fdi 2

Available ONLINE www.visualsoftindia.com/journal.html

VSRD-IJBMR, Vol. 1 (2), 2011, 103-114

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1Research Scholar, Management Department, Singhania University, Jhunjhunu, Rajasthan, INDIA . *Correspondence : [email protected]

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Impact of FDI on GDP – “A Critical Evaluation” 1Pradeep Kr.*

ABSTRACT

Foreign direct Investment and Gross domestic product are the major determinant of the economy of any country.

FDI affects the GDP of a country directly and hence they are positively correlated. But the FDI in a country is

not the only economic factor on which causes the GDP to increase or Decrease there are so many quantitative

and qualitative economic and non economic variables which influences the GDP of a country. In order to

determine the affect of those economic or non economic variables on GDP a new model has been proposed and

the strength with which they are correlated positively or negatively with GDP has been measured. This model is

proven a success in determining the intensity with which they affects our GDP and hence our economy. In this

research paper the movement of the GDP with the factors like Foreign Direct Investment, Index of Industrial

Production, Per Capita Income, Employment and Inflation has been analyzed to predict the behavior of GDP. It

seems that government is working on introducing new policies to increase our GDP by making investment laws

more liberal and ignoring the other factors. In this paper a detailed analysis has been made to evolve a new

model which could be more realistic and objective. Therefore figures of ten years have been analyzed so that

objectivity could be maintained.

Keywords : GDP, FDI, Per Capita Income, Index of Industrial Production, Un Employment, Inflation.

1. INTRODUCTION

1.1. Gross Domestic Product

The most important measure of economic activity in a country, the Gross Domestic Product is the crossing point

of three sides of the economy: expenditure, output, and income.

As a measure of well-being of a country for international and temporal comparisons, it provides a good first

approximation. Still, it ignores many crucial elements of general well-being, like environment conservation,

safety, life expectance, and population literacy. In this respect, one should rather look at the Human

Pradeep Kr. et. al / VSRD International Journal of Business & Management Research Vol. 1 (2), 2011

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Development Index.

1.2. Composition

To measure economic activity, one needs a meaningful aggregation of all kinds of productions. The territory's

productions are the crossing result of 1) effective demand, 2) production capabilities, and 3) income. Income

arises from payments distributed to production factors and it provides the necessary finance for demand.

A numerical example will explain the fact that GDP is expressive of these three sides or, in other words, of the

contemporary action of buyers, sellers, producers and the income receivers.

Italy's GDP in 1996 can be computed as a sum from three lists of components :

In the first column, attention is given to the buyers. GDP is then measured as the sum of all domestic and

foreign effective demand for national goods. Domestic demand is the sum of household, government, and firm

expenditure (respectively called: consumption, public expenditure, and investment). Foreigners buy national

goods as exports.

Domestic demand is attracted not only by national goods but also by imports, which reduce the GDP sum. A

minuscule additional element is the change in inventories (the goods that nobody wants at the moment).

The second column shows the position of the sellers and the kind of things they sell: GDP is now obtained by

summing up "value added" over the economic branches of the economy. VAT revenue is added to obtain GDP.

The third column points at the remuneration of production factors (labour and capital) with the share of the state.

The same income serves as source of finance for the demand of the first column.


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This identity expenditure = output = income holds always as a matter of definition and national accountancy

conventions.

2. Determinants

The three sides of GDP interact to determine the aggregate. An increase of effective demand (consumption,

investment, public expenditure, exports) will increase GDP, provided national producers can meet the

quality/price requirements of buyers. If not, imports will grow instead. If national production cannot grow for

physical reasons, firms producing already at full capacity probably will decide to raise prices, vanishing

effective demand with inflation.

The diffusion of technological and organizational innovation can impact on productivity, on product/process

quality and on costs (thus potentially on value added). Capital accumulation and the increase of labour quality

and motivation are important ingredients for a growing GDP.

Short term business cycles and long term trends can be - to a certain extent - traced back to the individual

growth path of heterogeneous firms, as this paper point out.

3. OBJECTIVE OF THE RESEARCH

To determine the correlation of FDI on GDP

To determine the Impact of FDI on GDP

To determine the relation and impact of other economic factors on GDP

4. RESEARCH DESIGN

This research design is based on historical data collected from various sources which can be regarded as

secondary data further this research has been divided into various part to maintain its clarity. Many statistical

tools have been used for concrete analysis of data and their interpretation in this research which are as follows:

Average

Sum of observation / Number of observation

Least Square Method for trend analysis

Y = a + bx

∑ y = na + b∑x

∑xy = a∑x + b∑x2

Correlation r= ∑xy -∑x ∑y/n

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√∑x2-(∑x)2/n √∑y2-(∑y)2/n

Bar Charts

Line Charts

Tables

5. A NEW Economic Model

In the light of the above factors that has been introduced in the paper We will examine how GDP correlates with

the FDI inflow, Literacy rate, Index of Industrial production, Per Capita Income of a country, unemployment

rate, Inflation of a Country.

In short we can say that GDP is the function of all these as follows:

If all the remaining economic variable remain constant then;

GDP=f(FDI,L,IIP,PCI,U,I)

Where, FDI=Foreign Direct Investment

L=Literacy rate of a Country

IIP=Index of Industrial Production

PCI=Per Capita Income

U=Unemployment

I=Inflation

Foreign Direct Investment : When a firm controls (or have a strong say in) another firm located abroad, e.g. by

owing more than 10% of its equity, the former is said "parent enterprise" (or "investor") and the latter "foreign

affiliate".

Foreign Direct Investment (FDI) is the financial investment giving rise and sustaining over time the investor's

significant degree of influence on the management of the affiliate.

Per capita income or income per person is the numerical quotient of national income divided by population, in

monetary terms. It is a measure of all sources of income in an economic aggregate, such as a country or city. It

does not measure income distribution or wealth.

Index of Industrial Production (IIP) in simplest terms is an index which details out the growth of various

sectors in an economy. E.g. Indian IIP will focus on sectors like mining, electricity, Manufacturing & General.

Also base year needs to be decided on the basis of which all the index figures would be arrived at. In case of

India the base year has been fixed at 1993-94 hence the same would be equivalent to 100 Points but now it


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changed its based year to 2004-2005.

Index of Industrial Production (IIP) is an abstract number, the magnitude of which represents the status of

production in the industrial sector for a given period of time as compared to a reference period of time.

The index is computed using the weighted arithmetic mean of quantity relatives with weights being allotted to

various items in proportion to value added by manufacture in the base year by using Laspeyre's formula:

I = ∑ (WiRi)/ ∑ Wi.

Where I is the index, Ri is the production relative of the ith item for the month in question and Wi is the weight

allotted to it.

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When

the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also

reflects an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange

and unit of account in the economy.A chief measure of price inflation is the inflation rate, the annualized

percentage change in a general price index (normally the Consumer Price Index) over time.

Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects

of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over

future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if

consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring

central banks can adjust nominal interest rates (intended to mitigate recessions),and encouraging investment in

non-monetary capital projects.

Literacy has traditionally been described as the ability to read and write. It is a concept claimed and defined by

a range of different theoretical fields.

The United Nations Educational, Scientific and Cultural Organization (UNESCO) defines literacy as the "ability

to identify, understand, interpret, create, communicate, compute and use printed and written materials associated

with varying contexts. Literacy involves a continuum of learning in enabling individuals to achieve their goals,

to develop their knowledge and potential, and to participate fully in their community and wider society.

6. DATA ANALYSIS AND INTERPRETATION

Year GDP - Real Growth Rate (%) Equity Inflow in Millions $

2000-2001 5.5 2908

2001-2002 6 4222

2002-2003 4.3 3134

2003-2004 4.3 2776


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2004-2005 8.3 2549

2005-2006 6.2 5,546

2006-2007 8.4 6,081

2007-2008 9.2 9,277

2008-2009 9 18,708

2009-2010(October) 8.337 17,604

Table 1: Showing Relation between GDP and FDI

Coefficient of Correlation r (calculated from the data during 2006-2010) = .4983

6.1. Interpretation

From the statistical analysis it is quite clear that there is positive correlation between FDI and GDP of a nation it

means it is a essential factor in determining GDP, it increases with FDI .FDI is increasing from 2001 to 2010

during which the GDP is quite fluctuating .It indicate that’s that there must be some other factors on which GDP

must depend.

Year GDP - Real Growth Rate (%) Industrial Production Growth Rate (%)

2000-2001 5.5 7.5

2001-2002 6 4.7

2002-2003 4.3 6

2003-2004 4.3 6.5

2004-2005 8.3 7.4

2005-2006 6.2 7.9


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2006-2007 8.4 7.5

2007-2008 9.2 8.5

2008-2009 9 4.8

2009-2010 (October) 8.337 14.6

Table 2: Showing Relation between GDP and Industrial production growth rate (%)

Coefficient of Correlation r (calculated from the data during 2006-2010)= .098

6.2. Interpretation

From the statistical analysis it is quite clear that there is positive correlation between IIP and GDP of a nation it

means it is a essential factor in determining GDP, it increases with IIP .IIP is also fluctuating with the GDP of

the country it is increasing from 2006 to 2008 during which the GDP is quite fluctuating .It was quite low in

2008-2009 due to some recessionary pressure but GDP was quite stable again IIP increased in 2010 to 14.6 with

stable GDP which indicate that’s that there must be some other factors on which GDP must depend.

Table 3: Showing Relation between GDP and Per Capita Income (In US $)

Year GDP - real growth rate (%) Per Capita Income(In US $)

2000-2001 5.5 2200

2001-2002 6 2540

2002-2003 4.3 2540

2003-2004 4.3 2900

2004-2005 8.3 3100

2005-2006 6.2 3400


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2006-2007 8.4 3800

2007-2008 9.2 2600

2008-2009 9 2500

2009-2010(October) 8.337 3700

Coefficient of Correlation r (calculated from the data during 2006-2010)= -.533

6.3. Interpretation

From the statistical analysis it is quite clear that there is negative correlation between PCI and GDP of a nation

which may be a essential factor in determining GDP, it increases with decrease in PCI .From the date collected

from 2006-2010 which is not much sufficient to make a proper analysis therefore it is quite amazing to find that

there is negative relation between PCI and GDP but may be important one in determining GDP of a nation.

Table 4: Showing Relation between GDP and Unemployment rate (in %)

Year GDP - real growth rate (%) Unemployment rate (in %)

2002-2003 4.3 8.80 %

2003-2004 4.3 9.50 %

2004-2005 8.3 9.20 %

2005-2006 6.2 8.90 %

2006-2007 8.4 7.80 %

2007-2008 9.2 7.20 %

2008-2009 9 6.80 %

2009-2010(October) 8.337 10.70 %


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Coefficient of Correlation r (calculated from the data during 2006-2010)= -.097

6.4. Interpretation

From the statistical analysis it is quite clear that there is negative correlation between unemployment and GDP

of a nation which may be a essential factor in determining GDP, it increases with decrease in unemployment

.From the date collected from 2006-2010 which is not much sufficient to make a proper analysis therefore it is

quite obvious to find that there is negative relation between unemployment and GDP and certainly a important

one in determining GDP of a nation. Therefore if want to increase our GDP we must bring down

Unemployment.

Table 5: Showing Relation between GDP and Inflation rate (consumer prices) (%)

Year GDP - Real Growth Rate (%) Inflation Rate (Consumer Prices) (%)

2000-2001 5.5 5.4

2001-2002 6 5.4

2002-2003 4.3 5.4

2003-2004 4.3 3.8

2004-2005 8.3 4.2

2005-2006 6.2 4.2

2006-2007 8.4 5.3

2007-2008 9.2 8.32

2008-2009 9 10.83

2009-2010(October) 8.337 12.21


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Coefficient of Correlation r (calculated from the data during 2006-2010)= .6122

6.5. Interpretation

From the statistical analysis it is quite clear that there is positive correlation between inflation and GDP of a

nation it means it is a essential factor in determining GDP, it increases with inflation .It is also fluctuating with

the GDP of the country it is increasing from 2008 to 2010 and is expected to increase further . The inflation

figures are more reliable because the base year to calculate inflation has been changed from 1996 to 2004.It also

indicates that inflation shows the progress of a country though it must be moderate around 9%. But it is certain

that along with GDP it shows growth of country and move in same direction.

7. FINDINGS

There are many economic forces not only two or three in numbers which directly or indirectly affects GDP

of a country.

Therefore we can say that GDP cannot be isolated from the other forces of the economy.

The Qualitative forces like literacy, unemployment etc which seems to be unrelated to the GDP also

contributed indirectly to the GDP of a country.

The factors like Inflation, FDI, Export, Industrial production directly contributed to the growth of the GDP

which further represent the growth of the Country.

The Coefficient of Correlation shows that the strength to which the different forces are correlated with

GDP.

The Coefficient of Correlation shows that the major contributing factors rare FDI, IIP, and Exports of a

Country.

The GDP of the country was quite fluctuating in the starting of the decade but it started stabilizing towards

the end of the decade due to increase in FDI, Exports, and IIP.

It is also clear that high inflation in a country leads to tighter monetary policies which further slower down

the IIP and hence GDP.


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8. CONCLUSION

From the research it is concluded that the GDP of the country is the symbol of the progress of the country and

the economic model proposed earlier in the research is quite complete and seems to be right. It may leads to

some variation from the practical results of the real world because the results are drawn from the data of the year

2006 onwards.

Simply we can say that GDP of a country cannot be treated isolated as there are many other secondary economic

forces which simultaneously act together with primary forces to guide the GDP of a Country.

So the authorities must consider all these secondary forces all together with the primary forces while framing

there policies for the GDP progress, though it is not possible to correct the variation in all these forces for any

economy and also policies cannot be framed with all these factors in consideration but efforts can be made.

As far as the economic interpretation of the model is concerned, the size of the domestic market is positively

related to foreign direct investment. The greater the market, the more customers and the more opportunities to

invest. Since FDI is mostly in the form of physical investment, investors would prefer the markets with better

infrastructure. The attractiveness of the host market also affects the FDI positively and significantly. In many

ways India’s principal problem remains that of boosting its rate of saving and investment from the current about

23% of GDP to over 30% of GDP in order to make growth prospects take a quantum jump and become

comparable with the high growth phases of the Chinese and East Asian economies. FDI becomes important in

its own right if it makes contributions towards technology progress; productivity spillovers and consolidating

niche export markets. This paper emphasizes the view that an enlightened FDI policy is to be seen as part of a

general policy of enhancing investment in this economy under conditions of sustained production efficiency.

9. REFERENCES [1] Economic Liberalization and India’s Foreign Policy/Chan-Wahn Kim. Delhi, Kalpaz

[2] John H. Dunning’s “GLOBALIZATION INDUCED CHANGES AND THE ROLE OF FDI POLICIES”

[3] Website: http:/indiabudget.nic.in

[4] Government of India (2002) “Report of the Steering Committee on Foreign Direct Investment” Planning

Commission, August.

[5] Recent Trends in FDI Flows and Prospects for India – Raghbendra Jha

[6] www.unctad.org/wir or www.unctad.org/fdistatistics

[7] Abel, Andrew; Bernanke, Ben (2005). Macroeconomics (5th ed.). Pearson

[8] Barro, Robert J. (1997). Macroeconomics. Cambridge, Mass: MIT Press. pp. 895. ISBN 0-262-02436-5

[9] Blanchard, Olivier (2000). Macroeconomics (2nd ed.). Englewood Cliffs, N.J: Prentice Hall.

ISBN 013013306x

[10] Mankiw, N. Gregory (2002). Macroeconomics (5th ed.). Worth

[11] Hall, Robert E.; Taylor, John B. (1993). Macroeconomics. New York: W.W. Norton. pp. 637. ISBN 0-393-

96307-1

[12] Burda, Michael C.; Wyplosz, Charles (1997). Macroeconomics: a European text. Oxford [Oxfordshire]:

Oxford University Press. ISBN 0-19-877468-0


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[13] "The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1976. Press release".

Nobelprize.org. October 14, 1976.

[14] "The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2006. Press Release".

Nobelprize.org. September 11, 2006.

[15] Walsh, Carl E. (2003). Monetary Theory and Policy, 2nd Edition. Cambridge, MA: The MIT Press.

ISBN 0-262-23231-6.

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