Impact of FDI on Economic Growth

Introduction

The concept of Foreign Direct Investment (FDI) has gained a reputation for being an essential resource that is capable of fostering economic development. Most scholars have argued that FDI has the potential of filling the gap between the needed national investment and domestic savings. FDI can also enhance the tax revenue and improve the local technology, management practices, and the labor skills of the countries involved. Kaličanin, Hanić, Jovanović, Knežević, & Hasan (2017) added that FDI helps a country to break the cycle of underdevelopment that would have otherwise existed devoid of such interventions. Various investigators have conducted studies on the impact of FDI on economic growth both at a national and firm-level. Kapurian & Singh (2019) documented that FDI has been intensified all over the world in the last decade because of the increased role of FDI in enhancing capital flows. The direction of capital flow is majorly from the developed countries to the developing countries.

Different studies have reported divergent evidence regarding the degree to which FDI affects the economic growth of the countries involved. FDI could have an impact on the growth of the economy majorly because it contributes to the accumulation of capital and the transfer of new technologies to the receiving countries (Khamphengvong, Xia, & Srithilat, 2018). Besides FDI improves the economy indirectly where the direct transfer of technologies involves the expansion of the existing knowledge in the recipient country(s) through training laborers, acquisition of new skills, institutional arrangements, and management systems. In the past decades most resource-intensive countries, especially in the Gulf region, received an increased flow FDI that led to escalated the economic growth of these countries, reduced their trade barriers, enhanced their national and regional policies and strengthened other institutions such as environmental regulatory bodies that made these markets more attractive to other foreign investors. At the same time, countries within the same region also tried to implement various measures that were meant at boosting the appeal of their investment environments. These strategies involved reducing corporate tax, reducing the bureaucracies and red tapes such as accelerating the process of giving visas, creating a central point that would approve all the foreign investments, and reducing barriers and tariffs such as the minimum capital requirement. Even so, most countries in this region are still behind in terms of their privatisation patterns. The stringent national labour laws in these countries act as a hindrance to FDI.

Area of Specification

The study will majorly focus on three countries which are the Kingdom of Saudi Arabia (KSA), the United Arab Emirates (UAE), and Kuwait. A common feature of these three countries is that they all belong to the Gulf Cooperation Council (GCC). Thus, there are some inherent features of these countries share, which help in assessing various environments in these countries regarding FDI (Vohra, 2017). Generally, the GCC is a political and economic regional bloc that was established in 1981 to integrate and coordinate the member states in various fields and formulating common policies in the fields of legislation, economy, trade, and general management. As a part of the integration process, in 2003 the GCC members adopted a Custom Union that unified and harmonised trade tariffs in all member states. In 2008 six members adopted a Common market although various stipulations are yet to be finalized on the same framework (Mina, 2017). Recently, the bloc has been holding talks on how to introduce a single currency for all its members. All these advancements and plans conducted by the GCC would affect FDI positively or negatively.

Currently, Saudi Arabia, the UAE, and Kuwait hold close to a quarter the word’s oil reserves. As a bloc, the GCC contributed to about 20% of all global oil production and 42% of all oil exports in 2016. By 2013, the sum net of total assets of the GCC countries was more than 4 million trillion USD (Samir, Shahbaz, & Akhtar, 2018). High energy prices give leverage to these governments with a good opportunity to address various structural reforms. There is an evident change from the public sector to the private sector as the main driver for economic growth. The growth of national investments is aimed at reducing the oil-producing countries from majorly depending on oil (AlKhars, Miah, Qudrat-Ullah, & Kayal, 2020). Despite such an optimistic economic perception of diversification and investment, these countries have faced various economic risks and challenges. One major challenge is that despite, the motive to diversify, currently all three countries focused on this study majorly rely on hydrocarbons both for energy production and export. The reliance on oil has exposed the region to volatile energy. The region is also politically unstable due to various political interests (Alfalih & Hadj, 2020). Due to political unrest the region has faced an ever-growing problem of inflation, especially in UAE that has been reporting double digits. From a global outlook, the GCC play an essential role in the world politics and economy and holds a nominal GDP of about 1.5% of the total world’s GDP (Mensi, Hammoudeh, Tiwari, & Al-Yahyaee, 2019). With a population of about 50 million the GCC region has remained to be relatively small as compared to its counterparts, but it is important to note that the consumers in the region have a relatively higher purchasing power as compared to other regions such as the ASEAN (Ghassan & Alhajhoj, 2016). The high consumer purchasing power has attracted various foreign directors and businesses who are keen to tap on this market. The high consumer purchasing power can be attributed to higher economic growth rates experienced in this region in comparison to the average economic growth rates in South America, and the larger middle east. Furthermore, the GDP per capita income in countries like the UAE and Saudi Arabia are among the highest in the whole world. However, the high numbers of unemployment in these states have acted as constraints to the corporate environment, other constraints such as lack of government transparencies have remained to become a key structural challenge.

Research Objectives

The main aim of the study would be to determine the impact of FDI on the economic enhancement of resource-intensive countries which in this case is the UAE, KSA, and Kuwait. The paper will delve into the various ways the three countries mentioned have acknowledged the essence of FDI in the process of fostering their economic growth. As a result, the paper aims to unveil the measures that have been adopted by these countries to attract foreign capital and encourage foreign investment. Specifically, the study will test the link between FDI and the rate of economic growth using indicators such as the gross domestic product, in the three countries which will be studied as a heterogeneous panel. Using the evidence that would have been collected the study will identify the determinants of FDI in the GCC states.

The rationale of the Study

According to Fedorova, Fedorov, & Tolkachev (2016) the administration regimes in developing countries, FDI is a major source of economic development. The notion has been exemplified by an intense competition by states to attract FDI at a scale hitherto unseen in international business. Abid, Goaied, & Ammar (2019) noted that potential foreign investors are faced with the mandate to choose between the best government incentives so that they can decide on the best state to host their investment. In the last two years, the FDI inflow was 33% lower as compared to the previous decades. The significant reduction of oil prices has been the primary factor behind the decrease in inflow FDI. Figure 1 shows the FDI trends in the three countries from 200 up to date. Out of the three countries, it is clear that Kuwait has been receiving low FDI flow throughout history as compared to its counterparts, while Saudi Arabia and the UAE have been receiving relatively high numbers of FDI over time. Though in 2009, Saudi Arabia had the highest number of foreign investments in comparison to the three countries. However, since 2012 the levels of FDI have been relatively low as compared to the previous years, with UAE recording relatively higher sums of FDI, followed by Saudi Arabia and Kuwait.

Literature Review

The evidence from Dkhili, & Dhiab, (2018), Altaee & Al-Jafari (2018), Mourad (2018), and Dellis, Sondermann & Vansteenkiste (2017) revealed that FDI plays an essential role in the growth of an economy. Even so, the level of development of local financial markets is important for the impact of FDI to be felt in the industry. The world Bank (2017) introduced a concept referred to as ‘absorptive capacity,’ to refer to the underlying principles such as the microeconomics of management, inflation, trade barriers, infrastructures, and human capital that would determine the efficacy of FDI. Kaličanin, Hanić, Jovanović, Knežević, & Hasan (2017) explored the impact of FDI by assessing the spillovers effects of technologies on the results of productivity in Saudi Arabia, Tunisia, Egypt, and Oman for 20 years. The study revealed that FDI has not had any positive spillover on technology and productivity over the years. On the other hand, there were some indicators that the impact of FDI on total factor productivity was lower than domestic investment in some of the states over the period that the study was conducted, which could be an indicator for a possibly dominating negative crowding out impacts. A study by Habibi & Sharif Karimi (2017) and Adeel‐Farooq, Abu Bakar, & Olajide Raji (2018) has indicated that the impact of FDI on growth majorly depended on various factors like the magnitude of complimentarily and substitute between FDI and the local investment, and the state-bases specific traits. Alshubiri, Elheddad, & Doytch (2019) purported the extent to which FDI helped in economic development majorly depended on the social and economic conditions of the country receiving the investment.

Countries that have a higher rate of savings, open trade regime, and advanced technological levels are likely to benefit from increased flows of FDI in their respective economies. Similarly, the effects of FDI could be negative on the economic opportunities of the country receiving the investment, especially if these investments are likely to lead in a substantial reverse flow in the form of interests, profits and if the investing company obtains various concessions from the host state. Al Samman & Jamil (2017) argued that for a country to benefit from the long-term inflow of FDI, it would need to have a sufficient number of human capital, adequate infrastructure, open and free markets, and economic stability.

The perception that FDI supports economic development in the recipient state, given that the country has the necessary underlying structures to accommodate FDI was backed up by a study conducted by Aziz & Mishra (2016). Kumari & Sharma (2017) also suggested that FDI was a crucial vehicle that would help in the transfer of technology, which eventually contributes to the growth of the economy in the host country and also improves its domestic investment capacities. The researchers used an endogenous growth model, where the rate of technical progress was used as the key determinant of long-term growth. The other topic of empirical research of FDI to growth relationship majorly concentrated on assessing the determining the flow of FDI and examining the impact of these determinants on the attractiveness of the primary country and increasing the volume of such flows.

Two major facets have always been cited as the main background for facilitating the efficacy of FDI in facilitating economic development, the first facet that was identified included the size of the market, relative factor prices, and harmonising payment constraints. The second set of facets revolves around factors such as the degree of transparency and trade guidelines, law execution, and legislative environments (Albulescu, Tiwari, Yoon, & Kang, 2019). Acknowledging the essence of FDI on the growth of various economies through incentives attract more FDI, tax breaks are among such incentives. Abidi, Antoun, Habibniya, & Dzenopoljac (2018), Xin & Jiong (2016), Paul & Jadhav (2019), Elayah, Hu, & Han (2019), and Mina (2020) identified factors that determined foreign direct investment as GDP expansion, the country’s population, political stability, and governance systems and institutions. Other minor factors revolve around the level of research and development in the country, the level of existing domestic availability, education, and general risk and security levels. It is important to note that various factors majorly determine both the growth of GDP in the receiving state as well as the growth of FDI. Various studies have revealed that the degree of FDI majorly depends on various facets. Emphasis has been laid on the extent and breadth of the domestic market in the host country as a determinant for FDI efficacy (Alshubiri, Jamil, & Elheddad, 2019). A combination of an effective FDI strategy and the necessary baselines would help in enhancing the domestic purchasing power of countries. Further analysis of the local drivers of FDI efficacy on the host country revealed that the market does not only compromise the economy of the host nation, but it also compromised the regional trade.

Research Methodology

This study aims to examine what factors influence the allocation of FDI in three host countries (UAE, KSA, and Kuwait) and in each 14-sector grouped into 3 categories: (primary, secondary and tertiary) over the period 2006 -2014. The factors are classified as a government strategy, market size, macroeconomic stability, labor costs, openness, infrastructure development, tax incentives, corruption, and government regulations. There are three GCC countries and 66 source countries worldwide that are grouped into 6 source regions (Asia, Africa, Europe, North America, South America, and Australia). We are going to use three different estimation techniques (OLS, PPML, and Heckman) to investigate the performance of these estimators.

The study majorly used secondary data from various secondary sources, such as bank reports, word bank reports on various sections of the economy such as GDP, average FDI, and GNI among other publications. FDI data obtained from the fDi Intelligence, other host and source countries data are gained from Federal Competitiveness and Statistics Authority – UAE, Ministry of Development Planning and Statistics –General Authority for Statistics – KSA, Ministry of Finance in the UAE, KSA, and Kuwait, KPMG’s corporate tax table and the World Bank. As data on value-added (𝑉𝐴) (2000 base year AED, GDP and GFCF for the source countries attained from the World Bank’s World Development Indicators (Constant 2005 USD). The dataset is from the period of 2006-2014.

The three destination countries of the GCC are UAE, KSA, and Kuwait. The 14 sectors are classified as a classic breakdown to three main activities of economic sectors in our estimations. First, the primary sector, which includes mining and quarrying (includes crude oil and natural gas). Second, the secondary sector contains (1) manufacturing, (2) electricity, gas, and water supply; waste management, and (3) construction. Third, is the tertiary sector, which consists (1) wholesale and retail trade; repair of motor vehicles and motorcycles, (2) transportation and storage, (3) accommodation and food services, (4) information and communication, (5) financial and insurance, (6) real estate, (7) administrative and support services, (8) education, (9) human health, and (10) social work arts recreation services. The 66 source countries are grouped as 6 regions; (1) Asia: Azerbaijan, Bahrain, Bangladesh, China, Hong Kong, India, Iran, Iraq, Japan, Jordan, Kazakhstan, Kuwait, Lebanon, Malaysia, Nepal, Oman, Pakistan, Philippines, Singapore, South Korea, Sri Lanka, Syria, Thailand, Turkey. (2) Africa: Egypt, Ghana, Morocco, Nigeria, South Africa, Togo, Tunisia. (3) Europe: Austria, Belarus, Belgium, Bulgaria, Croatia, Cyprus, Czech Republic, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Luxembourg, Netherlands, Norway, Poland, Portugal, Romania, Russia, Spain, Sweden, Switzerland, United Kingdom, Ukraine. (4) North America: Bahamas, Canada, Mexico, United States. (5) South America: Argentina, Brazil. And (6) Australia: Australia and New Zealand.

Data regarding the host country level, sectoral level, and year 𝑖𝑘𝑡 are FDI (𝐹𝐷𝐼), value added (𝑉𝐴), capital - GFCF (𝐾), worker wages(𝑊), openness(𝑂𝑃𝑁), strategic sector(𝐺𝑆𝑆) and strategic government 100% ownership for foreign investors (𝐺𝑆𝑊). Data in host country level for each year 𝑖𝑡 are native population (𝑃𝑂𝑃), expenditure(𝐸𝑋𝑃), internet (𝐼𝑁𝑇), and infrastructure(𝐼𝑁𝐹𝑅). Data in source country level for each year 𝑗𝑡 are GDP(𝐺𝐷𝑃) and openness(𝑂𝑃𝑁). And data combines both host and source country per year 𝑖𝑗𝑡 are: inflation(𝐼𝑁𝐹), investment incentives – tax(𝑇𝐴𝑋), corruption(𝐶𝑂𝑅), government regulations (𝐺𝑅𝐸𝐺), strategic source(𝐺𝑆𝑅), distance to technology(𝑇𝐹𝑃), and distance to business(𝐷𝑇𝐹).

One of the determinants of the FDI category in this study is the government strategy which includes three variables:(𝐺𝑆𝑆),(𝐺𝑆𝑅), and (𝐺𝑆𝑊). The purpose of measuring and constructing these variables is to investigate the host countries government strategies in attracting FDI per their priority of sectors, source country and the effectiveness of allowing the law of 100% ownership for foreign investors as they planned within their needs of FDIs to diversify their economies away of oil. These variables will reflect the government strategy in attracting FDI and FDI law as a pull factor of FDI and in existing literature, no studies have linked government strategy as one factor of determinants of FDI. For the strategic sector(𝐺𝑆𝑆) variable, from the host country's government strategies 2030, we focus on the main sectors that these host countries prioritized and mentioned them in their government strategy 2030 of attracting FDIs. UAE’s government strategy selected priority sectors to attract FDI. These sectors are manufacturing, construction, real estate, human health, wholesale and retail trade; repair of motor vehicles and motorcycles, financial and insurance, tourism, and information and communication. In the KSA host country, sectors selected by the government’s strategy to attract FDI are manufacturing, human health, and social work, transportation, and storage, education, wholesale and retail trade; repair of motor vehicles and motorcycles, financial and insurance, information and communication and real estate. For Kuwait, the priority sectors selected by the government’s strategy to attract FDI are real estate, wholesale and retail trade; repair of motor vehicles and motorcycles, financial and insurance, manufacturing and information, and communication.

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