Human Development and Foreign Direct Investment in Developing Countries: The Influence of FDI Policy and Corruption

World Development Vol. 38, No. 12, pp. 1678–1691, 2010 Ó 2010 Elsevier Ltd. All rights reserved 0305-750X/$ - see front matter www.elsevier.com/locate/worlddev

doi:10.1016/j.worlddev.2010.04.005

Human Development and Foreign Direct Investment in Developing Countries: The Influence of FDI Policy and Corruption S.L. REITER Washington and Lee University, Lexington, VA, USA

and H. KEVIN STEENSMA * University of Washington, Seattle, WA, USA Summary. — While policymakers place great importance on foreign direct investment (FDI) in advancing development in developing countries, the links between FDI, economic development, and human development remain tenuous. We attempt to better understand these relationships by looking at the influence of FDI policy and corruption on these relationships. We find that FDI inflows are more strongly positively related to improvement in human development when FDI policy restricts foreign investors from entering some economic sectors and when it discriminates against foreign investors relative to domestic investors. The relationship between FDI and improvement in human development is also more strongly positive when corruption is low. Ó 2010 Elsevier Ltd. All rights reserved. Key words — foreign direct investment, economic development, human development, developing countries

1. INTRODUCTION

been lifted in favor of incentives. But the belief that indiscriminate entry of FDI will improve a country’s economic development continues to be questioned by the empirical evidence. The conclusion reached after a vast number of empirical studies on the relationship between FDI and economic development is that we still do not understand the role of FDI in economic development. The relationships between FDI and factors that promote economic development, such as industry structure and performance (Agosin & Machado, 2005; Aitken & Harrison, 1999; Blomstro¨m & Kokko, 1996; Blomstro¨m, Lipsey, & Zejan, 1994; Blomstro¨m & Wolff, 1994; Haddad & Harrison, 1993; OECD, 2002; Smarzynska, 2002; UNCTAD, 2000), technological spillovers (Aitken & Harrison, ´ lvarez & Molero, 2005; Blomstro¨m, 1986; Blomstro¨m 1999; A & Sjo¨holm, 1999; Borensztein, De Gregorio, & Lee, 1998; Bwayla, 2006; Haddad & Harrison, 1993; Konings, 2001; Lall, 1980; Smarzynska, 2002), and human capital development (Elmslie & Milberg, 1996; Feenstra & Hanson, 1997; Jessup, 1999; Kucera, 2002; Levinsohn, 1996; OECD, 2002; Oman, 1999; Slaughter, 2001), have been analyzed. In nearly all relationships, the results vary widely; some studies show a positive relationship, others a negative relationship, and still others show no relationship at all. Even with regard to the relationship between FDI and economic growth (Balasubramanyam, Salisu, & Sapsford, 1996; Borensztein et al., 1998; Carkovic & Levine, 2005; JBIC, 2002; World Bank, 2002; Zhang, 2001), one that, some argue, should be the most unambiguous, the results are mixed. Furthermore, studies that do show a positive correlation between FDI and GNP still say nothing of causation (Caves, 1996).

In recent years, developing countries have increasingly relied on private capital as a source of funding. Since the early 1990s, private sources of funding have made up over 75% of their external capital flows. The major contributing group to this private capital has consistently been foreign direct investment (FDI), with its share going from less than 30% in the early 1990s to nearly two-thirds of the total by 1998 (UNCTAD, 2003). While there was a decrease in FDI in the first few years of the 21st century, 2004 started a new trend in accelerated growth, with 2007 having the highest level of FDI ever recorded (UNCTAD, 2008). Thus, it is important that we understand the effect FDI has on developing countries. Policymakers strongly believe that FDI is an important element of economic development in developing countries. In the final report of the 2002 United Nations-hosted conference on development, the following was stated: Foreign direct investment contributes toward financing sustained economic growth over the long term. It is especially important for its potential to transfer knowledge and technology, create jobs, boost overall productivity, enhance competitiveness and entrepreneurship, and ultimately eradicate poverty through economic growth and development (United Nations, 2002, p. 5).

Beginning in the mid-1980s, many countries in the world started on a path to liberalize their FDI policies, and from 1993 to 2003, 94% of the 1,718 regulatory changes made by countries around the world were favorable to FDI (UNCTAD, 2006). Developing countries, in particular, have created an environment that is increasingly more amenable to foreign investors (UNCTAD, 1999). Government policy changes have made it easier for foreign investors to enter more economic sectors and establish operations. Many restrictions on foreign equity participation and ownership have been removed. Screening and authorization of the establishment of foreignowned enterprises have been replaced by simple registration in some sectors, and many performance requirements have

* We are grateful to Angela M. Smith and three anonymous reviewers for World Development for their helpful suggestions and guidance on earlier drafts of this paper. For funding this research, I would like to thank the Hess and Lenfest families for their support of faculty summer research at Washington and Lee University. Final revision accepted: April 28, 2010. 1678

HUMAN DEVELOPMENT AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES

Several reasons have been suggested as to why we continue to receive such mixed results. Some argue that our empirical methods have been inadequate (Gorg & Strobl, 2001), which has provided an impetus in recent years for the use of more panel studies rather than the previously often used cross-sectional study. While panel studies have allowed us to control for time-invariant differences and have increased our understanding of temporal relationships, both of which are important in this research question, it has not eliminated the variance in results (Go¨rg & Greenaway, 2004). Similarly, Lipsey and Sjo¨holm (2005) look at a host of studies that investigated wage and productivity spillovers and conclude that methodological differences do not determine variance. Others contend that this lack of consensus among the studies is due to the disregard of several factors that are essential for understanding the role of FDI in development, such as country characteristics and policies (Blomstro¨m & Kokko, 1996), which are not part of the model in the many studies that focused on a single industry in a single country. Additionally, the level of corruption can also influence the benefits that are accrued from FDI (Bitzenes, Tsitouras, & Vlschos, 2009; Blackburn & Sarmah, 2008). Blackburn and Sarmah (2008) found that corruption is negatively associated with FDI inflow and economic development. Country and industry differences are so important that Lipsey and Sjo¨holm (2005) suggest that maybe there are no universal relationships. An additional issue with the current research stream is that the focus has been on understanding the relationship between FDI and economic development, which, some argue, is an overly narrow view of development. The purpose of development, broadly speaking, is to enhance people’s lives and to allow for individuals to achieve their legitimate aims in life (Rawls, 1971; Sen, 1999). It means that individuals must have access to those things that are required to achieve these aims, such as liberties, health, education, and economic means. While it is often assumed that economic growth leads to this broader notion of development, there is evidence to the contrary (Sen, 1999; Stiglitz, 2006). Infant mortality in Jamaica, for example, is nearly half that in Brazil, despite Jamaica’s per capita income being nearly half of Brazil’s. Life expectancy in Cuba is 77 years with a per capita income of $5,259, but only 49 years in South Africa, which has a per capita income of $12,650 (UNDP, 2004). Even in the current economic downturn, the United States shows signs of recovery when looking at economic factors such as GDP; yet, joblessness continues to increase and is forecasted to be high for some time. Thus, economic growth does not provide the full picture of human development; country characteristics and policies are also determinants of the level of human development. We have seen many indications particularly since the strong push for free markets and trade liberalization in the 1990s that markets alone do not provide the full answer to development. Stiglitz (2006) argues that government plays a major role in determining the pace of human development and that development requires getting the right balance between markets and the government. Additionally, successful development requires that governments are motivated to work toward this end. Oftentimes, particularly in developing countries, the government does not have the interest of the people in mind. In light of the critical role policymakers have given to FDI in advancing development in developing countries as well as the tenuous linkages between FDI and economic development and between economic development and human development, this study explores the interaction between FDI, FDI policy, level of corruption, and their effects on human development. We first discuss arguments for both positive and negative ef-

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fects FDI might have on economic development. We then explore how FDI policy may affect this outcome. Finally, we look at the influence FDI policy has on the relationship between FDI and human development. We argue that FDI inward flows are more positively related to human development when FDI policy strategically controls foreign investment by limiting the economic sectors open to foreign investment or by discriminating against foreign investors in favor of domestic ones. Additionally, we argue that corruption reduces the positive effect of this relationship. We test our hypotheses by looking at a sample of 49 countries over a 26year time period (1980–2005) using a panel study. We find that FDI inward flows are more strongly positively related to human development when FDI policies are such that they restrict foreign investment from entering some economic sectors and when they discriminate against foreign investors in favor of domestic ones. The relationship between FDI inward flows and human development is also more strongly positive when corruption is low. Finally, we discuss the implications of our findings for firms and policymakers. 2. THEORY (a) The role of FDI in economic development From a neo-classical economic perspective, FDI from developed countries is deemed an integral ingredient to the economic growth of underdeveloped countries, and economic development is best served when the state plays a limited role in controlling the market (Caves, 1996; Hymer, 1976; Kindleberger & Herrick, 1977; Todaro, 1989; Vernon, 1966). It is argued that developing countries benefit directly from FDI through an inflow of capital, tax revenues, and employment, and indirectly through spillover of the foreign investor’s technology and knowledge to local enterprises and workers, and through access to foreign markets. Domestic suppliers, competitors, distributors, customers, and employees learn from their interaction with foreign investors, and their ability to compete globally is enhanced. It is also argued that the entry of competitive foreign enterprises takes the competitive structure of the industry to a new level. Local firms that survive in this increasingly competitive environment do so only by becoming more efficient and, thus, more competitive, raising the productivity of the local industry and, in turn, the economic growth rate of the developing country. There is some evidence to support the position that FDI enhances the competitiveness of indigenous firms. The productivity of local Mexican firms, for example, was found to converge to the level of foreign enterprises that had located in Mexico (Blomstro¨m & Wolff, 1994). The labor productivity of Indonesian manufacturers was found to be higher among those that had some foreign equity (Blomstro¨m & Sjo¨holm, 1999). Smarzynska (2002) found that domestic suppliers in Lithuania benefited from the backward spillover that occurred from supplying foreign customers that had located in country. Similarly, Bwayla (2006) found that there were significant technology spillovers from foreign firms in upstream sectors to local firms in downstream sectors in manufacturing industries in Zambia. Hence, FDI can be an important vehicle for the transfer of technology to certain local firms and for increasing the overall competitiveness of the industry, which will have a positive effect on economic growth (Borensztein et al., 1998). On the other hand, FDI may crowd out local enterprises and actually be detrimental to economic development. Foreign

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enterprises are often significantly superior to domestic enterprises and either buy out or drive out domestic firms, leading to a concentration of power in the industry (Agosin & Mayer, 2000; Aitken & Harrison, 1999; Blomstro¨m & Kokko, 1996). The net effect is a decrease in competition and domination by foreign entities. Whether this occurs seems to depend on the level maturity of the local markets and the type of sectors that FDI enters. Agosin and Mayer’s (2000) panel study found that the effect of FDI in Asia, and to a lesser extent in Africa, crowded in domestic investment, and, yet, in Latin America, the study found that FDI crowded out domestic investment. They theorize that in Asia, where investment was strong, FDI had a positive effect on domestic investment through forward and backward linkages. FDI’s positive effect in Africa, however, was more likely due to foreign investors entering into sectors where domestic investors were unable to invest due to the lack of technological or capital requirements. On the other hand, the crowding out that occurred in Latin America, the authors argue, is because these governments were much less choosy than Asia about what FDI came in; they had no screening process and were not trying to attract particularly desirable firms. Thus, Agosin and Mayer (2000) conclude that the effects of FDI are not always positive and that FDI policy plays a role in determining the outcome. With regard to the theory that development occurs in an indirect way as a result of FDI spillovers, the results are mixed as well. Konings’s (2001) firm-level panel-data study of Bulgaria, Romania, and Poland found that there were no positive spillovers to domestic firms, and, in fact, on average, there were negative spillovers in Bulgaria and Romania. He surmises that this negative effect may be because the technology gap was too large in these less advanced countries and the dominant factor was the increased competition of the foreign firms. While Bwayla’s study (2006) of manufacturing in Zambia did not find any evidence of horizontal or intra-industry spillovers, he did find evidence of significant vertical technology spillovers. His study indicates that local firm productivity decreased as the presence of foreign firms in the sector increased. An additional factor that appears to influence the degree to which spillovers take place is the absorptive capacity of the host. Similar to Konings’s (2001) explanation of the lack of spillovers in Bulgaria and Romania, Glass and Saggi (1998) believe that the larger the technology gap between the host and home country, the lesser the chance of technological transfer. This can occur for two reasons: one, the host country is unable to absorb the technology due to inadequacies in human capital and physical infrastructure or, two, the multinational corporation may not invest in the latest technology in the host country because of its perception of the lack of absorptive capacity. In support of this hypothesis, the Kokko (1994) study of Mexico spillovers found no evidence of spillovers in industries where multinational firms used highly complex technologies. So we see that foreign investors may crowd out domestic investors and tightly control spillovers, particularly in the horizontal direction. Moreover, the ability of host countries to absorb externalities may be limited, particularly in developing countries. Thus, foreign investment’s contribution to development may not be positive and, in fact, may actually interfere with development. Hence, the empirical evidence continues to provide contradictory results. There are clear instances where FDI does contribute to economic growth, but, not always. This suggests that there are other factors that interact with FDI that determine the outcome. Whether FDI has a positive or a negative effect on economic growth depends on such things as the sectors it operates in, the ability of locals to participate and learn

for foreign investors, and the ability and willingness of host governments to use FDI with development in mind. Country policy can play a role in strategically positioning FDI for the benefit of the country in terms of economic development. (b) FDI policy’s influence on the FDI-economic development relationship When multinational corporations enter markets of developing countries, it is often market failures that attract FDI and give them the advantage in the market. Foreign investors anticipate that their superior technology and knowledge entering into a less efficient market with fewer and less capable competitors will give them the opportunity to capture a large percentage of the market. It is when FDI is dominant in developing countries that foreign investors’ objectives may clash with those of the developing countries, and government protection is particularly needed. Rueschemeyer and Evans (1985) explain that, especially in the third world countries where “smaller markets and imported technology make oligopolies even more pervasive, one can’t rely on the market to both stimulate and discipline entrepreneurial behavior” (Rueschemeyer & Evans, 1985, p. 45). Multinational corporations are interested in profit, not in local accumulation or local industrialization. It is up to the state to redirect multinational corporations’ rationality and oppose them, if necessary, to ensure that local objectives are met (Evans, 1979). The host government has a legitimate seat at the bargaining table with the foreign investor. It can strategically use FDI by controlling investors’ behavior through state policy. In this way, the state plays an important role in shaping the market and creating policy that ensures growth, development, and social equality and that the state is not beholden to foreign interests but can devise an economic strategy that leads to development. Thus, important variables for understanding growth and development in developing countries are the autonomy and strength of the state and the development policies and structure of the political processes (McMillan, 1999). The state can use its power and position to intervene in the economic system through various means: by influencing the behavior of private entrepreneurs through fiscal, monetary, and trade policies; by regulating economic agents’ behavior through worker, consumer, or environmental protection laws; by redistributing capital through subsidies or transfer payments; by producing goods and services itself; by mediating conflicts between capital and labor; and by planning a comprehensive economic system Biersteker (1990). Often cited examples of economic development where the state played a strong role are Japan, South Korea, and Taiwan. The governments nurtured their industries and helped them succeed in the world economy and, thereby, interfered with the free market. Amsden (1989) points out that these states heavily subsidized private enterprise and in exchange imposed performance standards on the firms. In South Korea, the state owned and controlled all commercial banks, limited the number of firms it allowed to enter each industry, negotiated price controls, had controls on capital flight, and enacted legislation to protect domestic industries from foreign investment (Amsden, 1989). Additionally, the state played a vital role in setting performance standards and in creating and maintaining economic growth. Amsden (1989) notes that this policy of quid pro quo was not followed in countries such as Argentina, Mexico, and Turkey, where subsidies were giveaways with no requirement on capital; businesses were given something for free in hopes that it would generate something socially worthwhile. According to Amsden (1995), the differ-

HUMAN DEVELOPMENT AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES

ence in the degree to which Asian governments intervened depended on the size of the country’s competitive assets. Taiwan and Korea, for example, had cotton spinning and weaving industries that could not even compete domestically with Japan’s products, so much more intervention was required. Taiwan used FDI to help meet its strategic economic goals by welcoming FDI in those sectors it wished to grow. Additionally, the states did not rely on spillover effects from the foreign investors to build up its domestic expertise. While FDI was building the economy, the state was wisely using the revenue to build up internal expertise through education and R&D infrastructure. Amsden (1985) argues that while the exportoriented growth strategy that Taiwan used might appear to be a strategy of liberalization, the government was not guided by a free market, and it did not let foreign MNCs dominate the capital markets or manufacturing. All banks were either wholly owned or partially owned by the state, and lending practices were strictly controlled by the state. Additionally, the state controlled the key sectors of the economy, with stability the overriding economic consideration (Amsden, 1985). Hong Kong, on the other hand, did not intervene as much as either Taiwan or South Korea, but it did what was needed to meet its economic objectives. For example, its competitive asset of cheap labor gave it a strong advantage in the export-oriented clothing manufacturing industry, but it was the state’s mass subsidized housing that allowed the labor force to continue to get by on low wages (Amsden, 1995). Overall, East Asian countries did increase their reliance on FDI, but this did not translate into a lesser role for government as FDI was liberalized selectively. Nevertheless, even when it appears that FDI policy can be formulated so as to bring about economic development, this does not tell us anything about the effect of such policies on human development. (c) FDI policy’s influence on the FDI–human development relationship Stiglitz (2006) claims that a narrow focus on GDP growth often comes at the expense of other factors that are needed for human development, such as health and education. Ultimately, the purpose of development is to enhance the lives we lead and to provide us with the capabilities to achieve our legitimate aims in life. Stiglitz argues that success in development “means sustainable, equitable, and democratic development that focuses on increasing living standards, not just on measured GDP” (2006, p. 44). For true development, Stiglitz believes that not only are markets essential but also that governments are equally important. And the role of government is to figure out what is the right balance between markets and government, which varies by country and over time. He goes on to say that potential areas for government involvement are in providing education, legal frameworks, infrastructure, a social safety net, and in regulating competition, banks, and environmental impacts (2006, pp. 48, 49). Similarly, Sen (1999) argues that social, political, and economic institutions influence our access to those things which are essential for enabling us to achieve our aims, namely, good health, basic education, and employment opportunities. While it may be argued that economic wealth will lead to the availability of these other components, Sen (1999) cites several examples where this is not the case. He points out that as a group, African American men in the United States have less of a chance of reaching advanced ages than people in China, Sri Lanka, Jamaica, or Costa Rica (Sen, 1999, p. 21). Thus, living in an economically rich country may not be a sufficient condition for flourishing and human development. Addition-

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ally, he claims that, in fact, the causal arrow can go in the opposite direction and that an increase in capabilities can actually increase economic growth. The difference in the recent economic growth in China and India, for example, is partly attributable to the two countries’ different approach to the availability of capabilities. China focused on education and the availability of health care for its citizens, while in India, half of its adult population was illiterate when it opened itself to the market economy in 1991 (Sen, 1999, p. 42). Thus, in understanding human development, one should not simply assume that economic development is the primary or only component. When considering development in this broader sense, the influence of FDI is somewhat ambiguous. Although FDI may lead to overall economic growth in the aggregate, it can hamper development of local firms and human development for the long term. Moreover, even if we focus on economic development alone, it does not appear that more liberal FDI policies necessarily lead to greater economic development. For example, one of the lessons of economic development in Asia is that there can be a natural tension between the objectives of MNCs and the goal of economic development, and that FDI policy can play a significant role in ensuring that economic development takes precedence. It stands to reason, then, that FDI policy might play a similarly important role in ensuring that human development takes precedence over the objectives of MNCs. The question to be asked, then, is this: Just as in the case of economic development, does FDI contribute more to human development when it is directed and channeled into areas where the country wants to develop and needs help in doing so? This is a question that has not been widely explored empirically, but one might think that the relationships would be similar. Two of the fastest growing developing countries, China and India, for example, clearly have taken a path toward development that focuses and constrains FDI into areas that the state views as instrumental to the countries’ overall development. Moreover, their improvement in human development has been significant both absolutely and relative to other countries. Using the United Nations Development Program’s (UNDP’s) Human Development Index (HDI) as an indicator of human development and looking at the countries for which the UNDP calculated an HDI in 1980 (UNDP, 2007/2008), China improved in HDI rank from 78th in 1980 to 57th in 2005, and, similarly, India improved from 94th to 83rd. Other countries that had restricted FDI policies and improved their HDI rank during 1980–2005 are the following: Indonesia from 83rd to 72nd; Malaysia 62nd to 48th; Oman 81st to 44th; Mexico 44th to 41st; and Tunisia 74th to 63rd. In comparison, some countries that have liberal FDI policies that allow foreign investors to pursue their objectives unhindered do not always achieve improvement in human development relative to other countries. Both Jamaica and Zambia, for example, have liberal FDI policies and have fallen in HDI rank during 1980–2005: Jamaica dropped from 62nd to 70th, and Zambia fell from 95th to 114th. Thus, it may be that those countries that adopt restrictive FDI policies which allow them to strategically use FDI and prioritize the state’s objective, namely, improvement in human development, rather than the objectives of MNCs, may be more successful in achieving this aim. In summary, the government plays a large role in how FDI contributes to economic development. Policy can favor either the objectives of the foreign investor or those of the state. It is, however, by using FDI strategically and discriminately that economic growth is more likely to occur. Since foreign inves-

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tors’ primary concern is its self-interest, government controls are required to align FDI with the state’s objectives. The restrictive FDI policies may not lead to the highest volume of FDI, but it more likely will have a positive effect on economic development. Similarly, it may be the case that government plays a large role in how FDI contributes to human development. Policy can favor either the objectives of the foreign investor or those of the state, and it may be that by using FDI strategically and discriminately that human development is more likely to occur. This leads us to the following hypotheses: Hypothesis 1. FDI inflows will be more positively related (or less negatively related) to improvements in human development when countries restrict the economic sectors in which foreign investors may operate. Hypothesis 2. FDI inflows will be more positively related (or less negatively related) to improvements in human development when countries maintain policies that favor domestic investors over foreign investors. This assumes, however, that the state’s objective is improvement in human development, which may not always be the case. All too often, corrupt governments are more concerned with the welfare of its members and the elite than with human development of its citizens. This leads us, then, to our third hypothesis: Hypothesis 3. FDI inflows will be more positively related (or less negatively related) to improvements in human development when corruption within the country is limited. 3. DATA AND METHODS (a) Sample Our sample consists of a panel data set from 49 developing countries over the time period of 1980–2005, which allows us to control for unobserved sources of country differences. Due to some missing dependent variable data during this period for some countries, our maximum number of data points is 904. Throughout the sample period, we have some missing data on the independent variables, which reduce our data set for each model differently. Our sample focuses on lesser developed countries because our hypotheses are concerned with the impact of FDI on human development. If human development is already high in a country, it will be difficult to see the effect of FDI in these areas. Additionally, the relationship between FDI and economic development has been shown to be different for lesser developed countries and developed countries (Blonigen & Wang, 2005), and, thus, it is plausible that the relationship between FDI and human development would also be different. While the countries were chosen partly because of the availability of FDI policy data, the sample is a good distribution of lesser developed countries relative to region, level of FDI, type of FDI policy, and development level. The country characteristics can be seen in Tables 1–8, which show the range of values of observed measures for each country over the sample period. Looking at our sample of 49 developing countries from 1980 to 2005, 21 of these countries changed their FDI policies in the two areas of policies that we examine from some form of restrictions to completely liberal policies. No countries in our data set changed their policies in the other direction, that is to say, from liberal policies to restrictive ones. Of the 21 countries that did change, two of them modified their policies by opening up virtually all economic sectors to foreign investors, 11 of them eliminated any policies that discriminated

against foreign investors in favor of domestic ones, and 8 countries became more liberal in both areas (see Fig. 1). Of the eight countries that both eliminated barriers to entry for foreign investors for virtually all economic sectors and removed any policies that discriminated against foreign investors (see Table 1), seven of the eight saw an increase in HDI over the sample period (only South Africa did not). In looking at the percent improvement in HDI per year on average during the time period when a country had the less liberal policies and comparing it to the value when the policies became more liberal, four countries showed a higher percentage improvement in HDI per year when policies were restrictive (Algeria, Egypt, El Salvador, and South Africa), and four did better when the policies removed the restrictions (Colombia, Nicaragua, Madagascar, and Paraguay). But in terms of FDI dollars’ contribution to improvements in HDI, all eight countries showed that it did more with its FDI dollars in improving HDI (i.e., percent change in HDI per year per average FDI per capita) when policies were less liberal. Of our sample of 49 developing countries, the 13 countries that continued with policies that both restricted some economic sectors in which FDI could participate and discriminated against foreign investors in favor of domestic ones (see Table 2), all saw an increase in HDI over the sample period except for Namibia, which has a lower HDI at the end of the sample period. The countries that did the best in terms of improvement in HDI are Oman, China, India, and Indonesia, with percent change in HDI per year over the sample period of 1.88%, 1.50%, 1.44%, and 1.41%, respectively. Looking at the contribution of FDI, the percent improvement in HDI per year per FDI per capita dollar (in millions) shows for the four countries 0.02%, 0.08%, 0.81%, and 0.26%, respectively. Thus, while Oman had the highest gains in HDI during 1980–2005, India seems to be doing the most with its FDI investment in terms of improving HDI. But how does this compare to countries that had liberal FDI policies throughout the period? Of the 49 developing countries in our sample, seven countries had liberal policies throughout the entire sample period (see Table 3). The reason for this may be that, for most of the countries in this group, we did not have data for the decade of the 1980s, a decade when many countries still had less liberal policies. Two of these countries had a lower measure of HDI at the end of the sample period than at the beginning (Cote D’Ivoire and Zambia). In comparing a country in this group that had liberal policies and one from the group that had restrictive policies, let us look at Lebanon and the Philippines. Lebanon, had a similar measure of HDI in 1995 to that of the Philippines: 0.730 and 0.739, respectively. Lebanon, with liberal policies and a considerable amount of FDI, increased to an HDI of .772 in 2005. The Philippines, on the other hand, had restrictive policies for the entire period and small amounts of FDI. Its HDI increased to .771 in the same period. So with restrictive policies and little FDI, the Philippines increased in HDI at virtually the same amount as Lebanon, which had liberal FDI policies and significant amounts of FDI. Another comparison of two countries, one that had restrictive policies and one that did not, is one of Malaysia and Jamaica. Malaysia attracted a considerable amount of FDI even though its policies were restrictive for the entire sample period, and its HDI results were quite impressive, increasing from .662 to .811 from 1980 to 2005. Jamaica also had a considerable amount of FDI but, unlike Malaysia, its policies were quite liberal for the entire period. It did not fair as well as Malaysia, however, in HDI, moving from .689 to .736 over the same time period.

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Table 1. Sample countries characteristics for countries with FDI policies changed: Restr. and Discrim R = Yes, D = Yes ! R = No, D = Noa Country

FDI per capita (avg., millions)b

Corr. index (avg.)c

HDId

‘80s/chg yr

‘90s/chg yr

‘00s

‘80s

‘90s/chg yr

‘00s

‘80

‘90

‘05

1.6 15.0 17.4 2.6 0.7 1.0 7.2 0.6

8.1 54.6 12.5 23.6 1.6 20.9 31.4 19.0

27.8 83.9 22.0 47.9 4.9 41.4 9.5 52.3

2.6 3.4 2.9 3.6 1.7 3.0 1.5 5.6

2.6 2.9 2.9 3.6 1.7 2.9 1.5 5.5

2.7 3.7 3.3 3.9 2.3 2.5 1.8 4.8

.562 .694 .482 .590 .444 .593 .701 .670

.668 .739 .641 .711 .469 .671 .726 .722

.733 .791 .708 .735 .533 .710 .755 .674

Algeria (chg = ‘94) Colombia (chg = ‘92) Egypt (chg = ‘98)e El Salvador (chg = ‘99)e Madagascar (chg = ‘96) Nicaragua (chg = ‘00)e Paraguay (chg = ‘92) South Africa (chg = ‘98)

a R = Restricted sectors policies: Yes = restricted sectors; No = no restricted sectors; D = Discrimination policies: Yes = discriminate against foreign investors; No = equal treatment of foreign and domestic investors. Arrow indicates direction of a change in policy. b UNCTAD (1980–2005). c Transparency International (1995–2007). d UNDP (2007/2008). e FDI and Corr. index have 1980s data in “80s” column and 1990-change year in “90s” column.

Table 2. Sample countries characteristics for countries with FDI policies. Restricted = Yes, Discr = Yes R = Yes, D = Yes for sample perioda

Corr. index (avg.)c

FDI per capita (avg., millions)b

HDId

Country

‘80s

‘90s

‘00s

‘80s

‘90s

‘00s

‘80/1st yr

‘90/1st yr

‘05/last yr

China Ghana Honduras India Indonesia Malaysia Mexico Namibia (‘95–‘03) Oman Philippines Tunisia Uganda (‘88–‘05) Vietnam (‘85–‘00)

1.5 0.7 5.7 0.1 1.9 62.8 31.4 – 82.2 5.7 25.7 0.1 0.1

24.2 6.2 15.2 1.5 11.2 236.5 91.6 53.9 44.3 17.4 47.0 3.2 17.9

42.8 5.5 63.8 4.9 1.5 126.1 213.9 114.8 175.6 14.6 69.3 8.6 16.3

2.2 3.3 1.7 2.8 1.9 5.3 3.2 – 6.3 2.8 5.0 2.6 2.5

2.7 3.3 1.8 2.8 1.9 5.3 3.2 5.3 6.3 2.9 5.0 2.6 2.5

3.4 3.5 2.6 2.8 1.9 5.0 3.6 5.3 6.3 2.7 5.0 2.3 2.5

.559 .471 .578 .450 .533 .662 .739 – .547 .688 .575 .428 .590

.634 .517 .634 .521 .626 .725 .768 .698 .697 .721 .662 .434 .620

.777 .553 .700 .619 .728 .811 .829 .653 .814 .771 .766 .505 .711

a

R = Restricted sectors policies: Yes = restricted sectors; D = Discrimination policies: Yes = discriminate against foreign investors. UNCTAD (1980–2005). Transparency International (1995–2007). d UNDP (2007/2008). b c

Table 3. Sample countries characteristics for countries with FDI policies: Restr. = No; Discrim. = No R = No; D = No for sample perioda

Corr. index (avg.)c

FDI per capita (avg., millions)b

HDId

Country

‘80s

‘90s

‘00s

‘80s

‘90s

‘00s

‘80

‘90/1st yr

‘05

Bolivia (‘90–‘05) Cote D’Ivoire (‘95–‘05) Jamaica Lebanon (‘95–‘05) Malawi (‘91–‘05) Niger (‘90–‘05) Zambia (‘91–‘05)

– – 3.4 – – – –

54.5 20.1 89.6 214.1 1.0 1.2 14.1

41.7 13.8 225.2 489.9 4.0 1.3 23.5

– – 3.8 – – – –

2.8 2.7 3.8 3.0 4.1 2.2 3.5

2.3 2.3 3.8 3.0 3.1 2.2 2.7

– – .689 – – – –

.606 .436 .713 .730 .399 .279 .469

.695 .432 .736 .772 .437 .374 .434

a

R = Restricted sectors policies: No = no restricted sectors; D = Discrimination policies: No = equal treatment of foreign and domestic investors. UNCTAD (1980–2005). Transparency International (1995–2007). d UNDP (2007/2008). b c

Of the five countries that had liberal policies for the entire sample period, Niger, Bolivia, and Malawi had the largest increase in HDI per year during the period, with 2.13%, 0.92%,

and 0.63% improvement per year, respectively. In looking at the contribution of FDI to HDI improvement for the three countries, the percent increase in HDI per year per FDI per

1684

WORLD DEVELOPMENT Table 4. Sample countries characteristics for countries with FDI Policies. Restricted = Yes, Discr = No

R = Yes; D = No for sample perioda

Corr. index (avg.)c

FDI per capita (avg., millions)b

HDId

Country

‘80s

‘90s

‘00s

‘80s

‘90s

‘00s

‘80/1st yr

‘90/1st yr

‘05

Bangladesh Kenya Morocco (‘95–‘05) Panama Peru (‘91–‘05) Thailand Turkey (‘95–‘05)

0.0 1.6 – (2.2) – 10.0 –

1.4 0.8 26.0 180.4 72.1 54.9 12.7

3.3 1.5 48.1 209.7 60.2 82.9 46.6

0.4 2.5 – 3.7 – 2.8 –

0.4 2.5 3.9 3.7 4.5 2.9 3.6

1.1 2.0 3.6 3.5 3.9 3.4 3.4

.365 .514 – .737 – .654 –

.422 .556 .581 .752 .715 .712 .717

.547 .521 .646 .812 .773 .781 .775

a

R = Restricted sectors policies: Yes = restricted sectors; D = Discrimination policies: No = equal treatment of foreign and domestic investors. UNCTAD (1980–2005). Transparency International (1995–2007). d UNDP (2007/2008). b c

Table 5. Sample countries characteristics for countries with FDI policies changed. Discrim. R = Yes, D = Yes ! R = Yes, D = Noa

FDI per capita (avg., millions)b

Country

‘80s/chg yr ‘90s/chg yr

Armenia (R: ’95–‘05); (D: ’92–‘05, chg = ’95) Brazil (chg = ‘95) Dominican Rep (chg = ’95) Ecuador (‘80–‘95; chg = ’93) Ethiopia (‘85–‘05; chg = ’93) Guatemala (chg = ’98) Jordan (chg = ’95) Mauritius (chg = ’01)e Nigeria (chg = ’95) Saudi Arabia (chg = ’01)e Venezuela (chg = ’93)

– 11.9 14.3 10.5 0.0 14.2 13.0 9.9 8.2 212.6 17.7

28.0 108.8 70.5 44.8 1.5 14.1 37.2 43.9 13.1 13.7 114.5

‘00s

Corr. index (avg.)c

HDId

‘80s/chg yr ‘90s/chg yr ‘00s ‘80/1st yr Chg Yr ‘05/last yr

49.0 107.1 102.4 – 7.1 25.8 131.3 19.7 17.1 135.1 100.7

– 2.7 3.1 2.3 3.2 3.1 4.7 5.0 1.9 4.5 2.6

2.5 3.7 3.1 2.3 3.2 2.9 4.7 4.9 1.8 4.5 2.5

2.9 3.9 3.2 – 2.9 2.6 4.9 4.3 1.5 4.1 2.5

– .685 .660 .678 .311 .550 .647 .662 .378 .666 .737

.701 .753 .723 .726 .341 .659 .710 .786 .432 .793 .767

.775 .800 .779 .734 .406 .689 .773 .804 .470 .812 .792

a

R = Restricted sectors policies: Yes = restricted sectors; D = Discrimination policies: Yes = discriminate against foreign investors; No = equal treatment of foreign and domestic investors. Arrow indicates direction of a change in policy. b UNCTAD (1980–2005). c Transparency International (1995–2007). d UNDP (2007/2008). e FDI and Corr. index have 1980s data “80s” column and 1990-change year in “90s” column.

Table 6. Sample countries characteristics for countries with FDI policies. Restricted = No, Discr = Yes R = No; D = Yes for sample perioda Country Mozambique (‘93–‘05)

Corr. index (avg.)c

FDI per capita (avg., millions)b

HDId

‘80s

‘90s

‘00s

‘80s

‘90s

‘00s

‘80

‘90/1st yr

‘05

–

7.2

12.3

–

2.7

2.7

–

.328

.384

a

R = Restricted sectors policies: No = no restricted sectors; D = Discrimination policies: Yes = discriminate against foreign investors.’ UNCTAD (1980–2005). c Transparency International (1995–2007). d UNDP (2007/2008). b

capital dollar (in millions) was 1.73%, 0.02%, and 0.28%, respectively. Thus, other than Niger, which had relatively little FDI, contribution of FDI to HDI seemed to be greater in countries that had less liberal policies. In terms of percent improvement per year in HDI, Niger did the best with a 2.13%, which is better than any country that had restrictive policies. The next best country in terms of HDI improvement was Bolivia, which increased its HDI on average 0.92% per year over the sample period. When one considers the contribution of FDI toward HDI improvement, Niger has so little FDI that it does well with 1.73% change in HDI per year per FDI per capita dollar (in millions). Bolivia does not do as well as

most of the countries that had restrictive policies: Bolivia’s 0.02% improvement in HDI per year per FDI dollar (in millions) is less than the same measure for 10 of the 13 countries with the restrictive policies for the entire sample period. (b) Measures (i) Dependent variables Improvement in human development. We used the UNDP’s (2007/2008) Human Development Index (HDI) to develop a measure of improvement in human development. This index was designed with the specific intention of creating a measure

HUMAN DEVELOPMENT AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES

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Table 7. Sample countries characteristics for countries with FDI policies changed: Discrim. R = Yes, D = Yes ! R = No, D = Yesa

Corr. index (avg.)c

FDI per capita (avg., millions)b

HDId

Country

‘80s

‘90s/chg yr

‘00s

‘80s

‘90s/chg yr

‘00s

‘80

‘90

‘05

Pakistan (chg = ’97)e

0.9

3.5

5.3

2.3

2.3

2.4

.394

.505

.551

a R = Restricted sectors policies: Yes = restricted sectors; No = no restricted sectors; D = Discrimination policies: Yes = discriminate against foreign investors. Arrow indicates direction of a change in policy. b UNCTAD (1980–2005). c Transparency International (1995–2007). d UNDP (2007/2008). e FDI and Corr. index have 1980s data “80s” column and 1990-change year in “90s” column.

Table 8. Sample countries characteristics for countries with FDI policies changed: Discrim. R = Yes, D = No ! R = No, D = Noa

FDI per capita (avg., millions)b

Country

‘80s

‘90s/chg yr

‘00s

‘80s

‘90s/chg yr

‘00s

‘80

‘90

‘05

–

11.5

5.1

–

3.4

3.1

–

.459

.499

Senegal (‘97–‘05; chg = ’01)

Corr. index (avg.)c

HDId

a

R = Restricted sectors policies: Yes = restricted sectors; No = no restricted sectors; D = Discrimination policies: No = equal treatment of foreign and domestic investors. Arrow indicates direction of a change in policy. b UNCTAD (1980–2005). c Transparency International (1995–2007). d UNDP (2007/2008).

We interpolated the values for years between these 5-year end-points. We are interested in the improvement in HDI as a function of our independent variables. The improvement in HDI is the difference between HDI in year t and year t  1. Improvement in life expectancy. We test a couple of the indices of the HDI to see if they verify the results of HDI. First, we look at the year-over-year change in life expectancy at birth. Similar to the HDI index, the United Nations Population Division database (2008), which we used, provides data in 5year increments, and we interpolate for years in between. The improvement in life expectancy is the difference between life expectancy in year t and year t  1. Improvement in adult literacy. The second component of HDI that we look at is literacy of the population over the age of 15 years. We calculate the literacy rate from the adult illiteracy rate provided by the UNESCO data set (1980– 2005), which was given for every year in our sample. We use the year-over-year change in literacy. The improvement in adult literacy is the difference between adult literacy in year t and year t  1. Figure 1. Country policy movement.

that took into account human development as well as economic development. Modeled after Sen’s (1999) capabilities approach, the index incorporates three dimensions of development: health, education, and income. An index is calculated for each of the three dimensions, which are then combined to calculate the HDI. The health dimension is represented by the measure of life expectancy at birth, from which a life expectancy index is calculated. The education dimension is represented using adult literacy and the gross enrollment ratio, from which an education index is calculated. The income dimension is represented by GDP per capita, from which a GDP index is calculated. The HDI is calculated using a simple average of the three indices: life expectancy, education, and GDP. See Table 9 for the formulas of the indices. The source of our data was the UNDP Human Development Report of 2007–2008 (UNDP, 2007/2008), which provided HDI trends from 1975 to 2005 in 5-year increments.

(ii) Independent variables Foreign direct investment inward flow. Many studies that investigate the relationship between FDI and economic growth or development use FDI stock as a percent of GDP or FDI flow as percent of gross fixed capital formation. We have chosen, rather, to use FDI inflow per capita because we are primarily concerned with the effect on the population and human development, which we think is better captured in a measure of per capita rather than as a percent of GDP. A per capita measure also controls for population. Our measure of FDI inflow per capita (in millions) is as defined by the United Nations Conference on Trade and Development (UNCTAD), the components of which consist of equity capital, reinvested earnings, and other capital (e.g., intra-company loans). Our data were obtained from the online UNCTAD World Investment Report database (UNCTAD, 1980–2005). To take into account the effect of FDI over time, this variable is lagged by 1–4 years. Restricted sectors for foreign investors. Our model consists of two types of FDI policy variables to reflect state control over

1686

WORLD DEVELOPMENT Table 9. HDI calculation

Dimension index ¼

–

–

Max value 85 100 100 40,000

Min value 25 0 0 100

actual value  min value max value  min value

Goal posts for each dimension Indicator Life expectancy at birth (years) Adult literacy rate (%) Combined gross enrollment ratio (%) GDP per capita (PPPUS$) Education index calculation EducationIndex = 2/3  adult_literacy_rate + 1/3  gross_enrollment Index GDP index calculation GDP Index = (log(actual_value  log(min_value))/(log(max_value)  log(min_value)) HDI calculation HDI = 1/3  Life Exp. Index + 1/3  EducationIndex + 1/3  GDP Index UNDP (2007/2008).

FDI. The first is policy that defines the economic sectors in which foreign investors may operate. We use a dichotomous measure. The values were determined from four sources: the World Trade Organization’s Trade Policy Reviews (1995– 2006), Economist Intelligence Unit’s Country Commerce Reports (1996–2003), UNCTAD’s Investment Policy Review Reports (1999–2005), and U.S. Department of State’s Country Reports on Economic Policies and Trade Practices (2001). We reviewed available full reports for each country to determine the law for each year in our sample period. If the law in effect for a given year prohibits FDI in any economic sector, other than those related to national defense arms and ammunition, this measure is assigned a value of one for the given year, otherwise, it is assigned a value of zero for that year. If our sources do not address the topic, the field is left blank. Foreign investor discrimination. The second FDI policy measure that we use to reflect state control over FDI is the treatment of foreign investors relative to domestic investors, which is also a dichotomous measure. The same four sources that were used to determine FDI sector restrictions were used to determine discrimination policy. We assess whether foreign investors have the same rights and are treated equally relative to domestic investors. It may be the case that foreign investors undergo greater scrutiny and must conform to different standards with regard to the following business activities: investment approval, labor hiring and firing, and dispute resolution. We reviewed the available full reports for each country to determine the law for each year in our sample period. If the law in effect in a given year discriminates against foreign investors in any of these areas, this measure is assigned a value of one; otherwise it is assigned a value of zero. If our sources do not address the topic, the field is left blank. Corruption. We use Transparency International’s Corruption Perception Index (1995–2007) as a proxy for the level of corruption in each country. This is a measure of the degree to which corruption is perceived to exist in public officials and politicians in the country. The index is calculated using a combination of assessments by country analysts and surveys of business people. The index value ranges from 0 (highly corrupt) to 10 (highly clean). This index is relatively new and does not cover the earliest years of our sample period (1995 is the first year the index was published). We assume a corruption index value of the first year it was published for years prior to the said year.

(iii) Control variables Foreign aid. The availability of resources to provide access to capabilities needed for human development may be greatly influenced by the amount of foreign aid a country receives. To control for this effect, our model incorporates a weighted amount of official development assistance (ODA) received in our sample period. The source of our data is the United Nations Statistical Database (2008). We control for country population by using the per capita amount of ODA (in millions). 4. ANALYSIS AND RESULTS All explanatory and control variables are lagged 1–4 years, reducing concerns of reverse causality and avoiding simultaneity. The panel is unbalanced as some countries had missing values during the window of observation. We estimate our models using panel linear regression with country fixed effects to control for all unobserved, temporally stable country differences. By using a fixed effects model, it is unnecessary to control for specific country level factors that do not vary across time in the sample such as initial wealth endowments, initial levels of human development, or national culture. These factors will be subsumed by the country-level fixed effect (i.e., dummy variable). Because the impact of foreign direct investment flows is not likely to be felt immediately in terms of human development, we used a distributed lag model (Judge, Hill, Griffiths, Lutkepohl, & Lee, 1988). The one-period, two-period, three-period, and four-period lagged values for all independent variables were included as covariates. To be conservative, all significance tests in our models are two-tailed tests, even though, in principle, one-tailed tests would have been statistically justified because of the directionality of our hypotheses (Neter, Kutner, Nachtsheim, & Wasserman, 1996). Table 10 reports the means, standard deviations, and correlation coefficients between the dependent, independent, and control variables. In hypothesis 1, we suggest that FDI flow will have a stronger positive (or weaker negative) influence on improvements in human development when the country has FDI policies that restrict foreign investors from entering some sectors. Table 11, Model 1 provides a test of the influence of the interaction between FDI flow and FDI restrictions on the improvement in the human development index. A positive interaction term

HUMAN DEVELOPMENT AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES

would be consistent with the hypothesis. As speculated, the influence is somewhat delayed and the fourth lag is significantly positive (p < .01). Based on the empirical model, an increase in FDI flow from the sample mean to one standard deviation above the mean decreased year-to-year improvement in HDI by 11% when there are no restrictions. However, when there are FDI restrictions, the same increase in FDI flow had virtually no influence on HDI improvement. Thus, our results suggest that restrictions on FDI buffer against the negative as-

1687

pects of foreign direct investment with regard to human development. In hypothesis 2, we suggest that FDI flow will have a stronger positive (or weaker negative) influence on human development when the country has discriminatory policies toward foreign investors. Table 11, Model 2 provides the analysis to test this hypothesis. We find a significant and positive interaction between FDI flow and discrimination at the four-year lag (p < .001). Based on the empirical model, an increase in FDI

Table 10. Correlations among dependent, independent, and control measures

1 2 3 4 5 6 7 8

Variables

Mean

SD

1

2

3

4

5

6

7

Human Development Index Life expectancy Adult literacy rate Foreign aid (mil/per capita) Restricted sectors for foreign investors Foreign investor discrimination Corruption FDI flow (mil/per capita)

.63 63.93 69.72 .03 .80 .61 3.15 .03

.13 8.25 19.26 .03 .40 .49 1.17 .08

– .91 .83 .08 .14 .00 .42 .33

– .63 .08 .15 .03 .34 .28

– .00 .04 .11 .19 .23

– .28 .11 .10 .05

– .52 .09 .05

– .13 .11

– .26

Table 11. The influence of FDI flow on the improvement in Human Development Index Variable

Model 1

Model 2

Model 3

Constant Aidt  1 Aidt  2 Aidt  3 Aidt  4 FDI restrictionst  1 FDI restrictionst  2 FDI restrictionst  3 FDI restrictionst  4 FDI discriminationt  1 FDI discriminationt  2 FDI discriminationt  3 FDI discriminationt  4 Corruptiont  1 Corruptiont  2 Corruptiont  3 Corruptiont  4 FDI flowt  1 FDI flowt  2 FDI flowt  3 FDI flowt  4 FDI flow  restrictionst  1 FDI flow  restrictionst  2 FDI flow  restrictionst  3 FDI flow  restrictionst  4 FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  corruptiont  1 FDI flow  corruptiont  2 FDI flow  corruptiont  3 FDI flow  corruptiont  4 R2

.0071 .0219** .0104 .0056 .0062 .0009 .0007 .0010 .0006 .0018 .0014 .0014 .0014 .0010 .0010 .0014 .0008 .0126* .0140* .0050 .0149*** .0066 .0077 .0045 .0152**

.0063 .0228*** .0098 .0059 .0072 .0009 .0007 .0010 .0008 .0017 .0012 .0018 .0018 .0010 .0009 .0013 .0008 .0099* .0098* .0117* .0137***

.0066 .0223** .0105 .0065 .0074 .0008 .0005 .0013 .0011 .0019 .0016 .0012 .0014 .0012 .0012 .0012 .0006 .0029 .0027 .0254 .0378**

.0046 .0039 .0145 .0180***

1 2 3 4

.023

n = 868, conservative two-tailed tests used for all relationships. Fixed country-level effects are included but not shown for the sake of brevity. * p < 0.05. ** p < 0.01. *** p < 0.001.

.028

.0027 .0014 .0056 .0090* .025

1688

WORLD DEVELOPMENT

flow from the sample mean to one standard deviation above the mean decreased year-to-year improvement in HDI by 3% when there are no discriminatory policies. However, when there are discriminatory policies, the same increase in FDI flow had no influence on HDI improvement. We find somewhat similar support regarding discriminatory policies when considering their influence on life expectancy (Table 12, Model 2) and adult literacy Table 13, Model 2). In hypothesis 3, we suggest that FDI flow will have a stronger positive (or weaker negative) influence on the improvement in human development when the corruption of the country is limited. Table 11, Model 3 provides the results. A positive and significant interaction coefficient involving FDI flow and corruption is indicative of a stronger positive relationship between FDI flow and HDI improvement when corruption is low. The fourth lag of the interaction term is significant (p < .05) (Table 11, Model 3) providing some support for hypothesis 3. Based on the empirical model, an increase in FDI flow from the sample mean to one standard deviation above the mean decreased HDI improvement by 7% when corruption was high (i.e., corruption is greater than the mean by one standard deviation). In contrast, an increase in FDI flow from the sample mean to one standard deviation

above the mean increased HDI improvement by 3% when corruption was low (i.e., corruption is less than the mean by one standard deviation). Somewhat similar results are found for improvements in life expectancy and adult literacy (Table 12, Model 3 and Table 13, Model 3). 5. DISCUSSION The effect of FDI on economic growth in developing countries is an important question and has been widely studied. While policymakers strongly believe that FDI is an important element in economic growth, past empirical studies are divided on how important FDI really is. It has been argued that this lack of consensus is partly due to inadequate methodologies, which has shifted the field to use panel studies, a model that can more adequately address this research question. A second explanation for the variance in results is a disregard for country characteristics and policies. Additionally, there is an increasing skepticism of the linkage between economic development and a broader notion of development, one in which humans can flourish (Sen, 1999; Stiglitz, 2006). Past studies looking at the relationship between FDI and development

Table 12. The influence of FDI flow on the improvement in life expectancy Variable

Model 1

Model 2

Model 3

Constant Aidt  1 Aidt  2 Aidt  3 Aidt  4 FDI restrictionst  1 FDI restrictionst  2 FDI restrictionst  3 FDI restrictionst  4 FDI discriminationt  1 FDI discriminationt  2 FDI discriminationt  3 FDI discriminationt  4 Corruptiont  1 Corruptiont  2 Corruptiont  3 Corruptiont  4 FDI flowt  1 FDI flowt  2 FDI flowt  3 FDI flowt  4 FDI flow  restrictionst  1 FDI flow  restrictionst  2 FDI flow  restrictionst  3 FDI flow  restrictionst  4 FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  corruptiont  1 FDI flow  corruptiont  2 FDI flow  corruptiont  3 FDI flow  corruptiont  4 R2

.7718 .1852 .4968 .4220 .9864 .1450 .0305 .1429 .0121 .1366** .0111 .0669 .1453** .0554 .0285 .0139 .1117* .1118 .0552 .0904 .7150 .3602 .1115 .2815 .4739

.7294 .1901 .4878 .3867 .9657 .1418 .0340 .1385 .0223 .1477** .0168 .0745 .1282* .0540 .0284 .0077 .1081* .0889 .0949 .0776 .6504***

.8128 .2040 .4897 .3250 .8946 .1380 .0242 .1323 .0400 .1251* .0091 .0719 .1195* .0424 .0235 .0293 .1243** .0854 .2667 1.2930* 2.5471*

.8500 .1294 .3678 .4669*

1 2 3 4

.154

n = 904, conservative two-tailed tests used for all relationships. Fixed country-level effects are included but not shown for the sake of brevity. * p < 0.05. ** p < 0.01. *** p < 0.001.

.161

.0096 .0937 .3492* .5459* .177

HUMAN DEVELOPMENT AND FOREIGN DIRECT INVESTMENT IN DEVELOPING COUNTRIES

1689

Table 13. The influence of FDI flow on the improvement in adult literacy Variable

Model 1

Model 2

Model 3

Constant Aidt  1 Aidt  2 Aidt  3 Aidt  4 FDI restrictionst  1 FDI restrictionst  2 FDI restrictionst  3 FDI restrictionst  4 FDI discriminationt  1 FDI discriminationt  2 FDI discriminationt  3 FDI discriminationt  4 Corruptiont  1 Corruptiont  2 Corruptiont  3 Corruptiont  4 FDI flowt  1 FDI flowt  2 FDI flowt  3 FDI flowt  4 FDI flow  restrictionst  1 FDI flow  restrictionst  2 FDI flow  restrictionst  3 FDI flow  restrictionst  4 FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  discriminationt  FDI flow  corruptiont  1 FDI flow  corruptiont  2 FDI flow  corruptiont  3 FDI flow  corruptiont  4 R2

.8869 .0167 .0646 .0979 .4697 .0059 .0111 .0172 .0252 .1078* .0254 .0235 .0359 .0213 .0598* .0344 .0666* .5380 .0896 .1525t .1370 .1045 .3929t .4592t .0711

.8188 .0000 .1302 .0621 .4781 .0038 .0014 .0108 .0358 .1198 .0304 .0435 .0180 .0255 .0552 .0353 .0582 .3264** .0793 .1261 .1742*

.8876 .0556 .1394 .0386 .4125 .0133 .0056 .0013 .0361 .0980* .0263 .0268 .0182 .0374 .0664** .0257 .0702* .0807 1.0901* .5103 .9685

.8626* .3433* .8074* .1147

1 2 3 4

.17

.21

.1714 .3290* .1852 .2177 .20

n = 807, conservative two-tailed tests used for all relationships. Fixed country-level effects are included but not shown for the sake of brevity. t p < 0.1. * p < 0.05. ** p < 0.01.

have focused primarily on economic factors, with the assumption that economic growth will lead to human development. But there is evidence that such an assumption is not valid. Our study tries to address each of these issues by using a panel study to look at the interaction between FDI and FDI policy and the effect it has on human development. The two types of policies we investigate are economic sector restrictions and discrimination. Additionally, we look at the interaction between FDI and corruption and its effect on human development. In this paper, we suggest that while FDI may promote economic growth in developing countries, it is not a certainty. If brought in strategically, FDI can contribute to a country’s development directly by providing capital and jobs, and indirectly through technology spillovers. If left to its own devices, however, FDI may increase industry concentration, drive out domestic firms, and not pass on advanced techniques and technologies to domestic investors. Foreign investors’ primary interest is profit and not national development. Thus, it is more likely that FDI will promote human development only when FDI policy ensures that FDI aligns with and promotes development. Accordingly, policies that restrict foreign investors to sectors of the economy where foreign expertise is needed and that, when possible, favor domestic investors over

foreign ones so that a strong local economy can be established, we hypothesize, will more likely ensure that FDI contributes to improvements in human development. Additionally, corrupt governments can block human development improvements that might arise from FDI, and, thus, we hypothesize that high levels of corruption will negatively influence the positive effect that FDI can have on human development. We find that when countries have policies that restrict foreign investors from entering some sectors, FDI has a more positive influence on improvement in human development. This suggests that, possibly, foreign investment’s contribution to development is enhanced when it is restricted to those sectors where foreign expertise is needed to promote development. Additionally, we found that FDI inflow decreased year-toyear improvement in HDI when there were not discriminatory policies in place. Similar results were found when considering the effect on improvement in life expectancy. A possible explanation of this result is that when domestic investors are given preferential treatment over foreign investors, it may be the temporary boost needed to grow and compete, leading to more sustainable and organic growth and development. Finally, we found that FDI inflow decreased improvement in HDI when corruption was high. This result is strengthened

1690

WORLD DEVELOPMENT

by similar results when looking at the effect on improvement in life expectancy and adult literacy. This suggests that corruption obstructs the benefits of FDI from reaching the population. While these results are tentative, they do suggest that when constraints are put on foreign investors, a country is more likely to see improvements in human development. When foreign investors are allowed free access, the effect it has on human development depends on the whether or not foreign investors’ objectives align with those that will promote human development, which would be merely fortuitous. Clearly, this is all dependent on whether the country elite, those that are making or influencing policy, are committed to human development, and, thus, corruption is an issue. Restricting economic sectors from FDI and discriminating against foreign investors may reduce the volume of FDI, but this study implies that the trade-off of less FDI for FDI that is strategically used is more beneficial to human development in the long run. Part of the reason for this may be that foreign investors’ primary objective is profit and not development and, thus, it may be working at cross-purposes to development. Moreover, it seems that what is important for development is that those in the host country are motivated to learn from foreign investors but are still able to participate. Domestic investors need to be able to take advantage of spillovers, which may require the existence of FDI but not direct competition with FDI. As one is learning and getting up to speed, the constraints on FDI allow for some protection from the most advanced competitors, similar to protection of infant industries. For the general host population to develop, what is help-

ful may be an overall environment that displays excellence and provides a benchmark to which one can aspire. It is not that one needs to compete or interact with excellence to more clearly understand what excellence is and what is required to achieve it. Through an environment that contains excellence, the population in the host country aspires to learn and develop capabilities. This creates an encouraging environment where aspirations are built rather than a ruthless one where hope is lost. Nevertheless, there are limitations as to what can be concluded from this study. We look at two policy conditions with a rather obtuse measure, and while they provide us with some initial findings, more detailed studies could further our understanding. The high level measure of simply the existence of restricted sectors or the existence of discrimination does not capture the intricacies of what may be happening. Whereas we treat any policies of restriction and discrimination equally in our study, the impact of some may be more severe than others. It also assumes that policymakers are correctly restraining foreign investors and using FDI in areas that make sense for development. Our study does not make any judgments as to whether this is in fact the case. An understanding of the existing capabilities and how compatible they are with restricted sectors or areas of discrimination would be an area for further research. Thus, additional studies that refine the types of restricted sectors or discrimination are needed. While the results of this study provide a preliminary understanding of the influence of FDI policy on FDI and its effect on human development, further studies are needed to parse out in more detail the influence of FDI policies.

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