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    TIẾN SĨ A Study on the Impact of Foreign Direct Investment on Economic Development of Lao P.D.R.

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  6. A Study on the Impact of Foreign Direct Investment on Economic Development of Lao P.D.R.

    1.1 Research Background
    Laos is a small landlocked country with an area of 236,800 square kilometers. It shares its borders with Vietnam in the East, China in the North, and Cambodia in the South, Thailand and Myanmar in the west. Two third of the country is mountainous (northern part) thus its geographic circumstances constrain both the quality and quantity of agriculture and cause difficulties to the development of trade, social infrastructure and transportation and communication links. However, the country has transformed from a landlocked to a land link and cross road to other parts of the world.
    In 1986, the Lao government implemented the New Economic Mechanism (NEM) to open the country and provided incentives for developers and investors and moved from a centrally planned economy to a market oriented economic model.
    FDI inflows in Laos have grown dramatically over the past decade and have played an important role in the growth of the world economy as well as the ASEAN Nations. In the developing world, FDI has become the most stable and largest component of capital flows. As a result, FDI has become an important alternative in the development finance process (Global Development Finance, 2005.)
    Laos is a small and still poor country. Therefore, the investment from foreign countries in terms of FDI is needed because FDI plays an important role in job creation, economic growth, capital inflow, technology transfer, human resource development, and wealth in the host country. Thanks to the economic reform, the number of FDI projects and the income on international trade have increased significantly and have had a direct impact on national income as well as GDP growth.
    1.2 Rationale for the Research
    It has been suggested that Foreign Direct Investment (FDI) inflows have played an important role in promoting economic growth in developing countries, especially in the Southeast Asian countries (Nguyen, 2008).
    Given the importance of FDI especially in developing countries like Laos, theoretically as well as practically, there are however still inconclusive arguments for and against the role of FDI inflows in enhancing economic development in a country (cf., Nguyen, 2008). It has still been debate about whether FDI inflows are beneficial or not to economic development, and what governments should do to attract and use FDI inflows effectively (Kokko et al., 2003; Longani & Razin, 2001; Masina, 2002; Nguyen, 2008). In addition, it has been suggested that the relationship between FDI and economic growth may be country and period specific (cf., Adegbite & Ayadi, 2010). Therefore, this study aims to explore the impact of FDI inflows on some indicators of economic development in the context of Laos, a developing country in Asia.

    1.3 Research Objectives and Research Questions
    This study seeks to analyse FDI inflows into Laos and to investigate their impact on the economic development of Laos. The desired outcome of this research aims at confirming the linkage between FDI inflows in Laos and the economic development indicators including GNI per capita, financial capital, level of technology, human capital, energy and natural resources, transportation and communication.
    This research tried to answer the questions: 1) What are the relevant literature and the theoretical background on FDI and its impact on economic development? and 2) Does FDI have a significant contribution to economic development of Laos?
    With regard to the impact of FDI on economic development, the research aims to answer the following specific questions:
    · Does FDI have a significant role on the GNI per capita?
    · Does FDI have a significant role on the Financial Capital?
    · Does FDI have a significant role on the country's level of technology of Laos?
    · Does FDI have a significant role on Human Capital of Laos?
    · Does FDI have a significant role on the Energy and Natural Resources availability of Laos?
    · Does FDI have a significant role on the Transportation and Telecommunication infrastructure of Laos?

    1.4 Scope of the Study
    This study focuses on the role of FDI on some indicators of economic development in the context of Laos. Other aspects of development such as social and environmental issues (i.e., poverty ratios of different sectors, education and health care, environment pollution and damage) are not addressed in this dissertation.
    This study mainly employed the data to analyse the relationships between FDI and Laos’ economic development indicators during the period 1990-2012. The analyses of correlations were used to serve the objectives of this research.

    1.5 Contributions of the Study
    This study aims to examine the impact of FDI on several economic development indicators in the context of Laos. The study is important to help Laos enjoy further economic development as well as contributes to the literature of FDI and economic growth in the context of developing countries.
    FDI has been suggested as a determinant of economic development in both developed and developing countries. Its important role in promoting economic growth and bringing many benefits to the economy is especially emphasized in the context of developing countries. However, the literature also provides mix findings pertaining to the effects of FDI, and there has been suggested that the link between FDI and economic development may be country and period specific. Therefore, it is important and meaningful to examine the impact of FDI inflows on economic development in Laos, a developing country which has received very modest research attention to date.
    By focusing on six main research questions pertaining to the relationships between FDI inflows and various indicators of economic development, the research has contributed to both theoretical and practical sides. From theoretical perspective, the research helps to enrich the knowledge about the important topic pertaining to FDI’s impacts on economic development in general and in the context of a developing country in particular. From practical perspective, the research findings provide significant implications to policy makers in Laos.
    The issue of FDI and its important role is more important for developing countries and the countries in transition like Laos because they lack capital, know how, and managerial skills. Understanding the role of FDI would help making good policies to attract more FDI for the purpose of economic development.

    1.6 Dissertation Structure
    This dissertation includes six main chapters as follows.
    Chapter 1: Introduction
    Chapter 2: Literature review on the impact of FDI on economic development
    Chapter 3: Overview of economic development and FDI in Laos
    Chapter 4: Research methodology
    Chapter 5: Research findings
    Chapter 6: Conclusions and discussion


    This chapter reviews the literature on IJVs’ performance and the factors influencing it. In the first section of the chapter, the literature on the five common measures of IJV performance were reviewed, followed by the review of the key determinants of IJV performance. Finally, the proposed conceptual framework is presented.
    2.1 Definition and Indicators of Economic Development

    2.1.1 Definition of Economic Development
    Economic development is a normative concept. It means that it applies in the context of people's sense of morality (right and wrong, good and bad). The definition of economic development given by Todaro (1994) is an increase in living standards, improvement in self-esteem needs and freedom from oppression as well as a greater choice. The most accurate method of measuring development is the Human Development Index which takes into account the literacy rates and life expectancy which affect productivity and could lead to economic growth. It also leads to the creation of more opportunities in the sectors of education, healthcare, employment and the conservation of the environment. It implies an increase in the per capita income of every citizen (Todaro, 1994).

    The terms economic development and economic growth are used interchangeably but there is a big difference between the two. Economic growth can be viewed as a sub category of economic development. Economic development refers to government policy to increase the economic, social welfare and ensure a stable political environment. Economic growth on the other hand refers to the general increase in the country products and services output (source: whatiseconomics.org).

    2.1.2 Indicators of Economic Development
    In literature, previous studies have examined various aspects of economic development. In this study, the author examines the impact of FDI on economic development in Laos, focusing on some economic development indicators including:
    - Gross National Income (GNI) per capita
    - Financial Capital
    - Level of technology
    - Human Capital
    - Energy and Natural resources
    - Transportation and Communication

    2.1.3 Theoretical Economic Overview
    This section review several economic models such as Lewis' Dual Economy model (1954), Solow's model (1956), the Harrod-Domar growth model, and Dependency theory (Pool & Stamos, 1990).
    2.2 FDI and its Impact on Economic Development

    2.2.1 Definition and Determinants of FDI Definition of FDI and reasons for FDI inflows to developing countries

    FDI is defined as cross-border investment by a resident entity in one economy with the objective of obtaining a lasting interest in an enterprise resident in another economy. The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence by the direct investor on the management of the enterprise. Ownership of at least 10% of the voting power, representing the influence by the investor, is the basic criterion used (OECD, 2012).
    In the same line, according to investopedia.com, FDI refers to an investment made by a company or entity based in one country, into a company or entity based in another country.
    Yoonbai (2000) examined the reasons behind the flow of FDI in countries like Korea, Malaysia, Chile, and Mexico. The research found that this flow was influenced by two factors on a global level: recessions faced by many industrialized economies and the global interest rate drop. Internal factors like (a) country-specific productivity shocks, (b) demand shocks, (c) inflation shocks,(d) monetary shocks, (e) credit worthiness because of macroeconomic stabilization, (f) widespread liberalization of financial market, and (g) a successful resolution of debt problems were found relatively less important. Determinants of FDI
    There have been a number of theories and approaches that help explain the motivations of FDI and identify FDI’s determinants.
    - Internalization
    - Eclectic paradigm
    - Complement Theory of FDI
    - The Resource-Based Theory
    - The Theory of New Economic Geography
    - Diversified FDI and risk diversified model
    - Policy determinants of FDI
    2.2.2 Impact of FDI on economic development

    In this section, first the author review previous studies on the impact of FDI on economic growth and some other aspects of economic development, mainly in the context of developing countries. After that, a review of the studies on the impact of FDI on economic development through human capital and technology is provided. Finally, the author presents FDI and its spillover effects. Impact of FDI on economic growth and other economic development aspects Impact of FDI on Economic Development through Human Capital Impact of FDI on Economic Development through Technology Foreign Direct Investment and Spillovers

    3.1 Overview of Laos’ Economy

    This section presents various aspects of Laos’s economy, inclusing economic growth, economic structural changes, etc.

    3.1.1. Economic growth

    On average, the Gross Domestic Product (GDP) during the Sixth Plan period was 219,853 billion kip, approximately 43,970 billion kip per year. GDP grew at an annual rate of 7.9%, which was higher than the Sixth Five-Year Plan target (the plan target was 7.5%). In FY 2009-2010, the value of GDP was 54,282 billion Kip which was 1.89 times higher than FY 2004-2005. The growth in share of agriculture in GDP was 4%, of industry was 12.6%, and of services was 8.4%.
    3.1.2 Economic structural changes

    The economic structure has changed as an economy transforms from a subsistence agriculture economy based on raw materials to a market-oriented economy based on processing.
    3.1.3 Financial sector growth

    During the past years, the banking sector has contributed to financial stability, and the foreign exchange rate has remained stable. This is reflected in the money supply growth at 23% per year which contributed to19.6% of GDP. Foreign exchange grew and contributed to approximately 35% of GDP in 2009-2010. An increase in the money supply or M2 was contributed by the increasing numbers of foreign investors.
    3.1.4 Banking sector development

    The banking sector is one of the sectors that grew rapidly and distinctly during the period of the Sixth Five-Year Plan.
    3.1.5 Inflation has been effectively managed
    3.1.6 The appreciation of the Kip currency
    3.1.7 Workforce and employment balance

    3.1.8 Balancing the sources of funds for development

    3.1.9 Balancing the State budget

    3.1.10 Balancing imports and exports

    3.1.11. Sectoral development, regional and international economic integration

    3.1.12 Infrastructure

    3.2 Foreign Direct Investment in Laos

    FDI plays very important role in many developing countries in generating capital, job employment and technology transferring. As a trend of FDI moves forward to country which rich in natural resources and have advantage in cheap labor, in the case of Lao PDR it is also no exception.
    Before 1985, there was not any FDI inflow to Lao PDR. With the Investment Law in 1994 onward the government of Laos PDR has paid attention in attracting FDI by improving business environment, political stability and macroeconomic policy, its commitment to be member of WTO and AFTA which giving foreign investors in flavor of investment incentive especially in tax policy and land policy. However with the implementation of Investment Law in 2004 which given huge investment incentive to foreign investors especially tax incentive, as the resulted in 2005 onward the FDI inflow has been significantly increased especially in mining sectors and hydropower sectors. In 2006 the FDI inflow soared to US$187 million and reached a peak at US$323.5 million in 2007.
    FDI inflows to Lao PDR fell considerably in 2008 due to the impact of the global economic crisis. The nominal FDI inflow value was decline from about US$323.5 million in 2007 to US$227.7 million in 2008 (or by about 30 percent) due to recent delays of new hydropower and mining projects, as well as slow growth in the non-resource sectors. However, the FDI inflow to Laos has quickly recovered at around US$300 million in 2009- 2011 period.
    The majority of FDI goes to natural resource sectors. Major FDI to Lao PDR in recent years comes from the region, mainly from Thailand, China, Vietnam, Australia, India, Japan, and Korea. Vietnam now has become the Laos' biggest foreign investor during the period since the Lao Government first adopted foreign investment incentive policies (1989-2012). The most popular fields for foreign investors are the mining industry (accounting for 27 percent), electricity production (25 percent), agriculture, services, processing, hotels, restaurants, telecommunications, construction, industry, and banking.

    This chapter describes research methodology used in this study. First, research questions are briefly presented and the statistical method used to test the impact of FDI on economic development in Laos. Next, variables and their measures are provided. Finally, the author presents a detailed description of data employed for this study.

    4.1 Research Questions

    In addition to reviewing the relevant literature, the research tried to answer the question: Does the FDI have a significant contribution to economic development for Laos? In particular, the research answers the six specific questions regarding the relationships between FDI and six aspects of economic development.
    4.2 Variables and measures

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