The link between economic growth and FDI inflows

CROSSROADS (Toward Philippine Economic and Social Progress) By Gerardo P. Sicat
(The Philippine Star) Updated August 15, 2012 12:00 AM


President Benigno Aquino wants more evidence before supporting the Enrile-Belmonte initiative to amend the restrictive economic provisions of the Constitution. In several columns, I have presented the case for these amendments.

This time I will emphasize mainly country evidence, starting first from the simplest to the more complex. [Space limitations prevent elaboration on the references from the technical economic literature.]

1. Hong Kong is the best example of a country with very few economic barriers to economic activity. Starting out as a poor territory, but with its seven million people today, its GDP is larger than ours and its per capita GDP is $36,160 or 16 times greater than ours.

2. Singapore, Thailand, Malaysia, and Indonesia regulate FDIs but this is done by their laws and regulations passed by legislation, not by “constitutional” provisions. They also allow FDIs greater role in their economies than we do.

3. Singapore, like Hong Kong, is a bastion of liberal economic policies even though the state plays a strong role in a few limited sectors. Its four million people enjoy standards of per capita GDP that is 21 times ours at $42,930.

4. Thailand started its economic development program initially compared to ours, but today it has achieved a per capita GDP which is twice as ours. Its growth was fueled by open embrace of foreign direct investments in almost all areas of economic activity. Inflows of FDI have strengthened not only its foreign trade but also its domestic economy and benefited many Thai businesses.

5. Malaysia’s industrialization program started one generation later than ours and welcomed FDIs. Today, Malaysia’s industrialization program is more sophisticated than ours. Its GDP per capita is almost four times ours.

6. Indonesia’s industrial and economic policies were more restrictive than ours for several decades after independence. In 1987, the government adopted bold liberalization policies necessitated by political and economic crises. Even during its earlier years, some of Indonesia’s resource-based policies admitted more foreign investment participation. Its per capita GDP surpassed ours in the last decade.

7. South Korea and Taiwan started with the same import substitution policies like us. In the 1960s and 1970s, their policies became market oriented as they opened their country to more FDIs. These FDIs fueled the expansion of these countries’ export booms of the 1970s which enabled them to further integrate their domestic economies with their export sectors.

8. Vietnam’s recent economic resurgence is due mainly to the inflow of FDIs. The suddenness of the levels of inflows in Vietnam has burdened that country’s absorptive capacity for such change. The changes began exceeding Philippine performance in trade. Some FDIs to Vietnam were reflows of FDIs coming from the Philippines! Vietnam has no economic restrictions in its constitution to detract it from attracting FDIs but has local laws to define their FDI policies.

9. China was an economic basket case under communism (although Mao consolidated political power over its wide and complex territory). Then, its new leader Deng Hsiao-Peng instituted reforms in the communist system in agriculture and, later, in industry which allowed market forces to dominate economic decisions. As China was opened to FDIs, first the Chinese ethnic investors (Hong Kong and Taiwan) came and then Japanese, US and European. The industrial resurgence of China from the 1980s was fueled by a very liberal and well-directed approach to use FDIs as a means of lifting China out of its long years of economic instability and uncertainty. It has succeeded.

10. Before the 1990s, India had complicated regulations and policies that discouraged FDIs. Then it undertook macroeconomic reforms followed by liberalizing policies toward FDIs. It is still held back by many traditional restrictions, protection and political hindrances. But India’s steps to open its economy progressively toward FDIs have helped to invigorate its economy and add greater strength to its industrial sector. (India’s problems and solutions remind me a lot about the problems we have in the Philippines!)

11. Faced with competition from Japan in the US market, many US manufacturing companies migrated to East Asian countries. GE established TV plants in 1968, followed by RCA and Zenith, Fairchild, Texas Instruments, National Semiconductor and Motorola through to 1973. Once these sites were integrated to serve world markets, the US firms upgraded their Asian subsidiaries while introducing new technology and upgrading output toward more complex systems, including design.

12. Actually, Fairchild, Texas Instruments, Intel, and National Semiconductor came to the Philippines! Although we have retained some of these companies in the electronic sectors, they are all confined to the PEZA-zone and have essentially not fully integrated with many domestic economy firms. Philippine industrial problems are traceable to the restrictive economic provisions of BOI incentives which favor mainly local joint ventures.

13. The FDI-related auto industry in Mexico used to have sub-scale plants catering only to their domestic market. Once GM made a decision to use Mexico as a production base for exporting car engines, other major foreign car and auto parts companies followed suit. Within five years, 320 domestic suppliers for car parts and accessories had sprung to serve the FDI-related exporters. Local suppliers and foreign investors introduced best practice and technical assistance so that six out of the largest 10 auto parts manufacturers were locally owned.

14. Does the above remind us more about the success of Thailand compared to the relatively modest Philippine success in auto manufacturing?

15. The link between FDIs and local firms in Malaysia in the machine tool industry are illustrative. At first, FDIs sub-contracted their simple needs to local firms, such as machining and stamping. Soon, such procurement relations moved on to precision tooling and parts fabrication. Of the nine Malaysian companies that were studied, seven firm owners were former FDI employees where they learned their production niche; and 10 percent of workers employed in the domestic firms were similarly former employees of FDIs.

16. In South Korea and Taiwan, many domestic owners of electronic and other industries bought up the manufacturing operations were their former FDI firms as the FDIs decided to move up to the marketing and distribution end of the these industries. The process started first with sub-contracting to the local firms, the to manufacturing operations. Hence the ownership of FDIs changed hands to domestic entrepreneurs.

(From this point on, the examples become more complex and only summarizations are made.).

17. “Spillovers” is the terms used to describe these progressive activities that FDIs bring to domestic firms, institutions and factors. Spillovers are high and desirable because they raise total domestic output and improve technical and competitive abilities of domestic factors.

18. FDIs have large impact on economic growth when host countries are in the same development stage. When countries with unique host country factors inhibit the inflow of FDIs or distort their contributions, the outcomes on growth are less definitive.

19. An example of the uniquely different conditions that hamper such outcomes is the presence of the restrictive economic provisions in the Philippine Constitution that block salutary gains arising from FDIs.

20. In general, who gains from reforms? When economic liberalization reforms became the issue in Taiwan, South Korea and Turkey, the biggest opposition was domestic industry. When the reforms took their effects, the biggest winners were the business interests then who were afraid to adopt the reforms.