A Panel Data Study on the Factors Affecting Foreign ...

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Keywords: foreign direct investments, developing countries ..... household consumption? 2) How is the study relevant in policy making for the Philippines?
A Panel Data Study on the Factors Affecting Foreign Direct Investments in the Philippines and Other Developing Asian Countries

Dinsay, Kevin Dominic Enriquez, Jeanne Margaret Lim, Marco Miguel Lopez, Tara Hocson

ABSTRACT

The economies of East Asian countries have been experiencing rapid economic growth in recent years. This growth can be partially attributed to the tremendous improvement of trade and foreign direct investments (FDI).This study aims to analyse the factors that affect of Foreign Direct Investment (FDI) in the case of the Philippines and its neighbouring developing Asian countries. Given that the increase in FDI in the Philippines, and its neighbours, was driven by the growth in capital and investment of savings. To accomplish the study, the researchers plan to use data retrieved from selected countries across time regarding capital growth, investment savings and economic growth. This panel-data study will allow for the researchers to identify the strength of the factors of foreign direct investment and its influence and relationship to economic growth. The Pooled OLS Regression Model, Fixed Effects Model (FEM), and the Random Effects Model (REM) will allow for a definitive idea on how the Philippines is faring compared to its neighbouring countries.

Keywords: foreign direct investments, developing countries JEL Classification: E60, F21

Contents INTRODUCTION ........................................................................................................................... 3 Background of the Study .......................................................................................................... 3 Statement of the Problem ........................................................................................................ 4 Significance of the Study.......................................................................................................... 5 Scope and Limitations .............................................................................................................. 5 Review of Related Literature ....................................................................................................... 5 Foreign Direct Investments in the ASEAN + India and Bangladesh ................................. 6 THEORETICAL FRAMEWORK .................................................................................................. 8 The Accelerator Effect .............................................................................................................. 8 Neo-classical Theory: The Mundell Model ............................................................................ 8 Theory of Internationalization .................................................................................................. 9 Eclectic Paradigm Theory ........................................................................................................ 9 Vernon’s Product Cycle Theory .............................................................................................. 9 OPERATIONAL FRAMEWORK................................................................................................ 10 Description of the Variables ................................................................................................... 10 Hypothesized Relationship of the Variables ....................................................................... 11 Hypothesized Model ............................................................................................................... 13 METHODOLOGY ........................................................................................................................ 13 Data ........................................................................................................................................... 13 Model Specification ................................................................................................................. 14 LSDV Model 1 .............................................................................................................................. 25 Corrective Measure................................................................................................................. 26 Policy Implications and Recommendations............................................................................. 27 References ................................................................................................................................... 30

INTRODUCTION Background of the Study According to the Organization of Economic Co-operation and Development, foreign direct investments (FDIs) are key elements in international economic integration (OECD Factbook, 2013). FDIs allow countries to progress independently through investments, which in turn, creates globalization in an environment of nurturing relationships between nations. As of late, the Philippines has been growing at an increasing pace; it has overtook other economies in terms of the country’s rate of growth. Due to its success, the region has become a preferred platform for FDIs and has also managed to attract foreign investors, primarily from the United States (Tullao, 2009).

Among the countries in Asia, Singapore has been the biggest recipient of FDIs in recent years. This boom in the economy was not a result of an overnight phenomenon but rather a long-term calculated approach in addressing economic downfall. When Singapore was expelled from Malaya in 1965, it lost most of its previous domestic market. In order to mitigate its plummeting economy, the country resorted in inviting other countries to contribute to its recovery through FDIs. By way of trade agreements, tax cuts and incentives, Singapore was able to open up its economy and attract foreign investors. Tax cuts and incentives turned out to be beneficial to the both the country and its investors; these allow international firms to avoid added costs through tax while simultaneously allowing the country to employ more individuals under the foreign businesses being put up by investors (Chen & Amin, 2013). Today Singapore is one of the most advanced, stable, and developed Asian nations that is comparable to other international superpowers. Singapore proves that FDIs are indeed essential in achieving economic development. Countries, especially developing ones, should engage in more liberalized foreign acceptances and trading regimes. The Philippines and other developing countries could adopt Singapore’s direction in order to hasten its development. The main difference between how Singapore and the rest of the world conducts its business was the incentive and the tax cuts that the Singaporean government gives to foreign investors. Until recently, what kept firms from pursuing the Philippines was the Red Tape Policy that poses certain restrictions on foreign businesses on Philippine soil. Recently, The National Competitiveness Council (NCC) has said that the red tape would be cut so that conducting businesses in the country won’t be as tedious (De Vera,

2013). This will entice investors to choose the Philippines which is very much beneficial to the country, employment and growth.

The Philippines has improved on the state of its FDIs.

But in comparison to its

neighboring Asian countries, the country is really lagging behind. With only $2.8 billion in FDI coming into the country last 2012, this is a small amount compared to neighboring countries like Singapore with $56.65 billion and Vietnam with$8.4 billion, in the spectrum of Asian countries and their FDIs, the Philippines is in the extreme (Lowe, 2013).

Foreign direct investments are expected to help develop and further encourage an economy to grow. They are an advantage for developing economies, especially the Philippines. Knowing that the role of FDI is this, there is a need to understand which factors of FDI can affect the Philippines the most.

Statement of the Problem With the prevalence of corruption in the Philippines, foreign investors are quite hesitant in making substantial investments in the country. This has become a problem that the country has to face. An example of this can be taken from the recent typhoon Yolanda wherein an order from the United Nations stated that relief goods should be shipped directly to the victims instead of passing through the government. This situation shows that nations all over the world have grown weary of trusting government officials with material things (Su, 2013). This kind of hesitance by foreign institutions can be carried on to monetary investments made in the country. Though the FDIs are steadily going up, compared to other countries in Asia, there is a vast difference in the amount that enter their country and the ones that enter the Philippines. There are 2 main questions that this paper wishes to answer: 1) How great is the magnitude of foreign direct investment affected by GDP, inflation, interest rate, government expenditure, external debt, labor force, trade openness and household consumption? 2) How is the study relevant in policy making for the Philippines?

Significance of the Study With fast growing regions such as that of South and Southeast Asia, foreign enterprises are taking their mark in setting their sights on them. With this, there is a need to study how GDP, inflation, interest rate, government expenditure, external debt, labor force, trade openness, and household consumption affect foreign direct investments. While the state of the GDP in the Philippines is quite desirable with a steady growth, there is much left to be desired when it comes to FDIs (Lowe, 2013). This study aims to generate estimations to determine which factors of foreign direct investments are beneficial and detrimental to the state of FDIs.

A study such as this is necessary to be able to determine what variables impact FDIs in a positive way. In this light, government institutions that are concerned with FDI can emphasize on factors which have a positive relationship with FDIs and minimize those with a negative relationship. Scope and Limitations This study is focused on GDP, inflation, interest rate, government expenditure, external debt, labor force, trade openness, and household consumption on foreign direct investments. With the 7 countries: Bangladesh, India, Indonesia, Malaysia, Philippines, Singapore, and Thailand from years 1990-2012, the data will present different situations with the different countries. Data was collected from the World Bank website. Due to the varying availability of data for among countries of interest, the researchers limited it to this time frame in order to generate accurate estimations.

Review of Related Literature Foreign direct investment (FDI) plays an important role in international economic integration. FDI is a major source of external finance, which means that countries with limited amounts of capital can receive finance beyond national borders from wealthier countries. So why is Foreign direct investments important? FDIs are important because it constructs a direct and stable links between economies. It also induces the transfers of technology and human capability between countries, and allows the host economy to promote its products more in the international markets.

According to the International Monetary Fund, FDI is described as an investment made to acquire lasting interest in business operations and enterprises that are present outside of the economy of the investor. The investment is direct because the foreign investor, company or group of entities, is seeking to control, manage, or have significant influence over the enterprise outside of the country of origin.

This section will focus on the economic impacts of foreign direct investments of migrant workers and as well as the overall growth of the receiving country. Additionally, factors that affect Foreign Direct Investments will be further discussed and how it can significantly affect FDI and the economic development over a course in time throughout the ASEAN + India and Bangladesh. Foreign Direct Investments in the ASEAN + India and Bangladesh One of the factors that contributed to the rapid economic growth of the East Asia region in recent years is the tremendous improvement of trade and foreign direct investments (FDI). According to Lipsey and Sjöholm(2010), FDI has played, and continues to play, a large role in Asian development. China given its mass production output and labor force for cheaper hold its postion as one of the world‘s largest recipients of FDI and Japan is a major source. Some countries in the region, such as Singapore, have based much of their development strategy on reliance on foreign multinational firms. Following historical trends, Lipsey and Sjöholm again explain in their journal that developing countries in the East Asian region for a long time used import substitution to encourage formation and growth of domestic firms with the intention of national development. However the positive result from this economic endeavour has not always been the case.

A natural part of this strategy was to restrict access of foreign multinational firms to the domestic market and to use other methods to acquire foreign technology. A number of Asian countries eventually experimented with a different development strategy, including a stronger reliance on foreign multinational firms, thus in time was reliant on FDI to contribute in their quest for development. According to Tullao et. Al (2009), the increasing popularity of East Asia including India as a preferred destination hub for FDIs shows the success of the region in catching the attention of foreign investors mainly from the US despite stiff competition from neighboring and the already developed countries. Now, comparing the performance of the East Asian region with

that of the international community in terms of FDI inflows and outflows, it will be good enough to weigh that East Asia is catching up.

According to a report written by Castell et. Al (2009), the European Union and the United States continue to control FDI inflows in terms of scale. However, the East Asia region has emerged as one of the principal growth centers with an average growth rate of 7.9%, in the years starting 2000, The marginal increase in growth rate for the East Asia region was at 1.8% exceeding world average rate of -7.7%.

Inflation Rate Macroeconomic factors that affect development include real growth rates, investment per capita, price inflation and etc. All these are subject to volatility given that there is no political and economic stability. High incidence of regional conflicts present in a nation, high and volatile rates of inflation, and frequent currency crashes play an important role in explaining why certain countries slowdown in attracting FDI.

According to Udoh & Egwaikhid, (2008), volatility in the inflation and exchange rates increased uncertainty and risk element facing foreign investors and thus adversely affected foreign investment in the country. Gross Domestic Product Growth Rate GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. It is one of the most recognizable indicators of development for any nation. As the papers discusses the foreign direct investments and how it influences GDP in the Asian region as the focus of this study, trends in GDP growth can be used intuitively to assess the situation of the countries within the study. According to the website of the ASEAN, most member’s economies remained buoyant as GDP grew by 5.7 percent in the year 2012. Most recent figure showed that averaged income of ASEAN5 (Indonesia, Malaysia, Philippines, Singapore and Thailand). The increasing trend of GDP growth can mainly be attributed to the manufacturing and services sectors of each nation. Trade Openness

According to Dowrick (2004), openness to trade is a factor that has determines whether a country is prone to sudden stops in capital inflow, currency crashes, or severe recessions. Trade openness exposes countries to internationalization and integration of nations. Although it may be risky in the sense that it can expose a country to heavy economic failures through the integrated trade and financial systems. In Asia, there is a huge production channel situated in the continent thus trade openness is prevalent.

THEORETICAL FRAMEWORK In order to achieve a successful economic analysis, one must take into account the existing economic theories that dictate the foundations of the study on foreign direct investments. The study aims to achieve a validation of economic theories through the suggested econometric model. The study is founded on the following economic theory. The Accelerator Effect The accelerator effect demonstrates that the investments inflow are related to the rate of change in the GDP. The theory suggests that as demand or income increases in an economy, so does the investment made by firms. There is an apparent relationship between investor confidence and investments inflow. The theory further explains how this growth attracts more investors, which accelerates growth. According to EconomicsHelp.Org (2008) the accelerator effect states that investment levels are related the rate of change of GDP. As the rate of GDP increases, the confidence of investors as a function of the rate, intuitively increases as well;

To put it simply, investors and other entities would opt to invest more in a foreign country because of the expectations that the economy will give a high return in the future. Neo-classical Theory: The Mundell Model Mundell (1957) incorporates FDI into the Neo-Classical framework as the result of barriers to trade in goods. If barriers to trade are then liberalized, Capital flows are not rationalized because FDI is now part of the factor endowments of the host-country - sunk and fixed costs. He suggests in his work that Trade barriers encourage FDI and trade liberalization neither reduces FDI nor increases trade. Therefore, he concluded that FDI and trade are substitutes.

An argument to the Mundell’s explanation is that for the Neo-Classical framework, countries cannot be outward and inward investors at the same time since cross-flows of FDI cannot exist. The study aims to hold into account Mundell’s claims and validate the researchers given argument.

Theory of Internationalization The Theory of Internationalization attempts to explain the growth of transnational companies and their motivations in going into foreign direct investments. Profound Economist Stephen Hymer, explains in his seminal contribution the significance and emergence of globalization and internationalization at the time of his work during the seventies.

In his study, Hymer (1976) explains that a firm may wishes to exploit competencies or technological advantage. He explained that FDI take place only if the benefits of exploiting firmspecific advantages outweigh trade costs of the operations abroad. An outside investor take over the inferior firms in the host country thus increasing proximity to foreign customers, boosting variable profits from sales abroad by an increase in market power. Hymer concluded that direct investments are capital movements associated to international operations of firms.

Eclectic Paradigm Theory The Eclectic paradigm theory proposed by John H. Dunning (1980) introduces a threefold framework in terms of advantage. This framework is composed of Ownership advantage, Location Advantage and Internationalization advantage .This framework is set for companies to follow when determining if it is beneficial to pursue direct foreign investment. The paradigm is based on the assumption that institutions will avoid transactions in the open market when internal transactions carry lower costs rather than externally. Vernon’s Product Cycle Theory According to Denisia (2010) Foreign Direct investment phenomenon can also stem from the levels of production. The Production cycle theory developed by Vernon in 1966 was used to explain certain types of foreign direct investment. The theory suggests that early in a product's life-cycle all the parts and labor associated with that product come from the area in which it was invented. After the product becomes adopted and used in the world markets,

production gradually moves away from the point of origin. Thus explains the transfer of technology and demand for investments.

OPERATIONAL FRAMEWORK Description of the Variables Before the analysis of the model, we must first discuss the different variables of the model. The regressand is foreign direct investment. There are many variables that are said to affect foreign direct investment. The researchers chose to focus on eight regressors: external debt, gross domestic product growth rate, government expenditure, household consumption, inflation rate, interest rate, labor force and trade openness. Definitions of the different variables are presented in a table below: VARIABLE

DESCRIPTION REGRESSAND

Foreign Direct Investment (FDI)

Foreign direct investment are the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor’s Source: Worldbank.org REGRESSORS

External Debt

Gross Domestic Product (GDP) Growth Rate

Government Expenditure

Total external debt is debt owed to nonresidents repayable in foreign currency, goods, or services. Source: Worldbank.org Gross domestic product growth rate is the measure of the goods and services which were produced in a given time period, compared to that of the previous time period. General government expenditure includes all government current expenditures for purchases of goods and services It also includes most expenditures on national defense and security, but excludes

government military expenditures that are part of government capital formation. Data are in current U.S. dollars. Source: Worldbank.org Household consumption is the amount from their income which is spent on goods and services.

Household Consumption

Inflation Rate

Inflation rate is the rate which prices of goods and services change based on the price index, compared to that of the previous time period.

Interest Rate

Interest rate is the amount that a lender charges the borrower, in percentage.

Labor Force

Labor force is the portion of the population who are eligible to work.

Trade Openness

Trade is the sum of exports and imports of goods and services measured as a share of gross domestic product.

Hypothesized Relationship of the Variables Given that foreign direct investment is affected by the chosen variables. Each variable will have a corresponding relationship to the independent variable: VARIABLE External Debt

A-PRIORI EXPECTATION Negative (-)

INTUITION Given a high external debt, investors would not be attracted.

Gross Domestic Product (GDP) Growth Rate

Positive (+)

A high GDP would mean that the economy is growing. If the economy is growing or stable, it is safer to invest. This would attract investors.

Government

Positive (+)

Expenditure

With high government expenditure, this would mean that the economy is improving. Since the economy is improving, investors would not be reluctant to invest.

Household

Positive (+)

Consumption

If household consumption is high, that would mean that the economy is doing well because people are able to buy goods and services. Investors would be attracted.

Inflation Rate

Negative (-)

High inflation rates would mean a higher cost for goods and services. Investors would not be attracted by this because they will not get the value for their money. The money they invested would not be able to buy as much if it was invested somewhere with a lower inflation rate.

Interest Rate

Negative (-)

If interest rate is high, investors may not invest anymore. Not all the money that investors use is theirs, some of it is borrowed. If interest rates are high, it is expensive to borrow money to invest.

Labor Force

Positive (+)

With a high labor force, it means that there are more workers. With more workers, investors are enticed. In case of an expansion, there are will be workers that are available.

Trade Openness

Positive (+)

Trade openness means there is an existence of foreign ties. Good relations with other countries could attract

investors.

confidence

in

There

is

exchange

of

commodities and goods. Hypothesized Model The general form of the econometric model would be like this:

In this model, all of the variables are taken account. In order to take each of the variables into account, we allow the intercept to vary. Even if we allow the intercepts to vary, slope coefficients should remain constant.

METHODOLOGY Data In order to test the hypothesis, the researchers has gathered data of various developing countries in South and Southeast Asia. The data gathered was taken from the World Bank. The World Bank is an institution which provides financial assistance for various countries around the world. There are 188 countries which are members of this institution. Modestly, the data from

the World Bank were used because the countries of interest are members of this institution. Yearly economic data is readily available and updated.

The researchers arranged the data in a time series and spatial stacked format. The seven countries was observed from 1990 to 2012, 23 years in total. The study shows how the different factors affect the change in foreign direct investments through the years. We can say that foreign direct investments will be the response variable. Model Specification The study uses a panel data approach across selected developing countries in Asia from 1990 to 2012. This approach best suits our study for we would be better able to account for dynamic changes. Also, panel data models help mitigate aggregation bias as it will account for unobserved heterogeneity of cross-section and time-series elements which introduces an unknown form of omitted variable bias. Moreover, panel data analysis provides more informative results through greater variability, less collinearity between the independent variables, and relatively more degrees of freedom (Gujarati & Porter, 2009). It is essential for us to know what factors contribute to the inflow of foreign direct investments as to better increase economic growth. To be more particular, our study will conduct several estimation method to better understand the study of foreign direct investments on the selected economies. Pooled OLS Regression, Fixed Effects Regression Model, and Random Effects Model will be used as the means of estimation. Step 1 – Pooled (Naïve) Model In our Pooled OLS model, we will basically pool all observations and approximate a “grand” regression, while neglecting the cross-section and time-series nature of our data. In this type of estimation, we assumed that all explanatory variables are strictly exogenous as the variables do not depend on the value of the error term Naïve Model . reg fdi gdpgrowth inflation interestrate governmentexpenditure externaldebt laborforce tradeopeness householdconsumption

Corrected Naïve Model . reg fdi gdpgrowth inflation interestrate governmentexpenditure externaldebt laborforce tradeopeness householdconsumption, robust

However, this type of approach is vulnerable to problems such as autocorrelation, spatial correlation, and heterogeneity. As such, the estimated coefficients may be biased and inconsistent as there will be a possibility that the error term and regressors are correlated. Hence, the need for another estimation method.

Step 2 – Fixed Effects Model

The second step was to estimate both the FEM and the Least Squares Dummy Variables (LSDV) and determine their respective RSS. The fixed effects model allows heterogeneity among subjects by allowing each entity to have its own intercept value (Gujarati & Porter). We would either make the model time-invariant, space-invariant, or both to have a better estimated value of our explanatory variables. Also, we would be introducing dummy variables (DV) using the differential intercept dummy technique.

FEM

LSDV M1 . xi:reg fdi gdpgrowth inflation interestrate governmentexpenditure externaldebt laborforce tradeopeness householdconsumption i.country i.country _Icountry_1-7 (naturally coded; _Icountry_1 omitted)

Source | SS df MS -------------+-----------------------------Model | 1.0394e+22 14 7.4244e+20 Residual | 4.6962e+21 139 3.3786e+19 -------------+-----------------------------Total | 1.5090e+22 153 9.8630e+19

Number of obs = F( 14, 139) Prob > F R-squared Adj R-squared Root MSE

154 = 21.98 = 0.0000 = 0.6888 = 0.6575 = 5.8e+09

LSDV M2 . xi:reg fdi gdpgrowth inflation interestrate governmentexpenditure governmentexpenditure governmentexpenditure externaldebt laborforce tradeopeness householdconsumption i.year

i.year _Iyear_1990-2012 (naturally coded; _Iyear_1990 omitted) note: governmentexpenditure omitted because of collinearity note: governmentexpenditure omitted because of collinearity note: _Iyear_2012 omitted because of collinearity

LSDV M3 . xi:reg fdi gdpgrowth inflation interestrate governmentexpenditure externaldebt laborforce tradeopeness householdconsumption i.country i.year i.country _Icountry_1-7 (naturally coded; _Icountry_1 omitted) i.year _Iyear_1990-2012 (naturally coded; _Iyear_1990 omitted) note: _Iyear_2012 omitted because of collinearity

Step 3 – Model competition between Naïve and LSDV Models The Wald’s Test is implemented in order to determine which among the Naïve and LSDV models is best. The Wald’s Test is given by: H0 – Restrictions are valid (restricted model is superior)

H1 – Restrictions are NOT valid (unrestricted model is superior)

Note that in this instance, the naïve model is the restricted model.

where m = the number of restrictions made Model

RSS

Naïve LSDV1 LSDV2 LSDV3

Observations

5.2284e+21 4.6962e+21 4.2345e+21 4.0119e+21

Parameters (omitted variables deducted in bold)

154 154 154 154

Degrees of Freedom 145 139 124 118

The following feasible tests will be made: Restricted Model Naïve

Unrestricted Model LSDV1

m

F-statistic 2.625378

F-critical

Naïve

LSDV2

1.385935

F0.05 (21), (124)= Naïve is superior to 1.64178571 LSDV2

Naïve

LSDV3

1.376166

F0.05 (26), (118)= Naïve is superior to 1.58970903 LSDV3

LSDV1

LSDV3

1.006349

LSDV2

LSDV3

1.309444

F0.05 (20), (118)= LSDV1 is superior 1.66018288 to LSDV3 0.05 F (5), (118)= LSDV2 is superior 2.29115789 to LSDV3

0.05

F (6), (139)= 2.16440877

Decision LSDV1 is superior to Naïve

Here the researchers set the various models against each other to now which is the most superior. In the first test, the Naïve Model was set against the LSDV M1. Since the Fcritical value of the LSDV M1 was found to be 2.166408077 compared to the Naïve’s 2.625378; hence, we reject the null hypothesis. The rest of the results are summarized in the table above. The results of the Wald’s Test indicate that LSDV1 is the most superior model. Step 4 – Breush-Pagan Lagrange Multiplier Test Moving on, we then estimate the REM using a general STATA command. REM is applied when some omitted variable is believed to be time invariant yet varies among panels, and others may be time variant yet fixed among panels. After doing so, we have to determine whether the REM is better than OLS. For this we use the Breusch-Pagan Lagrangian Test.

The Breush-Pagan Test is used to determine which among the Random Effects Model (REM) and the Naïve Model is superior. It is based on the chi-square test statistic. H0 –

(Naïve Model is superior)

H1 –

(REM is superior)

Note that the Random Effects Model assumes that the differential intercept takes the form of a random variable. Hence, it discounts the need to introduce dummy variables into the model. Below are the results of the REM estimation and the BP LM Test: . xtreg fdi gdpgrowth inflation interestrate governmentexpenditure externaldebt laborforce tradeopeness householdconsumption, re

From the Breusch-Pagan Langrangian Multiplier Test it was found that the Prob > chibar2 is equal to 1.0000. Hence, the null hypothesis is rejected. Thus, the REM Model is superior to the Naïve Model. Step 5 – Hausman Test Here, we have to choose between the Fixed Effects Model and the Random Effects Model. To determine the most suitable model among the two, the Hausman test can be used. To run the Hausman test in Stata, the coefficients from each of the models have to be saved respectively. Given that we have proven the superiority of both LSDV1 and REM to the Naïve Model, it will be inescapable upon us to determine which among these remaining models is superior to the other. To determine whether or not the FEM or the REM is superior, we employ the Hausman Test which has the following hypotheses: H0: REM is better

H1: FEM is better

In the null hypothesis, we establish that the FEM and Error Component Model (ECM) estimates do not differ. Thus, REM would be better. In the alternative, the opposite is established. If the FEM and ECM will differ, FEM is said to be better. The result of the Hausman Test is shown in the table below.

. xi:reg fdi gdpgrowth inflation interestrate governmentexpenditure externaldebt laborforce tradeopeness householdconsumption i.country i.year i.country _Icountry_1-7 (naturally coded; _Icountry_1 omitted) i.year _Iyear_1990-2012 (naturally coded; _Iyear_1990 omitted) note: _Iyear_2012 omitted because of collinearity

. est store fixed . xtreg fdi gdpgrowth inflation interestrate governmentexpenditure externaldebt laborforce tradeopeness householdconsumption, re

. est store random . hausman fixed random Note: the rank of the differenced variance matrix (5) does not equal the number of coefficients being tested (8); be sure this is what you expect, or there may be problems computing the test. Examine the output of your estimators for anything unexpected and possibly consider scaling your variables so that the coefficients are on a similar scale.

The Hausman test assesses the null hypothesis. If the coefficients projected by the REM estimator are the same as the ones projected by the FEM estimator then it is sound to use REM. However, if it is found that they differ, then FEM should be used.

The result show that the FEM and the ECM are different. Hence, it can be concluded that the FEM-LSDV Model 1 is superior to the REM. Therefore, our final model will take the form of:

LSDV Model 1 Source | SS df MS -------------+-----------------------------Model | 1.0394e+22 14 7.4244e+20 Residual | 4.6962e+21 139 3.3786e+19 -------------+-----------------------------Total | 1.5090e+22 153 9.8630e+19

Number of obs F( 14, 139) Prob > F R-squared Adj R-squared Root MSE

= = = = = =

154 21.98 0.0000 0.6888 0.6575 5.8e+09

--------------------------------------------------------------------------------------fdi | Coef. Std. Err. t P>|t| [95% Conf. Interval] ----------------------+---------------------------------------------------------------gdpgrowth | 3.24e+08 1.53e+08 2.13 0.035 2.27e+07 6.26e+08 inflation | 8.99e+07 1.41e+08 0.64 0.524 -1.88e+08 3.68e+08

interestrate | 1.65e+08 2.25e+08 0.73 0.465 -2.80e+08 6.09e+08 governmentexpenditure | .2561528 .0577044 4.44 0.000 .142061 .3702446 externaldebt | -.0142651 .0332209 -0.43 0.668 -.0799488 .0514185 laborforce | -51.99486 40.81299 -1.27 0.205 -132.6894 28.69967 tradeopeness | 1.01e+08 2.47e+07 4.10 0.000 5.22e+07 1.50e+08 householdconsumption | -3.41e+08 2.06e+08 -1.66 0.100 -7.48e+08 6.64e+07 _Icountry_2 | -1.23e+10 1.21e+10 -1.02 0.310 -3.62e+10 1.15e+10 _Icountry_3 | -3.06e+10 1.67e+10 -1.83 0.069 -6.36e+10 2.43e+09 _Icountry_4 | -1.25e+10 1.39e+10 -0.90 0.369 -4.01e+10 1.50e+10 _Icountry_5 | -1.93e+10 1.49e+10 -1.30 0.195 -4.87e+10 1.00e+10 _Icountry_6 | -3.66e+10 1.85e+10 -1.98 0.050 -7.32e+10 -5.03e+07 _Icountry_7 | -4.25e+09 1.24e+10 -0.34 0.732 -2.88e+10 2.03e+10 _cons | 2.63e+10 2.31e+10 1.14 0.257 -1.94e+10 7.19e+10 ---------------------------------------------------------------------------------------

The underlying principle of the FEM-LSDV Model 1 is that the slopes are fixed, while the intercepts are time invariant. This paper has estimated the LSDV M1 as the superior model in the study. Referring to the results above, there are a few matter that can be discussed. It was found that GDP growth, government expenditure, and trade openness are the most significant variables that affect the inflow of FDIs on the specified countries. This is consistent with the apriori expectation that was mention in the early part of this paper. It is concluded that a high GDP growth would mean that the economy is growing at the same proportion. If the economy is growing or is stable, it is safe to invest in. This, then, attracts investors. To add, trade openness means there is an existence of foreign ties. Good relations with other countries does attract investors. There is confidence in exchange of commodities and goods. Moreover, with high government expenditure, this means that the economies are improving. The government are taking an initiative to improve their country. Since the economy is improving, investors would not be reluctant to invest. Corrective Measure To correct for violations, we employ a Generalized Least Squares (GLS) regression. . xtgls fdi gdpgrowth inflation interestrate governmentexpenditure externaldebt laborforce tradeopeness householdconsumption i.country i.year

Policy Implications and Recommendations As shown by the results, the predominating factors that affect FDI would be GDP growth, government expenditure and trade openness. When it comes to trade openness, this becomes necessary because companies that do wish to invest may be discouraged from doing so if the economy isn’t open to foreign investors, or is strict in the regulation. It was the policy that was applied in Singapore, they focused on trade openness to allow investors in the country. This way the FDIs that are coming in can help with the GDP growth. A good recommendation for this case is that for the government to be a little bit more lenient when it comes to imposing regulations on foreign investors. This openness will give breathing room for the company and will encourage them to actually set up business in the Philippines that will be beneficial when it comes to employment. Also, if the government were to give incentives, like lowering the taxes that are imposed, to foreign companies for them to be able to set up business in the country, then that would be highly appreciated by the investors. This will be appreciated because this will lessen the cost for the foreign company.

GDP growth becomes important because a foreign country would not wish to invest time and money building a company in another country with a withering GDP. GDP becomes essential in attracting foreign investors to a country. A good policy recommendation for this would be for the economy to strive to develop further and avoid possibilities of growth to slow down. In the case of the Philippines, with GDP growth at 7.8% earlier this year, if the economy continues to follow that progression along with stability, eventually investors will see that banking on the Philippines will be a right choice. As is with the case of the other countries, having a steadily growing GDP will help instill investor confidence in the country. Consistent GDP growth will allow for investors to picture a booming economy in the future that is stable enough for their business.

Government expenditure becomes important because investors see that the government itself is investing in its own country then they are more confident in investing in the country. An immediate recommendation for this is for total transparency and accountability when it comes to government finances. Countries that truly want to improve should center on this idea. The difficulty in executing something like this is that not everyone is willing to be transparent. So to ensure this transparency, all accounts must be audited by a third party, separate from the government that can tackle such an undertaking. Doing something like this, first on a quarterly

basis would be putting a strict parameter wherein which the government can partake in with their spending. Also, these possible audits should be conducted not just by a third party but as a surprise audit. Which means that the government must be prepared at all times to have their expenditures balance out and for every last coin to be accounted for. Furthermore, spending by the government should be limited to the necessary like repairing or building sidewalks especially if there are none. Spending on such things as roads which have just been built then destroyed again to be able to be built again should be avoided. Giving stricter guidelines will give confidence to investors that money in the economy is really moving around and that the government is not just wasting it.

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