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Determinant of Fdi

By azzuanna May 30, 2013 1393 Words
1. 0Introduction

Malaysia is one of the countries in Asia that has benefited from strong foreign direct investment inflow. FDI was a major source of growth for manufacturing development in Malaysia that mainly targeted for the export market. The economy relied on the foreign fund as a major source of capital, modern technology and technical skills. Globalization, international financial integration and expansion of global production have intensified FDI.

1.1Literature Review
Financial development, wage rates, income, economic growth, government spending on infrastructure, openness, exchange rate, inflation rate and corporate tax are among the variables commonly analyze in the FDI dynamic. In Malaysia, study by Ang (2008) detects the significant effect of the variables in five models that that takes turn excluding some of the variables via 2SLS estimation. Thus, the aim of this paper is to investigate the determinants of FDI in Malaysia during the period 1970-2008 using an autoregressive distributed lag (ARDL) technique.

2.0 Methodology and Data

2.1. Autoregressive distributed lag (ARDL)

An autoregressive distributed lag model allows cointegration at different orders of integration and is a robust estimation in a small sample data. Failure to model appropriately the relationship may not give accurate results of the relationship and this is crucial especially when it involves with policy recommendations. The existence of long-run relationship between FDI and selected macroeconomics variable is modeled as follows.

Lfdi = f ( Lm2, Lgdp, gro , Ldev ,open, Lexc, tax, infl, crisis )

Where L refers to variable in logarithmic form, fdi is the foreign direct investment inflows (RM million), m2 is the money supply, a proxy for financial market development, gdp represents the market size of the economy (RM million) and gro is the growth rate of gross domestic product (%). Government infrastructure expenditure (RM million) is represented by variable dev, open is the ratio of import and export over GDP which measures economic openness, exc is the exchange rate (RM/USD), tax is the corporate tax (%), infl is inflation rate (%) and crisis is a dummy variable represents the effect of Asian financial crisis (1998=0 and otherwise=0). The hypothesized sign of Lm2, Lgdp, gro , Ldev ,open, Lexc is positive and negative for tax, infl, crisis variables. (1)

2.2. Estimating model

The econometrics model of the causality of FDI and its key determinants is as follows:

Lfdi t  α 0 | β 1 Lm 2 t|  β 2 Lgdp| t  β 3 gro| t|  β 4 Ldev| t|  β 5 open t| | β 6 Lexc| t  β 7 tax t|  β 8 inf| lt|  β 9 crisis| t| εt|

2.3. Data

Data spanning from 1970-2008 are obtained from various sources of publications. Data on FDI, rate of growth, openness, and government development expenditure are taken from various issues of Bank Negara Malaysia Reports. International Financial Statistics provides data on exchange rate, money supply, and inflation rate. Statutory corporate tax data is taken from the Department of Inland Revenue Annual Reports.

3. Theoretical Framework

* Financial development
* Wage rates
* Income
* Economic growth
* Government spending on infrastructure,
* Openness
* Exchange rate
* Inflation rate
* Corporate tax

Foreign Direct Investment

The dependent variable is determinant of FDI in Malaysia which is variable of primary interest. There are seven independent variables which are financial development, wage rate, income, and government spending on infrastructure, openness, exchange rates and corporate tax.

Financial development is measures and analyses the factors enabling the development of financial systems in a number of economies around the world. It aims to provide a comprehensive means for countries to benchmark various aspects of their financial systems and establish priorities for improvement. It is published annually so that countries can benchmark themselves and track their progress over time.

Wage rate is the rate at which a certain class of workers is compensated as an hourly increment of pay. In free market economies wage rates are determined through supply and demand forces; however, political and social factors often influence their direction. Many governments have enacted minimum wage laws to create a wage rate floor. Income is the consumption and savings opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Government spending on infrastructure is basically the base in which economic growth is built upon. The basic physical systems of a country's or community's population, including roads, utilities, water, sewage, etc. These systems are considered essential for enabling productivity in the economy is known as infrastructure. Developing infrastructure often requires large initial investment, but the economies of scale tend to be significant. Exchange rates is the price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. For example, the higher the exchange rate for one euro in terms of one yen, the lower the relative value of the yen. Corporate tax is a levy placed on the profit of a firm, with different rates used for different levels of profits. Corporate taxes are taxes against profits earned by businesses during a given taxable period, they are generally applied to companies' operating earnings, after expenses.

4 . Findings

The results for unit root test using Augmented Dickey Fuller (ADF) test suggests that all of our variables are I(1) except gro and infl which are I(0). This test suggests an ARDL approach is the appropriate method of estimation of the relationship since the variables are mixture of I(1) and I(0). The F-test has a non-standard distribution. If the computed F-test statistic exceeds their respective upper critical values there is evidence of a long-run relationship between the variables. On the other hand, the null hypothesis of no cointegration cannot be rejected if the test statistics less than the lower bound critical values. The hypothesis remains inconclusive if the F-statistic lies between the upper and lower bound of the critical values.

The calculated F-statistic F(Lfdi|Lm2, Lgdp, gro, Ldev, open, Lexc, tax, infl, crisis) is 1.1557 which is less than the lower bound critical value at 5% level of significance. This implies that the null hypothesis of no cointegration cannot be rejected and hence there is no cointegration among the variables in equation (1). The F-statistics of Wald test for F(Lfdi| Lm2, gro) is 4.8644 which exceeds the upper bound critical value at 5% level of significance. Therefore, the null hypothesis of no cointegration can be rejected. Obviously the finding of this paper shows that FDI has a long run relationship with financial development and growth rate. The empirical results of the long-run model show that both money supply (Lm2) and growth rate (gro) are important determinants of FDI inflow in Malaysia. The signs of the coefficient of money supply and growth rate are consistent with prior expectation and statistically significant at the 1% and 5% level significance, respectively. It is concluded that financial development and growth rate are the key variables affecting FDI from this long-run link. The estimated coefficients suggest that a 1% increase in the money supply and GDP growth rate attract FDI inflows into the country by approximately 0.9% and 0.2%, respectively. The coefficients reports in this paper are greater than reveals by Ang (2008). In his analysis, the effect of financial development is about 0.5% - 0.6%, while the growth rate increases FDI by .09% - .03%. real exchange rate has the biggest impact on FDI.

5. Conclusion

Unfortunately, recent estimates of the causality between FDI inflow and its determinants, namely financial development and economic growth are not appropriately estimating the long-run relationship of the variables. In this study, the bound testing for a restricted model revealed that there is a significant positive relationship between FDI and money supply and growth rate. The positively significant sign of money supply and growth rate in short-run and long-run demonstrates that money supply and GDP growth rate are important in explaining FDI in Malaysia. Since we are using money supply, M2, as a proxy for financial development, the existence of a long-run relationship between FDI and M2 suggests that advancement in financial market instrument is an important factor attracting foreign investor to this country. In contrast with previous findings, we found that GDP growth does play an important role in attracting foreign investment to this country.

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