Effectiveness Of Foreign Direct Investment And Foreign Aid

The international flow of financial resources can take two main forms. First is the official development assistance from individual national governments and multinational donor agencies for the purpose of promoting development in the recipient countries. The second form of resources comes through foreign private investment which is transferred for commercial purposes. As far as growth and development, and income difference among the developing countries is concerned, there are three aspects of economic impact of international capital flows are becoming contesting topic of current research among the distinguished policy makers and scholars. First aspect is how far the economic growth in the developing countries are attributed to foreign direct investment and foreign aid, and secondly, how far both foreign direct investment and foreign aid work together in the host countries in terms of growth and development. The final one is what domestic and external factors that determine the movements of these capital flows.This empirical study focuses on these three aspects taking four South Asian countries; Bangladesh, India, Pakistan and Sri Lanka, into account during the period of 1995 to 2008 because following liberalization policies initiated by most of the South Asian countries in 90s and early 2000s; foreign direct investment in these countries has increased ever before and have been great attention of developed and emerging economies associated with moving FDI into this region. In case of foreign aid, South Asian countries have long history in receiving foreign aid from various developed countries, organizations and emerging economies. Further, interestingly, the structure of foreign aid for these countries is with unique characteristics and likely to have positive impact on the growth as well as facilitate foreign direct investment by developing a good environment for foreign investors. Therefore, this study investigates the determinants, growth effect and the complementarity of foreign direct investment and foreign aid in these countries.This study adopts balanced time series panel data and employs various econometric techniques such as Generalized Method of Moment estimator, and the Fixed and Random-Effect estimators in data analyses. Firstly, this study investigates the determinants of FDI and foreign aid adopting a gravity concept. The results on the determinants of FDI suggest that distance and both home and host country characteristics significantly play a crucial role in determining the FDI inflows into the South Asian region. The cyclical factors in the economies of home and the host countries seem to be an important factor to determine the magnitude level of the FDI flows; not only these but some other factors such as trade openness, human development, population and infrastructure are also found to have significant factors motivating FDI inflow in South Asian countries. In addition, FDI flows are inversely related to the distance between home and host country, supporting the view that distance implies costs associated with FDI activities. The results on the determinants of the foreign aid suggest that foreign aid is not transferred under a conditional policy environment. Further, foreign aid flow has negative function subject to national income of the host countries. The results also suggest that despite the magnitude effect of FDI on foreign aid is low it is positively associated with foreign aid. In addition, foreign aid is positively associated with human capital development in these countries. Therefore, it is important to notify that FDI, foreign aid and human capital development have close relationship in South Asian countries.Secondly, the growth effect of FDI, and foreign aid and its volatility are investigated. Looking at the growth effect of FDI in these countries, the affect of FDI on growth rate is average. FDI gets relatively high significant level in the presence foreign aid, comes under the fact that these two variables could serve as complementary in these countries. Turning attention on the analysis of growth effect of foreign aid and volatility, first, using random-effects estimator, the growth impact of gross, development and pure aid is tested. Secondly, development aid is further classified into short-and long-run aid for the test. The results derived from the study conclude that both short-run and long-run type aid are positively associated with the growth rate. The volatility of short-run aid damages growth whereas volatility of long-run aid has no effect on growth in the South Asian countries. Long-run aid promotes growth more than short-run aid does. Further, pure aid and volatility are found to have no impact on growth.Finally, this study investigates the relationship between FDI and foreign aid with the intention of exploring the complementary relationship between FDI and foreign aid in the South Asian countries. First, the aid disaggregated into infrastructure aid and non-infrastructure aid, and found that infrastructure aid is effective in facilitating FDI into the South Asian countries whereas non-infrastructure has weak relationship with FDI. Secondly, the infrastructure aid is further disaggregated into aid for social infrastructure, aid for economic infrastructure, and aid for production activities so as to investigate more specific structural effect of aid. This investigation found that aid for social infrastructure and aid for production activities play a crucial role in attracting FDI, whereas aid for economic infrastructure has marginal effects on FDI. Among these three elements of aid, aid for social infrastructure has strong effects in facilitating FDI inflows. Finally, in order to investigate specific donor country effect, aid is disaggregated with respect to the major donor countries that are USA, UK, Japan, Netherlands and Germany. The analysis found that aid from UK has significant effect on FDI whereas aid from USA, Germany and Netherlands has marginal effect. The aid from Japan does not facilitate FDI flow. The overall findings in this study permit to conclude that international capital flow into South Asian countries is effective in terms of growth and working together as complementary.