ii

GSAPS THE SUMMARY OF DOCTORAL THESIS

DETERMINANTS OF FOREIGN DIRECT INVESTMENT INFLOWS IN ASIA: The Impact of China on FDI Attracting Ability of Other Asian Economies

– An Analysis of pre and post crisis Japanese FDI –

40004S010-2 Nimesh Salike Chief Advisor: Prof. Shujiro Urata

Keywords: China , FDI, crowding out The surge of Foreign Direct Investment (FDI) in China beginning in

1990s, coupled with declining share of other Asian economies has raised serious concerns if FDI in China is coming at the expense of other economies in the region. The crowding out of FDI issue is of greater concern for all the economies involved since it brings in benefits like capital accumulation, technology transfer and international networking. From the theoretical standpoint however, there could be both investment diversion and creation effects. First, MNEs may choose China over other economy because of its forte as low wage production site and appetite for huge domestic market. Alternatively, China may promote FDI inflow into the region if there is production and resource linkage between China and rest of Asia so as MNEs involves in international production fragmentation (Chantasasawat et al., 2004).

Against this backdrop, this dissertation attempts to critically analyze the issue of crowding out on various levels and aspects of FDI. Previous studies which focused only in aggregate FDI, suggest that China either have no effect or “crowded in” effect, rather than crowing out. This study is a first attempt to look into the issue from micro level. First, we examined the issue from the perspective of three source country specific FDI: Japan, the United States and Korea. Second, we drilled further with industry- specific Japanese FDI for thirteen industries, including seven from manufacturing and six from non- manufacturing sector. Furthermore, the industry level analysis of Japanese FDI was carried out in pre and post crisis periods comprehending to the fact that crisis of 1997 has been a significant episode in altering the structure of FDI in Asia. We undertake statistical analysis on panel data to empirically examine the concern of crowding out on a group of Asian economies which included Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand and Viet Nam. The econometric technique employed for the analysis was dynamic panel model using the equation for determinants of FDI. The research strategy is to control for the standard determinants of FDI and then add an indicator variable to capture the so called “China effect”. The indicator used in this analysis is “FDI to China over FDI to the region”, which literally meant China’s share of FDI in the region. Because of the possible problems of serial correlation and simultaneous causality bias, we adopted advanced from of estimation techniques, namely; Arellano Bond (AB) and instrumental variable (IV) (Roodman, 2006). We estimated our model in these estimation methods for eight different specifications to take care of multicollinearity so that the variables with high correlation could not be included simultaneously. This in other way has become the basis for robustness check.

We found that on source country specific FDI analysis, Japanese FDI and Korean FDI did not produce any empirical basis to support the claim that FDI in China is crowding out FDI from other economies of Asia. However, US FDI in China is found to have complementary effect. Moreover, the results of the industry level analysis revealed interesting results, with varying degree of effects. Among thirteen industries of Japanese FDI, six were found to have complementary effects; five had

crowding out effects and two with no effect. Industries with positive effects were food; machinery; service; textile; trade and transport. Those with negative effects were electrical; finance & insurance; metal; mining; and transportation service. And chemical and real estate had no effect.

Furthermore, the analysis of pre and post crisis Japanese FDI revealed that most of the crowding out took place during post crisis period while complementary during the pre crisis period. Especially, the biggest manufacturing industry, electrical/ electronics, is found to negative effect along with other two big industries, trade and finance & insurance from non- manufacturing. On the other hand, transport/ automobile is found to have complementary effect in both the periods.

An extended study carried out on the basis of annual JBIC surveys helped us to explain this behavior. The analysis provided us inferences that substantial substitution of FDI might have been taking place from ASEAN and NIEs towards China, chiefly in electrical and electronics industry because Japanese manufacturing MNEs deemed China to be the most promising destination owing to its abundant cheap labor and domestic market. Nevertheless, we also had inferences that Japanese FDI had been complemented by the FDI surge in China, particularly in automobile parts and components, chiefly because of international allocation of production via diversification of general purpose products giving rise to the production fragmentation process. With this we concluded that

• The rise of China has both investment diversion and creation effects for other Asian economies. These effects depend upon characteristics of both source and host economies.

• The crowding out effect is spurred by the low wage labor and huge domestic market of China. And the complementary effect is chiefly due to the production fragmentation strategy adopted by Japanese MNEs.

• The crisis of 1997 had adverse effects on economies of Asia resulting in the crowding out of Japanese FDI. The extent of this could be assumed to be serious as we witnessed the diversion on three big industries in post crisis period.

References

Chantasasawat B., Fung K. C., Iizaka H., and Siu A., 2004, Foreign Direct Investment in East Asia and Latin America: Is there a People’s Republic of China Effect? ADBI Discussion paper no. 17 (Asian Development Bank Institute, Tokyo).

Eichengreen B., and Tong H., 2007, Is China’s FDI coming at the expense of other countries? Journal of the Japanese and International Economies 21, 153-172

Mercereau B., 2005, FDI flows to Asia: Did the Dragon crowd out the Tigers? IMF Working Paper, WP/05/189 (International Monetary Fund, Washington, DC).

Roodman D., 2006, How to Do xtabond2: An Introduction to "Difference" and "System" GMM in Stata, Working Paper Number 103 (Center for Global Development).