PROJECT TITLE- EFFECTS OF FDI ON EMPLOYMENT

TEAM MEMBERS
RAHUL DEB-17072
JYOTIKA RAYMOND-17222
 CONTENTS

1. INTRODUCTION--------------------------------------------------------------------

2. RESEARCH METHODOLOGY-----------------------------------------------------
a) OBJECTIVES OF RESEARCH------------------------------------------------------
b) LIMITATIONS OF RESEARCH-----------------------------------------------------
c) HYPOTHESIS-------------------------------------------------------------------------
d) DATA COLLECTION-----------------------------------------------------------------

3. LITERATURE REVIEW--------------------------------------------------------------

4. DATA INTERPRETATION----------------------------------------------------------

5. CONCLUSION-------------------------------------------------------------------------

BIBLIOGRAPHY-----------------------------------------------------------------------

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 Abstract
A substantial amount of development has been observed in the inflows of Foreign Direct
Investment (FDI) in India over the last two decades. The extraordinary growth of FDI in 1990
around the world has made it an essential constituent of development strategy for both,
developed and developing countries. However, the most profound effect has been observed in
developing nations. Macroeconomists have performed various studies in order to prove that
FDI plays an important role in generating employment and improving the economic
development, in other words, increasing the level of gross domestic product (GDP) of host
countries. A multiple-regression model will be used intensely in order to analyze whether FDI
has an impact on the employment and GDP in India. The role of FDI in the growth process has
been a burning topic of debate in several countries including India. This paper is an attempt to
analyze the causal relationship between Foreign Direct Investment (FDI) and economic growth
in India and tries to analyze and empirically estimate the effect of FDI on economic growth in
India, using the cointegration approach for the period, 1990-91 to2010-11. The empirical
analysis on basis of ordinary Least Square Method suggests that there is positive relationship
between foreign direct investment(FDI)investment and GDP and vice versa. The unit root test
clarified that both economic growth and foreign direct investment were found to be integrated
of order one using the Kwiatkowski, Phillips, Schmidt and Shinn (KPSS) test for unit root only.
The cointegration test confirmed an existence of long run equilibrium relationship between the
two as confirmed by the Johansen cointegration test results. The Granger causality test finally
confirmed the presence of uni-directional causality which runs from economic growth to
foreign direct investment. The error correction estimates gave evidence that the Error-
Correction Term is statistically significant and has a negative sign, which confirms that there
isnt any problem in the long-run equilibrium relation between the independent and dependent
variables. For FDI to be a noteworthy provider to economic growth, India would do better by
focusing on improving infrastructure, human resources, developing local entrepreneurship,
creating a stable macroeconomic framework and conditions favorable for productive
investments to augment the process of development.

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 CHAPTER 1
Introduction

The definition of FDI is not only limited to a simple transfer of money, but has now extended to
being defined as a measure of foreign ownership of domestic productive assets such as
factories, land and organizations and other intangible assets like technologies, marketing skills
and managerial capabilities. Economic literature has been dominated by FDI over the last 30
years, especially the developmental areas of economics due to the highly receivable potential
benefits of a host country. The effects experienced spread over a wide range, from influencing
production, generation of employment, change in income levels, import and exports, impact on
economic growth, balance of payments and general welfare of the host country. FDI was found
to have emerged in India since the British rule but its presence was considered negligible. It was
natural for India to consider foreign capital as one of fear and suspicion as the British played an
exploitative role by draining away resources from the country. Gradually, as India achieved
independence, it became necessary for FDI to become a part of her national interest. FDI has
observed to portray a different trend in India since 1991 as finally the national economy was
opened to global trade. There has been an evident increase in the inflows of FDI in India which
continued to rise to peaks till 2008. According to various studies, currently India is among the
top 5 preferred destinations for FDI. (Ansari and Ranga, 2010) There have been many
arguments stating that inflows of FDI improves the economic growth, and consequently
enhances employment opportunities. FDI provides technological advances (increasing GDP) and
widens the scope for the domestic market (increasing employment). With the help of the
regression tool, a multiple-regression analysis will be carried out in order to confirm the above
statement and if not true then to study to what extent the employment and GDP are affected
by FDI in India.

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 Importance of FDI

FDI plays a major role in developing countries like India. They act as a long term
source of capital as well as a source of advanced and developed technologies. The
investors also bring along best global practices of management. As large amount
of capital comes in through these investments more and more industries are set
up. This helps in increasing employment. FDI also helps in promoting international
trade. This investment is a non-debt, non-volatile investment and returns
received on these are generally spent on the host country itself thus helping in
the development of the country.
Some of the sectors that attract high FDI inflows in India are the hotel and
tourism industry, insurance sector, telecommunication, real estate, retail, power,
drugs, financial services, infrastructure and pollution control etc. FDI is not
permitted in the following sectors:

Railways
Atomic energy
Defense
Coal and lignite

An investor has to take a decision regarding the following aspects while investing:

Exchange Rate - The stronger the foreign currency is in comparison to that of the
host country, lesser will be the amount of investment required. In other words,
depreciation of currency in the host country will lead to more investments.
Market Size - This refers to the GDP growth. Developing and emerging countries
are more likely to attract investments.
Infrastructure - Investors will invest in a country if they think that the country has
suitable infrastructure to support the business.
Tax regime - MNCs are subject to tax in both the parent as well as host country.
The host country which attempts to reduce this double taxation of MNCs will
attract more FDI.
Labor market conditions - The educational levels of the labor as well as the wage
rates also play a major role in determining the flow of FDI.
Financial and economic stability
Political stability

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Following are some of the sectors in our country which attract massive FDI
investments:

Retail Sector
This industry accounts for 13% of countrys GDP. Retail outlets acts as an interface
between the producers and the consumers of a good. Indian government
liberalized FDI in 2005 in this sector to 100%, thus enabling foreign investors to
set up retail companies in India.
Retail industry is divided into organized and unorganized sectors. Organized
sectors include hypermarkets and retail chains whereas unorganized sector
include local kirana shops (mom and pop stores). The latter is more prevalent in
India. Due to massive development taking place, organized sector is increasing its
foothold in the country. Since advanced technology and management structure is
used with foreign investments the price of the goods in the organized retail
industry falls and productivity of the firm increases. Today modern retail outlets
provide everything from basic amenities to luxury goods. They also provide
consumer with a wide variety. They have become the one-stop shop for
customers. This trend is destroying the sales of unorganized retail sector.
Therefore on one hand FDI helps in reducing prices of the manufactured goods
and on the other, it is rendering our unorganized retail sector paralyzed. The
government has recently made it mandatory for foreign investors in multi-brand
retail sector to do their bulk sourcing from small farmers. With this move
government is preventing wipe-out of shopkeepers and small retailers.

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 Manufacturing Sector
Government has allowed 100% FDI in this sector except in defense industry and
cigarette manufacturing. Foreign investments in this sector will help in
employment of semi-skilled labor by providing them with access to developed
technology.

Real Estate, Construction Development and Tourism

Any countrys growth and development is determined by its infrastructure. Due to
increasing population and migration of people from rural to urban areas, the real
estate sector is booming. Tourism industry is one of the major earners of foreign
exchange for the country. It has a huge potential for our economy. It is also one of
the major sectors in employment. Large amount of investments are needed to
build roads, bridges, infrastructure so as to promote overall economic
development of the country.

Power Sector
Power is considered most crucial sector for development. Since public sector
alone was not able to meet the demands, investments from private and foreign
investors was encouraged. Power generation, transmission and distribution are
main areas of consideration. India has a vast scope of development in hydel
power, nuclear power, solar power, thermal energy as well as in wind energy.
Renewable sources of energy require vast amount of investments for research
and development.
FDI, thus on one hand helps in increasing the output through usage of advanced
technology and management techniques and on the other it is a threat to local
companies in the country. Government should take steps in the direction of
integrating foreign investors with local businesses. This will help in overall
economic development as well as preservation of countrys heritage. MNCs
should be allowed to set up in such a manner that they help increase the standard
of living of our country instead of sole profit making.

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 Role of FDI on Employment

1-Employment Creation
It means the FDI brings new production capacity and new jobs. Meanwhile it can
improve the development of relevant industries.

2- Employment Crowding-out
It means the inflow of the FDI makes the competition more intensive. So some
domestic enterprises have had to reduce employment to improve their
competitiveness.

3- Employment Shift
It means the cooperation between foreign and domestic companies will create
joint ventures. That will make workers transfer to new enterprises.

4- Employment Loss
It means the foreign-invested enterprise have their own management methods.
Those who have not efficiency or are not suitable for this corporate environment
will lose their jobs. There is direct and positive relationship between FDI and
employment. As firms are operated in India they require skilled and unskilled
labour. In India labour is cheap source and available in abundant. Therefore, FDI
provides employment to all the section of the people. They contribute a good
proportionate of the total employment. Normally Greenfields generates
employment when they start a project or firm but mergers and acquisitions do
not generate employment at the time of entry but over the period it creates
employment and also develops trade linkages in the long run. One of the

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objectives of development of special economic zones is generation of
employment. More than two-fifth of the market capitalization originates in Class-
3 cities. FDI-enabled firms in manufacturing sectors provide employment to about
15.6 lakhs persons, accounting for about 4 to 5% of the total employment in the
organized sector. Class-3 cities provide employment to about 7.9 lakhs workers
(more than 50% of the Pakanati Someshu. Sectors providing a relatively high
share of employment in Class-3 cities include transport equipment; growing and
processing of crops; construction parts; textiles; and non-metallic mineral
products. FDI has played an important role in the process of globalization during
the past two decades. The rapid expansion of FDI by multinational enterprises
(MNEs1) since the mid-eighties may be attributed to significant changes in
technologies, liberalization of trade and investment regimes, and deregulation
and privatization of markets in many countries including developing countries like
India. Fresh investments, as well as mergers and acquisitions, (M&A) play an
important role in the cross-country movement of FDI While the quantity of FDI is
important, equally important is the quality of FDI. The major factors that might
provide growth impetus to the host economy include the extent of localization of
the output of the foreign firm's plant, its export orientation, the vintage of
technology used, the research and development (R&D) best suited for the host
economy, employment generation, inclusion of the poor and rural population in
the resulting benefits, and productivity enhancement.

FDI in India and Its Growth Linkages

In India stood at $23 billion, showing a growth rate of 43.2 per cent over 2006. In
2008, total FDI inflows into India stood at $33 billion. One of the most important
and sensitive areas for developing countries is foreign direct investment (FDI). It is
now defined as not only a simple transfer of money, but as a mixture of financial
and intangible assets such as technologies, managerial capabilities, marketing
skills and other assets. There is a major debate in the literature regarding the
impact of FDI on economic growth. The traditional argument states that an inflow
of FDI improves economic growth and thereby enhances employment
opportunities. Most studies (Hill and Athukorala 1998 have shown that FDI's
social and distributional impact on the host country has been generally favorable
in developing countries of various regions. Apart from bringing in a package of
highly productive resources into the host economy there have been a visible

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positive impact on the creation of jobs not only in those sectors attracting FDI
inflows but also in the supportive domestic industries. Foreign Direct Investment
(FDI) is often seen as a driver for economic development as it may bring capital,
technology, management know-how, jobs and access to new markets. Policy-
makers have, therefore, tended to emphasize the benefits that FDI can bring to
host economies, particularly in developing countries. Accordingly, many
governments have developed policies to encourage inward FDI. While FDI and
multinational enterprises (MNEs) are often perceived to be beneficial for local
development, they have also aroused much controversy and social concerns. For
example, MNEs have often been accused of taking unfair advantage of low wages
and weak labor standards in developing countries. MNEs also have been accused
of violating human and labor rights in countries where governments fail to
enforce such rights effectively.

In Indian Service Sector

The number of service sector jobs (skill and unskilled) has increased in India, new
findings have revealed. A survey conducted by the country's Labor Ministry
indicated that during the last quarter, employment in the industry rose to 15.72
million, Channel News Asia reported. The research revealed that two sectors have
shown the strongest improvement in terms of hiring levels; information
technology and business process. Outsourcing Commenting on the findings,
Nimish Adani, chief executive of workosaur.com, told Channel News Asia: "As far
as employment is concerned, there have been certain short-term initiatives taken
by the government." There has been an infusion of stimulus packages in sectors
which were labor-intensive. So, there has been a marginal improvement."Finance
Services sector is growing with rapid rate, Finance sector is the second preferred
choice of students of management post-graduation top B-Schools in India,
following figures are explaining the preference of skilled professional in Indian
service sector. For analyzing the perception of skilled toward various segment of
service sector.

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 CHAPTER 2
Research Methodology

I. Objectives of the Research

The major reason behind taking up this particular topic as our project for
economics is the Effect of FDI on Employment. Thus it is essential to get an
insight into how the growth in FDI affects the employment aspect of India.
In India, FDI is considered as a developmental tool, which can help in
achieving self-reliance in various sectors of the economy.

The study covers the following objectives:

1. To present the current status of FDI in Indian retail along with further scope.
2. To analyze the rationality of allowing FDI in Indian retail with special
importance to multi brand retailing.
3. And thus evaluate the impact of FDI on the overall employment Growth of
the country and to indicate some measures that may be taken into
consideration as part of the policy making process.
4. This paper attempted to highlight the general overview of FDI based on
secondary information gathered from diversified sources which include
literature survey, newspaper articles and internet.
5. Microsoft Office Word, Excel and Charts, mainly Column and Line Graph,
associated with it were used extensively for visual and better understanding.

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II. Limitations of Research
The assumption that FDI was the only cause for development of Indian
economy in the post liberalized period is debatable.
Lack of availability of data over a wide range of years limited the scope
of investigation.
Time limitation also acted as a hurdle to have in depth study of the topic.
As European Monetary Union was not formed before 1990, so this
restricted the investigator to analysis more number of years.
As the investigator is not a full time scholar, the study is narrowed down
the line.
My incapacity to conclude over the above topic of study due to its diverse
nature and relevance under different scenario.

III. Hypothesis

The paper is based on the following hypotheses for testing the causality and co-
integration between GDP and FDI in India

(i) Whether there is bi-directional causality between GDP growth and FDI
(ii) Whether there is unidirectional causality between the two variables
(iii) Whether there is no causality between GDP and FDI in India
(iv) Whether there exists a long run relationship between GDP and FDI in India.

Model Specification
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The choice of the existing model is based on the fact that it allows for generation
and estimation of all the parameters without resulting into unnecessary data
mining.

The growth model for the study takes the form:

GDP=f (FDI) ------------------- (1)

Where GDP and FDI are the gross domestic product and foreign direct investment
respectively.

Equation (1) is treated as a Cobb-Douglas function with foreign direct investment

into India, (FDI), as the only explanatory variable.

The link between Economic growth (measured in terms of GDP growth) and
foreign direct investment in India can be described using the following model in
linear form:

LnGDPt= + Ln FDI t + t -------------- (1.1)

and >0

The variables remain as previously defined with the exception of being in their
natural log form. t is the error term assumed to be normally, identically and
independently distributed.

Here, GDP t and FDI t show the Gross Domestic Product annual growth rate and
foreign direct investment growth at a particular time respectively while t
represents the noise or error term; and represent the slope and coefficient
of regression. The coefficient of regression, indicates how a unit change in the
independent variable (foreign direct investment) affects the dependent variable
(gross domestic product). The error, t, is incorporated in the equation to cater
for other factors that may influence GDP. The validity or strength of the Ordinary
Least Squares method depends on the accuracy of assumptions. In this study, the
Gauss-Markov assumptions are used and they include; that the dependent and
independent variables (GDP and FDI) are linearly co-related, the estimators (, )
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are unbiased with an expected value of zero i.e., E (t) = 0, which implies that on
average the errors cancel out each other. The procedure involves specifying the
dependent and independent variables; in this case, GDP is the dependent variable
while FDI the independent variable.

But it depends on the assumptions that the results of the methods can be
adversely affected by outliers. In addition, whereas the Ordinary Least squares
regression analysis can establish the dependence of either GDP on FDI or vice
versa; this does not necessarily imply direction of causation. Stuart Kendal noted
that a statistical relationship, however, strong and however suggestive, can
never establish causal connection. Thus, in this study, another method, the
Granger causality test, is used to further test for the direction of causality.

Step I: Ordinary least square method:

Here we will assume the hypothesis that there is no relationship between foreign
direct investment (FDI) and Economic Growth in terms of GDP. To confirm about
our hypothesis, primarily, we have studied the effect of foreign direct investment
inflow on economic growth and vice versa by two simple regression equations:

FDI=a+ b*GDPi ..(2)

GDP=a1+ b1*FDIi..(3) GDP = Gross domestic product.

FDI = Foreign Direct Investment into India. t= time subscript.

This study aimed to examine the long-term relationship between foreign direct
investment and GDP growth in India between 1990-91 and 2010-11. Using co-
integration and Vector Error Correction Model (VECM) procedures, we
investigated the relationship between these two variables. The likely short-term
properties of the relationship among economic growth and foreign direct
investment were obtained from the VECM application. Next, unit root, VAR,
cointegration and Vector Error Correction Model (VECM) procedures were utilized
in turn. The first step for an appropriate analysis is to determine if the data series
are stationary or not. Time series data generally tend to be non-stationary, and
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thus they suffer from unit roots. Due to the non-stationary, regressions with time
series data are very likely to result in spurious results. The problems stemming
from spurious regression have been described by Granger and New bold (1974).
In order to ensure the condition of stationarity, a series ought to be integrated to
the order of 0 [I(0)]. In this study, tests of stationarity, commonly known as unit
root tests, were adopted from Dickey and Fuller (1979, 1981) and Phillips-Perron
test. As the data were analyzed, we discovered that error terms had been
correlated in the time series data used in this study.

Step II: The Stationarity Test (Unit Root Test)

When dealing with time series data, a number of econometric issues can
influence the estimation of parameters using OLS. Regressing a time series
variable on another time series variable using the Ordinary Least Squares (OLS)
estimation can obtain a very high R2, although there is no meaningful relationship
between the variables. This situation reflects the problem of spurious regression
between totally unrelated variables generated by a non-stationary process.
Therefore, prior to testing Cointegration and implementing the Granger Causality
test, econometric methodology needs to examine the stationarity; for each
individual time series, most macro economic data are non stationary, i.e. they
tend to exhibit a deterministic and/or stochastic trend. Therefore, it is
recommended that a stationarity (unit root) test be carried out to test for the
order of integration. A series is said to be stationary if the mean and variance are
time-invariant. A non-stationary time series will have a time dependent mean or
make sure that the variables are stationary, because if they are not, the standard
assumptions for asymptotic analysis in the Granger test will not be valid.
Therefore, a stochastic process that is said to be stationary simply implies that the
mean [(E(Yt)] and the variance [Var (Yt)] of Y remain constant over time for all t,
and the covariance [covar (Yt, Ys)] and hence the correlation between any two
values of Y taken from different time periods depends on the difference apart in
time between the two values for all ts. Since standard regression analysis
requires that data series be stationary, it is obviously important that we first test
for this requirement to determine whether the series used in the regression
process is a difference stationary or a trend stationary. The Augmented Dickey-
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Fuller (ADF) test is used. To test the stationary of variables, we use the
Augmented Dickey Fuller (ADF) test which is mostly used to test for unit root.
Following equation checks the stationarity of time series data used in the study:

y + t + y + y + -----(4)

t = 11 t-1 t-1 t

Where is white nose error term in the model of unit root test, with a null
hypothesis that variable has unit root. The ADF regression test for the existence of
unit root of yt that represents all variables (in the natural logarithmic form) at
time t. The test for a unit root is conducted on the coefficient of yt-1 in the
regression. If the coefficient is significantly different from zero (less than zero)
then the hypothesis that y contains a unit root is rejected. The null and alternative
hypothesis for the existence of unit root in variable yt is H0; = 0 versus H1: <
0. Rejection of the null hypothesis denotes stationarity in the series.

If the ADF test-statistic (t-statistic) is less (in the absolute value) than the
Mackinnon critical t-values, the null hypothesis of a unit root can not be rejected
for the time series and hence, one can conclude that the series is non-stationary
at their levels. The unit root test tests for the existence of a unit root in two cases:
with intercept only and with intercept and trend to take into the account the
impact of the trend on the series.

The PP tests are non-parametric unit root tests that are modified so that serial
correlation does not affect their asymptotic distribution. PP tests reveal that all
variables are integrated of order one with and without linear trends, and with or
without intercept terms.

PhillipsPerron test (named after Peter C. B. Phillips and Pierre Perron) is a unit
root test. That is, it is used in time series analysis to test the null hypothesis that a

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time series is integrated of order 1. It builds on the DickeyFuller test of the null
hypothesis = 0 in , here is the first difference operator. Like the augmented
DickeyFuller test, the PhillipsPerron test addresses the issue that the process
generating data for yt might have a higher order of autocorrelation than is
admitted in the test equation - making yt 1 endogenous and thus invalidating
the DickeyFuller t-test. Whilst the augmented Dickey Fuller test addresses this
issue by introducing lags of yt as repressors in the test equation, the Phillips
Perron test makes a non-parametric correction to the t-test statistic. The test is
robust with respect to unspecified autocorrelation and heteroscedasticity in the
disturbance process of the test equation.

Once the number of unit roots in the series was decided, the next step before
applying Johansens (1988) co-integration test was to determine an appropriate
number of lags to be used in estimation. Second, Eagle-Granger residual based
test tests the existence of co integration among the variables-FDI and GDP at
constant prices for the economy. Third, if a co integration relationship does not
exist, VAR analysis in the first difference is applied, however, if the variables are
co integrated, the analysis continues in a cointegration framework.

Several tests of non-stationarity called unit root tests have been developed in the
time series econometrics literature. In most of these tests the null hypothesis is
that there is a unit root, and it is rejected only when there is strong evidence
against it. Most tests of the Dickey-Fuller (DF) type have low power (see Dejong et
al. 1992). Because of this Maddala and Kim (1998) argue that DF, ADF (augmented
Dickey-Fuller) and PP (Phillips and Perron) tests should be discarded. We,
therefore, use the KPSS (Kwiatkowski, Phillips, Schmidt and Shin 1992) test which
is considered relatively more powerful (Bahmani-Oskooee et.al.,1999). The KPSS
Lagrange Multiplier tests the null of stationarity (H0: < 1) against the alternative
of a unit root (H1: =1).

In econometrics, KwiatkowskiPhillipsSchmidtShin (KPSS) tests are used for

testing a null hypothesis that an observable time series is stationary around a
deterministic trend. The series is expressed as the sum of deterministic trend,
random walk, and stationary error, and the test is the Lagrange multiplier test of

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the hypothesis that the random walk has zero variance. KPSS type tests are
intended to complement unit root tests, such as the DickeyFuller tests. By
testing both the unit root hypothesis and the stationarity hypothesis, one can
distinguish series that appear to be stationary, series that appear to have a unit
root, and series for which the data (or the tests) are not sufficiently informative to
be sure whether they are stationary or integrated.

The KPPS (1992) Test is based on the residuals( ) from an ordinary least square
regression of the variable of interest on the exogenous variable(s) as follows:

Yt = Xt + t .(5)

whereYt is the variable of interest (real exchange rate) and Xt is a vector of

exogenous variable(s). The Lagrange Multiplier (LM) statistic used in the test as
follows:

LM T 2 S (t ) 2 / f0 (6)

i 1

where T is the sample size, S(t) is the partial sum of

residuals which is calculated as S (t ) Sr .

i 1

Here is the estimated residual from (3.1). f0 is an estimator of the residual

spectrum at frequency zero. This statistic has to be compared with KPSS et al.
(1992) critical values.

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Step-III: Testing for Cointegration Test(Johansen Approach)

Cointegration, an econometric property of time series variable, is a precondition

for the existence of a long run or equilibrium economic relationship between two
or more variables having unit roots (i.e. Integrated of order one). The Johansen
approach can determine the number of co-integrated vectors for any given
number of non-stationary variables of the same order. Two or more random
variables are said to be cointegrated if each of the series are themselves non
stationary. This test may be regarded as a long run equilibrium relationship
among the variables. The purpose of the Cointegration tests is to determine
whether a group of non stationary series is cointegrated or not.

Having concluded from the ADF results that each time series is non-stationary, i.e
it is integrated of order one I(1), we proceed to the second step, which requires
that the two time series be co-integrated. In other words, we have to examine
whether or not there exists a long run relationship between variables (stable and
non-spurious co-integrated relationship). In our case, the mission is to determine
whether or not foreign direct investment (FDI) and economic growth (GDP)
variables have a long-run relationship in a bivariate framework. Engle and
Granger (1987) introduced the concept of cointegration, where economic
variables might reach a long-run equilibrium that reflects a stable relationship
among them. For the variables to be co-integrated, they must be integrated of
order one (non-stationary) and the linear combination of them is stationary I(0).

The crucial approach which is used in this study to test r cointegration is called the
Johansen cointegration approach. The Johanson approach can determine the
number of cointegrated vectors for any given number of non-stationary variables
of the same order.

Step-IV: The Granger Causality test :

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Causality is a kind of statistical feedback concept which is widely used in the
building of forecasting models. Historically, Granger (1969) and Sim (1972) were
the ones who formalized the application of causality in economics. Granger
causality test is a technique for determining whether one time series is significant
in forecasting another (Granger. 1969). The standard Granger causality test
(Granger, 1988) seeks to determine whether past values of a variable helps to
predict changes in another variable. The definition states that in the conditional
distribution, lagged values of Yt add no information to explanation of movements
of Xt beyond that provided by lagged values of Xt itself (Green, 2003). We should
take note of the fact that the Granger causality technique measures the
information given by one variable in explaining the latest value of another
variable. In addition, it also says that variable Y is Granger caused by variable X if
variable X assists in predicting the value of variable Y. If this is the case, it means
that the lagged values of variable X are statistically significant in explaining
variable Y. The null hypothesis (H0) that we test in this case is that the X variable
does not Granger cause variable Y and variable Y does not Granger cause variable
X. In summary, one variable (Xt) is said to granger cause another variable (Yt) if
the lagged values of Xt can predict Yt and vice-versa.

FDI and GDP are, in fact, interlinked and co-related through various channel.
There is no theoretical or empirical evidence that could conclusively indicate
sequencing from either direction. For this reason, the Granger Causality test was
carried out on FDI and GDP.

The spirit of Engle and Granger (1987) lies in the idea that if the two variables are
integrated as order one, I(1), and both residuals are I(0), this indicates that the
two variables are cointegrated. The Granger theorem states that if this is the case,
the two variables could be generated by a dynamic relationship from GDP to FDI
and, vise versa.

Therefore, a time series X is said to Granger-cause Y if it can be shown through a

series of F-tests on lagged values of X (and with lagged values of Y also known)
that those X values predict statistically significant information about future values

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of Y. In the context of this analysis, the Granger method involves the estimation of
the following equations:

If causality (or causation) runs from FDI to GDP, we have:

dLnGDPit =i+ 11dLnGDPi, t-1+ 11dLnFDIi, t-1 +1t

(7)

If causality (or causation) runs from GDP to FDI, it takes the form:

dLnFDIit = i+12dLn FDIi,t-1 +12dLnGDPi,t-1

+ECMit+2t.(8)

Where GDPt and FDIt represent gross domestic product and foreign direct
investment respectively, it is uncorrelated stationary random process, and
subscript t denotes the time period. In equation 4, failing to reject: H0: 11 = 11
=0 implies that foreign direct investment does not Granger cause economic
growth. On the other hand, in equation5, failing to reject H0: 12= 12 =0 implies
that economic growth via GDP growth does not Granger cause foreign direct
investment.

The decision rule:

From equation (7), dLnFDIi, t-1Granger causes dLnGDPi t if the coefficient of the
lagged values of FDI as a group (11) is significantly different from zero based on
F-test (i.e., statistically significant). Similarly, from equation (8), dLnGDPi,t-1
Granger causes dLnFDIit if 12is statistically significant.

Step V: Error Correcting Model (ECM) and Short Term Causality Test :

Error correction mechanism was first used by Sargan (1984), later adopted,
modified and popularized by Engle and Granger (1987). By definition, error
correction mechanism is a means of reconciling the short-run behavior (or value)
of an economic variable with its long-run behavior (or value). An important
theorem in this regard is the Granger Representation Theorem which

21 | P a g e
demonstrates that any set of cointegrated time series has an error correction
representation, which reflects the short-run adjustment mechanism.

Co- integration relationships just reflect the long term balanced relations between
relevant variables. In order to cover the shortage, correcting mechanism of short
term deviation from long term balance could be cited. At the same time, as the
limited number of years, the above test result may cause disputes (Christpoulos
and Tsionas, 2004). Therefore, under the circumstance of long term causalities,
short term causalities should be further tested as well. Empirical works based on
time series data assume that the underlying time series is stationary. However,
many studies have shown that majority of time series variables are non stationary
or integrated of order 1 (Engle and Granger, 1987). The time series properties of
the data at hand are therefore studied in the outset. Formal tests will be carried
out to find the time series properties of the variables. If the variables are I (1),
Engle and Granger (1987) assert that causality must exist in, at least, one
direction. The Granger causality test is then augmented with an error correction
term (ECT) and the error correcting models could be built as below:

dLnGDPit = i+ 11dLnGDPi,t-1+ 11dLnFDIi,t-1+

ECMit+it.(9)

dLnFDIit = i+12dLn FDIi,t-1 +12dLnGDPi,t-1

+ECMit+it.(10)

Where t represents year, d represents first order difference calculation, ECMit

represents the errors of long term balance which is obtained from the long run
co-integrating relationship between economic growth and foreign direct
investment. If = 0 is rejected, error correcting mechanism happens, and the
tested long term causality is reliable, otherwise, it could be unreliable. If 1=0 is
rejected, and then the short term causality is proved, otherwise the short term
causality doesnt exist.

5. ANALYSIS OF RESULT:

22 | P a g e
5.1. Ordinary Least Square Technique:

This section presents the nexus between foreign direct investment and economic
growth in terms of OLS Technique.

The lifeblood of business and commerce in the modern world is information.

The ability to gather, analyze, evaluate, present and utilize information is
therefore is a vital skill for the manager of today.
In order to accomplish this project successfully I have taken following steps.

1) DATA COLLECTION:
The analysis is done with the help Secondary data (from internet site and
journals).

2) Analysis:
Appropriate Statistical tools like correlation, regression and Time series
are used to analyze the data.

3) Diagram:
Suitable diagrams are used where necessary for better interpretation and
understanding.

4) Pictures:
Pictures tells a lot then words, keeping this in mind many tables pictures are
also used for better understanding.

23 | P a g e
 CHAPTER 3
Literature Review

The FDI-growth nexus is evidently identified by the neoclassical growth models.

The neoclassical growth model considers technological progress and labor force
as exogenous, and thus argues that FDI increases level of income only while it has
no long run growth effect if it does not expand technology. Long run growth can
only be increased through technological and population growth and if FDI
positively influences technology, then it will be growth advancing (Solow 1956).
Somwaru and Makki (2004) indicate that according to recent endogenous growth
theory, FDI can be growth advancing if it results in increasing returns in
production through spillover and technological transfers via diffusion processes.
In addition, Easterly et al. (1995) argue that technology transfer depends on the
diffusion process and that can take place through four modes: transfer of new
technologies and ideas; high technology imports; foreign technology adoption;
and level of human capital.

Findlay (1978) presents the contagion effect of managerial practices and

advanced technology introduced by foreign firms on the host countrys
technology. Yangruni Wu (1999) emphasizes the role of the learning process
through FDI in the growth of a country. In contrast, Charkovic and Levine (2002)
claim that FDI creates the crowding out effect on domestic capital and hence the
effect of FDI on growth is either insignificant or negative. In addition, other
studies reason that causality can be the other way and market seeking FDI tends
to serve the growing economies. Similarly, multinational corporations are
attracted towards growing and productive economies. Therefore, this bi-
directional behavior between FDI and GDP can create simultaneity bias between
the two variables. Further, there is the similar two-way causality discussion
between exports and GDP. The first is the export led growth hypothesis, while the
other equally appealing hypothesis is that output growth causes export growth.

Finally, there is a same bi-directional argument in the case of FDI and the export
nexus. Petri and Plummer (1998) argue that it is not clear whether FDI causes

24 | P a g e
exports or exports cause FDI. Then there are other concerns such as specified by
Gray (1998) regarding market seeking (substitute) FDI or efficiency seeking
(complement) FDI. Furthermore, Kjima (1973) analyze whether FDI is trade
oriented or anti trade oriented. Vernon (1966) explores whether FDI is at the
early product life cycle stage (substitute) or at the mature stage (complement).

The theoretical and empirical literature on the growth effects of FDI by

transnational corporations (TNCs) on host countries is enormous. Recent
researches attempt to analyze the impacts of FDI on host countrys economy and
competitiveness of firms, empirical results show that the consequence is
different. Some studies indicate that FDI can stimulate the economic growth
through spillover effect such as new technologies, capital formulation, the
expansion of international trade and the development of human capital (labor
skills and employment) (Alguaciletal., 2002; Baharumshan and Thanoon,
2006;Balasubramanyamet al., 1996, 1999; Bende-Nabende and Ford, 1998;
Borenszteinet al., 1998; Chakraborty and Basu, 2002; De Mello, 1997, 1999; Liu et
al., 2002; Wang, 2005). However, others point put that FDI can offset then
economic growth (Bende-Nabendeet al., 2003; Carkovic and Levine, 2005).
Bende-Nabendemet al. (2003) found that FDI in some countries had a negative
relation with economic growth.

Hsiao and Hsiao (2006) assert that exports increase FDI by paving the way for FDI
by gathering information of the host country that helps to reduce investors
Transaction costs. Also FDI may reduce exports by serving foreign markets
through establishment of production facilities there.

Balasubramanyamet. al. (1996) tested the hypothesis that exports promoting (EP)
FDI in countries like India confer greater benefit than FDI in other sectors. They
have used production function approach in which FDI is treated as an
independent factor input in addition to domestic capital and labour. As FDI is a
source of human capital accumulation and development of new technology for
developing countries, FDI captures such externalities as learning by watching
and/or doing and various spillover effects. Exports are also used as an additional
factor input in this production function. Once FDI enters a country, some of the

25 | P a g e
erstwhile imports become domestic products. Hence, their output becomes a part
of GDP which needs consideration as a part of output or growth effect of FDI. In
their model, real GDP depends on labour, domestic capital stock, foreign capital
stock, exports, and technical progress through time. Time is an all inclusive proxy
variable which captures the influence of all factors, including changing
technology, that are impounded under the assumption of ceteris paribus. This is
why time is defined as the parameter of functional shift. Thus, it is erroneous to
interpret the coefficient of T as representing change in technology alone.
However, it has become a customary to treat time as a representative of
technological change.

Borensztein et al. (1998) examine absorptive capacity of recipient country, which

is measured by stock of human capital required for technological progress; it
takes place through 'capital deepening' associated with new capital goods
brought into an economy by FDI. It has been found out that the fructification of
growth effect of FDI requires adequate infrastructure as a pre-requisite.

A comprehensive study by Bosworth and Collins (1999) provides evidence

concerning the effect of capital inflows on domestic investment for fifty-eight
developing countries during 197895. The authors distinguish among three types
of inflows: FDI, portfolio investment, and other financial flows (primarily bank
loans). It has been found out that an increase of a dollar in capital inflows is
associated with an increase in domestic investment of about fifty cents. This
result covers significant differences among different types of inflows. Foreign
direct investment appears to bring about close to a one-for-one increase in
domestic investment; there is virtually no discernible relationship between
portfolio inflows and investment (little or no impact), and the impact of loans falls
between those of the other two. These results hold both for the fifty-eight-
country sample and for a subset of eighteen emerging markets.

An additional striking feature of FDI flows that was noted in previous literature is
that the share of FDI in total inflows is higher in riskier countries, as measured
either by countries credit ratings for sovereign (government) debt or other
indicators of country risk. There is also some evidence that the FDI share is higher

26 | P a g e
in countries where the quality of corporate governance institutions is lower. One
explanation for this is that FDI is more likely, compared with other forms of
capital flows, to take place in countries with missing or inefficient markets. In such
settings, foreign investors will prefer to operate directly instead of relying on local
financial markets, suppliers, or legal arrangements.

According to the study done by Pradeep Agrawal (2000) on economic impact of

foreign direct investment in south Asia by undertaking time-series, cross-section
analysis of panel data from five South Asian countries; India, Pakistan,
Bangladesh, Sri Lanka and Nepal, that there exist complementarily and linkage
effects between foreign and national investment. Further he argues that, the
impact of FDI inflows on GDP growth rate is negative prior to 1980, mildly positive
for early eighties and strongly positive over the late eighties and early nineties.
Most South Asian countries followed the import substitution policies and had high
import tariffs in the 1960s and 1970s. These policies gradually changed over the
1980s, and by the early 1990s, most countries had largely abandoned the import
substitution strategy in favor of more open international trade and generally,
market oriented policies (Pradeep Agrawal, 2000). But the analysis of Brecher and
Diaz-Alejandro (1977), gives us evidence that foreign capital can lower the
economic growth by earning excessive profits in a country with severe trade
distortions such as high tariffs. Maria Carkovic and Ross Levine (2002) also
concluded in their econometric study on FDI and GDP growth that the exogenous
component of FDI does not exert a robust, independent influence on growth.

FDI inflows had a significant positive effect on the average growth rate of per
capita income for a sample of 78 developing and 23 developed countries as found
by (Blomstrm teals, 1994). However, when the sample of developing countries
was split between two groups based on level of per capita income, the effect of
FDI on growth of lower income developing countries was not statistically
significant although still with a positive sign. They argue that least developed
countries learn very little from MNEs because domestic enterprises are too far
behind in their technological levels to be either imitators or suppliers to MNEs.

27 | P a g e
Borensztein, et al.,( 1998) found that the effect of FDI on host country growth is
dependent on stock of human capital. They infer from it that flow of advanced
technology brought along by FDI can increase the growth rate only by interacting
with countrys absorptive capability. They also find FDI to be stimulating total
fixed investment more than proportionately. In other words, FDI crowds-in
domestic investment. However, the results are not robust across specifications.

A recent study by Banga (2005) demonstrates that FDI, trade and technological
progress have differential impact on wages and employment. While higher extent
of FDI in an industry leads to higher wage rate in the industry, it has no impact on
its employment. On the other hand, higher export intensity of an industry
increases employment in the industry but has no effect on its wage rate.
Technological progress is found to be labor saving but does not influence the
wage rate. Further, the results show that domestic innovation in terms of
research and development intensity has been labor utilizing in nature but import
of technology has unfavorably affected employment in India.

Rajit Kumar Sahoo(2005) has pointed out that FDI has a direct and indirect impact
and on a certain particular sectors of the economy. A study on the impact of FDI
on manufacturing sector reveals that FDI inflows in chemicals, electrical and
electronics shows direct impact and FDI inflow in drugs and pharmaceutical
sectors shows indirect impact (spillover effects). FDI is an important vehicle for
the transfer of technology and knowledge and it demonstrates that it can have a
long run effect on growth by generating increasing return in production via
positive externalities and productive spillovers. Thus, FDI can lead to a higher
growth by incorporating new inputs and techniques (Feenstra and Markusen,
1994).

Jaya Gupta (2007) made an attempt to review the change in sectoral trends in
India due to FDI Inflows since liberalization. This paper also examines the changed
policy implications on sectorial growth and economic development of India as a
whole.

28 | P a g e
Jayashree Bose (2007) in his book studied the sectorial experiences faced by India
and China in connection with FDI inflows. This book provides information on FDI
in India and China, emerging issues, globalization, foreign factors, trends and
issues in FDI inflows, FDI inflows in selected sectors. A comparative study has also
been conducted on FDI outflows from India and China. This book also revealed
the potential and opportunities in various sectors in India that would surpass FDI
inflows in India as compared to China.

Several studies have focused on theoretical positive impact of FDI on growth. But
there are only few empirical studies of this facet. Both macro and micro studies
have generally been conducted to study the relationship between FDI and
growth. Micro studies find no positive evidence to support the thesis that FDI
positively contributes to growth. Macro studies, have, however, thrown up some
evidence to show that FDI positively affects economic growth under certain
conditions. Although there are many literatures between FDI and growth, there
are also ambiguous in this issue. UNCTAD (2002) found that FDI might have
positive effect on output for some countries and negative for others, because of
different dependent variables. First, there are not enough determined proofs to
show that FDI has direct real benefits on growth (or output level), except spillover
effect. Second, FDI is a new phenomenon in social, economic and global politics,
but the empirical studies in the long-term relationship between FDI and output
are still very few.

A number of studies have analyzed the relationship between FDI inflows and
economic growth, the issue is far from settled in view of the mixed findings
reached. Most of these studies have typically adopted standard growth
accounting framework for analyzing the effect of FDI inflows on growth of
national income along with other factors of production. Existing studies do not
fully control for simultaneity bias, country-specific effects, and the routine use of
lagged dependent variables in growth regressions. Thus, the profession needs to
reassess the macroeconomic evidence with econometric procedures that
eliminate these potential biases. Although there are literatures using VAR or
VECM analysis to do Granger causality test, but most of them were lacking
economic theory or ignored important disturbance variables. Our study will strive
29 | P a g e
to highlight the nexus between FDI and economic growth in India under co
integration framework.

CURRENT SCENARIO OF FDI INFLOW IN INDIA

Since economic reforms initiated in 1991, Government of India has taken many
programs to magnetize FDI inflows, to improve the Indian economy. An important
objective of promoting FDI in India and other developing countries has been to
promote efficiency in production and increase exports. However, any increase in
equity stake of the foreign investors in existing joint ventures or purchase of a
share of equity by them in domestic firms would not automatically change the
orientation of the firm. That is, the aim of FDI investors would be to benefit from
the profit earned in the Indian market. As, a result, in such cases FDI inflows need
not be accompanied by any substantial increase in exports, whether such
investment leads to modernization of domestic capacity or not. Therefore, it is a
challenge for a developing country like India to channelize its capital inflow
through FDI into a potential source of productivity gain for domestic firms. As a
result, India has received total FDI of US$ 180,034 million from the year 1990-91
to 2009-10 which is due to the initiatives taken by the Government of India in
attracting FDI inflows in India. The FDI inflows have shown a rising trend from
1991-92 to 1997-98 owing to the sincere programmers of structural liberalization
and open-market reforms. The rise in flows of FDI till 1997 was due to not only of
the liberalization policy but also due to the sharp expansion in the global scale of
FDI outflows during the 1990s. Another causal factor may have been the recovery
of the Latin American economies, which had begun to emerge from the Debt
Crisis of the 1980s. Then after during 1998-99 and 1999-00 there was decline in
FDI inflow which was due to the decline in industrial growth rate in the economy
and also due to the result of the East Asian Financial Crisis. But again in the next
following year, foreign investment started to bounce back. During 2002-03 and
2003-04, again there was fall in flow of foreign direct investment which was due
to the cast of Global Recession on the Indian economy. The FDI Equity inflows
30 | P a g e
during the five years 2005-06 to 2009-10 showed a massive increase of more than
seven times than those of the previous years 1991-92 to 1999-00 and 2000-01 to
2004-05. This increase was due to the revised FDI Policy in March 2005, an
important element of the policy was to allow FDI up to 100% foreign equity under
the automatic route in townships, housing, built-up infrastructure and
construction-development projects. The year 2005 also witnessed the enactment
of the Special Economic Zones Act, which entailed a lot of construction and
township development that came into force in February 2006.

Statement showing FDI Inflows in India (Amount in US $ million)

ANNUAL GROWTH
YEAR FDI INFLOWS RATE(%)

31 | P a g e
 1991-92 129 33
1992-93 315 144
1993-94 586 86

1994-95 1314 124

1995-96 2144 63

1996-97 2821 31

1997-98 3557 26

1998-99 2462 -30

1999-00 2155 -12

2000-01 4029 87

2001-02 6130 52

2002-03 5035 -17

2003-04 4322 -14

2004-05 6051 40

2005-06 8961 48

2006-07 22826 155

2007-08 34835 52

2008-09 35180 1

2009-10 37182 5

Total 180034
FDI inflows show a skewed pattern in terms of their originating destinations.
Between 1991 and 2005, investment of Top 10 countries accounted for about 80
percent of total FDI. The share of top investing countries has increased to 91
percent during the period 2005-09. The major investing countries in India are

32 | P a g e
Mauritius, USA, Singapore, UK, Netherlands, Japan, Germany and others as shown
in table. According to the data relating to the period 1991-2005, Mauritius has
been the biggest source of FDI. This could be because of common cultural
patterns in both the countries and also close political and bilateral ties.Mauritius
has low rates of taxation and an agreement with India on double tax avoidance
regime. For these reasons, some MNCs set up companies in Mauritius before
investing in India.

Apart from Mauritius, the US is the second major investor in India from 1991 to
2004 contributing about 16% of total inflow. The reason could be that both
countries have close relations and US is the largest trading partner of India and a
broad Indian community lives in it. More interestingly, from the period 2005-09,
Singapore replaces US as the second major investor in India.

FDI inflows show a skewed pattern in terms of their originating destinations.

Between 1991 and 2005, investment of Top 10 countries accounted for about 80
percent of total FDI. The share of top investing countries has increased to 91
percent during the period 2005-09. The major investing countries in India are
Mauritius, USA, Singapore, UK, Netherlands, Japan, Germany and others as shown
in table. According to the data relating to the period 1991-2005, Mauritius has
been the biggest source of FDI. This could be because of common cultural
patterns in both the countries and also close political and bilateral ties. Mauritius
has low rates of taxation and an agreement with India on double tax avoidance
regime. For these reasons, some MNCs set up companies in Mauritius before
investing in India.

Apart from Mauritius, the US is the second major investor in India from 1991 to
2004 contributing about 16% of total inflow. The reason could be that both
countries have close relations and US is the largest trading partner of India and a
broad Indian community lives in it. More interestingly, from the period 2005-09,
Singapore replaces US as the second major investor in India.

Share of Top 10 Investing Countries in India (%)

33 | P a g e
 Aug.1991- 2001-
S.No. Country Dec.2000 2004 2005-2009

1 Mauritius 31.51 38.81 49.62

2 Singapore 2.76 2.22 11.33

3 USA 20.1 14.36 7.28

4 UK 5.44 7.8 5.64

5 Cyprus 0.2 0.18 4.41

6 Netherlands 5.19 9.48 3.83

7 Japan 7.41 7.32 3.22

8 Germany 5.61 4.13 2.61

9 UAE 0.08 0.66 1.75

10 France 2.59 3.22 1.24

Sub-Total 80.9 88.19 90.8

Others 19.1 11.81 9.2

Total FDI Inflows 100 100 100

CHAPTER 4
DATA INTERPRETATION

34 | P a g e
 FDI Inflows in India (Amount in US $ million)

FDI INFLOWS
1% 1% 1%
0% 1%
2%
0% 0% 1% 2% 1991-92
0% 1% 1%
1%
2% 1992-93
6% 1993-94

50% 10%
1994-95
10%

10% 1995-96

1996-97

Share of Top 10 Investing Countries in India (%)

35 | P a g e
 Aug.1991-Dec.2000
1 Mauritius
2 Singapore
11%
1%

3 USA
7% 4 UK
2% 6 Netherlands
10 Total FDI 5
Cypru 2%
Inflows
36% s 7 Japan
0% 3%
8 Germany
2% 10 9 UAE
France 0%
1%
10 Sub-Total
29%
10 Others
7%

CHAPTER 5
CONCLUSION

36 | P a g e
Conclusions Modern sector employment growth is in many developing countries
as important as it is difficult to achieve. This article examined whether FDI can
play a role in manufacturing employment growth. The analysis contributes to a
relatively scarce existing literature in several respects: by examining the causality
of FDI on employment; by looking at the effect of trade regimes; and by
examining the timing of employment effects. Foreign-owned Indonesian
manufacturing plants grew more rapidly in employment than plants that
remained in Indonesian ownership during 19752005, given the other
characteristics of the plants. The more rapid growth is confirmed by several tests
of the data, including a close examination of takeovers of locally owned plants by
foreigners and of foreign-owned plants by local owners. Employment in plants
that were foreign-owned throughout our period grew, on average, about 5.5
percentage points faster than always domestically owned plants. Plants that were
acquired by foreigners grew about 11 percentage points faster than their pre-
acquisition level, according to fixed-effect estimates. Considering that foreign
plants are on average considerably larger than domestic plants, the difference in
the number of jobs created was large. The propensity score matching consistently
confirmed the advantages of foreign ownership for employment growth. There is
also some indication that the employment growth effects of foreign ownership
are sensitive to host country trade policy, with liberalization encouraging the
expansion of Table 9. Estimated effects of foreign acquisitions on growth of
domestically owned plants (dependent variable: industry-level employment
growth rate of domestic firms in decimals) Regression1 Regression2 Regression3
Regression4 Employment growth rate of foreign takeovers (in decimals) 0.094***
(0.001) 0.094*** (0.001) 0.032*** (0.007) 0.018*** (0.006) Industry fixed effects
NNYY Year fixed effects NYNY No of observations 275 275 269 269 Adjusted R-
squared 0.9916 0.9928 0.0598 0.3605 Notes: *Significant at the 10% level;
**Significant at the 5% level; ***Significant at the 1% level. 1144 R.E. Lipsey et al.
Downloaded by [KU Leuven University Library] at 09:17 02 August 2015
employment through foreign takeover. There were indications in several tests
that there was a decline of employment growth in shifts from foreign to domestic
ownership, although that result is not statistically significant. Most of the
employment effects of foreign takeovers took place in the year of takeover. There
37 | P a g e
was relatively little effect on growth rates in the following years, but the absolute
additions to employment in the years after takeover were larger than they would
have been under continued local ownership because the base was much larger.
The negative or insignificant effect of domestic acquisition on foreign-owned
plants, as in the fixed effects estimate and the difference-in-differences estimate
from a matched sample, shows that the advantages of foreign-owned plants that
accounted for more rapid growth required continued foreign ownership. They are
apparently lost if the plant returns to domestic ownership. One possible
implication of the concentration of growth in the year of acquisition is that the
distinction between greenfield investment and acquisitions is not as sharp as is
often assumed. Many of the acquisitions apparently involve major changes in the
size and possibly other dimensions of the target firms. The results also contribute
to the recent discussion on job creation in large versus small businesses. Much of
the existing evidence shows an inverse relationship between firm size and
employment growth rates (Neumark, Wall, & Zhang, 2011), which has in some
countries led to various policy interventions in favour of small businesses.
However, our results suggest that bigger firms have higher chances of being
acquired by foreign firms, which boosts their employment growth even after
controlling for the firm size. This has important implications for developing
countries like Indonesia trying to catch up with the developed economies.
Foreign-owned firms tend to be bigger and more productive. Thus, their
expansion will help to address the issue of resource misallocation in developing
economies (Hsieh & Klenow, 2009) and improve productivity and growth.7
Indian companies are reaching overseas destinations to tap new markets and
acquire technologies. While some of the investment has gone into greenfield
projects, a major portion of Indian overseas investment went into acquiring
companies abroad. Acquisitions bring with them major benefits such as existing
customers, a foothold in the destination market and the niche technologies they
require. Due to the rapid growth in Indian companies M&A activity, Indian
companies are acquiring international firms in an effort to acquire new markets
and maintain their growth momentum, buy cutting-edge technology, develop
new product mixes, improve operating margins and efficiencies, and take

38 | P a g e
worldwide competition head on.

The role of FDI in the up gradation of technology, skills and managerial

capabilities is now well accepted. Additional investments, over and above that FDI
flows could rise moderately to US $ 1.4 trillion in 2013 and US $ 1.6 trillion in 2014
as the global economy is expected to make an uneven recovery over the coming
two years.

39 | P a g e
 BIBLIOGRAPHY

www.fdiintelligence.com
www.article.aascit.org
www.redfame.com/journal
www.wiekipedia.com

40 | P a g e
 Acknowledgement
It was really difficult for me to complete the economics research project without getting cooperation of
certain people. In other words there are so many external people who directly or indirectly help me in
my research project.

First of all, I am very grateful to our collage Prof. Dr. Rachna Kale for her able leadership and our project
report who providing their valuable time and guideline to me regarding the economics research project
report.

41 | P a g e