The relation between foreign capital and economic growth: A comparative study of South Korea and the Philippines

This dissertation analyzes the relation between foreign capital and economic growth. The standard theory of international capital movements predicts that this relation is unambiguously positive and that the problem of debt repayment should not arise. The debt crisis of the 1980s challenged the empirical validity of this theory. This is because the prediction of the standard theory holds only if three criteria are fulfilled independently or jointly: that foreign capital is invested by the borrowing country (transformation criterion), that these investments are productive (efficiency criterion), and that the country generates the foreign exchange required for debt service (transfer criterion). A simple model was constructed and used to show that the success of a country in translating foreign capital into economic growth depends on its ability to satisfy the three criteria above. To the extent the foreign capital inflows may discourage the fulfillment of the three criteria, the direct relation between foreign capital and economic growth is not warranted. Because of this, the government of the borrowing country can play an important role in increasing the country's ability to satisfy the three criteria and hence ensure that foreign capital accelerates economic growth. This study compares the experiences of two countries: South Korea and the Philippines. Both countries used significant amounts of foreign capital in order to accelerate economic growth and satisfy other development objectives. The empirical findings in this study showed that the success of South Korea is attributable to the country's ability to satisfy all three criteria required by the standard theory. In contrast, the failure of the Philippines was found to arise from the country's inability to channel foreign resources into investment and to generate the foreign exchange required for debt service. These conclusions were derived from using various methods to test the three criteria, namely, Granger causality test (for the transformation criterion), estimation of productivity of foreign-financed investments (for the transfer criterion), and estimation of each country's ability to earn or save foreign exchange and each country's government budget position (for the transfer criterion).