Convergence and FDI

1
Bridging the Gap the Role of Trade and FDI in
the Mediterranean
June 8-9, 2006
Convergence and FDI in the Mediterranean basin
an empirical evidence
Giuseppe Notarstefano - Raffaele Scuderi
Dipartimento di Contabilità Nazionale ed Analisi
dei Processi Sociali Università degli Studi di
Palermo, Italy
2
Structure
1 Purpose
2 Statistical approaches to test convergence
hypothesis i. Review of literature choice of
the methodology ii. Methodology the
Stochastic Kernel iii. Empirical findings
3 Relationship between FDI and growth i.
Review of literature ii. Methodology the
Stochastic Kernel in a deterministic conditioning
scheme iii. Empirical findings
4 Conclusions
5 - Conclusions
3
1. Purpose
To assess growth dynamics of countries agreeing
to the Euro-Mediterranean Partnership (EMP)
In particular
Per capita income convergence test
Role of Foreign Direct Investments (FDI) for
economic growth
4
2.i Convergence Review (1)
Implication of neoclassical theory of growth
long term reduction of per capita income gaps
(Solow, 1956 Cass, 1965 Koopmans, 1965)
Decreasing marginal productivity of capital
CONVERGENCE HYPOTHESIS (CH)
5
2.i Convergence Review (2)
CONVERGENCE HYPOTHESIS TESTS
Contributions are classified into two categories
Absolute convergence
Per capita incomes of a given set of countries
converge to the unique steady state
Conditional convergence
Each economy converges towards its own steady
state, proxied by variables
Per capita income needs to be conditioned to a
set of proxies
Test the influence of proxy variables to economic
growth (endogenous growth theory)
No strong empirical evidence is found about
factors influencing economic growth
Durlauf and Quah (1998) - the choice of steady
states proxies depends on the interest of the
researcher
6
2.i Convergence Review (3)
CONVERGENCE HYPOTHESIS TESTS
Absolute convergence
Conditional convergence
7
2.i Convergence Review (3)
CONVERGENCE HYPOTHESIS TESTS
there are reasons other than the testing of
economic growth theories for the empirical study
of economic convergence. We, as economists, are
interested in knowing whether the distribution of
income changes over time (Sala-i-Martin,
1996) the new research no longer makes
production function accounting a central part of
the analysis. Instead, attention shifts more
directly to questions like, Why do some countries
grow faster than others? It is this changed focus
that, in our view, has motivated going beyond the
neoclassical growth model (Durlauf and Quah,
1998)
Absolute convergence
Conditional convergence
Classification of the approaches, according to
the methodology employed
Cross-section
Panel data
Time series
8
2.i Convergence Review (4)
Cross-section approach
Sigma convergence variability of per capita
income, as measured by the coefficient of
variation, reduces over time
Beta convergence
absolute no Xi,t
? reject CH on a set of world countries Baumol
(1986)
conditional
? accept CH on a set of world countries Barro and
Sala-i-Martin (1992) Mankiw et al. (1992)
country is per capita income at time t
9
2.i Convergence Review (4)
Cross-section approach
Sigma convergence variability of per capita
income, as measured by the coefficient of
variation, reduces over time
Beta convergence
absolute no Xi,t
? reject CH on a set of world countries Baumol
(1986)
conditional
? accept CH on a set of world countries Barro and
Sala-i-Martin (1992) Mankiw et al. (1992)
country is per capita income at time t

• Quahs criticisms
• parametric tests generally refer to the
  behaviour of a representative unit, and they are
  then unsuitable to catch the more real situations
  of polarization and club convergence
• sigma and beta convergence approaches are shown
  to be uninformative about convergence in some
  cases
• beta convergence approach does not properly
  consider dynamics

10
2.i Convergence Review (5)
Panel data approach
Islam (1995) each steady state is better proxied
by employing a fixed effects panel estimator,
otherwise convergence effect would be
underestimated.
? accept CH on a set of world countries
Quahs criticism individual heterogeneities
conditioned out by panel data regression contain
those characteristics which are treated as
something not consistently estimable (Quah, 1999)
Time series approach
Bernard and Durlauf (1995) test the presence of
common long-run trends between per capita GDP
series Hobjin and Franses (2000) propose an
algorithm to detect clubs of converging countries
? reject CH
? accept CH
Evans and Karras (1996) perform a unit root test
on panel data
Quahs criticism these tests do not put in
account cross-sectional information
11
2.ii Convergence Methodology (0)
parametric tests generally refer to the
behaviour of a representative unit, and they are
then unsuitable to catch the more real situations
of polarization and club convergence
12
2.ii Convergence Methodology (0)
parametric tests generally refer to the
behaviour of a representative unit, and they are
then unsuitable to catch the more real situations
of polarization and club convergence
Univariate density estimates of per capita income
1982
All (1960-2003)
1971
1993
26 countries Algeria, Austria, Belgium, Cyprus,
Denmark, Egypt, Finland, France, Germany, Greece,
Ireland, Israel, Italy, Jordan, Lebanon,
Luxembourg, Malta, Morocco, Netherlands,
Portugal, Spain, Sweden, Syria, Tunisia, Turkey,
United Kingdom
13
2.ii Convergence Methodology (1)
Quahs distribution dynamics approach the
stochastic kernel (SK)

• - Time series methodology which also considers
  sectional information
• - Each periods observation is not a scalar or a
  finite-dimensional vector, but a distribution
• Nonparametric estimate of the law of motion of
  the evolving income distribution based on some
  properties of Markov chains

SK is a transition probability matrix in the
continuum. It tracks income distributions
evolution over time
14
2.ii Convergence Methodology (1)
Quahs distribution dynamics approach the
stochastic kernel (SK)

• - Time series methodology which also considers
  sectional information
• - Each periods observation is not a scalar or a
  finite-dimensional vector, but a distribution
• Nonparametric estimate of the law of motion of
  the evolving income distribution based on some
  properties of Markov chains

SK is a transition probability matrix in the
continuum. It tracks income distributions
evolution over time
is a measure corresponding to Ft (the
cross-country distribution of per capita income
at time t)
?t
?t1 M ?t
(1)
the relation that links ?t1 with ?t is analogous
to a standard time-series first-order vector
autoregression
M maps then how yt evolves at t1 it also
contains information about distribution dynamics
and shape.
Iteration of (1) estimates future density
distribution
?ts (M M M) ?t Ms ?t
15
2.ii Convergence Methodology (2)
Stochastic kernel estimation (Quah, 1995 1997)
We consider relative to the mean income
- Epanechnikov kernel nonparametrically estimates
the joint density of relative income at dates t
and t5
Silvermans criterion is employed for the choice
of the bandwidth h
- The current-period marginal density, implied by
that estimated joint density, is calculated by
integration
- Stochastic kernel is obtained by dividing the
joint density by the marginal
16
2.ii Convergence Methodology (3)
Stochastic kernel output and interpretation
Ft
Ft1
?t
?t1
then M ?t1 M ?t

• PROBABILITY MASS
• Located along the 45-degree diagonal
  persistence in the economies relative position
• Concentrated along the perpendicular line to the
  45-degree diagonal overtaking of economies in
  their rankings.
• Parallel to tk axis the probability of being
  in any state at period tk is independent of
  economies position at t
• Parallel to the t axis convergence

17
2.iii Convergence Results
Convergence analysis of relative per capita GDP
over 1960-2003, 5 years transition (EMP)
26 countries Algeria, Austria, Belgium, Cyprus,
Denmark, Egypt, Finland, France, Germany, Greece,
Ireland, Israel, Italy, Jordan, Lebanon,
Luxembourg, Malta, Morocco, Netherlands,
Portugal, Spain, Sweden, Syria, Tunisia, Turkey,
United Kingdom
Data source The World Bank (2005)
18
3.i FDI-growth Review (1)
Foreign debt crisis of developing countries
(Eighties)
Attention to no debt creating flows like FDI
Many countries offered tax incentives and
subsidies to attract foreign capital
FDI nowadays accounts for over 60 percent of
private capital flows
Increase of FDI towards Mediterranean developing
countries (DCs) has been considerably smaller
than the one shown by all the DCs
LMIC Low and Middle Income Countries MPC
Mediterranean Partner Countries
FDI/GDP ratio
19
3.i FDI-growth Review (2)

• Theoretical FDI spillover effects
• stock of human capital
• propension to invest
• per capita income

but
Carkovic and Levine (2002) While there are
sound conceptual reasons for believing that FDI
can ignite economic growth, the empirical
evidence is divided
20
3.i FDI-growth Review (3)
Macroeconomic analyses
Prevailing literature positive relationship
between FDI and growth
Borensztein et al. (1995) set of 69 developing
countries receiving flows from industrialized
countries Balasubramanyam et al. (1999) Asian
and South American countries Alfaro et al.
(2000) three samples of countries, ranging from
developing to advanced Berthélemy and Démurger
(2000) Chinese provinces Nair-Reichert and
Weinhold (2001) sample of 24 developing
countries Notarstefano and Scuderi (2004) EMP
countries
Carkovic and Levine (2002)
They criticise methodologies employed by
macroeconomic approaches, which often do not
control for simultaneity distortions and specific
country effects.
Dynamic panel estimation on a set of countries,
ranging from developing to advanced. FDI are
found to be not related with growth
21
3.i FDI-growth Review (4)
Microeconomic analyses at firm level
Positive spillover effects of FDI
Liu (2002), 29 manufacturing Chinese
industries Branstetter (2006) Japanese firms
investing to the US
Absence of spillover effects
Aitken and Harrison (1999) firms in Venezuela
see also Germidis (1977), Haddad and Harrison
(1993), Mansfield and Romeo (1980)
22
3.ii FDI-growth Methodology (1)
Stochastic Kernel deterministic conditioning
scheme (Quah, 1997)
Nonparametric analysis of original distribution
compared to its conditioned version
The approach aims to catch how a conditioning
factor alters the original distribution
Regression-like rationale
23
3.ii FDI-growth Methodology (1)
Stochastic Kernel deterministic conditioning
scheme (Quah, 1997)
Nonparametric analysis of original distribution
compared to its conditioned version
The approach aims to catch how a conditioning
factor alters the original distribution
Regression-like rationale
an integer indicating the lag in time
a subset of countries from the set I
Conditioning scheme G collection of the triple
a set of probability weights, which sum to 1
value of the original distribution Y at time t in
region i
conditioned version of
24
3.ii FDI-growth Methodology (2)
Our estimation
is the absolute distance of FDI value in region i
from the value in region j.
Following Quah (1995, 1997)
mean-relative per capita GDP
Silvermans criterion for the choice of the
bandwidth h
Epanechnikov kernel
is the ratio
25
3.iii FDI-growth Results (1)
Original and conditioned-to-FDI-inflows per
capita GDP, over 1990-2003 EMP countries
32 countries Algeria, Austria, Belgium, Cyprus,
Czech Republic, Denmark, Egypt, Estonia, Finland,
France, Germany, Greece, Hungary, Ireland,
Israel, Italy, Jordan, Latvia, Lebanon,
Lithuania, Morocco, Netherlands, Poland,
Portugal, Slovak Republic, Slovenia, Spain,
Sweden, Syria, Tunisia, Turkey, United Kindgom
Data source The World Bank (2005)
26
3.iii FDI-growth Results (2)
Original and conditioned-to-FDI-inflows per
capita GDP, over 1990-2003 non-EU-in-1992 EMP
countries
10 countries Algeria, Cyprus, Egypt, Israel,
Jordan, Lebanon, Morocco, Syria, Tunisia, Turkey
Data source The World Bank (2005)
27
3.iii FDI-growth Results (3)
Original and conditioned-to-Italian-FDI-inflows
per capita GDP, over 2000-2003 EMP countries
34 economies Algeria, Austria, Belgium, Cyprus,
Czech Republic, Denmark, Egypt, Estonia, Finland,
France, Germany, Greece, Hungary, Ireland,
Israel, Jordan, Latvia, Lebanon, Lithuania,
Luxembourg, Malta, Morocco, Netherlands, Poland,
Portugal, Slovak Republic, Slovenia, Spain,
Sweden, Syria, Tunisia, Turkey, United Kindgom,
West Bank and Gaza
Data source The World Bank (2005) and Italian
Exchange Office (Ufficio Italiano Cambi, 2006)
28
3.iii FDI-growth Results (4)
Original and conditioned-to-Italian-FDI-inflows
per capita GDP, over 2000-2003 non-EU-in-1992 EMP
12 economies Algeria, Cyprus, Egypt, Israel,
Jordan, Lebanon, Malta, Morocco, Syria, Tunisia,
Turkey, West Bank and Gaza.
Data source The World Bank (2005) and Italian
Exchange Office (Ufficio Italiano Cambi, 2006)
29
4 Conclusions

• - Literature on convergence hypothesis tests has
  been divided about the methods to employ, and the
  presence of convergence in real data
• - The choice of the methodology has been driven
  by statistical consideration about methodologies
  previously applied and by characteristics of per
  capita income density estimate
• - SK analysis suggests that no convergence has
  occurred between countries agreeing to the
  Euro-Mediterranean Partnership, as expected.
  Income gaps have then persisted over 1960-2003.
• - A regression-like rationale has been applied to
  SK as done in Quah (1997). Evidence indicates
  that FDI have a positive influence on income
  distribution. This confirms the evidence of the
  prevailing macroeconomic empirical analyses.
• Cluster persistence within EMP countries, as
  well as the influence of FDI for growth, have
  also been shown in a previous contribution
  (Notarstefano and Scuderi, 2004)
• Future research may be based on the concept of
  growth as multidimensional phenomenon, as pointed
  out by recent literature on living standards, and
  as also done in our previous work