FOREIGN DIRECT INVESTMENT POSITIVE SPILLOVER ON PRODUCTIVITY INCREASES

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FOREIGNDIRECT INVESTMENT POSITIVE SPILLOVER ON PRODUCTIVITY INCREASES: THECASE OF SOUTH KOREA AND JAPAN

Abstract

Theutilization of industrial policy as a mechanism for fosteringeconomic growth has been heavily debated amongst economists. Thispaper will bring forth the perspectives of distinct approachesutilized to promote the industry including the use of subsidies andtariffs, which have been heavily criticized. In contrast, thepromotion of foreign direct investment for this purpose has enjoyedmuch praise. Foreigndirect investment (FDI) flows have been steadily growing, with Asiabeing the top recipient. This paper studies how the flow of FDI hasaffected the industry in some of the countries in this region. Thetop two destinations for FDI flows, Japanand South Korea, initially had policies in place that aimed toprotect local firms but later liberalized their economies to welcomeFDI with hopes of enhancing competitiveness in world markets byattracting the know-how and capital of multinationals. This paperfocuses on how opening up to FDI impacted the development of industryin Japan and South Korea by using comparative empirical analysis toexamine how productivity levels were affected by FDI in thesecountries. Studyingthis issue allows for a better understanding of at least one elementof the economic success of Japan and South Korea which havesuccessfully lifted themselves out of poverty and have even beenreferred to as growth miracles. Learning more about what enabledthese countries to develop at such impressive rates can contributeefforts aimed at lifting developing countries out of poverty.

FDIis thought of as a better way of supporting industrialization becausemultinationals create knowledge spillovers to help domestic firmslearn from them. Based on this assumption manycountries encourage inward foreign direct investment through tariffexemptions, tax holidays, and subsidies for infrastructure. Theexpected result is that foreign firms will enable domesticenterprises to become technologically more advanced and bring bettermanagement as well as organizational methods for local companies tolearn. AlthoughFDI flows have largely been towards developed economies, there hasbeen a significant increase in the amount of FDI towards developingcountries in recent years with a large share of it going to EastAsian economies like Japan and Korea. This flow is believed to havecontributed to the growth of the major economies in this region.Therefore, this paper will study what those contributions are and howthey have impacted the economic well-being of the host economies. Hasit positively affected these states?

Thestream of private resources to developing nations has been on anupward trend in recent times. In the last fifteen years, generalprivate capital inflows improved from US$42 billion to an estimatedfigure of US$250 billion. In particular, the rise of the privatecapital stream has been enabled primarily by the intensification inFDI. Between 1991 and 2005, the flow of FDI to third world countriesrose from approximately US$22 billion to more than US$165. Themeteoric rise in private equity flow signifies that such flows aregrowing to be vital sources of financing than official sources, alsoknown as the official development assistance. In comparison, officialflows to emerging economies reduced from US$54 billion to US$33billion at the same time1.

Benefits

FDIplays an essential part in improving progression of many countriesworldwide. In particular, FDI offers both the technology and mostimportantly the capital that these growing countries need. FDI canflow into a country in only two channels. First is by makingavailable the money to create the productive aptitude in the economyas well as availing the required technological and organizationalknow-how that will in return help to boost the productivity orefficiency of investment. FDI enhances the productivity of the hosteconomy in terms of the introduction of the more improvedtechnologies, and management techniques of overseas firms stretch tolocal companies. Multinational companies are always at the forefrontwhen it comes to new technology. Automatically, it is supposed that,as they invest in industries in the host state, they will ultimatelytransfer these top-notch technologies to other plants locally2.

Dueto this reason, FDIs have become a vital issue for legislators indeveloping countries. For instance, under the ForeignInvestment Promotion Act (FIPA) in Korea, a promotional agency,Invest Korea, was formed to fuel FDI3.Various governments have adopted policies toencourage this kind of capital flow by establishing overseasinvestment promotion mechanisms or allowing fiscal and tax incentivesto foreign organizations that develop industries in the country.However, these exemptions can be relatively costly, in respect torevenues foregone. As a result, it is essential that the gains of FDIare explicitly established so as to rationalize the cost ofactivities commenced to attract FDI.

Inthe general neoclassical model for economic improvement, growth inlabor force and capital stock enhance higher economic development.Consequently, the flow of FDI, through the increase of domesticcapital reserve, will play a huge role in aiding the rise of aneconomy. Essentially, it has been contested that FDI add to growthpast the direct impact of boosting the capital stock. Apart from theintroduction of new technology, FDI also improves a host country`saccess to foreign markets and modern management skills. Due to this,many upcoming economies offer special incentives to attract thisvaluable resource. Furthermore, FDI is commonly perceived tosubstitute for domestic savings and thereby enabling a massiveconsumption for a particular level of investment.

Alexanderobserves that, in both Korea and Japan’s situations, there arenumber sectors of the economy that highly benefited from theintroduction of FDI model: these were: education, manufacturing,energy, technology, Media (except television and radio), Commerce,telecommunication, transport among others. The banking sector hasexperienced the most overseas investment portfolio in contrast toother areas4.Most of the foreign equity is observed to come from the UnitedStates, which a close political ally of the two nations. In addition,the professional spillover of the American service based serviceeconomy has profoundly impacted the economies of the two Asiangiants. In Japan, the services industry is known to exhibit inferiorproduct development and productivity in comparison to the U.S. InKorea, it is highly evident that business services have the mostnumber of foreign M&ampA dealings. For companies, LGElectronics` joint venture with theRoyal Philips Electronics of Hollandis an outstanding example of some of the companies that havebenefitted from the FDI. In the deal, LG Electronics received $1.6billion for Royal Philips’ acquisition of a 50 percentile share ofLG Philips LCD, a recently established venture.5

Inrelation to productivity, as per the above presented evidence, theadvantage noticed from the adoption of FDI models is directlyproportional to the growth in productivity of an economy. Extensivestudies have gone on to prove the significance of foreign capital tothe overall increase of an economy by investigating the experiencesof Japan and Korea over a period of 40 years from 1950-1990. Thereport established that FDI boosted economic growth three-fold. Thisis in comparison to aggregate investment. More research discoveredthat, higher-income emerging countries experience more growth thanthe lower-income ones which prioritize other factors like secondaryeducation6.

FDIdevelopment calls for the development of educational facilities andother institutions of knowledge, leading to the growth in productionas the labor force becomes technologically sophisticated. Thespillage of technology from the Multinational investors enhances thedevelopment advanced technological infrastructure. In addition, FDIencourages a liberal regime which in turn enables competition betweenthe multinationals and local firms. As a result, this improveslearning and innovation that leads to productivity in the economy7.

Disadvantages

Onthe flipside, According to data from the developed countries, vanPottelsberghe de la Potterie and Lichtenberg demonstrate thattechnology exchange is only feasible if the country investsintensively in foreign countries involved in research and Development(2001). Hence, Incoming FDI from R&ampD-intensive countries neverseems to improve productivity. This is an indication that overseasfirms spend abroad in order to take advantage of their technologicalleverage instead of diffusing their innovation. In addition, thereexists extensive proof in the literature that archives thecontribution of FDI to a country`s growth. The notion that FDI offersadditional gains to the host economy is not internationally shared.Through the use of statistics of the U.S. FDI investment abroad, aconnection between economic growth and FDI was observed to berelatively weak. For the benefits to be mutual, the host countryneeds to have favorable characteristics like more educated laborforce, openness to trade, and better institutions. However, they areskeptical about the profits of FDI. They assert that it isundemanding to lure FDI than to derive gain from it8.

Secondly,overseas business capitalists may have various possible impacts on ahost economy. Due to the common supposition that foreign companieshave an upper hand in technological advancement, management, or otheradvantages in contrast to local businesses, there ought to be amixture of more output, higher quality products and services, orlesser costs from the overseas venture. The above outcomes are morelikely to affect the welfare of local consumers and workers directly.Another risk is that incoming investment appends to the reserve ofthe domestic capital way past what it is required. Another riskimpact of this trend is the likelihood of indirect transfers throughspillovers. The foreign company may add the productivity, exportcapabilities, wages, or other elements of performance of domesticfirms if some knowledge exchange occurs.

Researcherslist four ways through which a host country might gain fromspillovers: skills acquisitions, imitation, exports, and competition.Imitation is the standard mechanism that headlines discussionsbetween poorer and advanced economies it usually happens through theinvalidated engineering of goods and processes or just imitatingorganization and management through a type of demonstration effect.Consequently, investors are well aware of this predicament and alwaysrefrain from sharing their latest innovations to their foreignbusinesses9. Recommendations

Dueto the above reasons, both merits and demerits, the adoption of FDIshould ensure that there is a mutual gain for both parties. Toachieve this, it is prudent to establish enforcement policies to actas a guideline in these kinds of transactions. First, the hosteconomy should strive to improve its technological infrastructure inbefore luring foreign investment. This may be in the form ofuplifting its human resource, develop educational institutions toabsorb the new models from the investors, as well as the purchase ofmodern facilities in anticipation of these deals. A highly qualifiedlabor force will ensure that it adapts quickly to the availabletechnology being introduced10.

Secondly,the policymakers should establish laws and policies that are meant tocurb or control the influence of these foreign investments. Excellentlaws make sure that the host country reaps the most from jointventures. This may involve introducing new tax laws that are meant tocushion the government from offering too much incentive to thevisiting overseas based companies. In addition, the majority of theprofit made from the deal should remain in the host country. It coulddetrimental for developing countries to forgo revenue from taxes andstill fail to leverage on the profit made from foreign-domesticmergers11.

Finally,as a condition to being provided with an ample business environment,the foreign companies should be compelled to avail their products andservices at an affordable cost. It will be a great advantage to caterto the general welfare of the consumers and workers by providingcommodities that are of high quality and equally affordable. Inreturn, this will improve the spending power of the citizen. As acomplement to cheaper product price, the wages of the typical workersshould be within the required international standard as well assustainable to the outsourcing company. Consequently, this willimprove their living standard that is one of the fundamentalprinciples of any government12.

Conclusion

Generally,there has been a tremendous improvement in the economic situations ofhost countries in relation to FDI investments. The above researchreports indicate the advantages of FDI against disadvantages. As muchas there are drawbacks, the merits of this kind of investment farmore outweigh the demerits. The economies of Japan and Korea are agreat indicator of this development. 50 years ago, the two countriescould not sustain all the sectors of their economy effectively butsince the United States offered FDI investments to essential segmentsof the economy like the telecommunication, the growth has beenevident. Korea utilized the technology spillover to enhance itsmobile phone manufacturing capabilities in the form LG Electronicsand Samsun Mobiles. On the other hand Japan has a vibrant carmanufacturing sector which includes companies like Toyota, Suzuki,and Honda. All these are manifestations of the importance of FDI to ahost economy. Furthermore, China is another beneficiary of this kindof investment. Due to FDI, it has been able to offer employmentopportunities to its citizens both locally and abroad. The generalstate of its economy has also improved a great deal13.

Bibliography

Alexander,Arthur J. &quotKorean Economy Series.&quot (2008).

Cambazoglu,Birgül, and Hacer Simay Karaalp. &quotDoes foreign directinvestment affect economic growth? The case of Turkey.&quotInternationalJournal of Social Economics41, no. 6 (2014): 434-449.

DeLa Potterie, Bruno Van Pottelsberghe, and Frank Lichtenberg. &quotDoesforeign direct investment transfer technology across borders?.&quotReviewof Economics and Statistics83, no. 3 (2001): 490-497.

Lemi,Adugna. &quotForeign Direct Investment, Host country productivityand export: The case of US and Japanese multinational affiliates.&quotJournalof Economic Development29 (2004): 163-188.

Lipsey,Robert E., and Fredrik Sjoholm. Foreigndirect investment and wages in Indonesian manufacturing.No. w8299. National Bureau of Economic Research, 2001.

Moran,Theodore H., Edward Montgomery Graham, and Magnus Blomström, eds.Doesforeign direct investment promote development?.Peterson Institute, 2005.

Ng,Thiam Hee. &quotForeign direct investment and productivity: evidencefrom the East Asian economies.&quot UNIDO,Staff working paper3 (2006): 2006.

1 Moran, Theodore H., Edward Montgomery Graham, and Magnus Blomström, eds. Does foreign direct investment promote development?. Peterson Institute, 2005.

2 Ng, Thiam Hee. &quotForeign direct investment and productivity: evidence from the East Asian economies.&quot (UNIDO, Staff working paper 3 (2006): 2006.)

3 Alexander, Arthur J. &quotKorean Economy Series.&quot (2008).

4 Alexander, Arthur J. &quotKorean Economy Series.&quot (2008).

5 Same as 4 above

6 Same as 5 above

7 Lemi, Adugna. &quotForeign Direct Investment, Host country productivity and export: The case of US and Japanese multinational affiliates.&quot Journal of Economic Development 29 (2004): 163-188.

8 De La Potterie, Bruno Van Pottelsberghe, and Frank Lichtenberg. &quotDoes foreign direct investment transfer technology across borders?.&quot (Review of Economics and Statistics 83, no. 3 (2001): 490-497).

9 Cambazoglu, Birgül, and Hacer Simay Karaalp. &quotDoes foreign direct investment affect economic growth? The case of Turkey.&quot (International Journal of Social Economics 41, no. 6 (2014): 434-449).

10 Lemi, Adugna. &quotForeign Direct Investment, Host country productivity and export: The case of US and Japanese multinational affiliates.&quot (Journal of Economic Development 29 (2004): 163-188).

11 Moran, Theodore H., Edward Montgomery Graham, and Magnus Blomström, eds. Does foreign direct investment promote development?. (Peterson Institute, 2005).

12 Lipsey, Robert E., and Fredrik Sjoholm. Foreign direct investment and wages in Indonesian manufacturing. No. w8299. National Bureau of Economic Research, 2001.

13 Alexander, Arthur J. &quotKorean Economy Series.&quot (2008).