There are many differentsides and risks involved when investing overseas, which influence the foreigncapital in the specific country. This includes but are not limited to the ruleof law, transparency, governance, level of international trade, business andfinancial conditions, and so on. This study consists of more than 20 years ofstudy between 1995-2014; analyzing the role of domestic investment climate inaddition to many other macroeconomic variables in South Asia by using panel datatechniques (Heritage Foundation Economic Freedom Index). This study shows thatoverall economic freedom is an important factor influencing Foreign DirectInvestment (FDI). The conclusion of this study is that in order for South AsianNations to increase foreign capital they need to improve their domesticinvestment. Summary: One of the number one sources forlong term sustainable economic progression in developing countries is FDI. Itis crucial in the development of countries by helping their overall economicsuccess, with technological development, capital accumulation, improvingresource allocation, and strengthening financial capital.
Better investmentclimate helps the firms have an even greater amount of discretion in whatstrategies they choose. Certain characteristics such as market-supporting andinvestment friendly institutional environment facilities are the reason thatthere are less hurdles and hardships in certain business operations thatmaintain and operate certain activities within the specific countries. In addition,strong institutions in the country also attract FDI for various reasons – firstoff, it would decrease transaction costs.
Second, a very strong developedinstitutional framework is better for a more powerful discretion in theirchoices and their discretion in what their strategy is. Lastly, it willdecrease the information asymmetries meaning there will be less risk withintransactions. Economic freedom in a country impliesthere aren’t any restrictions, pressuring or tasks to be completed in exchangeor transfer for personal assets which have been obtained legally. Economicfreedom includes the protection for one’s individual property, but also thefreedom to compete. In a free society people are allowed to work according totheir preference, produce, consume, and also invest any way that they see fitfor themselves.
More importantly, the importance of domestic environment andhow it attracts foreign capital must be determined, which is a motivatingfactor in studying the relationship between the impact of FDI in five South Asiancountries – Pakistan, Bangladesh, India, Nepal, and Sri Lanka, ranging fromover a 20-year period, 1995-2014. The flow of foreign investment inSouth Asia has largely increased, with fluctuations periodically. Foreigninvestment in South Asian nations in 1985 was rather low, but slightlyincreased due to policies liberalized by the nation in the 1990s. India kept ahigher FDI throughout the entire period, followed by Pakistan. India kept thehigh inflows of FDI until nearly 2014, and is one of many countries with anemerging improving economy in the world today, which enables them to provide agreat climate for investors and foreign firms.
India receives the mostautomotive inflow, receiving several projects that ranked over $100 millionbetween 2013 to 2014. The 2015 World Investment Report states that India wasranked ninth overall in 2014, increasing their FDI by 22%. In the two previousyears, it was ranked 15th..
Nepal’s FDI stayed very small for over30 years. In fact, it was so minimal and even in the negative from 1985-1989, averagingjust $4.31 million. During the 1990s, there was some increase, but this was notsignificant until 2000. As a result, Nepal is not attractive for FDI. FDI helpsmake capital and labor more efficient and greater. During a survey report between2010-2012, China ranked highest for FDI followed by India. The reason beingthat there has been a large increase in the economic development and state ofthe country, with the following areas experiencing an increase – services,construction activities, telecommunications, computer software and hardwareindustries.
The leading sources of the flow of foreign investment is the UK, theUS, Singapore, and Mauritius. Pakistan captured 27%, Sri Lanka 24% and Bangladesh13% of the foreign capital during the years 2000-2013. As stated before, Nepal hadthe smallest inflows, 4% to be exact. In order to find differentdeterminants of the FDI and what it does for the economy foreign directliterature is used.
The economic surroundings are an integral part ofencouraging FDI. This is the interaction between several things, including thenormative, cultural, and regulative cognitive institutional components. It isargued that “the policy and institutional environment is an essential factor ofeconomic growth because sound institutions inspire productive actions anddepress predatory behavior” (Gwartney, 2009). In addition, this lessens highcosts for foreign investors in a very efficient market-supporting institutionalsystem, also this does not delay easy access to organizational capabilities.
There are certain things within economic freedom that could be changed in orderto raise FDI – reducing government intervention, increasing property rightsprotections, and lowering barriers to capital flows. Economic freedom does havea large impact on FDI, and has been studied closely in South Asian countriesbetween the time frame of 1995-2008. This makes sense since markets of largersize have a better possibility for attracting foreign investors. Anotherimportant determining factor for FDI is the property rights protectionregarding less government intervention, ensuring the necessary enforcement ofpermitted contracts. Also, FDI is affected if discretionary authority is notused correctly, when it is not endorsed, or is not checked correctly by weakerlegal frameworks in certain countries. It was found by Beheshtitabar andIrgaliyev (2008) that both investment and trade freedom also have a big impact onthe ability to attract FDI as well, meaning that reducing tariff and non-tarifftrade barriers positively affects FDI.
It was also found that the countrieswith lower taxes, a corruption-free operating environment, and businessfriendly regulation are a huge enhancement for FDI to increase in countries. Imposingboth direct and non-direct taxes is a way for costs to rise for establishingand maintaining business in foreign countries. EU studies find a negative sideof higher tax rates for FDI. Having stronger economic management, lessgovernment participation, reducing corruption, lessening restrictions oninvestment, higher protection of personal property, independence of thefinancial system, and labor freedom all enhance and increase FDI. Having morefreedom economically allows for FDI to have not only its best potential, butfor the foreign investors in host nations to have their best chance in foreigninvestments.
This study was done my implying a panel regression method, exploringhow economic freedom effects FDI in South Asian countries from 1995-2014. Apositive 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 representationof 3 different models in which FDI is a dependent variable, showing that an increasein economic freedom increases FDI in South Asia. This does not only affect theimproved investment in the country, it will also help with laws, and regulatoryefficiency with an open market economy. This study also examines human capitalwhich has a positive relationship with FDI. The reason being that it is a straightindicator when there is a good and strong workforce, which attracts foreigninvestors.
Another independent variable is trade and an open market, whichenables greater economic welfare. A closed market is less beneficial. For thisreason, investors are more likely to invest in countries with greater trade andopen markets. Model 2 includes natural resources, including ores and metalexports 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 isquite insignificant. Model 3 has infrastructure, which is shown to have apositive effect on FDI, attracting more FDI. Even with the value being verysmall, it is still a significant part. The reason for this is betterinfrastructure means less transaction costs. Infrastructure such as highways, roads,ports, electricity, and communication networks most likely increaseproductivity which increases FDI.
Economic freedom, the market size, humancapital, trade and quality of infrastructure have a positive impact on FDI;while things such as natural resources have a positive yet less significantimpact. To conclude, this study is exploring the role of the domestic business environmentmeasured by Heritage Foundation Economic Freedom Index in attracting FDI in certainSouth Asian countries (Pakistan, Bangladesh, India, Nepal, Sri Lanka) between 1995-2014.It is shown that economic freedom does have a positive relationship on FDI incertain South Asian countries. Improving economic openness, open markets, and goodworker ethic will improve the likeliness that FDI will increase. Overall this study was successful inshowing what is and is not beneficial to foreign direct investment in SouthAsian countries.
I found this study to be quite informative as it provided mewith knowledge about foreign direct investment. Countries with an open marketand economic freedom are more likely to attract foreign investment. Foreigninvestment is imperative for countries to grow and prosper. In an effort toattract foreign investment, countries must make their country more viable thanothers. This study and article enabled me to see the overall effect of foreign investmenton a country’s ability to compete in an ever changing world and market.