Inflow of FDI has a positive impact on the per capita income of India

The previous article empirically examined the impact of Foreign Direct Investment (FDI) inflows in India on its GDP. The rate of growth of GDP mainly reflects the growth performance of the country. Since growth and development are related concepts in Economics, this article attempts to relate FDI to a development indicator. In particular, this article investigates the impact of FDI inflows in India on the reduction of poverty. It examines whether FDI has a positive relationship with per capita income.

Per capita income as a proxy for poverty

FDI can be related to development in various ways. In respect of different types of advancing private sector investment, FDI enhances corporate administration. FDI can help enhance natural and labour living standards by generating taxes that support to reduce income inequality. Furthermore, FDI inflows help to bring advanced technologies and create employment opportunities. This, in turn,  improves the standard of living by increasing per capita income (Islami, Mulolli, & Skenderi, 2016). This article contends that FDI is a key element for economic development.

The figure below shows the trend between per capita income and FDI for the period 1980 -2016. In recent years, per capita income has increased with an increase in FDI barring the global financial crisis period.

Figure 1: Per Capita Income and FDI Inflows in India as percentages of GDP. Source: World Bank, 2018.

Figure 1: Per Capita Income and FDI Inflows in India as percentages of GDP. Source: World Bank, 2018.

Empirical analysis

Data and Study Period

The annual time series data for FDI and per capita income as a proxy of poverty is taken from World Bank for the period 1980 to 2016. For undertaking the empirical analysis, the World Bank data for the following variables are used.

(a) Foreign Direct Investment as a percentage of GDP

(b) Per capita income as a percentage of GDP

Tests applied

Name of the Test
Objective
Variables
Unit Root Test To check stationarity in the data FDI, per capita income
Johansen Cointegration Test To check the long-run relationship FDI, per capita income
Granger Causality Test To determine the direction of causality FDI, per capita income
Time Series Regression To determine the impact of FDI on per capita income FDI, per capita income

Table 1: Tests applied for the Empirical Analysis

Variables and the model

For the regression analysis, per capita income as a proxy for poverty is the dependent variable and FDI is the independent variable. The basic model to find out the impact of FDI on poverty is

  PCI = f(FDI)

We test the null hypothesis that FDI has no impact on per capita income.

Unit root test for checking stationarity

First, the stochastic property of the variables is checked. For this, the Augmented Dickey-Fuller unit root test is used (Dickey & Fuller, 1981). Table 2 presents the results.

Series
(ADF) t statistic
ADF at 1% Level
ADF at 5% Level
FDI -1.4197 -3.6267 -2.9458
ΔFDI -6.8668* -3.6329* -2.9484*
PCI -2.5150 -3.6394 -2.9511
ΔPCI -5.7026 -3.6463* -2.9540*

Table 2: Augmented Dickey-Fuller Unit Root Test Statistics for PCI and FDI

Note: A variable is stationary when the ADF t-statistics is greater than the critical values and non-stationary when t-statistics is less than the critical value.

The t statistic values confirm that both the variables are non-stationary at levels. After first order difference, they became stationary. So, we can investigate the long-run relationship between the variables.

Co-integration test

There are many tests that were acknowledged in the literature for co-integration analysis such as the Co-integrating regression, Durbin-Watson test, Engle-Granger Co-integration test, and Johansen Co-integration test. But Johansen’s test for co-integration between the variables in the empirical model is used because it has an advantage over other mentioned tests. It takes into consideration the possibility of multiple co-integrating vectors (Johansen, 1988).

Maximum Ranks
Trace Statistic
5% Critical Value
Max Statistic
5% Critical Value
0 25.5350 15.49 24.5001 14.26
1 1.0349* 3.84 1.0349 3.84

Table 3: Johansen Co-integration between FDI and per capita income

Note: Johansen Co-integration Test (Trace and Max Value stat) Results for per capita income and FDI

The above table presents the results based on two statistics. One is the Eigenvalue statistic and the second is a max statistic. When the rank is zero, it means there is no co-integration relationship and if the rank is one, it means there is one co-integration equation and so on. The above results of Johansen co-integration are based on lag 1 with the linear deterministic trend.  The results of both trace and max statistic suggest that there exists a long run relationship between per capita income and FDI. Thus,  this means both the variables are moving in the same direction in the long-run.

Granger causality test

In this section, it is estimated the causality from FDI to per capita income and vice versa. Granger causality is applied to check the causal relationship between FDI and PCI. The results are presented below.

Null Hypothesis
F-Stat
Prob
FDI does not Granger cause  PCI 4.2250 0.0242*
PCI does not Granger cause FDI 6.9463 0.0033*

Table 4: Granger Causality between FDI and per capita income

The result of the Granger Causality test confirms that there is bidirectional causality between the two variables. Based on the p-values, both the null hypotheses in table 4 are rejected at 5% level of significance. The reverse causality holds in light of the fact that FDI Granger causes per capita income and vice versa. Moreover, the results indicate that if the FDI inflow increases, per capita income, will increase. This will enhance the standard of living and reduce poverty. On the other hand, the increase in per capita income will increase FDI inflows. It means both the variables have a strong causal effect and dependency on each other.

Regression analysis

We use a simple linear regression model to study the impact of FDI on per capita income.

PCI
Coef
t-value
P-value
FDI 1.0543* 2.78 0.009
Cons 3.5356* 7.42 0.000

Note: Superscripts “*” denote 1% level of significance

Table 5: Regression Coefficient of FDI

The results reveal that an increase in FDI will increase per capita income and validates FDI led income growth hypothesis. The coefficient shows that a 1% increase in FDI will cause an increase of 1.0543% in per capita income. The p-value is statistically significant at 1% level of significance. This helped to reject the null hypothesis.

A positive relationship between FDI and the per capita income

Foreign direct investment is a strategy that has numerous potential advantages for poverty reduction. This article investigated the relationship between per capita income and FDI inflows in India over the period of 1980-2016 by employing cointegration and Granger causality tests. Furthermore, the result of cointegration analysis shows that there exists a long-run relationship between FDI and per capita income. Furthermore, Granger causality tests resulted in bidirectional causality between them. Moreover, regression results imply that FDI has a positive and statistically significant impact on per capita income. The results are consistent with each other. Therefor, this proves that FDI inflows in India have had a significant impact on poverty reduction by increasing per capita income. This is because of the creation of skilled labour, infrastructure, investment opportunities and more jobs in multinational companies. However, there are various other indices used in Economic literature to measure poverty and there is disagreement among experts as to which are the most appropriate measures. In this respect, the relation between FDI and other poverty indices such as the ones based on purchasing power parity (PPP) and consumption patterns of essential goods can also be investigated. 

References

Umer Jeelanie Banday

Umer Jeelanie Banday

Research Analyst at Project Guru
Umer Jeelanie Banday is Pursuing PhD, Economics and has an M.Phil degree in economics. He is currently working as a Research Associate with Ministry of Commerce, Govt of India. His work is centered on Macroeconomics with modern econometric approach. Broadly, his methodological research focuses on Panel data and Times series data analysis for causal inference and prediction.
Mr. Banday has been a recipient of “Young Scholar Grant’ to attend the 40th National Bureau of Economic Research (NBER) summer Institute in Massachusetts USA, selected by Indian Council for Research on International Economic Relations (ICRIER). He has to his credit various research papers in national and international journals. He also serves as a reviewer to various Journals of Taylor & Francis Group, Emerald, Sage and Member of editorial board Macrothink Institute, United States.
Umer Jeelanie Banday

Related articles

Discuss

We are looking for candidates who have completed their master's degree or Ph.D. Click here to know more about our vacancies.