THEORETICAL M OTIVATION : DYNAMIC RELATIONSHIPS AMONG THE VARIABLES

The FDI literature has extensively been reviewed in Chapter Two. This chapter, therefore, only intends to clarify certain aspects necessary for the investigation of causal relationships. The idea of a development threshold, country specific characteristics, stages of development (developed or underdeveloped), and the methodologies employed suggest that FDI could have a positive or negative impact on the economy. Yet, t here i s n o c onsensus 0 n t he r elationship b etween FD I a nd key macroeconomic variables. In recent years, there has been a growing view that not only does FDI Granger-cause key macroeconomic variables but key macroeconomic variables also affect FDI.

Theoretically, the interrelationship between FDI and other macroeconomic variables has been strengthened by recent developments in growth and trade theories. An explanation for FDI-driven growth and trade was already presented in Chapter Two. It is possible to view FDI-driven growth rather optimistically, mainly due to wide range of

complementarities MNEs can have through local fIrms. It could stimulate development

in h ost c ountries. FDI c ould p romote e conomic growth i n t wo w ays: first i s through capital accumulation in the host countries. FDI encourages new inputs and superior foreign technologies, which enhances growth (Blornstrom et aI., 1 996; Borensztein et

aI., 1 998; Lim, 2001). Secondly, there could be a transfer of knowledge, in the form of

labour training and skill acquisition (de Mello, 1997, 1 999).

There are strong arguments, on the other hand, that causality runs from growth to FDI. When rapid growth occurs foreign investment is a concomitant development. Fast growth and characteristics like macroeconomic stability, economic liberalisation, improvement in infrastructure and reformed institutional factors also encourage FDI. If these characteristics are found to be determinants of FDI, then economic growth may be created in order to attract FDI.

Higher levels of aggregate demand are another factor, which stimulates demand for overall investment, including FDI. FDI on its own can add to growth of the market (Zhang, 2 000). The 1 arger t he m arket, the greater w ill b e t he o pportunities t o r ealise

economies 0 f scale. F urthermore, t he d irection 0 f c ausation a Iso depends 0 n e xisting

factor endowments. Larger economies are always more attractive to FDI than smaller ones. Economies of scale, geographical location, and the availability of infrastructure are vital components in the decision-making process of MNEs. It is therefore clear that the direction of causality depends to a considerable extent on the scale effects and the existence of other conditions impacting upon growth.

Studies by Dowling and Hiemenz (1 982) and Lee and Rana (1 986) showed that rapid

growth could induce an inflow of FDI. In certain instances a two-way causality between

FDI a nd growth i s p ossible. C aves ( 1 996), s howed that a s trong connection b etween FDI growth and growth could be an outcome of either growth-driven FDI or FDI-driven

growth. It is, however, equally plausible for both variables to move in tandem. Further, whether FDI is complementary or a substitute for domestic investment emphasises the importance of the causal relationship between FDI and domestic investment.

In a similar vein, the trade-FDI nexus shows that

"as c ountries develop a nd approach industrialised-nation s tatus, i nward F DI contributes to their further integration into the global economy by engendering and boosting foreign trade flows. Apparently, several factors are at play. They include the development and strengthening of international networks of related enterprises and an increasing importance of foreign subsidiaries in MNEs ' strategies for distribution, sales and marketing. In both cases, this leads to an important policy conclusion, namely that a developing country 's ability to attract FDI is influenced significantly by the entrant 's subsequent access to engage in importing and exporting activities " (OEeD, 2002b, p. 1 1).

FDI increases in the host country may lead to changes in the trading pattern. FDI not only affects a country's export structure, but causes imports to change from consumer to intermediate and capital goods. FDI can also have a negative impact on the economy through increased imports. The crux of the argument is that FDI tends to have a higher propensity of importable inputs, which leads to a balance of payments deficit (Lipsey, 1 99 1 ; Graham and Krugman, 1995). It is therefore necessary, in addition to investigating the FDI-export relationships, to study the import side. The causal relationship between FDI and trade is generally complicated and depends largely on the nature of FDI and trade (Liu et aI., 2001 ).

The interrelation between FDI and trade theories is, as noted in Chapter Two, relatively understudied4 although the importance of FDI and international trade, as individual variables in economic growth, has been commonly documented. Most studies have

4 The connection between outward FDI and exports appears to be widely treated empirically. See, for example, Lipsey and Weiss ( 1 98 1 ); Yamawaki ( 1 99 1 ); Pfaffermayr ( 1 994); Alguacil and Orts (200 1 ). Yet, only a few studies are related to inward FDI and exports or imports. See, for instance, de Mello and Fukasaku (2000); Liu et al. (200 1 ); AIguacil and Orts (200 I ); Liu et al. (2002).

considered mainly the substitution-complementarity impacts between FDI and trade whereas studies that have explicitly tested for causal links between FDI and trade are extremely rare.

It is clear that host country characteristics determine the impact of FDI. The empirical fmdings reported in Chapter Five of this study indicated how FDI has been a significant factor in the growth and development of a small, developed country. There is evidence to show that there is potential for significant benefits from FDI towards improvements in labour productivity. Yet, they do not occur automatically. Benefits depend on the ability and innovation of local finns to engage in investment and learning so as to absorb foreign technology and skill. Competition and education are maj or requirements to achieve benefits. FDI flows create potential benefits for spillovers to the local labour force. However, the host country's human capital level determines the amount of FDI it can attract. This association between FDI and spillover can form the necessary foundation for policy and strategic development.

Within a cointegrated single equation approach, the significance of FDI's influence on these variables has been investigated. Yet, the relative importance of their interdependence and the feedback effects were not identified. As shown in the analytical schema (see Figure 4. 1 ), the interrelationship between FDI and other macroeconomic variables needs to be investigated to obtain a complete understanding of the role played by F DI on a host economy. These connections are vital for policy implications in a small, developed country like New Zealand. The outcomes would show whether FDI could be deemed as a catalyst for economic growth, capital formation and trade, and could lead to an explanation of the pre-conditions required to encourage larger FDI inflows.

This study, therefore, forms further expansion on the previous empirical findings. It

uses the cointegrated VAR approach. Multivariate techniques have been developed to

investigate counterparts of the econometric models developed in Chapter Four. Based on the results from the single equation approach the most robust equation from each of

the models has been examined in this multivariate approach. These models will examine possible causal relationships among major variables (such as economic growth, exports, domestic investment, FDI, and labour productivity). They will at the same time also consider the other factors influencing the major macroeconomic

variables such as GDP per capita, human capital, the exchange rate, and so on. In

addition, this study also investigates the impact of the flow and stock concept of FDI on trade.