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Foreign Investment Has a Double-Edged Effect in Asia-Pacific

When businesses in one country establish operations in another country, it’s called foreign direct investment (FDI). Developing economies often compete for FDI, assuming it will spur growth.

But an analysis of 14 Asia-Pacific countries revealed a surprising divergence in the impact of FDI. While some types of FDI do boost growth, FDI in the trade services sector actually has a “deleterious” spillover effect on domestic manufacturing. The study, conducted by Professors Nadia Doytch and Merih Uctum (Brooklyn College and The Graduate Center, CUNY), was published in the Journal of Asian Economics.

The professors looked at the impact of FDI on manufacturing and services from 1985 to 2012 in Australia, Bangladesh, China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, Pakistan, Philippines, Singapore, Thailand, and Vietnam.

Overall, they found that FDI in the services sector had a “significant positive impact on GDP growth,” while FDI in the manufacturing sector had “no effect” on GDP. They then broke the FDI services data down further, and found that investment in financial services spurred growth in both the services sector and in manufacturing. Expanding financial services apparently helped manufacturers grow by providing access to new credit and markets.

So why, in contrast, did FDI in trade services — a sector that delivers “technology and know-how” — have a detrimental effect on manufacturing?

The explanation illustrates the “complex influences” of globalization. When commerce is small-scale and local, small firms produce “a limited range of products” for buyers with no other options. But FDI in trade services makes it easier for sellers and buyers to connect. By integrating markets, trade services helps foreign retailers introduce new brands to locals. If the foreign sellers are more cost-efficient, domestic manufacturing can’t compete.

Services FDI, the economists conclude, “has a double-edged effect” on economies. While financial services FDI increases access to credit, allowing local businesses to expand, trade services FDI increases international competition, and that hurts domestic manufacturing. Deindustrialization, in turn, has “negative consequences for employment and income distribution.”

Beyond SUM

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Nadia Doytch (Associate Professor, Economics) | Profile 1 | Profile 2
Merih Uctum (Professor, Economics) | Profile 1 | Profile 2