The role of foreign direct investment in economic growth of Turkey: before and after 2003

With the process of globalization, foreign capital flows have become one of the most important tools in developing countries to achieve their economic development goals. Nowadays foreign direct investment among these foreign capital flows is seen as the part of open and efficent economic system. foreign direct investment is different compared to other types of investments because it provides technology transfer for local firms in the country where the investments are made. In recent years, Turkey ensuring macroeconomic stability, has begun to attract many foreign direct investments. Law No: 4875 which entered into force in 2003 has contributed to this situation. For this reason the objective of this study is to analyze the differences between foreign direct investment attracted by the law of 17 June 2003 and those who came after the law of encouragement of foreign investment in 1954. Foreign direct investment is an investment that reflects the objective of establishing a lasting interest by an entreprise that is resident in another economy. The lasting interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the enterprise. The direct or indirect ownership of 10% or more of the voting power of an enterprise resident in another economy shows this long-term relationship. Foreign direct investment has many positive effects on host county's economy like reducing balance of payment deficit, increasing employment rate and fixed capital formation. However Foreign direct investment differed from the other types of investment due to its particularty of technology spillovers towards domestic firms which results from the superior technology and management methods of multinationals firms. For this reason many developing countries are trying to attract foreign direct investments offering for multinational firms cheap and qualified labor, infrastructure support, tax exemptions, price stability and competitive exchange rate. In Neoclassical Growth Theories foreign direct investment has the same effect as domestic investments on economic growth. Because multinational firms have superior technology, the investments which they make create technology spillovers and this spillovers contribute to economic growth increasing productivity of domestic firms. Host country can benefit from these technology spillovers generated by multinational firms provided that it has a minimum threshold stock of human capital. When multinational firms renonce exportation by investing abroad with horizontal integrations to satisfy the demand of international markets, exportation and foreign direct investments become substitute. Nevertheless when these firms decompose production process in differents countries with vertical integrations to obtain cost advantages, exportation and foreign direct investments become complement. Furthermore Export Promotion Strategy is likely to attract a higher volume of foreign direct investment than Import Substitution Strategy. In long term foreign direct investment by decreasing balance of payment deficit contributes to economic growth but in short term it may negatively affect balance of payment as a result of the importation of intermediate inputs by multinational firms from the rest of the world. Multinational Firms which realize foreign direct investment prefere countries with cheap labor to obtain cost advantages in production process. However in recent years because of the fact that the part of labor factor in production costs has decreased, multinational firms are paying less attention for the labor costs. On the other hand when multinational firms entered to host country's markets the demand for labor grows and consquently general wage level increases. Multinational firms pay higher wages than domestic firms to prevent their production technologies from imitating by domestic firms after a potential transfer of their workers to these firms. One of the main factors which determines a country's foreign direct invesmtment attracting capacity is economic stability. Inflation rate is an indicator of economic stability. High and volatile inflation rate creates for the investors an uncertain investment environment and real productivity of investments decreases. Moreover frequent changes of political balances in the counrty where investments are made decrease profits of investments. For this reason countries which desire to attract more foreign direct investment must have both economic and political stability. Corruption is one of the most important factors which dissuades foreign investors to invest in a country. The greater the difference in the level of corruption between home and host countries the lower the likelihood that they know how to deal mutually. After the Second World War, as a result of the emergence of neoclassical theory's insuffisance to explain foreign direct investments many theories were developed by economists like Vernon, Hymer and Dunning. According to Vernon's Product Cycle Model in first stage of the production a new product innovated in a developed country using high technology is produced in order to satisfy the demand of domestic markets but afterwards production is transferred to developing countries through foreign direct investments in order to obtain cost advantages against rivals which learned production technics of this product. In the final stage, developed country which was the inventor and the first exportator of the product starts over time to import this product from the developing counties. According to Hymer foreign direct investment are made only in the presence of market imperfections. In perfect competition, firms can purchase intermediate products whenever they need paying their price determined by supply and demand of the market. However when the markets are imperfect and have an oligopolistic structure and the informations aren't perfect, firms choose foreign direct investment to prevent from competition and reduce uncertainities. Hymer suggests that foreign fims have disadvantages vis à vis domestic firms and must have some firm specific advantages to compensate these disadvantages. According to Dunning's Eclectic Theory it is necessary that three conditions must be satisfied simultaneously for the multinational firms which want to engage foreign direct investment. First firms must have some ownership advantages that arise from the proprietary (ownership advantages) of specific assets of the firm. Second There are some Location advantages in using the firm's ownership advantage in a foreign location rather than at home. Third it must be beneficial to internalise those advantages rather than to use the market to pass them to foreign firms. Foreign direct investment which gained importance after the Second World War has become a type of investment which was made between developed countries during that time. From the 1980's as a result of liberalization of global markets and the end of developing countries's negative opinion associated with foreign direct investment, these countries have also started to take important parts from world foreign direct investment Flows. In 1980's manufacturing sector which was the main sector for foreign direct investment has left over time its first place to the service sector. Since the first years of foundation of Republic of Turkey, importance of foreign capital for the economic development was realized however foreign investment flows towards Turkey have almost stopped because of the abolution of capitulations which foreign countries have benefited. On 18 January 1954 The Law of Encouragement of foreign direct investment entered into force. Although this law have many liberal regulations Turkey couldn't attract foreign direct investment as it wished. But in 1980's as a result of the beginning of globalization process, Turkey has started to attract a lot of foreign direct investment. In these years foreign direct investments in Turkey were made in manufacturing sector. In 1990's because of the negative effects of 1994 and 2001 crisis foreign direct invesments in Turkey have considerably decreased. In 2003 the Law of foreign direct investmens No:4875 entered into force. This law has abolished the obligation of obtaining Ministery of Finance's permission for foreign direct investments and provided to pass request system. Moreover definition of "Foreign Investor" has widened and Investment made in Turkey by Turkish nationals resident abroad were included in foreign investments. Since 2003 Turkey received record amount of foreign direct investment in its history. However quality of these investments is as important as its quantity for economic development. foreign direct investment can contribute to economic development in long term provided that these investments are made as the greenfield investments rather than mergers and acquisitions. In the first section of this study, The concept of foreign direct investment was first defined and its effects on the economy were analyzed. In the second section the determinants of foreign direct investment were explained. Then theories which occupy an important place in the literature of economics and attempts to explain the existence of foreign direct investment have been mentioned. In the third section the differences between foreign direct investment attracted by the Law of 17 June 2003 and those who came after the law of encouragement of foreign investments in 1954 were analyzed. Then the informations about International conventions on Foreign Direct Investment have been given. Finally in order to investigate the effects of Foreign Direct Investment on Economic Growth in Turkey, using yearly data for the period 1980-2012 a cointegration analysis was applied between the variables GDP, FDI, Total Investment, Trade Openess and then A Granger Causality Test between these variables was carried out. As a result a cointegration relationship between these varibles was found out but the Granger Causality Test didn't detect any causal relationship except a uni-directional causality running from GDP to FDI. In the final section by evaluating these results, some advice were given for the future.