Foreign Direct Investment is defined as a long-term investment of an entity of one country in another country (Aknfrahi,M. and Almsafir, M., 2014). More specifically, FDI is seen as broad capital flows in which a company from one country expands through a subsidiary in another country; both through direct control and transfer of resources (Mun et al., 2008).
Traditionally, it is seen as capital stock or technology that can impact the economy of the other country by introducing new labour training, new managerial know-how, and new technology (De Mello, L., 1999). This impact however, it is argued to be different across different sectors of the economy. Thus, this research will try to investigate FDI impact on one of the primary sectors, more specifically the mining sector in a developing country that is rich on mineral resources.
The country in which this research project will be based on is the Republic of Kosovo, a state founded on February 17th, 2008, located in Southeast Europe, in the central part of the Balkan peninsula. There has been no prior research that explains the impact of FDI in this specific sector in Kosovo, hence the need to investigate the impact. Kosovo as a developing country, has had severe economic and political fluctuations in the past twenty years. Minerals and energy has been the main pillar of the country’s economy and one of the main economic drivers until the 1990’s. The investment in this industry has declined exponentially during this period, and it got worse in 1999 when the war started. This time period was characterized with more than 50% unemployment and severe poverty (World Bank, 2005). However, with the end of the conflict in year 2000, there was a huge inflow of international donations and investment in the country. Foreign Direct Investment inflows also increased during this time and it is believed that they impacted the annual GDP growth. Thus, policy makers in the country have focused on creating favourable conditions for attracting foreign investment. According to the World Bank, “Kosovo is one of the most open countries to foreign equity ownership in Eastern Europe and Central Asia”. The Law on Foreign Investments enables foreign investors to have equal rights to own local companies, based on the principle of national treatment (World Bank, 2014). Based on the indicators of Investing Across Sectors, almost all sectors in Kosovo are open to foreign equity ownership.
Kosovo has an abundance of non-renewable natural resources, being one of the richest countries in mineral deposits in Europe. Kosovo is the fifth country with most lignite reserves in the world, it has around 10.9 billion tons of lignite reserves which could translate to 1,300 years of lignite supply (Olters, J., 2014). Other mineral deposits such as ferronickel, lead, zinc, magnetite, and others are also in abundant supply. The lead and zinc reserved are also ranked as the third in the world (Flounders,S., 1998). In 2014, there has also been a high grade gold discovery by one of the foreign investors in Kosovo (Bacal, D., 2014). It is generally believed that if there is enough investment in this sector, the country could benefit economically, especially in terms of employment and exports.
However, such wealth of natural resources can either be a blessing or a curse. Historically, such resource-rich countries have not benefited from their mineral deposits. One reason why such negative impact could result from having excessive minerals is that such minerals are being extracted from developing countries and being sold as raw materials to developing countries for a very low price. Thus the benefit for the developing countries is minimal and the resources are then depleted. However, it is believed that Kosovo’s potential has been largely left intact, as investment in this sector has not been as evident. There are however, more than twenty foreign companies operating in the mining sector in Kosovo, and ICMM (Independent Commission for Mines and Minerals), between 2005 and 2009 has issued around 200 licenses for exploration and mining (World Bank, 2014).
This study’s purpose is to assess if there is a relationship between GDP and FDI inflows in the mining sector by looking at data for the past ten years. Numerous similar studies for other countries have discussed that there need to be some pre-conditions in a country in order for FDI to have a positive impact. Thus to check the effect of such pre-conditions, the analysis will also include factors such as openness and macroeconomic stability.
The study is relevant to Kosovo because policy makers for the past sixteen years have been focused to attract foreign investment with the belief that it will contribute to country’s economic growth without really quantifying the impact it would have. Thus, potential benefits borne by this study would be that it would offer more insight on whether FDI in this specific sector impacts the economy of the country and how it affects it.
Literature review
Foreign direct investment is believed to have a very important impact on the economic growth of developing countries. Policy makers state that FDI can have a very significant positive spill-over effect on the host country’s economic development. It is generally believed that FDI impacts the host country’s exports, leading to a positive increase in productivity and further increase in FDI inflows. Ultimately this increase in exports contributes to economic growth of that country (Rutaihwa, J. and Simwela,A., 2012).
However, this positive impact of FDI has been questioned by some researchers. A study by Jeon based on numerous cross-country data concluded that there was a negative relationship between FDI and exports as proxy for economic growth (1992). Whereas Sharma found that there was no statistically significant impact of FDI on Indian exports (2000). This due to the fact that FDI impact varies between countries and is also affected by other characteristics of the specific country such as employment rates, inflation rates, political stability, regulations etc. Therefore, concluding that FDI does not necessarily always lead to a positive economic growth for a country. The effect of FDI however, seems to vary among developed and developing countries, Blomstrom, Lipsey, and Zejan, in a cross-country analysis of 78 countries concluded that FDI has a positive effect on growth in higher income developing countries, but that effect is negative in lower income countries (1994). Further differences in the effect of FDI are shown in a study of 46 developing countries using annual cross-sectional data which found that the FDI impact is positive in countries that promote export but negative in those who promote imports (Balasubramanyam, Salisu, & Sapsford, 1996).
Furthermore, researchers also argue that the positive impact of FDI varies between sectors. Even though, it is common to believe that FDI can positively affect the economic growth of the host country, such effects might be different throughout different sectors. UNCTAD World Investment Report argues that in the primary sector specifically the mining sector and agriculture, the possibility for positive effects is more limited (2001). FDI benefits such as labour training, technology transfer, or managerial know-how tend to be more related to the manufacturing sector and the service sector (Findlay, 1978). Not all sectors can have the same absorbing ability to connect the impact of FDI to the rest of the economy (Wang and Bloomstrom, 1992). Thus, such low linkages limit the positive effect FDI can have in an economy. Hirschman explains that these low linkages of FDI in the primary sector and positive economic growth come “due to this ability of primary products from mines, wells, and plantations to slip out of a country without leaving much of a trace in the rest of the economy” (1958).
An econometric analysis using Ordinary Least Square (OLS) techniques for regression analysis conducted by Rutaihwa, J. and Simwela, A. examined FDI in the mining sector and its impact on exports in Tanzania and the result showed that FDI contribution to exports and economic growth has been very low and even negative (2012). The relationship between FDI in the mining sector and exports was statistically insignificant and negative even though mining sector in Tanzania has been one of the biggest sources of FDI inflows (Rutaihwa, J. and Simwela,A., 2012).
Laura Alfaro’s study using 47 countries in the sample also found that FDI inflows into different sectors of the economy result in different effects on economic growth (2003). FDI inflows in the primary sector had negative effect on growth mainly because investment in this sectors namely agriculture and mining, have slight spillover effect for the host economy, suggesting that not all FDI can be positive for a country (Laura, A., 2003).
Some of the studies in this literature review have been used as a benchmark for the initiation of this research. More literature review will be added throughout the study and it will include journal articles, country reports, and statistical data.