The Impact of the Recent Global Crisis on Foreign ... - ScienceDirect

Procedia Economics and Finance 3 (2012) 1012 – 1017

Emerging Markets Queries in Finance and Business

The Impact of the Recent Global Crisis on Foreign Direct Investment. Evidence from Central and Eastern European Countries Adina Dorneana,*, Vasile I c

b

, Dumitru-Cristian Oaneac

a, b of Iasi, Carol I Boulevard no.11, Iasi 700505, Romania Chief Analytics Officer, BC Web Technologies LTD, 5 Fowey Avenue, London IG4 5JT , U. K.

Abstract Few studies have investigated the relationship between the recent global financial and economic crisis and FDI flows. This paper aims to analyze such a relationship for Central and Eastern European countries (EU members). The crisis had a major impact on capital flows to the region, although the magnitude of the impact differed notably, depending on the type of capital inflows and the receiving country. In order to highlight this, we use a regression model and panel data methodology, trying to find if there is some difference between the analyzed countries. The results will be very useful if there is a pattern for different countries regarding the main effect of the financial crisis and the interaction with economic growth over the FDI. Taking into consideration the fact that we found that economic growth has a significant influence over the level of FDI and, moreover, a positive influence, the present study is very important in supporting the regulatory environment of those specific countries, in order to attract more FDI, as a solution for recovery of the economies affected by crisis.

2012 Published Elsevier Ltd.access Selection peer-review under responsibility of the © 2012 The©Authors. Published byby Elsevier Ltd. Open under and CC BY-NC-ND license. Selection and peer review under responsibility Emerging Markets Queries in Finance and Business local organization. Markets Queries in Finance of and Business local organization

Emerging

Keywords: Foreign direct investment; financial crisis; CEE countries; economic growth; regression model.

1. Introduction Investments across countries are a powerful tool in promoting economic relationships between different parts of the world. Over the past two decades, the global foreign direct investments (FDI) flows had rapidly

* Corresponding author. Tel.: +40-232-201610; fax: +40-232-217000. E-mail address: [email protected].

2212-6716 © 2012 The Authors. Published by Elsevier Ltd. Open access under CC BY-NC-ND license. Selection and peer review under responsibility of Emerging Markets Queries in Finance and Business local organization. doi:10.1016/S2212-5671(12)00266-3

Adina Dornean et al. / Procedia Economics and Finance 3 (2012) 1012 – 1017

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increased. Despite turmoil in the global economy, global FDI flows exceeded the pre-crisis average in 2011, reaching 1.5 trillion USD. However, they still remained some 23% below their 2007 peak (UNCTAD, 2012), when the value of FDI was 1,971 billion USD, about ten times more than the value recorded in 1990. Our paper will analyze the relationship between the FDI flows and the financial crisis which started in 2008, emphasizing the case of CEE countries. Our study is the second attempt on a more extensive project that aims to study, to analyze and to argue the macroeconomic and microeconomic effects of the global crisis on FDI. Subsequently, this paper will be followed by more analyses, using existing data and recent research in the field. Overall, the project aims to offer a fully documented response to the question: is it necessary a special treatment (promotion policy) for FDI in time of crisis? This paper is organized as follows: section 2 presents a short literature review on the relationship between FDI, economic growth and crisis. In section 3, we describe the methodology used, we show the data selection process and the characteristics of our sample and we report our results. Finally, we present our main conclusions. 2. Literature review on the relationship between FDI, growth and crisis This is not the first financial crisis that caused a lot of debates. Researchers (Reinhart and Rogoff, 2008) Norway (1987), Finland (1991), Sweden (1991) and Japan (1992) and other small banking and financial crisis such as: Australia (1989), Canada (1983), Denmark (1987), France (1994), Germany (1977), Greece (1991), Iceland (1985), Italy (1990), New Zealand (1987), United Kingdom (1973, 1991, 1995) and United States (1984). A significant number of studies found similar results regarding the linkage between FDI and economic growth, through a comprehensive empirical analysis, using countries from around the world as samples. Alforo et all. (2000) pointed out the positive influence of FDI on economic growth, emphasizing the importance of local financial markets in this process. Furthermore, these results are confirmed by a series of studies which analyzed countries from different parts of the world. For Asia, Zhang (2001) found that the positive effect of FDI in promoting economic performance is stronger in the costal part of China than the inland area. Moreover, Choong et all. (2004) emphasized that, for Eastern Asian countries, it is very important the development level of the financial sector. This can be seen as a source of competitive advantage in attracting FDI by host countries and, in the end, in promoting economic growth, results that are valid also for Taiwan (Chang, 2006), Malaysia and Thailand (Chowdhury and Mavrotas, 2006). This positive linkage between FDI and economic growth was also found for 18 Latin American countries (Bengoa and Sanchez-Robles 2003), and it could be improved by several elements from the host country, namely: adequate human capital, economic stability or liberalized markets. The same relationship was found to be true for other 10 African countries (Esso, 2010). But the results stated above were not confirmed by the empirical analysis conducted by Carkovic and Levine (2005), through which it was pointed that the FDI do not exert an independent influence on economic performance and their influence depends by other determinants of economic growth. Even if there are a lot of papers that analyze different crisis in time, there is a scarce research regarding the relationship between the recent global financial crisis and FDI. The interest of researchers, who approached this topic, was to measure the strength of financial crisis over the FDI level. More specifically, the empirical study conducted by Ucal et all. (2010) revealed that the financial crisis had a powerful influence on FDI. After recording an upturn in the year(s) before the crisis, the level of FDI decreased in the followings years. Of r for host countries and it can play a very complex and important role in micro economic responses to the financial crisis. This aspect is supported by the empirical analysis conducted by Alfaro and Chen (2010), through which, it is emphasized the importance of FDI in economic growth, volatility and economic interdependence across the countries in order to minimize the negative aspects

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of financial crisis. Moreover, researchers wondered if the last financial crisis had less or much strength on FDI than other past crisis. To answer this question, Poulsen and Hufbauer (2011) compared the current FDI recession with the response in FDI to past crisis and they found that indeed, the financial crisis from 2008 was the biggest one. At the same time, the global level of this crisis had led to a greater change in FDI. After more than four years that the crisis started, there is a scarce research regarding the relationship between the current global financial crisis and FDI and there is still room for further analysis. Thus, with this paper, we aim to put another piece to the whole picture regarding this topic, by analyzing this link for CEE countries. 3. Methodology 3.1. The model The model used in this paper has as starting point the hypothesis of Growth-led FDI that relates with the Multinational Corporations theory. The background is represented by the Eclectic Paradigm or OLI (Ownership, Location and Internalization) described by Dunning (2000) and firstly discussed in 1977. According to the location sub-paradigm of countries, a MNC with some ownership advantages will choose to invest in countries with a location advantage, emphasizing the market size (usually proximate by GDP). The rationality behind this theory is that an increase in the market size of the host country will led to an increase in the level of FDI, due to a higher expected profitability. In our paper, we will extend the model, because we want to capture the financial crisis effect on FDI, so the basic model will be given by Equation (1).

FDI i ,t

0

1

GROWTHi ,t

2

CRISIS

i ,t

(1)

where FDIi,t - the level of FDI for country i and year t as percentages of GDP; GROWTHi,t - the economic growth for country i in year t (percentage change of GDP); CRISIS - is a dummy variable taking 1 for years 2009, 2010, 2011 and 0 otherwise 0, 1, 2 i,t - error term. The econometric method that will be used to estimate the regression model is last square method (LS) based on balanced panel data. Also, we are interested in checking the robustness of our regression model. To achieve this objective, we follow the methodology used by Carkovic and Levine (2005) and we select a control variable represented by Openness trade. Based on table 3, we can see that our regression model is valid, economic growth and financial crisis maintain their sign and significance. 3.2. Data and descriptive statistics Data for CEE countries is available for the period 1994 2011 from United Nations Conference on Trade and Development (UNCTAD) for FDI, GDP growth (without 2011) and imports as percentages of GDP (as a proxy for Openness trade). For the last year of our analysis, 2011, we estimate the GDP growth rate based on EUROSTAT data. Officially, the financial crisis started in September 2008, when Lehman Brothers filed for Chapter 11 bankruptcy protection, followed by other financial institutions (e.g. Merrill Lynch, American International Group). CEE countries have experienced the financial crisis more aggressively after the beginning of 2009. In 2009, the level of FDI decreased to 2.52% of GDP, compared to the level of 2008 of 6.02% of GDP. A worst situation was recorded by GDP growth that has fallen from 19.31% in 2008 to -15.73% in 2009. The evolution of average FDI and average GDP growth can be clearly observed in Figure 1.

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30% 25% 20% 15% 10% 5% 0% -5%

Financial crisis

-10% -15% -20%

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Fore reign g Dire r ct c In Investmen ent (% of GD GDP)

2004

2005

2006

2007

2008

2009

2010

2011

GDP Gr GD Growt w h (%) %

Fig. 1. Average FDI and average GDP growth for CEE countries (1994 - 2011)

Source: based on data from UNCTAD, available at: http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx. The descriptive statistics for FDI, GDP growth, crisis and openness trade series are given in Table 1. Table 1: Descriptive statistics Variable Average series FDI (%) GDP growth (%) CRISIS (dummy) Openness trade Country level series Bulgaria Czech Rep. Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia

Mean

Median

Max.

Min.

Std. Dev.

Skewness

Kurtosis

4.95 10.37 0.14 8.84

3.94 10.03 0 8.66

29.42 44.31 1 17.46

-1.18 -24.46 0 3.56

4.19 13.04 0.35 2.91

2.36 -0.18 2.12 0.55

11.67 3.02 5.49 3.01

FDI (% of GDP) Mean 8.97 5.01 7.81 5.34 4.59 3.36 3.44 3.86 5.36 1.73

Max. 29.42 10.82 20.63 11.20 8.38 8.22 5.74 9.26 16.93 7.01

GDP Growth Min. 0.68 1.49 1.20 1.62 0.36 0.47 1.73 0.71 -0.06 -1.19

Mean 9.96 10.51 10.31 7.75 10.87 11.46 10.47 11.91 12.19 8.24

Max. 34.99 26.64 34.42 25.92 44.31 31.33 28.26 39.06 36.00 39.16

Min. -24.46 -12.99 -19.36 -17.90 -22.72 -22.19 -18.67 -19.57 -8.51 -10.43

At first glance, we see that the highest level of FDI is recorded in Bulgaria (8.97%), while the lowest level belongs to Slovenia (1.73%). Even if the highest value for average GDP growth is recorded for Slovakia (12.19%), the maximum level of GDP growth was recorded in 2007 for Romania, when GDP has grown with almost 39%. In order to capture through the regression model the characteristics of FDI and GDP growth (both being time series), we apply the Augmented Dickey Fuller (ADF) test to see if the time series are stationary. According to the results both series are stationary.

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Table 2: Stationary Test Results

***

Variable H0: I(1)

FDI (%) 59.84***

GDP growth (%) 56.92***

- Indicates significant at the 0.01 level

3.3. Results The empirical analysis is split in two parts. First, we conducted the Augmented Dickey Fuller Test and secondly we estimated the regression model. The first step was necessary to check whether the series are stationary in order to apply the appropriate regression model. Based on results from Table 2, we can see that both series are stationary. The results are summarized in Table 3. Table 3: FDI, Economic growth and Crisis Variablea

Constant

GDP growth

Crisis

Basic model

0.0456*** (0.0047)b

0.0643** (0.0256)

-0.0168* (0.0089)

Model robustness

-0.0044 (0.0093)

0.0621*** (0.0234)

-0.0194** (0.0082)

Openness trade

0.5729*** (0.0941)

R-squared 0.0894

R-squared (adjusted) 0.0790

0.2478

0.2351

a

dependent variable is represented by foreign direct investments - (standard errors in parentheses) *, ** , *** - Indicates significant at the 0.1 level, 0.05 level and 0.01 level

b

Our findings suggest that economic growth has a significant influence over the level of FDI and, moreover, a positive one. These results are according to authors cited in section 2 of our paper (Ucal et all., Poulsen and Hufbauer, Alfaro and Chen etc.). An expected and interesting result is that the dummy variable included in the model to capture the financial crisis effect has a significant impact on FDI. Moreover, the sign of this variable is negative, like we expected it to be. Financial crisis is a phenomenon that is hard to capture through a single variable, but the magnitude of the financial crisis started in 2008 in Unites States, amplified the effects, so the crisis had a powerful negative effect on CEE countries. 4. Conclusions In order to contribute to existing literature, we have analyzed the relationship between the financial crisis and FDI in CEE Countries. The results show that the financial crisis affects directly the level of FDI. The results seem to be logical, because the magnitude of the financial crisis started in 2008 in United States, amplified the effects, so the crisis had a powerful negative effect on CEE economies. The regression model might have some limitations due to the small size of the sample, only 18 annual observations for a sample of 10 countries, over the period 1994 2011. Further studies can replicate our analysis using a different sample of data in order to identify if there are some special characteristics of selected countries which might affect the intensity and effects of financial crisis on FDI. Another direction for further studies will be to analyze are influencing more or less economic results in times of crisis compared to normal times through comparative analysis by dividing the analyzed period into two subperiods (normal times and crisis times).


Taking into account our findings, the present study is very important in supporting the regulatory environment, in order to attract more FDI, as a solution for recovery of the economies affected by crisis. Acknowledgements This work was supported by the project "Post-Doctoral Studies in Economics: Training Program for Elite Researchers - SPODE" co-funded by the European Social Fund through the Development of Human Resources Operational Program 2007-2013, contract no. POSDRU/89/1.5/S/61755. References Alfaro, L.; Chen, M. (2010), Surviving the Global Financial Crisis: Foreign Direct Investment and Establishment Performance, Harvard Business School Working Paper 10-110. Bengoa, M.; Sanchez-Robles, B. (2003). Foreign Direct Investment, Economic Freedom and Growth: New Evidence from Latin America. European Journal of Political Economy, 19(3), 529-545. Carkovic, M.; Levine, R. (2005). Does Foreign Direct Investment Accelerate Economic Growth? In T.H. Moran, E.M. Graham, and M. Blomstrom. Does foreign direct investment promote development? Washington, DC: Institute for International Economics and Center for Global Development, pp. 195-220. Chang, S., (2006). The Dynamic Interactions among Foreign Direct Investment, Economic Growth, Exports and Unemployment: Evidence from Taiwan. Economic Change, 38, pp. 235-256. Choong, C.; Zulkornain Y.; Soo, S. (2004). Foreign Direct Investment, Economic Growth, and Financial Sector Development: A Comparative Analysis. ASEAN Economic Bulletin 21: 3, 278 289. Chowdhury, A.; Mavrotas, G. (2006). FDI and Growth: What Causes What? The World Economy, Vol. 29, No. 1, pp. 9-19. Dunning, J.H. (2000). The Eclectic Paradigm as an Envelope for Economic and Business Theories of MNE Activity, International Business Review, 9(1), pp. 163-90. Esso, L. (2010). Long-Run Relationship and Causality between Foreign Direct Investment and Growth: Evidence from Ten African Countries, International Journal of Economics and Finance, Vol. 2, No. 2, pp.168-177. EUROSTAT, http://epp.eurostat.ec.europa.eu/portal/page/portal/statistics/search_database. Poulsen, L.; Hufbauer, G. (2011). Foreign Direct Investment in Times of Crisis, Peterson Institute of International Economics. Available at http://www.piie.com. Reinhart, C. M.; Rogoff, K. S. (2008). Is the 2007 Sub-Prime Financial Crisis So Different? An International Historical Comparison, National Bureau of Economic Research Working Paper 14587. Cambridge, MA: National Bureau of Economic Research. Ucal, M.; Özcan, K. M.; Bilgin, M. H.; Mungo, J. (2010). Relationship Between Financial Crisis and Foreign Direct Investment In Developing Countries Using Semiparametric Regression Approach, Journal of Business Economics and Management 11(1): 20 33. UNCTAD (2012). World Investment Report 2012: Towards a New Generation of Investment Policies, United Nations Conference on Trade and Development, New York and Geneva. UNCTADstat, http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx?sCS_referer=&sCS_ChosenLang=en. Zhang, K. (2001). How Does Foreign Direct Investment Affect Economic Growth in China, Economics of Transition, 9(3), 679-93.

Appendix A. Central and Eastern Europe Countries According to OECD definition, Central and Eastern European Countries (CEECs) is an OECD term for the group of countries comprising Albania, Bulgaria, Croatia, the Czech Republic, Hungary, Poland, Romania, the Slovak Republic, Slovenia, and the three Baltic States: Estonia, Latvia and Lithuania. In our analysis, we include only the European Union member states: Bulgaria, the Czech Republic, Hungary, Poland, Romania, the Slovak Republic, Slovenia, Estonia, Latvia and Lithuania.

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