A Study on the Impact of Foreign Direct Investment on Economic Development of Lao P.D.R.

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MINISTRY OF EDUCATION MINISTRY OF EDUCATION AND TRAINING LAOS NATIONAL UNIVERSITY NATIONAL ECONOMICS UNIVERSITY KHAMSEN SISAVONG A STUDY ON THE IMPACT OF FOREIGN DIRECT INVESTMENT ON ECONOMIC DEVELOPMENT OF LAO P.D.R A thesis submitted to the National Economics University in fulfillment of requirements for the degree of Doctor of Philosophy in Economics Hanoi, 2014 ii ACKNOWLEDGMENTS The Vietnam – Lao Cooperative Program Doctor of Philosophy (PhD) between NEU and NUOL is very important, necessary, valuable and beneficial to our nations because this project allows Lao people to upgrade and enhance their level to Doctorate Degree Therefore, I would like to acknowledge the leaders, Administrators, Professors of the National Economics University of Vietnam and National University of Laos to give me this excellence opportunities to achieve my dream of PhD I would like to express my gratitude to Prof Dr Tran Tho Dat, Assoc Prof.Dr Nguyen Thanh Ha and other professors who were in the committees for evaluation of my dissertation in the early stages of my PhD study I am deeply indebted to Assoc Prof Dr Nguyen Thi Tuyet Mai, my supervisor who gives me clear guidelines and contributing her advises to my dissertation I am also grateful to Prof Dr Somkod Mangnormek, Governor of Xiengkhuang Province, member of Central Committee Party, Prof Dr Kikeo Khaikhamphithoun, Head of National Accademic of Politic and Public Administration, member of Central Committee Party, Prof Dr Thongsalith Mangnormek, Head of National Economic Research, Prof Dr Bounpong Keonoradome, President of Savannakhet University who encouraged and supported me to reach my goal of PhD My special thanks go to my family, Sengsavanh College’s staff and my friends They are always pleased to encourage and to assist me during my PhD research Without your supports I could not complete and realize my dream iii CONTENTS DECLARATION i ACKNOWLEDGMENTS ii ABBREVIATIONS .v LIST OF FIGURES vii LIST OF TABLES viii CHAPTER INTRODUCTION 1.1 Research Background 1.2 Rationale for the Research .3 1.3 Research Objectives and Research Questions .4 1.4 Scope of the Study 1.5 Contributions of the Study .6 1.6 Dissertation Structure CHAPTER LITERATURE REVIEW ON THE IMPACT OF FDI ON ECONOMIC DEVELOPMENT 2.1 Definition and Indicators of Economic Development 2.1.1 Definition of Economic Development 2.1.2 Indicators of Economic Development 10 2.1.3 Theoretical Economic Overview 11 2.2 FDI and its Impact on Economic Development 14 2.2.1 Definition and Determinants of FDI 15 2.2.2 Impact of FDI on Economic Development 30 CHAPTER OVERVIEW OF ECONOMIC DEVELOPMENT AND FDI IN LAOS 51 3.1 Overview of Laos’ Economy 51 3.1.1 Economic Growth .52 3.1.2 Economic Structural Changes 53 3.1.3 Financial Sector Growth 54 3.1.4 Banking Sector Development .55 iv 3.1.5 Inflation has been effectively managed 55 3.1.7 Workforce and Employment Balance 56 3.1.8 Balancing the Sources of Funds for Development 58 3.1.9 Balancing the State Budget 60 3.1.10 Balancing Imports and Exports 61 3.1.11 Sectoral Development, Regional and International Economic Integration .65 3.1.12 Infrastructure 88 3.2 Foreign Direct Investment in Laos 90 CHAPTER RESEARCH METHODOLOGY 95 4.1 Research Questions 95 4.2 Variables and Measures .95 4.3 Data Description 97 CHAPTER RESEARCH FINDINGS 107 5.1 FDI and GNI per Capita 107 5.2 FDI and Financial Capital 108 5.3 FDI and Level of Technology 111 5.4 FDI and Human Capital .112 5.5 FDI and Energy and Natural Resources 113 5.6 FDI and Transportation and Communication 114 CHAPTER CONCLUSIONS AND DISCUSSION 116 6.1 Conclusions 116 6.2 Implications of the Study 117 6.3 Limitations of the Study and Future Research Direction 121 REFERENCES 123 v ABBREVIATIONS AFTA Asean Free Trade Area AGOA Africasn Growth and Opportunity Act APTA Asia Pacific Trade Agreement ASEAN Association of South East Asian Nations ATIGA Asean Trade in Goods Agreement BIT Bilateral Investment Treaty BOP Balance of Payments CAP Carribean African Pacific CEPEA Comprehensive Economic Partnership in East Asia EAFTA East Asia Free Trade Area ECE Economic Commission of Europe ECOWAS Economic Organization of West African States EU European Union FDI Foreign Direct Investment FPI Foreign Portfolio Investment FY Financial Year GDI Gross Domsetic Income GDP Gross Domestic Product GNI Gross National Income IMF International Monetary Fund IPRs Intellectual property rights ISCED International Standard Classification of Education ISIC International Standard Industrial Classification Lao PDR the Lao People’s Democratic Republic vi LDCs Least developed countries MFs Multinational firms MIGA Multilateral Investment Guarantee Agency MNC Multinational Corporation NEM New Economic Model NIEs Newly Industrializing Economies NTA National Tourist Authority ODA Official Development Assistance OECD Organization for Economic Co-peration and Development OLI Ownership, Locational, Internalization OLS Ordinary Least Square OPIC Overseas Private Investment Corporation PPP Purchasing Power Parity SAPTA South Asian Preferential Trade Agreement TDS Total Debt UN United Nations US the United States VAT Value Added Tax WTO World Trade Organization vii LIST OF FIGURES Figure 1: Economic structure 2006 – 2010 54 Figure Export and Imports from 2005-2009 64 Figure Average size of agricultural land per household 66 Figure Average share of value added in the industrial sector 2006-2010 70 Figure Structure of service sector 2006-2010 75 Figure Foreign direct investment, net inflows (BoP, current US$) 92 Figure Distribution of FDI in Lao PDR (US$ m) .93 Figure Share of accrual FDI by country (% of total, as of August 2009) 93 Figure Ten biggest foreign investors in Laos (1989 – 2012) 94 Figure 10 Graph of Correlation between FDI and GNI per capita 107 Figure 11 Graph of Correlation between FDI and long-term debt service on external debt 110 Figure 12 Graph of Correlation between FDI and level of technology .112 Figure 13 Graph of Correlation between FDI and School enrollment, tertiary 113 Figure 14 Graph of Correlation between FDI and Natural Resources 114 Figure 15 Graph of Correlation between FDI and Mobile cellular subscriptions .115 viii LIST OF TABLES Table Comparison between actual and targeted GDP growth rate in the Sixth Plan (2006-2010) 52 Table GDP per capita (plan vs actual) 53 Table Share of labour by sectors .58 Table Private domestic and foreign investment from 2006-2010 (USD billion) 60 Table Export structure of Lao PDR by commodities 2005-2009 (%) .62 Table Import structure of Lao PDR by commodities 2005-2009 (%) .63 Table Inter-Country Comparison on Opened Trade or Integration 2006-2010 86 Table Export Market Structure with Main Trade Partners, 2008 87 Table Foreign direct investment, net inflows 98 Table 10 GNI per capita .99 Table 11 Gross capital formation (annual % growth) 100 Table 12 Financial capital 101 Table 13 Industry, value added (% of GDP) 102 Table 14 Human capital 103 Table 15 Oil consumption per capita 104 Table 16 Transportation and communication .105 Table 17 FDI and GNI per capita Coefficient of Correlation 108 Table 18 FDI and Financial Capital Coefficient of Correlation 108 Table 19 FDI and Level of Technology Coefficient of Correlation 111 Table 20 FDI and Human Capital Coefficient of Correlation 112 Table 21 FDI and Energy and Natural Resources Coefficient of Correlation 113 Table 22 FDI and Transportation and Communication Coefficient of Correlation 114 CHAPTER INTRODUCTION 1.1 Research Background Laos is a small landlocked country with an area of 236,800 square kilometers It shares its borders with Vietnam in the East, China in the North, and Cambodia in the South, Thailand and Myanmar in the west Two third of the country is mountainous (northern part) thus its geographic circumstances constrain both the quality and quantity of agriculture and cause difficulties to the development of trade, social infrastructure and transportation and communication links However, the country has transformed from a landlocked to a land link and cross road to other parts of the world Laos is located in the center of energetic and prosperous region of South East Asia and possesses a high potential of natural resources, raw material and hydropower The country is divided into three main regions: northern, central and southern regions The current total population of Laos is 6.9 million (2012) with major of those live in valleys of the Mekong river and its tributaries The population density is about 27 per Sq meter Vientiane is the capital and the largest city, and its population is about 800,000 residents After becoming independent in 1975, Laos established control over the economy through the centralized fiscal and socialist government until 1985 but during that period, the government had seen that the performance of the economy was unable to reach expected goals Economic management was weak due to the lack of skilled labor force External assistance was provided but projects were not completed at a satisfactory level In 1986, the Lao government implemented the New Economic Mechanism (NEM) to open the country and provided incentives for developers and investors and moved from a centrally planned economy to a market oriented economic model The goals of the NEM were: Launching open market policies and the introduction of market economy principles The reform has attracted FDI projects in the agricultural, industrial, hydropower electricity, mining and the service sectors These sectors of development have played an important role in the support of the economic development in Lao P.D.R Laos has continuously pursued significant economic and institutional reforms, aiming at improving social and economic wellbeing of its population by consistently building itself a market oriented economy Laos has achieved remarkable economic growth and macroeconomic stability It has witnessed a significant rise in public and private investment These factors contributed to the annual average growth rate of over percent per annum from 1990 to 2009 and the annual average growth rate of about percent in 2012 In order to promote and attract FDIs in Laos, the government has created Special Economic Zones (SEZ) in compliance with the general investment policies of the government The government has implemented incentive policies to promote both domestic and foreign investment in the special economic zone by shortening the investment approval process in SEZ, facilitating business operations, production, and services based on the mechanism of “smaller administration units but wider society” or “one stamp mechanism” to generate a good environment for investment FDI inflows in Laos have grown dramatically over the past decade and have played an important role in the growth of the world economy as well as the ASEAN Nations In the developing world, FDI has become the most stable and largest component of capital flows As a result, FDI has become an important alternative in the development finance process (Global Development Finance, 2005.) 115 Figure 15 presents the graph of correlation between FDI and Mobile cellular subscriptions Figure 15 Graph of Correlation subscriptions between FDI and Mobile cellular In summary, in this study the author employed the method of correlation analysis to test the relationship between FDI inflows and various indicators measuring six aspects of economic development in the context of Laos over the period 1990-2012 The research findings, although are exploratory in nature, in general provide empirical evidence to support the important and positive role of FDI inflows on economic development 116 CHAPTER CONCLUSIONS AND DISCUSSION This chapter presents conclusions of the research findings and discussion of the findings First section presents conclusions Next, implications for policy makers are provided The final section presents limitations of this study and suggests directions for future research 6.1 Conclusions This research aims to explore the role of FDI inflows on economic development in Laos, a developing country which has received very mosdest research attention to date The correlation analysis method was employed to serve this purpose The research results show that in general, FDI plays a significant role on economic development Specifically, FDI inflows were found to be positively correlated with almost all indicators measuring six aspects of economic developent The research findings are summarized in the following • FDI and GNI per capita: The findings suggest an important role of FDI inflows on GNI per capita by showing a strongly positive correlation between the two measures • FDI and Financial Capital: The findings show that FDI inflows are significantly and positively correlated with some indicators of financial capital including the Gross capital formation (% of GDP), the Debt service on external debt, longterm (TDS, current US$), and the Debt service on external debt, total (TDS, current US$) • FDI and Level of Techonology: The findings show that FDI inflows has a positive and important role on level of technology, based on a strong and positive correlation between FDI and the Industry value added (% of GDP) • FDI and Human Capital: The findings show that FDI inflows are significantly correlated with all five indicators of human capital All correlation coefficients 117 are positive, except the one between FDI and Mortality rate, under-5 (per 1,000 live births) This results may need to have further study for clarify the relationship between the two measures The strongest correlation is the one between FDI and School enrollment, tertiary (% gross) • FDI and Energy and Natural Resources: The findings failed to provide empirical evidence for the significant role of FDI inflows on Energy and Natural Resources Perhaps, it is partly due to the measure limittaion of Energy and Natural Resources with only one indicator - the oil consumption per capita This may need further exploration with more comprehensive measure • FDI and Transportation and Communication: The findings suggest that in general FDI inflows have an important and positive role on the Transportation and Communication, by showing significantly positive correlations between FDI and five indicators of Transportation and Communication including Air transport, passengers carried, Air transport, registered carrier departures worldwide, Mobile cellular subscriptions (per 100 people), Internet users (per 100 people), and Roads (total network - km) The strongest correlations are those between FDI and Roads (total network - km), Mobile cellular subscriptions, and Internet users 6.2 Implications of the Study Theoretical implications From theoretical perspective, this study is important because it contributes to better understanding the relationship between FDI inflows and economic development in the context of a developing country This is especially interstesing and important since the research context in this study is Lao P.D.R., a country that has received very little research attention from scholars up to date Therefore, the findings from this study help to enrich the literature on FDI and its role on economic development in general and in developing countries, in particular 118 In addition, in this study the author empirically examined the relationship between FDI inflows with a number of aspects of economic development, rather than just focusing on one aspect as in many previous studies Implications for policy makers On the basis of the findings, this study is also expected to provide a number of implications for policy makers in Laos with the purpose of making effective use of FDI for enhancing economic development in this country Some implications and suggestions are presented in the following Promoting and attracting FDI inflows Attracting FDI has been becoming increasingly important for developing countries like Laos As reported in the previous chapter, FDI inflows in Laos, in general, show significant and positive role on different aspects of economic development such as economic growth, financial capital, human capital, level of technology, and transportation and communication Therefore, it is important for policy makers to develop appropriate policies to create favorable environment to attract FDI inflows There are a number of areas that should receive strong attention from policy makers including institution/policy, infrastructure, labor skills, capabilities of making use of technology to reduce the risks and increase incentives to attract foreign investors Trade policy reforms and structuring industrial networking known as "clusters" are important incentives for FDI "Clusters" are concentrations of firms in one or a few industries They are comprised of competitors, buyers, and suppliers networks Industrial networking helps in creating efficient and strong local market, and in turn more advantage of technology spillover from the foreign companies Implementing sustainable policy reforms improves investment environment and increases the country's credit worthiness in the eyes of the foreign investors 119 Institutional factors of the recipient country are essential elements determining the type and volume of FDI Morrissey and Rai (1995) indicated that the degree of political stability and government intervention in the economy, the existence of property rights legislation determining the legal rights of foreign firms and limitations on foreign ownership, the property and profit tax system, and the extent and severity of bureaucratic procedures are all institutional factors influencing the type and size of FDI inflow In addition, international agreements on trade and investment can significantly influence the volume and patterns of FDI Foreign investors calculate the amount of risk involved in their investment strategy abroad Expropriation is unlikely to resurface in the near future, and many developing countries now protect FDI investors from expropriation by introducing that protection in their law chapters Developing countries that have liberalized their economies and privatized their state services are not willing to retract ownership of these services (Minor, 1994) Clarke (2001) assessed the effect of institutional quality represented by 'risk of expropriation' and 'rule of law' on research and development Using regression analysis on a panel of data from between 1983 and 1994 for low and middle-income countries he concluded that the risk of expropriation is more significant than the 'rule of law', and expenditures on R&D is lower in countries having higher risk of expropriation and weaker rule of law Globerman and Shapiro (2003) evaluated the importance of infrastructure governance (legislations, regulations, and legal system that condition freedom of transacting, security of property rights, and transparency of government and legal process) as prerequisite for receiving FDI Intellectual property rights and innovation have a significant role in attracting FDI (Chen & Puttitanun, 2005) The determinants of FDI have changed over time While specific policy interventions (e.g trade barriers) have affected FDI in many countries for long periods of time, FDI investors have increasingly been looking for “sticky” places, 120 with good economic fundamentals in places: market size and growth, good quality and appropriate skills and infrastructure This has implications for how policy makers can work on attracting inward FDI Maximizing the effective impact of FDI on economic development It has been noted that the impact of FDI will largely depend on the economic conditions of the specific countries Domestic investment, savings, the mode of entry of FDI (e.g merger, acquisition, or new investment), the sector involved, and the country's ability to regulate foreign investment are all factors affecting the impact and the size of the FDI Many previous studies have also suggested that the level of infrastructural development and human factor may limit the effective impact of FDI on the economic growth (Adegbite & Ayadi, 2010) Therefore, Laos government may need to put sufficient investment into upgrading infrastructure and developing human capital so that the country can maximize the techonological spillovers and other benefits associated with FDI inflows Policy makers in Laos also need to work on the necessary activities and developing relevant policies to promote favorable environment for FDI and enhance the government’s capability to maximize the benefits of FDI inflows Laos’government may need to increase their investment in fundamental infrastructures, human capital development, and facilities for enhancing international trade and investment climate (Kotrajaras et al., 2011) so that FDI can effectively promote economic growth Enhancing capabilities of controlling and regulating FDI for better economic developemnt As indicated in the findings of this study, although FDI generally show positive relationship with various indicators of economic development in Laos, it still shows some negative side such as FDI was significantly associated with the Debt service on external debt, long-term (TDS, current US$), and the Debt service on external debt, total (TDS, current US$) In order to maximize the positive impact 121 of FDI, policy makers may need to pay attention to the following issues such as considering the area to attract FDI – not all types of FDI should be given the same priority It should be integrated with the national goals and the development strategy of the country Laos government needs to develop its capabilities of controlling and regulating FDI for better economic development FDI should be directed to the right sectors and areas so that the economy can have sustainable development The government also needs to have ability to select the appropriate FDI projects, develop relevant policies toward different types of FDI projects, and have ability to make decision of rejecting some inappropriate projects Developing an effective mechanism affecting foreign direct investors to ensure mutual benefits of the foreign investors and the host country’s development In order to ensure the positive impact of FDI inflows on economic development of the country, at the same time to attract FDI projects, policy makers need to put effort to develop an effective mechanism that can affect foreign direct investors, especially the multinational corporations to ensure mutual benefits of the foreign investors and the host country’s development It means that the foreign investors can operate successfully in Laos market for their profit but at the same time these investors also commit to the development of the host country (i.e Laos) This can help ensure sustainable development of the market for the foreign investors, and thus can bring long-term benefits for them as well as the development for the local economy 6.3 Limitations of the Study and Future Research Direction This study has significant contribution in terms of both theory and practices However, it has several limitations that can be explored further in the future studies 122 First, regardless of the long period of the data collected (1990-2012), some variables had limited and small number of observations, like the Energy and Natural Resources data which gave mixed results of the unavailability of that data Second, with regard to measurement issue, there is some limitation in terms of a limited number of indicators measuring some variables in this study For example, Level of Techonology and Energy and Natural resources each was measured by only one indicator Future research should use more comprehensive scales with multiple items to increase the validity of the results Third, many other aspects of economic developemnt could be affected by FDI inflows other than the ones selected in this study The future research could explore the impact of FDI on more aspects of economic developemnt Fourth, in this study the author just explored the role of FDI on economic development by empirically examined the correlations between FDI inflows and various indicators of economic development in Laos It would be desirable for future research to test the impact of FDI on economic development employing more advanced technique such as regression Another suggestion for future research would be having a micro level analysis for Laos to come up with a reform strategy for improving their GNI per capita following the path in accomplishing that goal Future research could also examine the factors influwncing the attraction of FDI inflow to Laos In conclusion, despite some limitations associated with this study, the author believes that this study has obtained certain achievements The findings of this study on the relationship between FDI and various indicators of economic development in Laos contribute to better 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FDI have a significant role on the Energy and Natural Resources availability of Laos? • Does FDI have a significant role on the Transportation and Telecommunication infrastructure of Laos? 1.4 Scope of the Study This study focuses on the role of FDI on some indicators of economic development in the context of Laos Other aspects of development such as social and environmental issues (i.e., poverty ratios... for a given rate of human capital accumulation, higher saving or lower population growth leads to higher level of income and thus a higher level of human capital Hence, accumulation of physical capital and population growth has greater impacts on income when accumulation of population growth rates This would imply that omitting human capital accumulation biases the estimated coefficient on saving and... They are the foundation for any economic development stimulation The scarcity of these resources will stall the economy and make it difficult to make growth progression Research Questions This research tried to answer the questions: 1) What are the relevant literature and the theoretical background on FDI and its impact on economic development? and 2) Does FDI have a significant contribution to economic. .. economic development of Laos? With regard to the impact of FDI on economic development, the research aims to answer the following specific questions: • Does FDI have a significant role on the GNI per capita? • Does FDI have a significant role on the Financial Capital? 6 • Does FDI have a significant role on the country's level of technology of Laos? • Does FDI have a significant role on Human Capital of Laos?... international market access Since the 1990's, the global flows of FDI have grown phenomenally and have become the largest source of foreign private capital to reach developing countries like Laos The attraction of the FDI is becoming increasingly important for Laos to bring certain benefits to the national economy like the contribution to the GDP, the total investment, and the balance of payment for the. .. trade, and human capital (e.g., Adegbite & Ayadi, 2010; Kotrajaras et al., 2011; Mengistu & Adams, 2007; Phimphanthavong, 2012; Prasad & Sharma, 2012) In this study, the author examines the impact of FDI on economic development in Laos, focusing on some economic development indicators including: - Gross National Income (GNI) per capita The GNI per capita is the dollar value of a country’s final income... Dual Economy, the Dependency Theory, and other scholarly models in the field assisted in establishing the base theory for the research The research problem revolves around the notion that Laos is incapable to achieve economic growth Natural resources, human capital, financial capital, transportation and communication, level of technology, and leadership, are all important elements of sustainable economic. .. important factors of inward FDI Ledyaeva and Mishuna (2006) analyze FDI distribution in Russian regions and show that only a fraction of aggregated profit in a particular region is robustly related to regional distribution of investment in Russia, which is unfavorable and only high profit can compensate for the risks and attract investors Suggesting regional homogeneity of FDI factors for transaction economies,... confirming the linkage between FDI inflows in Laos and the economic development indicators including GNI per capita, financial capital, level of technology, human capital, energy and natural resources, transportation and communication The major economic development theories and models such as The Stage Theory of Rostow, the Harrod-Domar model of savings and productivity of investment, the Lewis Model of Dual... stated that underdevelopment could only be explained in a historical context The state of underdevelopment was the result of colonization that allowed a small minority to own and control the majority of the land, the primary raw materials, and the illegitimate political power (Pool & Stamos, 1990) Dependency theory (Pool & Stamos, 1990) on the other hand, has explained the underdevelopment based on the
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