Foreign Direct Investment and Economic

Growth in South Korea and Policy Lessons

for Nepal

(A Master Degree Dissertation)

Submitted by:
Raj Kumar Rai
MSc. International Finance
Student Ref No: M00235713

Submitted to:

Middlesex University Business School, London

2008/09

September 25, 2009

London, United Kingdom

 I

Abstract

Foreign direct investment (FDI) is taken as one of the key factor of rapid economic
growth and development. FDI, it is believed to stimulate domestic investment, human
capital, and transfers technology. It is associated qualities which causes the faster
economic development in the host countries. South Korea, for instance had one of the of
the poorest economies during 1960s, but yet achieved double digit economic growth
with substantial amount of FDI inflows and become one of the most advanced
economies in the world less than in a half century and a member of OECD country.
This paper evaluates the role of FDI in South Korea’s economic growth employing
macro economic times series data from 1980-2005.The other variables such as foreign
direct investment, human capital, export, employment and domestic investment. This
study uses the endogenous growth model to explore the role of FDI in economic
growth. The role of FDI in economic growth is not statistically significant; however, the
interaction between FDI and human capita, export and domestic capital is positive.
This study supports the findings of Kim and Hwang (2000) in the case of Korean
economic study of FDI and economic growth.

Key word: Foreign Direct Investment, Economic growth, South Korea

 II

Acknowledgements

I am heartily thankful to my supervisor, Mr. Leslie Taylor, whose guidance and

supervision from the beginning to the concluding level enabled me to develop an
understanding of the project. I would like to express my gratitude to Dr. Michela Vecchi
for her support my queries in this dissertation writing.

I would like to take this opportunity to thank to my family members who directly
supported me to satisfy the thirst of higher education in abroad. Especially, I am heartily
obliged to my parents, elder brother Sarba Rai and sister in law Durga Devi Rai and
brother Prashan Rai (USA) for their continuous support and encouragement for my
studies at the University. I would love to remember niece Alina and Melina and
Nephew Siddharth for their warm smiling at my approaches to them for making joyful
life in the UK.

It is my pleasure to thank some of my friends who made research works more

interesting and useful, especially; I would remember Mr. Lok Bhandari, Mr. Shree
Basnet, Mr. Ramesh Shrestha, Mr. Tap Rai, Mr. Naresh Rai, Mr. Pratap Bhatarai, Miss.
Ritu Rai, Miss. Lina,and Bina Rai.

Last but not the least, I would like to express may gratitude to the library staffs at the
Middlesex University for providing necessary reading materials for my dissertation.

Raj Rai
21, September 2009
 III
TABLE OF CONTENTS

Abstract…………………………………………………………………I

Acknowledgement……………………………………………………..II

Table of contents………………………………………………………III

List of tables……………………………………………………………IV

List of figures…………………………………………………………..V

Abbreviations………………………………………………………….VI

CHAPTER

1. Introduction………………………………………………..

Rationale for the study…………………………………….

Statement of problem………………………………………

Research Objectives………………………………………..

Limitations of the Study……………………………….......

Organization of the Study……………………………….....

CHAPTER

2. Review of Literature………………………………………

FDI Theories……………………………………………….

FDI and Motives…………………………………………..

FDI and Entry Modes…………………………………….

Factors Affecting Location Choice of FDI………………

Empirical Studies…………………………………………

CHAPTER

3(A) An Overview of South Korean Economy ……………..

3.1.1 A brief Korean Economy after 1950s………………….....

3.1.2 Korean economic performance after Asian Financial Crisis…

CHAPTER

3(B) An Overview of Nepalese Korean Economy ………………..

3.2.1 Foreign Trade pattern of Nepal………………………………..

3.2.2 Foreign Trade and FDI policies in Nepal

CHAPTER

4 Research Methodology

4.1 Conceptual Frame Work…………………………………

4.2 Research Methodology and Model……………………….

4.3 Data Collection and Data Sources……………………….

CHAPTER

5 An Over View of Recent FDI flows in South Korea

5.1 FDI inflow trend in South Korea………………………..

5.2 Sectorwise FDI inflow in South Korea………………….

5.3 Domestic Investment and Trade Statistics of South Korea

(1980-2005)
 5.4 Domestic Investment and FDI in South Korea……..

5.5 FDI policies in South Korea……………………………

5.6 Foreign Direct Investment and Economic Growth in Korea…

CHAPTER

6 Discussion and Analysis …………………………………….

6.1 FDI and Economic Growth………………………………

6.2 Regression results of estimated model…………………..

CHAPTER

7 Summary, Conclusion and Recommendations

7.1 Summary……………………………………………..

7.2 Conclusion Remarks…………………………………

7.3 Policy Recommendations…………………………....

References

Appendix

Map of South Korea

List of Tables

Sn Table No Page No

1. 3.1 Major top ten Korean Choebols 25

2. 3.2 FDI inflow in South Korea(1980-1990) 27
3. 3.3 Korean Economic Indicators in recent years 29
4. 3.4 GDP, FDI and Economic Growth in Asian Countries in 2007 32
5. 3.5 Product wise Export from Nepal 33
6. 3.6 List of Nepal’s Mfg goods and quota for export to India 34
7. 3.7 Sectorwise FDI inflow in Nepal 37
8. 5.1 FDI inflow in selected Asian countries 45
9. 5.2 FDI in South Korea by sectors(1985-1996) 50
10. 5.3 FDI in South Korea by sectors (1997-2005) 51
11. 5.4 Domestic Investment and export of South Korea 53
12. 5.5 Domestic investment and FDI in South Korea 54
13. 6.1 Unit root test for variables 64
14. 6.2 Estimating per capita GDO growth and other variables 65
15 6.3 Estimating per capita growth with interaction terms 66

List of figures

Sn Figure No Page No

1. 3.1 Product wise Nepal’s export 33

2. 3.2 Product wise Nepal’s import 35
3 5.1 FDI inflow trend in South Korea 47

4. 5.2 Major FDI Source countries in South Korea 48

5. 5.3 GDP and FDI trend in South Korea 50

6. 3.6 GDP per capita growth rate in South Korea 60

 CHAPTER-1
INTRODUCTION

1.1General Background

In the recent years, Foreign Direct Investment (FDI) policies has become one of the

central economic policies for the developing countries, learned from the experiences of

newly industrialised countries (NICs) like South Korea, Singapore, Hong Kong and

Taiwan which promoted FDI as the catalyst of rapid economic growth in the early

stages of their economic development. Empirical studies on the impact of FDI on

economic growth have shown positive impact in the host countries. Hence, it has

become an area of great interest with empirical determinants of policy implications for

enhanced FDI inflows and the mechanism through which it facilitates growth and

structural change in recipient countries.

The role of FDI in economic growth in the developing countries is that FDI generate

more benefits to the recipient countries rather than just full filling the short-term capital

deficiency problems. Transfer of technologies and its spill over effect to the local firms

will make the local firms more competitive and high standards which is necessary to

compete with the foreign products. Another, spill over effect of MNEs is that MNEs

may provide training and labour management which may make them available to the

economy in general. The training to local suppliers by MNEs may increase the high

standard production and managerial standards.

The relationship between foreign direct investment and economic growth is one the well

studied subject in the field of development economics. Especially, after the advent of

endogenous growth model (Borenzteins, et al, 1995, Balasubramanyam, et al, 1996)

made this relationship more vital for long run economic growth. The research interest in

this field has increased after 1990s wave of globalisation and massively increased FDI

across the globe and economic growth of FDI receiving countries.

UNCTAD (2008) foreign direct investment has potential to generate employment, raise

productivity, transfer skills and technology, enhance export and continue to the long-

term economic development of the world’s developing countries. Multinational

Companies (MNEs) and Translational Corporations (TNCs) are important as their

foreign affiliates, some 64,000 Translational Corporations, generate 53 million jobs.

FDI is also the largest source of external financing for developing countries.

Foreign Direct Investment is directly linked to the international trade of the country

which provides the opportunities to integrate the local economy with the world

economy. Enormous literatures on significance of FDI has shown positive role in the

economic growth (Borenztein, et al 1995, De Mello, 1996 and Balasubramanyam,

1996). However, there are controversies as some academics argue that the relationship

between FDI and growth is non-linear. This is a complex issue whether FDI cause

growth or growth causes the increase of FDI. Multinational companies go across the

world with the objectives maximizing profits. Hence, countries are providing most

suitable investment environment to MNEs to attract the investment. Policy reforms,

political stability, domestic growths, increased domestic entrepreneurial skills might

cause to grow the FDI in host countries.

Inflows of FDI can be important vehicle for technological change and human capital.

Blomstrom et al (1994, 1996) emphasized FDI that induced human capital

augmentation and economic growth by the help of the technology transfer,

accumulation of human capital and knowledge spill over in the FDI receiving countries.

There are two ways to deliver goods and services to foreign markets: international

production and trade. This means that there should be some interrelationship between

the two. This is confirmed by the positive correlation between world Foreign Direct

Investment (FDI) and world exports. Thus, economic growth and trade and investments

are interconnected.

1.2 Purpose of this study

At a theoretical level, FDI brings both capital and technology which makes the local

firms more competitive and encourages the economic development in the faster way.

The spill over effect of foreign companies will have a long-term effect in the host

countries. In the practical level, this study explores the role of FDI in economic growth

in South Korea. This case study explores, whether FDI played role in economic growth

or not? Another reason for the study is world’s big institutions like IMF, WTO and

UNCTAD promoting international trade and activities of Multinational activities for the

growth of world economies. South Korea is able to attract a significant amount of FDI
among Asian countries. This study explores the FDI policies adopted in South Korea to

attract more FDI over the years. Such policy recommendation would be useful for the

developing countries to attract more FDI. Further more, this study verifies the

theoretical model of endogenous growth theory of economic growth by using the macro

economic figures of South Korea. The present study examines the empirical assessment

of the impact of FDI in economic growth of South Korea over the period of 1980-2005.

1.3 Economic Growth, FDI and Korean Experience

South Korea is one of the highly developed countries in the world with 13th largest

economy and annual GDP of US$ 1.312 trillion (IMF, 2008) in 2007. South Korea

achieved double digit growth in the period of 1980s. South Korea’s overnight

transformation to a wealthy developed country less than half a century is often called

the miracle on the Han River and earned the recognition of “Asian Tiger” in the

international community (Time 2 October 2002 and Chin, 2004). South Korea is the

seventh largest trading partner of US Japan, Saudi Arabia and United Arab Emirates are

the main trading partners. South Korea’s export was US$ 371.8 billion and US $ 356.8

billion import in 2007 (www.state.gov,April, 2009). South Korea is the 4th largest

recipient of FDI in Asia and 25th in the world with US$ 119.63 billion in 2007(Unctad,

world investment report, 2008). This indicates the significant presence of FDI in South

Korean economy.
Before 1970s, South Korea’s domestic saving was encouraged by raising interest rates

and borrowed from abroad to invest in the economy and exports were encouraged by

direct subsidies, all taxes and restriction on import quotas (Savada and Shaw, 1990).

Mainly, South Korea’s economy was based on textile, clothing and electrical

machineries. South Korea started planned economic policy in 1962 through which

Korea achieved substantial economic growth in all sectors. After 1970s, South Korean

Government made huge investment in heavy and chemical industries investing in steel,

machinery, ship building, electronics and nonferrous metals (Lee, 2008).

South Korea adopted export oriented international trade after the industrialization in

1980s. Enormous amount of FDI was started to inflow tin South Korean industries.

Hence, South Korea achieved double digit growth after 1980s (Lee, 2008). Spill over

effect of FDI is considered on of the most important of host countries to make

competitive which increases the productivity of local resources. Indeed, FDI encourages

the capital formation as well human capital formation.

The study examines the role of FDI and economic growth in South Korea. In this

context, Nepal is a small land locked country situated in between the largest economies

of Asia; India and China. Both India and China have attracted significant amount of

‘FDI in the recent times and higher economic growth rate. China was the largest

recipient of FDI with US $ 83.52 billions and economic growth rate of 13.01% where as

India attracted US $ 22.95 billions with economic growth rate of 8.4% in 2007(Unctad,
world investment report, 2008). Foreign direct investment in Nepal was US $ 15 million

in 2007 and economic growth rate was 3.5%. The

1.4 Statement of Problem

Today, South Korea stands as one of the developed OECD member country in the

world. The country has a land of 98,799 Sq Km with 49.232 million populations

(UNESCO, 2008). South Koreans enjoy one of the world’s highest standards of living

today with the per capita income of US $19,738 (World Bank, 2008) which was one of

the poorest countries in the world with US $ 100 in 1960s. This study explores the role

of FDI in this amazing growth of South Korea and the FDI policies adopted by South

Korean policy makers.

FDI has been seen one of the big resources for industrial development in South Korea

over the years. FDI stock increased to US $ 119.billions in 2007 from US $ 1.13

billions in 1980 (WIR, 2008) and South Korea has gained the name of ‘miracle on the

Han river”. It is interesting to explore the impact of FDI on the rapid growth of Korean

economy.

Despite the natural resources availability in the country, economic policies and political

environment also influence the inflow of foreign investments in the countries. The

theoretical concept of impact of FDI is that FDI does not only bring capital but also it

brings technology, knowledge and due to the spill over effect development of process
remains for the long run. FDI works as the catalyst for the economic growth of a

country, especially for the developing countries. FDI is not only a single factor

determining the economic growth, rather foreign trade, domestic investment,

employment level, government consumption are also major factors affecting growth. On

the other hand, stock of human capital is factors determining the level of FDI inflow

besides the resources available in the host countries. How the growth is affected by

these variables? Does high level of FDI increase the higher level of economic growth?

What would be the interaction between FDI and Trade, human capital and domestic

investment? The study examines the effect of this variable in economic growth.

1.5 Research Objectives

The main objective of this study is to explore the impact of FDI on South Korean

economy growth and spill over effect of MNEs to the Korean firms. The study also

reviews the Korea’s foreign direct investment policies and initiatives for attracting FDI

over the years for enhancing economic growth and investment. The study aims to

recommend the trade and investment policies from the Korean experiences to the

developing countries like Nepal.

1.6 Scope of the Study

This research estimates the impact of FDI on economic growth in South Korea over the

period of 1980 – 2005. This dissertation attempts to determine empirical impact of FDI
on South Korea’s economy using macro economic time series data. Domestic

investment, employment, FDI, exports and human capital are considered as the

endogenous variable for economic growth. The study tries to explore the question

where high level of FDI cause higher level of economic growth.

1.7 Organization of the dissertation

This dissertation is divided in to seven chapters. Chapter one explains the background

of the study, purpose of the study, statement of the problem, objectives of the study,

scope of the study and organization of the study. Chapter two reviews the literature the

theoretical and empirical research on theories of FDI and impact of FDI on economic

growth of the previous research works. Chapter three (A) provides a brief history and

current overview of Korean economy which gives the glimpse of Korean economy and

Chapter three (B) provides an overview of Nepalese economy. Chapter four elaborates

the conceptual framework of this study, details of research methodology and models

specification for econometric model of the study. Chapter five presents an overview of

recent FDI inflow to South Korea with review of FDI policies over the study period.

Chapter Six presents the discussion and analysis of empirical study. Chapter seven

presents summary, findings and recommendations of this dissertation.

 CHAPTER -2

REVIEW OF LITERATURE

This chapter describes the theoretical and empirical literature on foreign direct

investment. Mainly, this chapter is divided into tow sections, first section explains

theoretical concepts of FDI and second section provides the research outcomes of

previous empirical studies in the field of FDI and economic growth.

2.1. Theoretical Concept of FDI

2.1.1 Theories of FDI

The early concept of FDI can be regard as the development of classical theories of

international trade. Heckscher-ohlin (1933) theory is one of the pillars for development

of concept of international movements of capital for international trade due to the

diversity of resources endowments between the countries.

Hymer (1960) introduced microeconomic theory on international production. Hymer

noted four discrepancies as noted by Heledd Straker ( Understanding the global firm),

(1) the older theory suggested that flow of capital was one directional, from developed

to underdeveloped countries, whereas in reality, in the post-war years, FDI was two-

way between developed countries; (2) a country was supposed to either engage in

outward FDI or receive inward FDI only. Hymer observed that MNEs, in fact moved in

both directions across national boundaries in industrialized countries, meaning countries

simultaneously received inward and engaged in outward FDI; (3) the level of outward
FDI was found to vary between industries, meaning that if capital availability was the

driver of FDI, then there should be no variation, as all industries would be equally able

and motivated to invest abroad; (4) as foreign subsidiaries were financed locally, it did

not fit that capital moved from one country to another.

Hymer described two reasons of firms being MNEs, (1960) as quoted by Aliber (1969)

(i) There is market imperfections; firms become MNEs due to the possession of a

competitive advantage and their ability to maximize their productivity by using this

competitive advantage in another country. (ii) The competitive structures of some

industries would encourage firms to internationalize more than those in other industries.

These advantages must not be available to host country firms on the same prices and

terms as to the source-country firms.

Caves (1971) classified multi plants in to three groups: (1) Horizontal multi plant

enterprises: multi plants which produces the same types of goods from its plants and

serve across the geographic markets and they can control with lower costs and higher

productivity to exist in the market. (2) Vertically integrated MNEs: Such MNEs

produce goods as the input for other plants to reduce the costs and reduce the

uncertainties of products. (3) Portfolio diversification and the diversified MNE. He also

argues MNEs pursues profits by moving equity from countries its return is to low

Countries where it is high. The firm’s make profit because of the activity.
Buckley and Casson (1976) in their internalization theory suggested that multinationals

came into existence because of market imperfections created the opportunity to

internalize transactions within a firm. Rather than conduct business externally between

two firms- in separate countries, it made sense to instead maximize profits by doing

business internally across national boundaries. Two things are important here (i) firms

would choose the least cost location and (i) firms would internalize until the cost

outweighed the benefits.

In reality, all MNEs do not choose the least cost location to internalize the profit from

abroad. Cultural, regulatory and environmental factors are also considered by the

entrepreneurs to set up MNEs instead of cost factors (Jigme, 2006).

Vernon’s (1966, 1976) Product Life Cycle theory is another development in theory of

Internalization in FDI literature. According to Vernon, the form of entry into foreign

market depends on stages of product life. Products pass through introductory phase,

growth, maturity and decline phase. Many firms launch in new products where the

products are developed and FDI will local market oriented. In later stage, when

products become standardized and mass production prevails. Cost considerations in the

context of increased competition will pressure on MNEs to relocate its production to

less advanced countries with comparative advantage of cheap labour. Hence, FDI in the

later phase of PLC will be export oriented, influenced by cheaper labor force. In the

decline stage of PLC, the product innovating country becomes the net importer of the

products.
PLC theory is applicable for some products but it is not applicable for the vertically

integrated MNEs. Some critics say that sometimes entrepreneurs purchase foreign

assets prior to actually launching the products (Jigme, S. 2006).

Kojima (1978) focused that FDI move abroad due to the location advantage because.

Hence, FDI should move from industries in countries which have less comparative

advantages to the host countries where better comparative advantages are prevailing and

not realized yet.

Prof. J. H. Dunning (1981, 1985, and 1988) synthesized the prior theories FDI and

developed the theory of eclectic paradigm. The operations of MNEs are determined by

three factors: Ownership-specific advantages (O), the firm of one nationality possess

advantages relative to those of another country in host country market. Internalization-

specific advantages (I), the extent to which enterprises find it profitable to use these

advantages themselves rather than externalize them through licensing or similar

contracts with independent firms. Location-specific advantages (L), the extent to which

firms find profitable to combine the use of internalized ownership-specific advantages

with resources in a foreign country rather than in the home country. FDI will take place

when three advantages come together. OLI guides MNEs regarding investment, ‘why’,

‘where’ and ‘how’.

Dunning (1985) “ The balance of the OLI advantages is determined by the geographical

disposition of immobile resources endowments, the extent to which MNEs believe they

can take advantage of the international division of labor by product of process

specialization, the competitive strategy of MNEs and the role played by governments in

influencing trade and/or international production. Non resident firms should be attracted

to sectors in which their (net) proprietary advantages over indigenous firms are most

pronounced and /or where there is X inefficiency among host country firms. Dunning’s

model for key factor determinants internalization process is shown as follows.

Factors Internalization FDI

Why undertake
Ownership Why?
FDI?

Why internalize
Internalizatio through FDI
How?
n instead of other
form?

Where to
Location Where?
undertake FDI?

Lall (1996) describes the advantage of ownership advantages “market failures lead to

the growth of large firms and oligopoly market structure in national economies (so

creating ‘ownership advantages). Those firm may choose to exploit these advantages by

direct investment rather than licensing to them to unrelated firms (because of the

transnational advantages of internalizing the relevant markets), and the process of

internalization may itself generate fresh ownership advantages”.

2.1.2 FDI and Motives

In general, the motives of MNEs are to maximize the profit by exploiting the resources

in abroad by utilizing the ownership-specific advantages through internalization.

However, the nature of MNEs may determine the types of opportunities they are

seeking abroad. Dunning (1996) Mainly MNEs are resource seeking, market seeking,

and efficiency seeking and strategic assets seeking MNEs. Horizontal integrated MNEs

are market seeking MNEs where as vertical integrated MNEs are product cost

minimizing MNEs.

The eclectic paradigm theory explained by Dunning (1981, 1985, and 1988) the reason

why MNEs go abroad for operations. Three main comparative advantages; Ownership-

specific, Internalization-specific and Location-specific advantages are motives for going

abroad MNEs. The ownership advantages urges that greater the competitive ownership

advantages of the investing firm compared to the firms where it intends to invest, they

are likely to increase the foreign production. Another competitive advantage is location

attraction to carry out the value added activities because of the availability of natural

resources and immobile factors of production and larger market size also in the foreign

country. The third is internalization specific advantages which provide the ways for

firms to utilize its ownership advantages in foreign country such as open market

competition, inter-firm non-equity agreements, integration of immediate product

markets and an outright purchase of foreign corporation.

2.1.3 FDI and Entry Model

Dunning (1996) firms initially engage in across national boundaries for one or two

reasons. One to acquire inputs at lower cost than from domestic sources and second to

protect existing market or to new seek markets for domestically produced goods. The

mode of entry in to foreign production will differ according to the reason for that entry.

Some MNEs go across the national boundaries seeking raw materials, some market

seekers and some low cost seeking countries. Green field investment, Merger and

Acquisition, and Joint venture mode of entry involves equity investments. In Greenfield

investment, foreign firms invest infrastructure development for the resource utilization

and production. The investment in Greenfield sectors develops infrastructure in addition

to create job opportunities.

In Merger and Acquisition, foreign firms enter the host countries by acquiring the

equities or buying the assets, investing technology, brands and information etc. Merger

and acquisition enhances the efficiency of the local firms from the foreign management

skills, technology and marketing strategies. Basically, merger and acquisition doesn’t

create new industry. Both Greenfield investment and merger and acquisition create a

single firm ownership of business. But joint venture business establishes the ownership

among two or more firms.

According to World Investment Report (UNCTAD, 2008) growth in FDI flows in 2007

was driven by cross-boarder M & A activity; a number of mega deals including over US
$ 1 billion pushed the total value of cross-boarder M&A to record of US $ 1,637 billion

in 2007.

2.1.4 Factors influencing Location Choice of FDI

A number of factors are affecting the choice of location for FDI. Natural resources,

market size, availability of suitable work forces and infrastructure are some of the

common factors for attracting FDI in the countries. Despite that economic and political

stabilities are also important for attracting FDI. Factor endowments are largely

immobile, Dunning (1981) they are to be used where they are located; inputs were

converted into outputs by the most efficient (and internationally identical) production

functions.

Bertrand et al (2004) studied the determinants of cross-boarder M&A location choice

between OECD countries during 1990-1999. They found geographic distribution of

M&A. They found that found that geographic distribution of M&A is not determined

only by the availability of domestic assets. The market size, the labor cost, the market

access and financial openness matters as well (positive and significant effect of the M

&A location. On the other hand corporate tax and productivity decreases the probability

decrease to attract M&A.

Nonnenberg and Mendonca (2004) studied the determinants of direct foreign

investment in developing countries used a sample of 38 developing countries(including

transition economies) was analyzed with period data for 1975-2000 in order to estimate

the determinants of FDI. They found that FDI are related to the firms are to source

country factors – push factors or location pull factors. The studied showed that level of

schooling, degree of economic openness, country risk were very significant. However,

inflation was not.

Asiedu, E. (2001) on his research on determinants of foreign direct investment to

developing countries finds that good infrastructure is important for non natural

resources based investments and liberalize trade policies to attract more FDI in their

countries.

2.2 Impact of FDI on economic growth: Some Empirical Evidences

The massive literature on role of FDI on economic growth has shown various types of

affects (positive, negative or insignificant) of FDI in various countries. This study aims

to explore the impact of FDI in Korean economy.

Berry and Kearney(2006) the most common character through which spillover are

understood to operate include technology transfer, demonstration effects (through

management skills and training to export) and greater competition(leading to productive

efficiency). A significant presence of MNEs can bring about fundamental changes in

industrial structure, particularly for smaller and medium sized countries. If foreign
MNEs operate in sectors that are imperfectly correlated with those dominated by

indigenous firms, FDI can help create a better diversified economy.

Chung et al (2003) Technology transfer occurs when there is contact between foreign

and local firms. Japanese auto transplants increased production process in North

American significantly influenced the industry’s productivity growth during this period

(1982-1991).

Caves (1974) argued that FDI also improves the allocative and technical efficiency

through competitive pressure. Foreign entrants break down entry barriers, compete for

factor inputs and customers and reduce the market power of entrenched firms.

Zhang et al (2004) studied on impact of MNEs behavior through FDI on international

trade and vice versa. They used Granger causality co integration approach to observe

the direction of FDI and trade linkage of Chinese economy in 1980- 2003 period. They

found that more imports lead higher level of FDI, more FDI leads to more exports and

more exports FDI. This virtuous process reflects China’s open door policy.

Chakraborty and Basu (2002) study showed two-way link between foreign direct

investment and growth for India using structural co integration model with victor error

correction mechanism. They found strong evidence of GDP Granger causing FDI flows

for India, there was not significant role in the short run adjustment process of GDP.

Short-run increase in FDI flows for India is labor displacing in nature. The technology
transfer brought in by FDI causes an excess supply of labour creating downward

pressure on unit labor cost.

Borenzstein et al (1995) introduced a new model showing the impact of FDI in

economic growth using an endogenous model growth model. They analyzed FDI flows

from industrialized countries to 69 developing countries during 1970-1989. They

argued that due to the direct FDI there is increase in capital accumulation and in host

countries and transfer of technology lead increases productivity which causes the

economic growth of the host countries. Their result showed that FDI is an important

vehicle of technology transfer, contributing more economic growth than domestic

investment where they make a case of minimum threshold stock of human capital

necessary to absorb foreign technologies and linkage between FDI and human capital

and domestic investment are crucial to achieve the economic growth. Other subsequent

studies by Subramanyam et al., (1996) within the growth theory frame work analyzed

the role of FDI in growth process in the context of 46 developing countries with

different trade policy regimes. From their cross-sectional panel data analysis, they

found that countries that pursue all outwardly oriented trade policies are strongly

benefited from FDI than those countries adopting an inward oriented policy.

De Mello (1996) based on neoclassical approach argue that FDI affects only level of

income and leaves long run growth unchanged. They argue that technological

progression and other external factors main source of economic growth. Their argument

is that long-run growth arises because of technological progress and population growths
both were exogenous. Hence, according to neoclassical models of economic growth,

FDI will only be growth advancing if it affects technology positively and permanently.

Endogenous growth theorists believe that economic growth is generated from within a

system as a direct result of internal process. Aghoin and Howitt(1998) the enhancement

of nation’s human capital by investing more on human capital formation would lead to

faster economic growth. The recent endogenous models show that FDI can affect

growth endogenously growth models if it generates increasing returns in production via

externalities and spillover effects Deme and Graddy (2006). In these models, FDI is

considered to be an important source of human capital and technological diffusion.

According to Romer’s (1990) endogenous growth model; growth is driven by

technological change from intentional investment made by profit maximizing firms. He

argues that stock of human capital determines the rate of growth. In his view, there is

increasing returns scale (IRS) in aggregate level where as constant returns to scale

(CRS) in the firm level and firms don’t take account of spillover effect of externalities

but economy as a whole experiences the increasing returns to scale which causes the

endogenous growth. Endogenous growth theoreticians FDI and trade stimulate the

technological diffusion and contribute economic growth.

Barell and Pain (1996) studied the econometric model of foreign direct investment and

examined the extent to which the model explain the level of outward direct investment

by U.S companies over last two decades. Their analysis show that market size and
factor cost, both labor and capital are important factors in the investment decision

because MNEs are trying to maximize the value of the firm by allocating the resources

in right place. Feder et al. (1983) analyzed export-led economic growth hypothesis.

They argued that exports increase factor productivity because of the better utilization of

resources and economies of scale. Some economists argue that open trade policies

foster FDI because of the conducive economic climate for the MNEs. In this regard,

Rodrizguez and Rodrik (1999) presented a skeptical view by linking between open-

trade policies and economic growth. They argue that previous studies didn’t consider

the institutional differences among countries in an upwardly biased estimate of trade

and other policy restrictions. Their analysis showed that the relationship between

average tariff rates and economic growth is only slightly negative and nowhere near

statistical significance.

The issue whether FDI and trade trigger economic growth or economic development

attracts FDI and trade is unsolved (Makki and Samwaru, 2004) since past studies were

one sided i.e. analyzed the impact of FDI and trade on economic growth (Borensztein et

al, 1995 and Balasubramanyam et al, 1996) or analyzed the effect of economic growth

on FDI (Barrel et al, 1996).

The recent study on role of FDI in economic by Kim and Hwang (2000) focused on

spillover effects in different six sub sectors. They examine the effects by using random

effects model employing the annual data for the period of 1970. They find that FDI

played a negligible role through out Korea’s economic development. Despite the
quantitative insignificance of FDI, they accepted the qualitative role of FDI on Korean

economy by knowledge spillover from foreign firms. Dhakal et al. (2007) conducted a

research on relationship between FDI and economic growth using granger causality test

for 9 Asian countries where they find there is no direct causal relationship in two

countries, causality ran from growth to FDI in 5 countries including South Korea and

causality ran from both sides in two countries.

Kim and Seo (2003) analysed the dynamic relationship between FDI and economic

growth and domestic investment in Korea for the period of 195-1999 using vector auto

regression model. They found that there some positive effects of FDI on economic

growth but insignificant. However, their findings show that domestic investment s

negatively affected by FDI shock, and FDI does not crowd out domestic investment in

Korea.

Lall, 1990 as quoted by Dunning (1996) the experiences of four newly industrializing

countries shows that economic success can be highly relied on TNCs (as in Singapore)

or less reliance( as in South Korea). South Korea entered into complex areas of industry

with the huge promotion of very large domestic firms, research and development and

significant protection of local firms. This indicates that South Korea’s industrialization

in 1970s was mostly pushed by government’s huge investment.

 CHAPTER -3 (A)

AN OVERVIEW OF SOUTH KOREAN ECONOMY

3.1.1 A brief Korean economic overview after 1950s

South Korea got independence after over three decades Japanese colonial rule in 1945.

The strategic economic development of South Korea started from 1960s onwards with

the establishment of Economic planning Board in 1961 and commencement of 5-year

state economic planning in 1962 (Bishop, 1997).

The Korean War is an important incident in political and economic history of South

Korea. The war between North Korea and South Korea (1950-1953) was a massive

destructive in the Korean peninsula. The Korean War occurred due to the political

interest of United States and USSR, leading capitalist way of American life and

expansionary ambition of communist system of USSR. USSR supported North Korea

where as United States supported South Korea. United States went into war because of

the fear of increasing communism including in China and USSR and thought that if

Korean peninsula becomes communist, Japan would be next. Savada and Shaw (1990)

explain United States fought against communism without directly attacking to Russia.

Chung (2007) South Korea’s government budget was dependent on foreign aid and US

was the main provider of financial assistance. Government made efforts to establish

industrial base for textile production and power generation after the end of war and

started to produce fertilizers and steel domestically for import substitutions (bishop,
1997. Korea’s rapid economic growth was highly supported by stable political

environment. CBO (1997) South Korea’s government from 1953-198 was mostly stable

but largely authoritarian. Savada and Shaw (1997) Syangman Rhee ruled South Korea

in 1950s until 1960 with iron fist. United Nations and member of the UN, mainly

United States provided financial assistances. According to Savada and Shaw (1997)

foreign aid constituted a third of total budget in 1954, rose to 58.4 percent in 1956, and

was approximately 38 percent in 1960.

General Park Chung Hee took power by military coup in 1961 and ruled on until 1979

in Korea. The Park government removed the corrupt and unqualified government and

army positions and initiated strategic economic plans. A program of rapid

industrialisation based on exports was launched and first five year economic

development plan was started (Bishop, 1997).

According to Savada and Shaw (1990), South Korea, as a colony of Japan (1910-1945),

Japan played an important role in Korea’s economic development. By the end of its

colonial period, Japan had built extensive infrastructure in roads, rail roads, electrical

power, government buildings and ports that facilitated the modernization of South

Korean economy. However, most the infrastructures were destroyed during Korean

War.

Korean Chaebols (business conglomerate) emerged in 1960s, they played important role

in the industrial productions of goods in South Korea. They were in the form of family
own business enterprises before 1960s.These groups hold a major industrial production

in South Korea today also. Top 10 Korean Chaebols in South Korea over the years.

Table 3.1

Major top ten Korean Chaebols

Rank Late 1950s Mid 1960s 1983 1990 2000

1 Samsung Samsung Hyundai Hyundai Hyundai
2 Samho Samho Samsung Daewoo Samsung
3 Gaepung LG Daewoo Samsung LG
4 Daehan Daehan LG LG SK
5 LG Gaepung Ssangyong Ssangyong Hanjin
6 Tongyang Samyang SK Hanjin Lotte
7 Keukdong Ssangyong Hanhwa SK Daewoo
8 Hankook Glass Hwashin Hanjin Hanhwa Kumho
9 Donglip Panbon Kukje Daelim Hanhwa
10 Teachang Tangyan Daelim Lotte Ssanyong
Source: Stephen Huggard et al. (eds) Economic crisis and corporate restructuring in Korea, reforming

chaebols p 41.

Daewoo was initially started from textile industry which exported major textiles to US

(Huggard et al, 2003). Gradually it entered in to other industry i.e. Motors vehicle,

Telecom, Financial Services, Consumer electronics, ship building and computer chips.

Samsung is another largest chaebols in South Korea which basically concentrated on

production of consumer electronics products. LG is one of the major chaebols in Korea

which was founded in 1947 which concentrates its production in consumer electronics.

The economic policies are the major determinants of economic growth of the countries.

South Korean policy makers adopted the interventionist approaches during 1960s and

1970s regarding the foreign direct investment mainly because of the infant stage of the

domestic firms and foreign investment were channelled in the certain areas of economy
which are seen as priorities of development. Foreign direct investments were directed

towards the export oriented manufacturing industries and import substitution products.

Bishop (1997) foreign investment played important role to the Korean industries as

learning agents for international marketing skills and technology transfer where

technology could not be acquired cost effectively. The government’s use of foreign

investment as a source of technology for apprentice industries is best seen in the

petroleum refining and petrochemicals and associated industries. Gulf Oil (first foreign

company) was invited to establish Korean petroleum refining industry in collaboration

with Korea oil (Bishop, 1997). Korean government permitted a number of large

chemical companies to establish in Korea in joint venture which played a major role in

the acquisition of technology by Korean firms, (Westphal, Kim and Dahlman,1985)

quoted by Bishop, 1997. However, steel and ship building industries were developed

without foreign join venture in Korea.

One paramount reason for inviting foreign direct investment in the developing countries

is to transfer the technology which could be very expensive if not through FDI. Initially,

foreign firms bring technology from which local firms learn method of productions and

improve efficiency thereby increase the competitive advantage. Korean firms obtained

technological know how from the Japanese firms because Japanese firms were the

dominant firms operating in South Korea during 1970s.

1980s is the period of liberalisation and globalisation across the world. South Korean

policy makers shifted FDI policy from interventionist to market oriented economy in
1980s. Market oriented economists believed that foreign direct investment could play

role in the restructuring of industrial sector through competition (Lee K.U., 1986), Park

and Kim 1992 as quoted by Bishop (1997).South Korea opened many other sectors up

to 100 percent for foreign investors since 1984 where as earlier policies restricted to the

priority sectors for the foreign investors. In 1987 further 26 more manufacturing sectors

were opened for foreign investment while service sector remained restricted where

foreign investors were interested to invest. Bishop (1997) South Korea’s international

competitiveness was decreased in 1987-1989 due to the rises in labour cost which

reduced the foreign direct investment in South Korea.

Japanese investment surged in South Korea in 1986-88 due to the wave of relocating

Japanese companies in South Korea because of the low cost of production and avoid the

effect of appreciating yen Bishop(1997). The FDI inflow in South Korea during the

period of 1980-1990 is reported in table 3.1.

Table 3.2

FDI inflow in South Korea (1980-1990)

Year Total FDI inflow US in Year Total FDI inflow US in

million million
1980 17 1986 436
1981 135 1987 602
1982 89 1988 848
1983 90 1989 737
1984 133 1990 759
1985 215
Source: UNCTAD, world investment report, 2008)
Samsung and Toshiba and Goldstar and Hitachi entered into joint venture to

manufacture VCRs for export market. Majority of the investing companies were

electronics which significantly increased the export value of electronics items.

There was internal pressure from the business community (Chaebols) and external

pressure (US) to adopt the market oriented approach. However, interventionist approach

was in mindset in the bureaucratic circle until 1993. The international economic

environment after 1993 made South Korea to be more market oriented because of the

new GATT agreement required member countries give greater access to their markets.

Like wise as the member of OECD, Korea had to give similar market access for the

member countries as other market oriented courtiers provided. In 1993, June, Korean

government announced time table for phase wise opening many industries which were

restricted earlier.

3.1.2 Korean economy after Asian Financial Crisis

The Asian financial crisis in 1997 badly affected the Asian countries including South

Korea which led to fell down South Korea’s economic growth (Chung, 2007). Heavy

borrowing by public and privates sectors from the foreign banks, created the financial

crisis and many of the borrowers were unable to repay the loans. South Korean

government had to accept financial rescue package and the conditions by IMF to

liberalise the closed and protective sectors to stop the wave of bankruptcies of

enterprises in South Korea. This required the government to privatise many state owned
enterprises. The government ratified the Foreign Investment Promotion act 1998 to

encourage and ensure the safety of foreign investments. With recovery of financial

crisis and better investment environment during 1998, FDI was surged to high level and

growth rate increase to 10.40% in 1999 ( IMF, 2008).

South Korea has developed six modern economic free zones equipped with modern

infrastructure and communication systems to attract and facilitate the foreign investors

with the objective of creating Korea as the of Asia trading hub (KOTRA).

North Korea is only the land connected neighboring country in the northern part of the

country. In the eastern coastal region Japan and Northern and western part China are the

neighboring country of South Korea which covers an area of 98,480 Sq/Km and

population of 48 millions. A glimpse of South Korea’s present economic performance is

presented in the following table.

Korean Economic Indicators in the recent years

Table-3.3

Year GDP in Annul Growth Export in Imports in FDI Stock in

Billion US $ rate (%) Billions US $ Billions US$ Billion US $
2001 481.77 3.837 150.44 141.10 53.21
2002 547.86 6.097 162.47 152.13 60.66
2003 608.33 3.097 193.82 178.83 66.07
2004 681.22 4.73 253.85 224.47 87.77
2005 791.57 4.198 284.41 261.24 104.88
2006 888.44 5.134 325.47 309.38 119.14
2007 969.87 4.973 371.55 356.65 119.63
Source: www.imf.org and www.unctad.org(hand book of statistics 2008)
The wave of liberalization in 1980s was adopted by Korean policy makers which

achieved double digit economic growth until 1990s. The Asian financial crisis in 1997

badly affected the South Korean economy which enabled the growth to the -6.85% in

1998 and again grew at 9.45% and 8.47% in 1999 and 2000. After this period, GDP

growth rate is around 4%. The volume of South Korea stood up as the 15th largest in

2008(IMF, 2008) with the amount of US $953.49 billions and 25th largest FDI stock

recipient country in the world with the value of US $ 119.63 in 2007. The import and

export value was US $ 371.55 and US $ 356.65 in 2007.

 CHAPTER -3(B)

AN OVERVIW OF NEPALESE ECONOMY

This section introduces the current economic performances and trade and investment

policies of Nepal. This chapter also reviews Nepal’s current trade and investment

policies for policy recommendation regarding attraction of FDI in Nepal as the source

of alternative source of financing of economic growth.

Nepal is a small land locked country situated between India and China, in the South

Asia with an area of 181,147 Sq/Km and 26.42 million populations (CBS Nepal, 2007).

Nepal is one of the poorest countries in the world with US $ 377.26 per capita income

(IMF, 2007). Nepal started its first five year economic plan in 1956 with main

objectives of infrastructure development in the country. National Planning Commission

scrutinizes the sectors for development. Various factors contributed poor economic

performances of the country including topography, lack of resource endowment,

landlocked position, lack of institutions for modernization, weak infrastructure and lack

of conducive economic and political environment for development (www.nssd.net,

2004).

The economic performance of Nepal in terms of GDP in 1980 was US $ 1.98 billion

which reached to 10.328 billion in 2007 (IMF, 2008). This figure is quite under
performance in compare to the neighboring countries in South Asia. Table 3.3 presents

the GDP and FDI status in 2007 with compare to Nepal.

Table 3.4

GDP, FDI and economic growth in South Asian countries in 2007

Bhuta Sri
Year 2007 Bangladesh n India Maldives Nepal Pakistan Lanka China
GDP Billions 1,102.3
US 73.689 1.197 5 1.054 11.28 144.032 32.349 3,382.45
FDI in million 83,52
US 666.4 78 22,950 15 15 5333 529 1
GDP growth
rate 6.6 15.2 8.4 4 3.5 6.5 7.5 13.01

Source: Unctad, world investment report, 2008 and IMF, World economic outlook database, 2008.

3.2.1 Foreign Trade Pattern of Nepal

Nepal’s foreign trade is heavily dependent on India. According to Nepal Rastra Bank

(Central Bank of Nepal) statistics (2008) 67.6% of all goods are exported to India and

remaining to rest of the worlds. Over 96% of goods are imported from India. Nepal

exports mainly the primary products which have less valued added and imports

secondary products with high value added costs. Being a land locked country; Nepal has

to trade via India which increases export costs and import costs of goods. Trade and

transit rights affected the movement of goods and increased transportation costs.

Saveda, A.M. and Shaw(1991) real economic growth averaged 4 percent annually in the

1980s, but the 1989 trade and transit dispute with India adversely affected economic

progress, and economic growth declined to only 1.5 percent that year as the availability

of imported raw materials for export industries was disrupted.

 Figure 3.1

Productwise Nepal's export in million Nepalese Rs.

(2006/07)

Tooth Peste,
663.40 , 3%
Soap, 502.70 , 2%
Woolen products,
Polister yarn,
5,600.20 , 25%
2,241.10 , 10%

Vegetable Ghee,
4,136.50 , 19%

Handicrafts, 270.20
, 1%

Raw Jute and Jute Ready Made

goods, 275.84 , 1% Garments, 5,977.90
, 28%
Pulse, 1,795.40 , 8%

Hides and Skins,

642.20 , 3%

Source: Nepal Rastra Bank, Macro Economic Indicators, 2008

Table 3.5

Productwise Export from Nepa (2006/07)

Items Amount in Millions NRs Percentage

5,600.2
Woolen products 0 25.33
5,977.9
Ready Made Garments 0 27.04
642.2
Hides and Skins 0 2.91
1,795.4
Pulse 0 8.12
275.8
Raw Jute and Jute goods 4 1.25
270.2
Handicrafts 0 1.22
4,136.5
Vegetable Ghee 0 18.71
2,241.1
Polister yarn 0 10.14
502.7
Soap 0 2.27
663.4
Tooth Peste 0 3.00
22,105.4
4 100.00
Source: Nepal Rastra Bank, Macro Economic Indicators, 2008

Figure 3.2 depicts that ready made garment was the main (28%) exportable item from

Nepal and next product is woolen products (25%). Vegetable ghee (19%) is another

exportable product from Nepal. Polyester yarn covered 10% of total export. Handicrafts

Pulses, leather and skins, Soap and Tooth paste are other major exports.

India is Nepal’s major trading partner. According to Indo-Nepal trade treaty 2002, India

has fixed quota for duty free accession to India. The limitation of quota system on major

exports reduces the competitive strength of Nepalese exports.

Table 3.6

Nepalese manufactured articles allowed entry into India

Free of customs duties on a fixed quota basis.

S.no. Nepalese Article Quantity in MT per year

1 Vegetable fats (Vanaspati) 100, 000 (One hundred thousand)

2 Acrylic Yarn 10, 000 (Ten thousand)

3 Copper products under Chapters 74 & 10,000 (Ten thousand)

Heading 85.44 of the H.S. Code

4 Zinc Oxide 2,500 (two thousand five hundred)

Source: Indo-Nepal trade treaty, 2002, March 22.

Vegetable ghee is one of the key export items from Nepal, primarily exported to India.

The quota system on major items, distorts the exports value of Nepalese goods. Nepal

has to bargain simplified trade arrangement with its trading partners to encourage

exports.
 Figure 3.2

Productwise import to Nepal 2006/07 ( in million Nepalese Rs.)

Other mechinery and

parts, 5,563.70 , 7%

Cement, 5,563.70 ,
7%

Electrical goods,
5,331.00 , 7%
Petrolium products,
34,090.60 , 42%
Medicines, 5,979.40 ,
7%

Textile, 4,209.50 ,
5%

Thread, 4,415.60 ,
5% Transport equipments
and parts, 12,503.70 ,
Raw wool, 1,630.80 ,
16%
2%

Chemical fertilizer,
1,241.30 , 2%

Source: Nepal Rastra Bank, Macro Economic Indicators, 2008

Figure 3.2 shows that 42% of total imports is of petroleum products. Transport

equipments are next major imported products which accounted for 16% of total import

in 2006/07. Medicines, Electrical goods, Cements, Textile, Thread, raw wool and

chemical fertilizers are other major imports. The export and imports pattern shows that

there is lack of industrial production in Nepal. Because of the import of high value

added products and export of low value products, trade deficit is increasing over the

years. Nepal’s trade deficit with India only is NRs. 105.89 billions (NRB, 2008).

Agriculture is the main contributor in GDP in Nepalese economy based on the tradition

subsistence level farming. Due to the lack of modern means of agricultural tools and

irrigation facilities, farming is based on seasonal rainfall and favorability of the weather.
3.2.3 FDI Policies of Nepal

Government’s foreign investment policies and its implications highly determine the

level of FDI inflow in the host countries. However, the political and economic factors

are also heavily influencing. China made many economic policy changes and policy

reforms in trade and investment during 1978-1990 which surged FDI in China and rapid

economic growth (Nicholas, 1991).

Foreign Direct Investment and One Window Policy of 1992, Foreign Investment and

Technology Transfer Acts of 1992, Electricity Act 1992, Privatization Act of 1994 and

Industrial enterprises Act of 1992 are the major trade and FDI related acts in Nepal. The

Foreign Investment and one window policy of 1992, foreign investments are allowed up

to 100 percent in the list of acceptable forms; establishes the currency repatriation

guidelines. Nepal became the member of WTO in 2004. So, Nepal has to comply with

international trade rules by opening its markets to the world and reducing the custom

duty rates. Nepal has launched the policies to encourage FDI, however, due to various

problems like bureaucratic delays, political instability, and lack of access to sea ports,

difficult land transport, scarce raw materials, inadequate power supply, non-transparent

tax administration and unclear labor relations (Pokhrel, K., 2008).

Before liberalization in 1980s, investment regime in Nepal was more restrictive.

Foreign investors had to obtain license before starting any business activities in Nepal
which was very lengthy process. FDI before 1980 was almost nil in Nepal. In the recent

years, FDI inflow has been increasing. Table 3.4 reports the sectorwise FDI inflow in

Nepal.

Table 3.7

Sector wise FDI inflow in Nepal up to 2006/07 ( NRs. Million)

Category No of industries Foreign Employment
investment
Agriculture 24 175.11 1,344
Construction 35 2,355.62 2,647
Energy Based 26 5,935.62 5,477
Manufacturing 572 15,517.24 69,426
Mineral 5 1,634.70 1,461
Service 393 9,691.66 22,170
Tourism 368 5,490.30 18,959
Total 1,423 40,799.68 121,484
Source: Industrial statistics, 2006/07, Department of Industry, Nepal.

Table 3.7 reports that total firms with FDI is 1,423 up to 2006/07 with the NRs.121,484

billions. These firms employ 121,484 people which are significant number of people

where unemployment is a big problem. Manufacturing sector dominates the FDI inflow

in Nepal. Tourism and service industries are next largest FDI involved industry. Energy

and mineral sectors have least numbers of FDI. On the basis of scale of firms majority

of the FDI are small and medium scale firms. India has the highest number of FDI in

Nepal, US investment is second largest amount of FDI, China third, South Korea fourth,

Norway fifth, Japan sixth and British Virgin Islands, seventh in Nepal (US department

of state, as of October, 2007). Nepal attracts small amount of FDI and therefore its

impact on the economy negligible (UNCTAD, 2003).However, foreign direct

investment in readymade garment heavily contributed foreign exchange earning from

export. Second tourism sectors another sector of attracting FDI which enabled the

standard of Hotels in Nepal. Tourism industry contributes one of major source of

foreign exchange earning. Nepal benefited from the activities of TNCs (UNCTAD,

2008). Developing countries are in need of heavy capital investment on infrastructure

but governments can’t finance that much. Therefore, foreign direct investment is the

alternative source of financing for faster economic growth.

 CHAPTER -4

RESEARCH METHODOLOGY

This chapter describes the research methodology of the study which explains the

conceptual framework, research design, data collection method and data analysis

methods of the study.

The main objective of the study is to assess the impact of FDI in South Korean

economy over the period of 1980 to 2005. South Korea received a huge amount of FDI

and achieved high economic growth rate with gradual liberal trade policy regimes. This

study analyzes the linkage between FDI and economic growth in South Korea.

4.1 Conceptual Frame work

Basically, the conceptual frame work of the study is derived from the Borensztein, Jose

de Gragorio and John-Wha Lee, 1995. They have shown the impact of FDI on

economic growth in the following linkage.

Capital accumulation

Direct → FDI
Indirect →crowding in lower cost of innovation
Productivity growth
Major source of innovation
Technology transfer
FDI Contagion effect Economic
Impact on human capital formation Growth
Linkages
Pecuniary (crowding in)
Technological (contagion, transfers)
According to their argument, Foreign Direct Investment accelerates capital

accumulation in host country by increasing total investment and lowering the cost of

innovation and indirectly by crowding in domestic investment and scarce resources of

the economy and productivity is enhanced by technology transfer but it is constrained

by human capital in the host economy. They argue that FDI develops stock of human

capital. There should be a linkage between domestic investment and human capital to

achieve the higher productivity.

4.2 Research Methodology and Model

The present study is focused on the evaluating the impact of FDI in economic growth in

South Korea’s economy during the period of 1980-2005. Only secondary data are used

for the analysis of the research objectives. The massive inflow of foreign capital and

double digit growth in the economy in South Korea has attracted the research interest on

it.

This study employs the endogenous growth theory as developed by Balasubramanyam,

Salisu and Sapsford, 1996 and Borensztein, Gragorio and Lee 1998. This model

assumes that FDI contributes to economic growth directly through new technologies

and other inputs as well as indirectly through improving human capital, infrastructure

and institutions and country’s level of productivity depends on FDI, trade, domestic

investment. The impact of FDI on economic growth is analysed by using the following

econometric equation.
G = α +β1K + β2FDI + β3Emp + β4HC + β5Exp + C1FDI*K +C2FDI*HC+C3

FDI *Exp + e

Where,

G = Per capita GDP growth rate

K = Domestic Capital Investment

FDI = Foreign Direct Investment

HC = Human Capital

Exp = Exports

Emp = Employment

The variables K, FDI, and Exports are measured as percentage of GDP. The model is

extended to the work Borensztein, Gragorio and Lee and included other variables to

observe the interaction between FDI and Trade, Domestic Investment and Human

Capital. Past studies had shown a positive impact of FDI, Export, human capital and

domestic investment on economic growth.

The stock of efficient human capital is required to absorb the technologies brought by

FDI and it determines whether the potential spillover effect is realized. The host country

requires sufficient number of human capital to utilize the technologies brought by FDI,

meaning that higher the level of human capital in the host country, higher the effect of

FDI in economic growth of the host country. The study assumes a positive relationship
between FDI and GDP growth rate as well as a positive interaction between FDI and

human capital in accelerating the economic growth. The issue relating to the interaction

between FDI and domestic investment; it is assumed that there is positive interaction

between FDI and domestic investment because FDI has is considered as an important

medium for transferring capital, technologies and host countries that encourages the

domestic investment level. The interaction term estimates the combined effect of FDI

and domestic investment in economic growth and a positive coefficient for the

interaction term would indicate that FDI and domestic investment reinforce

(complementary) to each other.

This study uses the time series data for the period of 1980-2005 for the analysis of the

objectives and uses the multivariate regression analysis (OLS) for the analysis of data.

The data is processed by using OxMetrics software (PcGive. All values of GDP, FDI,

and export are converted in to millions. Time series data may produce spurious

regression due to the existence of stationary of data. Hence, Dickey Fuller and

augmented Dickey Fuller tests are performed to check to unit root of the data. All the

variables are transformed in to logarithms before generating the statistical results.

4.3 Data Collection Method and Sources

Different sources are used to gather the data required for analysis. The aggregate inflow

of FDI is obtained from World Investment Report 2008 from UNCTAD. The detailed

information on FDI inflow by sector and imports exports data are obtained from

OECD’s International Direct Investment Statistics vol. 2008 via ESDS international
database and GDP figures, population statistics and employment are obtained from

World Economic Outlook Database, October 2008 from International Monetary Fund.

The data for domestic investment is obtained from www.nationmaster.com. There are

various indicators of human capital stocks in the country. Secondary level of education

is one of the indicators of human capital in the country. The statistics of secondary level

of education of South Korea is obtained from UNESCO Institute for Statistics

(www.uis.unesco.org).
 CHAPTER -5

AN OVERVIEW OF RECENT FDI INFLOWS TO SOUTH KOREA

This chapter presents the recent trends of FDI in South Korea including selected Asian

countries, sector wise inflow, domestic investment and export and FDI policies. The

trend comprises from 1980-2008.

According to UNCTAD’s World Investment Report 2008, the global FDI inflows was $

1,833 billions in 2007 rose by 30% over previous year. Among the total amount, 68 %

of FDI inflows were among the developed economies. US was the largest recipient

($232 billions), followed by United Kingdom ($ 223 billions), France ($157 billions),

Canada ($108 billions) and Netherlands ($99 billions).

UNCTAD statistics shows that FDI in developing economies were US $500 billion in

2007 increased by 21% in compare to previous year. Least Developed Countries

(LDCs) received $ 13 billions in 2007. Cross Boarder Merger and Acquisition was one

of reason of increment in global FDI in 2007. According to UNCTAD’s estimate

79,000 TNCs and their foreign affiliates produces $31 trillion sales, an increase of 21%

over 2006 and employ 82 million people.

5.1 FDI inflows trend in Korea

According to Unctad’s World Investment Report 2008, South, East and South East Asia

region received $ 247 billion in 2007, 13 % of world FDI inflows. South Korea is one
the developed economies in the South East Asia. South Korean policy makers were

extremely interventionist towards FDI before 1980s. They allowed FDI only to those

sectors where Korean firms had lack of technologies. Basically, Korean policy makers

wanted to transfer the technologies along with the capital. However, they were very

skeptical about the benefit of FDI to the host country. The open and liberal economic

policies adopted in 1980s which surged the exports of Korean trade. With the

membership of WTO in 1995, South Korea adopted more liberal economic policies,

such as one stop service systems in 1995 and friendly merger and acquisition of Korean

firms by foreign investors. South Korea offers an excellent business location with

sophisticated infrastructure and information communications systems for foreign

companies to do the business (www.kotra.or.kr). South Korea has developed six multi

mullions free economic zones (Busan/Jinhae FEZ, Daegu/Gyeongbuk FEZ, Gwangyang

Bay Area FEZ, Incheon FEZ, Saemangeum/Gunsen FEZ and Yellow Sea FEZ) to

attract foreign direct investment and facilitate establishment of companies. Korean

government also provides tax incentives and cash grant for building manufacturing

establishments to those foreign companies which fulfill the requirements. The FDI

inflow trend of some selected Asian countries is presented in table 5.1.

Table 5.1

FDI inflows in selected Asian countries (US $ million)

Year China HK Indonesia Korea Malaysia Philippines Singapore Taiwan India

1980 57 710 180 17 934 114 1,236 166 79

1981 265 2,063 133 135 1,265 243 1,660 151 92
1982 430 1,237 225 89 1,397 193 1,602 104 72
1983 916 1,144 292 90 1,261 247 1,134 149 6
1984 1,419 1,288 222 133 797 137 1,302 199 19
1985 1,956 -267 308 218 695 105 1,047 342 106
1986 2,244 1,888 258 436 489 157 1,710 326 118
1987 2,314 6,250 385 602 423 415 2,836 715 212
1988 3,194 4,979 576 848 719 999 3,655 916 91
1989 3,393 2,041 682 737 1,668 568 2,887 1,604 252
1990 3,487 3,275 1,092 759 2,611 550 5,575 1,330 237
1991 4,366 1,021 1,482 1,133 4,023 556 4,887 1,271 75
1992 1,1008 3,887 1,799 567 5,138 776 2,204 879 252
1993 2,7525 6,930 2,003 546 5,741 1,238 4,686 917 532
1994 3,3521 7,828 2,191 795 4,581 1,591 8,550 1,379 974
1995 3,7521 6,213 4,419 1,270 5,815 1,459 11,535 1,559 2,151
1996 4,1726 10,460 6,245 2,012 7,297 1,520 9,682 1,864 2,525
1997 4,5257 11,368 4729 2,641 6,323 1,249 13,753 2,248 3,619
1998 4,5463 14,765 -207 5,072 2,714 1,752 7,314 222 2,633
1999 40,319 24,578 -1,838 9,883 3,895 1,247 16,578 2,926 2,168
2000 40,715 61,924 -4,495 9,004 3,788 2,240 16484 4,928 3,585
2001 46,878 23,777 -2,926 4,086 554 195 15,621 4,109 5,472
2002 52,743 9,682 232 3,399 3,203 1542 7,200 1,445 5,627
2003 53,505 13,624 -507 4,384 2,473 491 11,664 453 4,323
2004 60,630 34,032 1,896 8,997 4,624 688 19,828 1,898 5,771
2005 72,406 33,618 8,337 7,055 3,967 1,854 13,930 1,625 7,606

Average annual growth

(%) : 45.22 4.65 27.11 55.04 29.64 51.98 21.52 69.23 58.43
S.D(%) 79.84 195.64 216.10 145.78 104.67 149.40 52.46 251.79 117.95

Source: Constructed from UNTAD, World Investment Report, 2008.

The annual FDI inflow amount was US $ 17 million in 1980 which rose to US $ 1.13

billions in 1991 and 1999 largest FDI was attracted in South Korea with US $ 9.88

billions. After 1999, FDI inflow was gradually decreasing. FDI inflow was globally

decreased in 2007 due to the global financial crisis. During the period of 1980-2005, the

volume of FDI inflows increased by more than 55% a year on average in Korea. Apart

from Taiwan and India, South Korea attracted the largest annual average FDI in this

region. The standard deviation of annual growth represents the variability in the inflow

of FDI in different Asian countries. Table 5.1 shows that China and Singapore had the

least variability in FDI inflow where as Indonesia and Taiwan has the largest variability

in FDI inflow. South Korea demonstrated a moderate variability in FDI inflows over the

study period.
 Figure 5.1

FDI inflows in South Korea

11,000
10,000 9,883

9,000 9,004 8,997

8,000
Millions US $

7,000 7,055

6,000
5,000 5,072
4,384
4,000 4,086
3,399
3,000 2,641

2,000 2,012

1,133 1,270
1,000 848 737 759 795
436 602 567 546
135 89 90 133 218
- 17

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Year

Source: Complied from UNCTAD, world Investment Report, 2008

From the figure 5.1 it is seen that annual FDI inflows in South Korea was gradually

increased with small amount of per year until 1997. South Korea remained restrictive

regarding FDI till 1997. After the Asian financial crisis in 1997, Korean government

shifted its FDI policies from control and regulation to promotion and support with the

enactment of new Foreign Investment Promotion Act (FIPA), 1998. The act opened

many areas for foreign investors which was restricted earlier. The Asian financial crisis

of 1997 dragged many leading Korean firms into high debt-equity ratios (Chung, 2007).

The government forced the Korean firms to reduce debt-equity ratios by selling of non-

core business. Majority of FDI during 1999 and 2000 came from the mergers and

acquisition of Korean firms with foreign companies. As a result, FDI inflow reached in

highest level in 1999 with US $ 9.88 billions. However, it dropped to US $3.39 billions

in 2002, inflow again increased until 2004. In the subsequent years, FDI inflows are

seen decreasing after 2004 onwards.

5.2 Sector wise FDI inflows in South Korea

Korea, being Japan’s colony for over 35 year time, huge amount of FDI came from

Japan until 1999. However, United Kingdom and Unites States are the major FDI

sources countries in South Korea. Figure 5.2 reports that United Kingdom is the main

FDI source country for South Korea in 2005, contributing 27% of FDI of total inflow

followed by United States by 24% and about 25% from Japan (calculated from

Unctad’s FDI statistics 2008). Japanese investment accounted nearly 70% of the total

investment during 1973-1978 (Bishop, 1997). South Korea encourages FDI especially

in the high tech industries by providing various incentives such as tax reduction for high

tech investors.
 Figure 5.2

Major FDI Source Countries in South korea 2005

2500

1936
2000
1751
US $ millions

1469
1500

1000

500 393
324
135
37 56 37 36
0

om

e
y

y
da
lia

d
e

te

or
an

a
nc

an
pa

gd

ta
a

rw
na

p
m
tr

ra

el
Ja

in

ga
S
o
us

er

Ir

K
F

N
C

in
G
A

ite
d

S
ite

n
U
n
US $ millions

U
Countries

Source: Constructed from Unctad.org, Hand book of statistics, 2008

Industrialization began after the Korean War in 1953 with consumer based industries

and then gradually to the heavy chemicals to high tech industries. Korean policy makers

took interventionist approach towards FDI until 1970s and allowed FDI in the priorities

for development with the intention of protecting domestic industries. Korean policy

makers identified that FDI is suitable to develop high technology industries because

FDI is the best way to acquire the technologies from abroad. A number of policies

changes have been enacted to facilitate the foreign investment in South Korea after the

enactment of Foreign Capital Inducement in 1960. During 1970s, FDI polices were

made to promote export oriented investments.

Table 5.2 represents the sector wise inflow of FDI inflow during 1985-1996.

Manufacturing sector remained the dominant sector of FDI inflow in South Korea

during 1985-1996. Heavy and Chemical products industries was second major FDI
inflow sector. Within the manufacturing industries, electronics and chemical products

showed the strong performance during 1985-1988 because of the relation of many

Japanese firms in South Korea due to the comparative cheaper labor cost in South

Korea. Samsung and Toshiba, Goldstar and Hitachi entered into joint venture to

manufacture VCRs for export markets. As a result, export increased by more than 28%

in 1989 in compare to previous year. Investment from 1989 started to decline because

of increasing labor cost in Korea led the Japanese companies to shift other Asian

countries.

Foreign investment in energy sector like electricity and gas was nil during the period of

1985-1996. Radio and TV communication sector received only $ 11 million in 1996

before that inflow as nil. These above mentioned sectors are highly invested sectors by

MNEs in many countries. These sectors are technology intensive industries.

Table 5.2
Foreign Direct Investment by sector in South Korea
US $ millions (1985-1996)
YEAR 198 198 198 198 198 199 199 199 199 199
5 6 7 8 9 0 2 3 4 5 1996
INDUSTRY
Agriculture and Fishing 0 0 0 5 0 0 -2 0 0 1 0
Mining 1 2 1 1 0 1 2 0 26 0 216
Manufacturing 168 245 376 565 507 368 380 242 282 494 850
Food products 4 21 41 33 40 28 99 12 6 12 44
Textiles and wearing
apparel 0 6 10 15 15 8 10 13 1 40 35
Wood,publishing and
printing 5 0 0 8 9 11 0 16 37 17 83
Refined petroleum 0 0 12 0 - 38 4 19 0 45 0
Chemical products 29 34 70 135 141 11 177 117 88 174 219

Pharmaceuticals - - - - - 30 27 11 27 50 36
Rubber and plastic - - - - - 31 19 6 10 7 18
Metal products 3 2 7 14 12 5 14 -7 37 85 14
Mechanical products 6 17 26 72 67 70 24 11 51 51 63
Motor vehicles - - - - - 148 44 60 10 56 286
 Electricity and Gas 0 0 0 0 - - 0 0 0 0 0
Construction 20 0 9 0 - 0 -4 1 7 9 31
Traders and repairs 14 1 1 7 22 79 104 196 136 178 349
Hotel and Restaurents 10 218 213 217 - 66 20 86 208 98 152
Transport and storage - - - - - 5 3 -1 25 5 47
Water transport - - - - - 1 0 0 0 2 30

Finanancial Intermediation 20 6 17 86 49 174 70 6 105 329 18

Insurance - - - - - 19 44 5 8 54 4
Real estate - - - - - 15 6 14 10 8 48
Computer activities - - - - - 8 0 11 4 -2 25
Advertising - - - - - 1 1 0 1 2
Other Service 2 4 8 7 6 4 3 0 1 11
Not allocated (reported) - 0 0 0 - 48 -16 -8 125 261
Unallocated - - - - - - -16 0 125 261
124
TOTAL 236 477 626 894 812 759 567 544 7 1993
Source: UNCTAD’s Hand book of statistics 2008

Table 5.3
Foreign Direct Investment by sector in South Korea
US $ millions 1997-2006)
YEAR 200 200
1997 1998 1999 2000 1 2 2004 2005 2006
INDUSTRY
Agriculture and Fishing 34 116 51 3 -18 -2 0 1 1
Mining -42 21 0 -3 -5 -10 1 2 0
107
Manufacturing 1480 2613 3166 3223 1 731 1403 512 945
Food products 460 662 283 78 542 -118 -77 -135 -166
Textiles and wearing apparel 95 43 29 -8 17 4 -3 -27 78
Wood, publishing and printing 210 443 318 118 49 42 22 91 -350
Refined petroleum 3 4 554 0 12 0 604 601 227
Chemical products 237 500 633 296 273 129 54 23 110
Pharmaceuticals, medicinal 35 88 13 82 21 37 21 2 18
Rubber and plastic products 19 21 169 24 19 7 85 117 143
Metal products 19 83 612 197 -153 145 35 -37 199
Mechanical products 52 464 440 1451 55 43 155 74 256
Medical& precision 1 32 17 3 17 11 -1 13 9
Motor vehicles 363 182 137 919 -6 401 261 746 178
Other transport equipments 0 0 -31 1 10 12 8 -47 329
Electricity and gas 0 0 417 149 12 44 -37 15 -121
Construction 44 -37 18 11 5 25 -55 47 296
Trade and repairs 441 955 921 24 515 435 788 668 2063
Hotel and restaurants 46 -13 36 94 26 -3 27 19 214
Transport and storage 184 406 512 126 91 559 359 1142 733
Transport and storage 29 8 13 22 17 426 285 357 507
 Water transport 13 0 2 6 1 296 79 109 78
Post and telecommunications 155 397 498 104 75 133 74 786 226
Telecommunications 155 397 498 104 75 133 74 786 226
Financial intermediation 167 521 2013 1631 855 643 3032 3096 2481
Insurance 7 73 332 445 132 273 225 9 188
Real estate 79 103 354 1113 442 356 84 1022 443
Computer activities 48 29 114 581 59 43 181 714 267
Research and development 2 1 0 1 17 71 0 6 2
Other business activities 24 71 195 259 136 136 127 150 170
Advertising 3 2 54 112 29 45 71 23 23
Not allocated (reported) 184 357 2137 2225 781 269 2097 -587 1992
Unallocated 184 357 2137 2225 781 269 2097 -587 1992
385 305
TOTAL 2624 5068 9635 8643 9 9 7726 6066 4964
Source: UNCTAD’s Hand book of statistics 2008

Table 5.3 shows that pattern of FDI inflow in various sectors in South Korea during the

period of 1997-2006 in different industrial sectors. Manufacturing sector continued to

show again strong performance of attracting FDI till 2000. Financial sector started to

lead the major inflow of FDI after 2004. Real estate sector also attracted a significant of

FDI during 2000-2001. Pharmaceuticals and medical sectors FDI has decreased in the

later years in compare to 1990s. Likewise, FDI in research and development is

negligible in South Korea over the years. Electricity and gas sector’s has negative FDI

in the later years which shows unfavorable environment for foreign investors in these

sectors. Foreign investment in Radio and TV communication equipments increased

during the period in 1997-2005 because FDI in this sector was nil before 1996.

5.3 Domestic Investment and Trade Statistics of South Korea (1980-

2005)

Foreign trade is one of the indicators of country’s economic growth. FDI and trade have

positive relationship. Domestic investment is necessary for economic growth and

development in the country. FDI is embedded with the new technology which is not

available in the host country. Hence, FDI stimulates the domestic investment and

encourages the faster technological progress in production process and help to achieve

the faster economic growth. Domestic investments include both public (capital

expenditure by government) and private domestic investment (capital expenditure

incurred by business sector).

Table 5.4

Domestic investment and Export of South Korea (1980-2005)

(In Percentage of GDP and total investment)

Year Domestic Inv. Growth (%) Export to GDP ratio(%) Growth %

1980 31.9 - 27.36 -

1981 29.9 -6.26 29.75 8.73
1982 28.9 -3.34 28.66 -3.67
1983 29.4 3.46 28.91 0.88
1984 30.6 4.08 31.37 8.49
1985 30.3 -9.80 31.32 -0.15
1986 29.2 -3.63 31.18 -0.44
1987 30.0 2.73 33.75 8.21
1988 31.1 3.67 32.33 -4.20
1989 33.8 8.68 27.06 -16.29
1990 37.1 9.76 24.64 -8.95
1991 39.1 5.31 23.31 -5.39
1992 36.8 -5.88 23.23 -0.34
1993 35.2 -4.12 22.71 -2.26
1994 36.1 2.55 22.67 -0.15
1995 37.2 3.04 24.18 6.64
1996 37.9 1.88 23.25 -3.86
1997 34.2 -1.09 25.82 11.09
1998 20.9 -38.88 37.97 47.03
1999 29.1 39.28 32.24 -15.06
2000 30.98 6.42 33.65 4.34
2001 29.33 5.32 31.22 -7.20
2002 29.03 1.02 29.66 -5.20
2003 29.95 3.17 31.66 7.43
2004 30.33 1.26 37.21 16.79
2005 29.93 -1.32 35.93 -3.44

Source: Constructed from IMF, hand book of statistics 2008.

South Korea’s economic development is considered as an export-led economy. Table

5.4 demonstrates that South Korea’s domestic investment rate remained around 30% of

the GDP over the period of 1980-2005. Ratio between exports to GDP ratio was from

24.18% to 37.97. This figure shows that export has a big contribution in the economy.

Export led FDI has shown positive impact in the economic growth in developing

countries (Emilio, 2001). The recent world financial crisis has challenged the export-led

economies due to the decline of goods and services in the international markets. Billions

of money was allocated as stimulus packages to keep the growth and domestic

consumption. China launched stimulus package of US $ 856 billions to encourage

growth and domestic consumption ( New York Times, 3 March, 2009.

5.4 Domestic Investment and FDI in South Korea

Domestic capital formation determines the country’s level of investment in the

productive sectors which fosters faster the economic growth of the country. Domestic

investment and foreign direct investment might have positive relation. Mileva (2008)

finds that there is strong relationship between capital inflows and domestic investment

and FDI helps to stimulate investment in other sector of the economy via spillover

effect. However, foreign portfolio investment doesn’t have any impact on domestic

capital formation. Merger and acquisition does not help to increase the capital formation

unless the foreign owners bring new capital for expansion and invest new technology.

There is a fear of crowding out of domestic investment by FDI when foreign companies

raise the productivity and wipe out the local companies from the market and MNCs use

widely imported inputs for the production. Chung (2007) identified that FDI was one
the direct means of affecting South Korea’s capital formation and economic

development.

Table 5.5
Domestic Investment and FDI in South Korea (1980-2005)
(In Percentage of GDP)

Year FDI (Millions US $) % of GDP Domestic Investment % of FDI over DI

(% of GDP)

1980 17 0.03 31.9 0.09

1981 135 0.19 29.9 0.63
1982 89 0.12 28.9 0.41
1983 90 0.12 29.4 0.40
1984 133 0.14 30.6 0.42
1985 218 0.22 30.3 0.72
1986 436 0.39 29.2 1.33
1987 602 0.43 30.0 1.43
1988 848 0.45 31.1 1.44
1989 737 0.32 33.8 0.90
1990 759 0.29 37.10 0.78
1991 1,133 0.37 39.1 0.94
1992 567 0.17 36.8 0.46
1993 546 0.15 35.2 0.42
1994 795 0.19 36.1 0.52
1995 1,270 0.25 37.2 0.67
1996 2,012 0.36 37.9 0.96
1997 2,641 0.50 34.2 1.46
1998 5,072 1.45 20.9 6.93
1999 9,883 2.22 29.1 7.62
2000 9,004 1.76 30.98 5.68
2001 4,086 0.85 29.33 2.89
2002 3,399 0.62 29.03 2.13
2003 4,384 0.72 29.95 2.40
2004 8,997 1.32 30.33 4.35
2005 7,055 0.89 29.93 2.97
Averages
1980-1985 114 0.11 30.14 0.44
1986-1990 676 0.36 32.24 1.17
1991-1995 862 0.23 36.88 0.60
1996-2000 1,998 0.95 30.62 4.52
2000-2005 2,003 1.03 29.71 2.94

Source: Constructed from IMF, hand book of statistics 2008 and UNCTAD Report, 2008

Table 5.5 shows that Korean government had made a substantial amount of money in

the domestic investment over the years which are above 30 per cent of GDP. The

percent of FDI over GDP is less than one percent except 1998, 1999, 2000 and 2004.
Majority of the FDI projects were technology intensive and produced products for

export purpose which didn’t compete with the domestic products in export market that

was good news for Korean firms. The portion of FDI over domestic investment is

sought less than one percent before 1996. After 1997, there is a gradual increase in the

ratio of FDI over GDP and decreased the level of domestic investment.

5.5 FDI policies in South Korea

Foreign Capital Inducement Law was brought in 1960 as the first law regulating foreign

direct investment in South Korea. Before 1959, FDI was not legally permitted in South

Korea (Chung, 2007). The law allowed FDI from the countries with having treaties of

friendship and commerce with South Korea. The foreign investors could repatriate 20%

of initial investment per year as a profit and tax holiday of 5 years. Economic Planning

Board was made responsible for control over the foreign direct investment policies to

channel to FDI in the priorities of national development with restrictions in many areas.

The government’s intention was to ease balance of payment and supply of needed

technology and FDI was allowed in light manufacturing export sector (Kim and Hwang,

2000). South Korean policy makers strictly permitted the foreign companies to establish

in Korea which significantly contribute the national economy in 1970s. South Korean

textile industry achieved comparative competitiveness during that time. They strictly

disallowed the FDI which would compete with Korean companies in the export market

to maintain bigger market share of Korean companies and they allowed the companies
which needed large scale of capital and technological capabilities which were lacked in

Korean industries.

FDI inflows in South Korea drastically slowed down from US $ 464 million to US $ 4

million partly due to the oil crisis in 1973(Bishop, 1997). South Korea still had strong

restrictive policy over FDI. The government brought new foreign capital inducement act

in 1977 to encourage the foreign direct investment in the country and liberalize the

economy. The act emphasized the projects which would bring new technology and

develop manpower skills and improve energy efficiency, reducing the environmental

pollution and industrial hazards. FDI inflow started to surge during 1980s with the

liberalization process in South Korea. Chung (2007) during the fifth five year plan

(1982-1986) average FDI in flow was US $ 193.03 million where as in the sixth five

year plan (1987-1991) reached to 815.83 million. In the Seventh five year plan (1992-

1997) average FDI inflow increased to US $1,038 million which substantially increased

to US $6,137 in the eighth five year plan (1997-2001). Korean government liberalized

FDI during mid of 1990s with the membership of WTO in 1995 and membership of

OECD 1996.

The Asian financial crisis in 1997 led South Korea to make major changes in its FDI

policies in order to fulfill the conditions set by IMF for financial assistance to South

Korea. Korean authorities started to give huge importance to FDI; president Dae-Jung

Kim named Korea as “the world’s best place to invest” (Chung, 2007). Foreign

investors were allowed to acquire outstanding shares of Korean companies through

friendly mergers and acquisitions from 1997. South Korea enacted Foreign Investment

Promotion Act in 1998. This new act focused on creating investor oriented environment

and establishing institutional framework for investors and grievance handling for them.

This process changed that traditional foreign debt based development to FDI based

development strategy. A number institution was established to facilitate one-stop

services to attract FDI. Korea Trade Investment and Promotion Agency (KOTRA)

established Invest Korea and Foreign Investment Ombudsman (established in 1999)

which address and resolve the difficulties faced by foreign invested companies in Korea

regarding tax and tariffs, labor management, customs and trade, investment incentives

etc. Foreign Investment Ombudsman especially provides the services to the foreign

invested companies’ investment after care services. The government set the FDI target

of $16 billion for 2000; however, actual FDI inflow in 2000 was US $ 9 billion. The

enactment of Foreign Investment Promotion Act (FIPA) in 1998; accelerated the

liberalization process and further promotion of FDI in South Korea.

Under the present FDI promotion policies, South Korea provides various incentives to

the foreign investors. South Korea has developed six sophisticated free economic zones

to facilitate the establishment of foreign companies. Especially high-tech industries

established in foreign investment zone companies are given tax holidays, financial

support for employment and training and cash grants. South Korea is the second largest

producer of semi conductor products in 2007; Samsung electronics (evertiq.com). South

Korea is promoting Gyeonggi province as the Asia investment base camp, is number

one in semi-conductor, mechatronics, bio pharmaceuticals and chemical industry

(www.invest.go.kr). South Korea’s stable political environment with liberalized

economic policies is attracting more FDI.

5.6 Foreign Direct Investment and Economic Growth

Foreign Direct Investment plays important role in economic growth as FDI not only

increase the capital stock in the country but also brings the technology which increases

the productivity of the resources. The massive increase in FDI in South Korea during

1980s and 1990s raises important queries about the possible impact of FDI in economic

growth. The studies of Borenzstein et al. (1995) and Balasubramaniyam, et al. (1996)

demonstrate that FDI induces human capital and transfer technologies and this spillover

effect of knowledge lead the economic growth in the host countries. They argue that the

effect of FDI remains permanent in the host country because of the development in the

infrastructures of the host country. Therefore, there exist the long rung relationship

between level of GDP and foreign capital stock. Kim and Hwang (2000) subsidiaries of

foreign firms heavily contribute the growth of domestic firms in semi-conductor and

pharmaceuticals industry in South Korea.

Figure 5.3 represents the trend of annual GDP and FDI in South Korea over the periods

of 1980-2005. The annual average growth rate of GDP was 11.45% and FDI was

20.35% during 1980-2005. GDP growth sought negative growth in 1997 due to the

Asian financial crisis. After the crisis, annual growth took place in higher rate along

with the surged in FDI.

 Figure5.3

GDP and FDI in South Korea

900,000

800,000

700,000
Millions US $

600,000

500,000
GDP
400,000
FDI
300,000

200,000

100,000

-
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Year

Sour

ce: Constructed from UNCTAD’s, world Investment Report, 2008 and IMF, World Economic Outlook,

2008.

The macro economic figure presented in table 5.5 showed that Korean government had

huge amount of domestic investment over the study period in compare to FDI. The

South Korea’s GDP economic growth rate is depicted in figure 5.4.

GDP growth rate in South Korea (1980-2005)

 Figure 5.4

12

10

0 2 4 6 8 0 2 4 6 8 0 2 4 6
198 1 98 198 1 98 198 1 99 199 1 99 199 1 99 2 00 2 00 2 00 200

Source: constructed from IMF report, 2008.

The economic growth was less then 2% per year in 1980. With the gradual increase in

GDP growth rate, South Korea achieved double digit growth rate in 1983. The double

digit growth rate were maintained in 1986, with record level high 11.10% in 1987 and

1988.High level of GDP growth was experienced high growth rate in 1999 and 2000

after the reforms in FDI policies in 1998.

 CHAPTER -6
DISCUSSION AND ANALYSIS

6.1 FDI and Economic growth

In early studies on economic growth, (GDP) used to be determined by the level of

capital and labor as the basic input (Cub Douglas production function). For higher level

of capital formation and investment, higher level of saving was a necessary condition.

Further studies on economic growth include exports, foreign exchange rate policy and

FDI as variables of openness and human capital and transportations are as internal

environmental variables in addition to the basic input variables.

The recent endogenous growth theories emphasize the importance of human capital and

technologies for faster economic growth. Since education and knowledge are the source

for industrialization for late comers to imitate learning by watching. Education and

human capital is also the most fundamental conditions for innovation and knowledge

creation. This study follows the endogenous growth theory developed by Borensztein et

al, 1995, Balasubramanyam, 1996 and Romer, 1990). According to the theory,

economic growth is enhanced by foreign direct investment because FDI is embedded

with new technology which may not be available in the host countries. The diffusion of

technology and spillover effect of foreign firms will have positive impact on the
productivity of domestic firms. Such advanced technologies may lead to higher level of

productivity with the same level of material input.

The basic equation for econometric analysis is formulated in research methodology

chapter. The present study is based on the endogenous growth model developed by

Borensztein, et al (1995) and John-Wha Lee (1995), this part will explore the empirical

evidences of impact of FDI in Korean economy. The endogenous growth model

specified for testing is:

G = α +β1Kt-1 + β2Emp t-1 + β2FDI t-1 + β3HC t-1 + β5Exp t-1 + C1FDI t-1 *HC t-1

+C2FDI t-1 *K t-1 +C3 FDI t-1 *Exp t-1 + e t-1 ………………. (I)

It is the common practice to take the natural logarithms of time series data to make the

data more linear and taken the first lag of all variables before running the regression.

The use of FDI statistics in production faction needs to careful consideration because

capital stock is accumulation of fixed assets investment that includes domestic

investment (DI) and foreign investment. The production function would be wrongly

specified if FDI, either measured as flow or along with capital stock (Wei, 2008) or

added as another explanatory variable along with capital stock. To avoid the multi-

colinearity and double accounting, variable FDI is used as ratio of FDI/(DI +FDI). This

definition would clear whether role of FDI is different from domestic investment. This

ratio would not have any significant effect in the production process, if they had the

same role in production process. If FDI has more important role on production, FDI
ratio will have a positive and significant statistical value. Export is defined as ratio of

export/GDP instead of taking the absolute value of export to avoid the problem of

possible multi-co linearity. Exports have been an important factor for growing economy

in South Korea because majority of exports in South Korea were produced by foreign

subsidiaries. There are various methods of measuring the level of human capital, e.g.

ratio of number of students enrolled in higher education over population, ratio of

students enrolled in secondary education over total population or percentage of

expenditure on education over total government expenditure. This study chooses the

number of students enrolled in the secondary education over population as the human

capital. The study expects positive effect of explanatory variable on dependent variable.

6.2 Regression results of estimated model

The estimated equation is estimated in 2 ways. Firstly, GDP per capita growth

(dependent variable) is estimated with five explanatory variables i.e. FDI, Domestic

Capital, Employment, Human Capital and export. Secondly, it is estimated with the

interaction terms of FDI with Domestic Capital (FDI*K), HC (FDI*HC) and export

(FDI*Exp).

Time series data may give the spurious regression results, if they are not co-integrated.

If data are co-integrated only then, variables can be correctly estimated. One of the

reliable ways to make sure that OLS regression is not spurious is to test for unit root test

of variables (Gujarati, 2004). Augmented Dickey Fuller test is one of the methods of

checking unit root test for the variables. Augmented Fuller test is estimated with

following equation.
 n
∆X t = κ + ρ ⋅t + θ i ⋅ X t −i + ∑ϕ i ⋅∆X t −i + ε t
i =1

Where, X is the variable under consideration, ∆ is the first difference operator, t

captures time trend, εt is a random error, and n is the maximum lag length. If it cannot

be reject the null hypothesis θ =0 , then it is concluded that the series under

consideration has a unit root and data is non-stationary

The results of the unit root tests for the variables with the first differences of the series

are presented Table 5.6. The general rule of thumb for testing unit root test is to take the

lag length up to one third to one quarter of time series (Gujarati, (2004). The unit root

tests at 6 lag length show that all the variables are non-stationary.

Table 6.1
Unit root tests for Variables

Variables GDP Domestic Human

Per capita growth FDI Investment Employment capital Export
DF -3.172* -1.296 -2.398 -2.480 -0.775 -1.293
ADF(1) -4.307* -1.840 -2.322 -2.285 -2.333 -1.341
ADF(2) -3.477* -1.718 -2.273 -2.487 -1.146 -1.314
ADF(3) -2.854 -1.396 -2.204 -2.565 -0.042 -1.475
ADF(4) -3.409* -1.262 -2.145 -2.649 -0.859 -1.221
ADF(5) -4.002* -1.297 -2.048 -2.888 -0.933 -1.095
ADF(6) -2.706 1.634 -1.973 -2.385 1.343 -1.075

*** denotes significance at 99% confidence level, ** denotes significance at 95% and * denotes significance at 90%
confidence level

The table 6.1 shows that dependent variable GDP per capita growth and all explanatory

variables are non-stationary times series at the lag length of six (compare with critical

values, appendix). The GDP per capita growth time series has statistically significant at

10% level of significance in some lags. Renaming variables are not significance at any

level. Hence, all the variables follow random walk process or AR1 process showing the
non-stationary of data. Hence, the regression co-efficient obtained from the model

would be correctly specified.

The strong arguments behind endogenous growth model are technological changes

caused by spillover effect of profit maximizing agents. The theory assumes that there is

positive relationship between FDI and economic growth as well as positive interaction

between FDI and human capital, domestic investment and exports. A sufficient stock of

human capital is necessary for the utilization of new technologies embodied by FDI to

achieve the faster economic growth.

The question regarding the interaction between FDI and domestic investment is a
controversial because some study has shown that FDI crowds out the domestic
investment, no effect in domestic investment and somewhere positive. The study
includes FDI and domestic investment separately as well as interaction terms between
FDI and domestic investment (FDI*K). The coefficient of interaction term estimates the
combined effect FDI and domestic investment on economic growth (Karbasi et al,
2005).
Table 6.2 reports the estimated regression results of specified regression equations (i)

Table 6.2
Estimating per capita GDP growth and other variables (with one lag)
Dependent variable (GDP per capita growth)

Coefficient Standard error t-value p- value

Constant -40.23 13.32 -3.02** 0.007
FDIt-1 -0.23 0.25 -0.94 0.357
Emp t-1 17.89 5.04 3.55** 0.0021
DI t-1 -2.34 0.85 -2.57** 0.0130
Exp t-1 0.99 1.61 0.54 0.5438
HC t-1 6.63 1.62 3.71** 0.0015
*** denotes significance at 99% confidence level, ** denotes significance at 95% and * denotes significance at 90%
confidence level
Table 6.2 shows the estimated co-efficient of FDI, employment, domestic investment,

exports and human capital. The coefficient of employment and human capital has the

positive and statistically significant at 5% level of significance which indicates the

growth is strongly enhanced by labor force and human capital. Domestic investment is

negatively affected by FDI coefficients indicating negative relations. The regression

coefficient shows that there is negative relation between growth and FDI but not

statistically significant.

The main argument of the endogenous growth theory is that growth is enhanced by

technological change brought by profit making agents in the host countries and assumes

that there is positive interaction between FDI and Human capital. Table 6.2 presents the

co-efficient of the OLS regression for the interaction terms with FDI, domestic

investment, human capital and exports individual. The interaction between FDI and

Domestic investment is positive; statistically significant at 10%. However, it is not

highly significant. This shows a positive combined effect of FDI and domestic

investment for growth. Similarly, FDI and human capital and exports have positive

relationship which interacts positively between FDI, human capital and exports.

Table 6.3

Estimating per capita GDP growth and other variables (with one lag)

(Dependent variable GDP per capita growth)

Coefficient Standard error t-value p-

value
Constant -34.90 15.71 -2.22** 0.04
FDIt-1 -21.01 11.39 -1.84* 0.11
Emp t-1 15.81 6.15 2.57* 0.20
DI t-1 -1.98 0.96 0.06** 0.05
Exp t-1 1.51 1.86 0.81* 0.42
HC t-1 3.89 2.99 1.30* 0.21
FDI*DI 0.53 0.29 1.78* 0.09
FDI*HC 5.08 2.99 1.70* 0.10
FDI*Exp 0.91 1.02 0.89* 0.38
*** denotes significance at 99% confidence level, ** denotes significance at 95% and * denotes significance at 90%

confidence level

*** 1% significance p-value 0.01

**5 % significance p – value 0.05
* 10 % significance p- value 0.10

The statistical findings from the OLS regression are not entirely consistent with the

previous studies’ positive relationship between the variables regarding the relationship

between FDI and domestic investment. Table 6.2 gives negative relationship between

FDI and growth, this shows controversial indications. However, it is consistent with the

findings of Kim and Seo (2003), Kim and Hwang (2000) in case of impact of FDI in

Korean economy. They used industry wise FDI flow and growth. They also found

negative response of FDI to domestic investment but statistically insignificant. Hence,

the role of FDI in the amazing economic growth of South Korea is quantitatively

negligible despite the qualitative importance of FDI .The regression analysis reported in

table 6.3 shows that there is positive interaction between FDI and domestic investment

(FDI*K) and FDI human capital (FDI*HC) and FDI and export (FDI*exp).This results

supports the theoretical statement of endogenous theory of growth. MNEs are vehicles

of transferring new technologies and ideas via FDI which cause a long run economic

growth in the host countries. This study is based on the macro economic time series

data. The ratio of FDI over GDP and domestic investment is very small. So that

regression co-efficient might no have significant relationship. Hence, it does not capture

the industry wise and firm level impact of FDI on growth.

 CHAPTER -7

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

6.1 SUMMARY

This chapter provides a summary, conclusion of the study and some recommendations

for the direction of trade and FDI policies in South Korea. And some policy lessons for

developing countries such as Nepal regarding foreign direct investment and trade.

Technological changes and human development are main factor of growth and

development which implements increasing returns to scale in the production of goods

and services. New technological innovations occur mostly in the advanced countries,

which is costly to transfer in the developing countries. Endogenous growth theoreticians

believe that diffusion of technologies causes a permanent economic growth in the host

countries.

In 1960s and 1970s, South Korea’s main economic interest regarding FDI was to

chanalise the FDI in the priority sector of government development plan. They adopted

interventionist FDI policies to protect domestic firms from foreign firms. Korean policy

makers allowed and invited FDI in sectors where they had lack of technological

capacities and export oriented firms. Gulf Oil was invited to establish oil refinery plant

in Korea in joint venture with Korea oil because they had lack of technical knowledge

in this industry. Likewise, a number of chemical firms were allowed to establish in

Korea. Koreans learned technologies from foreign firms (Bishop, 1997). Chung, (2007)

Korean firms obtained subcontracting production works with technologies due to the
relocation of Japanese textile and semi-conductor firms in Korea because of cheaper

labor cost.

After Asian financial crisis of 1997, South Korea made policy reforms in FDI policies

and enacted Foreign Investment Promotion act of 1998 which replaced the previous

foreign capital inducement act of 1977 Kim (2006). The new FDI policy identified FDI

as the engine of growth and initiated to promote Korea as the world’s best place for

investment. The majority of FDI came from M&A in 1998 in South Korea which was

facilitated by new Foreign Investment Promotion act of 1998. According to UNCTAD’s

world investment report (2008) South Korea had an annual FDI inflow of $ 17 million

in 1980. FDI inflow before 1995 was less than a billion per year which increased to US

$ 5.25 billion per year over the period of 1995-2005. The record level high FDI inflow

was $ 9.88 billion in 1998.

Economic growth rate was less than 1.48% in 1980 which increased to above 10% in

1983 (Figure 5.4). Double digit growth rate was maintained in 1986, 1987 and 1988

(IMF, world economic out look 2008). GDP Per capita income of South Korean’s was

US $ 1,678.75 in 1980 which rose to US $16,433.77 million in 2005. United Kingdom,

United States and Japan are the major source countries for FDI in South Korea.

Manufacturing sector dominates the FDI inflow in South Korea followed by chemical

industries. But in the recent years, services such financial and hotel sectors are also

being destinations of FDI in South Korea.

To realize the slogan in to reality ‘ Korea; the best place to invest, Korea has developed

six huge free economic zones which provides tax and cash grant facilities to the firms

established in these free zones. Today, South Korea hosts one of the liberalized

economy in the world; recognizing FDI as the engine of the growth.

The domestic investment remained above 30% of GDP on average over the study

period table 5.5). The ratio of FDI over GDP was less than one percent except some

fiscal years (table 5.5). However, majority of the FDI was in technology intensive

which definitely helped the domestic firms to make competitive. Export is one of the

strong aspects of Korean economy. Export to GDP ratios stood 22.71% to 37.97%

(table 5.4) over the study periods.

The study used the endogenous growth model to explore the role of FDI in South Korea

by using macro economic variables for the period of 1980-2005. Foreign direct

investment, domestic investment, human capital and exports are considered as the

factors affecting growth. The econometric analysis showed that (table 5.7) employment

and human capital are highly positively significant implying that these factors are driver

of economic growth. The study found a negative relationship between growth and FDI

(table 5.7) with the coefficient of FDI -0.23 but statistically highly insignificant (t-value

0.94). This result supports the findings of Kim and Hwang (2000) and Kim and Seo

(2003). South Korea’s domestic investment remained above 30% of GDP but the

FDI/GDP ratio was less than one percent. Hence, there might not be quantitative

significance of FDI on growth.

The study found that positive interaction (table 5.8) between FDI and domestic

investment, human capital and exports. This supports that the endogenous growth

theory that FDI stimulates domestic investment by augmenting human capital.

6.2 CONCLUSIONS REMARKS

This study analysed the role of FDI in economic growth in South Korea based on both

qualitative and quantitative ways. Qualitative analysis based on the review of

government’s FDI policies; showed that FDI policies were more interventionist

approaches to protect Korean firms from foreign competitions in local and export

markets. From the strictly screened foreign investment projects before 1980s,

government economic plans were succeeded in on hand, on the other hand, Korean

firms learned and developed technologies from foreign firms and achieved competitive

strength in the international markets. This showed the gradual opening of sectors for

foreign investors; domestic firms developed the competitive strength in terms of

technological change and production efficiency.

This study investigated quantitative the role of FDI based on the macro economic data.

The results from the OLS regression analysis showed that FDI has played negligible

role in throughout the Korea’s economic growth. FDI accounted less than one percent

of GDP (except few years after1998) where as domestic investment remained above 30

percent of GDP over the study period. FDI value is very small compare to domestic

investment. The macro economic data study during 1980-2005 fails to support the
significant role of FDI on growth case study evidences. Despite this, Korean firms

upgraded their technological and managerial skills from foreign companies to be world

competitive. Hence, the role of FDI in improving the quality of Korean firms can’t be

ignored to cause economic growth in Korea. The study leaves the analysis using

industry and firm level data with other variables for further research.

6.2 POLICY RECOMMENDATIONS

The study focused on the role of role of FDI in economic growth in South Korea.

Despite the qualitative evidences of role of FDI in the economic growth in South Korea,

quantitative regression analysis showed negligible impact of FDI in economic growth.

Korean policy makers directed the foreign direct investment in the priority sector of the

development at the time of taking off economic phase. Basically, economic and trade

policies should be carefully developed for a long term and economic growth in the

countries especially developing countries. Faster economic growth is the requirement of

least developed countries (LDCs). South Korean model of economic growth could be

useful for developing economies like Nepal. Focusing on FDI and economic growth in

South Korea, FDI was one of the change agents for industrial reforms. The careful

policy formulation and opening of sub-sectors helped to upgrade competitive positions

of local firms in South Korea. The study recommends the following major points to the

Korean policy makers for keep growing its economy and to accelerate the Nepalese

economic growth via foreign direct investment.

To Korean policy makers:

 1. Foreign direct investment should be encouraged especially in the high-tech

industries and value added products because Korea can not compete with

neighbouring country in terms of cost and local markets.

2. South Korea has attracted very small amount of in Pharmaceutical and bio-

medical sectors. More FDI should be attracted in these sectors to lead in this

industry in the region.

3. FDI in R&D activities is very negligible in South Korea. MNEs working in R &

D should be encouraged to establish in Korea.

4. FDI in electricity and gas sectors has been south negative FDI in the recent

years. Korean policy makers should provide favourable environment for MNEs

to retain their investment and increase the investment in the energy sectors.

For developing countries like Nepal:

FDI played important role on changing the industrial patterns of Korean firms to

achieve international competitiveness which helped to achieve rapid economic

development in South Korea. Basically, Korean firms learned the technologies and

skills from MNEs which made Korean firms competitive. Developing countries like

Nepal can learn from the Korean experiences regarding FDI policies to accelerate

the economic growth. The Korean experiences and some literature show export-led

economic growth. However, world financial crisis of 2008 challenged this

hypothesis due to decline of goods and services in the international markets. Hence,

Nepal can learn from these experiences that export-led growth may be short term

growth.
1. Identify the sectors for FDI where government’s strategic economic plan is

directed and channelizes the inflow of FDI in the early stage of economic

development.

2. Nepal is rich in water resources. Government should attract more FDI in this

sector to transform the Nepalese economy by producing sufficient energy for

self and export.

3. The natural beauties and Himalayan ranges has huge potential for tourism

industry, however, small amount of FDI has been attracted in these industry in

Nepal. Nepalese tourism industry can transform Nepalese economy by

developing Nepal as the best place to visit in the world.

4. Poor Infrastructure and transportation inaccessibility are the bottleneck for

Nepalese economy. FDI in Greenfield investors should be encouraged.

5. Government should develop basic infrastructure and free zones to facilitate and

attract FDI in different regions of the country.

6. FDI incentives should be provided the foreign investors and establish grievance

handling institutions to solve the problems by foreign investors.

7. One stop services should be provided to the foreign investors to faster

establishment of MNEs; slow registration process, bureaucratic hurdles,

corruptions and poor infrastructure are the main problems of foreign investors in

the developing countries.

8. Flexible labour laws should be permitted for the foreign firms to enhance the

efficiency of resources.
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