 0.2** -0.257 -0.417*

Latin America & the Caribbean

1990-2004 1998-2004 1990-2004

Europe & Central Asia South & East Asia and the Pacific Low income economies Middle inc economies High income economies Manuf. based economies Mixed economies Serv. based economies

1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004

Growth Effects of Services FDI

sample 1990-2004

Aggregate Services FDI Manuf. growth Serv.growth GDP growth -0.081 -0.412** 0.148 -0.239 0.224 -0.460 -0.521** -0.479** 1.131** 0.432 -0.092 -0.341 -0.107 -0.61** [0.428] 0.066 0.141* -0.04 -0.533 [-1.107**] 0.29** 0.308** 0.272 0.144 0.142 0.165 0.302* 0.432** 0.323 -0.194 [0.388**] 0.362** 0.218** 0.139** 0.75** 0.215 0.219* 0.220 -0.017 -0.050 0.17* 0.144 [0.188] -0.253 0.057 0.046 0.093 0.17** 0.388 0.062 0.190 0.046 0.224 0.047 [0.662**] 0.367 0.255** 0.236** 0.028 -0.232

All LAC EU&CA SE-A&P LIC MIC HIC Manuf. based Mixed Serv. based

1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004 1990-2004 1998-2004

Growth effects of financial and nonfinancial services FDI

Industry All countries Financial Services FDI Manuf. Service GDP
0.937* [0.91**] -1.328 -6.448 0.405** 0.437** [-0.131] -2.779 0.073 -0.657 0.278* 0.397** -1.309 -0.908 0.345* 0.31** [-0.734] -4.139 0.286* 0.202 0.431** 0.492** -0.516 -0.141

Nonfinancial Services FDI Manuf. Service GDP

-0.634** [0.213] -1.020 -1.526 0.525 0.604** -1.024** -0.856** 1.415** 0.630 0.092 0.120 [0.213] 0.086 0.051 -0.176 0.126 0.090 0.528 0.201 -0.033 -0.027 0.043 -0.755 [0.066] 0.019 -0.124 -0.091 0.824** 0.648**

LAC
-0.130

ECA

-0.988 0.919**

SEAP

0.913** 1.671

LIC

3.187**

0.381

[0.709] [0.476] 0.443**

[0.501] -0.040 0.386**

0.604 0.290 -0.696** [1.017**]

[0.304] 0.274 0.012

0.501 0.414 -0.149

MIC

-0.282 1.177**

HIC

[1.153**]

0.359**

0.362** [0.576** ] 0.329* 0.051 0.453 0.54** 0.441**

-0.052

-0.262**

Manuf based

1.233 1.809* -0.828

0.748 -0.825 0.059 0.758 0.314** 0.272**

[0.370] 0.403 1.256** 0.389 -0.944** [1.322**]

1.052 0.625 0.400 0.195 -0.040 -0.159*

0.664 0.567 0.599** 0.321** -0.203 -0.344**

Mixed Services based

0.245 1.248** 1.279**

Summary Results: Aggregate and Manufacturing FDI

Total FDI- Positive effect on aggregate growth in several groups of economies (ECA, SEAP, HIC, Mixed). Negative impact in servicebased economies. Manufacturing FDI- Positive effects on aggregate growth in LAC, LIC, MIC, manuf.-based economies. The effects are primarily due to own sector spillovers. No negative effects. Services FDI- mixed evidence. Negative spillovers to manufacturing in multiple country sub-samples (SEAP, HIC, Services- based economies). When disaggregated, services FDI produce two kinds spillovers: positive by financial FDI (SEAP, HIC, Services- based economies) and mixed by non-financial services FDI. Non-financial services FDI have predominantly negative effects on manufacturing growth (SEAP, HIC, Services- based economies). The implications of the shift in composition of FDI away from manufacturing towards services depends on whether the shift is towards financial or non-financial services FDI and on the profile of the absorbing economy.