Academic journal article The European Journal of Comparative Economics

FDI Inflows and Trade Imbalances: Evidence from Developing Asia

Academic journal article The European Journal of Comparative Economics

FDI Inflows and Trade Imbalances: Evidence from Developing Asia

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. Introduction

For most developing and transition countries, the relationships between trade and Foreign Direct Investment (FDI) are at the heart of globalization. On the one hand, overall growth dynamics in the developing regions have been stimulated by strong growth in their exports. On the other hand, the new international financial landscape has been characterized by an unprecedented growth in private financial flows to the detriment of official development assistance. Since 1993, FDI has become the most important external financing source in the developing world, followed by portfolio investment and private loans (see Figure 1). In 2010, the share of FDI inflows reached 51% of total capital flows to developing countries, while their inward stock of FDI amounted to about one third of their Gross Domestic Product4 (GDP) compared to just 10% in 1980 (UNCTAD, 2011a).

Among the developing regions of the world, East Asia and Pacific (EAP) have clearly been the most successful in increasing exports (by volume) and in attracting FDI. The increased international mobility of both goods, services and intangible assets, together with the greater flexibility and divisibility of the production process, has made the entry of Multinational Corporations (MNCs) into manufacturing and services the key vehicle for Asia's successful integration into the global economy. Boosted largely by MNCs from the North (as well as by those from the South), the increasing fragmentation of production in the global economy has in turn led to increased exports of manufacturing parts, components and associated services (see Figure 2). The largest wave of production-sharing schemes is to be found in developing countries, particularly in the dynamic Asian economies (UNCTAD, 2011b).

The rapidly growing Asian countries' successful experience with exports and FDI has reinforced the tendency of international organizations to prescribe policies in favor of trade liberalization and foreign capital attraction. This means that the overall pattern of export growth is dependent on participation in production fragmentation or the "global supply chains" that link developing countries to international markets (UNCTAD, 2011b). However, many observers argue that the dynamics of trade and financial integration have increased the vulnerability of national economies to the risks incurred by different cost, market and production connectivities. In contrast to the industrial economies in the Bretton Woods system, the developing and transition countries are much more open, with a greater trade component and more prevalent capital inflows. Open economies today react differently to relative price shocks, or demand and supply factors. In particular, the development of international production networks and related FDI flows has increased the import content of export production. While they enjoy the benefits of the processing trade regime, of policies designed to promote FDI and of special economic zones, most developing countries still face balance of payments problems in conjunction with their export-oriented growth (Soukiazis and Cerqueira, 2012). Financial crises in emerging market economies illustrate the risks stemming from the volatility of private international capital flows, especially speculative short-term flows. However, few studies have investigated how export-led growth with massive capital inflows may result in current account imbalances.

In view of this, the present research paper aims to investigate whether trade imbalances are linked to FDI inflows. Participation in production fragmentation operated by MNCs has enabled developing countries to enter international markets. However, one consequence of this is that their current account balances are increasingly shaped by FDI and trade. FDI can disrupt macroeconomic stability through monetary counterparts and relative price movements; it can also directly affect the balance of payments through the investment balance, as a share of GDP produced in the host country is repatriated abroad in the form of profits and dividends. …

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