Statistics Project

ABSTRACT

The study examines the determinants of economic growth in Canada over time, and finds out if there is any support for FDI-led growth hypothesis in Canada using simple regression analysis. To achieve this goal the study uses a model that is based on the Mankiw et al 1992 as theoretical foundation for the analysis in which they emphasized on human capital as an important variable for economic growth in addition FDI will be incorporated into their model as a variable capable of increasing physical capital as well as developing human capital and enhancing technological progress capable of stimulating economic growth. Using 11-year period of quarterly data.

INTRODUCTION

The rapid expansion of globalization marked by enhanced economic integration and trade liberalization has given rise to ever expanding investment around the world. The immense growth in the computer and telecommunications industries, and lowering of transportation costs has made it possible for each state of production to be located in any place that proves to be more conducive to efficiency. This situation has significantly increased the inflow of foreign direct investment (FDI) in the world which has risen to the second highest level ever recorded in 2006. As a result, developed countries, developing countries, and transition economies all experienced growth in FDI inflows. However, among developed nations. FDI in Canada plunged during the period of 2002 – 2004(which is not covered by our data set) in manufacturing sector due to attrition and maintained a stunted latency in terms of global share of FDI (huffingtonpost 2013;the globe and mail 2010). Although major concentration of these investment was on manufacturing its deterioration by 13 percent from 2009 to 2009 drove investors to mining and oil and gas which increased by 10 percent by 2000 to 2009. Also the finance and insurance industries was not left out by investors which witnessed an increase of 1.4 percent by 2009 to 2009. FDI shares in other Canadian sector either witnessed an increase of 1.9 percent or more to date. Proponent of FDI emphasized that host country benefit from capital spillovers (Morris, 2008, p. 4.). Local firms are bound to benefit from technological changes brought by foreign investors to host country (Görg and Greenaway 2002) via technological imitation by domestic investors, skill acquisition from advanced technological use by domestic workers which can enhance domestic human capital while Opponent of FDI argues of possible future repatriation of capital in monetary terms to country of foreign investor (Morris, 2008, p. 4). This could also lead to unfair market competition with local investors whom lack sufficient capital and manpower to purchase or make use of advanced technology brought in by foreign investors which can oust them from market (Görg and Greenaway (2002, pp. 2-3)

OBJECTIVES OF THE STUDY

The broad objective of this study is to examine the relationship between FDI and growth in Canada. The study will also focus on;

A. Explore theoretical foundations and empirical contribution of other researchers

B. Employ empirical analysis to determine relationship between FDI and growth

C. To proffer recommendations for enhancing FDI.

RESEARCH HYPOTHESIS

For the purpose of this research two hypothesis are been setup such as the null hypothesis and alternative hypothesis.

· NULL HYPOTHESIS: Ho: FDI does not contribute to growth in Canada.

· ALTERNATIVE HYPOTHESIS: H1: FDI positively contributes to growth in Canada

SCOPE AND LIMITATION OF THE STUDY

The study is on the impact of FDI on economic growth in Canada. The scope of this study covered the period 1901-2001. The data used are publications from stats Canada(CANSIM)

The study is largely a secondary research and is limited by the following;

DATA PROBLEM:

Data collected on human capital represented by labor in real gross domestic product (GDP) might not be an adequate measure for human capital. The period covered was not wide enough to give an accurate result because of period limitation from stats Canada. Most of the data collected are not reliable because of easy manipulation for political and economic reasons as such the conclusion differ and whenever the data are not reliable the prediction based on it will be unreliable.

TIME CONSTRIANT: the time given to conduct the research and make conclusion might not be enough

DIFFICULTY IN COLLECTING DATA: the data been secondary is difficult to get enough and required information which can affect the result of my regression analysis

LITERATURE REVIEW

Studies range from proposing that there is a significant relationship between FDI growth and GDP growth to suggesting that there is not a significant relationship between these two variables. In this section we review several of these studies and present their conflicting results. Cave (1974) was probably the first researcher to report empirical results about spillover effect stemming from the presence of foreign firms in domestic market. He used cross-sectional data for Canada and Australia and found evidence of positive spillovers affecting domestic firms and argue that FDI increases the productivity of host nations’ resources by improving their allocation through competition among firms and accelerates the transfer of technology and innovation to domestic firms. Benhua Yang (2007) conducts a similar study but ends up with conflicting conclusions. This study also measures the effect of FDI on economic growth by regressing economic growth on FDI inflows as a percentage of GDP and other control variables. However, unlike the previous study, the author lets the coefficients for the explanatory variables differ for up to seven different regions. Using panel data, the study employs a large sample of nations and covers from 1973 to 2002 time-period, with the data averaging over five year periods. First, a base regression on all regions is estimated. The results show that the coefficient on the FDI variable is positive but statistically insignificant. Second, the effect of FDI on economic growth is allowed to differ between OECD countries and developing countries and between OECD countries and six other regions. His results show that, unlike the previous study, the coefficient associated with FDI for the OECD countries is positive and significant. . Third, the data is divided into two fifteen-year periods to see if the effect has changed over time. For the OECD nations, he learns that the coefficient for the first period (1973-1987) is negative and insignificant, but the coefficient for the second period (1988-2002) is positive and significant.

Robert Lensink and Oliver Morrissey (2006) also examine the relationship between FDI and economic growth; however, they add another aspect to the analysis –volatility. Their analysis indicates that there is not a significant relationship between FDI and economic growth. As the review of empirical studies indicates, most of the existing researches in the area of FDI are very limited in their scope by examining only the impact of FDI either on economic growth or on one of the variables that affect economic growth. This is especially true in the case of Canada. This research differs from the existing empirical studies by taking a boarder approach, examining the causal relationship between economic growth and its determinants in Canada.

METHODOLOGY

The study will make use of secondary data obtained from stats Canada(CANSIM) from period of 1901-2001 in which simple regression analysis will be conducted using Mankiw et al 1992 as theoretical foundation for the analysis they emphasized that human capital is an important variable for economic growth as such FDI will be incorporated into their model as a variable capable of increasing physical capital, as well as developing human capital and enhancing technological progress capable of stimulating economic growth . Therefore coefficient of the variables, R squared, F-statistic and t-values will be used to check for robustness of the regression result

THEORETICAL CONSIDERATIONS

Neoclassicists assumed that capital is a function of the highest risk adjusted rate of return. This assumption provided the main theoretical framework that was used by postwar neoclassical theory in the analysis of FDI. One of the main inferences of the neoclassical growth theory is that all nations eventually will approach the same level of productivity. The lack of evidence that this might take place sparked the development of “new growth theories” (see Grossman and Helpman, 1991). One of the main features of these new theories is to make technology as an endogenous variable. Additionally, according to new theories, technology is considered to have both “private good” characteristics and “public good” characteristics (Wakelin, 1997). This connotes that the gains of innovations can be partially appropriated assuming that technological diffusion occurs more easily within a nation than between nations, a technological gap between nations persists. In another words, no nation can completely depend on “imitation” to approach the technological frontier (Lundvall, 1992). The traditional neo-classical growth models postulate that long-run economic growth arises from both technological progress and labor force growth, which are both exogenously determined. In these models, FDI is considered to only have a short-run effect on the growth of output. However, the recent acceptance of endogenous growth theory has promoted research into channels through which FDI can be expected to encourage economic growth in the long-run (Grossman and Helpman, 1991; Barro and Sala-i-Martin, 1995). This has led to the prevailing view that multinational corporations (MNCs) can complement the local industry and stimulates growth and welfare in the host nations. The merit of endogenous growth models is the assumption that long-run growth is not affected by technological changes alone, but also by institutional and nation-specific factors. The host country’s economic environment portrayed by its rate of economic growth, trade policy, political stability, legislation, domestic market size, and balance of payments constraints, can have significant impact on FDI inflows. (Dunning, 1993, Caves, 1996, de Mello, 1996, 1997, 1999). Thus, the government of host country can stimulate economic growth by devising policies that are more conducive for FDI. Additionally, FDI may intensify competition, altering the structure of imperfectly competitive industries. This, in turn, may generate demand for local output, stimulating supply industries. In various theoretical frameworks, a lot of attention has been paid to technological differences as the determinants of international competitiveness and growth of advanced nations. Modern growth theories accentuate the significance of innovative endeavors in the context of imperfect competition models of trade and growth (Grossman and Helpman, 1991). Dosi and his colleagues introduced neotechnology or evolutionary approaches to technological change and growth in 1990 (Dosi, G., Pavitt, K., and Soete, 1990). In their theoretical framework, absolute gaps in technology are perceived to be more significant than endowments-based comparative advantage in exemplifying trade flow and growth. Traditionally, given the assumption of perfect competition, the neoclassical trade and growth theory considers FDI as a form of international capital movement. Accordingly, international capital movements, and hence FDI, are explained in terms of differential profit, or differential interest rates found in different countries. However, following the earlier Hymer insights into the determinants of FDI, the inadequacy of the assumption of perfect competition in the analysis of FDI is well established. Today, given the assumption of imperfect competition, the eclectic theory of Dunning implies that firm-specific advantages and their interaction with location and internationalization advantages must also be incorporated into the formulation of international trade and growth theory (Dunning 1993b; Caves 1996). FDI affects the economy of a host country in a variety of ways. First, it brings with it the needed capital, and modern technology that enhances economic growth in the recipient country (Blomstrom et al., 1996; Dunning 1993). Second, through managerial and labor training it augments the knowledge of the host country, stimulating economic growth (de Mello, 1996,1997,1999). Third, it promotes technological upgrading, in the case of start-up, marketing, and licensing arrangements (de Mello and Sinclair, 1995, Markusen and Venables 1999). Thus, FDI can be considered as an instrument in promoting industrial development and technological upgrading. As such, FDI may enhance productivity and technological progress in the host country, contributing to its economic growth. Not only does FDI affect the economy of a host country, the economy of the host country has also some bearing on FDI. More specifically, the absorptive capacity of the host country impacts the volume and type of FDI that flows into that country. The absorptive capacity of a host country, in turn, depends on the country’s trade regime, legislation and political stability. It also hinges upon scale factors, such as balance of payments constraints, and size of domestic market for the goods produced through FDI. The consideration of such nation-specific factors allows for examination of such FDI-induced externalities or “spillovers.”(de Mello, 1999). The approaches taken in empirical studies in the area of FDI-led growth can be divided into two groups. The first group uses cross-sectional data. The second group applies time series data. Unfortunately, both of these approaches have met with problems. Potential problems with cross-sectional analysis stem from the assumption that nations share common characteristics. However, in practice such an assumption is not valid due to the fact that nations differ not only in their political, economic, and institutional structure, but also in their response to external shocks. In a nut shell, estimates from cross sectional data are misleading because they do not take into considerations nation-specific features. Potential problems with time-series analysis have been noted by a number of researchers. (Bewley and Yang 1996; Blomstrom et al., 1996; Giles and Mirza, 1998; Giles and William, 1999; Toda, 1994; Toda and Yammoto, 1998), and is related to the inappropriateness of applying F-test statistics to causality tests. It is now well established that the F-test statistics is not valid if time series are integrated (Toda and Yamamoto, 1995; Zapata and Rambaldi, 1997) and causality tests are sensitive to model selection (Giles and Williams, 1999). This article examines the causal relationship between economic growth and its determinants by examining unit root properties and the new Granger non-causality tests.

THE MODEL

The theoretical model employed in this study is based on Mankiw (1995) which emphasized that knowledge is sum of technological and scientific breakthrough or innovation and acknowledged human capital as master mind of these breakthroughs and innovations. Mankiw et al (1992) model known as augmented Solow growth model was driven from Solow (1956) growth model in which they incorporated human capital as factor responsible for growth as shown below;

Y= F (Kα_t Hβ t Lt At)

Where K is physical capital and α stands for rate of its investment, H is human capital with β as the rate of its investment, as decreasing returns to physical and human capital sets in, their respective rate of investment decreases α+β<1. They further stressed that saving used for investment in human capital and technological progress will increase output of labor and economic growth. This rate of investment can be financed via domestic savings as foreign capital inflow from FDI which can augment as domestic savings, with addition of human capital coupled with technological progress the level of output of labor will increase and stimulate growth, the rate of technological change in an economy can increase the marginal growth rate of the economy.

EMPIRICAL FINDING

RESULT, DISCUSSION AND CONCLUSION

In summary, regression analysis was conducted on impact of FDI on GDP the P value was greater than 0.05 that indicates rejection of alternative hypothesis and accepting null hypothesis which implies that FDI didn’t have impact on Canadian GDP during the period of study. The regression result on whether Canadian GDP attracts FDI indicates that growth rate of Canadian economy has less or no significance impact in attracting foreign investors to the country. The ANNOVA result for whether FDI led to growth in Canadian economy or foreign investors were attracted by Canadian economic growth rate were both insignificant. Foreign direct investment growth has no significant impact on Canada’s economic growth and total factor productivity in Canada. Canadian policy makers should develop or focus on FDI measures that are more favorable towards manufacturing sectorby strengthening regulations on weak labor productivity, business tax environment and excessive FDI regulations measures. As propagated by Sharpe and Banerjee (2008) government can focus on improving infrastructure that can enhance human capital better, embark on comprehensive tax reform system and adjustment in FDI regulation.

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