There are many different
sides and risks involved when investing overseas, which influence the foreign
capital in the specific country. This includes but are not limited to the rule
of law, transparency, governance, level of international trade, business and
financial conditions, and so on. This study consists of more than 20 years of
study between 1995-2014; analyzing the role of domestic investment climate in
addition to many other macroeconomic variables in South Asia by using panel data
techniques (Heritage Foundation Economic Freedom Index). This study shows that
overall economic freedom is an important factor influencing Foreign Direct
Investment (FDI). The conclusion of this study is that in order for South Asian
Nations to increase foreign capital they need to improve their domestic
investment.

 

 

 

 

 

 

 

 

           

 

 

Summary:

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            One of the number one sources for
long term sustainable economic progression in developing countries is FDI. It
is crucial in the development of countries by helping their overall economic
success, with technological development, capital accumulation, improving
resource allocation, and strengthening financial capital. Better investment
climate helps the firms have an even greater amount of discretion in what
strategies they choose. Certain characteristics such as market-supporting and
investment friendly institutional environment facilities are the reason that
there are less hurdles and hardships in certain business operations that
maintain and operate certain activities within the specific countries. In addition,
strong institutions in the country also attract FDI for various reasons – first
off, it would decrease transaction costs. Second, a very strong developed
institutional framework is better for a more powerful discretion in their
choices and their discretion in what their strategy is. Lastly, it will
decrease the information asymmetries meaning there will be less risk within
transactions.

            Economic freedom in a country implies
there aren’t any restrictions, pressuring or tasks to be completed in exchange
or transfer for personal assets which have been obtained legally. Economic
freedom includes the protection for one’s individual property, but also the
freedom to compete. In a free society people are allowed to work according to
their preference, produce, consume, and also invest any way that they see fit
for themselves. More importantly, the importance of domestic environment and
how it attracts foreign capital must be determined, which is a motivating
factor in studying the relationship between the impact of FDI in five South Asian
countries – Pakistan, Bangladesh, India, Nepal, and Sri Lanka, ranging from
over a 20-year period, 1995-2014.

            The flow of foreign investment in
South Asia has largely increased, with fluctuations periodically. Foreign
investment in South Asian nations in 1985 was rather low, but slightly
increased due to policies liberalized by the nation in the 1990s. India kept a
higher FDI throughout the entire period, followed by Pakistan. India kept the
high inflows of FDI until nearly 2014, and is one of many countries with an
emerging improving economy in the world today, which enables them to provide a
great climate for investors and foreign firms. India receives the most
automotive inflow, receiving several projects that ranked over $100 million
between 2013 to 2014. The 2015 World Investment Report states that India was
ranked ninth overall in 2014, increasing their FDI by 22%. In the two previous
years, it was ranked 15th.. Nepal’s FDI stayed very small for over
30 years. In fact, it was so minimal and even in the negative from 1985-1989, averaging
just $4.31 million. During the 1990s, there was some increase, but this was not
significant until 2000. As a result, Nepal is not attractive for FDI. FDI helps
make capital and labor more efficient and greater. During a survey report between
2010-2012, China ranked highest for FDI followed by India. The reason being
that there has been a large increase in the economic development and state of
the country, with the following areas experiencing an increase – services,
construction activities, telecommunications, computer software and hardware
industries. The leading sources of the flow of foreign investment is the UK, the
US, Singapore, and Mauritius. Pakistan captured 27%, Sri Lanka 24% and Bangladesh
13% of the foreign capital during the years 2000-2013. As stated before, Nepal had
the smallest inflows, 4% to be exact.

            In order to find different
determinants of the FDI and what it does for the economy foreign direct
literature is used. The economic surroundings are an integral part of
encouraging FDI. This is the interaction between several things, including the
normative, cultural, and regulative cognitive institutional components. It is
argued that “the policy and institutional environment is an essential factor of
economic growth because sound institutions inspire productive actions and
depress predatory behavior” (Gwartney, 2009). In addition, this lessens high
costs for foreign investors in a very efficient market-supporting institutional
system, also this does not delay easy access to organizational capabilities.
There are certain things within economic freedom that could be changed in order
to raise FDI – reducing government intervention, increasing property rights
protections, and lowering barriers to capital flows. Economic freedom does have
a large impact on FDI, and has been studied closely in South Asian countries
between the time frame of 1995-2008. This makes sense since markets of larger
size have a better possibility for attracting foreign investors. Another
important determining factor for FDI is the property rights protection
regarding less government intervention, ensuring the necessary enforcement of
permitted contracts. Also, FDI is affected if discretionary authority is not
used correctly, when it is not endorsed, or is not checked correctly by weaker
legal frameworks in certain countries. It was found by Beheshtitabar and
Irgaliyev (2008) that both investment and trade freedom also have a big impact on
the ability to attract FDI as well, meaning that reducing tariff and non-tariff
trade barriers positively affects FDI. It was also found that the countries
with lower taxes, a corruption-free operating environment, and business
friendly regulation are a huge enhancement for FDI to increase in countries. Imposing
both direct and non-direct taxes is a way for costs to rise for establishing
and maintaining business in foreign countries. EU studies find a negative side
of higher tax rates for FDI. Having stronger economic management, less
government participation, reducing corruption, lessening restrictions on
investment, higher protection of personal property, independence of the
financial system, and labor freedom all enhance and increase FDI. Having more
freedom economically allows for FDI to have not only its best potential, but
for the foreign investors in host nations to have their best chance in foreign
investments. This study was done my implying a panel regression method, exploring
how economic freedom effects FDI in South Asian countries from 1995-2014. A
positive relationship is assumed between economic freedom and FDI stocks.

INDEPENDENT
VARIABLES

MODEL 1

MODEL 2

MODEL 3

ECONOMIC FREEDOM

0.161(0.068)

0.137(0.035)

0.117(0.044)

MARKET SIZE

0.005(0.001)

0.006(0.001)

0.004(0.001)

HUMAN CAPITAL

0.054(0.013)

0.046(0.014)

0.031(0.007)

TRADE

0.083(0.017)

0.079(0.016)

0.045(0.017)

NATURAL RESOURCES

 

0.138(0.138)

0.051(0.284)

QUALITY OF INFRASTRUCTURE

 

 

3.96E-05(1.3E-06)

CONSTANT

-12.15(4.151)

-11.39(4.012)

-6.859(2.855)

DIAGNOSTIC TEST

 

 

 

OBSERVATIONS

99

95

95

R2

0.641

0.665

0.692

ADJ. R2

0.625

0.629

0.670

F-STATS

24.79

33.72

31.42

F (P-VALUE)

0.000

0.000

0.000

HAUSMAN
(P-VALUE)

0.000

0.000

0.000

 

 

 

 

            The above table is a representation
of 3 different models in which FDI is a dependent variable, showing that an increase
in economic freedom increases FDI in South Asia. This does not only affect the
improved investment in the country, it will also help with laws, and regulatory
efficiency with an open market economy. This study also examines human capital
which has a positive relationship with FDI. The reason being that it is a straight
indicator when there is a good and strong workforce, which attracts foreign
investors. Another independent variable is trade and an open market, which
enables greater economic welfare. A closed market is less beneficial. For this
reason, investors are more likely to invest in countries with greater trade and
open markets. Model 2 includes natural resources, including ores and metal
exports in South Asian countries, which are a key indicator for greater FDI,
however, this study shows that it is not that big of an indicator for FDI. It is
quite insignificant. Model 3 has infrastructure, which is shown to have a
positive effect on FDI, attracting more FDI. Even with the value being very
small, it is still a significant part. The reason for this is better
infrastructure means less transaction costs. Infrastructure such as highways, roads,
ports, electricity, and communication networks most likely increase
productivity which increases FDI. Economic freedom, the market size, human
capital, trade and quality of infrastructure have a positive impact on FDI;
while things such as natural resources have a positive yet less significant
impact. To conclude, this study is exploring the role of the domestic business environment
measured by Heritage Foundation Economic Freedom Index in attracting FDI in certain
South Asian countries (Pakistan, Bangladesh, India, Nepal, Sri Lanka) between 1995-2014.
It is shown that economic freedom does have a positive relationship on FDI in
certain South Asian countries. Improving economic openness, open markets, and good
worker ethic will improve the likeliness that FDI will increase.

            Overall this study was successful in
showing what is and is not beneficial to foreign direct investment in South
Asian countries. I found this study to be quite informative as it provided me
with knowledge about foreign direct investment. Countries with an open market
and economic freedom are more likely to attract foreign investment. Foreign
investment is imperative for countries to grow and prosper. In an effort to
attract foreign investment, countries must make their country more viable than
others. This study and article enabled me to see the overall effect of foreign investment
on a country’s ability to compete in an ever changing world and market.

 

 

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