Foreign Direct Investment, Merchandise and Services Trade in a Transition Economy: The Case of Cambodia

Abstract

Since the liberalization of trade and investment in the 1990s, inward foreign direct investment (FDI) has been seen to play a greater role in forging trade flows, integration into the regional and international markets and economic development for a transition economy such as Cambodia. Despite her recent progress in attracting FDI and fostering trade, the direction of causality between inward FDI, exports and imports of merchandise as well as services has not been empirically explored. The findings show that inward FDI not only can promote both merchandise and services exports but also indicate the presence of backward and forward linkages, which could result in positive externalities. However, based on the impulse response analysis, it seems that merchandise exports are more vulnerable than services exports to an unanticipated shift in FDI inflows in the medium run.

Keywords:

• Causality
• Cambodia
• trade
• foreign direct investment

JEL CLASSIFICATIONS :

• C22
• F21

Notes

¹Accessed at http://www.state.gov/e/eeb/ifd/2005/41991.htm (accessed on October 1, 2007).

²The empirical approach used by Cuyvers et al. (2006) was based on simple regression analysis examining the impact of sectoral relative FDI flows on sectoral international trade position, while the current study applies the VAR Granger causality test to determine the causal linkages between inward FDI, exports and imports of merchandise (services).

³They are altogether 28 countries, which include the US, the European Union (EU), Japan and Australia.

⁴For instance, based on labor cost comparison in US$ per hour in apparel manufacturing countries in 2008, Cambodia offered a lower labor cost (US$0.22/hour) than Vietnam (US$0.38/hour), China ((US$0.55–1.08/hour), Malaysia (US$1.18/hour) and Thailand (US$1.29–1.36/hour), to name a few (accessed at http://www.emergingtextiles.com/?q=com&s=contacts) (accessed on 13 August 2009).

⁵The other transition economies in Indo-China are Laos, and Vietnam. By a broadly defined term, a transition economy is an economy that is changing from a planned economy to a free market. Transition economies undergo economic liberalization (removal of price control and lowering trade barriers), macroeconomic stabilization where immediate high inflation is brought under control, and restructuring and privatization in order to create a financial sector and move from public to private ownership of resources. These changes often may lead to increased inequality of incomes and wealth, dramatic inflation and a fall of GDP (http://en.wikipedia.org/wiki/Transition_economy).

⁶To make a note, most of the empirical studies (e.g. Pfaffermayr, 1994, 1996; Alguacil & Orts, 1999; Bajo-Rubio & Montero-Muñoz, 2001, etc.) examine the causal relationship between outward FDI and exports, which is somewhat unrelated to the study concerning the causal linkages between inward FDI and trade (or exports and/or imports).

⁷As informed by the empirical literature, it is intuitively hard to accept that the exports, imports, and FDI variables are stationary in levels. If we assume this intuition is true that all of these variables are I (1) and the VAR system was estimated by the first-differenced variables, then the causality results inform us that only the services trade (service exports and service imports, individually) Granger-causes the FDI in Cambodia. Further tabular results are available from the authors. Nevertheless, following the results suggested by both the ADF and PP tests, the VAR estimates provide richer findings on the causation between FDI–merchandise trade (exports and imports) and FDI–services trade (exports and imports) (refer to Section 4).

⁸This claim may be subjected to the proportion of exports accounted for by light industries that have attracted major portions of inward FDI in Cambodia during the period under consideration.

⁹For details of backward and forward linkages, see Sieh-Lee (2000).