Effects of Outward Foreign Direct Investment On Domestic Investment: The Cases of Brazil and China
Effects of Outward Foreign Direct Investment On Domestic Investment: The Cases of Brazil and China
Effects of Outward Foreign Direct Investment On Domestic Investment: The Cases of Brazil and China
Abstract: Policymakers face a dilemma over their investment-promotion strategies for becoming
more competitive in international markets. Encouraging firms to invest abroad could reduce domestic
economic activity. We investigate this issue by analysing the long- and short-run relationships
between outward foreign direct investment and domestic investment for Brazil and China. We use
a time series approach, namely autoregressive distributed lag for the period between 1975 and
2013. Our findings indicate a crowding-in effect of outward foreign direct investment on domestic
investment for both countries. Copyright © 2018 John Wiley & Sons, Ltd.
1 INTRODUCTION
Traditionally, the leading investors responsible for foreign direct investment (FDI) have
been multinational enterprises (MNEs) from developed countries. Consequently, the
outward FDI (OFDI) literature has advanced with a focus on countries such as the
United States, Sweden, Germany, and Japan, presumably because MNEs from these
countries invest much abroad (Kim, 2000; Dasgupta, 2014). Furthermore, until very
recently, OFDI from developing countries was restricted to very few firms and had almost
negligible importance to home countries (Caseiro & Masiero, 2014). However, this
*Correspondence to: Dr Igor Gondim, Escola Superior de Propaganda e Marketing, R. Dr Álvaro Alvim, 123, Sao
Paulo 04018-010, Brazil.
E-mail: [email protected]
scenario has changed. Both domestic policy choices in developing countries and global
economic conditions helped shape these changes in the investment landscape (Perea &
Stephenson, 2017). An increasing OFDI share now comes from MNEs based in
developing countries (Cuervo-Cazurra, 2008; Luo & Zhang, 2016; Paul & Benito,
2018). Developing and transition countries increased their share of global OFDI from
0.3 to 39.2 per cent between 1970 and 2014 (United Nations, 2015).
One major controversial issue on the internationalisation of MNEs is whether OFDI
crowds in or crowds out domestic investment (DI) in home countries (Stevens & Lipsey,
1992; Feldstein, 1995). One of the main arguments in this debate is that OFDI replaces
domestic activities and consequently DI, especially when firms shift some proportion of
their production abroad (Ameer, Xu, & Alotaish, 2017). Some existing empirical studies
focusing on aggregate cross-country data conclude that OFDI reduces DI in an
approximately one-to-one ratio (Feldstein, 1995; Desai, Foley, & Hines Jr, 2005; Ameer
et al., 2017). In contrast, Herzer and Schrooten (2008) found that OFDI has positive
long-run effects on DI for the United States and negative long-run effect on DI for
Germany. Desai et al. (2005) argue that firms combine home production with foreign
production to generate a final output with lower costs than would be possible with
production in just one country. Nonetheless, such an expansion strategy can be
controversial for developing countries because the decision to invest scarce resources
abroad inevitably reduces the likelihood of concurrent investments at home (Stevens &
Lipsey, 1992). It is worth pointing out that research based on developed countries might
not be relevant for developing countries because developing countries are under imperfect
financial market conditions and are capital-scarce in OFDI (Alsadiq, 2013; Dasgupta,
2014). Moreover, the advantages and internationalisation of MNEs in developing countries
differ from those in developed country ones (Dunning, 2000).
While many theories explain the possible influence of OFDI on DI, the results are still
inconclusive (Alsadiq, 2013; You & Solomon, 2015). Thus, it is worth shedding some
light on this matter to bring out evidence of the effects of OFDI on DI because this
understanding might be a vital step towards internationalisation and national development.
In particular, the recent rise of MNEs in Latin America, India and Asian countries creates
opportunities to carry out comparative studies that explore the countries’ strategic motives
(Paul & Benito, 2018). Hence, we investigate Brazil and China because these countries
have been among the developing countries to start distinct internationalisation programmes
and adopt uniquely political strategies. Further, these two countries are relatively important
in their regions in terms of their economic and demographic sizes.
We developed the study and discussions by using an autoregressive-distributed lag
(ARDL) (Pesaran, Shin, & Smith, 2001) approach to test the presence of cointegration in
the data series. We also estimate the long- and short-run coefficients of these variables. The
results of the study indicate a significant and positive association between OFDI and DI. It also
indicates that a crowding-in effect is stronger for Chinese investments than Brazilian ones.
2 LITERATURE BACKGROUND
In the neoclassical growth model, FDI promotes economic growth by increasing the
volume of investment and its efficiency (X. Li & Liu, 2005). In this vein, FDI raises
Copyright © 2018 John Wiley & Sons, Ltd. J. Int. Dev. 30, 1439–1454 (2018)
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A significant empirical issue arises regarding the interaction between OFDI and DI. If a
one-dollar increase in OFDI leads to more than a one-dollar increase in DI, then a
crowding-in effect occurs. If a one-dollar increase in OFDI leads to a reduction in DI, then
a crowding-out effect occurs (Agosin & Machado, 2005). Knoerich (2012) conceptually
argues that OFDI supports economic development relating this benefit to reverse spillovers
(De Propris & Driffield, 2005). Reverse spillover refers to the process by which one
country learns from the host country when operating abroad, such as knowledge,
technology skills and efficiency that might be transmitted from subsidiaries operating in
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Table 1. Recent studies on outward foreign direct investment (OFDI) from developing countries’
perspectives
Study Major findings
Paul and Benito Literature review on OFDI from developing countries between 1993 and 2017
(2018)
Ameer et al. (2017) They analyse the association between OFDI and DI from China. Results applying a
multivariate model show that there is a definite long-run unidirectional causal
relationship running from OFDI to DI. In the short run, DI and OFDI do not show
Granger causality.
You and Solomon They analyse the influence of Chinese OFDI on DI, finding a positive effect and that it
(2015) depends on the level of government support in the particular industries.
Caseiro and Masiero They analyse how the Brazilian and Chinese OFDI policies can contribute to the
(2014) economic development of their home countries, finding a positive effect to the domestic
economy.
Alsadiq (2013) The author analyses 121 developing countries over the period 1990 to 2010, finding that
OFDI negatively affects DI.
Goh and Wong They found an adverse influence of OFDI and DI during the period 1999 to 2010 for
(2012) Malaysia.
Herzer (2011) The author examines the long-run relationship between OFDI and total factor
productivity for a sample of 33 developing countries (1980-2005), finding a positive
association.
Cui and Jiang (2010) They examine ownership decisions of Chinese OFDI. The findings suggest that Chinese
OFDI ownership decisions are influenced by the assets type, global strategy, their
technology motives and seeking of brand assets, the government restrictions and
cultural barriers they face in the host country, and the home government’s financial
support and approval restriction.
Cuervo-Cazurra The author describes multinational enterprises’ strategies from Latin America in their
(2008) selection of the country which to establish FDI. The analysis reveals multilatinas’ need
for sophisticated advantages for establishing FDI. They are induced by institutional
reforms. Multilatinas follow four alternative strategies for selecting countries in which
to first establish FDI.
Buckley et al. (2007) They associated Chinese OFDI with high levels of political risk, cultural proximity, host
market size and geographic proximity and host natural-resource endowments.
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because the firm is looking for resources unavailable in its market (Hejazi & Pauly, 2003).
In line with this, resource-seeking FDI may not adversely impact the domestic economy
because MNEs are interested in accessing and exploiting natural resources beyond their
borders (UNCTAD, 2006, p. 172). OFDI enables firms to not only enter new markets
but also gain access to foreign technology, and as a result, the entire domestic economy
benefits owing to the increased efficiency of the investing firms and the associated
spillovers to the local firms at home (Herzer, 2011).
One issue concerning FDI from developing countries relates to the possible substitution
of domestic production with international production. OFDI could constrain DI and fixed-
capital formation, replace exports from the home economy and reduce employment
(UNCTAD, 2006, pp. 180–182). Empirical evidence on OFDI and restructuring in
developing countries is limited and relates mainly to newly industrialised economies in
East and South-East Asia (UNCTAD, 2006, p. 178). Further, the expansion of FDI from
developing countries is a recent phenomenon; few studies have systematically assessed
the impact of developing countries on their home economies (UNCTAD, 2006, p. 169).
Hence, contemporaneous research tries to understand the crowding-in and crowding-out
effects of OFDI on DI mainly from developing countries because this understanding can
help their economic development and fill the literature gap. Table 1 shows recent studies
on OFDI from developing countries’ perspectives.
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DOI: 10.1002/jid
1444 I. Gondim et al.
Despite the impulse of Chinese policy towards OFDI, the Chinese government has also
played a negative role (Cui & Jiang, 2010). Davies (2013) points out that official OFDI
figures must be taken with caution because OFDI is used to inject funds into individual
purpose entities that then return the money to China as inward FDI to take advantage of
fiscal incentives, so the official total may be an overestimate. Most of Chinese OFDI goes
to countries such as Hong Kong, the Cayman Islands and the British Virgin Islands (Lau &
Bruton, 2008). In other words, some Chinese MNEs invest in these ‘tax havens’ to
transform themselves into ‘foreign domiciled’ companies, whereupon they can invest in
China as foreign investors to take advantage of tax and other concessions back home
(Peng, 2012). Therefore, the negative role of the Chinese government could be cited
regarding its discrimination against certain domestic firms, especially those that are not
state-owned (Ahlstrom, Chen, & Yeh, 2010).
Finally, a network of approximately of 130 bilateral investment treaties (BITs), as well
as some other international investment agreements (IIAs), protects China’s outward
investors. While these treaties were originally concluded with inward FDI in mind, they
have evolved considerably over time to reflect the rise of OFDI (Sauvant & Nolan, 2015).
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competitive leadership. The chosen sector was aeronautics, oil and gas, petrochemicals,
mining, steel, paper and pulp and meat, but this activity ceased in 2011 (Caseiro &
Masiero, 2014; Panibratov, 2017). Also, IIAs have seen increased use in the world
economy, thus promoting investment abroad by MNEs and protecting both domestic and
foreign investors (Gondim et al., 2017). In 2016, about 4.715 BITs and 2.806 other IIAs
were in force worldwide (UNCTAD, 2016). Regardless of the importance of such
agreements to promote international expansion, Brazil had 0 BITs and 13 IIAs in force,
which is a weak indicator of OFDI promotion policies because it guarantees isonomic
taxes.
Table 2 shows a comparison between the Brazilian and Chinese OFDI features that were
discussed above.
3 HYPOTHESIS DEVELOPMENT
If MNEs are market-seeking and OFDI replaces a country’s exports or shifts domestic
production abroad, it is likely to reduce DI. On the contrary, if MNEs are asset-seeking,
there is no negative impact on the local economy in the firm’s country of origin because
the firm is looking for resources unavailable in its market (Hejazi & Pauly, 2003).
Resource-seeking MNEs are mainly interested in acquiring particular types of resources
not available in their home or at a cheaper cost, so in this case, OFDI would have a positive
effect on DI. Strategic-asset-seeking helps MNEs to build up their ownership advantages at
home and abroad (You & Solomon, 2015). The idea is that MNEs can acquire and
complement ownership advantages rather than exploiting the existing assets.
Dunning and Lundan (2008) pointed out that OFDI could affect DI positively, neutrally
or negatively. In fact, empirical research has provided mixed results (Alsadiq, 2013; You
& Solomon, 2015; Ameer et al., 2017). Nevertheless, the Chinese government seems to be
more efficient in integrating OFDI policies with the primary objectives of its overall
industrial policy than its Brazilian counterpart (Caseiro & Masiero, 2014).
Many factors make up the idea of a comparative analysis with Brazil and China from
academic, managerial and policy-orientated points of view. Both countries are developing
markets and have large domestic markets. They also face diverse and somewhat opposing
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1446 I. Gondim et al.
political and productive contexts on their domestic fronts (Caseiro & Masiero, 2014). They
are responsible for the two most significant stocks of OFDI among developing countries,
having successfully internationalised several public and private companies within the past
decade (Verma et al., 2011; Nölke, 2014). Both countries face weak financial markets.
Capital markets in developing countries are not efficient and might have capital controls.
This may also crowd out DI because it is cheaper for firms to secure debt for the creation
of foreign assets rather than DI (Girma, Patnaik, & Shah, 2010; Dasgupta, 2014).
In light of these earlier arguments and discussions, we test the following hypothesis for
the Brazilian and Chinese cases:
H1 Increases in OFDI will increase domestic investment.
4 METHODOLOGY
This study uses the most extended available annual data collected from the World Bank,
ranging from 1975 to 2013 for Brazil and from 1985 to 2013 for China. The independent
variable is OFDI, which is a sort of cross-border investment associated with a resident in
one country having control or a significant degree of influence on the management of an
enterprise that is resident in another country (World Bank, 2018).
The dependent variable is DI. Previous studies use gross fixed capital formation (GFCF)
as a proxy for DI (Feldstein, 1995; Agosin & Machado, 2005; Herzer & Schrooten, 2008;
Alsadiq, 2013; You & Solomon, 2015). GFCF allows measuring to what degree the
allocation of resources to projects abroad leads to a fall or rise in DI. It is perhaps the most
common benchmark of the impact of OFDI on DI (UNCTAD, 2006, p. 180). In addition,
GFCF is one of the main components of final expenditures to calculating gross domestic
product (GDP) (United Nations, 1964), whereas FDI relates to financing, that is, the
purchase of shares in foreign companies where the buyer has a lasting interest (10 per cent
or more of voting stock). FDI can be used to finance fixed-capital formation. However, it
can also be used to cover a deficit in the company or to pay off a loan. Thus, one cannot say
FDI is always included in GFCF (World Bank, 2018).
We used EViews 9.0 for the estimation procedures. We applied an econometric technique
called ARDL bounds testing by Pesaran et al. (2001) as a comprehensive approach to
model specification and integration testing (Philips, 2016). ARDL has several advantages
over the traditional co-integration techniques. First, the method uses a single equation,
which reduces the number of parameters to be estimated. Second, the ARDL approach is
more statistically significant for small sample sizes (Ghatak & Siddiki, 2001). Third, this
method does not require that regressors are integrated in the same order. This means that
it could be either I(0) or I(1). In short, according to Philips (2016), the protocol to apply
ARDL encompasses four steps: (i) ensuring that the dependent variable is I(1); (ii)
checking whether the order of the independent variable is not explosive or higher than
I(1); (iii) estimating the ARDL model in error correction form and ensuring there is no
Copyright © 2018 John Wiley & Sons, Ltd. J. Int. Dev. 30, 1439–1454 (2018)
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autocorrelation; and (iv) performing the bounds test for cointegration. Following Desai
et al. (2005) and Herzer and Schrooten (2008), we can write the DI equation as follows:
DI OFDI
¼ a1 þ a2 t þ a3 þ εt (1)
Y t Y t
where (DI/Y)t denotes GFCF as a share of GDP, a are the coefficients, t is a linear trend,
(OFDI/Y)t denotes the OFDI from the home economy to the rest of the world as a
percentage of the GDP, and εt is the white-noise term. We also estimate the error correction
of the ARDL model, as follows:
DI DI OFDI DI
Δ ¼ b1 þ b2 t þ b3 þ b4 þ ∑ki¼1 ηi Δ
Y t Y t1 Y Y t1
k
t1
OFDI
þ ∑ γi Δ þ εt (2)
i¼0 Y t1
where b, η and γ are coefficients; t is the deterministic trend; Δ is the difference operator;
and εt the white noise term. In order to determine whether the model needs a trend (t), we
estimate Equation (2) with and without a trend for both countries.
The ARDL approach does not require a stationary test, but we need to ensure that none of
the time series is integrated at order 2 or higher. According to Ouattara (2006), if the series
is I(2), the F-statistics provided by Pesaran et al. (2001) are no longer valid, because the
bounds tests assume that the variables are either I(0) or I(1). To check this, we run a unit
root test on the first difference for OFDI and DI. The p-value for each series is zero,
implying that the series is either I(0) or I(1). To verify the stability of the model, we
perform unit root and structural break tests (Perron, 1989), ignoring structural breaks that
might lead to model misspecifications and inconsistent estimation results of model
parameters (Cergibozan & Demir, 2017). A dummy (D94) variable was created in 1994
to account for the Brazilian trade liberalisation and economic stabilisation programmes.
4.4 Estimation
The results from the unit root and stability tests indicate that we can continue the procedure
by investigating the presence of co-integration among the variables. We estimate the
existence of a long-run relationship between OFDI and DI by applying the ARDL bounds
testing approach. To verify whether the model needs a trend, we estimate Equation (2) with
and without a trend term. Thereby, the trend component is added for both models.
Additionally, the optimal lag length number of the variables was determined based on
the Schwarz information criterion.
The ARDL test is based on the joint F-statistic, the asymptotic distribution of which is
non-standard, so we test the long-run relationship between (DI/Y)t and (OFDI/Y)t in
Equation (2) under the null hypothesis H0 : b2 = b3 = b4 = 0 (there is no co-integration
between the variables) against the alternative hypothesis H1 : b2 ≠ b3 ≠ b4 ≠ 0 (there is
co-integration between the variables) by ordinary least square.
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DOI: 10.1002/jid
1448 I. Gondim et al.
There are two sets of critical values, the upper bound critical values, which assume that
all variables are I(1), and the lower bound critical values, which assume that all variables
are I(0). If the calculated F-statistic lies between the lower and upper bounds, then the test
is inconclusive. However, if the calculated F-statistic is higher than the upper bound, then
the null hypothesis of no long-run effect is rejected, and if it lies below the lower bound,
we cannot reject the null hypothesis.
We use the Wald test to compare the F-statistic to the critical values obtained from
Pesaran et al. (2001). Because the calculated F-statistics in Table 3 are higher than the
upper bound for both countries, we reject the null hypothesis and accept the alternative
hypothesis of co-integration at the 5 per cent significance level.
Furthermore, we perform some diagnostic tests to ensure that the regression is valid. We
test whether the variance of residuals is homoscedastic and that residuals are not
autocorrelated and rather follow a normal distribution. We show the results from Table 4
. On the basis of the results, we conclude that the residuals do not show any signs of
non-normality, autocorrelation or heteroscedasticity, which are the desired results.
We found that (DI/Y)t and (OFDI/Y)t are cointegrated. Thus, the next step is to estimate
the long-run coefficients for the model. The estimated coefficients of the long-run
relationship are presented in Tables 5 and 6.
In the case of Brazil (Table 5), dividing the estimated coefficients of 0.777 by the absolute
value of 0.509, we obtain 1.53. This result means that one additional dollar spent on
OFDI leads to an increase of 1.53 additional dollars in DI in Brazil. In other words, a
crowding-in effect exists. Considering the results for China (Table 6), we also obtain a
crowding-in effect of OFDI on DI of 8.23 (7.043/0.856). Comparatively, these results
indicate that China has stronger benefits in the long run (approximately 5.42 times higher
than Brazil).
The error correction coefficient term of (0.44) and (0.80) for Brazil and China
respectively are highly significant at 1 per cent and negative. This indicates a quick
adjustment of 44 per cent (Brazil) and 80 per cent (China) of the previous year’s
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China
Regressors Coefficient T-Statistic Prob.
5 CONCLUSION
Copyright © 2018 John Wiley & Sons, Ltd. J. Int. Dev. 30, 1439–1454 (2018)
DOI: 10.1002/jid
1450 I. Gondim et al.
The empirical evidence presented in this study indicates that there are crowding-in
effects for Brazil and China, suggesting that OFDI contributes to enhancing DI. At the
same time, it indicates the importance of establishing new linkages to transmit resources
and knowledge from developed countries to developing countries by reverse spillovers.
The idea is that domestic conditions, such as efficient institutions, high levels of human
capital and a supportive government can have a positive effect on a country’s
development.
These findings are in line with the strand of research that states that OFDI has a positive
impact on the home country and that the benefits are similar to those from developed
countries. Hence, the economic impact of OFDI can be similar to developed countries,
but the differences could be set in OFDI motivations or in OFDI’s development stage.
For instance, MNEs from developed countries may focus more on controlling knowledge
creation (Kuemmerle, 1999), whereas MNEs from developing countries may focus more
on accessing technologies and knowledge abroad (Cantwell & Santangelo, 1999).
In short, OFDI provides a way to access new knowledge and technology for economic
development. This sort of strategy helps MNEs move up the value chain and increase their
competitiveness in international markets. Furthermore, government support to encourage
OFDI can be understood as a development strategy.
As is the case with any research, this current research faces several shortcomings. First, in
regard to developing countries’ heterogeneity, given that MNEs from developing countries
are a recent phenomenon and that most developing countries have economic and legal
constraints, we must analyse the findings with caution. Thus, generalisations require
additional research support. Second, data from developing countries can be biased or
incorrect because the data might reflect those governments’ interests. Third, we use
aggregate data, which cannot capture the different levels of industry or government
support to a specific sector. Fourth, the interaction between OFDI and DI takes place
through various channels, such as interactions with institutions, which we did not consider
in this study. A combination of channels would improve the analysis results because the
effect of OFDI on DI is not necessarily straightforward.
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