Fdi Research A

ABSTRACT
Title of Thesis: The ROLE OF FOREIGN DIRECT INVESTMENT
IN HUMAN CAPITAL FORMATION IN
DEVELOPING COUNTRIES: AN EMPIRICAL
ANALYSIS
Issa Kamangaza, Master of Art, May 2009
Thesis chaired by: Randal L. Reed, Ph.D.

Department of Economics
Globalization has allowed a movement of various types of capital
across countries including foreign direct investment (FDI). The Third World
has experienced massive inflows of FDI since 1990, which resulted in a
multitude of studies seeking to demonstrate the link between FDI, economic
growth, technology transfer to local firms, and human capital enhancement in
developing countries. This study focuses on the impact of FDI on human
capital formation in developing countries. It uses an empirical approach to
determine the impact of FDI on human capital accumulation in 103 developing
countries. Enrollments at primary, secondary, and tertiary school levels were
used as a proxy for human capital. The result shows that FDI affects positively
enrollments at primary and secondary school levels, which implies that FDI
enhances the level of human capital in developing countries.

THE ROLE OF FOREIGN DIRECT INVESTMENT IN HUMAN CAPITAL
FORMATION IN DEVELOPING COUNTRIES: AN EMPIRICAL ANALYSIS
by
Issa Kamangaza
A Thesis Submitted in Partial Fulfillment
of the Requirements for the Degree
Master of Arts
MORGAN STATE UNIVERSITY
May 2009
UMI Number: 1474433
All rights reserved
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ii
THE ROLE OF FOREIGN DIRECT INVESTMENT IN HUMAN CAPITAL
FORMATION IN DEVELOPING COUNTRIES: AN EMPIRICAL ANALYSIS
by
Issa Kamangaza
has been approved
May 2009
THESIS COMMITTEE APPROVAL:
_____________________, Chair
Randal L. Reed, Ph.D.
_____________________
Muhammad G. Quibria, Ph.D.
_____________________
Tekie Fessehatzion, Ph.D.
iii
Acknowledgement
I am extremely grateful to my thesis chair, Dr. Reed, for his guidance
that was constructive and instructive throughout the development and
completion of this thesis. I also thank Dr. Quibria and Dr. Tekie for their
comments that gave this study a final shape. I am grateful as well to Dr.
Todhunter whose editing work made this thesis a little easy to read. I would
like to thank also special friends whose moral and financial support made the
completion of this thesis possible.

iv
Table of Contents
List of Tables ................................................................................................... vi
List of Figures ..................................................................................................vii
List of Acronyms ............................................................................................. viii
Chapter I: Introduction ...................................................................................... 1

Research Questions ..................................................................................... 2
Methodology ................................................................................................. 3
Significance of the Study .............................................................................. 5
Organization of the Study ............................................................................. 6
Chapter II: Literature Review ............................................................................ 7

Main Forms of FDI ........................................................................................ 7
FDI, Economic Growth, and Domestic Firms ................................................ 9
Human Capital as an Incentive for FDI Inflow ............................................. 14
Human Resources Development by MNEs for Host Countries ................... 16
Chapter III: Determinants of FDI..................................................................... 18

Statistics for FDI Distribution....................................................................... 19
Vertical and Horizontal FDI Locational Choices .......................................... 22
Human Capital, Natural Resources, and Regional Integration.................... 24
Chapter IV: The Empirical Analysis of FDI Determinants ............................... 28

Data Source ................................................................................................ 30
Data Limitation ............................................................................................ 31
Regression Results Discussion .................................................................. 31
Interpretation of Graphical Representation of Regression Results ............. 37
Chapter V: Factors Influencing Human Capital Accumulation ........................ 47

Life Expectancy and Migration .................................................................... 48
Education, Training, and Learning-by-doing ............................................... 52
FDI and Human Capital Enhancement ....................................................... 54
Impacts of Remittances and FDI on Formal Educational Attainment .......... 57
Chapter VI: FDI and Human Capital Formation: an Empirical Analysis .......... 63
Data Description ......................................................................................... 64
Data Limitation ............................................................................................ 64
Econometric Models ................................................................................... 65
Regression Results Discussion .................................................................. 67
Interpretation of Graphical Representation of Regression Results ............. 72
Chapter VII: Summary and Conclusion .......................................................... 90

v
Data Appendix ................................................................................................ 95
References ..................................................................................................... 97
vi
List of Tables
Table 1: FDI Determinants .......................................................................................36
Table 2: Determinants of Human Capital ...............................................................71

vii
List of Figures
Figure 1: GDP and FDI Flow....................................................................................38
Figure 2: Trade and FDI Flow ..................................................................................39
Figure 3: Life Expectancy and FDI Flow ................................................................40
Figure 4: Tertiary Enrollment and FDI Flow...........................................................41
Figure 5: Secondary Enrollment and FDI Flow .....................................................43
Figure 6: Primary Enrollment and FDI Flow ..........................................................45
Figure 7: FDI Flow and Primary Enrollment ..........................................................73
Figure 8: FDI Flow and Secondary Enrollment .....................................................74
Figure 9: FDI Flow and Tertiary Enrollment...........................................................76
Figure 10: Remittances and Primary Enrollment ..................................................77
Figure 11: Remittances and Secondary Enrollment ............................................79
Figure 12: Remittances and Tertiary Enrollment ..................................................80
Figure 13: GNI and Primary Enrollment .................................................................81
Figure 14: GNI and Secondary Enrollment............................................................82
Figure 15: GNI and Tertiary Enrollment .................................................................83
Figure 16: Life Expectancy and Primary Enrollment ............................................84
Figure 17: Life Expectancy and Secondary Enrollment.......................................86
Figure 18: Life Expectancy and Tertiary Enrollment ............................................87

viii
List of Acronyms
AFTA: ASEAN Free Trade Agreement
CEFTA: Central European Free Trade Agreement
CIS: Commonwealth of Independent States
COMESA: Common Market for Eastern and Southern Africa
EU: European Union
ETDZ: Economic and Technological Development Zones
FDI: Foreign Direct Investment
GDP: Gross Domestic Product
GNI: Gross National Income
HRD: Human Resource Development
IPA: Investment Promotion Agency
MNE: Multinational Enterprise
M&A: Mergers and Acquisition
NAFTA: North American Free Trade Agreement
RIA: Regional Integration Agreements
UNCTAD: United Nations Conference for Trade and Development
WB: World Bank
WEBS: World Environment Business Survey
WDI: World Development Indicators
WIR: World Investment Report
WTO: World Trade Organization

1
Chapter I: Introduction
In today’s global economy, different types of capital are free to move
from one country to another, which also allows firms to go multinational
through FDI. The latter is defined as an expansion of a firm’s operations from
a country where it is based to another. A volume of research has been
conducted to determine the effects of FDI on economies of host countries.
Since FDI is considered an addition to the capital stock of a host country, most
researchers have extensively explored its impact on developing countries’
economies. The existing literature has mainly focused on the impact of FDI on
economic growth, technology transfer, local firms, and human capital
enhancement. However, the latter has received much less attention from
economists (Lensik and Morrissey 479-480).
According to the data from the World Bank, a significant amount of FDI
is directed towards developed countries. This is a movement of FDI between
developed countries. But at the same time, the developing world has
witnessed an increase in FDI since 1990. Within the developing world itself,
FDI is unevenly distributed: there are countries that host more multinational
firms than others. Statistics show that East Asian and Latin American
countries have been the locational choice for most multinational firms, with
China itself receiving more than a third of total FDI inflows to the developing
world. In light of this unequal distribution of FDI, this paper looks at and
discusses not only FDI and human capital formation but also various factors
2
that influence locational choice for multinational enterprises (MNEs) in the
developing world. In addition, since this study is measuring the impact of FDI
on human capital formation, it is also important to discuss all the factors that
influence human capital accumulation, not only FDI and human capital
formation.
The existing literature pertaining to the links between FDI and human
capital is in short supply. The studies that already exist are country-specific or
based on a set of countries that have similar characteristics economically.
Therefore, the results from these studies are useful but not general with regard
to FDI and human capital formation in the world, especially in developing
countries. Subsequently, a cross-country study appears to be important so as
to further and enlighten the results of prior works. Therefore, this thesis uses
data from a wide range of developing countries in measuring the impact of FDI
on human capital formation.
Research Questions
This thesis examines the contribution of FDI to human capital formation
in developing countries. The following is a list of questions that are thoroughly
examined and answered throughout this paper:
1. What are the key determinants of FDI?
2. What are the types and levels of human capital that attract FDI inflow?
3. What are the factors influencing the acquisition of human capital?

3
4. What role does FDI play in human capital formation in comparison with
other factors?
Hypothesis
FDI is expected to enhance the level of human capital in host countries.
This study uses school enrollments at primary, secondary, and tertiary levels
as a proxy for human capital. However, there are various factors that influence
the acquisition of human capital through education. The literature
acknowledges the importance of remittances, gross national income (GNI), life
expectancy, and FDI in human capital accumulation. Therefore, this study
gathers data for all these factors to determine their impact and effectiveness
on human capital accumulation in developing countries.
Methodology
By looking at the data from the World Investment Report (WIR) of the
United Nations Conference for Trade and Development (UNCTAD) and also
the World Bank’s World Development Indicators (WDI), there has been a
surge in FDI flows to the developing world since 1990. In light of this fact, the
analysis of the effects of FDI with regard to human capital formation in
developing countries covers a period from 1990 to 2006.

4
For questions 1 and 2, this study utilizes information on investment
climate and level of human capital1 since 1990. Findings from prior studies are
used to show various factors that influence FDI. One way to conduct this
analysis is running a regression, which allows broad conclusions while
controlling for many factors. It involves the use of independent variables such
as GDP, enrollment rates at primary, secondary and tertiary levels, credit
worthiness and openness to trade, population life expectancy, and regional
integration. In this case, FDI inflow is considered a dependent variable whose
value is determined by explanatory variables already outlined in this
paragraph. The other way is qualitative, which involves examining the
predominant activities of MNEs or the results and conclusions of previous
studies through the review of the literature. Therefore, questions 1 and 2 are
answered qualitatively and empirically.
As for the factors that contribute to human capital formation with an
emphasis on FDI (in relation to questions 3 and 4), both qualitative and
quantitative approaches are used. Prior studies are well examined and
reviewed so as to pinpoint all those factors that contribute to human capital
formation. For the quantitative approach, the dataset (used for data analysis)
is made of series such as flows of FDI to developing countries, GNI per capita,
remittances, life expectancy, countries’ regional locations, and enrollment
1
The level of human capital is measured through enrollment rates at primary, secondary, and tertiary
levels.
5
rates at primary, secondary, and tertiary levels. The dataset is then used in a
regression analysis so as to measure the weight of each variable on human
capital formation and the results are thoroughly discussed. Subsequently, the
results from regressions show clearly the contribution of FDI to human capital
formation in developing countries.
Significance of the Study
The literature on FDI, which deals with developing countries’
economies, has focused mainly on economic growth, spillover effects to
domestic firms, technology transfer, and human capital formation. However,
the latter has yet to receive more attention from economists, thus limiting the
existing literature on human capital formation by MNEs. Therefore, this study
focuses mainly on the links between FDI and human capital accumulation.
Nonetheless, a large part of the work already done in this field has directed its
attention to either a specific region of the developing world or a single country,
leaving out sets of countries that could probably lead to a different outcome of
the analysis. In addition, the majority of prior studies are either theoretical or
qualitative; thus an empirical analysis, which is embedded in this thesis,
appears to be important in order to complement and strengthen the
conclusions of prior studies. Consequently, this study gathers data from every
region of the developing world in an effort to avoid a misleading result in data
analysis.
6
Organization of the Study
The rest of this thesis is organized as follows. Chapter Two provides a
thorough literature review on FDI in a broad approach, Chapter Three
discusses the determinants of FDI while Chapter Four provides an empirical
analysis of FDI determinants, Chapter Five outlines factors influencing the
acquisition of human capital, Chapter Six deals with data analysis and results
discussion, and finally Chapter Seven provides the summary and conclusion.
7
Chapter II: Literature Review

Globalization, which refers to cross-border economic activities that take
place between individuals, firms, and governments of different countries,
resulted in various forms of economic activities including FDI. FDI occurs
when firms based in one country expand their business operations by
investing in other countries. In his theoretical work, Mencinger states that the
flow of capital across countries promotes the allocation of resources efficiently
(491). Theoretical and a part of empirical studies found that FDI promotes
growth in host countries since it is an addition to their existing stock of capital
(Lensik and Morrissey 479). Several researchers have sought to investigate
the link between economic growth and FDI in emerging and developing
countries. Others have furthered and narrowed their research to focus on
growth effects of FDI in specific countries, or regions of the Third World. Much
attention though has been devoted to developing countries since the growth
theory suggests that FDI possess the ability to lift them to the economic level
of developed nations.
Main Forms of FDI
There are two main forms of FDI: mergers and acquisition (M&A) and
greenfield investments. M&A occur when assets of local firms are transferred
to foreign firms, making the local company an affiliate of the foreign company.
Greenfield investments involve new investments by a foreign company to

8
establish facilities in a host country where output is produced and distributed
either locally, regionally, or internationally. Greenfield investments and M&A
have different effects on host developing countries. Greenfield investments are
preferred over M&A for the fact the former is expected to participate actively in
human resource development while the latter is just a change in ownership
from a host country to MNEs (Miyamoto 12-13). Similarly, Michie argues that
Greenfield investments have a positive impact on human capital development
while M&A not only hinder the development of human capital but also limit the
extent at which incoming FDI participates in human capital enhancement
(364). Most researchers indicate that the type of FDI that is present in
developing countries is mostly greenfield investments, which has triggered the
attention of economists to investigate multiple relationships that could exist
between FDI and the local economies of the developing world. Several studies
have focused on the impact of FDI on economic growth, local firms,
technology transfer, and human capital formation (Balasubramanyam, Salisu,
and Sapsford 29).

9
FDI, Economic Growth, and Domestic Firms
The majority of previous studies on FDI and economic growth
concluded that FDI contributes to economic growth of a host country. FDI is
viewed as an addition to the capital stock of a host country and has potential
to contribute to the economic growth through the transfer of knowledge and
capital, technical and managerial skills, an increase in employment, exports
promotion, and a sharp competition in the domestic market (Scott-Kaman
628). However, there are economists that have added some limitations to the
link between FDI and economic growth. According to Bhagwati, FDI enhances
growth in a country where trade policies are directed towards export promotion
and does not have similar effects in a country pursuing import-substitution
policies (36-38). Bhagwati’s hypothesis was then tested by a team of three
researchers who concluded that FDI promotes growth in export-oriented
countries and has no growth effects in countries pursuing import-substitution
policies (Balasubramnyam, Salisu, and Sapsford 31-33). This result is
consistent with Bhagwati’s argument and reinforces it. In another study by
Blomstrom, Lipsey, and Zejan, they found that higher-income countries are
likely to have their economies enhanced by FDI as opposed to lower-income
countries (527-528).
Mencinger’s empirical study, which was based on eight emerging and
European Union (EU) candidate countries including Czech Republic, Estonia,
Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia, intended to

10
assess the overall performance of their economies based on FDI flow for the
1994-2001 period (492). As massive FDI were flowing towards these
countries, Mencinger intended to show whether or not FDI promotes growth as
supported by the economic growth theory. The choice of using these countries
and the period of time for his empirical study was related to the economic
transformations that were taking place internally and the projection of which
countries among them would be able to join the EU as a result of their
economic performance. However, the study provided an unexpected result.
Mencinger found that the presence of FDI hampered their economic
performance rather than enhancing it. The negative effect of FDI on these
economies was related to two main causes, as highlighted in his article. The
dominant type of FDI in all eight countries was M&A. He discovered that MNEs
were engaged in promoting more imports than exports. The proceeds from
sales were either used for import or consumption rather than investment in
new assets; thus driving the economies of the emerging countries downhill
(Mencinger 502). Similarly, an empirical study by Lensink and Morrissey
concluded that FDI volatility has a direct negative effect on growth, especially
in developing countries (490).
However, these results cannot be considered as a benchmark, that FDI
has always negative effects on the economy of a host country. Scott-Kaman
found positive spillovers from MNEs to local firms in New Zealand’s economy,
which in turn promoted economic growth at the macro level (646). Likewise, an
11
empirical study on the Vietnamese economy found positive spillover effects of
FDI on local firms, thus enhancing Vietnamese economic performance (Thuy
29).
As far as the effects of FDI on domestic firms are concerned, the views
and works of economists diverge. Some economists have empirically showed
that FDI is a catalyst for local firms’ growth while others have found that FDI
not only destroys local firms through a tough competition, but also hampers
economic growth in general. In the small economy of New Zealand, the
increasing share of FDI in its economy has been a key factor in its domestic
industry’s development since the 1980s (Scott-Kaman 625). However, New
Zealand is considered a developed country; thus local firms are likely to
possess physical and human capacity, allowing FDI externalities to be
effective and beneficial to local firms. Likewise, Vietnam, which is one of the
developing countries, has hosted a large number of MNEs. Its neighboring
countries such as Japan, Singapore, and Taiwan have a large share of FDI
affiliates operating in Vietnam (approximately 34 percent). Other FDI in
Vietnam originated from the EU countries including England, France, the
Netherlands, and others, which contribute significantly to the increase in
capital stock of the Vietnamese economy (Thuy 10). Despite the disparity in
human and physical capital between Vietnamese firms and MNEs, Thuy
indicates empirically that spillover effects from FDI were significantly positive
12
in the late 1990s. Subsequently, local firms enjoyed an increase in productivity
as a result.
On the other hand, Mencinger’s study on transition countries finds no
positive spillovers from FDI. The type of FDI that was predominant in emerging
countries was M&A whose economic activities were primarily trade and
finance. Their input goods were provided by MNEs rather than local firms, thus
increasing imports and significantly limiting spillover effects. Therefore,
domestic firms were facing a severe competition, which in turn hampered their
performance and led to the dissolution of some of them (Mencinger 502).
The existing literature acknowledges that technology can be transferred
internationally across countries through various channels. However, Saggi
recognizes that this same literature has failed to attach importance to each of
the channels that facilitate technology transfer across countries (3). Articles
that were reviewed in this study, which deal with the issue of technology
transfer, have identified several channels contributing to such transfer.
Channels include demonstration effects, horizontal and vertical linkages, labor
turnover, and labor spin-offs. All these channels have an impact on the
performance of local firms and overall performance of local economies. In his
article reviewing the literature, Saggi focused on three of the above channels,
which are demonstration effects, vertical linkages and labor turnover (18-19),
while Miyamoto’s study has added horizontal linkages and labor spin-offs (34).
13
Demonstration effects refer to learning by imitating or observing MNEs.
Saggi states that local firms of developing countries might lack knowledge and
resources for implementing a new technology if it is not first introduced by
MNEs; thus learning-by-observing appears to be a means of technology
transfer at lower or no cost to local firms (19). Horizontal linkages occur when
domestic firms in the same industry as MNEs acquire skills through
development institutions supported by MNEs. Vertical linkages involve the
participation of local firms in providing intermediate goods to MNEs or buying
their own goods. Labor turnover refers to the movement of workers from
MNEs to local firms whereas labor spin-offs occur when MNEs employees
start a new firm by implementing the knowledge acquired while working for
these MNEs.
However, domestic firms are expected to have acquired the physical
and human capacity necessary to accommodate skill transfer. The evidence
from prior research shows that a reduction in technology disparity between
MNEs and domestic firms helps increase technology transfer. Similarly, FDI
promotes growth when domestic firms possess the capacity to absorb MNEs
technology (Miyamoto 36). Developing human capital presents direct effects
that are beneficial for both companies and the economy at large. An enhanced
human capital provides higher productivity, which leads also to higher
profitability as employees acquire adequate knowledge in performing their
tasks (Michie 365). All in all, technology diffusion through FDI results in skill
14
transfer as well, which in turn is a contribution to human capital formation
(Krause 5).
Technology transfer is not the only positive spillover from MNEs; the
latter are also believed to contribute to human capital formation of the host
country. Researchers have sought to investigate the link between FDI and
human capital formation through various channels. The literature reveals that
there are few studies that have focused on human capital formation by MNEs.
A big portion of the existing literature has treated this issue on a regional level
or specific countries. Studies combining data from countries of each region of
the developing world have yet to be conducted. Therefore, this study uses
data from all developing regions in measuring the impact of FDI on human
capital formation.
Human Capital as an Incentive for FDI Inflow
In his article focusing mainly on FDI and human capital formation,
Miyamoto introduces the concept of the “Virtuous Circle” of inward FDI where
human capital plays a central role (39). His work seeks to demonstrate the role
of human capital in attracting and benefiting from FDI along with the ability of
using the upgraded human capital to attract not only FDI but also value-added
MNEs. From his perspective, we can clearly see that human capital has three
main functions with regard to FDI: attracting FDI, absorbing knowledge from
15
FDI through various channels, and using the high-skilled workforce to retain
and attract additional inflow of FDI.
Empirical and theoretical evidence suggest that human capital matters
in attracting FDI. Miyamoto’s study also seeks to investigate the role of human
capital in attracting FDI and the type or level of human capital that is the most
important determinant of FDI. Before reaching the conclusion on the
effectiveness of human capital in attracting FDI, there exist other conditions
that need to be fulfilled for any type of FDI inflow. These conditions include but
are not limited to political stability, population’s health, and reduction in
corruption and crime in a host country (Jun and Singh 4-6). These factors in
conjunction with a skilled workforce constitute what is called “Investment
Climate” that is crucial in determining inward FDI.
The evidence that human capital is an important determinant of FDI
was not enough for Miyamoto to draw any conclusion. He had to also look at
two empirical studies using separate sets of data for two different periods of
time. The first empirical analysis used data for the 1960-1980 period while the
second analysis utilized data covering the 1980s to mid-1990s period. The two
empirical analyses had different results. The first study found that human
capital was not a determinant of FDI. This result is consistent with Ritchie’s
study where the flow of FDI to developing countries from 1960 to 1980 was
mainly motivated by the presence of natural resources and cheap labor for the
manufacturing sector; thus making human capital unimportant for that period
16
of time (11-12). On the other hand, the second empirical work used data from
1980 to the mid 1990s period. The result shows that there exists a relationship
between human capital and FDI. The latter was in quest of efficiency and not
necessarily cheap labor or natural resources, thus a skilled workforce appears
to be among the determinants of FDI flow (Miyamoto 23).
Furthermore, Miyamoto states that the minimum level of education that
is needed to attract FDI is secondary education (24). This is consistent with
the empirical study that found that human capital with at least secondary
education exerts a positive influence on FDI flow (Checchi, Simone, and Faini
15). The authors indicate that post secondary education or precisely tertiary
education is required to attract value-added MNEs. In his case study of
Thailand, Michie points out that the level of education serves as an indicator
for the type of inward FDI (5).
Human Resources Development by MNEs for Host Countries
MNEs contribute to human capital formation via provision of training,
financial support to educational institutions, and transfer of various skills
needed to perform specific functions (Kaptein 12). A survey conducted by the
World Environment Business Survey (WEBS) shows that MNEs provide more
training than domestic firms of developing countries. Lack of resources,
knowledge shortage, and the possibility of labor turnover were found to be key
reasons hampering training within local firms in East Asia and Latin America.
17
Unlike these domestic firms, MNEs appear to be providing thorough training to
their employees. Access to foreign capital, information and technology, and
the ability to provide incentives to their employees are the main reasons
explaining the advantages MNEs possess over local firms in offering training
(Miyamoto 31).
Nevertheless, despite the gap in training between local firms and
MNEs, Miyamoto acknowledges MNEs’ participation in formal education in
countries where they have facilities. He provides the example of Intel
Corporation and Toyota. The former has been heavily involved in formal
education through curriculum design, provision of educational equipments to
universities, infrastructure and technical support. Likewise Toyota, in
collaboration with ASTRA Foundation (Toyota-Astra Foundation), has been a
big supporter of Human Resource Development (HRD) via education, training,
and Research and Development (R&D) programs by means of scholarships,
provision of educational materials to educational institutions, and research
grants to universities and research institutions. The author argues that MNEs
support formal education with the expectation of hiring graduates from these
institutions. Even when MNEs fail to hire them directly, Miyamoto argues that
these graduates might end up working for these MNEs through vertical or
horizontal linkages (33).

18
Chapter III: Determinants of FDI
Globalization, which allows business transactions to take place
between different countries, has also influenced firms to invest in other
countries under various conditions and incentives. However, FDI is unevenly
distributed across countries. Data from the World Bank shows that FDI flow to
developing countries is mostly directed to South-East Asian and Latin
American countries with a small fraction allocated to African nations. Even in
these two regions of the world (South-East Asia and Latin America), some
countries still receive much more FDI than others. However, the biggest share
of FDI is between advanced countries. In light of this evidence, this chapter
looks at the causes that contribute to this unequal distribution of FDI especially
in developing countries where FDI is considered a catalyst for economic
growth.
There is a vast literature that has examined the incentives for FDI in
developing countries. Shatz and Venables distinguish two main reasons why a
firm would choose to invest in other countries: the first reason is to serve the
local market while the second is the quest for lower cost inputs (5). Other
researchers have shown multiple other reasons why a firm would go
multinational. They acknowledge the importance of transport cost,
infrastructure, regional integration, human and natural resources, openness to
international trade, information services, level of industrialization, political
stability, and transparent policies towards FDI flow. These factors constitute a
19
country’s investment climate. This chapter discusses in depth these factors
and how they relate to MNEs locational choices.
Statistics for FDI Distribution
The distribution of FDI is very well illustrated in the UNCTAD database
for FDI inflows. The overall flow of FDI reached a record high in 2000, which
amounted to $1.4 trillion. These levels of FDI flow decreased over time but
were about $1.2 trillion in 2006, nearly reaching the record level of 2000. It
was a 34.3 percent increase from 2005 where total FDI flows were about
$916.3 billion. Developed countries account for a larger fraction of global FDI
flows. In 2006, developed nations received approximately 65 percent of total
FDI, while the share for the developing world was about 30 percent of overall
FDI flow. During the same year, Africa received 3 percent of total global FDI
and 10 percent of FDI flow to developing countries. Within developing and
transition economies, more than half of FDI goes to countries including
Argentina, Brazil, Chile, China, Hungary, Indonesia, Malaysia, Mexico, Poland,
and Singapore. However, China has been a locational choice for the majority
of MNEs in the developing and emerging world. In 2006, China accounted for
5 percent of global FDI flow and 19 percent of FDI flow to developing and
emerging countries. It is also worth noting that China and India not only do
they receive a significant amount of inward FDI, they also have outward FDI to
developed and developing countries.

20
China’s outward foreign direct investment (OFDI) is very well discussed
in the recent Organization for Economic Cooperation and Development
(OECD) investment report. Since the initiation of an open economy in 1979,
China has experienced massive inflows of FDI in various sectors. This trend
contributed to an increase in its capital stock, which gave rise to Chinese
OFDI. An increase in China’s OFDI became remarkable in 2000 when China
introduced a “go global strategy” targeting and supporting OFDI. Its OFDI
stock was about $1 billion in 2000. In 2006, the level of Chinese OFDI reached
a record high of $19.5 billion, which was a 19 fold increase from 2000. China
OFDI comprises mainly of state-owned enterprises and more than half of them
are directed towards the natural resources sector. In 2006, Africa became a
big recipient of Chinese OFDI primarily in the natural resources and
manufacturing sectors. In the 2003-2006 period, Africa witnessed a seven-fold
increase in Chinese OFDI. The motivation for these investments is grounded
in the presence of natural resources in Africa and also the quest for the market
in the manufacturing and construction sectors. Thus, a big fraction of Chinese
OFDI is directed towards resource-rich countries, including Algeria, Nigeria,
South Africa, Sudan, and Zambia. Despite the massive OFDI flow to Africa,
the latter still accounts for only 1 percent of Chinese OFDI compared to other
parts of the world such as Europe and North America (Coppel and Duffin 2-3).
Likewise, the rise of Indian OFDI is similar to that of Chinese’s. India is
a locational choice for a number of MNEs, especially in the IT (Information

21
Technology) field. India has been investing in various countries for a long time,
but its investments abroad were noticeable in the late 1990s as a result of its
advances in IT and manufacturing sectors. Indian OFDI stock was about $500
million in 2000 and reached its record high in 2004 where its level of OFDI
stock was approximately $2.5 billion (Milelli 2-3). The liberalization and
relaxation of the government policies have played a role in the expansion of
Indian OFDI. Currently, the most important places for Indian OFDI are the
United States, which accounts for 19 percent of overall Indian OFDI, and the
Russian Federation with 18 percent. In general, developing countries have
received more than two thirds of total Indian OFD (Miroux 2).
There exist four main factors that motivated Indian firms to invest
abroad. The first reason is the growing number of small size firms at home that
compete in providing IT services to outsourced businesses for foreign clients.
This competition has caused some Indian firms to move their production
abroad close to their clients for better opportunities. The second factor is the
quest for the market. There is a number of manufacturing and service firms
that have either expanded their production abroad or acquired foreign firms
through M&A agreements in various countries, including Australia, France,
South Korea, and the United Kingdom. The third factor is to get access to
technology and knowledge. For instance, in 2003, WIPRO (an Indian firm)
bought Nerve Wire Inc (a US firm) so as to get a broad understanding of the
way it operates and access to the market at the same time. The fourth factor is
22
getting access to natural resources. For example, in 2003, Hindalco (an Indian
firm) purchased two copper mines and an Oil and Natural Gas company in
Australia. It also acquired a 25 percent share in a Sudanese oil field controlled
by Talisman Energy, a Canadian company (Miroux 7-8).
Vertical and Horizontal FDI Locational Choices
The type of FDI that is intended to serve the local market is called
horizontal FDI. To this end, a firm faces costs of establishing itself in a foreign
country. These costs include, but are not limited to, dealing with the local
administration, tax systems, rules and regulations, and of course the cost of
establishing new facilities or plants in a host country. Despite the costs
incurred during this process, this type of FDI will benefit from proximity to the
local market, which in turn makes it responsive to local demand. Transport
costs as well as tariffs are reduced since the production is intended for the
local market. The size of the market in conjunction with GDP per capita plays
a key role in influencing horizontal FDI (Shatz and Venables 5-8). Likewise, a
study by Janicki and Wunnava finds the market size to be significantly
correlated to FDI flow (508).
The other type of FDI is called vertical FDI. It occurs when a firm
decides to relocate part of its production to a low-cost labor location. The
goods produced are mostly intermediate goods that are needed for the
production of final goods. Low-cost labor and resources are targeted during
23
the production process. The market size is not taken into account since the
entire output is intended for export. However, the multinational firm faces
transport cost since the output has to be shipped back to the firm’s
headquarters or other locations for the production of final goods (Shatz and
Venables 5-8). In this case, the quality and reliability of the transportation
infrastructure plays a crucial role. For instance, when China opened its
economy for foreign investment in the early 1980s, it designated some of its
coastal cities as Economic and Technological Development Zones (ETDZs) to
encourage FDI, especially vertical FDI. The idea behind the creation of these
zones was to reduce transportation cost during the shipment of goods to the
coast so as to encourage FDI inflow. Subsequently, there was a surge in FDI
and China is now among leading countries in hosting the vast majority of
MNEs (Zhuang 73-76). In the empirical model of Deichmann, he argues that
foreign investment is dependent on labor cost in the host country. Countries
with high unemployment rates are attractive to FDI since high demand for
employment will lead to lower wages (146-147). In addition, the empirical work
of Janicki and Wunnava finds a strong correlation between FDI and labor cost
where a change in wages between source and host economies results in
change of FDI inflow (508).

24
Human Capital, Natural Resources, and Regional Integration
The level of human capital has been discussed in various studies as an
essential factor contributing to attracting FDI. The role of human capital in
attracting FDI is well documented in Miyamoto’s paper, which is mainly a
review of the literature. He argues that secondary education is the minimum
level that a country needs to attract FDI influx. However, since many MNEs
are nowadays efficiency-oriented, the level of human capital needs to be
upgraded beyond the minimum level (secondary education) in order to
maximize the gains from FDI. Therefore, countries that are seeking to attract
value-added MNEs should have their human capital beyond the minimum level
(Miyamoto 22-24). The empirical work of Lewis uses multiple variables
explaining locational choice of MNEs. Among these variables, the level of
human capital acquired through formal education appears to be the most
influential when it comes to attracting FDI. However, in his statistical analysis,
he found that a country with a large number of technicians has a comparative
advantage in attracting value-added MNEs relative to a country with a limited
number of technicians. The author suggests the incorporation of technical
concentration in the education system in order to produce a labor force that
meets various demands of MNEs especially in the technical field (Lewis 104-
106).
Furthermore, similar results were reached by Eicher and Kalaitzidakis in
their theoretical model where human capital is an important factor for a country
25
to attract FDI (12). Host countries need to have a human capital with various
skills allowing the accommodation of MNEs at various levels. Thus,
technological and managerial skills need to be present in a country’s human
capital. The idea behind locational choice for MNEs in a country with a high-
skilled human capital is to minimize training cost since an unskilled labor force
will pose a high-cost training burden (Eicher and Kalaitzidakis 14-21).
Moreover, the empirical work by Noorbakhsh et al. shows the importance of
human capital for attracting FDI. They urge governments to implement policies
that sharpen the level of human capital in an effort to attract not only a huge
number of MNEs but also high-quality MNEs (1602-1606). Similar remarks
were made by Saggi where he put an emphasis on human capital and R&D to
allow FDI spillovers to occur (39).
Several studies have mentioned the importance of natural resources as
a means of attracting FDI. However, firms that are seeking natural resources
solely invest less or not at all in training since the exploitation of natural
resources does not require a high-skilled labor force. Therefore, FDI that is
seeking natural resources is neither attracted by the presence of skilled
human resources nor intending to enhance the level of human capital of the
host country. In their empirical work, Checchi, Simone, and Faini discover that
there is a negative correlation between FDI and school enrollment in African
and Asian poorest countries (7-8). This result is consistent with the
26
conventional wisdom that the presence of MNEs in these regions targets the
exploitation of natural resources and not necessarily a skilled labor force.
Regional integration is another contributor to attracting FDI. The
importance of regional integration relative to FDI has been a topic of interest to
various researchers. Countries, especially those that are located in the same
region, enter into regional integration agreements (RIAs) for facilitating
economic activities throughout the region. There are significant numbers of
regional agreements that were signed between different countries including:
the North American Free Trade Agreement (NAFTA) between the USA,
Canada, and Mexico; the European Union (EU) which is a single market for all
member countries; ASEAN Free Trade Area (AFTA) for Southeast Asian
countries; Central European Free Trade Agreement (CEFTA); Common
Market for Eastern and Southern Africa (COMESA), and many more. These
agreements are expected to benefit the signatories economically whether they
are made between developing countries, developed nations, or between
developing and developed countries. Subsequently, we will look closely at how
regional integration affects FDI influx in the developing world.
The benefits of RIAs are well documented in the empirical work of
Yeyati, Stein, and Daude. The effects on FDI flow differ depending on whether
it takes place between members of the same RIA or from a source country
outside the RIA. In the case of FDI between members of the same RIA, the
formation of the RIA targets the reduction or elimination of trade barriers. The
27
authors argue that horizontal FDI would be discouraged since goods produced
from any member country can move freely throughout the integrated region.
However, in a vertical FDI, firms seek to produce in a labor-abundant country
at low cost. The existence of tariffs and trade barriers increase transaction
costs in a vertically integrated FDI. When trade barriers are reduced or
eliminated completely in the RIA, vertical FDI is thus encouraged, which in turn
contributes to the surge of vertical FDI flow in the integrated region.
On the other hand, the effects of FDI from a source country outside the
RIA are quite different from the FDI impact within the RIA. In this case, the RIA
creates a favorable environment for both horizontal and vertical FDI. The
formation of the RIA results in the expansion of the market size, which is
favorable to horizontal FDI. Vertical FDI, which targets low-cost labor, enjoys a
reduction in transportation costs since barriers to trade are eliminated within
the integrated region. Subsequently, there might be losers and winners in the
RIA. A multinational firm that might have horizontal FDI in all countries of the
RIA may choose to concentrate all its production in one country and supply the
others through trade. As a result, only one country of the integrated region
captures most of the benefits from vertical FDI. In this event, the authors argue
that this environment may create a need for other regionally integrated
countries to introduce policies towards tax reduction, improve the quality of its
labor, and create hospitable rules of law so as to be able to host a significant
amount of vertical FDI (Yeyati, Stein, and Daude 7-11).

28
Chapter IV: The Empirical Analysis of FDI Determinants
Chapter Three discussed various factors that contribute to attracting
FDI. The literature used in that chapter acknowledges the importance of
market size, population’s wealth, international trade, life expectancy, and level
of human capital in influencing FDI flow. All these factors are key variables
that are used in the data analysis. The effectiveness of each factor is
estimated in the following equation:
ln(FDI)it = β0 +β1 ln(P)it +β2 ln(G)it+β3 ln(TR)it+β4 ln(L)it+β5 ln(PM)it+β6 ln(S)it+β7 ln(T)it +
β8 ln(Psq)it+β9 ln(Gsq)it+β10 ln(TRsq)it+β11 ln(Lsq)it+β12 ln(PMsq)it+β13 ln(Ssq)it+β14 ln(Tsq)it+
β15 ln(PG)it+β16 ln(PTR)it+β17 ln(PL)it+β18 ln(PPM)it+β19 ln(PS)it+β20 ln(PT)it+
β21 ln(GTR)it+β22 ln(GL)it +β23 ln(GPM)it+β24 ln(GS)it+β25 ln(GT)it +
β26 ln(TRL)it + β27 ln(TRPM)it+β28 ln(TRS)it + β29 ln(TRT)it +
β30 ln(LPM)it+β31 ln(LS)it+β32 ln(LT)it +
β33 ln(PMS)it+β34 ln(PMT)it+β35 ln(ST)it +
β36 RGit+ β37 RLit + β38 TMit + εit
where,
• FDIit is the dependent variable and captures the amount of FDI
influx to country i at time t
• Git and Pit measure respectively the population’s wealth per capita
and market size for a given country
• TRit is a variable that measures a country’s openness to trade
• Lit is a control variable for life expectancy

29
• PMit, Sit, and Tit represent the level of human capital through
enrollment rates at primary, secondary, and tertiary school levels
• Psqit, Gsqit, TRsqit, Lsqit, PMsqit, Ssqit, and Tsqit represent squared
terms of the original variables
• PGit, PTRit, PLit, PPMit, PSit, and PTit are cross terms that capture
the impact of Population on FDI when associated with GDP, trade,
life expectancy, primary, secondary, and tertiary school enrollments
• GTRit, GLit, GPMit, GSit, GTit are cross terms that measure the
impact of GDP when combined with trade, life expectancy, primary,
secondary, and tertiary school enrollments
• TRLit, TPMit, TRSit, and TRTit measure the impact of trade when
associated with life expectancy, primary, secondary, and tertiary
school enrollments
• LPMit, LSit, LTit capture the impact of life expectancy when coupled
with primary, secondary, and tertiary school enrollments
• PMSit and PMTit measure the effect of primary school enrollment
when associated with secondary and tertiary school enrollments,
and STit measures the impact of secondary school enrollment when
combined with tertiary school enrollment
• RGit, RLit, and TMit are respectively dummy variables for regional
integration, regional location of countries, and time
• and εit is the error term.

30
Data Source
The data used for this regression analysis is mainly from the World
Bank’s World Development Indicators (WDI) database available online. It is a
panel data that covers 103 countries of the developing world for a period of 17
years (1990-2006). The dataset comprises series such as FDI per capita,
regions, GDP per capita, population, trade, life expectancy, school enrollment
(primary, secondary, and tertiary), and regional integration. Some of the data
related to primary school enrollment exceeded slightly 100 percent. This was
due to the fact that a significant number of countries have achieved a full
enrollment at primary school level in addition to the students repeating grades.
The data pertaining to FDI and the information on countries’ regions were
obtained from UNCTAD database on FDI flow. The information on regional
integration agreements (RIAs) was available on the World Trade Organization
(WTO) website. The initial dataset comprised 160 developing countries but the
final version had only 103 countries. The 57 countries that were dropped from
the dataset had series with missing values for more than half of the sample
period (see data appendix for details).The sample period was from 1990 to
2006. This was done in order to have a significant amount of observations and
to avoid misleading results in data analysis. Values under life expectancy were
interpolated to increase the efficiency of the model (see data appendix for
details)
31
Data Limitation
The literature outlined several factors that contribute to attracting FDI.
These factors are variables used in data analysis. Data was not available for
all the variables, which did not affect the overall result of the analysis.
Variables pertaining to natural resources, level of industrialization, transparent
policies towards FDI, and political stability were not included in the model (see
data appendix for more details).
Regression Results Discussion
The results of the regression are shown in Table 1. The model is in log
form. Overall, the model performed well even though some variables had
unexpected signs. All variables, except dummy variables, were expected to
bear a positive sign, which would be consistent with theory and prior work on
determinants of FDI flow. However, the model included not only first order but
also second order variables and cross terms in order to determine their full
impact on FDI flow (see data appendix for more details). Variables were
demeaned (values used for the regression were variables’ deviation from the
overall sample mean), which makes the first order coefficients the elasticity at
the sample mean. A detailed discussion of statistically significant variables of
the regression results is presented below.
The model is estimated using 103 developing countries with 1112
observations. The coefficient on GDP per capita is positive, which indicates

32
that it has a positive effect on FDI flow. The elasticity for the GDP per capita is
about 1.01, which means that a 1 percent increase in GDP per capita is
associated with a 1.01 percent increase in FDI flow at the sample mean. GDP
per capita was used in the model as a measure of a country’s wealth.
Therefore, this result tells us that the country’s wealth matters in attracting
FDI, which is consistent with theory and prior works in determinants of FDI
flow. In addition, the second order parameter for GDP per capita is negative,
which suggests that GDP per capita has a diminishing return effect on FDI
flow. This result indicates that an increase in GDP per capita is coupled with
an increase in FDI flow; but countries with a higher GDP per capita are likely
to experience an increase in the levels of FDI flow at a decreasing rate. On the
other hand, the first order coefficient for population is positive but not
significant. Its second order parameter is very significant and positive, which
implies that population has a positive impact on FDI flow. Since this
relationship is based on the second order coefficient, it is an indication that
countries with a large population are likely to receive more FDI than countries
with a small or average population size. Thus, the market size (measured by
population size) plays a role in attracting FDI flow.
The result on trade shows that it has a strong positive correlation with
FDI flow. A 1 percent increase in a country’s participation to trade brings about
0.75 percent increase in the flow of FDI. Likewise, primary school enrollment
affects FDI flow positively. The elasticity for primary school enrollment is 1.09,
33
suggesting that a 1 percent increase in primary school enrollment brings about
1.09 percent increase in FDI flow. The first order coefficient for secondary
school enrollment is positive but not significant. The impact of secondary
school enrollment is reflected in its second order coefficient that is positive and
significant, which implies that a higher secondary school enrollment is
associated with an increase in FDI flow. This result is consistent with
Miyamoto’s arguments where he states that the minimum level of education
needed to attract FDI is secondary schooling (23). Kapstein added that MNEs
prefer workers with basic or secondary education that can easily be trained to
respond to various tasks within a firm (17).
However, life expectancy is negatively correlated to FDI flow, which is
an unexpected result. The regression result indicates that a 1 percent increase
in life expectancy is associated with a 2.5 percent decrease in FDI flow.
Nevertheless, when life expectancy is combined with primary school
enrollment, both variables have a strong positive effect on FDI flow. The result
indicates that when life expectancy and primary school enrollment are both
high, they have a strong influence on the flow of FDI. But the outcome is
different when life expectancy is combined with tertiary school enrollment. The
pair of life expectancy and tertiary school enrollment is coupled with lower
levels of FDI flow. Tertiary school enrollment itself has a negative impact on
FDI flow as well, which suggests that tertiary school enrollment is associated
with lower levels of FDI flow. The result shows that a 1 percent increase in
34
tertiary school enrollment brings about a 4.7 percent decrease in FDI flow.
Even when tertiary school enrollment is combined with secondary school
enrollment, the result still shows that a pair of secondary and tertiary school
enrollment is associated with lower levels of FDI flow. This is an indication that
there exists a limited number of MNEs in developing countries that employ
high skilled workers with tertiary education. This result is consistent with the
empirical work of Chechi, Simone, and Faini where school enrollment was
negatively correlated with FDI flow in African and Asian poorest countries.
MNEs were targeting the exploitation of natural resources and not necessarily
a skilled labor force (7-8). It is also consistent with Narula’s study where
tertiary education per capita was not a significant explanatory variable for FDI
inflows in 22 developing countries (83-86).
As far as regions are concerned in attracting FDI flow, the regression
result shows the following: countries belonging to regions such as the
European Union, CIS, and South America have higher FDI flows than
countries that are part of West Asia, South Asia, Oceania, and Sub Sahara
Africa. The result on other regions such as South East Asia, South East
Europe, Central America, North Africa, and the Caribbean showed them to be
the average regions as far as FDI inflows. Finally, the coefficients of time are
strongly significant from 1990 to 1996, showing lower levels of FDI flows
during that period of time. However, we can see a gradual increase of FDI
flows from 1990 to 2006 with an exception of the year 2002 when FDI flows
35
were lower. The year 2002 is the period of time that came immediately after
the September 11, 2001 terrorist attack that caused the collapse of the World
Trade Center in New York City, which in turn resulted in a global economic
distress. Subsequently, the latter appears to have affected negatively overall
flows of FDI to developing countries as indicated by the result of the data
analysis.
36
Table 1: FDI Determinants
Dependent Variable: fdidev

Number of Observations: 1112
F value : 52.32
2
Adjusted R : 0.74
Sample Period: 1990 – 2006
Variables Estimates Variables Estimates
Intercept 0.68418** ln(LS) 1.29419
Ln(P) 0.09942 ln(LT) -1.31504*
Ln(G) 1.01061*** ln(PMS) -1.9889***
ln(TR) 0.74851*** ln(PMT) 0.59514
Ln(L) -2.52987** ln(ST) -0.51536*
ln(PM) 1.08701* wasia -0.50117**
Ln(S) 0.10449 sasia -1.64715***
Ln(T) -0.46913*** seasia -0.19309
(RG) -0.74806*** ue 0.59785***
ln(Psq) 0.05173*** seeur 0.27221
ln(Gsq) -0.10735** CIS 0.63777**
ln(TRsq) -0.11287 samer 0.39952*
ln(Lsq) -1.34806 camer -0.09167
ln(PMsq) -0.57562 oceania -0.94483**
ln(Ssq) 0.91051** nafrica -0.3223
ln(Tsq) -0.02452 subsah -1.46377***
ln(PG) -0.00848 Y90 -1.1419***
ln (PTR) 0.02736 Y91 -1.0293***
ln(PL) -0.05992 Y92 -1.02029***
ln(PPM) -0.02715 Y93 -0.83733***
ln(PS) 0.23845** Y94 -0.71646***
ln(PT) -0.12765*** Y95 -0.6956***
ln(GTR) 0.21709** Y96 -0.48937***
ln(GL) 0.28828 Y97 0.00489
ln(GPM) 0.1366 Y98 0.18398
ln(GS) -0.3472 Y00 0.19772
ln(GT) 0.32813*** Y01 0.08372
ln(TRL) -0.76394 Y02 -0.08629
ln(TRPM) 0.79737* Y03 0.12584
ln(TRS) 0.64339* Y04 0.17164
ln(TRT) -0.92326*** Y05 0.34288*
ln(LPM) 8.92945*** Y06 0.60582***
Notes: the symbols, ***, **, and * indicate statistical significance at the
1%, 5%, and 10% level, respectively.
37
Interpretation of Graphical Representation of Regression Results
Regression results have provided parameters that can be used in
estimating the effectiveness of each variable in attracting FDI flow to a
country. Statistics on FDI flow to developing and emerging countries show that
more than half of FDI goes to ten countries. Eight from the ten countries were
chosen for graphical representation. The effectiveness and impact of each
variable on FDI flow were then calculated for the eight countries that are part
of the developing or emerging world. The impact of each variable on FDI flow
was measured by keeping all other variables constant at the mean so as to
determine where each variable stands among others. The result was reflected
into a graphical representation for easy visualization as shown on Figure 1
through Figure 6.
38
Figure 1: GDP and FDI Flow
Argentina Brazil China

India Indonesia Malaysia
Mexico South Africa
120
FDI per Capita (in US$)
100
80
60
40
20
GDP per Capita (in US$)
The curves on Figure 1 are upward sloping for all countries that were used for
the analysis. This result shows that GDP per capita impacts positively FDI flow
in those countries, which suggests that an increase in GDP per capita brings
about higher levels of FDI flow. GDP per capita was used as a proxy for
population’s wealth. GDP is an indicator of a country’s ability to produce. As
illustrated on Figure 1, GDP is an important factor that contributes to attracting
FDI flow. However the importance of GDP per capita vis-à-vis FDI inflow
differs from a country to another. China is on top of the list with a GDP per
capita that is strongly correlated with FDI flow. The literature acknowledges
39
that China is among leading countries in hosting the vast majority of MNEs.
This fact is also reflected on figure 1, which shows the relationship between
GDP and FDI flow. Overall, Figure 1 shows that countries with higher GDP per
capita are likely to attract a significant amount of FDI flow.
Figure 2: Trade and FDI Flow

Mexico South Africa
300
250
200
150
100
50
Trade
Trade has a positive impact on FDI flow among all countries, which
translates into the increase in FDI flow as countries are involved in trade.
Similar to the GDP per capita, the impact of Trade differs from a country to
another. China, Brazil, South Africa, and Mexico are shown on Figure 2 as
countries whose participation in international trade is strongly correlated with

40
the flow of FDI. Similar to figure 1, China is shown of figure 2 as a country
whose participation in trade is strongly correlated with FDI flow. It is also an
indication that the majority of MNEs tend to invest in countries with a
significant amount of existing FDI.
Figure 3: Life Expectancy and FDI Flow

Mexico South Africa
50
45
40
35
30
25
20
15
10
5
0
40 45 50 55 60 65 70 75 80
Life Expectancy (in years)
Figure 3 shows both positive and negative relationship between life
expectancy and FDI flow. Life expectancy is positively correlated to FDI flow in
countries such as Brazil, South Africa, and China, but overtime, FDI flow
increases at a decreasing rate with respect to an increase in life expectancy.
China is again shown on figure 3 as a country with high levels of FDI flow
41
resulting from an increase in its life expectancy. The remaining five other
countries are negatively correlated to FDI as a result of an increase in life
expectancy. The convexity of the curves indicates that the relationship
between life expectancy and FDI flow is stronger at lower life expectancy.
Figure 4: Tertiary Enrollment and FDI Flow

Mexico South Africa
350
300
250
200
150
100
50
0
10 15 20 25 30 35 40 45 50 55 60 65 70 75 80
Tertiary Enrollment (in %)
Figure 4 shows that tertiary enrollment has a negative impact on FDI
flow in the majority of countries used for the graphical representation. This is
an indication that an increase in tertiary enrollment is associated with a
decrease in FDI flow in developing and emerging countries. This result was
42
not expected because the literature acknowledges the importance of human
capital in attracting FDI flow. At the same time, it is a sign that MNEs operating
in developing countries are directed towards the manufacturing sector where
post secondary education is not so important. However, Argentina and Brazil
are the only countries on the graph whose tertiary enrollment brings about
increases in FDI flow. The rest of the countries have tertiary enrollments that
are negatively correlated to FDI flow. It is also worth noting that FDI flow
decrease at a small rate as tertiary enrollment gets bigger. Overall, Figure 4
presents two different outcomes: tertiary education presents a positive impact
on FDI flow in a limited number of countries while it has a negative impact on
FDI flow for the majority of developing countries. Thus, tertiary education
generates either higher levels or lower levels of FDI flow to developing
countries. It is worth noting that the data on FDI flow used in the regression
analysis was general; the model did not control for the distribution of FDI in
various sectors (extracting, manufacturing, and service sectors) in developing
countries.
43
Figure 5: Secondary Enrollment and FDI Flow

Mexico South Africa
60
50
40
30
20
10
Secondary Enrollment (in %)
Contrary to tertiary enrollment, secondary enrollment shows a positive
impact on FDI Flow. All curves of Figure 5 are upward sloping, which
translates into an increase in FDI flow as secondary enrollment goes up in all
countries. However, the impact of secondary enrollment on FDI flow is not the
same among countries. Indonesia, Malaysia, South Africa, and Mexico are the
top four countries whose secondary enrollment is strongly correlated to FDI
flow. Overall, Figure 5 tells us that secondary enrollment is important in
attracting FDI flow. This is an indication that the majority of MNEs operating in
developing countries seek human capital with secondary education. As
mentioned in the literature and Chapter Three, the minimum level of human
44
capital needed to attract FDI flow is secondary education. It appears that this
minimum level of human capital is the one targeted by the majority of MNEs.
Notice also that China and India are on the bottom of the list, which is an
indication that secondary education has a small positive impact on FDI flow in
those countries. China and India have been the locational choice for the
majority of MNEs, especially in the service sector. Thus, secondary education
is not the most important determinant of FDI flow. It is instead tertiary
education that is mainly targeted in the service sector.

45
Figure 6: Primary Enrollment and FDI Flow

Mexico South Africa
60
50
40
30
20
10
Primary Enrollment (in %)
Figure 6 shows a positive correlation between primary enrollment and
FDI flow in the majority of the countries studied. All curves are upward sloping,
which suggests that an increase in primary enrollment brings about high flows
of FDI. The levels of FDI are not the same among countries; China, Mexico,
Malaysia, and South Africa have higher levels of FDI flow as a result of an
increase in primary enrollment. However, since the minimum level of human
capital needed to attract FDI is secondary education, the impact of primary
education on FDI flow is minimal. The dataset used for this data analysis
shows that developing countries have achieved full enrollments at primary

46
level. This is an indication that governments of these countries have
established programs that encourage primary enrollment for all children, which
resulted in overwhelming enrollment rates at primary level.
Figures 1 through 6 were created to emphasize and expose in a
graphical manner the results of the regression analysis by using countries that
receive a significant amount of FDI. The interpretation of the graphs revealed
where each country stood in attracting FDI based on factors that influence the
flow of FDI. GDP per capita impacts FDI flow positively in all countries studied;
but FDI levels differ from a country to another. This is an indication that a
country’s ability to produce and wealth matter in attracting FDI flow. Likewise,
trade and education at primary and secondary levels impact FDI flow
positively; but the amount of FDI flows differs from a country to another, which
is similar to GDP per capita. The result tells us that human capital with basic
and secondary education and trade are among the factors that affect MNEs
locational choices in developing countries. On the other hand, life expectancy
and education at tertiary level have a negative impact on FDI flow in the
majority of countries used for the analysis. But the result shows also that as a
country achieves a higher life expectancy, its ability to attract FDI increases.
47
Chapter V: Factors Influencing Human Capital Accumulation
Human capital, which is defined as knowledge embodied in individuals,
is acquired via various sources and under different forms. The main forms of
human capital are education, on-the-job training, and learning-by-doing.
Romer calls human capital a non-rival good because it can be used
simultaneously by two or more individuals (75). There are several factors
influencing human capital accumulation. The largest factor is the pursuit of
higher wages. Several empirical and theoretical studies have found a high
correlation between human capital accumulation and higher wages. However,
the acquisition of human capital is made possible or stimulated by several
other factors. A number of studies have mentioned the importance of life
expectancy and good health as prerequisites for human capital accumulation;
while others have shown that parents’ income and level of education have a
direct influence on children’s school enrollment. There are also indirect factors
influencing educational attainment such as migration, remittances, foreign
direct investment (FDI), and military service. This chapter discusses the
importance of all these factors and traces, amongst them, the most important
relative to human capital enhancement, especially formal education, in
developing nations.
48
Life Expectancy and Migration
Several studies consider that formal education is acquired by means of
different factors such as life expectancy, good health, household income,
parents’ level of education, and the expectation of higher income at the
completion of the education process. At birth every individual is equipped with
an unskilled type of labor that can be supplied to the labor market. This
unskilled labor can be transformed into a skilled one through education. A
higher life expectancy makes education acquisition attractive to individuals
with different levels of financial resources (Cervellatti and Sunde 1656). An
individual has to be alive and in good health in order to have access to and
benefit from education. However, the latter requires investment in time and
financial resources, which is considered an opportunity cost since the time and
resources could have been used for other various purposes. Wolf states that
the acquisition of education is not free. Individuals incur tuition cost while in
school and face an opportunity cost of the forgone income by studying rather
than being part of the workforce. Wolf states also that it is the pursuit of higher
wages and job security that push individuals to acquire education in different
fields to meet the demand of the labor market (51-55).
Life expectancy has also been shown as a precondition for educational
attainment. The empirical work of Jayachandran and Lleras-Muney shows that
life expectancy provides incentives for human capital accumulation through
education. Longer life expectancy eliminates doubts on investing in human

49
capital accumulation, which in turn plays a big role in enhancing individuals’
health. A higher life expectancy allows individuals to invest in higher
education. The return on this investment will materialize in the long run as a
result of a longer life expectancy (Jayachandran and Lleras-Muney 12-26).
This empirical evidence shows also that a reduction in life expectancy causes
educational attainment rate to fall due to skepticism that a short life
expectancy will not allow the return on investment in education to be benefited
in the long run. In addition, Kirchsteiger and Sebald argue that the level of
parents’ education contributes heavily to the investments in their children’s
human capital accumulation. The higher the level of parents’ education, the
higher is the investment in their children’s education (2-3). They also show
theoretically that parents with a low level of education tend to care less about
investing in their children’s education. When this occurs, the authors suggest
the intervention of the government to provide subsidies for the acquisition of
education so as to avoid a decrease in human capital formation for the next
generation (Kirchsteiger and Sebald 13). Similar results were reached in an
empirical study by Burney where parents’ level of education was strongly
correlated to children’s school enrollment (30-32). In addition, household
income plays an important role in children’s school enrollment (Checchi et al.
6-7).
A significant volume of literature had been produced to show the
positive impacts of migration that is initially believed to cause “brain-drain” in

50
the majority of developing countries. Theoretical works as well as empirical
evidence have shown that migration is a stimulus to capital accumulation. In a
model developed by Stark, Helmenstein, and Prskawetz, it is assumed that
workers migrate from poor to rich countries where wages in the latter are
higher than in the former (364-365). They theoretically show that workers with
a certain level of human capital (or skilled workers in other words) leave their
home country for the quest of higher wages. This wave of migration causes
workers at home to invest in acquiring more human capital with a belief that
the return to human capital investment would be higher with the opportunity to
migrate to a wealthy country (Stark et al. 366-367). The authors state also that
a country with a well-designed policy that promotes migration has the ability to
reach an optimum social welfare compared to a country without a migration
policy (365).
Similarly, a study conducted by Stark and Wang provides additional
support to the link between migration and human capital accumulation. Their
theoretical model seeks to examine the effects of migration on human capital
formation in an economy supporting migration as opposed to an economy that
discourages it. In an economy with the possibility of migration, workers tend to
invest more in human capital formation as opposed to the absence of
migration. As a result, the level of human capital is increased in an economy
with an established and controlled migration policy. Similar to the arguments
made in the above paragraph, Stark and Wang analysis suggests that an
51
economy with a controlled migration policy leads to a welfare enhancement for
workers staying at home (34-38). The long time believed “brain-drain” is now
a “brain-gain” taking into account positive externalities brought about by
migration.
Furthermore, an empirical study by Checchi, Simone, and Faini
examines the impacts of migration and FDI on school enrollment. The study
uses data collected from 57 developing countries among which 33 are from
the African and Asian regions (4-12). With regard to the relationship between
migration and school enrollment, the analysis shows a different result
compared to previous studies. They find no positive relationship between
migration rates of people with tertiary education and secondary school
enrollment. Previous studies, using theoretical models, focused on the
possibility of human capital accumulation at home brought about by migration
of skilled workers. The type of human capital was not specified in these
models. Checchi, Simone, and Faini’s findings do not necessarily nullify these
prior studies’ findings since human capital accumulation is not furnished by
education solely. There are various other forms of human capital such as on-
the-job training or learning-by-doing whose acquisition may be influenced by
migration.
However, Kugler finds a link between migration and investment in
education through remittances (amount of money or goods sent by a migrant
to his/her family). In his theoretical model, Kugler finds that a household with
52
at least one migrant member invests more in education than a household
without a migrant member. As mentioned earlier, education acquisition
requires investment in time and financial resources. Kugler shows that the
acquisition of education can be partly or entirely financed by remittances (13-
14).
On the other hand, FDI was found to have a positive relationship with
tertiary school enrollment in host countries. Inflows of different types of FDI in
an economy require local workers to have acquired skills in different fields.
High-skilled workers have a high probability of securing employment with
MNEs, sending incentives to non-skilled workers to invest in education so as
to acquire knowledge that is needed by these MNEs. However, when using
dummy variables for each region of the developing world, it was found that FDI
has negative effects on school enrollment in the poorest countries of Africa
and Asia (Checchi, Simone, and Faini 7-8). This result is consistent with the
common belief that the presence of MNEs in these regions targets the
exploitation of natural resources and not necessarily a skilled labor force.
Hence the negative effect of school enrollment associated with the presence
of FDI in African and Asian poorest countries.
Education, Training, and Learning-by-doing
Education has been long considered a primary source contributing to
human capital formation. Several studies show that developed countries invest
53
heavily in education acquisition while developing countries lack the resources
to do so. As a result, developed nations enjoy a sustainable economic growth
as well as an increase in productivity. In a Chechhi, Simone, and Faini’s
empirical study, the GDP per capita was strongly correlated with school
enrollment. This result suggests that as more resources become available for
families, investments in education undergo the same effects, which lead to the
increase in the stock of human capital (6-7).
In the USA, military service has been proven to be the biggest employer
of young Americans. Several studies have been conducted to determine the
impact of military service in human capital development by measuring the rate
of employment and education in the post-service period. An empirical study by
Hisnanick focuses on the role of the military service in enhancing the human
capital of African-Americans. The study finds that veterans have higher
educational attainment, greater incomes, and more labor attachment than non-
veterans (36-40). Elder acknowledges that this result is the outcome of
training, discipline, leadership skills, sense of teamwork, and educational
assistance provided by the military (238-240).
Training, which is a practice targeting mostly productivity increase, is
another form of human capital. As mentioned by Acemoglu and Pischke in
their empirical work, firms develop a willingness to invest in training when
there is a negative relationship between wages and productivity – increase in
wages with a decrease in productivity (15-18). Firms incur the cost of training
54
in order to increase their overall output, which is somehow a compensation for
the training cost. In the case of a firm introducing new capital goods (new
machinery), the training cost is said to be a function of the worker’s existing
knowledge of how to use this new technology that has just been introduced
(Eicher 730-732). In their theoretical model, Kesler and Lulfessmann talk
about general and specific training. The difference between the two is that the
latter is a type of training that provides specific skills used within a firm and the
cost is to be shared between the employer and the employee; while the former
is a type of training that provides just general knowledge that is needed for the
production process within a firm (5-16). All in all, the knowledge acquired
through training is an addition to the stock of human capital for the worker and
is expected to elevate the productivity level of a firm.
Learning-by-doing constitutes another source of human capital as well.
As individuals perform their daily duties at work, they get good at them day
after day. As a result, the learning-by-doing process translates into an
increase in human capital over time. Labor turnover and spin-offs that MNEs
face illustrate the importance of on-the-job leaning-by-doing.
FDI and Human Capital Enhancement
A review of the literature on the linkage between FDI and human capital
formation reveals that FDI is involved, one way or the other, in providing the
three forms of human capital (education, training, and learning-by-doing) as

55
described above. Kapstein argues that MNEs provide a positive contribution to
human capital formation via educational and training programs that target
skills acquisition required to perform specific tasks within MNEs (12).
However, Enderwick states that the type of training that is mostly administered
provides just technical skills; managerial and quality control types of training
are firm-specific and are kept internal in order to avoid spillover to local firms
(46-48). Learning-by-doing is observable through vertical and horizontal
linkages between MNEs and local firms.
With regard to education, there is evidence that MNEs participate in
formal education in countries where they have facilities. This is the case of
Intel and Toyota corporations. Intel has been supporting formal education
through curriculum design, provision of educational equipment, and technical
support. Immediate examples are Intel in China and Costa Rica where it has
been supporting formal education by providing grants and equipment to
educational institutions. On the other hand, Toyota has also been promoting
HRD through education, training, and R&D (Research and Development)
programs by means of scholarships, provision of educational materials to
educational institutions, and research grants to universities and research
institutions (Miyamoto 33).
Moreover, Miyamoto argues that MNEs participate actively in training
their workers. His research shows that MNEs provide more training than local
firms thanks to their easy access to resources and information. A typical

56
example is Siemens in India where it administers a three-year training
program for 140 new workers. At the completion of the program, half of the
trainees are employed by Siemens whereas the rest are employed by mid-size
firms that are Siemens’ partners and providers of intermediate goods. Training
spillover can also be observed through different aspects including vertical
linkages where MNEs train workers that are suppliers of intermediate goods
(Miyamoto 34-35). Similar arguments were made by Saggi where MNEs are
involved in technology transfer that leads to the interaction between upstream
and downstream firms where a downstream firm is a supplier of intermediate
goods to the upstream firm (26-27).
Regarding learning by doing, it was found that MNEs face labor
turnover and labor spin-offs. The two occur when previously employed
workers by MNEs decide to sell their skills to other firms or start their own
firms. This is the evidence that these workers were able to acquire sufficient
skills that are marketable while working at MNEs. There is evidence
supporting the fact that workers leave MNEs to establish their own firms. A
typical example is the case of an MNE in Bangladesh, where 115 of 130 initial
workers left Desh (a garment firm) to start up their own firm (Saggi 24).
Similarly, Miyamoto gives examples from Costa Rica and Malaysia where
workers leave MNEs to go work for local firms or set up their own firms
(Miyamoto 35).
57
Impacts of Remittances and FDI on Formal Educational Attainment
The forms of human capital discussed above do not all represent the
same magnitude in human capital development. Several studies indicate that
education is the main form of human capital that contributes heavily to
countries’ economic development. Among the factors already discussed that
influence the acquisition of human capital, remittances and FDI have received
significant weight compared to others, especially in the developing world.
Getting education requires, among other things, financial resources.
Remittances are considered an addition to recipient families’ income and FDI
is looked at as a supplier of labor to local workers, which in turn, generates
income. Several studies show that a country with higher rate of remittances or
FDI invests more in education as opposed to a country lacking either FDI or
remittances.
Statistics from the World Bank database indicate that remittances to
developing countries were about $79 billion in 2002. This amount was bigger
than external funding for development in the developing world ($51 billion) and
was roughly about two-fifths of foreign direct investment inflows ($189 billion)
to developing countries during the same year (Yang 1). In 2006, overall
remittances to developing countries were about $105 billion. These numbers
on remittances got the attention of economists, which in turn motivated them
to investigate their impact on poverty reduction, child labor, and education.

58
Several country-specific researches have linked remittances to the increase in
educational attainment in home countries of migrants.
To illustrate the impact of remittances on education in recipient
households, I will refer to results from studies that were conducted on
countries that possess a significant amount of migrants abroad.
A study by Yang examines the link between migration and human
capital using data from the Philippines during and after the 1997 Asian
financial crisis. The Philippines is among countries that have huge numbers of
migrants abroad. It has 10 percent of its 89 million people working abroad in at
least 170 different countries. Recent statistics from the World Bank show that
remittances in the Philippines average $15 billion a year, which is a seventh of
the country’s GDP. The study finds that the appreciation of the migrants’
currency against the Philippine peso2 leads to more receipt in remittances,
which in turn, contributes to the increase in households’ expenditure with a
larger fraction of it being allocated to education. As a result, there was an
increase in child schooling, a decrease in child labor, and a rise in household
educational expenditures (Yang 19-21).
Moreover, a recent empirical work by Adams traces the difference
between recipient and non-recipient households of remittances in Guatemala
with regard to educational expenditures. The study is based on a survey of
2
Peso is the Philippines’ currency
59
7276 households’ expenditure behavior. These households were broken down
into three groups: internal-remittance receiving, international remittance-
receiving, and non-remittance receiving households. Internal and international
remittance receiving households have a marginal spending of 45.2 and 58.1
percent more, respectively, on education than households receiving no
remittances. However, these expenditures are not equally distributed across
the three main level of education (primary, secondary, and tertiary).
Households receiving internal and international remittances spend more on
secondary school education (19.6 and 14.4 percent respectively) than do non-
remittance receiving households. When it comes to primary school level, it
was found that they spend at a small margin. At the university level,
households receiving international remittances spend more at the margin than
do households receiving no remittances (Adams 12-19).
Similarly, a study by Kugler finds a direct link between remittances and
education. Using survey data from various Colombian municipalities, he
concludes that remittances affect positively educational attainment. The
survey analysis shows that 13 percent of households receiving remittances
invest heavily in education as their main priority (4-5). Likewise, studies on
Mexico and El Salvador have also reached the same conclusion that
remittances receivers spend more on education than anything else. In El
Salvador, the positive effects of remittances relative to education expenditures
are observable in urban as well as in rural areas (Kugler 6-7).

60
FDI on the other hand plays a role in contributing to human capital
enhancement in host countries. In his paper, Slaughter distinguishes two
modes by which FDI enhances human capital. The first mode is MNEs as a
labor-supplier at a firm level in the short-run. During this phase, FDI provides
on-the-job training and supports educational institutions in curriculum design
and vocational training so as to meet the professional skills sought by MNEs.
The latter are considered national suppliers of labor as specified in the second
mode by which FDI enhances human capital. The level of capital investment,
skills required to facilitate technology transfer, and higher wages create
demand for skilled workers. In the long run, individuals in host countries tend
to invest in skills acquisition through education or training. The increase in
economic activities by MNEs generates tax revenue for the government. Tax
revenue then relaxes budget constraint, which in turn, allows the government
to invest in education and training (Slaughter 18-20).
Furthermore, FDI facilitates the transfer of technology to host countries
through various channels, which in turn, contribute to human capital
accumulation. The main channels are horizontal and vertical linkages, labor
turnover and labor spin-offs (Miyamoto 34-35). This technology transfer results
in human capital acquisition which is passed on from MNEs to local firms and
then to individuals (Krause 4-5). However, this argument does not hold for all
the countries that happen to host MNEs. In the case of Thailand, it was
observed that there is a limited technical and managerial knowledge transfer.

61
This is due to two main reasons: the majority of FDI inflows comprise small to
medium size industry that does not require skilled labor force. Even in the
case of high level industry sector, the gap in technology between MNEs and
local employees hinders the latter to absorb the technology or simply MNEs
are discouraged from narrowing the gap due to the training cost this operation
might require (Michie 366-367). But in Singapore, the government has
invested heavily in formal education and training so as to attract FDI. In 1997,
Singapore’s Investment Promotion Agency (IPA) initiated a World Class
Program. Its goal was the creation of ten world educational institutions in
Singapore to deliver courses that will meet the demand of the high level
industry. The program intended also to make these schools a central
educational hub for the South East Asian region. The ultimate goal is to attract
MNEs, which in turn are expected not only to benefit from the skilled labor
force but also enhance it over time (Miyamoto 26).
There is empirical evidence and qualitative analysis for certain
countries that show the level at which FDI affects human capital accumulation.
Most researchers measure the level of human capital through education
attainment of the population at different levels (primary, secondary, and
tertiary or post-secondary).
China is among the ten developing and emerging countries that receive
most of the FDI (more than half of total FDI flow to developing countries) with
China itself getting approximately 15 percent. The influence of FDI on China’s

62
human capital is well documented in Zhuang’s paper. The latter traces the
economic changes in the contemporary economic history of China and relates
them to human capital formation. In 1978, China initiated an open-border
policy (Law on Chinese Foreign Joint Ventures), which allowed the inflow of
foreign investors. This law was then revised in 1984 and 1988 so as to allow
massive inflows of foreign investors in the country. Subsequently, a dramatic
increase in FDI followed in the early 1990s, which contributed strongly to
human capital enhancement of the Chinese. This FDI surge has made China
the number one recipient of FDI among developing and emerging countries
(Zhuang 73-76).
The surge in FDI flow to China in the early 1990s was a result of the
designation of certain zones and regions as ETDZ (Economic and
Technological Development Zones). Thus, MNEs were mainly concentrated in
ETDZs relative to non-ETDZs. Zhuang’s study seeks to measure the impact of
FDI on human capital by comparing the data from the two regions (ETDZs and
non-ETDZs) using statistical analysis tools. Educational attainments at
different levels (primary, secondary, and post-secondary) were used as a
measure of human capital. The results from the regression analysis show that
ETDZs have enjoyed an increase in educational attainment relative to non-
ETDZs since China opened its economy to foreign investors in the early 1980s
(Zhuang 84-89).
63
Chapter VI: FDI and Human Capital Formation: an Empirical
Analysis
We discussed in Chapter Five of this thesis a number of factors that
affects human capital formation. All these factors do not present the same
magnitude in influencing human capital accumulation. We came to a
realization that FDI and remittances are amongst the major driving forces for
human capital formation. FDI is considered an addition to the capital stock of a
host country, which in turn provides employment to local workers (Lensik and
Morrissey 479). Furthermore, it has been observed that MNEs offer higher
wages to high-skilled workers, which sends incentives to non-skilled workers
to invest into schooling for the pursuit of higher wages (Slaughter 18-20).
Likewise, remittances constitute a marginal income to the recipients. A number
of empirical studies have shown that households receiving remittances spend
a large portion of them into their children’s education (Kugler 7).
This chapter measures the weight of FDI, among other factors including
remittances, GNI, and life expectancy, in human capital accumulation with a
major emphasis on FDI, which is the center point of this study. Enrollment
rates at primary, secondary, and tertiary levels were used as a proxy for
human capital.
64
Data Description
This empirical analysis uses a panel data that covers 103 developing
and emerging countries. The data used in this analysis is primarily from the
World Bank’s WDI online database. It covers a period of 17 years (1990-
2006). The dataset comprises series such as FDI, remittances, regions, GNI,
life expectancy, and school enrollments at primary, secondary, and tertiary
levels. The data pertaining to FDI and the information on countries’ regions
were obtained from UNCTAD’s dynamic database on FDI flow. The original
dataset was made of 160 countries; but the dataset used for the analysis
comprised only 103 countries. The 57 countries that were excluded from the
dataset had a significant amount of missing values in their series (see data
appendix for details).
Data Limitation
There exist three main forms of human capital: formal education, on-
the-job training, and learning-by-doing. This empirical analysis uses school
enrollments at primary, secondary, and tertiary levels as a proxy for human
capital. Data on learning-by-doing and on-the-job training was not available
(see data appendix for more details).

65
Econometric Models
The three models below were built based on the data compiled for the
series mentioned under the section for data description. The effectiveness and
weight of each factor contributing to human capital formation is estimated in
the following equations:
PRIMit = β0 + β1 ln(F)it + β2 ln(R)it + β3 ln(G)it + β4 ln(L)it +
β5 ln(Fsq)it + β6 ln(Rsq)it + β7 ln(Gsq)it + β8 ln(Lsq)it +
β9 ln(FR)it + β10 ln(FG)it + β11 ln(FL)it +β12 ln(RL)it + β13 ln(RG)it + β14 ln(LG)it +
β15 REit + β16 TMit + εit (1)
SECit = β0 + β1 ln(F)it + β2 ln(R)it + β3 ln(G)it + β4 ln(L)it +
TERTit = β0 + β1 ln(F)it + β2 ln(R)it + β3 ln(G)it + β4 ln(L)it +
where,
• PRIMit, SECit, and TERTit are dependent variables and serve as a
measure of human capital through primary, secondary, and
tertiary school enrollments in a country i at time t
• Fit captures the flow of foreign direct investments

66
• Rit is a variable for the amount of remittances received by
households
• Git is the gross national income and represents the income
available for households
• Lit is a variable for life expectancy since it is well known that the
acquisition of education requires investment in time and financial
resources
• Fsq, Rsq, Gsq, and Lsq represent squared terms of the original
variables
• FRit, FGit, and FLit are cross terms that measure the impact of FDI
when associated with remittances, GNI, and life expectancy
• RLit is a cross term that capture the impact of remittances and life
expectancy when coupled together
• RGit is a cross term that measure the impact of remittances and GNI
when combined together
• LGit is a cross term measuring the impact of a pair of life expectancy
and GNI
• REit and TMit are respectively dummy variables for regions and
time,
• εit is the error term.

67
All three equations have same explanatory variables that are regressed on
three different dependent variables: PRIMit, SECit, and TERTit. All
explanatory variables are expected to be positive at the exception of
dummy variables that can be either positive or negative.
Regression Results Discussion
The results of the regression analysis are shown in Table 2. Similar to
the FDI determinants model, this model is as well in log form. Its performance
was sound even though some variables had an unexpected sign. The majority
of the variables, except dummies, were expected to bear a positive sign;
meaning that they have a positive impact on the dependent variable which, in
this case, is school enrollment at three levels (primary, secondary, and
tertiary) that measures the level of human capital. Explanatory variables were
demeaned from the overall sample mean, which makes the first order
coefficients be interpreted as the elasticity at the sample mean. The results of
the regression analysis show that independent variables have either a positive
or negative impact on the dependent variable. The full discussion of the
regression results is presented below.
The model is estimated using 103 developing countries with 965
observations. The results of the regression analysis indicate that FDI per
capita has a positive impact on primary school enrollment. Its elasticity is
about 1.48, indicating that a 1 percent increase in FDI per capita brings about
68
a 1.48 percent increase in primary school enrollment. The dataset used for the
analysis shows that the majority of developing countries have achieved full
enrollment at primary school level. It is an indication that governments and
heads of households have taken serious measures that encourage children to
go to school at the young age. Thus, FDI per capita may have a minimal
impact on primary school enrollment. At secondary school level, the first order
coefficient for FDI per capita is positive but it is not significant. However, its
second order coefficient is positive and significant. This result suggests that
countries with a higher FDI per capita have a bigger impact on secondary
school enrollment than countries with an average FDI per capita.
In contrast with enrollments at primary and secondary school levels,
FDI per capita has a negative impact on tertiary school enrollment. Its
elasticity is about -1.22, which implies that a 1 percent increase in FDI per
capita is associated with a 1.22 percent decrease in tertiary enrollment. This
result indicates that the majority of MNEs operating in developing countries
are not seeking workers with tertiary education. This outcome complements
the result on the relationship between FDI and secondary enrollment where an
increase in FDI flow per capita is coupled with an increase in secondary
school enrollments; which implies that the presence of MNEs in developing
countries exerts an influence towards the acquisition of secondary education.
On the other hand, the first order coefficient for remittances per capita
is positive at primary school enrollment but negative at secondary and tertiary

69
school enrollment. The coefficient is not significant at all three school levels,
which means that remittances have a minimal impact on primary, secondary,
and tertiary enrollments. However, when remittances are combined with GNI,
they have a positive impact on primary and secondary school enrollments.
This result suggests that when remittances and GNI are both high, they
contribute to an increase in primary and secondary school enrollments.
Conversely, GNI per capita is positively correlated to secondary and
tertiary school enrollments. At secondary school level, the elasticity for GNI
per capita is about 4.3, which indicates a 1 percent increase in GNI per capita
is coupled with a 4.3 percent increase in secondary school enrollment. At
tertiary school level, a 1 percent increase in GNI is associated with a 3.8
percent increase in tertiary school enrollment. However, the second order
coefficient for GNI per capita is negative at tertiary school level. This result
indicates that tertiary school enrollment is likely to increase at a lower rate in
countries with a higher GNI per capita. Moreover, the first order coefficient for
life expectancy is positive at all three school levels but it is not statistically
significant. Its second order coefficient is significant and positive at primary
and secondary school levels but negative at tertiary school level. This result
suggests that a higher life expectancy is associated with higher enrollment
rates at primary and secondary school levels, but the impact gets smaller at
tertiary school level. Both results on GNI and life expectancy vis-à-vis school
enrollment are consistent with Cervellatti and Sunde’s study where they state
70
that the acquisition of human capital through formal education requires
investment in time (in this case life expectancy) and financial resources
(1656).
Furthermore, overall school enrollments at primary, secondary, and
tertiary levels differ from a region to another. At primary school level, regions
such as South Asia, South-East Asia, Central and South America, Oceania,
and Sub Sahara have higher enrollment rates than other regions. At
secondary school level, we have the EU, CIS, and South-East Europe that
have higher enrollment rates than West Asia, Central America, and Sub
Sahara. The result on other regions shows them to be the average regions as
far as FDI inflows. At tertiary level, South-East Asia, the EU, South-East
Europe, the CIS, and South America have higher tertiary enrollment rates than
South Asia, Oceania, and Sub Sahara. In addition, the coefficients of time
indicate that there has been a gradual increase in school enrollments over
time. They were lower in 1990 but increased gradually for all subsequent
years with the year 2002 having higher enrollment rates than all previous
years at primary and secondary school levels. These enrollment rates were
though lower from 2003 to 2006. This result may be an indication that the
global economic slowdown that occurred in early 2002 may have also affected
school enrollments at primary and secondary levels. At tertiary level, the
gradual increase in tertiary school enrollment is noticeable from 1990 to 2006,
with the latter having the highest enrollment rate

71
Table 2: Determinants of Human Capital

Dep. Variables: PRIM SEC TERT
F Value: 16.86 104.40 62.96
2
Adj R : 0.40 0.81 0.73
Obs: 965 965 965
Variables Estimates Estimates Estimates
Intercept 96.40086*** 72.17876*** 17.92873***
ln(F) 1.47737* 0.30367 -1.22305**
ln(R) 1.68732 -0.57556 -0.41576
ln(G) 1.7421 4.2986*** 3.77796***
ln(L) 6.479 9.04193 0.49638
ln(Fsq) 0.23138 0.40158** -0.08053
ln(Rsq) 0.14557 -0.14386 0.11867
ln(Gsq) -0.71569 2.28316*** -1.63629***
ln(Lsq) 130.5674*** 85.73949*** -24.3293*
ln(FR) 0.32983 -0.03896 -0.09977
ln(FG) -1.34776* -1.53912*** 0.29613
ln(FL) -16.544*** -1.67848 0.77734
ln(RL) 1.8038 1.9567 -3.61839*
ln(RG) 0.93317* 0.83053** 0.20756
ln(LG) -13.6147* -37.5723*** 14.34722***
Wasia 0.61911 -7.61874*** 2.86531
Sasia 19.04351*** -1.07549 -6.0214***
Seasia 11.79533*** -1.2171 6.19761***
EU 5.1022 12.09529*** 23.96086***
Seeur -0.33631 7.44923*** 11.95838***
CIS 4.27796 22.40488*** 21.09825***
Samer 19.5015*** -0.72725 8.31626***
Camer 10.70485*** -13.454*** 3.13826
Oceania 21.83199*** -4.90429 -6.25453**
Nafrica 5.42435 -1.83695 1.5417
Subsah 8.31842** -11.4077*** -10.7301***
Y90 -3.97475 -10.0946*** -5.93063***
Y91 -4.08058 -10.2029*** -6.4099***
Y92 -2.98025 -9.46365*** -5.05469***
Y93 -1.85898 -8.27054*** -4.53308***
Y94 -1.64451 -6.47639*** -4.36273***
Y95 -1.8185 -5.07518** -4.43638***
Y96 -0.88609 -4.22469** -3.61429**
Y97 -1.1559 -4.59296 -2.54138
Y98 0.2279 3.8587 2.52597
Y00 0.44487 1.20493 0.80918
Y01 1.95549 2.86468 2.98767*
Y02 1.17993 4.80169** 4.07186**
Y03 -1.03829 3.35434 5.05052***
Y04 -0.59661 1.61957 4.91409***
Y05 -0.53582 -0.53502 6.72921***
Y06 -2.1739 -0.51566 9.22264***
Notes: the symbols, ***, **, and * indicate statistical significance at the
1%, 5%, and 10% level, respectively.
72
Interpretation of Graphical Representation of Regression Results
The regression analysis has generated coefficients that can be used for
a graphical representation of countries used for the model. The sample used
for the analysis comprised of 103 countries. However, only eight countries
were used for the graphical representation. The eight countries are part of the
ten countries that receive more than half of FDI flow to developing and
emerging countries. This analysis is similar to that of FDI determinant. The
effectiveness of each variable with regard to school enrollment at primary,
secondary, and tertiary levels is calculated for all eight countries that are part
of the econometric model sample. The impact of each variable was measured
by keeping all other variables constant at the mean. Countries used for the
graphical representation are similar to those used in Chapter Four of this
study. The impact of each factor vis-à-vis school enrollment at primary,
secondary, and tertiary levels is graphically reflected on Figure 7 through
Figure 18.
73
Figure 7: FDI Flow and Primary Enrollment

Mexico South Africa
130
125
120
115
110
105
100
95
90
FDI per capita (in US$)
Figure 7 shows that FDI affects primary school enrollment positively in
all countries except Argentina where the relationship is negative. The curves
for Mexico, Brazil, and Malaysia are flat, which implies that FDI flow has no
impact on their primary enrollment. Despite the inequality in enrollments, it is
clear that all countries have achieved full enrollments at primary level. Notice
also that China has a higher enrollment rate than other countries.
74
Figure 8: FDI Flow and Secondary Enrollment

Mexico South Africa
100
95
90
85
80
75
70
65
60
55
50
45
40
Figure 8 depicts the relationship between FDI flow and secondary
enrollment. All curves are upward sloping but their steepness and level they
occupy is not the same, which implies that the impact of FDI on secondary
education differs for country to country. It is clear from Figure 8 that an
increase in FDI flow is associated with an increase in secondary school
enrollment. This phenomenon indicates that the presence of MNEs in
developing and emerging countries exerts a positive impact on secondary
school enrollment. Overall, Figure 8 illustrates that all the countries used for
the analysis have achieved secondary enrollments above 50 percent as a

75
result of FDI flow. Recall from Chapter Three that the minimum level of
education required to attract FDI is secondary education, which is an
indication that the majority of MNEs is concentrated in the manufacturing
sector where the level of education sought is secondary education. Figure 8
shows that an increase in FD flow is coupled with an increase in enrollment
rates at secondary school level. This reciprocal impact of FDI and secondary
school enrollment is an indication of the “Virtuous Circle of FDI and Human
capital” where human capital attracts FDI flow, and FDI in turn, contributes to
the acquisition of human capital in host countries. Notice also that India has
lower levels of FDI as a result of increases in FDI flow. It is an indication that
FDI in India is not mainly directed to the manufacturing sector; the service
sector is instead the one targeted by the majority of MNEs. This result is
consistent with the existing literature that acknowledges that India has been a
location of choice for a number of MNEs, especially in the IT field (Milelli 2-3).
76
Figure 9: FDI Flow and Tertiary Enrollment

Mexico South Africa
50
45
40
35
30
25
20
15
10
5
0
Figure 9 shows the relationship between FDI flow and tertiary
enrollment. Notice first the shape of all curves on the graph. All curves are
slightly downward sloping with almost the same steepness, which translates
into a small decrease in tertiary enrollment as FDI flow goes up. This is an
indication that the majority of MNEs present in developing and emerging
countries are not in quest for workers with tertiary education. Secondary
education appears to be the level of education that is targeted by MNEs. This
is consistent with the remarks made by Kapstein where he states that MNEs
prefer workers with basic or secondary education that can easily be trained to
77
respond to various tasks within a firm (17). However, the levels of tertiary
enrollment are not the same across countries. Despite this negative
relationship, countries including Malaysia, South Africa, China, Brazil and
Indonesia have higher enrollment rates than the rest of the countries. The
concavity of the curves shows that the negative relationship between FDI flow
and tertiary education is stronger at lower levels of FDI flow. Tertiary
enrollment rates decrease at a decreasing rate as FDI flow goes up.
Figure 10: Remittances and Primary Enrollment

Mexico South Africa
125
120
Primary Enrollment ( in %)
115
110
105
100
95
90
85
80
40 60 80 100 120 140 160 180 200 220 240 260 280 300 320 340
Remittances per Capita (in US$)

78
Figure 10 illustrates the relationship between remittances and primary
enrollment. Notice first the similarities in the shape of curves: all curves slope
slightly upward except the curves representing India and Indonesia that are
slightly downward sloping. Overall, remittances affect primary enrollment
positively, which implies that an increase in remittances brings about an
increase in primary enrollment. Notice also that all countries on the graph have
achieved full enrollment at primary level as a result of remittances.
Remittances were described in Chapter Five as the amount of money or
goods that a migrant sends to his family at home. As shown on Figure 10, we
can say that remittances (which occur as a result of migration) impact primary
enrollments positively in source countries. This result is consistent with case
studies discussed in Chapter Five where households receiving remittances
spend more on child schooling than non-remittances receivers.

79
Figure 11: Remittances and Secondary Enrollment

Mexico South Africa
95
90
85
80
75
70
65
60
55
50
45
40
35
40 60 80 100 120 140 160 180 200 220 240 260 280 300 320 340
Contrary to the result of Figure 10, Figure 11 shows that remittances do
not have any impact on secondary enrollment across all countries. All the
curves on the graph are flat, which suggests that an increase in remittances
does not have any effect on secondary enrollment. Notice also that the levels
of secondary enrollment as a result of increases in remittances differ from
country to country. Brazil, Indonesia, Malaysia, Mexico, and South Africa have
higher secondary enrollments than the rest of the countries. It appears that a
big fraction of remittances is spent towards primary education as indicated on
Figure 10.
80
Figure 12: Remittances and Tertiary Enrollment

Mexico South Africa
50
45
40
35
30
25
20
15
10
5
0
1 25 50 75 100 125 150 175 200 225 250 275 300 325 350
Figure 12 illustrates the relationship between remittances and tertiary
enrollment. Notice first the shape of all curves: they are slightly downward
sloping, which suggests a small decrease in tertiary enrollment as remittances
go up. Despite this negative relationship, the levels of tertiary enrollment as a
result of increases in remittances differ from country to country. Malaysia and
Indonesia have higher enrollment rates than the rest of the countries. The
curves are concave but almost flat when remittances per capita are about
$350. This is an indication that when remittances get higher, they are likely to
be coupled with a slight increase in tertiary school enrollments, which would

81
be consistent with case studies discussed in Chapter Four where remittances
play a role in tertiary education expenditures.
Figure 13: GNI and Primary Enrollment

Mexico South Africa
130
125
120
115
110
105
100
95
90
85
80
GNI per Capita (in US$)
Figure 13 depicts the relationship between GNI and primary enrollment.
The majority of the curves are upward sloping at the exception of Brazil,
China, and Malaysia whose curves indicate an increase in primary enrollment
at a decreasing rate as GNI goes up. Overall, Figure 13 shows that an
increase in GNI is associated with an increase in primary enrollment. Notice
also that all the countries have full enrollment at primary school level. This
82
result is consistent with Cevellatti and Sunde’s study where they state that
parents’ level of income play an important role in child schooling (1656).
Figure 14: GNI and Secondary Enrollment

Mexico South Africa
120
110
100
90
80
70
60
50
40
Figure 14 illustrates that GNI is positively correlated with secondary
school enrollment. All the curves are upward sloping, suggesting that an
increase in GNI is associated with an increase in secondary school enrollment.
However, Figure 14 indicates that the levels of secondary enrollment are not
the same among countries: some countries have higher enrollment rates than
other countries as a result of an increase in GNI. Again, this result is

83
consistent with Cevellatti and Sunde’s remarks where parents’ level of income
play a role in child schooling.
Figure 15: GNI and Tertiary Enrollment

Mexico South Africa
50
45
40
35
30
25
20
15
10
5
0
Figure 15 shows that GNI is positively correlated with tertiary
enrollment, which implies that an increase in GNI is coupled with an increase
in tertiary enrollment. The curves are upward sloping, but their convexity
indicates that the relationship between GNI and tertiary enrollment is stronger
at lower levels of GNI per capita. Notice also that countries on Figure 15 have
different levels of tertiary enrollments as GNI per capita increases. This result
84
is consistent with Wolf’s study where the acquisition of higher education
requires financial resources to cover tuition cost (51-55).
Figure 16: Life Expectancy and Primary Enrollment

Mexico South Africa
130
125
120
115
110
105
100
95
90
85
80
50 55 60 65 70 75 80
The curves on Figure 16 are upward sloping but their shape is
somewhat different from curves of previous graphs. It is clear from Figure 16
that curves are downward sloping up to approximately the forty eighth year of
life expectancy and upward sloping beyond that. This is an indication that
when a country’s life expectancy is around 50 years, it discourages enrollment
at primary level. And when a country’s life expectancy is beyond 50 years, it

85
affects positively enrollment at primary level. This result is consistent with the
empirical work of Jayachandran and Lleras-Muney where they state that a
longer life expectancy provides incentives for human capital accumulation
through education and eliminates doubt on investing in education (12-26). The
curves are concave for all countries used in the analysis. Figure 16 shows also
that countries have different levels of primary enrollment as a result of
increases in life expectancy. Notice also that all countries have full enrollments
at primary school level, which has been the case for all factors discussed
previously.
86
Figure 17: Life Expectancy and Secondary Enrollment

Mexico South Africa
100
90
80
70
60
50
40
30
20
50 55 60 65 70 75 80
Figure 17 shows that life expectancy has a positive impact on secondary
enrollment in countries including China, India, and Indonesia while it has a
negative impact on other countries used in the analysis. The concavity of the
curves implies that a longer life expectancy is likely to be associated with
higher levels of secondary school enrollment. As mentioned in Chapter Five of
this thesis, the pursuit of education requires investment in time (in this case life
expectancy) and financial resources. The uncertainty of a longer life
expectancy discourages enrollments at secondary school level.

87
Figure 18: Life Expectancy and Tertiary Enrollment

Mexico South Africa
50
45
40
35
30
25
20
15
10
5
0
40 45 50 55 60 65 70 75
Figure 18 depicts the relationship between life expectancy and tertiary
enrollment. The curves on Figure 18 show that life expectancy affects tertiary
enrollment positively; which suggests that an increase in life expectancy brings
about higher enrollments at tertiary level. This result is consistent with the
argument of Cervellatti and Sunde where a higher life expectancy makes the
acquisition of education attractive to individuals with different levels of financial
resources (1656). All in all, we can see from Figure 18 that a higher life
expectancy is associated with higher levels of enrollments at tertiary school
level. In addition, the levels of tertiary enrollments are different among

88
countries: Malaysia has higher enrollments at tertiary school level than other
countries as a result of increases in life expectancy.
Figures 7 through 18 were produced to illustrate the impact of FDI,
remittances, GNI, and life expectancy on enrollments at primary, secondary,
and tertiary school levels in developing countries. Primary, secondary, and
tertiary enrollments were used as a proxy for human capital. The interpretation
of the graphs reveals the impact of each factor used in the regression analysis
on human capital, which, is this case, is school enrollments at three levels
(primary, secondary, and tertiary). FDI shows a positive impact on primary and
secondary enrollments but negative on tertiary enrollments. The result
indicates also that the levels of enrollment at all three school levels are
different among countries. Some countries have higher enrollment rates than
others as a result of an increase in FDI.
Remittances, on the other hand, affect positively primary enrollments
but do not have any impact on secondary enrollments across all countries
used for the analysis. This result tells us that an increase in remittances
causes higher primary enrollments but at secondary level, enrollments remain
constant. At tertiary level, the result shows that increases in remittances bring
about lower enrollments among countries but enrollment levels differ from
country to country.
Regarding GNI and life expectancy, they both affect primary,
secondary, and tertiary school enrollments positively in the majority of

89
countries used for the analysis. But the levels of enrollments are different
among countries. The level of enrollments at all three school levels varies as a
result of increases in either GNI or life expectancy. All countries used for the
analysis have showed an increase in enrollments at primary, secondary, and
tertiary school levels as GNI goes up. For life expectancy, the majority of the
countries have their school enrollments at all three levels positively correlated
to life expectancy. Thus, a longer life expectancy and larger GNI play a role in
educational attainment at primary, secondary, and tertiary school levels, which
is consistent with remarks mentioned in Chapter Five of this study.

90
Chapter VII: Summary and Conclusion
The centerpiece of this study was to show the role of FDI in enhancing
the level of human capital in developing countries. The review of the existing
literature was conducted in an effort to find what has already been done and
discussed about FDI in the Third World. Several studies have linked FDI to
economic growth, technology transfer, expansion or collapse of local firms
and, minimally, to human capital formation in developing countries. In light of
this discovery, this study sought to identify various factors that contribute to
human capital formation with FDI being the main focus. This was done both
qualitatively and quantitatively.
The review of the literature has demonstrated a divergence among
economists on the issue of FDI and economic growth. The vast majority of
prior studies have acknowledged that FDI promotes economic growth in host
countries while others have proven that FDI creates a fierce competition within
local economies, which in turn drives local firms out of business and hinders
economic growth. Likewise, researchers have separately argued that
technology transfer that happens through FDI can only be possible when local
firms have physical and human capital capable of absorbing such technology;
otherwise such transfer would not be effective. Regarding human capital
enhancement, it was found that MNEs provide more training than local firms
thanks to their access to foreign capital, information technology, and the ability
to provide incentives to their employees so as to avoid labor turnover as well

91
as provision of financial assistance to educational and research institutions
and scholarships.
Furthermore, since this study sought to show primarily the relationship
between FDI and human capital accumulation, it also seemed important to first
look into the factors that contribute to FDI flow. Previous studies have provided
various factors, which include but are not limited to market size, transport cost,
infrastructure, regional integration, human and natural resources, openness to
international trade, information services, level of industrialization, and
transparent policies towards FDI that contribute to FDI flow.
An empirical analysis was conducted to measure the effectiveness of
each factor in FDI flow. The result was consistent with theory and prior works.
It shows that an increase in the market size (measured by the size of the
population), a country’s GDP, secondary and primary school enrollment rates,
and trade is associated with an increase in FDI flow. Enrollment at tertiary
school level has a negative impact on FDI flow. This result indicates that an
increase in tertiary school enrollment is coupled with lower levels of FDI flow. It
is a sign that the majority of MNEs in developing countries are directed
towards the manufacturing sector. Regional location matters as well. It was
observed that some regions have higher levels of FDI than others. Regions
such as the EU, CIS, and South America have higher FDI flows than West
Asia, South Asia, Oceania, and Sub Sahara Africa. The result on other regions
such as South East Asia, South East Europe, Central America, North Africa,
92
and the Caribbean showed them to be the average regions as far as FDI
inflows. The result has also indicated a gradual and steady increase of FDI
flow from 1990 to 2006.
With regard to factors that influence the acquisition or accumulation of
human capital, the literature has mentioned several factors. The latter include
life expectancy, parents’ level of education and income, migration, GNI,
remittances, learning-by-doing, on-the-job training, and FDI. Based on these
factors, an econometric model was built to test each factor’s influence on
human capital formation, which was measured through school enrollment at
primary, secondary, and tertiary levels. The regression analysis provided the
result that was sound and interesting.
Starting with remittances, it was observed that they have a significant
positive impact on tertiary school enrollment. However, the positive impact of
remittances on primary and secondary school enrollment is achieved when
remittances are coupled with GNI. This result suggests that when remittances
and GNI are both high, they contribute to an increase in primary and
secondary school enrollments. GNI per capita was also found to have a
positive impact on both secondary and tertiary school enrollments, which
implies that an increase in GNI per capita is associated with an increase in
secondary and tertiary school enrollments.

93
The result on life expectancy suggests that countries with higher life
expectancy have a bigger positive impact on primary and secondary school
enrollments, but this impact gets smaller at tertiary school level.
Finally, FDI, which is the main focus of this thesis, was found to have a
positive impact on both primary and secondary enrollment with a result that is
statistically significant, indicating an increase in primary and secondary school
enrollments as FDI flow goes up. However, FDI was negatively correlated to
tertiary school enrollment, which was an interesting and unexpected result. It
was an indication that tertiary education is associated with low levels of FDI
flow. All in all, it is clear that FDI has a positive impact on human capital
formation through school enrollments at primary and secondary school levels,
but negative at tertiary school level. It is an indication that MNEs are not
looking for individuals with tertiary education in the countries where they
choose to locate. It also implies that countries with higher tertiary enrollment
rates possess an existing large capital stock, which accomodates employment
needs for individuals with tertiary education; thus limiting MNEs to use high
skilled individuals since they are already serving their own economy.
It is also worth noting that the value for FDI was used in this study as an
absolute number. Sectoral allocation of dollar amount for FDI flow was not
used in this study due to lack of data. Subsequenlty, I am expecting future
research including my own to try to look into the impact of FDI on human
94
capital formation based on the actual FDI dollar amount by sector (natural
resources extracting, manufacturing, and service sectors)

95
Data Appendix
1. Countries dropped from the dataset: the initial dataset comprised
160 countries but the dataset used for the regression analysis had only
103 countries. The sample period was for 17 years. Countries that had
missing values for more than half of the sample period under any series
of the dataset had to be excluded from the analysis so as to increase
the efficiency and performance of the econometric model. As a result,
57 countries were excluded from the dataset.
2. Values interpolation: values pertaining to life expectancy were
interpolated; which means that for any given three consecutive years, if
the middle year had a missing value, its value was calculated by taking
the average of the other two years.
3. Use of cross terms: the equations used in data analysis were
primarily made of original variables relative to factors discussed in the
literature and corresponding chapters. However, in order to have a full
impact, these variables were combined in pairs and then included in the
equations along with the original variables.
4. Data limitation:
a. The model estimating the determinants of FDI did not include all
variables or factors contained in the literature. Variables
pertaining to natural resources, level of industrialization,

96
transparent policies towards FDI, and political stability were not
included in the model because the data was not available. Even
prior empirical studies that were reviewed in this thesis
discussed these factors in a qualitative approach. It is an
indication that there has not been yet an accurate way of
measuring these variables so as to be used in empirical
analyses. Regarding political stability, the sample used in the
regression analysis comprised of countries that are relatively
stable politically. Therefore, the exclusion of the variable
pertaining to political stability from the model did not affect the
overall result of the regression.
b. The model estimating the determinants of human capital did not
include variables pertaining to training and learning-by-doing.
Learning-by-doing and training are part of the three main types
of human capital. The data related to those variables was not
available for the sample (103 countries) used in the analysis.
Once data is available, I expect future studies (including my own)
to use those variables in their empirical analyses so as to have a
full impact of FDI on all various types of human capital.

97
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ABSTRACT

Title of Thesis: The ROLE OF FOREIGN DIRECT INVESTMENT

IN HUMAN CAPITAL FORMATION IN

DEVELOPING COUNTRIES: AN EMPIRICAL

Issa Kamangaza, Master of Art, May 2009

Thesis chaired by: Randal L. Reed, Ph.D.

Globalization has allowed a movement of various types of capital

has experienced massive inflows of FDI since 1990, which resulted in a

multitude of studies seeking to demonstrate the link between FDI, economic

growth, technology transfer to local firms, and human capital enhancement in

developing countries. This study focuses on the impact of FDI on human

capital formation in developing countries. It uses an empirical approach to

determine the impact of FDI on human capital accumulation in 103 developing

countries. Enrollments at primary, secondary, and tertiary school levels were

enhances the level of human capital in developing countries.

FORMATION IN DEVELOPING COUNTRIES: AN EMPIRICAL ANALYSIS

A Thesis Submitted in Partial Fulfillment

of the Requirements for the Degree

MORGAN STATE UNIVERSITY

All rights reserved

INFORMATION TO ALL USERS

THE ROLE OF FOREIGN DIRECT INVESTMENT IN HUMAN CAPITAL

FORMATION IN DEVELOPING COUNTRIES: AN EMPIRICAL ANALYSIS

has been approved

THESIS COMMITTEE APPROVAL:

I am extremely grateful to my thesis chair, Dr. Reed, for his guidance

that was constructive and instructive throughout the development and

completion of this thesis possible.

List of Tables ................................................................................................... vi

List of Figures ..................................................................................................vii

List of Acronyms ............................................................................................. viii

Chapter I: Introduction ...................................................................................... 1

Chapter II: Literature Review ............................................................................ 7

Chapter III: Determinants of FDI..................................................................... 18

Chapter IV: The Empirical Analysis of FDI Determinants ............................... 28

Chapter V: Factors Influencing Human Capital Accumulation ........................ 47

Chapter VII: Summary and Conclusion .......................................................... 90

Table 1: FDI Determinants .......................................................................................36

Table 2: Determinants of Human Capital ...............................................................71

Figure 1: GDP and FDI Flow....................................................................................38

Figure 2: Trade and FDI Flow ..................................................................................39

Figure 3: Life Expectancy and FDI Flow ................................................................40

Figure 4: Tertiary Enrollment and FDI Flow...........................................................41

Figure 5: Secondary Enrollment and FDI Flow .....................................................43

Figure 6: Primary Enrollment and FDI Flow ..........................................................45

Figure 7: FDI Flow and Primary Enrollment ..........................................................73

Figure 8: FDI Flow and Secondary Enrollment .....................................................74

Figure 9: FDI Flow and Tertiary Enrollment...........................................................76

Figure 10: Remittances and Primary Enrollment ..................................................77

Figure 11: Remittances and Secondary Enrollment ............................................79

Figure 12: Remittances and Tertiary Enrollment ..................................................80

Figure 13: GNI and Primary Enrollment .................................................................81

Figure 14: GNI and Secondary Enrollment............................................................82

Figure 15: GNI and Tertiary Enrollment .................................................................83

Figure 16: Life Expectancy and Primary Enrollment ............................................84

Figure 17: Life Expectancy and Secondary Enrollment.......................................86

Figure 18: Life Expectancy and Tertiary Enrollment ............................................87

AFTA: ASEAN Free Trade Agreement

CEFTA: Central European Free Trade Agreement

CIS: Commonwealth of Independent States

COMESA: Common Market for Eastern and Southern Africa

EU: European Union

ETDZ: Economic and Technological Development Zones