la01.005 a study on the impact of foreign direct investment on economic development of lao p.d.r

MINISTRY OF EDUCATION

LAOS NATIONAL UNIVERSITY

MINISTRY OF EDUCATION AND TRAINING

NATIONAL ECONOMICS UNIVERSITY

KHAMSEN SISAVONG

A STUDY ON THE IMPACT OF

FOREIGN DIRECT INVESTMENT ON

ECONOMIC DEVELOPMENT OF LAO P.D.R.

A thesis submitted to the National Economics University

in fulfillment of requirements for the degree of

Doctor of Philosophy in Economics

Hanoi, 2014

Viết thuê luận văn thạc sĩ, luận án tiến sĩMail: [email protected]

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DECLARATION

I hereby declare that this dissertation is my own work and effort. The

dissertation has not been submitted anywhere for any award. All the sources of

information used have been well acknowledged.

Date: Signature

KHAMSEN SISAVONG


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ACKNOWLEDGMENTS

The Vietnam – Lao Cooperative Program Doctor of Philosophy (PhD) between

NEU and NUOL is very important, necessary, valuable and beneficial to our nations

because this project allows Lao people to upgrade and enhance their level to Doctorate

Degree.

Therefore, I would like to acknowledge the leaders, Administrators, Professors

of the National Economics University of Vietnam and National University of Laos to

give me this excellence opportunities to achieve my dream of PhD.

I would like to express my gratitude to Prof. Dr. Tran Tho Dat, Assoc. Prof.Dr.

Nguyen Thanh Ha and other professors who were in the committees for evaluation of

my dissertation in the early stages of my PhD study.

I am deeply indebted to Assoc. Prof. Dr. Nguyen Thi Tuyet Mai, my

supervisor who gives me clear guidelines and contributing her advises to my

dissertation.

I am also grateful to Prof. Dr. Somkod Mangnormek, Governor of Xiengkhuang

Province, member of Central Committee Party, Prof. Dr Kikeo Khaikhamphithoun,

Head of National Accademic of Politic and Public Administration, member of Central

Committee Party, Prof. Dr. Thongsalith Mangnormek, Head of National Economic

Research, Prof. Dr. Bounpong Keonoradome, President of Savannakhet University

who encouraged and supported me to reach my goal of PhD.

My special thanks go to my family, Sengsavanh College’s staff and my friends.

They are always pleased to encourage and to assist me during my PhD research.

Without your supports I could not complete and realize my dream.


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CONTENTS

DECLARATION ..........................................................................................................i

ACKNOWLEDGMENTS .......................................................................................... ii

ABBREVIATIONS ..................................................................................................... v

LIST OF FIGURES .................................................................................................. vii

LIST OF TABLES ................................................................................................... viii

CHAPTER 1. INTRODUCTION................................................................................. 1

1.1 Research Background ............................................................................................ 1

1.2 Rationale for the Research ..................................................................................... 3

1.3 Research Objectives and Research Questions ....................................................... 4

1.4 Scope of the Study ................................................................................................. 6

1.5 Contributions of the Study ..................................................................................... 6

1.6 Dissertation Structure ............................................................................................ 8

CHAPTER 2. LITERATURE REVIEW ON THE IMPACT OF FDI ON

ECONOMIC DEVELOPMENT .................................................................................. 9

2.1. Definition and Indicators of Economic Development .......................................... 9

2.1.1 Definition of Economic Development ........................................................... 9

2.1.2 Indicators of Economic Development ......................................................... 10

2.1.3 Theoretical Economic Overview ................................................................. 11

2.2 FDI and its Impact on Economic Development .................................................. 14

2.2.1 Definition and Determinants of FDI ............................................................ 15

2.2.2 Impact of FDI on Economic Development .................................................. 30

CHAPTER 3. OVERVIEW OF ECONOMIC DEVELOPMENT AND FDI IN

LAOS 51

3.1. Overview of Laos’ Economy .............................................................................. 51

3.1.1. Economic Growth ....................................................................................... 52

3.1.2 Economic Structural Changes ...................................................................... 53

3.1.3 Financial Sector Growth .............................................................................. 54

3.1.4 Banking Sector Development ..................................................................... 55


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3.1.5 Inflation has been effectively managed ...................................................... 55

3.1.7 Workforce and Employment Balance .......................................................... 56

3.1.8 Balancing the Sources of Funds for Development ...................................... 58

3.1.9 Balancing the State Budget .......................................................................... 60

3.1.10 Balancing Imports and Exports .................................................................. 61

3.1.11. Sectoral Development, Regional and International Economic Integration

............................................................................................................................... 65

3.1.12 Infrastructure .............................................................................................. 88

3.2 Foreign Direct Investment in Laos ...................................................................... 90

CHAPTER 4. RESEARCH METHODOLOGY ...................................................... 95

4.1 Research Questions .............................................................................................. 95

4.2 Variables and Measures ....................................................................................... 95

4.3 Data Description .................................................................................................. 97

CHAPTER 5. RESEARCH FINDINGS .................................................................. 107

5.1 FDI and GNI per Capita.................................................................................... 107

5.2 FDI and Financial Capital ................................................................................. 108

5.3 FDI and Level of Technology ............................................................................ 111

5.4 FDI and Human Capital ..................................................................................... 112

5.5 FDI and Energy and Natural Resources ............................................................ 113

5.6 FDI and Transportation and Communication .................................................... 114

CHAPTER 6. CONCLUSIONS AND DISCUSSION ............................................ 116

6.1 Conclusions ........................................................................................................ 116

6.2 Implications of the Study ................................................................................... 117

6.3 Limitations of the Study and Future Research Direction .................................. 121

REFERENCES .......................................................................................................... 123


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ABBREVIATIONS

AFTA Asean Free Trade Area

AGOA

APTA

ASEAN

ATIGA

BIT

BOP

CAP

CEPEA

EAFTA

ECE

ECOWAS

EU

Africasn Growth and Opportunity Act

Asia Pacific Trade Agreement

Association of South East Asian Nations

Asean Trade in Goods Agreement

Bilateral Investment Treaty

Balance of Payments

Carribean African Pacific

Comprehensive Economic Partnership in East Asia

East Asia Free Trade Area

Economic Commission of Europe

Economic Organization of West African States

European Union

FDI Foreign Direct Investment

FPI

FY

Foreign Portfolio Investment

Financial Year

GDI

GDP

Gross Domsetic Income

Gross Domestic Product

GNI Gross National Income

IMF

IPRs

International Monetary Fund

Intellectual property rights

ISCED

ISIC

Lao PDR

International Standard Classification of Education

International Standard Industrial Classification

the Lao People’s Democratic Republic


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LDCs Least developed countries

MFs Multinational firms

MIGA

MNC

NEM

NIEs

Multilateral Investment Guarantee Agency

Multinational Corporation

New Economic Model

Newly Industrializing Economies

NTA

ODA

OECD

National Tourist Authority

Official Development Assistance

Organization for Economic Co-peration and Development

OLI

OLS

Ownership, Locational, Internalization

Ordinary Least Square

OPIC

PPP

Overseas Private Investment Corporation

Purchasing Power Parity

SAPTA

TDS

UN

South Asian Preferential Trade Agreement

Total Debt

United Nations

US the United States

VAT Value Added Tax

WTO World Trade Organization


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LIST OF FIGURES

Figure 1: Economic structure 2006 – 2010 ................................................................... 54

Figure 2 Export and Imports from 2005-2009. ............................................................. 64

Figure 3 Average size of agricultural land per household ............................................. 66

Figure 4. Average share of value added in the industrial sector 2006-2010 ................. 70

Figure 5. Structure of service sector 2006-2010 ........................................................... 75

Figure 6 Foreign direct investment, net inflows (BoP, current US$) ........................... 92

Figure 7. Distribution of FDI in Lao PDR (US$ m) ..................................................... 93

Figure 8. Share of accrual FDI by country (% of total, as of August 2009) ................. 93

Figure 9. Ten biggest foreign investors in Laos (1989 – 2012) .................................... 94

Figure 10. Graph of Correlation between FDI and GNI per capita ............................ 107

Figure 11. Graph of Correlation between FDI and long-term debt service on external

debt .............................................................................................................................. 110

Figure 12 Graph of Correlation between FDI and level of technology ..................... 112

Figure 13. Graph of Correlation between FDI and School enrollment, tertiary ........ 113

Figure 14. Graph of Correlation between FDI and Natural Resources ...................... 114

Figure 15. Graph of Correlation between FDI and Mobile cellular subscriptions ..... 115


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LIST OF TABLES

Table 1. Comparison between actual and targeted GDP growth rate in the Sixth Plan (2006-2010) ................................................................................................................... 52

Table 2. GDP per capita (plan vs. actual) ...................................................................... 53

Table 3. Share of labour by sectors ............................................................................... 58

Table 4. Private domestic and foreign investment from 2006-2010 (USD billion) ...... 60

Table 5. Export structure of Lao PDR by commodities 2005-2009 (%) ....................... 62

Table 6. Import structure of Lao PDR by commodities 2005-2009 (%) ....................... 63

Table 7. Inter-Country Comparison on Opened Trade or Integration 2006-2010 ........ 86

Table 8. Export Market Structure with Main Trade Partners, 2008 .............................. 87

Table 9. Foreign direct investment, net inflows ............................................................ 98

Table 10. GNI per capita ............................................................................................... 99

Table 11. Gross capital formation (annual % growth) ................................................ 100

Table 12. Financial capital .......................................................................................... 101

Table 13. Industry, value added (% of GDP) .............................................................. 102

Table 14. Human capital .............................................................................................. 103

Table 15. Oil consumption per capita.......................................................................... 104

Table 16. Transportation and communication ............................................................. 105

Table 17. FDI and GNI per capita Coefficient of Correlation .................................... 108

Table 18. FDI and Financial Capital Coefficient of Correlation ................................. 108

Table 19. FDI and Level of Technology Coefficient of Correlation........................... 111

Table 20. FDI and Human Capital Coefficient of Correlation .................................... 112

Table 21. FDI and Energy and Natural Resources Coefficient of Correlation ........... 113

Table 22. FDI and Transportation and Communication Coefficient of Correlation ... 114


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CHAPTER 1. INTRODUCTION

1.1 Research Background

Laos is a small landlocked country with an area of 236,800 square

kilometers. It shares its borders with Vietnam in the East, China in the North, and

Cambodia in the South, Thailand and Myanmar in the west. Two third of the

country is mountainous (northern part) thus its geographic circumstances constrain

both the quality and quantity of agriculture and cause difficulties to the

development of trade, social infrastructure and transportation and communication

links. However, the country has transformed from a landlocked to a land link and

cross road to other parts of the world.

Laos is located in the center of energetic and prosperous region of South East

Asia and possesses a high potential of natural resources, raw material and

hydropower. The country is divided into three main regions: northern, central and

southern regions. The current total population of Laos is 6.9 million (2012) with

major of those live in valleys of the Mekong river and its tributaries. The population

density is about 27 per. Sq. meter. Vientiane is the capital and the largest city, and

its population is about 800,000 residents.

After becoming independent in 1975, Laos established control over the

economy through the centralized fiscal and socialist government until 1985 but

during that period, the government had seen that the performance of the economy

was unable to reach expected goals. Economic management was weak due to the

lack of skilled labor force. External assistance was provided but projects were not

completed at a satisfactory level. In 1986, the Lao government implemented the

New Economic Mechanism (NEM) to open the country and provided incentives for

developers and investors and moved from a centrally planned economy to a market

oriented economic model.


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The goals of the NEM were: Launching open market policies and the

introduction of market economy principles. The reform has attracted FDI projects in

the agricultural, industrial, hydropower electricity, mining and the service sectors.

These sectors of development have played an important role in the support of the

economic development in Lao P.D.R.

Laos has continuously pursued significant economic and institutional

reforms, aiming at improving social and economic wellbeing of its population by

consistently building itself a market oriented economy. Laos has achieved

remarkable economic growth and macroeconomic stability. It has witnessed a

significant rise in public and private investment.

These factors contributed to the annual average growth rate of over 6 percent

per annum from 1990 to 2009 and the annual average growth rate of about 8 percent

in 2012.

In order to promote and attract FDIs in Laos, the government has created

Special Economic Zones (SEZ) in compliance with the general investment policies

of the government. The government has implemented incentive policies to promote

both domestic and foreign investment in the special economic zone by shortening

the investment approval process in SEZ, facilitating business operations,

production, and services based on the mechanism of “smaller administration units

but wider society” or “one stamp mechanism” to generate a good environment for

investment.

FDI inflows in Laos have grown dramatically over the past decade and have

played an important role in the growth of the world economy as well as the ASEAN

Nations. In the developing world, FDI has become the most stable and largest

component of capital flows. As a result, FDI has become an important alternative in

the development finance process (Global Development Finance, 2005.)


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Laos is a small and still poor country. Therefore, the investment from foreign

countries in terms of FDI is needed because FDI plays an important role in job

creation, economic growth, capital inflow, technology transfer, human resource

development, and wealth in the host country. Thanks to the economic reform, the

number of FDI projects and the income on international trade have increased

significantly and have had a direct impact on national income as well as GDP

growth.

1.2 Rationale for the Research

It has been suggested that Foreign Direct Investment (FDI) inflows have

played an important role in promoting economic growth in developing countries,

especially in the Southeast Asian countries (Nguyen, 2008). They are the source of

large capital, knowledge, expertise, technology transfer, and international market

access. Since the 1990's, the global flows of FDI have grown phenomenally and

have become the largest source of foreign private capital to reach developing

countries like Laos.

The attraction of the FDI is becoming increasingly important for Laos to

bring certain benefits to the national economy like the contribution to the GDP, the

total investment, and the balance of payment for the host country. However, the

impact of FDI largely depends on the economic conditions. Domestic investment,

personal savings, the mode of entry (merger, acquisition, or new investment), the

industry sector involved, and the country's ability to regulate foreign investment are

all factors affecting the impact size of the FDI (Earth Summit, 2002).

FDI has a substantial influence on social and infrastructure development as

well as technology transfer. It helps in stimulating employment, raising wages, and

replacing declining market sectors, consequently having cultural and social impact

if the investment is directed toward non-traditional sophisticated product (Earth

Summit, 2002).


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Attracting FDI is the major concern and a desired outcome of Laos to catch

up and achieve economic growth. Since investors have certain requirements to

invest abroad, the host countries must posscess a standard macroeconomic

environment to attract those investors to bring their capital, technology, and

expertise. Hence, the role of the government in devising policies and building

economic infrastructure is a pre-determinant to attract FDI.

Location-specific attractiveness, political and economic stability, the

property and profit tax system, the market size and labor-force composition,

geographic proximity, the number of competitors, freedom of entry and exit from

domestic financial markets are all factors influencing the volume and the type of

capital inflows to Laos. In addition, energy and water resources, transportation and

telecommunication infrastructure are critical elements that have a great influence on

capital inflows and investments in the host countries.

Given the importance of FDI especially in developing countries like Laos,

theoretically as well as practically, there are however still inconclusive arguments

for and against the role of FDI inflows in enhancing economic development in a

country (cf., Nguyen, 2008). It has still been debate about whether FDI inflows are

beneficial or not to economic development, and what governments should do to

attract and use FDI inflows effectively (Kokko et al., 2003; Longani & Razin, 2001;

Masina, 2002; Nguyen, 2008). In addition, it has been suggested that the

relationship between FDI and economic growth may be country and period specific

(cf., Adegbite & Ayadi, 2010). Therefore, this study aims to explore the impact of

FDI inflows on some indicators of economic development in the context of Laos, a

developing country in Asia.

1.3 Research Objectives and Research Questions

This study seeks to analyse FDI inflows into Laos and to investigate their

impact on the economic development of Laos. It identified this impact by

responding to the country's characteristics and infrastructure as determinants for


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capital inflows, transfer of technology, augmentation of human capital, and other

spillover benefits.

The desired outcome of this research aims at confirming the linkage between

FDI inflows in Laos and the economic development indicators including GNI per

capita, financial capital, level of technology, human capital, energy and natural

resources, transportation and communication.

The major economic development theories and models such as The Stage

Theory of Rostow, the Harrod-Domar model of savings and productivity of

investment, the Lewis Model of Dual Economy, the Dependency Theory, and other

scholarly models in the field assisted in establishing the base theory for the

research.

The research problem revolves around the notion that Laos is incapable to

achieve economic growth. Natural resources, human capital, financial capital,

transportation and communication, level of technology, and leadership, are all

important elements of sustainable economic growth. They are the foundation for

any economic development stimulation. The scarcity of these resources will stall the

economy and make it difficult to make growth progression.

Research Questions

This research tried to answer the questions: 1) What are the relevant

literature and the theoretical background on FDI and its impact on economic

development? and 2) Does FDI have a significant contribution to economic

development of Laos?

With regard to the impact of FDI on economic development, the research

aims to answer the following specific questions:

• Does FDI have a significant role on the GNI per capita?

• Does FDI have a significant role on the Financial Capital?


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• Does FDI have a significant role on the country's level of technology of

Laos?

• Does FDI have a significant role on Human Capital of Laos?

• Does FDI have a significant role on the Energy and Natural Resources

availability of Laos?

• Does FDI have a significant role on the Transportation and

Telecommunication infrastructure of Laos?

1.4 Scope of the Study

This study focuses on the role of FDI on some indicators of economic

development in the context of Laos. Other aspects of development such as social

and environmental issues (i.e., poverty ratios of different sectors, education and

health care, environment pollution and damage) are not addressed in this

dissertation.

This study mainly employed the data to analyse the relationships between

FDI and Laos’ economic development indicators during the period 1990-2012. The

analyses of correlations were used to serve the objectives of this research.

1.5 Contributions of the Study

Investigation into the effects of FDI on the economies of host countries is

considered one of the two most important and most researched issues in

international business (Driffield & Love, 2007). This study aims to examine the

impact of FDI on several economic development indicators in the context of Laos.

The study is important to help Laos enjoy further economic development as well as

contributes to the literature of FDI and economic growth in the context of

developing countries.


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FDI has been suggested as a determinant of economic development in both

developed and developing countries. Its important role in promoting economic

growth and bringing many benefits to the economy is especially emphasized in the

context of developing countries. However, the literature also provides mix findings

pertaining to the effects of FDI, and there has been suggested that the link between

FDI and economic development may be country and period specific. Therefore, it is

important and meaningful to examine the impact of FDI inflows on economic

development in Laos, a developing country which has received very modest

research attention to date.

By focusing on six main research questions pertaining to the relationships

between FDI inflows and various indicators of economic development, the research

has contributed to both theoretical and practical sides. From theoretical perspective,

the research helps to enrich the knowledge about the important topic pertaining to

FDI’s impacts on economic development in general and in the context of a

developing country in particular. From practical perspective, the research findings

provide significant implications to policy makers in Laos.

The issue of FDI and its important role is more important for developing

countries and the countries in transition like Laos because they lack capital, know

how, and managerial skills. Understanding the role of FDI would help making good

policies to attract more FDI for the purpose of economic development. Therefore,

the results of this dissertation are expected to provide significant implications for

policy makers. The results can be applied in the area of attracting the FDI flows.

The dissertation can also provide recommendations for a better business conditions

for investment and doing business.

Briefly, the findings of this study help to enrich the knowledge about the

important topic pertaining to FDI’s impacts on economic development in general

and in the context of a developing country in particular. The study also provides

implications to policy makers.


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1.6 Dissertation Structure

This dissertation includes six main chapters. The brief content of each

chapter is presented in the following.

CHAPTER 1. INTRODUCTION

Chapter 1 briefly introduces the research background, research motivations,

the objectives, and the structure of the dissertation.


ECONOMIC DEVELOPMENT

This chapter reviews the literature on economic development, FDI and

focuses on the impact of FDI on economic development.

CHAPTER 3. OVERVIEW OF ECONOMIC DEVELOPMENT AND FDI

IN LAOS

Chapter 3 focuses on providing an overview of the state of FDI in Lao

P.D.R., Lao government policies and Laos’ economic growth since 1990.

CHAPTER 4. RESEARCH METHODOLOGY

This chapter outlines the research methodology and data sources used to

answer the research questions.

CHAPTER 5. RESEARCH FINDINGS

This chapter presents the key findings on the relationships between FDI

inflows and various indicators of economic development in Laos over the period

1990-2012.

CHAPTER 6. CONCLUSIONS AND DISCUSSION

The final chapter summarizes the research findings, provides implications,

and discusses limitations of the study and offers suggestions for future research.


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ECONOMIC DEVELOPMENT

2.1. Definition and Indicators of Economic Development

2.1.1 Definition of Economic Development

Economic Development is the progress in an economy and is a measure of

the welfare of humans in a society. It usually refers to the adoption of new

technologies, transition from agriculture-based economy to industry - based

economy, and general improvement in living standards (Businessdictionnary.com).

Similarly, the International Economic Development Council defines economic

development as an “activity that seeks to improve the economic well-being and

quality of life for a community, by creating and/or retaining jobs…”

(smallbusiness.chron.com).

Economic development is a normative concept. It means that it applies in the

context of people's sense of morality (right and wrong, good and bad). The

definition of economic development given by Todaro (1994) is an increase in living

standards, improvement in self-esteem needs and freedom from oppression as well

as a greater choice. The most accurate method of measuring development is the

Human Development Index which takes into account the literacy rates and life

expectancy which affect productivity and could lead to economic growth. It also

leads to the creation of more opportunities in the sectors of education, healthcare,

employment and the conservation of the environment. It implies an increase in the

per capita income of every citizen (Todaro, 1994).

Economic development can also be referred to as the quantitative and

qualitative changes in an existing economy. Economic development involves

development of human capital, increasing the literacy ratio, improve important

infrastructure, improvement of health and safety and others areas that aims at


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increasing the general welfare of the citizens. The terms economic development and

economic growth are used interchangeably but there is a big difference between the

two. Economic growth can be viewed as a sub category of economic development.

Economic development refers to government policy to increase the economic, social

welfare and ensure a stable political environment. Economic growth on the other

hand refers to the general increase in the country products and services output

(source: whatiseconomics.org).

2.1.2 Indicators of Economic Development

According to United Nations Human Development Report (2001) and report

research of bbc.co.uk, some key indicators of economic development are presented

as follows.

- GDP per capita (Gross Domestic Product- the value of all the finished

goods and services produced within a country’s borders in a specific time period).

- Human Development Indicators (life expectancy, Infant mortality rate,

Poverty, Access to basic services, Risk of disease)

- Literacy rates (Access to education )

- Measures of poverty

- Demographic indicators

- Unemployment

- Government spending priorities

- Gender equality

- Infrastructure development

In literature, previous studies have examined various aspects of economic

development such as economic growth, GDP per capita, transportation (road


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access), information network, industry establishment, techonology, financial capital

flow, foreign trade, and human capital (e.g., Adegbite & Ayadi, 2010; Kotrajaras et

al., 2011; Mengistu & Adams, 2007; Phimphanthavong, 2012; Prasad & Sharma,

2012).

In this study, the author examines the impact of FDI on economic

development in Laos, focusing on some economic development indicators

including:

- Gross National Income (GNI) per capita

The GNI per capita is the dollar value of a country’s final income in a year,

divided by its population. It reflects the average income of a country’s citizens.

Knowing a country’s GNI per capita is a good first step toward understanding the

country’s economic strengths and needs, as well as the general standard of

living enjoyed by the average citizen (Wikipedia).

- Financial Capital

- Level of technology

- Human Capital

- Energy and Natural resources

- Transportation and Communication

2.1.3 Theoretical Economic Overview

Rostow (1960) argued that all countries passed through the same historical

stages of economic development and underdeveloped countries were at an early

stage compared to the advanced world (e.g., Europe and North America). He

identified societies in their economic status as passing through one of five stages:

the traditional society, the preconditions for take-off, the take-off, the drive to

maturity, and the age of high mass- consumption.


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Lewis' Dual Economy model (1954) was based on the assumption that many

LDCs had dual economies with both a traditional agricultural 'informal' sector and a

modern industrial 'formal' sector. The traditional agricultural sector was described

with low income, low productivity, low saving, and high unemployment rate. The

industrial sector on the other hand was technologically advanced, with high

investment level operating in urban environment. According to this model, surplus

labor in the traditional agricultural sector should migrate to the modern sector where

the high rising marginal product is. Migrating surplus labor would have no effect on

agricultural productivity since marginal productivity of the rural workers is close

to zero.

In his 1954 paper on Economic Development with Unlimited Supplies of

Labour, Lewis argued that the modern sector would have larger savings,

accumulation of capital, and investment, and consequently economic growth.

Capital accumulation comes from the higher wages in the modern sector compared

to the rural sector. The underdeveloped countries have a larger population than

capital and natural resources, employing workers with insignificant productivity,

zero or even negative (Fields, 2004).

According to the traditional model of economic development and its

proponents like the Harrod-Domar growth model, the absence of the high level of

savings in underdeveloped countries contended that the stimulus for economic

growth could only be achieved from an outside capital provided by MFs through

foreign direct investment (FDI) since they have the capabilities and the resources to

provide that capital and transfer modern technology to the underdeveloped nations.

Harrod-Domar model suggested that the economy's rate of growth depends on the

level of saving and the productivity of investment; that is, the capital output ratio.

The model was developed to help analyze the business cycle. However, it was later

adapted to explain economic growth. It argues that the main ingredient of economic

growth is to expand the level of investment both in terms of fixed capital and human


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capital. To do this, policies are needed to encourage saving and/or generate

technological advances that enable firms to produce more output with less capital or

lower their capital output ratio (Pool & Stamos, 1990).

Opposing the traditional model, the equity structuralist model stated that

underdevelopment could only be explained in a historical context. The state of

underdevelopment was the result of colonization that allowed a small minority to

own and control the majority of the land, the primary raw materials, and the

illegitimate political power (Pool & Stamos, 1990).

Dependency theory (Pool & Stamos, 1990) on the other hand, has explained

the underdevelopment based on the Marxian analysis. It argues that the MFs have a

negative impact on developing nations and market structure, challenging both the

traditional and the structural models. Because of the MFs power of economy of

scale and barriers to entry (technology and capital resources), they are an obstacle to

competition from the local firms in the host countries.

The Dependency theory has presented the practice of transfer pricing

(overpricing imports and under pricing exports) by the MFs to gain benefits at the

expense of the developing countries. Additionally, developing countries were

targeted by MFs to transfer their economic surplus to the developed world by

extracting and controlling raw materials, and accessing cheap labor markets.

In his classic 1956 work, Solow proposed that the study of economic growth

should begin by assuming a standard neoclassical production function with

decreasing returns to capital. He suggested that the rate of saving and population

growth could determine the steady state of per capita income. Since these variables

vary across nations, they reach different levels of GDP per capita. Therefore, when

the rate of saving is high, the richer the country is, and when the population growth

is high, the poorer the country is (Mankiw et al., 1992).


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Mankiw et al. (1992) said that Solow's model was successful in predicting

the effects of saving and population growth on economic development but did not

predict the magnitude of that effect. Therefore, they augmented Solow's model by

including accumulation of human as well as physical capital to the formula of

economic growth. They concluded that for a given rate of human capital

accumulation, higher saving or lower population growth leads to higher level of

income and thus a higher level of human capital. Hence, accumulation of physical

capital and population growth has greater impacts on income when accumulation of

population growth rates. This would imply that omitting human capital

accumulation biases the estimated coefficient on saving and population growth.

Heady (1979) indicated that the real problem in the least developed countries

is the imbalance between the accumulation of capital and the production level.

These countries face a necessity to increase the exports level of their raw materials

of which their prices constantly fall, while imports of industrialized materials,

technology, and other finishes products of which the prices rise up. Consequently,

per capita income gap between the developed nations and LDCs is always

increasing, in addition to the relative increase of population growth.

2.2 FDI and its Impact on Economic Development

In literature, there are various FDI theories including production cycle theory

of Vernon, strategic behaviors, industrial organization, internalization eclectic

paradigm, complement theory of FDI, the theory of internationalization of FDI (OLI

paradigm), the resource based theory, the business network theory, the theory of

new economic geography, diversified FDI and risk diversification model, policy

determinants of FDI, etc. It is important to have critical points of view towards the

theories relating to FDI. This chapter focuses on some main issues related to FDI

theories and FDI’s impact on various aspects of economic development. However,

the first section will present definition of FDI and the reasons for FDI.


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2.2.1 Definition and Determinants of FDI

2.2.1.1 Definition of FDI and reasons for FDI inflows to developing countries

Definition of FDI

FDI has been defined by OECD (2012) and OECD International Direct

Investment Statistics (database), that are presented as follows.

FDI is defined as cross-border investment by a resident entity in one

economy with the objective of obtaining a lasting interest in an enterprise resident

in another economy. The lasting interest implies the existence of a long-term

relationship between the direct investor and the enterprise and a significant degree

of influence by the direct investor on the management of the enterprise. Ownership

of at least 10% of the voting power, representing the influence by the investor, is the

basic criterion used.

Inward stocks at a given point in time refer to all direct investments by non-

residents in the reporting economy, while outward stocks are the investments of the

reporting economy abroad. Corresponding flows relate to investment during a

period of time. Negative flows generally indicate disinvestments or the impact of

substantial reimbursements of inter-company loans.

The FDI index gauges the restrictiveness of a country's FDI rules through

four types of restrictions including foreign equity limitations, screening or approval

mechanisms, restriction on key foreign employment, and operational restrictions.

The OECD FDI regulatory restrictiveness indexes presented here

demonstrate that the service sector tends to have higher FDI restrictions across

countries, followed by primary sectors. The manufacturing sector remains the most

opened economic sector.

In the same line, according to investopedia.com, FDI refers to an investment

made by a company or entity based in one country, into a company or entity based


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in another country. FDI differs substantially from indirect investment such as

portfolio flows, wherein overseas institutions invest in equities listed on a nation's

stock exchange. Entities making direct investments typically have a significant

degree of influence and control over the company into which the investment is

made. Open economies with skilled workforce and good growth prospects tend to

attract larger amount of FDI than closed, highly regulated economies.

When analyzing FDI, it is important to differentiate it from Foreign Portfolio

Investment (FPI). FPI is passive, non-fixes holdings of foreign stocks, bonds, or

other financial assets. Investors look for profit from the rate of return on their

investment and no management control is assumed. It is noted that the most

accepted definition of FDI is the one given by the International Monetary Fund

(IMF). IMF defines FDI as the acquisition of at least 10% of the ordinary shares or

voting power in an enterprise by nonresident investors, and direct investment

involves a lasting interest in the management of an enterprise and includes

reinvestment of profits (cf., Agrawal & Khan, 2011). Therefore, the distinguishing

feature between FDI and FPI is that FDI has some form of control over operation

and influence over decision, but with control comes risk and commitment. Risk is

something which multinational enterprises (MNEs) prepared to take. MNEs can be

defined as “companies headquatered in one country but having some upstream

and/or downstream operations in other countries” (Lee & Rugman, 2009; p. 62). So,

those organizations which conduct FDI in other countries can be classified as

MNEs.

Reasons for FDI inflows to developing countries

Yoonbai (2000) examined the reasons behind the flow of FDI in countries

like Korea, Malaysia, Chile, and Mexico. The research found that this flow was

influenced by two factors on a global level: recessions faced by many industrialized

economies and the global interest rate drop. Internal factors like (a) country-specific

productivity shocks, (b) demand shocks, (c) inflation shocks,(d) monetary shocks,


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(e) credit worthiness because of macroeconomic stabilization, (f) widespread

liberalization of financial market, and (g) a successful resolution of debt problems

were found relatively less important.

A study by Ito and Rose (2002) explaining the nature of international

competition among MFs in the tire industry and the determinants of an MFs

decision to establish a subsidiary in a foreign country showed that the number of

competitors, the host country characteristics, and the foreign experience of the firm

defined the pattern and location of the firm investment. Oligopolistic reaction and

FDI theories with binomiallogit and logistic regression models were used in the

study. The data sample included eight major tire firms; (Bridgestone, Continental,

Dunlop, Firestone, General, Goodrich, Goodyear, Michelin, Pirelli, and Uniroyal),

and a total of 939 observations for the years 1982, 1987, and 1992. It was also

found that factors associated with FDI decision are (a) location-specific

attractiveness, (b) political and economic stability, (c) low corporate tax, (d) large

market size, (e) geographic proximity, (f) size of the foreign market, (g) number of

competitors, and (h) anticipation of profit.

An earlier cross-country data analysis using representative countries from

Asia and Latin America (Calvo, Leiderman, and Reinhart, 1996) also outlined the

causes of the capital inflows to developing countries in the 1990s, and the

macroeconomic effects on them because of this inflow. The concluded causes were

(a) the sustained decline in the world interest rate which motivated the investors to

the high-investment yields and improving economic prospects of Asia and Latin

America's economies, (b) the 1990s recessions in the U.S., Japan, and many

countries in Europe made the profit opportunities in developing countries appear

more attractive, (c) the trend toward international diversification of investments in

major financial centers and toward growing integration of world capital markets, (d)

the significant progress that many heavily indebted 12 countries made toward


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improving relations with external creditors as well as adopting sound monetary and

fiscal policies with trade liberalization.

The Earth Summit (2002) indicated that the most heavily indebted and

low- income countries are mostly dependent on bilateral and multilateral financial

aid to carry on their development strategies. However, since the 1990s the global

flow of FDI has grown phenomenally and has become the largest source of

foreign private capital to reach developing countries.

Albuquerque (2003) examined the volatility of the FDI inflows to developing

countries compared to other forms of financial inflows. Research showed that there

was substantial evidence that FDI flows are less volatile than other forms of

financial flows to developing countries, for example, the Latin America debt crises

in 1980. The FDI collapsed but other forms of capital inflows fall was seven times

greater. Mexico's debt crisis in 1994 is another example, where FDI fell in 1996

by 27%, while other forms fell by 89% for portfolio equity and by 45% for debt

flows.

The level and relative importance of FDI has fluctuated over time, and was

high in the early parts of the 20th century, low in the middle part and growing high

towards the end. Recently, there has been increase in FDI to developing countries,

though concentrated in a few regions and countries. Inward FDI to developing

countries has always been concentrated in a handful of countries, in part reflecting

their economic wealth, but also reflecting the ability of countries to create the

conditions to ensure efficiency and strategic asset for FDI needs including good

quality of human resource and technological capabilities.

There has been a marked shift towards liberalization of FDI regime, and FDI

is regarded more favorably. No longer can it be assumed that FDI is mainly

negative (as it may have been a dominant perception in the 1970s ). Appropriate


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policies benefit from FDI include building up local human resource and

technological capacities to capture productivity spillovers.

Renewed confidence in the positive benefits of FDI has led many countries

that were restricting FDI in the 1990s and 1980s to be more open towards FDI in

1990s (Safarian, 1999) and beyond. Governments are liberalizing FDI regimes as

they associate FDI with positive effects for economic development in their countries

(e.g., Lall, 2000s). Much of potential for economic development was not realized 3-

4 decades ago because many countries have severe restrictions toward foreign

ownership, and many of quality local capabilities were not in place. This is

gradually changing. Almost all countries now actively welcome FDI.

They have liberalized their investment regime, but at different points in time.

South – East Asian economies: in 1960s, Hongkong {China}, Singapore, Malaysia

were first, while other Asian countries (Republic of Korea, China and India) and

Latin America countries began to liberalize in 1980s and 1990s (even the Republic

of Korea, which had previously restricted FDI and imported technology through

licensing, decided after the Asian crisis in 1997 to open more to FDI for the capital

and technology it could bring). Many African countries followed only in 1990s.

Countries now actively try to attract FDI and have established FDI promotion

agencies for this, thereby aiming to change an FDI screening task into true FDI

promotion. The proliferation of other tools included incentives, expert processing

zones, Science parks, etc. Restrictions on FDI on the other hand have declined as

competition for FDI increased: there has been a decrease in the inclined as

performance requirements (UNCTAD, 2003).

2.2.1.2 Determinants of FDI

It has been considered that imperfections in market throughout the world

create the desire to invest in other countries, and therefore, firms conducting FDI

are opportunists who are continually looking for possibilities to explore. Firms are

motivated to engage in FDI for a number of reasons. Wall and Rees (2004) have


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identified three main factors including 1) supply factors, which include reduced

production cost, more favorable location, lower distribution costs, better availability

of natural resources and access to technology; 2) demand factors, which include

better marketing power through a presence on the ground, protection of a brand

name through a better monitoring and closer proximity to business customers; and

3) political factors, which are the benefits of avoiding set trade barriers as well as

tax and economic incentives from host governments. The presence of just one of

the aforementioned reasons supports the decision to engage in FDI rather that

pursuing an alternate means of serving a foreign market, such as exporting,

licensing or franchising.

Firms who choose to invest abroad are commonly more competitive than

their peers, who remain satisfied with a domestic market. Not all firms choose FDI,

as it is inherently risky due to the degree of unknown when operating in a foreign

market. However, increased risks mean greater incentives, and those firms who

manage to become more successful of a result of their FDI activities receive large

reward (United Nations, 2006).

There have been a number of theories and approaches that help explain the

motivations of FDI and identify FDI’s determinants. The following will present

some of these.

Internalization

Internalization was conceptualized by Ronals Coase (1937), who found that

FDI and associated internalization take place when transaction costs, i.e. the cost of

negotiating, enforcing and overseeing a contract, are high and in such cases firms

internally can be suitable substitute for market. Alternatively, when these costs are

low, this positively supports the case for working in partnership with other firms,

being parts of the market, and using mutually beneficial licensing and franchising

agreements. The firm is left to decide whether it is more cost effective to own and


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run a facility oversea (internalize) or it is better to establish a contract with a foreign

firm to run, license or franchise on their behalf (Wall & Rees, 2004). The

internalization theory developed from the imperfections in the market.

Internalization can be seen as a form of vertical integration, where the firms takes

ownership of duties and/or goods that it formerly relied on a third party to provide.

Hood & Young (1979) argue that it is not just the ownership of a firm’s specific

asset that gives it its advantages, which is the process of being able to internalize

the asset, rather than selling it, which gives the MNE its overriding advantage.

Overall, knowledge provides a firm with a monopoly advantage and only through

discriminatory pricing, instead of licensing for example, can MNEs capitalize fully.

Transactions with other firms consume time, and additional costs can be

incurred during searching periods and in uncontrollable events. Therefore, replacing

these market inherent obstacles with internal processes can reduce insecurity. The

internalization argument provides reasons why firms prefer FDI in some

circumstance to importing and exporting, and why they may refrain from licensing

or franchising (Moosa, 2002). The internalization argument does not appear to have

any theoretical foundations, and Rugman (1986) supports this by stating that due to

its generality, internalization can be seen as more of an approach than a theory.

Also, with internalization, centralization is promoted. This may not be beneficial in

all firms, especially those that are innovative (ibid).

The costs of internalization need to be taken into consideration: more

accounting and ownership of information is required; the costs of communication

increase; and the dislike of MNEs in some host countries cause political

discrimination that could affect the firm adversely. All of these costs need to be

justified (Hood & Young, 1979). MNEs have to consider the full picture when

making future FDI decisions and as Grosse (1985) put it, MNEs are complex and

that the internalization principle features are a small part of a larger picture in the


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FDI decision making process. Nevertheless, FDI evidence across many countries is

in general supports of the hypothesis of firm’s preference for FDI (Moosa, 2002).

Eclectic paradigm

The eclectic paradigm, constructed by Dunning (1981) proposes three

determinants of FDI of which each relates to advantages of conducting direct

investment as a preference to other methods of serving foreign customers (Bende –

Nabende, 1999). The three variables of the eclectic paradigm are ownership,

location, and internalization (OLI), and these act like a three legged stools, of which

each leg is equally as important as the other (Dunning, 2000). Dunning asserts that

firms will become involved in FDI when all three factors are present.

Ownership advantage (O): A unique advantage must be present which can

counter the disadvantage of competing with firms on their home grounds. A firm

can gain this by having one of three forms of assets. Two main advantages arise

from having one of the aforementioned: First, a firm will have more effective

production and marketing, and second, a firm will have an international,

competitive advantage due to having a string ownership advantage over the local

firms (Bende- Nebende, 1999; Griffin & Putsay, 2002).

Location advantage (L): There must be increase in profitability from

exploiting a firm’s ownership advantage in a different location rather than in its

domestic market, and this may come in the form of economic, market, cultural, or

prospect benefit (Wall & Rees, 2004 ). The advantages of the location can either be

used to directly serve the foreign market or as a convenient base from which to

export. The location advantage needs to be considered in relation to the current state

the host country as well as the foreseenable development path of the home country

(Bende – Nebende, 1999).

Internalization advantages (I): There must be increasing benefits from having

full control over the foreign business rather than using an independent local firm to


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carry out those duties. There are a rang of situations where internalization can be

beneficial, from circumstances where local firms cannot be trusted either for

tarnishing the brand of a firm or being incapable of performing the required duties,

through to being overpriced (Griffin & Pustay, 2002). With internalization, firms

have the opportunity to fully exploit the ownership advantages. Firm advantages

commonly revolve around their knowledge of making a product or provide a

service, and internalization provides opportunity to keep that particular information

secure, as this could be the core of their competitiveness (Czinkota, Ronkainen and

Moffett, 2005).

The three elements of Dunning’s eclectic theory have been assembled using

the supports of other theories, namely Sermon’s product life cycle, Hymen’s

ownership advantage, and internalization by Coase. When combined, they bring

together separate areas, which allow them to provides greater and more detailed

criteria to judge the suitability of FDI. Therefore, eclectic paradigm has three times

the power of each of the theories which make it up. Dunning (1997) also suggests

four type of seeking behavior that stimulate firms to engage in FDI. These include

resource seeking to attain physical or human resources, market seeking to use or get

close to a foreign market, efficiency seeking to gain access to more efficient labor

or technology, and strategic assets seeking to acquire resources and capabilities that

help to capitalize on competencies or to prevent an asset being lost to a competitor.

Traditionally, FDI was motivated by lower cost of production overseas with the

view of exporting to serve other markets rather than serving domestic market, but

reasons for investing abroad vary tremendously. More recently, FDI has been

undertaking to serve domestic markets, and this is particularly evident in developing

countries (IMF, 2003).

The eclectic paradigm does justify the who, where and how of FDI, but

unlike the product life cycle theory, the eclectic paradigm is incapable of indicating

exactly when a firm should invest overseas. If its plans are delayed, a firm may find


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itself beaten by other investors because local partners are scarce or natural resources

are limited. Also, if the country has a small market, the firms who move first could

saturate the market and confrontation could result in reduced profitability for a

firm. Timing is an important consideration. When firms move into developing

countries and fail to consider, it could mean that a firm invests after the optimum

time (Ramasamy, 2003). Foreign investment does not happen instantly, but once

the commitment has been made it may be irreversible. After investment, and while

waiting for operations to commence, a firm’s golden benefits of a market may slide

away. This could cause a knock-on effect and result in delays in entering the next

market, as all of this affect the firm negatively when compared to proactive

competition.

Complement Theory of FDI

The complement theory, as synthesis of the Heckscher-Ohlin model, the

Rybczinski theorem, Linder’s hypothesis, and the Vernon product cycle hypothesis,

was developed by Kojima in the late 1970s. Kojima’ thesis offers an alternative

hypothesis to Mundell’s substitution Theory (Ozawa, 1979). He argued that FDI

originates from the comparatively disadvantaged industries of the home country,

which are potentially comparatively more advanced industries in the host country,

depending on the different stages of economic development in home and host

countries.

Kojima’s approach predicts that export-oriented FDI occurs when the source

country invests in those industries which have a comparative advantage in the host

country. FDI is considered as the transfer of superior production function to replace

inferior ones in the host country (Kojima, 1975).

Thus, Kojima derived the result that export-oriented FDI is welfare

improving and trade creating since it can promote both host countries’ and source

countries’ export, in particular, Japanese export business to market distortion


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created by government policies in the developing countries (Tsurnmi, 1979).

Obviously, besides Asia, this can be extended to other transition countries.

The Resource-Based Theory

Summarizing multiple MNCs’ incentives, Behrman (1972) proposed and

developed a typical FDI. This classification is based on industrial organization

theory and corporate governance. According to Behrman, MNCs are always seeking

one of four types of results: resources, markets, efficiency (global Sourcing FDI),

and strategic assets. However, because ownership and internalization advantages are

supply-side factors, they are not considered by Behrman. The resource-based theory

of the firm (Bamey, 1991; Grant, 1991; and Davidow, 1986) creates a methodical

basis for MNC investment strategy to achieve competitive advantage by

understanding the external forces that strongly effect an organization (Lindelof and

Lofsten, 2004).

Accordingly, MNCs aim to possess resources that are rare, unique, and

limited to beat their competitors. The resource-based theory has been developed to

explain how organizations achieve sustainable competitive advantage (Caldeira and

Ward, 2003). Accordingly, firms must look for unique attributes that may provide

superior performance (Barney, 1991; Caldeira & Ward, 2003). This theory focuses

more on the advantages associated with the complexity of managing multiplicity of

activities and functions in a volatile but innovated global economy (Dunning, 2000).

The finding of Tondel (2000) supports a hypothesis of market-seeking and resource-

seeking investments prevailing in Central and Eastern Europe and former Soviet

republics. Kudina and Jakubiak (2008) also find that market-seeking orientation has

the most positive effect on investment performance, followed by skilled labor and

cheap input orientation countries.

Resmini (2000) argues that a statistically significant position between FDI

and market size, wage differential, the stage of the transition process and the


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openness of the economy. However, MNCs emerging in the transition economies

with the government as main stakeholder are limited in the natural-resource –

seeking activity of foreign investors. This situation especially contains

characteristics of rent – seeking countries (Filippov, 2008). The rent-seeking

empires of the oligarchs become monopolist on the domestic resources market. As a

result, foreign investors should seek labor and efficiency and form horizontal FDI

patterns. This may partially explain the predominance of horizontal FDI pattern in

transition economies.

The Theory of New Economic Geography

According to the theory of new economic geography (Krugman, 1991,

1999), the ‘home market effects’ interprets agglomeration as the outcome of the

interaction of increasing returns, trade costs and factor price differences. If trade is

largely shaped by economies or sales, as Krunman’s theory argues, then those

economic regions with most production will be more profitable and will therefore

attract even more production and FDI. In other words, instead of spreading evenly

around the world, production will tend to concentrate in a few countries, regions or

cities, which will become densely populated but will also have higher levels of

income.

In line with Krungman and Vendables (1994), Damijan and Kostve (2008)

find very strong evidence that in most of the transition countries analyzed, trade

liberalization has caused a declined and divergence in relative regional wages, but

the relative wages then adjusted toward the stock mainly through economic

geography factors. For instance, in Central and Eastern European countries,

important inter-regional relocation of manufacturing activity have taken place after

trade liberalization with the EU, and inward FDI mostly to the capital and border

regions has help to the foster these adjustment processes. However, since economic

integration with EU provides important opportunities for individual regions, it can

also have severe polarization effects. In fact, such a polarization can be observed in


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all transition countries. For example, Ledyaeva, and Linden (2006) note that the

central region of Russia has a rather high value of accumulated FDI per capita

compared with other regions. In fact, it accumulated almost 40 percent of total FDI

stocks in Russia and has the highest FDI per capita.

According to Pan – European Institute estimate (Pan – European Institute

report, 2004 ), out of the 20 Russia receiving the most FDI; 11 of them have cities

of more than a million inhabitants. Hence, big city advantages like high levels of

business infrasture and large market size are important factors of inward FDI.

Ledyaeva and Mishuna (2006) analyze FDI distribution in Russian regions and

show that only a fraction of aggregated profit in a particular region is robustly

related to regional distribution of investment in Russia, which is unfavorable and

only high profit can compensate for the risks and attract investors.

Suggesting regional homogeneity of FDI factors for transaction economies,

Deichmannetal (2003) examine the extent to which none-spatial determinants of

FDI are affected by spatial proximity. Thus, within the group of transition factors,

we can also distinguish some regional subgroups according to historical, economic

and cultural conditions.

Diversified FDI and risk diversified model

A large stream of empirical contributions have analyzed the role of risk

factors on explaining FDI patterns and MNCs, incentive to invest abroad (Miller

and Pras, 1980; and Caves, 1996). Faeth (2009) noted that while horizontal and

vertical patterns of FDI can be explained well by the transaction- cost approach and

knowledge – capital model, diversified FDI, which is growing in importance,

cannot be explained, as it is considered a minor factors of MNCs’ desire to spread

investment risk. Firms’ risk aversion, which has been considered a minor factor of

FDI, is gradually emerging as one of the main determinants of FDI. Rugman’s

diversification to hypotheses has been widely supported by empirical evidence. In


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contrast to horizontal and vertical patterns, conglomerates arise as a response to

high risk business environments. Kopites was the first to describe this form of MNC

in 1979. Bettis (1981) suggested that firm achieved better performance because of

openness to the possibility of differentiation and segmentation based on identified

risk factors.

Policy determinants of FDI

The earliest study by Bond Samuelson (1986), Black and Hoyt (1986),

Haufler and Wooton (1999), and Haland and Wooton (1999) argued that there are

strong links between MNC strategy and government policy in the host countries.

Empirical studies show that an MNC’s decision to invest can be influenced by

factors such as information asymmetry, structure of the host economy, market size,

market evolution, openness, the level of infrastructure and the level of

political, economical and financial risk (e.g. see Resmini, 2000).

Altomonte (1998) obtained evidence by including variables measuring the

Institutional and economic uncertainty under which the investment is made. In the

context of institutional and risk factors, we can identify a dual role of

government in transition countries. The government is not only interested in

attracting FDI but can also provide large support for domestic MNCs, being a key

stakeholder in them. This phenomenon has been explored in a wide empirical

literature (Brouthers & Bamossy, 1997; Cass, 2007; Drahokoupil, 2008).

Deicmann, studying the origins of FDI in Poland (2004) and in the

Czech Republic (2010) finds that origin effects and government promotion

abroad play an implicit contradictions that complicate FDI into transition

economies. Using political leverage (an administrative resource like close ties to

the government or lobbying in Parliament) and domestic media leverage, emerging

MNCs protect and promote their business, but also successfully compete with


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foreign companies within the host market and regional markets (Khanna & Yafeh,

2008).

Changes in the determinants of FDI.

The way that FDI affects growth and development depends, for an important

part, on the type and volume of FDI. Thus, when understanding the impact of FDI,

it is importance to understand what attracts FDI, how this has changed over time,

and what these changes in determinants and type of FDI mean for differential

growth prospects. The main determinants of inward FDI can be divided in to several

categories, and relate to:

- General policy factors (e.g. political stability, privatization)

- Specific FDI policies (incentives, performance requirements, investment

promotion, international trade and investment treaties)

- Macro economic factors (human resources, marketing size and growth)

- Firm specific factors (e.g., technology): For instant, ICT development have

had a profound impact on the way companies structure their international activities.

Most importantly, it has facilitated a more competitive environment for any given

activity.

There have been treads in all of these factors over the past decades and

between them. They can explain large parts of why FDI has gone more to some

countries and regions than others. There has also been changes in their relative

importance. The main point is that, and we will also see later, factors that have

become increasingly important in attracting FDI (building up appropriate and good

quality, local capabilities are also increasingly important in marketing FDI work for

economic development).


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2.2.2 Impact of FDI on Economic Development

FDI has been considered to be one of the most important drivers in

upgrading the country-specific resources as well as the firm-specific capabilities of

host countries. FDI’s contributions to the development of host countries can be

implemented through several channels such as transferring financial resources

directly to the FDI recipient countries, technological and managerial spillovers to

local firms of the host countries, and/or helping host countries join the global

trading, investment and technology networks of foreign MNEs. The importance of

FDI to the development of host countries has recently increased due to the role

‘flagship’ of MNEs, who are considered the main FDI implementors (cf., Lee &

Rugman, 2009).

In the following sections, first the author review previous studies on the

impact of FDI on economic growth and some other aspects of economic

development, mainly in the context of developing countries. After that, a review of

the studies on the impact of FDI on economic development through human capital

and technology is provided. Finally, the author presents FDI and its spillover

effects.

2.2.2.1 Impact of FDI on economic growth and other economic development

aspects

New growth theorists, Levine and Renelt (1992) have identified investment,

including FDI as one of the main determinants of economic growth (Adegbite &

Ayadi, 2010. According to UNDCTAD (1999), much have been written about

relationship between FDI and development. The author reviews the main impact

areas and suggest there have been major changes within these, with an emphasis on

FDI relates to economic growth (we do not deal separately with equality and

poverty). There are several areas through which FDI affects development

(UNCTAD, 1999), including: Employment and incomes, capital formation, market


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access, structure of skills, technology and skills, fiscal revenues, political, cultural,

and social issues.

FDI affects economic growth through all of the above channels. FDI can

raise economic growth by increasing the amount of factors or production (by

increasing capital or employment, directly in local suppliers and competitors), in the

traditional growth accounting context, or increasing efficiency by which these

factors are using (by using superior technology, or locating in high productivity

areas, or through productivity spillovers), as expressed in the literature in

endogenous growth (e.g. Aghion and Howitt, 1988) where FDI represents the port

through which new ideas are gained. In the long-run, FDI induced productivity to

local capabilities, while FDI induced building up of factors may only raise growth

temporarily (e.g. by establishing a garment assembly factory).

Those countries whose local capabilities have been enhanced because of FDI

(e.g. in Singapore and island, where local suppliers have become global exporters)

have also been able to benefits most from FDI in the long- term. However, those

countries that attracted FDI in the apparel sector because of trade policy distortions

(due to the multi Fiber Arrangement quotas which governed world trade in textiles

and clothing until 2005) without building up local capabilities or linkages, may have

derives fewer long – term benefits from FDI. For instance, there are now fears that

investors in Lesotho would withdraw, at a time that much apparel capacity is

relocated to China.

It has been argued that FDI enhances long run economic growth via

technological progress, capital accumulation and human capital augmentation (Chee

& Nair, 2010). Gao (2005) investigated the interrelationship between FDI and

growth. Using a two-country model in which FDI and growth are endogenous, he

found that both FDI and growth respond endogenously because of the change in the

world economic integration.


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Zhang (2001) studied the link between FDI inflows and economic growth

in developing countries. Using a sample of 11 countries in Asia and Latin America

with estimation and cointegration tests, the research found that, depending on

countries' characteristics, FDI can be growth-enhancing when they have liberalized

economies, sufficient human capital derived from education system

improvements, export-oriented policy, and macroeconomic stability.

Balasubramanyam et al. (1996) examined the role, which FDI plays in the

growth process in countries characterized by different trade policy regimes. Using

regression analysis on determinants of growth rate of real GDP on cross-section

data relating to a sample of 46 developing countries, research suggested that the

beneficial effect of FDI in terms of enhancing economic growth is stronger in

those countries that pursue an export promoting policies than it is in those

countries adapting an import substituting policies.

In the context of developing countries, it has been suggested that FDI can

bring benefit if the countries have the capabilities to absorb advanced

techonologies. A recent study by Agrawal and Khan (2011) has showed that FDI

has significant impact on economic growth in China and India. Specifically, they

found that 1% increased in FDI would results in 0.07% increase in GDP of China

and 0.02 increased in GDP of India. So, FDI can have different affects on economic

growth in different countries.

Similarly, a study by Kotrajaras et al. (2011) have examined the impact of

FDI on economic growth in groups of 15 East Asian countries classified by level of

economic development. The results suggested that the impacts of FDI depend on

complementary factors, particularly each host country’s economic conditions such

as levels of financial market development, institutional development, better

governance, and appropriate macroeconomic policies.


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In India FDI is considered to play an important role in the development of

the Indian economy. In many ways, FDI has enabled India to achieve a certain

degree of financial stability, growth and development (Prasad & Sharma, 2012).

The sudy by Adegbite and Ayadi (2010) investigates the relationship

between FDI flows and economic growth in Nigeria. The study became necessary

because as never before, the civilian governments since 1999 have employed

several strategies to ensure increased flow of FDI into Nigeria because of its

perceived benefits as lauded in the theoretical literature as the panacea for economic

underdevelopment. The study utilized simple OLS regression analysis and

conducted various econometrics tests on the model so as to obtain the best linear

unbiased estimators. The study confirmed the beneficial role of FDI in growth.

However, the role of FDI on growth could be limited by human capital. The study

concluded that indeed, FDI promotes economic growth, and hence the need for

more infrastructural development, ensuring sound macroeconomic environment as

well as ensuring human capital development is essential to boosting FDI

productivity and flow into the country.

The research by Mengistu & Adams (2007) has examined the dynamic

relationship between FDI, domestic investment, institutional environment, and

economic growth in developing countries. The results indicate that the two most

important determinants of economic growth over the study period were FDI and

institutional infrastructure. The study also found that FDI’s effect on economic

growth was more through its efficiency effects than through its augmentation of

domestic investment. Accordingly, developing countries need to focus on policies

that promote institutional development and become attractive destinations for FDI

to sectors that lead to increasing returns to domestic investment and production.

In a comparative analysis, Nataliya Ass and Matthias Beck (2005) observe

that a negative relation between FDI and “Trade Balance” which is much stronger

for the Central Asian countries, co-exists with a positive relationship between FDI


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34

and “Export per capita” for this region. This appears to indicate that resource

centered FDI is likely to increase per capita export. However, these gains are wiped

out by excessive public and private spending which negatively affects the country’s

overall trade balance.

The relationship between FDI and some other economic indicators provide

further evidence. Thus, EU accession countries are the only group for which FDI is

negatively correlated with inflation. By contrast, in all post Soviet states, FDI

inflows are not associated with the reduction of the rated of inflation. Moreover, in

case of the post soviet European states (Belarus, Moldova, Russia and Ukraine) FDI

shows a strong positive relationship with “debt per capita”, while for all other

groups this relationship is weakly negative. This indicates thast this region attracts

riskier and lower quality debt- increasing investment.

The opposite situation can be observed for ‘unemployment’. The EU

accession countries are the only group for which unemployment reveals strong

enough (in comparison to all other cases) positive relationship with FDI vis-avia

post Soviet countries where FDI is negatively related with unemployment. This

finding, through contradictory to the original argument on lower FDI quality in

post- Soviet states, indicates that EU accession countries are now attracting FDI

which is not contributing to the increase of employment in the region. The inference

can be made that, after reaching a certain level of development by transition

countries, FDI changes its quality from being unemployment reducing to not

contributing to the increase in employment. Negative relationship between

unemployment and FDI in case of post-Soviet European countries, in turn, can be

explained by the high levels of underreporting figures on unemployment in these

states.

In their regional study on the Arab World Economic Development and

Growth over the past four decades, Sala-i-Martin and Artadi (2003) have related

the lack or the slow economic growth in that region to the inefficient public


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35

investment, which requires heavy tax revenues but has minimal positive impact

on the national productivity due to the wrong sector choice, or the intention to

attain just political or private gain. In addition, the negative rate of growth in the

Arab World can be tied to several other factors: The Inefficient financial sector

and its negative role played in the productive investments, the excessive reliance

on public investment, the political instability represented by the wars, violence,

and social conflicts, the excessive government intervention and complex

overregulation for business licensing, which creates environment for bribery and

high level of corruption, the lack of transparency, and the inadequate, unqualified

human capital.

Based on Frederick Mmieh, Nana Owusu-Frimpong research paper on “State

Policies and the Challenges in Attracting Foreing Direct Investment: Areview of the

Ghana Experience” (Septemeber, October 2004), effects of FDI are at the center of

a continuing controversy in the economic transformation of Ghana. Many Ghanaian

economists believe that the impact of such investment is positive, since it brings to

the country a package of capital, foreign exchange, technology, managerial

expertise, skills, and other inputs typically in short supply locally. It is also being

argued that while FDI and participation in the global market might bring about a

higher growth rate, it is often at the expense of economic stability, employment,

income distribution, and even political freedom, with minimal technological

transfer. In the 1970s and 1980s, Ghana became heavily indebted and, finding it

difficult to raise new foreign loans to mobilize domestic resources, FDI looked

increasingly attractive, not as an additional source of capital but for the technology

and market access such investment brings.

This study takes the view that without FDI the country would not have been

able to achieve the progress it has made so far, resulting in a modest increase in FDI

flows into the country. This article, however, recognizes that countries such as

Nigeria and Angola are able to attract higher returns of FDI in the extractive


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36

industries to compensate for political instability, even though they abandoned the

reform program in the early 1990s. It is acknowledged in this study that as long as

foreign business organizations are confident of being able to operate profitably in a

business environment without undue riskto their capital and personnel they will

continue to invest. Evidence demonstrates that under the SAP, the deterioration of

the economy has at least halted, and a modest growth rate of around 4% has

transpired evidence of a remarkable recovery” (Debrah, 2002). The SAP’s limited

success also includes the lowering of inflation, promotion of an environment of

financial stability, elimination of licensing requirement, opening of previously

closed sectors, removal of tariff barriers that prohibit FDI inflows, abolishing

exchange controls, and reducing opportunities for the foreign exchange black

market. In spite of the limited degree of success of the SAP, there are still problems

that impede the attraction of high value-added FDI into Ghana. Some of these

problems include bribery and corruption, which are deeply rooted in the political,

socioeconomic systems, thus confirming the findings of Wei (1998) and Van

Vuuren (2002) on the subject. This article suggests that it might be worthwhile for

the government to embark on a nationwide campaign to tackle this endemic

problem head-on among people in positions of authority.

Alfaro et al. (2004) investigated the impact of the financial market

development on the FDI attraction to achieve economic development using cross-

country data between 1975 and 1995 for multiple developing and developed

countries. Empirical analysis through growth regressions showed that the role of the

FDI in economic growth alone is ambiguous. The research suggested that the

development of strong financial market could increase an economy's ability to

absorb and efficiently manage FDI capital inflow and take advantage of potential

FDI benefits.

FDI has been considered to have a substantial influence on social and

infrastructure development as well as technology transfer. It helps in stimulating


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employment, raising wages, and replacing declining market sectors, consequently

having cultural and social impact if the investment is directed toward non-

traditional sophisticated products (Earth Summit, 2002).

FDI are always involved in research and development that bring new

products and manufacturing techniques that would benefit and augment the local

industry. Additionally, technology spillover can occur from the labor turnover from

foreign to domestic firm. Additionally, the FDI spillover of technology and its

significant financing capability should be the desired outcome of attracting foreign

investors to achieve economic growth. FDI can also create linkage for local market

for supplying needed inputs, which will enable local firms to achieve economy of

scale (Alfaro et al., 2004).

Mody and Murshid (2005) examined the relationship between long-term

capital inflows and domestic investment for 60 developing countries from 1979 to

1999. Regressions on data showed a declined impact of the foreign capital,

including portfolio and FDI flows, on the local investments. The reason for this

decline was due to either (a) the capital was not the binding solution for the desired

development, or (b) the inability of some economies to absorb the capital inflows.

Results also suggested that proper market policies and investment environment are

the keys to enhance the capital inflows- investment relationship. Capital control for

example, can intensify this relationship by directing capital inflows to specific

investment projects or restricting domestic capital outflows.

Rodriguez-Clare (1996) investigated how MFs affect underdeveloped

countries through the generation of backward and forward linkages (Backward

linkages refer to technology transfer through supply chains from downstream

multinationals to local suppliers, while Forward linkages exist when increased

production by upstream firms provides positive pecuniary externalities to

downstream firms). Using a two-country model, the research found that MFs can

generate a positive linkage in the host country when the demand for intermediate


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inputs increases as a result of (a) the production of complex goods, (b) the

increase of communication cost between the production plant in the host country

and MFs headquarter, and (c) the difference in culture, social, and legal system.

The linkage coefficient is higher when the host market is more developed.

FDI is often seen as an important catalyst for the economic transformation of

the ECE transition economies. Its importance is seen to be not only in providing

finance for the acquisition of new plants and equipment, but also in the transfer of

technology and organizational forms from relatively more technologically advanced

economies. FDI can also result in positive “spillovers” to the local economy through

linkages with local suppliers, competition, imitation and training. It can also result,

however, in negative spillovers if it forces domestic enterprises to close down

because they cannot obtain the necessary financing for upgrading their technology.

Moreover, it is possible that spillovers to the rest of the economy may not occur at

all if there are institutional obstacles or deficiencies in the absorptive capacity of

domestic enterprises (Djankov & Hoekman, 1993).

The National Bureau of Economic Research, Working paper no 5057,

Borensztein et al. (1998)’s research results suggest that FDI is in fact an important

vehicle for the transfer of technology, contributing to growth in larger measure than

domestic investment. Moreover, they find that there is a strong complementary

effect between FDI and human capital, that is, the contribution of FDI to economic

growth is enhanced by its interaction with the level of human capital in the host

country. However, their empirical results imply that FDI is more productive than

domestic investment only when the host country has a minimum threshold stock of

human capital. In their research paper, they also investigated the effect of FDI and

domestic investment, namely, whether there is evidence that the inflow of foreign

capital “crowds out” domestic investment. In principle, this effect could have either

sign: by competing in product and financial markets, MNS’s may displace domestic

firms; in contrast, FDI may favour the expansion of domestic firms by


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39

complementarity in production or by increasing their productivity through advanced

technology spill over effects.

While the explosion of FDI flows is unmistakable, the growth effects remain

unclear. Theories provide conflicting predictions concerning the growth effects of

FDI. The economic rationale for offering special incentives to attract FDI frequently

derives from the belief that foreign investment produces externalities in the form of

technology transfers and spillovers (Romer, 1993).

FDI may boost the productivity of all firms, not just those receiving foreign

capital. Thus, transfer of technology through FDI may have substantial spillover

effects for the entire economy (Maria Carkovic, Ross Levine, 1994). Other

researchers argue that FDI is only growth enhancing in countries with low

educational attainment (Maria Carkovic, Ross Levine, 1994).

FDI remains significantly and positively linked with growth when

controlling for inflation or government size. However, FDI becomes insignificant

once we control for trade openness, the black market premium, or financial

development (Maria Carkovic, Ross Levine, 1994).

In the transition economies, Hungary and Estonia showed early signs of FDI-

led growth. In Hungary, there were significant inflows of FDI in the early 1990s,

before GDP started to recover (from the transition recession) in 1994. The output of

FIEs was already expanding in 1992-1993 while that of domestic firms continued to

decline (it was only later that the FIEs dominated economic performance). In

Estonia, too, relatively large FDI inflows preceded the economic upturn in 1995. A

similar pattern may be observed somewhat later in Latvia. In both cases, the

governments’ strategies involved an early infusion of FDI through the sale of

strategic state assets. On the other hand, in Poland an economic recovery (starting in

1992) preceded the surge in FDI by several years. Due to its size, location, etc.,


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Poland was from the very beginning of the transition considered one of the most

attractive countries for foreign investment.

However, despite this and its early favourable economic performance,

foreign direct investors essentially held off until 1996, when the country’s large

external debt was reduced in agreements with London and Paris Club creditors.

Subsequently, FDI inflows and high rates of economic growth appear to have joined

in a virtuous circle (as has probably also been the case in Hungary and the Baltic

states). The fact that in Croatia, Slovakia and Slovenia there were extended periods

of fairly rapid growth without attracting much FDI is explained by domestic

policies (as already noted). The experiences of Croatia and Slovakia underline the

fact that FDI will only begin to flow after a commitment has been made to reform

(including a privatization programme) and investor friendly policies are in place.

Over the past decades, there have been several major shifts in relation to the

impacts of FDI. First, in parallel to shifts in the nature and composition of FDI, the

time and direction of impacts have changed. Secondly, the literature on the macro

effects of FDI has evolved and become more sophisticated over time. Thirdly,

governments have increasingly involved. They can influence the types and direction

of impact through appropriate mix of policies, and they have increasingly made use

of such policies. At the same time, some policies used in the past are now regulated

in various international treaties.

2.2.2.2 Impact of FDI on economic development through human capital

The human capital stock has a very significant value in the process of

economic development. It is required to acquire new skills and benefit from the

technology diffusion. Labor has to be sufficiently educated and trained to absorb

technology and to be an infrastructure for FDI investment in the host countries. In

modem economies, human capital is the prime engine of economic growth, while

during the industrial revolution physical capital was the focus.


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Becker et al. (1990) indicated that human capital is the economic growth

backbone that goes hand in hand with technology and science acquisition. They

emphasized that investing in human capital would lead to a rise in production in

the future, opposing the notion by other scholars that with population growth

resources would diminish (Aguirre, 2002)

The FDI possess more advanced knowledge, pioneering as lower-cost

new product producers. However, human capital stock in developing countries

becomes a prerequisite to take advantage of and absorb such advanced technologies

to achieve economic growth. FDI in tum should work on stimulating technological

progress for the developing countries, rather than increasing the total capital

accumulation (Borensztein et al., 1998).

Labor has to be sufficiently well educated and trained, and domestic non-

reproducible inputs have to satisfy minimal quality standards, to justify investment

and technology transfers into the host country. The latter leads to human capital

augmentation in the presence of FDI, given that the host country has passed the

development threshold needed for the existence of basic labor skills and

infrastructure (Blomstrom et al., 1994; Borensztein et al., 1998).

Galor (2004) argued that human capital has become the prime engine of

economic development, replacing the physical capital and altering the qualitative

impact of income inequality on economic development. In the beginning of the

Industrial Revolution, the physical capital was the focus since development relied

on the people with higher saving rates. This shift and replacement was due to the

import of capital and technology.

Saving is a crucial factor in economic growth. As society pays attention to

the birth of children, investment in each child along with long-term physical capital

provides human capital abundance. Consequently, the rate of return on human

capital investment becomes high compared to the rate of return on the number of


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children. Countries with limited human capital usually have large families with less

investment in each child, while those with abundant human capital have smaller

number of children with a higher human and physical capital (Becker et al., 1990).

Rosenzweig (1990) confirms Becker's research in that high-income countries

have been characterized by low fertility and high level of human capital, while low-

income countries have high fertility and low level of human capital. The countries

that have experienced high rates of per capita income growth in the last four

decades have also experienced relatively rapid declines in fertility and increases in

human capital levels.

Analyzing the role of decisions about the human capital accumulation in

determining the rate of growth, Stoket (1991) concluded that international trade

affects growth by influencing the incentives for schooling or other investments in

human capital.

Investment in research and development (R&D) and human capital is also

essential to produce higher quality goods. It was found that the growth per capita in

countries like Japan, Korea, and Hong Kong was associated with the rapid

expansion in the volume of exports, investment in education, and the composite of

output (Stoket,1991).

2.2.2.3 Impact of FDI on economic development through technology

Technology was defined by many scholars as the increase in the output

using a fixed amount of labor and capital. Literature on technology relationship

with economic growth had focused primarily on diffusion and transfer of know how

and processes from technologically advanced FDI to developing countries, and as

an infrastructure to attract FDI. Education and R&D are two main elements of the

technology infrastructure.

Bartel et al. (2005) studied the relationship between technological change in

the world today and it effect on outsourcing. They indicated that the revolution in


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the computer and information technology has resulted in a significant rate of

technological change, therefore, an increase in outsourcing. Additionally, these

technologies have reduced the sunk cost incurred by firms' activities around the

world.

Kim and Lee (1999) investigated the effects of the change in technology

on income growth rate and human capital. Using an overlapping generations

model, they concluded that the increase in the technology uncertainty will

decrease the income growth rate and human capital due to the decrease in

creating new knowledge and adopting newer technology and consequently, low

economic growth. Economic principles hold that the higher the expected rate of

technology, the higher the human capital investment, and the higher the uncertainty

of a technology, the lower the income and human capital.

Hogler and Strobl (2003) examined whether the presence of FDI has an

effect on the survival of both domestic and foreign plants in the high-tech and low-

tech sectors in the Republic of Ireland market. Cox hazard-rate regression model

was used on plant- level data for a sample of 17,789 plants. Results showed that

had a positive impact only on plants in high-tech industries through technology

spillover. They also had a negative impact on plant survival through the reduction

in output price, or through crowding out domestic rivals by raising the average

wage rate in the domestic market. Research also found no evidence for effect on

the survival of domestic low-tech plants. That could be related to the lack of

absorbing capability in low-tech plants of the knowledge spillover from the FDI.

Glass and Saggi (2002) assessed the role of labor mobility as a mechanism

of technology transfer from FDI to host country firms, and the implications of this

transfer for host country policy toward FDI. By constructing an oligopoly model

where an FDI possesses a superior technology compared to local firms in the host

country, the research concluded that technology spillover to the host firms might

occur when local firms hire workers who were exposed to a high-tech knowledge


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working for an FDI. For that reason, FDI would pay premium wages for these

workers to prevent technology spillover to the host firms

Using panel data on 4000 Venezuelan plants between 1979 to 1989, Aitken

et al. (1999) investigated the impact and the benefits gained from FDI in Venezuela.

Regression analysis showed that there was a positive relationship between

increased foreign equity participation and local firm productivity, suggesting a

benefit from FDI. However, the effect was only on smaller firms with less than 50

employees, while no effect found on larger enterprises. In general, the productivity

gained from technology transfer in domestic plants declined when FDI increased,

suggesting a negative spillover from foreign to domestic firms. Balancing between

the small firms and large enterprises, the absolute impact of FDI technology

spillover on the local plants productivity is quite small.

Yifi Lin (2003) argued that after the World War II many underdeveloped

countries put extensive efforts toward technology to industrialize and improve their

economies to achieve high level per capita. However, small number of them was

successful in catching up with the developed nations. He attributed the failure to

achieve economic performance to inappropriate development strategies. The

research suggested that because of their lack of capital and the abundance of

labor, most LDCs should pursue labor-intensive technology instead of capital-

intensive technology to alleviate poverty. This strategy will create more jobs

and increase wage level to share the fruits of the economic growth. Capital-

intensive strategy on the other hand will reduce jobs, decrease wages, and hinders

sustainable economic growth. To benefit from imported technology, LDCs

should focus on increasing labor skills through human capital accumulation and

training; otherwise, a mismatch will create a significant difference in output per

worker and total factor productivity.


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Chung (2001) investigated the effect of FDI presence on both host and

source nations. The target study was the United States manufacturing industries

from 1987 through 1991. The reason for selecting the US was attributed to the

availability of data needed on FDI, and the relative large size of the FDI inflows

received by the US in the last 2 decades. Researcher used price-cost markup to

measure industry competitiveness. Regression analysis showed that the increase

in FDI presence would decrease the price- cost markup, therefore, an increase in

competition will be expected. With FDI introducing competition and technology

spillover, incumbent's cost will be reduced, and markup compression will be

offset. It was also found that close proximity of FDI investment has less effect on

industry markup compression than distant FDI.

2.2.2.4 Foreign direct investment and spillovers

Although there have been many studies examining the effect of FDI on host

economies (see Lall, 1993 for a review), arguments over their possible costs and

benefits are still inconclusive. On the one hand, stories of the economic growth and

success of Asian NIEs (newly industrializing economies) such as Taiwan,

Singapore, Hong Kong, and South Korea suggest that their industrialization

trajectories are geared toward open-economic, trade, and investment policies that

are related to FDI’s activities. On the other hand, FDI is viewed as a new form of

foreign imperialism creating patterns of economic and political dependency (Hart-

Ladsberg and Burkett, 1998). Natural resources as well as economic surplus are

exploited by MFs through transfer pricing, transfer of inappropriate technologies,

etc. In addition, some have argued that even though FDI may contribute to a

developing country’s economic growth, the benefits are spatially concentrated in a

few locations leaving other regions behind. In other words, critics charge that

economic growth is uneven. However, MFs’ social and political impacts on host

economies are beyond the scope of this research. Instead, this dissertation will


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evaluate FDI’s impact in terms of its spillover effects (technological as well as

backward linkages) which occur between foreign-owned firms and local firms.

On balancing the success of Asian NIEs in the 1980s, it appears to have

created a literature that is positive regarding FDI investment in developing countries

particularly in aspects of technology transfer, development of local enterprises, and

increased export performance (Lall, 1985, Poon and Thomson, 2003, Zhou and Xin,

2003). Many developing countries have tried to replicate Asian NIEs’ industrial and

trade policies that are based on inward FDI. Blomstrom and Kokko’s (1996) review

of the empirical evidence of the effects of FDI on host countries in terms of

technology transfer and spillovers from MFs, trade performance, and the effects on

competition and industry structure indicate that MFs may promote host countries’

economic development in terms of productivity growth and export performance.

Graham and Wada (2001) also studied the impact of FDI on China economic.

Their results confirm that FDI positively contributes to economic growth in

China, especially in those provinces which have been major recipients of FDI.

Nevertheless, not all types of FDI enhance steady economic growth; and there are

many ways to classify FDI. Within international business literatures, there are four

types of FDI, which are (i) natural resources seeking FDI, (ii) market seeking FDI,

(iii) efficiency seeking FDI, and (iv) strategic asset seeking FDI (Dicken, 2003;

Rugman and Verbeke, 2001). The first two types of FDI can be perceived as

motivations that are associated with physical resources, human resources, domestic

and regional markets. The next two types of FDI are sequential-motive FDI which

usually aim to increase the efficiency and to sustain core competencies of FDI in

regional as well as global markets.

One of the earliest papers on the effect of origin-of-country effect on FDI is

that of Kojima’s (1978) who argued that Japanese outward investment to Asia is

explained by (i) resource-seeking, (ii) labor-seeking, and (iii) market-seeking.

Kojima terms these factors to be more trade-oriented FDI or “Japanese-type” FDI.


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He claims that Japanese FDI in developing countries aimed to complement the

comparative advantage position of Japan; and it “plays the role initiator and tutor in

the industrialization of less developed countries” (p.16). In contrast to Japanese-

type FDI, Kojima pointed out that “American-type” FDI is anti-trade oriented since

it seeks for competitive advantage or oligopolistic type of market oriented FDI

which is described by Hymer’s firm-specific advantage and Vernon’s product cycle

models.

Based on Kojima’s theory, Poon and Thompson (1998) tested the effect of

FDI from the US and Japanese on the economic growth of Asia and Latin America.

The results of their analysis indicate that Japanese’s manufacturing FDI had

contributed Asia’s economic growth during 1987 to 1994, while US service FDI

positively contributed to Latin American countries’ economic growth. However,

Thompson and Poon (1998) also pointed out that Kojima’s theory (developed in the

1970s) may not be applicable when Japanese industries become more mature. Their

results suggest that Kojima’s argument may still be partially correct. In addition,

they also recommend using micro level firm data for further research instead of just

macro level data.

A more detailed discussion of FDI and technological spillovers may be

examined within the context of firms’ internationalization process. Lall (1993)

points out that MFs exist to capture monopolistic power. Their internationalization

process can be explained by the eclectic theory or ‘OLI’ (ownership, locational,

internalization) theory of Dunning (1981, Chapter 2). Here, the impact of FDI on

economic development can be explained in terms of firms choosing to directly

invest instead of licensing to other firms so as to capture the internalization

advantages of its subsidiaries in host countries. Further, internalization advantages

may in turn generate ownership advantages. Firms may choose not to serve the local

market that they are not familiar with. They may want to set up export platforms

and capture locational advantages through securing of natural resources, cheap


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labor, etc. FDI’s impact on the host country arises from the combination of assets

invested by FDI and the multiplier effects generated through their spending, tax,

local supplier’s linkages, technology spillovers, and employment. However, FDI’s

effect on the economic growth and development of host countries depend on many

factors such as technology absorption, local entrepreneurs, level of development of

the host country, relevant institutional structures, and so on.

Technology can be defined in many ways. The United Nations (1987)

defines it as technical knowledge or know-how, with respect to the methods and

techniques of production of goods and services. Typically, technology is extended

to capital goods such as tools, machines, equipment, and the entire production

system. The literature divides technology into embodied technology (technology

that is embodied to capital goods) and disembodied technology (technology that is

accessed through external relationships).

Within this broad definition, technological knowledge may be codified or

tacit (Nelson and Winter, 1982). Drawing on the idea of the locally bounded nature

of knowledge, Malmberg, Solvell, and Zander (1996) propose a conceptual model

to explain the process of local knowledge accumulation. They emphasize the

various barriers to the diffusion of knowledge that limit knowledge spillovers from

one local milieu or cluster to another. Whether knowledge mobility is high or low

will depend on the types of knowledge.

Knowledge can be embedded in physical capital, human capital, and social

capital. With this framework, they conclude that the diffusion of knowledge within

a local cluster is faster than between two clusters since most knowledge is locally

embedded. Further, large groups of middle- and lower-level managers and workers

responsible for knowledge formation are locally bounded. They also explain further

that the operation units of MFs can be characterized as insiders just like other local

firms within a local cluster (for example see Yeung, 2000). These operation units

are also formally and informally linked to local firms, local research and education


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facilities, and government agencies. Their knowledge accumulation process

depends on the strength of local clusters, where they are located, to maintain long-

run competitiveness. In addition, the transfer of knowledge to a host economy is not

only driven by non-local firms or FDI, but it also largely depends on local actors

tapping into outside knowledge (Bathelt, Malmberg, and Maskell, 2004). In

addition to regional systems of innovations, there are also national innovation

systems (Lundvall, 1992) which frames the geography of knowledge formation and

diffusion in a national than regional context.

The economic success of Japan and other East Asian countries has been

linked to their national innovation systems (Parayil and Sreekumar 2004). The

technologically absorptive capacity of a nation depends mainly on investments in

scientific and technical training as well as sound industrial and economic policies

that promote competition among domestic firms (Mowery and Oxley, 1995). For

example, the study of Sedgwick (1999) on the internal process of technology

transfer within subsidiaries of Japanese MFs in Thailand suggests that Japanese

managerial skill cannot be easily transferred: “…the social milieu of

multinationals…matters to the organization of production and the quality of

managerial technology transfers” (p.177). At the same time, low educational levels

and the relatively low technological level of Thailand’s local industries also make

technology transfer more difficult. Other geographers have suggested that local host

economies can gain competitive advantage by connecting themselves to the global

networks of FDI (Park, 1998). The results from Park’s survey show that firms in the

new industrial districts in Korea can remake their competitive advantages by

intensifying local and global networks. These benefits are also confirmed by Zhou

and Xin (2003). They find that local firms in a high-tech cluster in Beijing, China,

can develop their market networks and innovative capacity through technological as

well as organizational training and collaboration with FDI. Finally, technology

transfer depends on the role of FDI’s subsidiaries in host economies. Poon and

Thompson (2003) distinguish between developmental and quiescent subsidiaries.


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Developmental subsidiaries are more likely to engage in technological transfers

because their objective is to produce technologies sourced from local host markets.

Briefly, FDI has been suggested as a determinant of economic development

in both developed and developing countries. Its important role in promoting

economic growth and bringing many benefits to the econmy is especially

emphasized in the context of developing countries. However, the literature also

provides mix findings pertaining to the effects of FDI and there has been suggested

that the link between FDI and economic development may be country and period

specific. Therfore, it is important and meaningful to examine the impact of FDI

inflows on economic development in Laos, a developing country which has

received very modest research attention up to date.


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CHAPTER 3. OVERVIEW OF ECONOMIC DEVELOPMENT AND

FDI IN LAOS

3.1. Overview of Laos’ Economy

The government of Laos began decentralizing control and encouraging

private enterprise in 1986. The results, starting from an extremely low base, were

striking - growth averaged 6% per year from 1988-2008 except during the short-

lived drop caused by the Asian financial crisis that began in 1997. Laos' growth

exceeded 7% per year during 2008-2012. Despite this high growth rate, Laos

remains a country with an underdeveloped infrastructure, particularly in rural areas.

It has a basic, but improving, road system, and limited external and internal land-

line telecommunications. Electricity is available in urban areas and in many rural

districts. Laos' economy continues to rely on subsistence agriculture, dominated by

rice cultivation in low land areas, which accounts for about 30% of GDP and 75%

of total employment. Economic growth has reduced official poverty rates from 46%

in 1992 to 26% in 2010.

The economy also has benefited from high-profile FDI in hydropower,

copper and gold mining, and construction though some projects have drawn

criticism for their environmental impacts. Laos gained Normal Trade Relations

status with the US in 2004. On the fiscal side, Laos initiated a VAT tax system in

2010. Simplified investment procedures and expanded bank credits for small

farmers and small entrepreneurs will improve Laos' economic prospects. The

government appears committed to raising the country's profile among investors,

opening the country's first stock exchange in 2011 and participating in regional

economic cooperation initiatives. Laos was admitted to the WTO in 2012. The

World Bank has declared that Laos' goal of graduating from the UN Development

Program's list of least-developed countries by 2020 is achievable.


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3.1.1. Economic Growth

On average, the Gross Domestic Product (GDP) during the Sixth Plan period

was 219,853 billion kip, approximately 43,970 billion kip per year. GDP grew at an

annual rate of 7.9%, which was higher than the Sixth Five-Year Plan target (the

plan target was 7.5%). In FY 2009-2010, the value of GDP was 54,282 billion Kip

which was 1.89 times higher than FY 2004-2005. The growth in share of agriculture

in GDP was 4%, of industry was 12.6%, and of services was 8.4% (the growth in

share of sectors in GDP is shown in Table 1). The reason for this satisfactory

growth was the overall economic direction guided by the Party; peaceful and secure

political, social and economic stability; and global and regional economic

integration. Moreover, laws such as the Investment Promotion Law on private

domestic and foreign investment have been updated which has attracted foreign

capital and boosted competition. When compared to other countries in the region,

Lao PDR‘s economic growth has been considerably higher.

Table 1. Comparison between actual and targeted GDP growth rate in

the Sixth Plan (2006-2010)

Sector Target (%)

(2006-2010)

Target ( Average %per

annum)

Actual (Average % per

annum)

Agriculture and forestry

3~3.4 3.2 4.0

Industry 13~14.0 13.7 12.6

Services 7.5~8.0 7.3 8.4

Total 7.5~8.0 7.6 7.9

Sources: National Socio-Economic Development Plan 2006-2010, and

Annual Statistics Yearbooks (2005-2008).

For fiscal year 2005/2006 to 2007/2008 is implementation, for 2008/2009

and 2009/2010 is estimated 10 GDP per capita in both Kip and US Dollar has

increased considerably, exceeding the target of the Sixth Five-Year Plan. GDP per

capita reached USD 818 in the year 2007-2008, USD 906 in 2008-2009 and USD


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1,069 in 2009-2010, which was an increase of approximately18% from the year

2008-2009. These figures indicate that there has been an increase in the Household

Consumption Index per month, which doubled from 1.1 million Kip in 2002-03 to

2.2 million Kip in 2007-08, in which consumption increased from 1.7 to 2.9 million

Kip in urban areas, and increased from 900,000 to 1.8 million Kip in rural areas. In

summary, average household consumption per month has risen by14.8% per year.

Table 2. GDP per capita (plan vs. actual)

Period Plan ( USD per

capita per annum) Actual ( USD per capita per annum)

Difference between actual and

plan ( %)

2005/2006 556 573 3.1

2006/2007 619 687 11.0

2007/2008 682 818 19.9

2008/2009 752 906 20.5

2009/2010 823 1069 29.8

Source: Department of Statistics, Ministry of Planning and Investment

3.1.2 Economic Structural Changes

The economic structure has changed as an economy transforms from a

subsistence agriculture economy based on raw materials to a market-oriented

economy based on processing. There has been also a positive impact on Lao

economy from the domestic potentials and neighbouring countries. Economic

structure and value added in each sector has shown an increase, which is in

accordance with the set direction. In 2008-2009, the share of agriculture and

forestry sector in GDP accounted for 30.4% with value added at 14.36 trillion Kip;

the industrial sector accounted for 24.9% with value added at 11.74 trillion Kip; and

services contributed to 38.4% with value added at 18.14 trillion Kip. In 2009-2010,

it is projected that agriculture and forestry sector will account for approximately

29%, industrial sector 26% and services sector 39% of the GDP.


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In summary, over the past five years, the sectoral composition of GDP

suggests that agriculture and forestry sector accounted for 30.4%, industry 26.1%

and services 37.2%.

Figure 1: Economic structure 2006 – 2010

Sources: Department of Statistics, Ministry of Planning and Investment

(from 2005-2006 to 2007-2008 the information is based on actual calculations; for

2008-2009, the figures are projections; and for 2009-2010, the figures are initial

projections based on preliminary data).

3.1.3 Financial Sector Growth

During the past five years, the banking sector has contributed to financial

stability, and the foreign exchange rate has remained stable. This is reflected in the

money supply growth at 23% per year which contributed to19.6% of GDP. Foreign

exchange grew and contributed to approximately 35% of GDP in 2009-2010. An

increase in the money supply or M2 was contributed by the increasing numbers of

foreign investors. Narrow version of the money supply (i.e. finances outside the

banking system and daily savings in Kip) accounts for approximately 30% of the

total money supply, while the rest of the money supply accounts for 70%. Of this,

an estimated 80% of the total savings were in foreign currency during the period


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2006-2008 (increased 3% compared to 2005). Both net foreign and domestic assets

have increased. Foreign exchange reserves have increased, and the country holds

enough stock of foreign currencies to pay for import goods and services for

approximately six months. In short, the banking and finance sector is stable.

3.1.4 Banking Sector Development

The banking sector is one of the sectors that grew rapidly and distinctly

during the period of the Sixth Five-Year Plan. This is because the government made

efforts to create better conditions for promoting the ease of conducting business. In

particular, laws and regulations have been amended to increase business

competition in global markets to encourage economic development and growth. In a

short time, a number of new banks have been established which have benefitted

society; particularly, businesses have more alternatives in banking services and have

access to world-class banking services and modern technologies at lower service

charges. Moreover, the government strived to open a stock market. The Lao Stock

Exchange opened in early 2011. The loans to the business sector increased by

approximately 85% at the end of 2008 and increased by 82.3% in March 2009 when

compared to March 2008. These achievements suggest that the society has

increased confidence in the banking system. At the same time, non-performing

loans (NPL) have significantly decreased, from 10.52% in 2006 to 3.84% in July

2009. This is lower than the plan projections of approximately 5% of the total

credit. However, the rural poor still have only limited access to institutional loans.

In sum, the quality of services and access to loans have both improved and the

banking system has been modernised.

3.1.5 Inflation has been effectively managed

The inflation rate decreased from 8% in 2005-2006 to 4.1% in 2006-2007,

increased to 7.9% in 2007-2008, and decreased to 0.74% in 2008-2009 (inflation

has decreased to negative inflation in the last six months, the lowest in recorded

history since 1990). In 2010, inflation was likely to increase by approximately


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4.71%. However, the overall consumer prices remain stable and the inflation rate

during the period of the Sixth Plan was an average of 5.09%, which remains at a

one-digit level per year, and lower than the economic growth rate.

3.1.6 The Appreciation of the Kip Currency

In 2005-2006 the dollar Kip exchange rate (average) was 10,411.0 Kip/USD;

it shifted to 9,679 Kip/USD in 2006-07; 8,980 Kip/USD in 2007-2008; and 8,532

Kip/USD in 2008-09. In 2009-2010, the exchange rate was 8,372 Kip/USD. The

difference between the bank rate and market rate was about 0.25% in December

2005, which reduced to 0.01% in November 2009. In terms of Baht, the figures

were 0.14% and 0.15% respectively. The appreciation of the Kip is in line with the

depreciation of the USD and the influx of foreign investment into country. The

appreciation of the Kip is only minimally affecting the country's exports, because

exports to an extent still depend on natural resources whose costs and prices are not

subject to exchange rates. On the other hand, the Kip is still depreciating relative to

other currencies, particularly Baht. This depreciation is partly because of the

extensive trading between Lao PDR and Thailand.

3.1.7 Workforce and Employment Balance

The workforce structure in the economic sectors has changed in

correspondence to the economic restructuring and the industrialisation and

modernisation strategy that has taken place. Capacity building of the workforce,

improvement of the curriculum at the vocational level, the government coordination

mechanism, and the employment opportunities and outside the country have all

progressively improved. Labour intensive sectors have collaborated with both

public and private training centres with a view to provide training to unskilled

workers. Training is especially for those workers who have just finished lower and

upper secondary school levels in order to prepare them for real jobs. The number of

those who have participated in vocational training and obtained adequate skills has

increased from 5,070 in 2006 to 5,374 persons in 2007, and further increased to


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16,158 persons in 2008 and to 29,766 persons in 2009. In the last four years,

training has been provided to 56,368 persons, an achievement of 81.33% compared

to the Sixth Plan target. Taking into account the target for 2010 (currently being

implemented), the total number of trainees will reach 74,069 persons, which will

have exceeded the target of the Sixth Plan by 6.88% (the target in the Sixth Plan

was 69,300 persons). Looking at each sector, those trained in the agriculture and

forestry sector will total 16,152 persons, industry and construction 27,856 persons

and services 30,061persons. Jobs have been created through improving the

government coordination mechanism in accordance with the current market

demand. Moreover, there has been collaboration between relevant parties (in both

public and private sectors) to provide information on demand and supply. The

number of employment agencies is gradually expanding; employment agencies and

their affiliates have expanded from three in 2005 to nine. These agencies placed

6,404 workers in jobs in 2006; 21,099 workers in 2007; 74,992 workers in 2008;

and 241,949 in 2009.

Overall, 317,444 workers found jobs during the Sixth Plan, which is

equivalent to 58.35% of the target (the target was 544,000 workers, with an annual

average of 108,800 workers). New jobs are expected for 325,440 workers in 2010,

which will result in a total of 642,884 workers employed, exceeding the Sixth Plan

target by 18.2%. Of these, domestic employment will be assured for

626,691workers: 584,589 workers in the agricultural and forestry sector, 38,435

workers in the industrial and construction sector, and 3,667 workers in the service

sector. Job opportunities outside the country will be provided for 16,193 workers:

1,042 workers in the agricultural and forestry sector, 13,396 workers in the

industrial and construction sector, and 1,755 workers in the services sector. The

government also made attempts to collect data and register people who need jobs.

The number of people in need of work totalled 298,775, of which 192,904 wished to

work in the agricultural and forestry sector, 74,194 in the industrial and construction

sector, and 29,677 in the services sector. While the Sixth Plan targeted 390,000


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persons for employment, the actual employment rate was 76.6% of the target. In

cooperation with the employment agencies of other countries, it was identified that

there was an estimated demand for 10,434 positions in Thailand (152 for women),

300 positions per year in Japan and 1,000 positions per year in Malaysia.

Cooperation was also sought with the Ministry of Labour in the Republic of

Korea, in order to prepare for the export of Lao labour to Korea. The labour

structure by economic sector has been slowly transformed towards industrialisation

and modernisation, in the same direction as the economic structure. The share of

labour in the agriculture and forestry sector has slightly declined, from 78.5% in

2005 to 75.1% in 2010, and correspondingly the share has increased in the industrial

and construction sector from 4.8% to 5.5%, and in the service sector from 16.7% in

2005 to 19.5% in 2010 (see Table 3). The proportion of labour shifted from the

agricultural sector to the non-agricultural sectors is 0.7% annually. The services

sector accounted for larger numbers of those who shifted from the agricultural

sector when compared to the industrial sector.

Table 3. Share of labour by sectors

No. Sector Year Estimate

2005 (%) 2010 (%) 2006-2010 (%)

1 Agriculture and forestry 78.5 75.1 73.9

2 Industry 4.8 5.5 9.3

3 Service 16.7 19.5 16.9

Source: Calculations based on Population Censuses 2005 and NSEDP VI

(2006-2010)

3.1.8 Balancing the Sources of Funds for Development

Public investment. The implementation of Public Investment Programmes

(PIP) during the last five years suggests that funds for PIPs in each sector and

locality has been effectively allocated for the government‘s priority 11 programmes

and 111 projects. In total, 24,747 billion Kip was invested. Of this, 3,982 billion

Kip was from domestic sources which accounted for 98.7% of the five-year


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approval (2,150 billion Kip was invested in the economic sector, 956 billion Kip in

the social sector and 876 billion Kip in other sectors) and 20,765 billion Kip from

foreign sources.

These figures are based on the last Population Census in 2005, so would be

different in the Sixth Plan (2006-2010) (Jobs in the agricultural sector 76.6%,

industry 7.7% and service 15.6% in 2005). Attracting Official Development

Assistance (ODA) During the last five years, given the difficult economic

circumstances worldwide, Official Development Assistance (ODA) globally and in

some regions marked a declining trend. However, development partners and those

partner countries with close ties to Lao PDR that have promised to assist the nation,

have continuously provided assistance to support the socio-economic development

policies of the Party and the Government. During these five years, funds from ODA

were used for 2,251 projects in total, and as reported in the annual Foreign Aid

Report of the ODA implementation, these funds amounted to USD2,443 million, or

on an annual average USD 488 million. Moreover, a national contribution fund

(public fund) contributed USD 88.66 million (an annual average of USD 17.73

million). The implementation of grant projects has considerably contributed to the

socio-economic development of the country. In general, the ODA funds have been

effectively used.

Attracting Foreign Direct Investments (FDI). The economy has attracted a

total of 1,022 private (domestic and foreign) investments projects during the last

five years. The approved projects during the plan period were valued at USD 11.01

billion, of which domestic investors made investments worth USD 2.2 billion. The

largest share of approved funds was in the electricity sector with USD 3.44 billion

(31.24 %), followed by the mining sector with USD2.88 billion (25.82%), the

services sector with USD1.48 billion (13.44%) and the other sectors with USD3.21

billion (29.15%). During 2008-2009 alone, approved projects amounted to USD4.3

billion. The largest investment in-flows are from China, Vietnam and Thailand.


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Table 4. Private domestic and foreign investment from 2006-2010 (USD

billion)

Fiscal year Total investment Local investment

Total 11.01 2.2

2005-2005 2.70 0.4

2006-2007 1.14 0.2

2007-2008 1.22 0.3

2008-2009 4.31 0.9

2009-2010 1.64 0.3

Source: Investment Promotion Department, Ministry of Planning and

Investment.

Foreign investment has significantly contributed to economic growth and

reform of the economic structure, commercial production, job creation and

provincial development. Moreover, support has been provided to strengthen the

private sector. Overall, the achievements were made due to the strong measures and

policies put in place by the government for attracting funds; for example, the

Investment Promotion Law has been amended, the investment approval process has

been improved with the one-window approach, the power of local authorities in

approving and managing foreign investments has been strengthened, based on types

of projects and values of investment. The government sets up meetings with local

and foreign investors and entrepreneurs on an annual basis in order to monitor

progress and discuss difficulties and solutions. Moreover, promotional activities

abroad for investment promotion have been carried out to attract more foreign

investors to the country.

3.1.9 Balancing the State Budget

The Sixth Plan targeted the share of state revenue at 14-16% of GDP and

public expenditure at approximately 20-22% of GDP. Budget deficit was to be

limited at approximately 6-8% of GDP. Through the implementation of the Sixth

Plan, the status of the public budget has gradually improved. Revenue collection has

exceeded the target for three consecutive years. The increase in revenue is due


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largely to taxes and customs, which accounted for approximately 70% of the total

revenue. During 2006-2010, the estimated total revenue was 38.05 trillion Kip,

which accounted for 17.31% of GDP, equivalent to 105% of the Plan. Of this, the

domestic revenue was 32.31 trillion Kip. The total budget expenditure was 49

trillion Kip, which accounted for 22.29% of GDP and is equivalent to 103% of the

Sixth Plan target. This has resulted in a budget deficit of 10.95 trillion Kip (after

including the grants), which is an average budget deficit of 4.98% of GDP, (the Plan

target was 6.1% of GDP). Overall, the main expenditure item was the recurrent cost

of public sector salaries, which is the first priority of government. The salary index

rose during the three subsequent years at an annual average rate of 18.66%. At the

beginning of 2007, the amended version of the State Budget Law was put into

effect. The main purpose of the amendment was to improve the budget management

mechanism, by centralising three sectors, namely treasury, customs and tax, in the

national budget. In mid-2007, the Audit Law was enforced. The State Audit

Organisation can now directly report to the National Assembly. In general, the

government‘s financial status has gradually improved.

3.1.10 Balancing Imports and Exports

The Sixth Plan aimed to benefit from trade and to stimulate economic growth

through competition and effective use of the country‘s absolute advantage,

international economic commitments (under the ASEAN Free Trade Area (AFTA),

and the bilateral and multilateral trade agreements, including WTO accession.

Expansion in international trade has boosted domestic trade by opening up trade

between cities and rural areas. In addition, the government has made efforts to

promote commercial production and increase exports, promote cross-border trade,

and promote production for both domestic consumption and export. Expansion in

trade has improved human development. The living conditions of the ethnic people

have improved in many ways, through employment creation, labour migration,

cross-border trade, rural electrification and others. The overall priorities of the Sixth


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Plan were to increase the share of export goods that have high added value and

therefore contribute to economic growth; moreover, the Plan aimed to integrate

exports into each sector in order to increase employment opportunities and generate

higher income to benefit the people as well as the country. During the period 2006-

2010, the export value of Lao PDR‘s goods was USD 5.69 billion which accounts

for 23.4% of GDP. This demonstrates an increasing trend each year, especially the

export value in 2009, which is expected to reach USD 1,005.3 million. This was a

slight decrease compared to the value in 2008. It is anticipated that exports will

reach USD 1,789 million in 2010, which is double the target of the first year of the

Sixth Plan. The majority of the export commodities are mining products (silver,

gold and copper), garments, agricultural products (coffee, corn, tea, peanuts, rice,

livestock etc.), electricity, and wood and wood products. In 2009, the largest

proportion of export earnings came from mining, 45% of the total export of which

copper had the largest share (33% of total exports), while the share of gold and

silver combined was 9.28%. The second largest share was of garments, accounting

for 12.7%, which declined by 10-11% when compared to exports in 2008.

Electricity accounted for 9.97% of exports, which was a slight increase compared to

the 2008 figures. In addition, wood products constituted 4.9%, and coffee 2.25%.

The details are shown in Table 5.

Table 5. Export structure of Lao PDR by commodities 2005-2009 (%)

Commodities 2005 2006 2007 2008 2009

Wood products 14.13 11.09 9.71 6.02 4.90

Coffee 1.35 1.11 3.13 1.69 2.25

Agricultural products /NTFP

3.65 2.52 1.80 4.82 9.06

Others 3.74 2.72 2.52 2.60 15.43

Garments 20.04 14.45 13.69 23.45 12.70

Electricity 17.81 11.47 9.13 9.89 9.97

Mining 39.16 56.55 59.94 51.44 45.26

Gold and silver 15.69 12.47 10.06 7.38 9.28

Copper 20.40 41.99 47.89 40.85 33.51

Other 3.07 2.08 1.99 3.21 2.47


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Fuel 0.13 0.09 0.09 0.09 0.44

Total export FOB 100.00 100.00 100.00 100.00 100.00

Source: Bank of Lao PDR.

Imports to Lao PDR during the period 2006-2010 had a value of USD6.61

billion, which accounted for 27.3% of GDP and shows an increasing trend. In 2009,

the total value of imports was approximately USD 1,413.5 million, which was a

slight increase compared to 2008. It is estimated that imports will further increase to

USD 1,670.97 million by 2010. The imported products were largely for

investments; machinery and equipment, for activities ranging from production to

construction and electricity generation (for example in 2008, these items of import

accounted for 40% of the total imports, which further increased to 69.61% in 2009).

Imported products also included goods for consumption such as food, medicines

and clothing (for example in 2009 those imports constituted 21.87% of the total

imports, which was a decrease by half compared to that in 2008). Finally, the share

of raw materials and equipment for the garment sector was 4.72% of the total

imports (their share fell three times compared to that in 2008). Details are shown in

the table below:

Table 6. Import structure of Lao PDR by commodities 2005-2009 (%)

Commodities 2005 2006 2007 2008 2009

Import for investment

44.14 46.75 55.69 40.45 69.91

Machineries and production equipment

14.35 13.44 16.62 22.46 47.23

Vehicles ( 50% of total )

5.33 5.65 10.91 3.92 11.10

Fuel (50% of total)

9.75 9.16 16.31 10.65 6.28

Construction / electronic equipment

14.71 18.50 11.85 3.42 5.00

Import consumption

45.20 41.52 33.93 43.57 21.87


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Materials and garment machines

7.92 9.31 7.55 12.48 4.72

Luxury products 1.14 0.99 0.95 1.44 1.20

Electricity 1.38 1.23 1.66 1.92 2.45

Fuel 0.23 0.21 0.22 0.13 0.14

Total Import (CIF)

100.00 100.00 100.00 100.00 100.00


The foreign trade balance of Lao PDR remains in deficit. During the period

2006-2010, the trade deficit amounted to USD 0.92 billion (average deficit:

USD184 million per year), equivalent to 16.17% of the total exports. However, the

improved performance of the trade sector has resulted in the trade deficit as a

proportion of GDP declining from 10.79% during 2001-2005 to 3.8% during 2006-

2010 (the target for 2006-2010 is 5% of GDP).

Figure 2 Export and Imports from 2005-2009.



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3.1.11. Sectoral Development, Regional and International Economic

Integration

Sectoral Development

Agriculture and Forestry. The Agriculture and forestry sector grew at 4%

and accounted for 30.4% of the total GDP in recent years. Crop and livestock

production grew at 4.07%, which accounted for 88.6% of value added in the sector.

Fisheries production also grew at 4.03%, and accounted for 11.4% of the value

added in the sector. Overall, agriculture and forestry production has improved and

supplies sufficient production for basic domestic needs. The main area for

plantations and agricultural production, particularly rice crops, is located in the

central region of the country, accounting for 55% of sown area, and 57% of sectoral

production. The southern region accounts for 23% (of both sown area and

production) while the northern region accounts for 22% of sown area and 20% of

production. Savannakhet Province has the largest area ofcrops (mainly rice)

accounting for 22% of the area used for growing rice in the country, followed by

Champassack Province (12%), Vientiane Capital (9%), Saravane Province (9%) and

Vientiane Province (8%). The agricultural land per household is approximately 1.6

hectares in the country. Figure 3 presents a map showing the differences in size of

agricultural land per household in different provinces.


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Figure 3 Average size of agricultural land per household

Source: Socio-Economic Atlas of Lao PDR

Promoting Food and Vegetable Production: The production of some of the

main food and vegetable items has been promoted, namely rice, corn, sugarcane,


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coffee, tea, tobacco, peanuts, soybeans, green beans, cassava, cotton, and livestock.

Since 2006, locally grown rice has been sufficient for self-consumption and also

enough has been produced to set aside some for sale. On average annual rice

production reached 2.9 million tonnes in 2009 (increased from 2.56 million tonnes

in 2005). This is 88% of the target set by the Sixth Plan (3.3 million tonnes), which

increased by 26.4% compared to the figure in 2005-2006. Paddy rice production per

person as per latest available estimates is 470 kg per person per year. This is

sufficient to meet the basic needs of society. However, the price of rice has

fluctuated seasonally from time to time, due to issues relating to distribution.

Land yield rate increased from 3.49 tonnes per hectare in 2005 to 3.54 tonnes

per hectare in 2008. Rice production was estimated to have reached 3.14 million

tonnes in the planting season of 2009, of which wet seasonal rice was estimated to

account for 78%, irrigated rice 14.4% and upland rice 7%. Between 2006 and 2010,

the wet seasonal rice crop was sown in an estimated 631,000 hectares, yielding 2.3

million tonnes of rice each year; and irrigated rice was sown in an estimated 89,000

hectares, yielding 423,000 tonnes. Irrigated rice production, however, has not met

its target due to both internal and external factors including natural disasters,

environment, oil price fluctuation, production costs and market imperfections.

Areas under upland rice production have reached an estimated 110,000 hectares per

year, yielding 205,000 tonnes. Apart from rice, production of other crops has also

risen significantly compared to recent years, and is able to meet the basic

consumption needs of society. Buying and selling remains stable (in that there is no

panic buying or selling), production is sufficient, and prices are steady. Self

production of vegetables, tacos, cassava and other crops has steadily risen to replace

importing. Along with producing food for domestic consumption, the Sixth Plan

also encouraged agricultural produce to be processed in factories to add value; for

examplecorn (for making animal feed) for domestic markets and exports. Corn

plantation areas increased by 32.7% between 2005 and 2010: from 113.8 thousand

ha to 151 thousand ha. The production of this crop increased 88.3% from 403.5


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thousand tonnes in 2005 to 760 thousand tonnes in 2010. It is grown mainly in the

Northern provinces: Xayaboury, Bokeo, Huaphanh, Oudomxay, Luang Prabang and

Xiengkhuang. Furthermore, cassava production tripled between 2005 and 2010:

from 51 thousand tonnes to 161 thousand tonnes. It is being exported for processing

to flour factories. Sugarcane production also tripled, from 218 thousand tonnes in

2005 to 703 thousand tonnes in 2010. In addition, coffee, vegetables and organic

vegetables (cabbage, chayote, coriander and other vegetables) are grown in

Pakxong and the Bolevan Plateau, again mainly for export. Livestock and fisheries

production: In order to supply larger quantities of food for consumption, there has

been a shift in the production system from the traditional (natural) methods (of open

grazing or feeding) towards livestock husbandry in captivity, so that the animals are

better reared. Some additional steps being undertaken are: encouraging

community/collective growing, controlling animal migration, supplying vaccines

and expanding veterinary services to villages (coverage of cattle vaccination is

36%, pig vaccination 26% and poultry vaccination 24%). Bird flu is well under

control. The livestock and fisheries sector has modernised to an extent, and

contemporary livestock farms in locales close to big cities, and in mountainous

areas, have begun to emerge. In addition to meeting the urban demand, this trend

has encouraged cross-border trade in livestock (cattle, pigs and poultry) and fish.

The total domestic supply value of livestock and fisheries is USD 102.4 million (the

main production is of cattle and buffaloes: 40,000 cattle and 45,000 buffaloes). In

addition, the production of fish seedlings has been expanded in 32 governmental

stations for supplying these to farmers and to the community as a whole. The supply

is able to meet 46% of the country‘s demand, or approximately 300 million fish

seedlings.

Forest production: This sector is able to supply products domestically worth

USD 31.4 million, and export worthUSD74.4 million. Reforestation and tree

plantation are encouraged among all communities and government agencies, the

private sector, other organisations and citizens. Commercial trees are planted such


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as eucalyptus, teak, agar wood, and rubber. Foreign investment from Vietnam,

Thailand and China has also steadily increased in the tree plantation sector. These

countries are mainly investing in rubber plantations in the northern, southern and

central provinces, and eucalyptus plantations in the central provinces. Although tree

plantation has increased (with cooperation from all stakeholders), the up-keep of

plants still faces challenges due to lack of funds for supporting technical staff in

local areas.

Wood and Non-Timber Forest Products (NTFP): There are policies, rules,

laws and recommendations to guide implementation. Deforestation and illegal

logging have steadily decreased each year, which has encouraged the private sector

and businesses to concentrate on wood-processing to add value for export, as well

as reforestation, in order to increase the quantity of wood available for production in

the future. Trees may be cut down only when there is a need to construct important

government infrastructure where the trees are located. Additionally, cutting trees is

permitted in pre-surveyed sustainable forests.

Non-timber forest products are collected regularly. Some main products are

rattan (8.1 million lines), bamboo (5.1 million lumps), fence (38 thousand bars),

dried bark (for lighting firewood, 178 thousand lah, a traditional volume measure),

Agarwood (180 tonnes) and other NTFP (wood oil, skin, bark, flowers, roots,

tubers, etc.) 64,667 tonnes. Nowadays, reforesting and forest development has

spread to all communities. Saplings planted increased by 219%, from 36 million to

113 million saplings between 2005 and 2008, used for reforesting 40,000 hectares.

In 2005 14,000 hectares were planted– an increase of 191%. Degraded forested

areas were regenerated in 127,000 hectares in 2008, compared to 57,000 hectares in

2005, recording a 124% increase.

Industrial Sector. During the previous years, the industrial sector grew at

approximately 12.6% per annum. The average (2006-2010) share of mineral

exploration in the value added industrial sector is 35.4%; value-added (processing)


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activities account for 34.3%, and electricity and water sub-sectors form the rest (see

Figure 4).

Figure 4. Average share of value added in the industrial sector 2006-2010

Source: Statistic Department, Ministry of Planning and Investment, Energy

and Mining Sector, Electricity Sector

• Between 2006 and 2010, average electricity production increased 21.12%

(current price) and increased 9.3% (constant price) which covered 3.1% of GDP and

reached 97% of the Sixth Plan target. Since 2005, five dams have been completed:

Nam Mang 3 (40 MW), Nam Theun 2 (1,088MW), SeSet 2 (76MW), Nam Lik 1/2

(100MW) and Nam Ngeum 2 (615MW) which combined have a capacity of 1,919

Megawatts, which can supply energy of 8,022 GWH per annum, an increase of

approximately three times compared to 2005. Of these, three dams are the

Independent Power Projects (IPPs). Presently, there are 14 dams that have minimum

energy 1 MW, and if small dams are included there are 29 dams across the country,

which have a capacity of 2,583.72MW and can produce energy of 11,514 GWH.

Additionally, there were six hydroelectric dams to be constructed during the Sixth

Five Year Plan which are estimated to have a capacity of 662.2 MW. Of these, the

dam construction that aimed to be completed in 2011 consisted of SeKaman 3, Nam

Ngeum 5, Nam Yon and ThatSalan; those to be completed in 2012 include Theun


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Hinboun extension phase and NamXong dams. Furthermore, the Hongsa Thermal

Power Plant (1,878MW) is currently under the process of resettling people and

completing the necessary environmental requirements. The plant is expected to be

officially opened in 2011. The length of electricity transmission lines in the country

is 29,601 Km, of which 138 Km are very high pressure lines of 500 kv; 406 Km are

of 230 kv (mostly for export); 2,060.9 Km are high pressure lines of 115 kv;

14,577.2 Km are medium pressure lines of 22 kv, 34 kv, 35 kv; and 12,419 Km are

low pressure lines of 0.4 kv. By August 2010, 98% of all districts, 60.48% of all

villages and 72% of all households had electricity and access to a power connection.

Some power transmission lines are under construction: the NARPD Project in the

north, 1,627 Km in length, is 98% complete; REP1 Project in the south, 2,472 Km

in length, is 93% complete; GMS Project in Pakxong-Jiangxai-Bangyor area is 64%

complete; and Paksan-Thakek-Savannakhet, 285 Km in length, is 18% complete.

Additionally, there are 115 kv transmission lines in NamNgeum 5 which are 142

Km in lenght, 230 kv transmission lines in NamLik-HinHurb-ThaLard-Vientiane

Capital, and 500 kv lines from the NaBong-Thai border which are under

construction. Moreover, there are also medium-low lines in Sukuma District,

Mounlapamok District and Pin District-TadHai area, which are being constructed.

The total private investment in the electricity sector between 2006 to 2009 was

USD2,995.5 million, which is an increase of 88.5% compared that in the plan

period from 2001 to 2005. In total, electricity production increased 9.3% per year.

The electricity sector has shared 15% of total industrial production and accounted

for 3% of GDP. B. Mining Industry.

• The total mining production value amounted to 16,772.47 billion Kip, with

an average annual increase of 19.91% between 2006 and 2010 (at current price),

which is a five-fold increase compared to the last five years (2001-2005). The sector

accounts for 9.5% of GDP. Exploration and production of gold bars during the four

years between 2006 and 2009 reached 33.13 tonnes (2006 produced 12.65 tonnes,

2007 produced 9.2 tonnes, 2008 produced 5.81 tonnes, and 2009 produced 5.47


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tonnes) while in 2010 the aim is to reach 5 tonnes (the figures show a decline in

production of gold because there have been changes each year in the amount of gold

extracted from the gold ore). During these four years, theproduction of copper

plates was 321,487 tonnes and copper dust 585,607 tonnes; and the total sale of

copper reached USD 3,274 million. As a part of the agreement between the mining

companies and government, the government received its share worth USD 445

million from Sepone gold mining between 2006 and 2009. In 2010, the company is

expected to share USD 148 million with the government. Local level authorities

received USD 500,000 annually for rural development. Additionally, Phubia

Mining shared USD 18 million with the government in 2010 and USD 200,000

annually at the local level, earmarked for spending on rural development. The total

investment value in the mining sector in five years has been USD 2,545.3 million,

which is a five-fold increase compared to the previous five years (2001-2005).

Currently, there are 154 domestic and foreign companies operating in the mining

sector, operating 269 projects, 49 of which are at the exploration stage and 220 of

which are projects are under survey process. The Kali Salt Factory was completed

in Thongmung Village, Saythany District, Vientiane Capital andhas a capacity of

50,000 tonnes per annum and will be expanded to 1 million tonnes per annum in the

future. A similar factory is under construction in Thakek District, Khammouane

Province. Additionally a steel factory is being established in Vientiane Province.

• Geology: The most important activity in this sector is to create geo-mining

and mineral maps, since minerals can be identified best with larger and more

detailed maps. Mining and mineral maps with a ratio of 1:1,000,000 have now been

drawn up for every province. Maps with a ratio 1:200,000 have been completed for

54.86% of Lao PDR‘s total geographic area, and maps having a larger ratio of

1:50,000 have been completed for Sepon, Sanakharm, and along the Mekong River

Bank in the Northern provinces and target areas for exploration. [2]. Manufacturing

This industry and manufacturing sector is important due to having contributed in

terms of value added and job creation. The manufacturing sector has grown quickly


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with an average of 9.4% per year between 2006 and 2010. Manufacturing is a

relatively low investment sector, having a high rate of job opportunity when

compared to other industrial sectors. Some of the main sectors in manufacturing

have had a steady growth, such as garments and textiles, wood and food processing.

The total number of manufacturing enterprises is 24,331, accounting for 19.2% of

the total number of enterprises (source: Economic Census, 2006).

Textiles and garments: This is one of the sectors which has experienced a

positive growth rate, thereby generating employment opportunities and incomes for

communities. Currently, there are 463 garment factories in the country. Of these, 39

are large sized factories, 18 are medium sized factories and 406 are small sized

factories. Additionally there are some related factories including five laundry

factories, 12 sewn logo factories, 10 print logo factories, and three carton

production factories. The total investment of the private sector in textiles and

garments between 2006 to 2009 was USD 15,715,000 , an increase of 84.9%

compared to the previous five years (2001-2005). There are a number of pressing

issues in the textile and garments sector which need to be addressed including lack

of sufficient funds, lack of connection in production, discontinuous production, high

transportation costs, and production tax. Handicraft sector: Over the previous years,

handicraft products have been gradually developed in terms of decorative design

and skills. Because of the product design, the handicraft market has expanded both

in domestically and globally. In addition, these products have received awards at

handicraft competitions in the region. Currently, handicraft business units - both

individual and joint, -are being established, especially in rural and remote areas.

This sector plays an important role in creating jobs and generating income for

people as well as contributing to poverty reduction which is a policy of the party

and the government. The handicraft group was established due to the government‘s

promotion policy. Presently, the domestic and foreign investment in the handicraft

sector is around 40 units, and selling is able to increase approximately 7-8% per

year. In addition, there are 18 promoted handicraft businesses. Construction


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materials: This sector has experienced rapid growth resulting from market demand.

Cement production can now supply 80% of the country‘s demand. The production

is of international standards and is widely recognised and acceptable in the domestic

market. Investments in this sector show trends to increase. Presently, there are six

cement factories (there were only two in the last five-year plan period, namely, the

two factories at Vang Vieng). The largest factory now is in Khammuane Province.

Cement production has reached 1.2 million tonnes per year. The planned target was

to produce 1.3 million tonnes by 2010 which increased 44% per year. Additionally,

there are factories that can supply construction materials to meet domestic demand

to an extent. The factories including 24 steel factories which produce steel bars and

processing steel, 10 title factories and 308 concrete factories. Food processing and

beverages: The production of beer, other alcoholic beverages, soft drinks and

cigarettes has experienced steady growth; it now fully meets the domestic demand

and the surplus can be exported. During 2006-2009, beer production achieved

5,180,179 hectolitres with an average annual increase of 14%. A second beer

factory in Champassack Province, a Tiger Beer factory in Vientaine Mulnicipality,

and Savannaket beer were constructed, and are in operation. The Economic Census

of 2006 suggests that the food processing sector had 15,804 business units in 2006,

of which 28 units were large factories, employing more than 100 workers. Another

171 units employed 10-99 workers (classified as medium-sized units). The rest of

the 15,625 units were small, employing less than 10 workers per unit. This sector

has a potential to grow, because of the fertile soil which supports many crops and

livestock. However, food processing still faces difficulties, as most farmers are not

oriented towards producing for the market. In addition, there are difficulties related

to scarce raw materials in some seasons, as the transport system is not adequately

equipped to transport raw material over long distances. There are also market-

oriented issues; many farmers find it profitable to sell their products along the

border, as the price is higher compared to the price paid by the local food-

processing industries. Therefore, in order to compete in the international export


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market, this sector must improve both product quality and standards. In sum, the

manufacturing sector has the potential to grow and supply adequate quantities of

cement, steel bar/processed steel, natural fertilizer, processed food, beverages, etc.

to the society. Small and medium size enterprises (SMEs) have contributed

appreciably to the manufacturing sector because of an increase in business activities

in manufacturing. According to the Economic Census in 2006, there are 24,331

business units accounting for 19.2% of all businesses.

Services Sector. The services sector has grown at a lower rate than it of the

industry sector; its annual growth rate averaged at 8.4% during 2006-2010.

Development of the services sector is critical for socio-economic development.

During this period (average for 2006-2010), the contribution of the services sector

was 37.2% to GDP. Its major components are wholesale, retail trade and repairing

business, constituting 51%; public services 17.3%; and transport, warehousing, post

and telecommunication 12.5%. The rest of its constituents are financial services,

rental services and public services, including social and private services, hotels and

restaurants, and others.

Figure 5. Structure of service sector 2006-2010

Source: Department of Statistics, Ministry of Planning and Investment.


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Internal trade During 2006-2010, the trade sector substantially focused on

local market development, and a number of measures have been put in place to

promote the movement of goods across the country to ensure their supply to all of

the society, in both urban and rural areas in order to help build the foundations of a

market economy. Infrastructure for trade facilities such as a market system,

(including cross-border markets), cross-border trade, shopping malls, supply

systems (wholesale and retail), shops, warehousing system, vehicle parking, and

boat landing spots have all improved. The quality of services has also been

continuously improved; for example, the enterprise registration process has been

simplified, by shortening miscellaneous processes to facilitate business persons. In

order to enhance participation,facilitate the private sector to strengthen services,

trade and product circulation have been improved within the country. Trade

exhibitions were arranged, and distribution systems of agricultural products in rural

areas have been established. In all, the domestic market has been widely opened and

developed step by step. Product circulation has been gradually increased. From

2006-2010, the total value of product circulation was 29,395 billion Kip, which has

annually increased 11%. Trade infrastructure has been widely expanded. At present,

there are 628 markets ranging from urban to rural, of which 73 are large sized

markets, 156 are medium sized and 429 are small sized. In addition, shopping malls,

supermarkets, and night-markets have been established in four major provinces

include Vientiane Capital, Luangprabang, Savannakhet and Champasack. The

construction of markets and shopping malls is mostly funded by private (both

domestic and foreign) investors and managed in different forms such as concession

under a certain period assigned by the government and the provincial authorities

according to the regulations. In short, the markets in urban areas have greatly

extended resulting in the ability to distribute products to rural and remote areas.

Moreover, currently there are 17 international checkpoints, 43 domestic

checkpoints, and 63 border-trade areas between people who live in different parts of

the country. At the end of 2009, the number of enterprises, business units, and


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entrepreneurs who are registered and received approval to regularly operate their

business activities total 122, 182. This increase has also raised the value added in

trade; as a result, the average annual growth in trade is estimated at 7.6% between

2006 and 2010, contributing about 51% to the value added in services.

Communication, transport, post and telecommunication.

Communication and transport: During 2006-2010, public works and

transport focused on implementing 25 projects to support the priority 11

programmes and 111 projects, especially meant for the Eighth Master Plan on

Communication and Transport. There are two focal projects: (1) construct and

improve communication, transport and networking between sub-regions and

regions; and (2) construct and improve communication, transport and networking

within the country. Currently, the transportation system consists of four types: (1)

mechanised road transport with the length of 37,768 Km, handling 80% of the total

transport volume during 2006-2008 goods transport increased by 5-8%, and

passenger transport by 8-10% annually. This mode of transport has enabled

supplying goods and passenger transport to all districts throughout the country; (2)

water transport with the length of more than 3,000 km, accounting for 18% of the

total transport volume; (3) in the air transport sector, there are 11 airports that

handle 2% of the total transport volume; and (4) transport by train. The road-bridge

construction sector shows a better performance than others. The road network has

increased by 17% between 2006 and 2009, from 33,803 Km to 39,568 Km. On

average, it increased 4.6% annually or about 1,824 Km each year. Paved roads

increased from 4,582 Km to 4,882 Km, or about 7% annually. Bridges across the

Mekong River (Savannakhet – Moukdahan), Road No.1 in Vientiane Capital, Road

No. R3 (Bortan-Houisay), improvement of Road No. 9 (Sevannakhet-Seno), Road

No. 12 (Thakack-Gnommalard) have been completed. The bridge across the

Mekong River at Thakack-Nakonpranom was 40% completed, Road No. 2E

(Meungkoua-Taijang) was 31% completed, and Road No. 14A is under


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construction. Moreover, a railway station (Dongphousy-Thanalang) 3 km in length

has been completed. An ADB project for small city development has been

completed in 12 cities, and 69% of water supply projects in northern and central

regions have been completed. Despite the vast improvement and construction in the

road systems, the demand for road development is still very high since only a small

proportion of the roads are paved. Most roads are constructed from natural rocks

and earth, especially the provincial, district and rural roads. These roads are risky

for travel in the rainy season. Also, some roads connecting provinces and districts

are not operational throughout the year. The technical standards of a majority of the

national roads that fall within sub-regions and remote regions are low compared to

the quality of the national roads in neighbouring countries. This impairs benefits

which could otherwise be reaped by the country by providing transit transport

services. Basic techniques, material, equipment, and even transport vehicles are not

yet competitive here compared to those in the neighbouring countries. As a result,

coordination between the domestic transportation system and international systems

is weak. In sum, the basic infrastructure for communication and transport, as well as

relevant services, is still insufficient in both quantity and quality. Transport services

between 2006-2010 accomplished the movement of 111.9 million tonnes of cargo,

1% below the plan target. Passenger transport was 210 million persons, below the

target by two percent.

Posts and telecommunication: The post and telecommunication network has

grown and improved. The postal and telecommunication service has been growing,

and is now able to provide services within the country and overseas, such as

domestic and international money orders, EMS/Fedex services within the country

and overseas, domestic and overseas mailing, and collection of domestic and

overseas stamps. Public post boxes are gradually reaching rural areas. There are 119

post offices throughout the country. There are 108 smaller post offices, mainly in

the districts. One office was been added during the plan period. In 2009-2010, it is

estimated that there will be 3 additional offices set up in the districts, adding up to


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117 offices in the districts. Optical-fibre cables have been laid across 11,500 Km.

There are 99 telecommunication centres at present, 38 government enterprises, 58

Lao corporations, two Star-Telecom centres, and one Milicom Lao centre. All the

telecommunication centres combined provide 3.6 million connections. Of these,

149.3 thousand are for landlines (99.4 thousand have already been subscribed, a

2.7% increase from the previous year); 3.39 million are for mobile phones (2.59

million have already been subscribed, a 53% increase); and 50,000 are for Vin-

phone (wireless landlines) (29.57 thousand are subscribed, a 5% increase). The

2009-2010 plan entails encouraging firms to expand more telecommunication

services to rural areas, providing high quality services, and expanding services from

cities to villages to provide 80% coverage. In 2009-2010, additional optical-fibre

cables will be installed to cover a total length of 13.2 thousand Km, a 15% increase

from the previous year. Thus, 90% of the provinces and 80% of districts can be

reached by telephone. The establishment of the new Base Transceiver Station (BTS)

has enabled 2,000 receiving stations. By the end of 2009-2010, it is forecasted that

three million connections will be subscribed, an increase of 10% from the previous

year. This amounts to 48 telephone connections per100 persons. According to the

projection for 2009-2010, revenue income from postal services will amount to 40.11

billion Kip, an increase by 2% from the previous year. This will contribute 4.4

billion Kip to the budget, an increase by 2% from the previous year, and will

contribute to the total revenue from the post and telecommunication sector at 2,127

billion Kip, exceeding the planned target by 32%. The sector will be able to

contribute 600 billion Kip to the state budget, an increase of 7% over the previous

year.

Service infrastructure has expanded and improved regularly. Roads,

electricity networks, irrigation systems, airports and others, directly and indirectly

support production, transport, trade and investment, improving people‘s lives,

national stability, and peace. Land and air transportation have expanded and

synchronised within the region for supporting tourism and the telecommunication


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network. In conclusion, communication and transport, warehousing, and post and

telecommunication play an important role in generating revenues and critically

support other sectors to grow. On average, the sector‘s value added has increased by

7.8% per year and its contribution to GDP is approximately 4.6%.

Tourism. Tourism is an important sector, which creates multiple benefits and

generates income for the ethnic people, in both cities and rural areas. It has a direct

and indirect association with other economic sectors. Recently, tourism in Lao PDR

has experienced a rapid growth as indicated by the tourist arrival data. In 2009,

tourist arrivals were 2,008,363; an increase of 15.55% compared to 2008. It is

estimated that this would further increase to 2,216,986 in 2010 (an approximate

increase of 10.39%). Through the period 2006-2010 (combined), the number of

tourists coming to Lao PDR was 8.79 million, or 1.76 million per year. The average

annual increase was 15.8%. This generated USD 258.04 million in revenue. In the

Sixth Five-Year Plan period compared to that of the Fifth Plan, tourist arrival in Lao

PDR increased 44.5% and revenue generated from the tourism sector doubled.

Tourist arrivals to regions and provinces: During 2006-2008, the largest number of

tourists came to the central region -62.4% of the total tourist arrivals. This region

experienced an annual tourist increase of 22.7%. The northern region received the

next largest number of tourist arrival, at 28.2%. This region experienced an annual

increase of 37.5%. The southern region experienced the least number of tourist

arrivals with a share of only 9.4%. This region also experienced an annual increase

of 31.9% in tourist arrivals during 2006-2008. The province receiving the largest

number of tourists is Vientiane Capital, 28.7% of total tourists in the country, which

is 46.1% of all tourists to the central region. This is because Vientiane Capital is

where tourists first arrive, as it is the centre for transport and communication before

travelling to other provinces. The second largest proportion of tourist arrivals is in

Savannakhet province (15.5% of all tourists, and 24.9% of tourists to the central

region). Tourists can now travel to Savannakhet with relative ease, as the second

Friendship Bridge has been built between Savannakhet and Moukdahan (in


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Thailand). The third largest proportion of tourists goes to Luang Prabang Province;

about 11.3% of all tourists, and 40% of tourists to the northern region (data from

2008).This is because Luang Prabang is a famous world heritage city, and is also an

important eco- and cultural tourism attraction.

In terms of revenue generation from tourism, the largest amounts emerged

from the central region: 62.39% of the total revenue generation in the tourism

sector, equivalent to USD 160,653,188. The increase in revenue from tourism in

this region was 15% between 2006-2010.The northern region generated 28.2% of

the total revenue from tourism, equivalent to USD 72,609,457. The annual increase

in revenues from tourism in this region was 22.5% between 2006-2010.The south

generated 9.42% of the total revenue from tourism, equivalent to USD 24,523,113

million. The annual increase in revenues from tourism in this region was 19.75%

between 2006-2010. From a provincial perspective, Vientiane Capital generated the

largest revenue, contributing 28.7% of the total and rising annually by about 8%.

Next was Savannakhet, contributing 15.53% of the total and rising annually by

about 27%. Third was Luang Prabang, contributing 11.26% of the total and rising

annually by 24.15%. The total number of hotels and guesthouses was 1,385 in 2008.

This was an increase of about 4.1% from 2007. Of these, the number of hotels was

265, an increase of 25.6% from the previous year. The number of guesthouses was

1,120, staying unchanged from 2007. In 2009, the number of hotels and guesthouses

was 1,484, an increase of 7.2% from 2008. Of these, hotels numbered 357, an

increase of 34.7% over 2008. There were 1,127 guesthouses, an increase of 0.6%

from 2008. In 2010, the number of hotels was 383, the number of guesthouses and

resorts was 1,379, and the number of restaurants was 1,389. On average, between

2006-2010, the number of hotel increased by 21% annually, and guesthouses by

5%. Hotels were largely concentrated in Vientiane Capital accounting for 43% of

the total. Next is Champassack Province which accounts for13.2% of the hotels, and

then Luang Prabang Province with 11.7% of the hotels in 2008. Guesthouses and

resorts were also the most in the capital; at 16.5% of the total. They were 16% in


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Vientiane Province and 14.4% in Luang Prabang in 2008. There were a total of 742

restaurants in 2008, which increased to 1,148 in 2009, a 55%increase. They were

mainly located in the northern region (45.3%), followed by the central region

(44.5%), and then the southern region (10.2%). Vientiane Province had the largest

number of restaurants at 16.4%, followed by Borikhamxay province at 13.5%, and

Oudomxay 11.6%. Vientiane Capital had only 9.3% of the total number of

restaurants. There were 164 entertainment centres in 2008, which was a 20%

increase from 2005, and 7.2% from 2007. The central region has the highest number

of entertainment centres: 70% of the total. The northern region comes next (17.1%),

and then the southern region (12.8%). Vientiane Capital had the highest number of

entertainment centres at 56% of the total, Champassack at 9.1%, and Huaphanh at

4.9%. The number of tourist companies has doubled: there were 64 in 2005, 93 in

2006, 113 in 2007, 143 in 2008, and 169 in 2010. From 2005 to 2010, the number

of tourist companies increased by 105 companies or doubled when compared to

2005. The number of branches has also increased: in 2005 there were 36 branches,

in 2006, 44 branches, in 2007, 49 branches, in 2008, 65 branches and in 2010, 77

branches. Between 2005 and 2008, the number of tourist companies‘ branches

increased by 41 branches (in other words, doubled). Currently there are 1,493

tourist attractions in the country, of which 849 are eco-tourism attractions, 435

cultural tourist attractions, and 209 historical tourist attractions. Of these, 626

tourist attractions have been fully developed and are opened for visitors. There are

141 sites where surveys have been completed but the sites are yet not developed.

230 tourist attractions are currently being surveyed, and 496 have not yet begun the

survey process yet. These tourist attractions have been accorded a high priority in

order to develop them according to the local conditions and the tourist needs.

Collaboration between the National Tourist Authority (NTA) and provincial

authorities is essential for achieving this goal. The above achievements are a result

of the high priority attached to implementing an open door and promotion policy on

tourism. This is discussed in more detail below. Facilities have been established


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relating to the arrival and departure from the country; for example the new open

international checkpoint at Muengmom Village, Tonpeung District in Bokeo

Province. There are currently 22 international checkpoints, of which 18 checkpoints

issue tourist visas at arrival having 30-day validity, the same as the visa available at

consulates and embassies in abroad. In addition, visa holders can apply for an

extension in every province. In the past, this facility was only available in Vientiane

Capital. Visas are waived for citizens of ASEAN countries, Japan, Russia and

Mongolia. Additionally, it is now possible to obtain a three-month visa, if a person

obtains it at a Lao Embassy abroad, with a proviso to extend it for another three

months. At international checkpoints, a two-month visa can be granted with a

proviso to extend it for another two months.

The government has initiated market advocacy and promotion campaigns,

which include establishing and improving information centres related to tourism at

the NTA and in all provinces. It has also created tourism websites, and additionally

has regularly participated in international tourism expos, for example ITB in Berlin,

Germany, TTM in Bangkok, Thailand, CITM in Shanghai, China, Trade and

Tourism Expo in Nanjing, China, ASEAN Tourism Festival in Singapore, JATA in

Japan, and ITE in Ho Chi Minh City, Vietnam. Lao PDR was the host country for

the World Ecotourism Conference in Vientiane Capital in 2008-2009.

The government has coordinated and collaborated with culture-related

sectors and local authorities to organise events and traditional festivals for

promoting tourism in the country. This includes international stages, such as the

Wat Phu festival in Champassack; Kottabong Stupa Festival in Khammuane; the

Elephant Festival in Xayaboury; Ing Hang Stupa Festival in Savannakhet; Tai Dam

Ethnic Group Festival in Luangnamtha; Tuang Ethnic Group Festival in Oudomxay;

and the Cotton Flower Festival in Bokeo.

In addition to that mentioned above, the business sector is also an important

component in the development of tourism, for example improvement in the quality

of services. This helps attract high-income tourists, and prolong the length of tourist


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stays in the country. The top 10 countries sending high-spending tourists to Lao

PDR are Thailand, Vietnam, China, the United States of America, France, Britain,

Japan, Australia, Germany and Canada.

Regional and International Economic Integration

Integration of the Lao economy at the regional and international levels, by

implementing open-door economic policies on an independent and mutually

beneficial basis, has progressively increased economic and trade co-operation and

trade negotiations at the bilateral, regional, sub-regional and multilateral levels.

Multilateral trade cooperation, economic cooperation with ASEAN and the Asia

region, and cooperation with ASEAN‘s dialogue partners and APTA have been

highly successful; some examples are described below Multi-lateral trade

cooperation: Despite the fact that Lao PDR has yet to become a member of WTO

(though it was expected in the Sixth Plan), negotiations for entry have so far been

successful, albeit gradual. 700 questions raised by the WTO have been answered,

and meetings with operational units for WTO Entrance‘ have been organised on

five occasions. Field trips were conducted to China and Vietnam to prepare for

WTO entrance. Preparations for WTO entrance have also enhanced capacity in

many sectors: for example, improvements in laws and regulations – Law on Value

Added Tax, Law on Enterprise, Law on Intellectual Property, Law on Standards,

Law on Forestry, Decree on Implementation of Tax Law, Law on Livestock and

Veterinary, Law on Plant Protection, Law on Investment Promotion, National

Policy on Food Safety, Decree on Procedures of Import Approval, Law on

Fisheries, Provision on Fisheries, Presidential Provision on Collection of Fees and

Service Fees, and Decree on Food Safety. Economic cooperation with ASEAN and

the region: Lao PDR has signed the ATIGA, and an agreement with ACIA is under

process, both being pre-conditions for joining AFTA. They will soon be required to

be ratified by the National Assembly. An agreement has been made with the

ASEAN Service Trade Agreement under the ASEAN Agreement on Services for

seven categories of services, and the eighth is being negotiated.


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Cooperation on the scope of ASEAN and its dialogue partners: For

furthering free trade, ASEAN-China negotiation was recently completed and came

into force on January 1, 2010 (between ASEAN+6 and China). An Agreement of

Economic Cooperation between ASEAN and Japan was made earlier, and its

implementation began on December 1, 2008, wherein predefined import-export

proforma are being used. In 2009, an agreement establishing free trade between

ASEAN, Australia and New Zealand was signed.

Additionally, a Products of ASEAN and India‘ agreement was signed, an

agreement on investment between ASEAN and the Republic of Korea was made,

and a feasibility study was carried out on the establishment of a free trade area

between ASEAN+3 (EAFTA) and ASEAN+6 (CEPEA). These agreements should

form the basis for furthering economic cooperation with ASEAN, and Asia in

general. Implementation of Asia-Pacific Trade Agreement (APTA): Lao PDR is a

member of APTA and has continuously participated, performed and taken part in

negotiations on trade agreements, tax reduction plans, trade and service facilitation,

and so on, in the Asia-Pacific region. Bilateral trade cooperation: This has

expanded, particularly with countries nearby; for example Lao-Vietnam trade

relations, Lao-China trade relations, and Lao-Thailand trade relations. As of now,

Lao PDR has signed bilateral agreements relating to trade and economy with 18

countries, including Bulgaria, Thailand, Myanmar, North Korea, China, Vietnam,

Cambodia, Malaysia, India, Russia, Belarus, Argentina, USA, Turkey and Kuwait.

In short, efforts to negotiate with other countries for finding support for Lao PDR to

join the WTO, and also expand openness in the economy, have made significant

progress. In the last five years, cooperation within ASEAN has been fairly

successful. Economic cooperation with ASEAN has been successfully achieved, as

suggested by the above-mentioned negotiations and agreements. In addition, Lao

PDR has jointly signed an agreement on ASEAN-Republic of Korea economic

cooperation and signed seven agreements related to ASEAN and ASEAN-China

Economic Cooperation. These agreements are to gradually enhance cooperation


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between the ASEAN and its negotiation partner countries, to achieve the goal of

establishing ASEAN Economic Association, and thus have collective markets in the

future. For implementing APTA, Lao PDR has the account list of reduced import

tariff on 1,803 items (within the scope of APTA), and due to these, other countries

have shown their support to expand free trade within the framework of APTA.

Opening for international trade: Trade cooperation has been enhanced,

creating new markets and enhancing market access in different regions. Export and

import volumes and values thereof, have also increased and the spectrum widened

during 2006-2010 reaching 83%, up from 65% in 2005. However, the trade

proportion (export plus import as a ratio of GDP) in Lao PDR is still low compared

to other ASEAN members, except Myanmar (see Table 7).

Table 7. Inter-Country Comparison on Opened Trade or Integration 2006-2010

Countries Opened Trade rate

(Export plus as a ratio of GDP )

Lao PDR 83.2

Vietnam 159.1

Cambodia 105.6

Thailand 151.1

Philippines 85.1

Hong Kong 406.5

Malaysia 205.9

Singapore 443.2

Myanmar 52.8

Source: Department of Statistics, Ministry of Planning and Investment and WTO

Export markets and structure: In 2010, the total value of export was

USD1,789 million and import was USD1,670 million. Of which exporting minerals

covered 58% and exporting energy covered 16% of total export. Import for public

projects was cover 40% of total import. In 2008, Lao PDR had traded with more

than 90 countries. The (import plus export) volume was USD 2,495 million, or

equivalent to 47.28% of the GDP. Lao PDR exported products to over 48 countries


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within the region and outside, totalling USD1,091.91 million, or equivalent to

20.69% of the GDP. The main export markets were, Thailand accounting for

59.60% of the total exports (or equivalent to USD650.78 million), Vietnam 13.37%,

Australia 6.19%, and China 1.85% (see Table 8).

Table 8. Export Market Structure with Main Trade Partners, 2008

No. Countries Value

( Million USD)

Percentage

(%)

1 Thailand 650.78 59.60

2 Vietnam 145.99 13.37

3 Australia 67.59 6.19

4 China 20.20 1.85

5 Switzerland 10.05 0.92

6 Poland 9.61 0.88

7 Republic of Korea 9.50 0.87

8 United States of America 4.04 0.37

9 Germany 5.13 0.47

10 Netherlands 4.37 0.40

11 Others 164.66 15.08

Total 1,091.91 100.00

Source: Calculation of Department of Statistics based on data from Tax

Department, Ministry of Finance and Bank of Lao PDR

In summary, the structure of the export market in the last five years including

the Asia market accounted for 67.54%, EU accounted for 20.40%, Oceania

(Australia) 10%, and South America 2.02%. Of this, ASEAN (10 countries)

accounted for 53.55%, and ASEAN+ 3 63.03%. In the Asia market, 10 ASEAN

countries shared 79.29% of Asia market. Of these, Thailand accounted for 36.09%,

Vietnam 11.37%, Malaysia 5.97% compared with ASEAN+3, China held 6.03%,

Japan 1.07%, and South Korea 9.93%. In the EU market, England accounted for

5.34%, France 2.3%, and Germany 3.34%. Regarding the structure of the import

market during the last five years, 96% was from Asia, 2.3% from EU, and the rest


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from North America (Canada and America) and Oceania (New Zealand and

Australia). For the Asia market, Lao PDR imported from 10 ASEAN countries

81.34%. Of this, Thailand had highest proportion with 67.26%, followed by

Vietnam 12.25%, China 8.3%, Japan 2.6%, South Korea 1.88% and Malaysia 0.6%.

In the EU market, Germany accounted for 1.04%, France 0.7%, and the rest other

countries .

3.1.12 Infrastructure

During the implementation of the Sixth Five-Year Plan (2006-2010),

construction of infrastructure was brisk. Average annual growth was 11.26%,

contributing to 4.8% of the GDP, through direct and indirect effects, trade and

others investments. Transport of passengers and goods transport has increased,

(agricultural) wood production has also increased, national security and stability has

been demonstrated and seamless year-round transportation ensured. The land and

air transportation network within the region is working better. Mekong River bank

erosion projects have been completed, such as the one in Tonpeung district, the one

Hatsayfong district, and also in other areas. Water supply projects have been

completed in the Dongmakhai area. Currently, there are a number of on-going

projects on small-scale urban development, Phase 1. Water supply and health

services projects in the northern and central parts of Laos, as well as water supply

improvement projects in Kaoliew and Chinaimo area have been instigated.

Construction of Nam Mung 3 hydroelectric project (of 40 MW) was completed in

2005; and Nam Lik 1 and 2 hydroelectric projects were also completed. Moreover,

there are several Projects that are expected to be completed in 2011 including: Nam

Ngum 2, Sekamarn 3, Nam Ngum 5, and Tad Salan. In 2012, several more projects

will be completed, such as the expansion of Theun-HinBoon and Nam Song Dam.

Electricity transmission line projects in the north, central-south region transmission

lines, and medium electricity transmission lines to seven districts in Oudomxay

Province were fully complete, as well as that to Nalae District. Furthermore, several


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irrigation projects were completed, such as the project in Nam Tin, Xayaboury

Province, and DongPhoSi, Vientiane Capital. In addition, irrigation improvement

projects in those areas hit by natural disasters have been initiated, in addition to

improving a several obsolete irrigation systems. National investment in tourism

facilities, especially those related to accommodation (hotels and guesthouses) has

increased, and during 2006-2010, the investment (only FDI) in tourism was valued

at USD 166 million (approximately USD 33 million was invested in construction

for accommodation (hotels and restaurants)). In addition, investment in various

tourism facilitating sectors, particularly telecommunication and transportation

infrastructure, have been made, valued at USD 34.45 million in 2008 and USD

83.77 million in 2009 which was doubled that of 2008. The government‘s

investment in tourism has mainly focused on improving inter-provincial roads,

water transport and air transport, introducing a number of new and high-technology

vehicles into the transportation system, increasing flights, and expanding bus

services and similar services. Investment in these sectors during 2006-2010 has had

a total value of 2,060 billion Kip, which is an increase of 7.3% compared to 2001-

2005.Of this, 272 billion Kip came from domestic funding (12 % increase), and

1,788 billion Kip from international funding (20% increase).

Luangnamtha Airport has been renovated and improved. R3 Road has been

constructed and this is the road-link to other countries in that region. Additionally,

Road No 12 has been constructed. Lao-Thai Friendship Bridge 2 (connecting

Savannakhet to Moukdahan in Thailand) and other roads have also been officially

opened. Furthermore, infrastructure at tourist sites has been improved, such as at

Konglor Cave and Tad Kuang Xi Waterfall. Work on facilities such as public

toilets, lookout sites, parking lots, and so on has been initiated at many other sites.

Electricity and water supply has also been improved. The basic infrastructure

development has created opportunities for ethnic people to be able to increasingly

access production, education, health care services, and markets. The industry and

commerce sector, investment (private and public), construction of basic


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infrastructures and rural electricity have been developed. The increased number of

(both domestic and foreign) tourists has led to improved repairs, transportation,

warehouses, telecommunication, hotels andrestaurants; and other services have

expanded.

3.2 Foreign Direct Investment in Laos

Before 1985, there was not any FDI inflow to Lao PDR. After the

government performed the NEM from 1986, issued the investment law in 1988, and

with that a numerous of FDI inflows to Laos, the economy has been growing. The

number of projects and investment values in the period of 1990-1996 were

increased to 571 and US$ 2 billion, respectively. In the 1997-2000 period, as the

FDI inflow was reduced, the number of projects was 235 with the values of

investment reached US$ 428 million, due to the affects of the Asian economic

crisis. Sommala Sisombat (2008) analyzed the trends and patterns of FDI in Laos.

He concluded that FDI has contributed to the development of the Lao economy

during the transition of the country in the market driven economy. FDI has

benefited the exchange earnings, technological advantages, increased gross

domestic product, and employment creation. In addition, FDI flows have assisted

the Laos economy in poverty alleviation. Laos has been learning to encourage FDI

in order to support his economic reforms and achieving significant development.

Over the past decade, FDI flows to Laos have gradually grown. The 1990 saw a

remarkable increase in the world FDI level as a result of liberalization of FDI

regulations in most part of the world. Developing country governments were driven

by the need to attract foreign investment by offering investment incentives and

removing major obstacles to foreign investment.

Bouthavy et al. (2007) analyzed the general situation of Laos FDI based on

the quantitative analysis. The results of the study show that FDI inflows from 1988

to 2005 changed irregularly up and down because of investment constrains such as

infrastructure system, inadequately workforce or knowledge and skills of the local


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people and regulatory environment. This period also witnessed the FDI volume of

USD 5,724 million in 1,334 projects, investing to 13 priority sectors of the

government especially hydropower electricity, mining, telecommunication, hotel-

restaurant, industry-handicraft and agriculture by the list and there are more than 30

countries to invest as Thailand, Vietnam, Australia, Malaysia, etc.

The result of the study showed that the value of FDI in Lao PDR from 1988-

2006 were USA8, 423 million, spreaded in 1,503 projects and in over 13 sectors.

The most valued investment was the hydropower electricity whichcovered 59.98

percent (2001-2006) of total investment value,which came from more than 30

countries.The biggest investor was Thailand, which accounted for 28.67 percent

(2001-2006). The result showed that movement of FDI was accordance with the

changing of the rate exchange and openness which was the same direction of FDI, it

means the rate exchange and openness can push increasing of FDI inflow to the

country, the study also shows that the Asia economic crisis should decreased the

FDI.

FDI plays very important role in many developing countries in generating

capital, job employment and technology transferring. As a trend of FDI moves

forward to country which rich in natural resources and have advantage in cheap

labor, in the case of Lao PDR it is also no exception.

With the Investment Law in 1994 onward the government of Laos PDR has

paid attention in attracting FDI by improving business environment, political

stability and macroeconomic policy, its commitment to be member of WTO and

AFTA which giving foreign investors in flavor of investment incentive especially in

tax policy and land policy. However with the implementation of Investment Law in

2004 which given huge investment incentive to foreign investors especially tax

incentive, as the resulted in 2005 onward the FDI inflow has been significantly

increased especially in mining sectors and hydropower sectors. In 2006 the FDI

inflow soared to US$187 million and reached a peak at US$323.5 million in 2007.


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FDI inflows to Lao PDR fell considerably in 2008 due to the impact of the

global economic crisis. The nominal FDI inflow value was decline from about

US$323.5 million in 2007 to US$227.7 million in 2008 (or by about 30 percent) due

to recent delays of new hydropower and mining projects, as well as slow growth in

the non-resource sectors. However, the FDI inflow to Laos has quickly recovered at

around US$300 million in 2009- 2011 period (Figure 6). Assuming the global

economy continues to recover, FDI to Lao PDR is expected to rise considerably in

the medium term, as large resource and non-resource projects resume, compounded

with the expected recovery of regional and global demand.

Figure 6 Foreign direct investment, net inflows (BoP, current US$)

Source: World DataBank (2013)

The majority of FDI goes to natural resource sectors. Foreign investment in

natural resources accounted for more than 80 percent of the total FDI during the

past few years although investment in non-resource sectors has also picked up

substantially but still at a low scale (Figure 7). Private investment in the banking

sector is expected to increase substantially since 2009. Interestingly, while banking

sectors in other countries have been severely affected by the global economic crisis,

several new private banks have been established in Lao PDR this year (Booyoung,

Indo China and ST banks).


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Figure 7. Distribution of FDI in Lao PDR (US$ m)

Source: MPI and staff estimates and projections.

Major FDI to Lao PDR in recent years comes from the region, mainly from

Thailand, China, Vietnam, Australia, India, Japan, and Korea. In 2009, Thailand was

the biggest foreign investor in Lao accounted for 27 percent of the total FDI inflows,

followed by China (23%) and Vietnam stayed at the third position (Figure 8).

Figure 8. Share of accrual FDI by country (% of total, as of August 2009)

Source: Lao authorities (MPI) and staff calculation.

However, Vietnam now has become the Laos' biggest foreign investor during

the period since the Lao Government first adopted foreign investment incentive


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policies (1989-2012). Vietnam has so far poured US$4.9 billion into 429 projects

in Laos. It is followed by Thailand with 742 projects worth US$4 billion and China

with 801 projects valued at US$3.9 billion (Figure 9).

The remaining ten biggest foreign investors in Laos include the Republic of

Korea (RoK) with a total capitalization of US$748 million, France (US$490

million), Malaysia (US$430 million), Japan (US$428 million), the US (US$150

million), Singapore (US$134 million), and India (US$61 million).

Figure 9. Ten biggest foreign investors in Laos (1989 – 2012)

Source: Asia News Monitor (2013)

The most popular fields for foreign investors are the mining industry

(accounting for 27 percent), electricity production (25 percent), agriculture,

services, processing, hotels, restaurants, telecommunications, construction, industry,

and banking.

Laos Government offers preferential policies including tax relief to

encourage foreign investors to operate in disadvantaged rural areas, generating

employment and increasing incomes. From 2011 to 2015, Laos aims to attract

approximately US$15 billion in FDI as a means of maintaining annual GDP growth

rates above 8 percent.


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CHAPTER 4. RESEARCH METHODOLOGY

This chapter describes research methodology used in this study. First,

research questions are briefly presented and the statistical method used to test the

impact of FDI on economic development in Laos. Next, variables and their

measures are provided. Finally, the author presents a detailed description of data

employed for this study.

4.1 Research Questions

In addition to reviewing the relevant literature, this research aims at

identifying the impact of the FDI on economic development in the context of Laos,

a developing country. The FDI inflows serve as a good indicator of the role played

by the MFs in economic development for Laos. The research tried to answer the

question: Does the FDI have a significant contribution to economic development for

Laos?

In particular, the research answers the following specific questions: Does the

FDI have a significant contribution to 1) the GNI per capita in Laos? 2) the

Financial Capital in Laos? 3) the country's level of technology in Laos? 4) the

Human Capital resources? 5) the Energy and Natural Resources availability in

Laos? And 6) the Transportation and Telecommunication infrastructure in Laos?

In this research, the author mainly focuses on the relationships between FDI

and six indicators of economic development in the context of Laos over the period

1990-2012. Specifically, in this study the impact of FDI on economic development

in Laos is tested using correlation analyses.

4.2 Variables and Measures

In this section, the author presents key variables used in this study (i.e. FDI

inflows and economic development) and the indicators measuring them. These

indicators are adopted from World Bank.


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FDI inflows:

In this study, FDI inflows are measured by BoP (current US$)

Economic developemnt:

In this study, the author focused on six aspects of economic development

including GNI per capita, financial capital, level of technology, human capital,

energy and natural resources, and transportation and communication. The

following presents measures of these aspects of economic development.

A. GNI per capita: constant 2005 US$

B. Financial Capital: Financial Capital is measured by the five following

indicators.

• Gross capital formation (% of GDP)

• Total debt service (% of exports of goods, services and primary income)

• Debt service on external debt, long-term (TDS, current US$)

• Debt service on external debt, total (TDS, current US$)

• Inflation, GDP deflator (annual %)

C. Level of technology: Level of technology is measured by the following

indicator.

• Industry, value added (% of GDP)

D. Human Capital: Human Capital is measured by the five following

indicators.

• Life expectancy at birth, total (years)

• Mortality rate, under-5 (per 1,000 live births)

• School enrollment, secondary (% gross)

• School enrollment, secondary (% net)

• School enrollment, tertiary (% gross)

E. Energy and Natural resources: Energy and Natural resources is measured

by the following indicator.


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• Oil consumption per capita (bbl/day per 1000 people)

F. Transportation and Communication: Transportation and Communication is

measured by the six following indicators.

• Air transport - passengers carried

• Air transport - registered carrier departures worldwide

• Mobile cellular subscriptions (per 100 people)

• Fixed broadband Internet subscribers (per 100 people)

• Internet users (per 100 people)

• Roads, total network (km)

4.3 Data Description

To serve the analyses, this study employed the secondary data which were

collected from the World DataBank (2013) queries from 1990-2012 and Index Mundi

website (2013). The following presents the specific data and data sources for all the

variables in this study.

Foreign direct investment, net inflows (BoP, current US$)

In this study FDI are the net inflows of investment to acquire a lasting

management interest (10 percent or more of voting stock) in an enterprise operating

in an economy other than that of the investor. It is the sum of equity capital,

reinvestment of earnings, other long-term capital, and short-term capital as shown in

the balance of payments. This series shows net inflows (new investment inflows

less disinvestment) in the reporting economy from foreign investors. Data are in

current U.S. dollars (see Table 9).


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Table 9. Foreign direct investment, net inflows

Years FDI (BoP, current US$)

1990 6,000,000.00

1991 6,900,000.00

1992 7,800,000.00

1993 29,900,000.00

1994 59,200,000.00

1995 95,100,000.00

1996 159,800,000.00

1997 86,300,000.00

1998 45,300,000.00

1999 51,608,266.56

2000 33,890,000.00

2001 23,904,284.13

2002 4,451,297.03

2003 19,484,000.80

2004 16,917,263.00

2005 27,720,000.00

2006 187,310,641.00

2007 323,520,000.00

2008 227,770,000.00

2009 318,598,209.10

2010 278,805,903.10

2011 300,743,507.10


GNI per capita (constant 2005 US$)

GNI per capita is based on purchasing power parity (PPP). PPP GNI is gross

national income (GNI) converted to international dollars using purchasing power

parity rates. An international dollar has the same purchasing power over GNI as a

U.S. dollar has in the United States. GNI is the sum of value added by all resident

producers plus any product taxes (less subsidies) not included in the valuation of

output plus net receipts of primary income (compensation of employees and

property income) from abroad. Data are in current international dollars (see Table

10).


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Table 10. GNI per capita

Years (constant 2005 US$)

1998 332.393

1999 355.0242

2000 359.7052

2001 375.4565

2002 393.3467

2003 403.4122

2004 429.7741

2005 461.0561

2006 476.1567

2007 513.0877

2008 535.1629

2009 574.5031

2010 587.8386

2011 626.9571


Financial Capital

Gross capital formation (% of GDP). Gross capital formation (formerly

gross domestic investment) consists of outlays on additions to the fixed assets of the

economy plus net changes in the level of inventories. Fixed assets include land

improvements (fences, ditches, drains, and so on); plant, machinery, and equipment

purchases; and the construction of roads, railways, and the like, including schools,

offices, hospitals, private residential dwellings, and commercial and industrial

buildings. Inventories are stocks of goods held by firms to meet temporary or

unexpected fluctuations in production or sales, and "work in progress." According

to the 1993 SNA, net acquisitions of valuables are also considered capital

formation. The data on gross capital formation are presented in Table 11.


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Table 11. Gross capital formation (annual % growth)

Years Gross capital formation (annual % growth)

2001 7.263822

2002 31.79453

2003 3.239344

2004 43.96516

2005 2.781682

2006 27.38054

2007 35.54247

2008 1.632811

2009 1.325829

2010 -12.8377

2011 21.86036


Total debt service (% of exports of goods, services and primary income).

Total debt service is the sum of principal repayments and interest actually paid in

foreign currency, goods, or services on long-term debt, interest paid on short-term

debt, and repayments (repurchases and charges) to the IMF. The data are presented

in Table 12.

Debt service on external debt, long-term (TDS, current US$). Debt service

payments are the sum of principal repayments and interest payments actually made

in the year specified. Long-term external debt is defined as debt that has an original

or extended maturity of more than one year and that is owed to nonresidents by

residents of an economy and repayable in foreign currency, goods, or services.

Datas are in current U.S. dollars (see Table 12).

Debt service on external debt, total (TDS, current US$). Total debt service is

the sum of principal repayments and interest actually paid in foreign currency,

goods, or services on long-term debt, interest paid on short-term debt, and

repayments (repurchases and charges) to the IMF. Data are in current U.S. dollars

(see Table 12).


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Inflation, GDP deflator (annual %). Inflation as measured by the annual

growth rate of the GDP implicit deflator shows the rate of price change in the

economy as a whole. The GDP implicit deflator is the ratio of GDP in current local

currency to GDP in constant local currency. The data are presented in Table 12.

Table 12. Financial capital

Years

Total debt service

(% of exports of goods, services

and primary income)

Debt service on external debt,

long-term

(TDS, current US$)

Debt service on external debt,

total

(TDS, current US$)

Inflation, GDP deflator (annual

%)

1990 8.549713 8,372,000 8,943,000 37.90738

1991 6.140886 8,285,000 8,456,000 12.97176

1992 4.753507 9,358,000 9,488,000 5.993841

1993 8.300263 28,196,000 28,362,000 11.18258

1994 4.935452 19,698,000 19,727,000 7.700596

1995 6.123103 23,357,000 25,417,000 19.68536

1996 6.52406 25,162,000 28,471,000 13.72521

1997 6.27068 22,107,000 27,290,000 19.35282

1998 6.214372 24,018,000 30,699,000 84.50446

1999 7.790892 28,496,000 37,295,000 127.974

2000 7.964774 32,095,000 40,880,000 24.79778

2001 8.912686 33,994,000 43,798,000 8.868074

2002 19.56713 84,654,000 94,217,000 6.318459

2003 21.88249 92,628,000 102,067,000 13.4501

2004 22.69304 115,587,000 123,921,000 10.69043

2005 17.40619 126,057,000 132,695,000 8.640322

2006 16.2447 178,242,000 182,215,000 10.8051

2007 15.27935 186,529,000 190,149,000 7.438286

2008 13.60248 202,986,000 207,520,000 8.863451

2009 14.75069 214,170,000 220,032,000 -2.93207

2010 13.23698 299,686,000 305,468,000 10.01846

2011

276,144,000 281,236,000 3.461741

2012

3.503319



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Level of technology

Industry, value added (% of GDP). Industry corresponds to ISIC divisions

10-45 and includes manufacturing (ISIC divisions 15-37). It comprises value added

in mining, manufacturing (also reported as a separate subgroup), construction,

electricity, water, and gas. Value added is the net output of a sector after adding up

all outputs and subtracting intermediate inputs. It is calculated without making

deductions for depreciation of fabricated assets or depletion and degradation of

natural resources. The origin of value added is determined by the International

Standard Industrial Classification (ISIC), revision 3. Note: For VAB countries,

gross value added at factor cost is used as the denominator.

Table 13. Industry, value added (% of GDP)

Years Industry, value added (% of GDP)

1990 14.50836

1991 16.8156

1992 17.7566

1993 17.74331

1994 18.14074

1995 19.24144

1996 21.14757

1997 21.04775

1998 22.4988

1999 22.63418

2000 16.60577

2001 17.14755

2002 19.47779

2003 21.31875

2004 20.51281

2005 24.61259

2006 27.73479

2007 26.90575

2008 28.55519

2009 26.66212

2010 31.80166

2011 34.66597



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Human Capital

Life expectancy at birth, total (years). Life expectancy at birth indicates the

number of years a newborn infant would live if prevailing patterns of mortality at

the time of its birth were to stay the same throughout its life. The data on this

indicator in Laos are presented in Table 14.

Table 14. Human capital

Years

Life expectancy

at birth, total (years)

Mortality rate, under-5

(per 1,000 live births)

School enrollment, secondary (% gross)

School enrollment,

secondary (% net)

School enrollment,

tertiary (% gross)

1990 54.11956 162.9 23.67283 1.15008

1991 54.8978 158.9

1992 55.69654 154.7 20.64435 14.19396

1993 56.50129 150.5 22.44351 14.69705 1.35537

1994 57.2991 146.2 24.34807 17.42835 1.34623

1995 58.08146 141.7 25.01681 1.68337

1996 58.84141 137.2 25.26427 2.43978

1997 59.58039 133 27.24104 21.13922 2.60333

1998 60.2959 128.7 29.62516 23.41179 2.06232

1999 60.98544 124.4 32.75423 26.17126 2.36587

2000 61.64446 120 34.90986 28.03597 2.70686

2001 62.27 115.7 36.83383 29.66322 3.12276

2002 62.86602 111.4 39.62774 30.69899 4.18685

2003 63.43505 107.1 42.42698 34.11909 4.97626

2004 63.97854 102.7 44.27713 35.79461 5.79792

2005 64.50046 98.4 44.6944 36.05104 7.87845

2006 65.00383 94.2 43.81833 35.22627 9.09025

2007 65.49159 90 44.12082 36.13853 11.62547

2008 65.96878 86.1 44.65939 36.93829 13.41379

2009 66.43639 82.1 45.72139 38.3491 16.44862

2010 66.89844 78.4 47.08383 40.07298 16.62275

2011 67.35495 74.9 45.79744 40.67901 17.67166

2012

71.8


Mortality rate, under-5 (per 1,000 live births). Under-five mortality rate is

the probability per 1,000 that a newborn baby will die before reaching age five, if


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subject to current age-specific mortality rates. The data on this indicator in Laos are

presented in Table 14.

School enrollment, secondary (% gross). This refers to the total

enrollment in secondary education, regardless of age, expressed as a percentage of

the population of official secondary education age. GER can exceed 100% due to

the inclusion of over-aged and under-aged students because of early or late school

entrance and grade repetition. The data on this indicator in Laos are presented in

Table 14.

School enrollment, secondary (% net). This refers to the ratio of children of

the official secondary school age who are enrolled in secondary school to the

population of the official secondary school age. The data on this indicator in Laos

are presented in Table 14.

School enrollment, tertiary (% gross). This refers to the total enrollment in

tertiary education (ISCED 5 and 6), regardless of age, expressed as a percentage of

the total population of the five-year age group following on from secondary school

leaving. The data on this indicator in Laos are presented in Table 14.

Energy and Natural resources

Oil consumption per capita (bbl/day per 1000 people)

Table 15. Oil consumption per capita

Years Oil consumption per capita (bbl/day per 1000 people)

2003 0.46

2004 0.45

2005 0.44

2006 0.46

2007 0.46

2008 0.45

2009 0.44

2010 0.47

2011 0.3

Source: Index Mundi (2013)


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Transportation and Communication

Air transport, passengers carried. Air passengers carried include both

domestic and international aircraft passengers of air carriers registered in the

country. The data on this indicator in Laos are presented in Table 16.

Table 16. Transportation and communication

Years

Air transport,

passengers carried

Air transport, registered

carrier departures worldwide

Mobile cellular

subscriptions (per 100 people)

Fixed broadband

Internet subscribers

(per 100 people)

Internet users (per

100 people)

Roads, total

network (km)

1990 115,400 3400 0

1991 115,400 3400 0

1992 118,500 3700 0.00654

1993 118,500 3700 0.007461

1994 118,500 3700 0.01336

1995 124,500 3900 0.032095

1996 124,500 3900 0.077221

1997 124,500 3900 0.097975

1998 124,100 3900 0.126014 0.009657814

1999 197,200 6300 0.231339 0.037780708

2000 210,847 6411 0.238496 0.111044032

2001 210,847 6652 0.546228 0.181664461

2002 219,598 6971 1.003511 0.267899241 32620

2003 218,652 7068 2.011366 0.000448 0.333912466 31210

2004 271,706 8413 3.603124 0.000882 0.36143449 33861

2005 293,442 9002 11.42863 0.005458 0.85035749 35260

2006 326,730 9959 17.28242 0.012685 1.169893428 36831

2007 328,326 9957 24.92519 0.078026 1.64 34994

2008 323,401 10007 33.57909 0.101411 3.55 39568

2009 302,596 9793 52.92157 0.137448 6 32620

2010 443,778 11374 64.56158 0.193924 7

2011 532,707 12262 87.16315 0.663466 9

2012 877,950 15836 101.8523 1.462205 10.74767619


Air transport, registered carrier departures worldwide. Registered carrier

departures worldwide are domestic takeoffs and takeoffs abroad of air carriers


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registered in the country. The data on this indicator in Laos are presented in Table

16.

Mobile cellular subscriptions (per 100 people). Mobile cellular telephone

subscriptions are subscriptions to a public mobile telephone service using cellular

technology, which provide access to the public switched telephone network. Post-

paid and prepaid subscriptions are included. The data on this indicator in Laos are

presented in Table 16.

Fixed broadband Internet subscribers (per 100 people). Fixed broadband

Internet subscribers are the number of broadband subscribers with a digital

subscriber line, cable modem, or other high-speed technology. The data on this

indicator in Laos are presented in Table 16.

Internet users (per 100 people). Internet users are people with access to the

worldwide network. The data on this indicator in Laos are presented in Table 16.

Roads, total network (km). Total road network includes motorways,

highways, and main or national roads, secondary or regional roads, and all other

roads in a country. A motorway is a road designed and built for motor traffic that

separates the traffic flowing in opposite directions. The data on this indicator in

Laos are presented in Table 16.


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CHAPTER 5. RESEARCH FINDINGS

This chapter presents the research findings. Specifically, the correlations

results regarding the relationships between FDI inflows and economic development

indicators in Laos are provided. The correlation coefficients (Pearson correlation)

are estimated at significance level of 0.05. In particular, a high level of correlation is

implied by a correlation coefficient that is greater than 0.5 in absolute terms (i.e.

greater than 0.5 or less than –0.5); a midium level of correlation is implied if the

absolute value of the coefficient is greater than 0.2 but less that 0.5; and a low level

of correlation is implied if the absolute value of the coefficient is less than 0.2.

5.1 FDI and GNI per Capita

In 1998-2011 period, GNI per capita of Laos had a regular growth trend

through the years. Although the FDI inflows did not follow the same pattern as GNI

per capita in the early years of the research period, these figures had fluctuated in

the similarly trend in recent years. This fact has been confirmed by analyzing the

correlation of FDI inflows and GNI per capita. Figure 10 presents the graph of

correlation between FDI and GNI per capita and Table 17 presents coefficient of

correlation between FDI and GNI per capita.

Figure 10. Graph of Correlation between FDI and GNI per capita


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Table 17. FDI and GNI per capita Coefficient of Correlation

GNI per capita (constant

2005 US$)

FDI, net inflows (BoP, current US$)

Pearson Correlation .881**

Sig. (2-tailed) .000

N 14

As indicated in Table 17, Pearson correlation of FDI inflows and GNI per

capita is 0.881 (> 0.5) at significant level p < 0.05, that confirms a strong correlation

between FDI inflows and GNI per capita. The correlation coefficient also reveals that

this is a significant and positive relationship. It implies the significant and important

role of growth of FDI inflows on the growth of GNI per capita.

5.2 FDI and Financial Capital

The results of correlation analysis between FDI and six indicators of

financial capital are presented in Table 18.

Table 18. FDI and Financial Capital Coefficient of Correlation

Financial Capital

Gross capital

formation (% of GDP)

Gross capital

formation (annual % growth)

Total debt service (% of exports of goods, services

and primary income)

Debt service on external

debt, long-term

(TDS, current US$)

Debt service on external

debt, total (TDS, current US$)

Inflation, GDP

deflator (annual

%)


Pearson Correlation

.819** -.167 .173 .820** .812** -.267

Sig. (2-tailed)

.001 .623 .453 .000 .000 .229

N 12 11 21 22 22 22

FDI and Gross capital formation (% of GDP)

It can be seen from the data of FDI inflows and Gross capital formation (% of

GDP) in 2000–2011 period that, these figures had experienced similar fluctuation

trend. As indicated in Table 18, Pearson correlation of FDI inflows and Gross capital


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formation (% of GDP) is 0.819 (> 0.5) at significant level p < 0.05, that confirms a

strong correlation between these indicators. The correlation coefficient also reveals

that this is a significant and positive relationship. That means the growth of FDI

inflows have a significant role on the Gross capital formation (% of GDP).

FDI and Gross capital formation (annual % growth)

In 2001 – 2011 period, the Laos’ economy witnessed an unstable fluctuation

trend in Gross capital formation (annual % growth). The Pearson correlation of FDI

inflows and Gross capital formation (annual % growth) is -0.167 at significant level

p > 0.05 (see Table 18), that indicates a weak and negative correlation between

these indicators. The correlation coefficient also reveals that there is no evidence

confirming the role of growth of FDI inflows on the Gross capital formation (annual

% growth).

FDI and Total debt service (% of exports of goods, services and primary income)

In the 1990 – 2010 period, the trend of total debt service (% of exports of

goods, services and primary income) did not correspond to the trend of FDI inflows.

As indicated in Table 18, the Pearson correlation of FDI inflows and Total debt

service (% of exports of goods, services and primary income) is 0.173 (< 0.5) at

significant level p > 0.05, that indicates a weak correlation between these indicators.

The correlation coefficient also reveals that despite of positive correlation between

the growth of FDI inflows and the Total debt service (% of exports of goods,

services and primary income), there is no evidence confirming the role of FDI on

the Total debt service.

FDI and Debt service on external debt, long-term (TDS, current US$)

It can be seen from the data of FDI inflows and Debt service on external

debt, long-term (TDS, current US$) in the 2000 – 2011 period that these figures

had experienced similar fluctuation trend. The Pearson correlation between FDI


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inflows and Debt service on external debt, long-term (TDS, current US$) is 0.820

(> 0.5) at significant level p < 0.05 (see Table 18), that confirms a strong correlation

between these indicators. The correlation coefficient also reveals that this is a

positive relationship. That means the growth of FDI inflows have a positively

important role on the Debt service on external debt, long-term (TDS, current US$).

Figure 11 presents the graph of correlation between FDI and long-term debt

service on external debt.

Figure 11. Graph of Correlation between FDI and long-term debt service on external debt

FDI and Debt service on external debt, total (TDS, current US$)

As indicated in Table 18, the Pearson correlation of FDI inflows and Debt

service on external debt, total (TDS, current US$) is 0.812 (> 0.5) at significant

level p < 0.05, that confirms a strong correlation between these indicators. The

correlation coefficient also reveals that this is a significantly positive relationship.

That means the growth of FDI inflows have an important and significantly positive

role on the Debt service on external debt, total (TDS, current US$).


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FDI and Inflation, GDP deflator (annual %)

In the 1990 – 2010 period, the trend of Inflation, GDP deflator (annual %)

did not correspond to the trend of FDI inflows. The Pearson correlation of FDI

inflows and Inflation, GDP deflator (annual %) is -0.267 (> - 0.5) (p > 0.05) that

indicates a weak and negative correlation between these indicators. This correlation

coefficient also reveals that there is no evidence confirming the role of FDI inflows

on the Inflation, GDP deflator (annual %).

5.3 FDI and Level of Technology

There was a lack of data relating to High-technology exports (% of

manufactured exports) and High-technology exports (current US$). Therefore, the

“Level of Technology” indicator was only measured by “Industry value added”

data. As indicated in Table 19, the Pearson correlation of FDI inflows and Industry

value added (% of GDP) is 0.838 (> 0.5) that confirms a strong correlation between

these indicators. The correlation coefficient also reveals that this is a significantly

positive relationship. That means the growth of FDI inflows has a positive and

important role on level of techonology (the Industry value added, % of GDP).

Table 19. FDI and Level of Technology Coefficient of Correlation

Techonology

Industry, value added (% of GDP)


Pearson Correlation .838**


N 22

Figure 12 presents the graph of correlation between FDI and level of

technology.


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Figure 12 Graph of Correlation between FDI and level of technology

5.4 FDI and Human Capital

As indicated in Table 20, in the 1990-2012 period, the FDI inflows of Laos

had strongly positive relationship with the indicators of Human Capital. That is

confirmed by the correlation coefficients, which are all larger than 0.5. This means

that the growth of FDI inflows in Laos have a significantly positive role on the

Human Capital. Interestingly, the more FDI inflows increased the more Mortality

rate, under-5 (per 1,000 live births) declined.

Table 20. FDI and Human Capital Coefficient of Correlation

Human Capital

Life expectancy

at birth, total

(years)

Mortality rate,

under-5 (per

1,000 live

births)

School enrollment, secondary (% gross)

School enrollment, secondary

(% net)

School enrollment, tertiary (%

gross)


Pearson Correlation

.665** -.705** .538* .621** .856**

Sig. (2-tailed)

.001 .000 .012 .006 .000

N 22 22 21 18 20


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Figure 13 presents the graph of correlation between FDI and School

enrollment, tertiary (% gross).

Figure 13. Graph of Correlation between FDI and School enrollment, tertiary

5.5 FDI and Energy and Natural Resources

As indicated in Table 21, the Pearson correlation of FDI inflows and Oil

consumption per capita is -0.271 (> -0.5) (p > 0.05) that indicates a weak

correlation between these indicators. The correlation coefficient also reveals that

there is no evidence confirming the significant role of FDI inflows on the Oil

consumption per capita.

Table 21. FDI and Energy and Natural Resources Coefficient of Correlation

Energy and Natural Resources

Oil consumption per capita (bbl/day per 1000 people)


Pearson Correlation -.271


N 9

Figure 14 presents the graph of correlation between FDI and Natural

Resources (Oil consumption per capita).


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Figure 14. Graph of Correlation between FDI and Natural Resources

5.6 FDI and Transportation and Communication

As indicated in Table 22, in general, in 1990-2012 period, the FDI inflows of

Laos had strongly positive relationship with indicators of the Transportation and

Communication. That is confirmed by the correlation coefficients, which are all

larger than 0.5 at p < 0.05, except the relationship between FDI and Fixed

broadband Internet subscribers (p > 0.05). This means that in general the growth of

FDI inflows have an important and positive role on the Transportation and

Communication.

Table 22. FDI and Transportation and Communication Coefficient of Correlation

Transportation and Communication

Air transport,

passengers carried

Air transport, registered

carrier departures worldwide

Mobile cellular

subscriptions (per 100 people)

Fixed broadband

Internet subscribers

(per 100 people)

Internet users (per 100

people)

Roads, total

network (km)


Pearson Correlation

.721** .707** .833** .593 .815** .896**

Sig. (2-tailed)

.000 .000 .000 .055 .000 .006

N 22 22 22 11 15 7


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Figure 15 presents the graph of correlation between FDI and Mobile cellular

subscriptions.

Figure 15. Graph of Correlation between FDI and Mobile cellular subscriptions

In summary, in this study the author employed the method of correlation

analysis to test the relationship between FDI inflows and various indicators

measuring six aspects of economic development in the context of Laos over the

period 1990-2012. The research findings, although are exploratory in nature, in

general provide empirical evidence to support the important and positive role of

FDI inflows on economic development.


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CHAPTER 6. CONCLUSIONS AND DISCUSSION

This chapter presents conclusions of the research findings and discussion of

the findings. First section presents conclusions. Next, implications for policy

makers are provided. The final section presents limitations of this study and

suggests directions for future research.

6.1 Conclusions

This research aims to explore the role of FDI inflows on economic

development in Laos, a developing country which has received very mosdest

research attention to date. The correlation analysis method was employed to serve

this purpose. The research results show that in general, FDI plays a significant role

on economic development. Specifically, FDI inflows were found to be positively

correlated with almost all indicators measuring six aspects of economic developent.

The research findings are summarized in the following.

• FDI and GNI per capita: The findings suggest an important role of FDI inflows

on GNI per capita by showing a strongly positive correlation between the two

measures.

• FDI and Financial Capital: The findings show that FDI inflows are significantly

and positively correlated with some indicators of financial capital including the

Gross capital formation (% of GDP), the Debt service on external debt, long-

term (TDS, current US$), and the Debt service on external debt, total (TDS,

current US$).

• FDI and Level of Techonology: The findings show that FDI inflows has a

positive and important role on level of technology, based on a strong and

positive correlation between FDI and the Industry value added (% of GDP).

• FDI and Human Capital: The findings show that FDI inflows are significantly

correlated with all five indicators of human capital. All correlation coefficients


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are positive, except the one between FDI and Mortality rate, under-5 (per 1,000

live births). This results may need to have further study for clarify the

relationship between the two measures. The strongest correlation is the one

between FDI and School enrollment, tertiary (% gross).

• FDI and Energy and Natural Resources: The findings failed to provide empirical

evidence for the significant role of FDI inflows on Energy and Natural

Resources. Perhaps, it is partly due to the measure limittaion of Energy and

Natural Resources with only one indicator - the oil consumption per capita. This

may need further exploration with more comprehensive measure.

• FDI and Transportation and Communication: The findings suggest that in

general FDI inflows have an important and positive role on the Transportation

and Communication, by showing significantly positive correlations between FDI

and five indicators of Transportation and Communication including Air

transport, passengers carried, Air transport, registered carrier departures

worldwide, Mobile cellular subscriptions (per 100 people), Internet users (per

100 people), and Roads (total network - km). The strongest correlations are

those between FDI and Roads (total network - km), Mobile cellular

subscriptions, and Internet users.

6.2 Implications of the Study

Theoretical implications

From theoretical perspective, this study is important because it contributes to

better understanding the relationship between FDI inflows and economic

development in the context of a developing country. This is especially interstesing

and important since the research context in this study is Lao P.D.R., a country that

has received very little research attention from scholars up to date. Therefore, the

findings from this study help to enrich the literature on FDI and its role on

economic development in general and in developing countries, in particular.


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In addition, in this study the author empirically examined the relationship

between FDI inflows with a number of aspects of economic development, rather

than just focusing on one aspect as in many previous studies.

Implications for policy makers

On the basis of the findings, this study is also expected to provide a number

of implications for policy makers in Laos with the purpose of making effective use

of FDI for enhancing economic development in this country. Some implications and

suggestions are presented in the following.

Promoting and attracting FDI inflows

Attracting FDI has been becoming increasingly important for developing

countries like Laos. As reported in the previous chapter, FDI inflows in Laos, in

general, show significant and positive role on different aspects of economic

development such as economic growth, financial capital, human capital, level of

technology, and transportation and communication. Therefore, it is important for

policy makers to develop appropriate policies to create favorable environment to

attract FDI inflows.

There are a number of areas that should receive strong attention from policy

makers including institution/policy, infrastructure, labor skills, capabilities of

making use of technology to reduce the risks and increase incentives to attract

foreign investors.

Trade policy reforms and structuring industrial networking known as

"clusters" are important incentives for FDI. "Clusters" are concentrations of firms in

one or a few industries. They are comprised of competitors, buyers, and suppliers

networks. Industrial networking helps in creating efficient and strong local market,

and in turn more advantage of technology spillover from the foreign companies.

Implementing sustainable policy reforms improves investment environment and

increases the country's credit worthiness in the eyes of the foreign investors.


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Institutional factors of the recipient country are essential elements

determining the type and volume of FDI. Morrissey and Rai (1995) indicated that

the degree of political stability and government intervention in the economy, the

existence of property rights legislation determining the legal rights of foreign firms

and limitations on foreign ownership, the property and profit tax system, and the

extent and severity of bureaucratic procedures are all institutional factors

influencing the type and size of FDI inflow. In addition, international agreements

on trade and investment can significantly influence the volume and patterns of FDI.

Foreign investors calculate the amount of risk involved in their investment

strategy abroad. Expropriation is unlikely to resurface in the near future, and many

developing countries now protect FDI investors from expropriation by introducing

that protection in their law chapters. Developing countries that have liberalized

their economies and privatized their state services are not willing to retract

ownership of these services (Minor, 1994).

Clarke (2001) assessed the effect of institutional quality represented by 'risk

of expropriation' and 'rule of law' on research and development. Using regression

analysis on a panel of data from between 1983 and 1994 for low and middle-income

countries he concluded that the risk of expropriation is more significant than the

'rule of law', and expenditures on R&D is lower in countries having higher risk

of expropriation and weaker rule of law.

Globerman and Shapiro (2003) evaluated the importance of infrastructure

governance (legislations, regulations, and legal system that condition freedom of

transacting, security of property rights, and transparency of government and legal

process) as prerequisite for receiving FDI.

Intellectual property rights and innovation have a significant role in

attracting FDI (Chen & Puttitanun, 2005).

The determinants of FDI have changed over time. While specific policy

interventions (e.g trade barriers) have affected FDI in many countries for long

periods of time, FDI investors have increasingly been looking for “sticky” places,


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with good economic fundamentals in places: market size and growth, good quality

and appropriate skills and infrastructure. This has implications for how policy

makers can work on attracting inward FDI.

Maximizing the effective impact of FDI on economic development

It has been noted that the impact of FDI will largely depend on the economic

conditions of the specific countries. Domestic investment, savings, the mode of

entry of FDI (e.g. merger, acquisition, or new investment), the sector involved, and

the country's ability to regulate foreign investment are all factors affecting the

impact and the size of the FDI.

Many previous studies have also suggested that the level of infrastructural

development and human factor may limit the effective impact of FDI on the

economic growth (Adegbite & Ayadi, 2010). Therefore, Laos government may need

to put sufficient investment into upgrading infrastructure and developing human

capital so that the country can maximize the techonological spillovers and other

benefits associated with FDI inflows. Policy makers in Laos also need to work on

the necessary activities and developing relevant policies to promote favorable

environment for FDI and enhance the government’s capability to maximize the

benefits of FDI inflows. Laos’government may need to increase their investment in

fundamental infrastructures, human capital development, and facilities for

enhancing international trade and investment climate (Kotrajaras et al., 2011) so

that FDI can effectively promote economic growth.

Enhancing capabilities of controlling and regulating FDI for better

economic developemnt

As indicated in the findings of this study, although FDI generally show

positive relationship with various indicators of economic development in Laos, it

still shows some negative side such as FDI was significantly associated with the

Debt service on external debt, long-term (TDS, current US$), and the Debt service

on external debt, total (TDS, current US$). In order to maximize the positive impact


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of FDI, policy makers may need to pay attention to the following issues such as

considering the area to attract FDI – not all types of FDI should be given the same

priority. It should be integrated with the national goals and the development strategy

of the country.

Laos government needs to develop its capabilities of controlling and

regulating FDI for better economic development. FDI should be directed to the right

sectors and areas so that the economy can have sustainable development. The

government also needs to have ability to select the appropriate FDI projects,

develop relevant policies toward different types of FDI projects, and have ability to

make decision of rejecting some inappropriate projects.

Developing an effective mechanism affecting foreign direct investors to

ensure mutual benefits of the foreign investors and the host country’s development

In order to ensure the positive impact of FDI inflows on economic

development of the country, at the same time to attract FDI projects, policy makers

need to put effort to develop an effective mechanism that can affect foreign direct

investors, especially the multinational corporations to ensure mutual benefits of the

foreign investors and the host country’s development. It means that the foreign

investors can operate successfully in Laos market for their profit but at the same

time these investors also commit to the development of the host country (i.e. Laos).

This can help ensure sustainable development of the market for the foreign

investors, and thus can bring long-term benefits for them as well as the development

for the local economy.

6.3 Limitations of the Study and Future Research Direction

This study has significant contribution in terms of both theory and practices.

However, it has several limitations that can be explored further in the future studies.


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First, regardless of the long period of the data collected (1990-2012), some

variables had limited and small number of observations, like the Energy and Natural

Resources data which gave mixed results of the unavailability of that data.

Second, with regard to measurement issue, there is some limitation in terms

of a limited number of indicators measuring some variables in this study. For

example, Level of Techonology and Energy and Natural resources each was

measured by only one indicator. Future research should use more comprehensive

scales with multiple items to increase the validity of the results.

Third, many other aspects of economic developemnt could be affected by

FDI inflows other than the ones selected in this study. The future research could

explore the impact of FDI on more aspects of economic developemnt.

Fourth, in this study the author just explored the role of FDI on economic

development by empirically examined the correlations between FDI inflows and

various indicators of economic development in Laos. It would be desirable for

future research to test the impact of FDI on economic development employing more

advanced technique such as regression.

Another suggestion for future research would be having a micro level

analysis for Laos to come up with a reform strategy for improving their GNI per

capita following the path in accomplishing that goal. Future research could also

examine the factors influwncing the attraction of FDI inflow to Laos.

In conclusion, despite some limitations associated with this study, the author

believes that this study has obtained certain achievements. The findings of this

study on the relationship between FDI and various indicators of economic

development in Laos contribute to better understanding FDI and its role on

economic development in Laos, a relatively new research context. This helps to

enrich the literature on important issues of FDI and economic development in

general and in developing countries in particular.


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