With the increasing liberalization of the economies across the world, considerable attention has been devoted to study the merits and demerits of FDI on host countries. Theorists try to understand FDI through two viewpoints. Literature of FDI focuses on two different models to understand the implications of FDI on host countries. The MacDougall (1960) among others focus on measuring impact of FDI in terms of factor rewards, employment and capital flows to host countries. Hymer (1960) examines the motivations behind the firm’s decision to undertake investments abroad and thus stresses on measuring impact of FDI in terms of the indirect effects it creates like externalities or spillovers. We use the MacDougall approach in seeking to understand the direct impact of FDI on host countries. Thus the primary objective of our study is to measure the impact of FDI on two key parameters viz. Gross Domestic Product (GDP) and Gross Capital Formation (GCF) of the host countries. Using the data from World Investment Report for information on FDI stock and flows into developing world and national statistical databases for data on GDP and GCF, we examine the impact of FDI over GDP and GFCF using statistical tests. We hypothesize that increased FDI increases capital formation and GDP of the host country.

1. Does Foreign Direct Investment (FDI) Benefit
Host Countries: Uncovering the Relationship
between FDI, GDP and Capital Formation in
Host Countries
Prashant Kulkarni
Asst. Professor, Indian Business Academy, Bangalore
Anantha Murthy N.K.
Asst. Professor, Indian Business Academy, Bangalore
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

2. Foreign Direct Investment
 Net inflows of investment to acquire a lasting
management interest (10 percent or more of
voting stock) in an enterprise operating in an
economy other than that of the investor (World
Bank)
 Critical element in the flow of international
capital.
 Less volatile
 Shift towards services sector
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

3. Objectives
 To examine the trends and directions of FDI
flows and stock
 To understand the implication of FDI on host
countries.
 To examine the relation between FDI stock
and the GDP growth rate of the country.
 To gauge the extent of FDI flows in gross
fixed capital formation of the country
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

4. Literature Survey
 Hymer (1960)
 eclectic paradigm of FDI theory by focusing on firm specific
advantages
 Vernon (1966)
 concept of product life cycle into theories international trade
to explain the existence of international trade, production
and consequently capital flows
 Dunning (1981, 1986)
 Extended the framework of the OLI paradigm to develop the
investment development path (IDP) theory.
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

5. Contd..
 Gastanaga, Nugent, and Pashamova (1998)
 Countries with relatively liberalized capital accounts tend to
attract more foreign direct investment flows.
 Feldstein (2000)
 Case of risk reduction through free flows in the international
capital by allowing the owners of the capital to diversify their
lending and investment
 Bosworth and Collins (1999) and Mody and Murshid
(2001)
 Near unitary correlation between FDI and domestic
investment.
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

6. Methodology
 We define Growth as a function of
GROWTH= f(LABOUR, OPENNESS, EXCHANGE, CAPITAL,
GOVERNMENT, FDI)
Where
 GROWTH- Real GDP per capita
 LABOUR- Labour force in the economy
 OPENNESS- Export + Imports of the economy / 2
 EXCHANGE- Exchange rate
 CAPITAL- GCF as % of GDP
 GOVERNMENT- Government expenditure as % of GDP
 FDI- FDI inflows as % of Gross Capital Formation
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7.  The regression equation is
GROWTH= α +β0 LABOUR+ β1OPENNESS+ β2
EXCHANGE + β3CAPITAL + β4GOVERNMENT +
β5FDI + Error
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8.  Our analysis used the T-statistic to test our
hypothesis.
 We also used the co-relation study to
understand the relation between GDP and
FDI inward stock and also the relation
between FDI inflows and Gross Fixed Capital
Formation.
 We also made use of bar charts and
diagrams apart from the normal tools and
mean and standard deviation
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

9. Proposition
 H0: There is no Impact of FDI on economic
growth
 H1: There is an Impact of FDI on economic
growth.
We further test it for developed and developing
countries separately
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

10. Data Description
 World Investment Reports of 2004 and 2005.
(published by United Nations Commission on
Trade and Development. )
 World Development Indicators
 World Resources Institute
(earthtrends.wri.org).
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11.  Classified the countries into developed and
developing countries as per the classification
adopted by WDI databases.
 The time period of the data is between 1980-
2005.
 Our sample was initially 85 countries (25
developed and 60 developing). However in
some cases, the missing data resulted in a
final sample size of 76 countries (25
developed and 51 developing countries).
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

12. Results of Analysis
-4.000
-2.000
0.000
2.000
4.000
6.000
8.000
10.000
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49
Developing countries
Realgdppercapita
Fitted Values
Residuals
Real gdp pc
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

13. -2.000
-1.000
0.000
1.000
2.000
3.000
4.000
5.000
1 3 5 7 9 11 13 15 17 19 21 23 25
developed countries
Realgdppercapita
Fitted Values
Residuals
Real gdp pc
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

14. Correlation Table
Developing countries
Labou
r
Opennes
s
Exchange Capital Govt FDI
Labour 1.000
Openness -0.246 1.000
Exchange 0.002 -0.046 1.000
Capital 0.379 0.189 0.023 1.000
Govt -0.092 0.301 -0.218 -0.234 1.000
FDI -0.010 -0.086 -0.1000 0.157 0.005 1.000

15. Correlation Table
Developed countries
Labou
r
Opennes
s
Exchange Capital Govt FDI
Labour 1.000
Openness -0.060 1.000
Exchange 0.201 0.610 1.000
Capital -0.157 0.347 0.555 1.000
Govt 0.189 -0.093 -0.384 -0.576 1.000
FDI -0.101 0.278 -0.132 -0.058 -0.072 1.000

16. Correlation Table
Real GDP &FDI as %of GCF
Real
GDP per
capita
FDI
Real
GDP per
capita
1.000
FDI 0.163 1.000
Real
GDP per
capita
FDI
Real
GDP per
capita
1.000
FDI 0.624 1.000
Developed countries Developing countries
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

17. Multiple correlation and
coefficient of Determination
R R2
Adj R2
S.E
0.6626 0.4390 0.3902 1.4332

18. Multiple correlation and
coefficient of Determination
Developed countries Developing countries
R R2
Adj
R2
S.E
0.754
6
0.569
4
0.510
7
1.480
7
R R2
Adj
R2
S.E
0.667
0
0.444
9
0.259
8
0.660
5

19. Multiple Regression Results
Samples Overall
(F-Value)
Constant
(t-Value)
Labour
(t-value)
Openness
(t-Value)
Exchange
(t-Value)
Capital
(t-Value)
Govt
(t-
Value)
FDI
(t-Value)
76 Significant
at
1% los
Significant
at
1% los
Significant at
10% los
Significant
at
1% los
Significant at
5% los
51
(Developin
g)
Significant
at
1% los
Significant
at
1% los
Significant at
10% los
Signific
ant at
1% los
Significant at
10% los
25(Develo
ped)
Significant
at
10% los
Significant at
5% los
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008

20. Inferences and Scope for Future
Work
 The results of regression on growth provide
indicators of FDI influencing the growth.
 The influence however seems weak in case of
developing countries.
 Correlation between FDI and growth is stronger in
developed world as compared to developing world
 Capital formation does not show any significant
relationship with economic growth
International Conference on Recent Developments in Economics, Hotel Hans New Delhi, Sep 8-12, 2008