Abstract
This research is focused on direct foreign investment in Indonesia and to analyze its influence to the export and economic growth. The analysis on this research is based on time series data and is processed by utilizing the simultaneous equation model.
The result of the analysis indicates that market size variable and variation in the exchange rate yields in a positive FDI flow. Bigger GDP shows a large market size, the condition which reduces market offer value and lowers cost per output unit. Fluctuating exchange rate shows uncertain business prospect. Other variables such as real exchange rate, budget deficit ratio on GDP and interest rate yields a negative influence on FDI. The increase of real exchange value causes overseas commodity price increases and consumer would prefer domestic commodities. High budget deficit shows an unstable macro economy. High interest rate causes investors reluctant to invest.
Foreign Direct Investment (FDI) provides positive influence on the economic growth rate. The investment fills the resource gap between the target investment rate and the actual domestic savings. Besides that, the foreign investment encourages economic growth through transfer of technology. The positive externalities of technology effect provides the best possibility to FDI to encourage economic growth.
Direct Foreign Investment provides a positive effect on export performance. It means that Indonesia’s FDI is a pro-trade FDI. Hence, it increases trade and exchange balance. Pro- trade FDI means investment in industries where the country lacks of comparative strengths.
Therefore, the investment would accelerate bilateral trade and promote an industrial restructure which is beneficial for both countries.
1.1. Introduction
New order of government makes effort to attract foreign investment to make changes – fundamental change in the foreign investment policy. These conditions are applied because discriminatory policies against foreign investment occurred during the old order, particularly from western countries. Investment improvement was began with the enactment of Law No. 1 of 1967 on Foreign Direct Investment (FDI).
Development of foreign direct investment in Indonesia at the beginning of 1981 to 1996 showed an increasing trend from U.S. $ 133 million to 6194 million U.S. $. Decline of foreign investment value began to happen until 2001 and showed improvement in 2004 and 2005. When we review the ratio of foreign direct investment (FDI) to GDP in general, it can be seen that the value is still very low even it can’t reach 0.05.
The low ratio of foreign direct investment (FDI) to PDB gives a low impact on economic growth. Several empirical studies find that there is a positive correlation between foreign investment and economic growth. Empirical research results show that foreign direct investment promotes economic growth through increased productivity factor (Fry, 1996). Other similar studies also show that foreign investment has a positive effect on economic growth and domestic savings in developing countries in Central Asia (Rana and Dowling, 1988). Other studies done by Borensztein Et al (1995), Rilam (1997), De Mello, Jr. (1999), Flexner (2000), and Bailliu (2000) show similar results. From the results of the empirical research, it can be concluded that the low value of foreign direct investment will have an impact on the low economic growth.
Meanwhile, since the collapse of world oil prices at around the 1980’s led to the financing of the budget deficit in the development of Indonesia. Significant events that have an impact on the declining ability of the state to support a strategy based on import substitution industries. Therefore, the government tried to implement an export-oriented trade strategy, in order to replace the country’s foreign exchange earnings from oil revenues lost (Robinson, 1998). Export is one of the development strategies that can be implemented to overcome the scarcity of resources in addition to capital investment (to attract capital from international markets). The economic crisis on Indonesia’s export growth fell by 8.6% in 1998. Indonesia’s exports gradually experiencing significant growth from year 2002 – 2005, which in 2002 grew by 1.49% and increased to 19.52% in 2005. The figure is the highest since 1990.
Is the increase of Indonesia’s exports since 2002 to 2005 related to the presence of foreign direct investment? Because if we associate with the presence of export growth of foreign direct investment empirically known (Kojima, 1973): that foreign direct investment has two different effects on the macro economy; the first effect is called the impact of trade and the effects and the second one is the effect on anti-trafficking. If foreign direct investment has the effect of trade, foreign direct investment is expected to affect the increase in the trade balance. If foreign direct investment is as anti-trafficking, trade balance is expected to decrease.
Empirical research shows that foreign direct investment has a positive effect on exports or the trade balance of a country (Soliman, 2003). Other studies (Suryawati, 2000) show: that foreign direct investment has a positive impact on exports in the country – the East Asian countries. Foreign direct investment is able to enhance the exports of countries – countries of East Asia. This is because of the presence of business relations between multinational companies in countries of origin and destination of foreign direct investment.
Based on the above theories, the writer is interested in studying about “Factors Affecting Foreign Direct Investment Flows and Analyze the Effects of Foreign Direct Investment on Indonesia’s Export and Economic Growth”.
1.2. Methodology
1.2.1. Object
In more details, the objects of the study are Foreign Direct Investment, Real Gross Domestic Product, Interest Rates, Nominal Exchange Rates, Deficit, Economic Growth, Government Spending, Foreign Loans, Population Growth, Exports, Real Exchange Rates and Inflation.
1.2.2. Method of Analysis
The method of analysis used in this study is a quantitative analysis method. This method exposes all data and information related to estimation of processed objects through statistically-econometric research.
1.2.3. Operationalization of Variables
To give a clear explanation of the variables to be analyzed, it is necessary to emphasize the limits of operationalization of variables to avoid mistakes in the understanding of the variables used. For more detail explanation, see table 1.
1.2.4. Concept of Analysis
In this study, the data will be analyzed using regression models simultaneously (simultaneous equation model). The variables in the model were developed based on literature review and empirical study. For more details, see table 2.
The model used is as follows :
FDI /PDB= ζ 0+ ζ 1 (PDB)+ ζ 2(LIBOR) + ζ 3(PER) + ζ 4(RER) + ζ 5(DA/PDB) + ε……… 1
LPE = ν0 + ν1(FDI/PDB) + ν2(BP) + ν3(PLN) + ν4(Gwpop) + τ………………… 2
X = κ0 + κ1 (FDI/PDB) + κ2 (RER) + κ3 (INF) + φ…………………….. 3
Note :
FDI = Foreign Direct Invesment
GDP = Real Gross Dometic Product
LIBOR = LIBOR Interest Rate
PER = Changes in Nominal Exchange Rates
RER = Real Exchange Rates
DA = Budget Deficit
LPE = Economic Growth Rate
BP = Government Spending
PLN = Foreign Loans
X = Ekspor
INF = Inflation
ε , τ, φ = Error Term
* Fitted
Table 1 Operationalization of Variable
| No | Variable | Concept of Variable | Proxy | Dimension | Scale | Label in the Model |
| 1 | Foreign Direct Investment | Investors’ investment in a country done by foreign private company | – | Million US$ | Ratio | FDI/GDP |
| 2 | Market Size | Potential markets in a region | Real PDB | People | Ratio | GDP |
| 3 | LIBOR | The Interest Rate set by Bank of London | – | % (percentage) | Ratio | LIBOR |
| 4 | Changes in Nominal Exchange Rates | Changes in Nominal Exchange Rates. The value is obtained by reducing the Nominal Exchange Rate in the period – n to the Nominal Exchange in the period n-1 | Point | Ratio | PER | |
| 5 | Real Exchange Rates | Relative price of goods in a country | – | Unit | Ratio | RER |
| 6 | Budget Deficit | The difference between government revenues and expenditure | Billion Rp | Ratio | DA | |
| 7 | Economic Growth | The Growth of Value of Real Gross Domestic product | – | % (percentage) | Ratio | LPE |
| 8 | Government Spending | Government spending in a particular year on Budget list | – | Billion Rp | Ratio | BP |
| 9 | Foreign Loans | A loan made by a country to another country or international financial organizations | – | Million US$ | Ratio | PLN |
| 10 | Population Growth | Population Growth in a particular year | % (percentage) | Ratio | Gwpop | |
| 11 | Export | Total export revenues earned in a particular year | – | Million US$ | Ratio | X |
| 12 | Inflation | Inflation is the rate of change of consumer price index | – | % (percentage) | Ratio | INF |
| 13 | Real Gross Domestic Product (GDP) | The value of goods and services measured by using a constant price. In this case using constant price 2000 ( 2000 = 100 ) | – | Billion Rp | Ratio | GDP |
