**2. Global trade and FDI**

#### **2.1 The relationship between trade and FDI**

Globalization and trade liberalization have increased integration of the world economy through financial and trade flows [12]. Global trade increased more than twice as fast as the global GDP in the last decade and growth of FDI outpaced the growth in global exports [1, 2]. **Figures 1** and **2** present the global FDI and trade trends from 1970 to 2019, former expressed in current billion US\$ and latter

*FDI and Its Impact on Trade in the East Asian Transition Economies DOI: http://dx.doi.org/10.5772/intechopen.97214*

#### **Figure 1.**

*Trends of global FDI and trade (current billion US\$). Source: World Bank.*

#### **Figure 2.**

*Trends of global FDI and trade (% of GDP). Source: World Bank.*

expressed in a ratio of GDP. Global trade volume accounted for 27% (\$767 billion) of global GDP in 1970, 38% (\$8.7 trillion) in 1990, and 51% (\$15.8 trillion) in 2000. But as in 2019, it accounts for 60% (\$49 trillion) of global GDP. Total global FDI net inflow was \$12 billion in 1970, passing \$100 billion in 1987, reaching \$1.4 trillion in 2000, and \$2.1 trillion in 2016.

The figures show that increase in global trade has been accompanied by a rapid growth of FDI. While trade gradually increases during the period both in terms of GDP or current US\$, FDI shows a more volatile trend than trade with more fluctuations. Both trade and FDI fell significantly during the global financial crisis in 2008, seemed to recover, but are slowing down and decreasing in recent years. In particular, current FDI inflow (\$1.6 trillion in 2019) is far below the highest record point of \$3.1 trillion in 2007.

Before investigating the relationship between FDI and trade, the role of trade and FDI in economic growth is briefly explained. In general, FDI and trade development are both regarded to positively contribute to economic growth although the trends of FDI and global trade are not always correlated [3]. Theoretically, FDI is considered as an important exogenous source that enables capital accumulation of recipient countries. Inflow of FDI enables the recipient country to create new job opportunities, improve infrastructure, increase productivity, and therefore promote economic growth. Especially for developing countries, FDI inflow enables transfer of technology and managerial skills from developed countries, hence leading to positive spillover [9].

A number of studies have investigated the casual relationship between the FDI and trade flows. **Figure 3** presents the trend of the relationship between global FDI inflows and global trade volume during the period 1970–2019, both expressed in current billion US\$. Clearly, the fitted line shows the complementary (positive) relationship between the two with some outliers. It is interesting that the lower the values of FDI and trade, more concentrated and fitted the values are to the fitted line. Referring from **Figures 1** and **2**, the low values are likely to present the early periods, therefore it can be implied that the variation increased over periods thus is harder to predict the relationship as time passes.

According to [3], global trade seems to generate FDI until the mid-1980s, but after this period, this cause-and-effect relationship reversed with FDI influencing the trade significantly. In addition, [3] finds that FDI outflow increases export of originating countries, and in recipient countries, import increases in short term, and export increases in long term. Nevertheless, he addresses that although FDI inflow can increase import rather than export, recipient country can still benefit from FDI by technology transfers, job creation, local subcontracting, and etc.

Likewise, the relationship between trade and FDI can be either complementary or substitute. Dinh and Hoai [4] investigate the impact of FDI and trade openness on economic growth in 22 Asia-Pacific developing countries from 1990 to 2011 using System GMM. They find that both FDI and trade openness positively contribute to economic growth in these countries and show complementary

**Figure 3.** *Relationship between global FDI and trade (% of GDP). Source: World Bank.*

#### *FDI and Its Impact on Trade in the East Asian Transition Economies DOI: http://dx.doi.org/10.5772/intechopen.97214*

relationship. Further, [5] examine the effect of FDI on trade in Vietnam from 1990 to 2007 utilizing a gravity model. They show that there exists a complementary relationship between FDI and trade although the impact is not significant. Cantwell and Bella (2000) argue there is a complementary relationship between FDI and trade with a growing influence of MNCs in international trade. Cantwell and Bellak [6] investigate 21 empirical studies on impact of FDI on trade in emerging countries, and conclude trade and FDI work as a complement in emerging countries.

On the other hand, utilizing system GMM estimators, [13] argue the combined effect of FDI inflow with trade openness negatively affect the economic growth, while they positively contribute when taken separately. They also address the importance of role of economic institutions on FDI and trade openness. Strengthening the argument, using gravity model, [2] also find the substitutability relationship between trade and FDI inflow in Portugal during 2000 and 2013. Interestingly, some studies suggest the effect of FDI on trade depends on the type of FDI, type of industry, or income level of recipient countries [3, 7, 8].

#### **2.2 Literature review on determinants of trade**

Global trade, a key economic indicator to examine a nation's health, is vital for developing countries, especially for the transition countries who opened its economy relatively recently, to attract investment, enhance competitiveness, and promote economic growth. It is influenced by various factors including factor endowments (land, labor, and capital), productivity, trade costs, trade policy (barriers to trade), exchange rate, inflation, tastes, and etc. Among the determinants of trade, productivity and factor endowments gained the most attention in the trade literature [14].

To examine the impact of FDI on trade, empirical studies on determinants of trade are investigated. Goswami [15] uses panel FMOLS (Fully Modified OLS) to examine the determinants of trade development of 5 South Asian countries (India, Pakistan, Bangladesh, Sri Lanka, and Nepal) from 1980 to 2010. Trade as a ratio of GDP is utilized as the dependent variable, while per capita income, average year of schooling (proxy for human capital), bank credit to private sector (proxy for financial development), tariff rate, FDI stock, exchange rate, and infrastructure index are utilized as explanatory variables. Effect of per capita income growth, human capital, infrastructure and financial development have shown significant positive on trade of South Asian countries, while the effect of exchange rate has shown significant negative.

Dauti [16] investigates the relationship between FDI and trade in the European region based on country characteristics, classifying into two groups of ten new members of EU and five South East European countries. Gravity model is utilized with FDI stock, GDP, skill and capital endowments and trade distances. Employing various static and dynamic panel estimation models, he finds positive impact of FDI on import, and negative impact of FDI on export. The coefficients of labor and capital endowments are shown positive and significant on both export and import. Interestingly, the impact of GDP per capita on export is shown negative and significant.

In the same line, [17] examine the trade determinants of 23 transition countries in Central and Eastern Europe countries using fixed effects, random effect, IV and GMM models from 2000 to 2015. FDI, GDP, investments (gross capital formation in a ratio of GDP), trade liberalization index (TLI), exchange rate are utilized as the trade determinants. FDI, investments, and TLI have shown positive impact on trade, while exchange rate and GDP have shown no significant effect. Using the result, they suggest transition countries to promote policies to improve human resources, business environment, governance, and infrastructure to increase export.

In addition, using ARDL (Autoregressive Distributed Lag) model, [18] analyze the determinants of trade in Finland for short-run and long-run from 1990 to 2019. Without using FDI as explanatory variable, they find the impacts of inflation, urbanization and exchange rate on trade balance are negative and significant, while the impacts of unemployment and GDP on trade balance are positive and significant for both for short-run and long-run.

Moreover, recent literature includes institutional factors as major determinants of trade balance [19, 20]. Employing GMM method, [19] investigate determinants of trade of 36 Sub-Saharan Africa (SSA) countries from 1996 to 2017. Not only FDI, but also regulatory quality, rule of law, inflation, population growth and access to sea are utilized as explanatory variables. Empirical result reveals that institutional determinants and FDI and access to sea lagged by one period enhances trade openness in SSA countries during the sample periods.

Furthermore, [21] studies the impact of FDI, exchange rate and trade openness on trade balance, which is measured by subtracting volume of import from volume of export. Using sample data covering over period during 2005 and 2018 in Vietnam, he finds the impact of FDI and trade openness on trade balance is negative and significant, while the exchange rate insignificantly influences trade balance.

Including the studies mentioned in this section, most empirical studies investigate the trade determinants of specific country or countries in same geographical area or in similar development level. There is limited empirical evidence about the determinants of East Asian economic transition countries' regional trade development.

### **3. East Asian economic transition countries**

#### **3.1 Concept of economic transition and performance**

Transition generally implies a conversion of political ∙ economic system into reformation ∙ open-door system [10]. Political system transition refers to a transformation from communism system, where only 1 party is admitted, to a democratic system, where bases on a multi-party system. Economic system transition refers to a transformation from socialism system, where every economic decision is determined by the planned economy of the central government, to a capitalistic market system, where bases on a market mechanism.

However, it is not easy to clearly distinguish which form the transitions the countries in reality are following. A number of literatures classify the transition into three types: Germany, Former Soviet Union, and East-Asian types [10, 11]. This study is interested in East-Asian type in specific, covering China, Vietnam, Cambodia, and Lao PDR. These countries transformed the economic system to capitalistic market system through reform and opening up. However, they maintain their political system of one-party communist system. This type is often referred to economic transition countries.

Going through economic transition, these countries initiated trade liberalization and market-oriented reform process in late 1980s, intensifying further in 1990*s. china*, Cambodia, Lao PDR, and Vietnam started economic reform in 1978, 1989, 1986, and 1986, respectively. They have shown a fast economic growth soon after they transited to socialist market economy system, which is shown in **Figure 4**.

**Figure 4** shows the trends of GDP per capita (in constant 2010 US\$) of four East Asian economic transition countries and the data was collected from the World Bank WDI (World Development Indicators). Among four countries, China has shown the fastest growth, increasing from \$720 in 1990 to \$8,254 in 2019. GDP per

*FDI and Its Impact on Trade in the East Asian Transition Economies DOI: http://dx.doi.org/10.5772/intechopen.97214*

#### **Figure 4.**

*GDP trends of east Asian transition countries. Source: World Bank.*

capita of China almost doubled in the last 10 years. In case of Cambodia, GDP per capita increased from \$321 in 1994 to \$1,269 in 2019 with a small decrease in 2009. GDP per capita of Lao PDR increased from \$462 in 1990 to \$1,840 in 2019. In Vietnam, it increased from \$433 in 1990 to \$2,082 in 2019. Although Cambodia, Lao PDR, and Vietnam had similar starting point in early 1990s, Vietnam shows the highest improvement in GDP per capita, followed by Lao PDR and Cambodia, respectively.

**Table 1** demonstrates current (2019) social and economic situations of the sample countries. Although they are all economic transition countries having same economic and political systems in common, they differ in development level, population growth, unemployment rate, and etc. First of all, except Lao PDR, rest of the countries have access to sea. In addition, Lao PDR has the highest population growth rate, following by Cambodia, Vietnam, and China, respectively. Furthermore, four countries show similar level of income inequality shown as Gini index score. Moreover, China has the highest unemployment rate of 4.6%, following by Vietnam of 2.04%, Lao PDR of 0.62%, and Cambodia of 0.13%, respectively. Last but not least, although China has the highest GDP per capita, Cambodia and Vietnam show higher GDP growth rate than China.


#### **Table 1.**

*Country characteristics of China, Cambodia, Lao PDR, and Vietnam.*
