Academic journal article Contemporary Economic Policy

Old Wine in a New Bottle: Trade Openness and FDI Flows-Are the Emerging Economies Converging?

Academic journal article Contemporary Economic Policy

Old Wine in a New Bottle: Trade Openness and FDI Flows-Are the Emerging Economies Converging?

Article excerpt

I. INTRODUCTION

The rapid growth experienced by the emerging economies in the recent past and their resilience to economic shocks, have led economists to question the reasons for this. These economies, in particular, Brazil, Russia, India, China, and South Africa (BRICS) have emerged as not only major recipients of foreign direct investment (FDI) but also important outward investors. FDI inflows to BRICS have more than trebled to an estimated US$263 billion in 2012 with their share in world FDI flows increasing during the financial crisis reaching 20% in 2012, from 6% in 2000. The outward investment from these countries has increased from US$7 billion in 2000 to US$126 billion in 2012, which is 9% of total world flows (UNCTAD 2013). Similarly, the combined share of emerging economies international trade flows have increased from 30% in 1995 to 45% in 2010 (World Bank 2013). The adoption of outward-oriented strategies by the emerging economies has led to increased growth and an expansion of trade and FDI flows into and from these countries. This leads us to question as to whether this rapid growth has been due to increased openness.

Trade openness can influence income convergence through each of three ingredients of national income: factor prices, factor quantities, and production technology (Baldwin 1992). By contrast, others deny the role of trade openness in convergence issues. Deardorff (1986) provides a two-country-two-factor and four good Heckscher-Ohlin type model in which trade tends to converge producer prices but diverge factor prices, thus, leading to diverging income patterns. The approaches that emerge in the relevant literature depend on the distinction between studies that investigate trade liberalization and those that deal with the degree of openness to trade. A few theoretical models are available and are related primarily to trade liberalization, which is not of explicit concern to this study here. Ben-David and Loewy (2000) develop models that predict that while trade liberalization will increase the steady-state output growths across all countries, those countries that participate directly in this liberalization will benefit the most in terms of their relative income levels, while our own concern is with convergence issues of existing levels, or amounts, of trade (as reflected in the degree of openness).

Moreover, FDI enhances economic performance, which in turn leads to a better economic environment for future international investments. Foreign investments in the domestic economy allow domestic firms to benefit from international knowledge and competition. FDI serves not only as a method of direct capital financing, but also as a conduit for bringing in positive externalities, that is, it is a vehicle for transfer of technology, contributing to long-run growth in larger measure than domestic investment. The diffusion of technology can be done through imports of high-tech products, and the acquisition of human capital. FDI includes financial capital as well as technological, managerial, and intellectual capital that jointly represent a stock of assets for the production of goods and services (Caves 1996). Moreover, net foreign resource inflows can augment private savings, and help countries reach higher rates of capital accumulation and economic growth (Bosworth and Collins 1999). However, FDI does not only bring in positive effects. The diffusion of technology may not be appropriate for the economy's factors of production and domestic firms may lose market share when facing severe competition from multinational companies. Econometric evidence indicates that the growth effect of FDI is positive and significant in a group of developed countries, but positive, though insignificant in the developing ones (Dimelis and Papaioannou 2010). Kottaridi and Stengos (2010) by applying nonparametric methodological approaches and, thus, taking into account nonlinear effects of initial income and human capital on economic growth, explore the FDI effect on growth. …

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