University of Economics, Prague Faculty of Economics
Major: Faculty of Economics and Economic Administration
The effect of FDI on Economic Growth of the Kazakhstan and Investment opportunities in different
regions of Kazakhstan Bachelor Thesis
Author: Anara Amangaliyeva
Supervisor: Ing. Martin Lukavec, Ph.D.
Year: 2021
I hereby declare that I wrote this Bachelor Thesis independently and used only the sources and aids indicated.
Anara Amangaliyeva Prague, December 2020
University of Economics, Prague Department of Economics
Faculty of Economics 2020/2021
BACHELOR THESIS TOPIC
Author of thesis: Anara Amangaliyeva
Study programme: Economics and Economic Administration Field of study: Economics
Thesis Supervisor: Ing. Martin Lukavec, Ph.D.
Topic: The effect of FDI on Economic Growth of the Kazakhstan and Investment opportunities in different regions of Kazakhstan Language version: English
General content:
1. A little less than three decades have passed since Kazakhstan became an
independent country and operates as one of the most successful countries among the current CIS nations with GDP(nominal) of 170.326 billion USD by 2019(The Global Economy) and thus ranked as 25th out of 190 countries in Doing Business and IP according to 2020 World Bank report. Kazakhstan occupies a strategically important location for sharing a border with two largest economies such as Russia and China, being the largest provider of energy and oil resources in Central Asia, and due to transportation routes. It also has a favourable business environment, protection of investors’ rights and investment incentives with sets of regulations that are directly related to guarantees in respect of investments and Law “On
Investment”. Kazakhstan offers new opportunities and huge potential for a
profitable investment, but at the same time profits from FDI as increasing AD of the economy and real GDP growth. The main aim of this thesis is to show what benefits and costs do various regions of Kazakhstan occur from the FDI. It will also test the
following hypothesis: the positive correlation between an increase in FDI and National Saving-Economic Growth upward trend in Kazakhstan regions.
2. Over the years of Independence in Kazakhstan, a lot of improvements has been done in the investment field. During its formative years, Kazakhstan needed external support, and it was the inflow of foreign investments that could contribute to the systematic development of the country’s economy and, even to some extent, become a growth driver. However, a 0.9% drop in domestic investment (AERC, 2020 for Kazakhstan) proved that that FDI had an adverse impact in some sectors, especially agriculture and manufacturing, crowding-out domestic investment. Not to mention, instability of FDI, caused by political issues and transitions, is also a large topic to be mentioned in this work. As evidence, the difference between FDI in January (5687.185 million USD) and March (3570.63 million USD) is 2166.55 million USD decline. This work will provide evidence on how foreign investment affected standards of living of the nation over the past years and will prompt where to invest next in the upcoming years.
3. The theoretical part of my paper is going to cover review, assessment and critical evaluation of theory related to FDI. This review will cover models related to international trade (comparative advantage theories, Heckscher-Ohlin model, the location theory and so on). Models dealing directly with FDI, such as the Uppsala theoretical model, the eclectic paradigm, exogenous factorial diversity, models on the business cycle, risk signals and others will also be reviewed and evaluated. This overview will give us the necessary context to be able to assess how changes in investment indicators affect productivity and labour growth. The empirical literature exploring FDI in general will be evaluated and used to provide a rationale for the topic of this dissertation. The literature on the FDI flows in other countries will be reviewed and evaluated and used as a comparison to Kazakhstan’s case to see how the economic growth of other countries is also influenced by FDI.
4. In the practical part of the thesis flows of foreign investment and changes in private equity funds of Kazakhstan going to be analyzed. Moreover, the connection
between FDI and economic growth of Kazakhstan regions as well as NS are to be examined by a multivariate regression model with a number of control variables.
Various combinations of the multivariate regression model are going to be tested for their predictive power and their statistical significance. During this optimization process, the independent variables are going to be tested for multicollinearity.
Additionally, spatial autocorrelation, the Moran Index and cluster analysis are going to be calculated, to evaluate whether they can enhance the findings. The findings will further be interpreted for their policy implications. All the data used in this work is provided by the Bureau of National Statistics of Kazakhstan, World Bank and OECD respectfully.
Length of thesis: 45
Selected bibliography:
1. International Monetary Fund. (2005) “Republic of Kazakhstan: Statistical Appendix,”
Country Report No. 05/239.
2. Kassymbek, A. (2019). Private equity market in Kazakhstan. KPMG in Kazakhstan and Central Asia.
3.Katirchioglu,S.T.,Naraliyeva,A.(2006).ForeignDirectInvestment,DSandEconomicgrowthi nKazakhstan: Evidence from Co-integration and Causality Tests. Investment Management and Financial Innovations, Volume 3, Issue 2, 34-40
4.Khalitova,M.,Berstembaeva,R.,(2014).GovernmentdebtofKazakhstanunderconditionsofth eglobal financial system‘s instability, Institute of Economics, the Science Committee, Ministry of Education and Science of the Republic of Kazakhstan (ISSN:1097-8135).
5. NationalBankofKazakhstan,(2019-
2020).FDIinKazakhstan,quarterlystatistics.tradeeconomics.com
6. Serın, V.; Yüksel, E. (2005). “Foreign Direct Investment Flows in Kazakhstan: The Role of Energy Sector”, Journal of Academic Studies . May-Jul2005, Vol. 7 Issue 25, p3-20
Bachelor thesis topic submission date: November 2020 Deadline for submission of Bachelor thesis: January 2021
Anara Amangaliyeva Solver
prof. Ing. Robert Holman, CSc.
Head of department
Ing. Martin Lukavec, Ph.D.
Thesis supervisor
prof. Ing. Zdeněk Chytil, CSc.
Dean NF VŠE
Acknowledgements
I would like to express my gratitude to my thesis supervisor Ing. Martin Lukavec, Ph.D., for the great support, patience, guidance and helpful advices he provided to me.
I also would like to thank the coordinator of ECON program Mgr. Lucie
Wagnerová, who was so kind and supportive during my studies at the university.
I am grateful to every professor with whom I had the opportunity to learn and cooperate, for the experience and knowledge I’ve gained. I will be forever grateful to every teacher.
Lastly, I would like to thank my friends and family for their love and trust. To my mother and father who gave me an opportunity to get the best education I could. To my sisters and brother for their unconditional love and pride in their older sister. To my best friend Marina, Anastasia and Aygerim for always cheering me up and showing what a real friendship is. To my beloved partner Chi Earn for the confidence and love he provides to me.
Abstrakt
Tato práce zkoumá dopad celosvětových toků přímých zahraničních investic a jejich vlivy na hospodářský růst Kazachstánu v období mezi 1993 a 2019. Také byly sledované špičkové investiční oblasti a jejich investiční potenciály, jakož i čísla FDI a makroekonomické ukazatele, jako je návratnost investic, směnný kurz, čistý kapitálový příliv, který poskytne údaje o vybraných regionech. Investiční atraktivita přechodných ekonomik byla analyzována ve srovnání s případem Kazachstánu. Korelace mezi růstem FDI a HDP byla testována časovými trendy, kde byla použita originální a 3-léta hladká verze. Ukázalo se, že s hladkým růstem HDP s 2-letým zpožděním, FDI má nejvyšší korelační koeficient. Regresní a reziduální mapy ukázaly regionální přítoky FDI po celé zemi, kde Atyrau, Aktobe a západní Kazachstán měly nejvyšší HDP na osobu vzhledem k vysokému přítoku FDI na hlavu.
Moranův index zachytil multicollinearitu mezi odhadovanými proměnnými a shlukování FDI v Kazachstánu. Výsledky spolintegrace ukázali dlouhodobou rovnováhu mezi jednotlivými páry výše uvedených proměnných, s výjimkou DS a FDI. Test Granger Causality ukázal příčiny, které rozšiřují DS, FDI a reálný růst HDP.
Key words: Kazaсhstan, FDI, Hospodářský Růst, Domácí Úspory.
JEL classification: C1, E220, E190
Abstract
This work examines the impact of FDI flows and its changes on Economic Growth of Kazakhstan for the period between 1993 and 2019. Moreover, the insight on top invested regions and their investment potentials will be outlined as well as FDI numbers and macroeconomic indicators such as return on investment, exchange rate, net capital inflow that will provide data on those selected regions. Investment attractiveness of transitionary economies will be analyzed and compared to the Kazakhstan’s case, as well as the evidence on FDI attractiveness of each country and their locations. Correlation between FDI and GDP growth was tested with time trends where we used original and 3-year smoothed average version. It showed that with smoothed GDP growth 2-year delay in FDI has a highest correlation coefficient. Regression and residual maps have displayed comparison of regional FDI inflow all around the country, where Atyrau, Aktobe and West- Kazakhstan regions had highest GDP per capita due to high FDI per capita inflows. Moran’s Index captured multicollinearity between estimated variables and that FDI in Kazakhstan is clustered. The outcomes of co-integration indicate a long-run balance between each pair of the above variables, except between DS and FDI. The findings of the Granger causality test indicate unidirectional causes that extend from both DS and FDI to real GDP growth.
Key words: Kazakhstan, Foreign Direct Investment, Economic Growth, Domestic Savings.
JEL classification: C1, E220, E190
Content Introduction
1. Theoretical section
1.1. Theory of FDI and Economic Growth………9
1.1.1. Models of Economic Growth and FDI relationship………12
1.1.2. Effect of FDI on Domestic Savings and Economic Growth………14
1.2.Negative effects caused by FDI………...16
1.2.1. Kazakhstan under conditions of FDI instability……….19
1.2.2. Effect of FDI on Domestic Investment ………20
1.3. Comparison of Foreign Investment flows in Kazakhstan with other Transition Economies………...21
1.4. Investment attractiveness in different regions of Kazakhstan ………25
2. Practical section 2.1. Methodology………..29
2.2. Data………34
2.3.Analysis………...36
2.4. Potential Improvements………..52
3. Conclusion List of abbreviations………..55
List of tables………..56
List of figures……….57
List of maps………...57
References……….58
Introduction
The deepening of international integration and the expansion of economic cooperation between countries have contributed to an increase in the role of external factors, including foreign direct investment, in the economic growth system. FDI has recently come to be a catalyst of economic growth, along with labor efficiency and technological development, as a part of total capital gains. FDI may make a major contribution to economic development, increase the productivity of the national economy, and intensify the use of resources and production factors in the recipient country, under appropriate conditions.
Currently, we witness a high level of distinction in the social and economic development of the regions of Kazakhstan, which is due to the influence of a complex of various factors, including FDI (foreign direct investment). FDI contains creation of corporations, branches and enterprises across the border, procurement of a share in the capital of foreign firms, the provision of loans to own enterprises abroad or firms in which there is a share. Therefore, this work aims to show the active investment of operating enterprises with the involvement of FDI in different regions of Kazakhstan and their impact on the economic growth of a country.
The economy of Kazakhstan is described by the disparity in economic development, thus, the investments necessary to restructure the country's economy can be attained if the conditions for their placement are better than in countries competing for appealing foreign capital flow. The lands of Kazakhstan are rich in minerals, as well as oil and gas reserves and its geographical location is very favorable for foreign investment, as the country is located on transit routes and exits to the Caspian and Aral seas, not to mention its neighbouring two major economic powers like Russia and China. The above reasons are indicators of the current state of FDI flows in Kazakhstan, as investment flows from abroad were equal to $3.8 billion in 2019 according to UNCTD1, which is by 18% less comparing to the previous year due to divestment and resettlement of Russian MSEs. Nevertheless, Russia's case has
1 United Nations Conference on Trade and Development
impacted many CIS countries, leading to the promised recession of 2019 in investment, where Kazakhstan showed strong numbers, securing a solid third position in the ranking of CIS countries with high FDI levels. Similarly, according to the World Bank data downfall in GDP growth from the previous 4.1% to 4.0% respective year was recorded, which became the basis for the analysis of this work.
Theoretical part of this work will compare economy of Kazakhstan at different stages of investment spate and how FDI became one of the main drivers of growth. Furthermore, it will cover the region specifics in terms of investment attraction and show annual amounts invested among leader regions and their specifics. The importance of FDI on current state of socio-economic well-being of Kazakhstan and top investor countries, as well as investor preferences are also to be mentioned in this part.
Despite of this, theoretical part of this study will also cover the drawbacks of dependence of Kazakhstan on FDI flows, such as investment instability and domestic production decrease in the regions with higher and lower foreign investment flows.
The main purpose of the practical part of this paper is to test the relationship between Foreign Direct Investment and Economic Growth with other important factors such as net export, population of labor and technology to outline strong dependence between two main variables.
For this, PP, ADF, regression maps, time trends and regression models of variables like net FDI inflow, GDP per capita, GDP growth (%) and population were used.
1. Theoretical section
1.1. Theory of FDI and Economic Growth
Foreign direct investment is the driver of integration of the recipient country’s economy in terms of foreign capital and its flow into the world economy, as well as one of the effective mechanisms for defining country's place in the international ranking. FDI provides transfer of advanced technologies, scientific and technical developments, experience of organization, management and development of enterprises, marketing, managerial techniques, introduction of world business standards, product quality, relations into the national economies to personnel and labor productivity, which in turns displays a fundamental impact on the long- term development of the recipient country.
Studying the mechanism of attracting FDI has shown that it has a huge effect on the economic development of many recipient countries. This is demonstrated by the history of Southeast Asian and Latin American countries. The countries considered have ensured high economic growth rates and have developed national industries and infrastructure sectors in a relatively short period of time.
Getting the most out of FDI is only conceivable with an appropriate active industrial and investment policy, which is the main tool for determining the place of FDI in the process of economic development of the country. Compliance of the types and directions of foreign investment with the strategic and tactical objectives of the economic development of the country, established by state and national sector, is the most essential criterion for the positive effect of FDI on economic development.
Several studies have attempted to research the FDI-GDP growth rate relationship. Some authors have shown that the correlation can be negative between FDI and economic development. Indeed, Saltz (1992) shows that the overall level of investment, efficiency, but also the rate of growth, can be increased by FDI. Saltz (1992) analyzed the relationship between FDI growth rates on a survey of several nations divided into two classes according
to the amount of FDI attracted to validate his results. He concluded that the correlation between FDI and growth in developed countries, which have removed restrictions on benefit repatriation, is still negative.
In comparison, a report by Borensztein, De Gregorio and Lee (1998) tested the economic growth impact of FDI in 69 developing countries. This research found the positive connection between the growth rate and FDI and shows that FDI's contribution to economic growth depends on the capacity of the host countries to assimilate technology. And complementarity is regarded as important between human capital and FDI.
In this context, Balasubramanyam et al. (1996) show that the expected beneficial effects of FDI on the host country's economy rely on the development strategy, either aimed at substituting imports or promoting exports. Empirical studies that evaluate this relationship between FDI and economic development, however, find different results that represent the host country's inherent characteristics.
The causation between FDI and economic growth also was studied by Zhang (2001) and Choe (2003). Zhang uses data from 11 countries in East Asia and Latin America that are emerging. Zhang (2001) found that economic growth is enhanced by FDI in five cases, using cointegration and Granger causality tests, but that host country conditions such as trade regime and macroeconomic stability are critical. Causality between economic growth and FDI runs in either direction, but with a propensity towards growth that causes FDI and according to the findings of Choe (2003), there is little evidence that FDI causes growth in the host country. An increase in FDI inflows may result from rapid economic growth.
Further analysis by Chowdhury and Mavrotas (2003) explores the causal relationship between FDI and economic growth by the use of an advanced econometric approach to study the path of causality between the two variables. For three emerging regions, namely Chile, Malaysia and Thailand, the analysis includes time series data covering the period from 1969 to 2000, all of which are major recipients of FDIs with varying records of macroeconomic occurrences, policy regimes and growth trends. Their empirical results demonstrate that, in
the case of Chile, it is GDP that induces FDI and not vice versa, although there is good evidence of bi-directional causality between the two variables for both Malaysia and Thailand. Using a bootstrap test used to test the validity of the outcome demonstrates the robustness of the above findings.
Another test was made using panel data for Latin America by Bengoa and Sanchez-Robles (2003) explored the relationship between FDI, economic freedom and economic development. Comparing estimates of fixed and random effects, they suggest that FDI has a major positive impact on the economic development of the host state, but the intensity depends on the circumstances of the host country, similar to Borensztein et al (1998). In order to examine the relationship between FDI inflows and economic development, Carkovic and Levine (2002) used a panel dataset covering 72 developing countries. The research uses GMM to conduct both a cross-sectional OLS analysis and a dynamic panel data analysis. The paper concludes that there is no robust correlation between internal FDI and economic growth in the host country.
This part will analyze the model of endogenous growth introduced by R. Lucas and P. Romer (1990), G.M. Grossman and E. Helpman (1994) , R. Barro (1985) which states that FDI contributes more into GDP growth and is more productive than internal investment as it encourages the use of emerging innovations in the host country's development functions.
Therefore, technology may also be established by some countries, but others may benefit from the spread of technology that is generated elsewhere (Borensztein et al., 1998).
According to endogenous models that are part of long-term economic growth frameworks, contribution of FDI to economic growth is outlined not only through capital formation and technology transfer (Blomstrom et al., 1996; Borensztein et al., 1995), but also through increasing the level of information, training of staff and the acquisition of know-how. In addition, empirical evidence indicates that an improvement in FDI2 is a contributor to both positive and negative externalities. Where developed countries are placed on the underlined issues and which model is being used, a vigorous conclusion are drawn, FDI has a positive relationship with economic development. Such a model will be very important for the SEE
2DeMello, 1997, 1999
nations, all FDI beneficiaries, but with different macroeconomic contexts, political regimes, and growth trends.
Today, as well as the great contribution that FDI flows have, great attention is paid to identifying factors that encourage economic growth. Many theoretical researches cover this topic, but this paper will focus on main models: theory of endogenous designation of FDI and economic growth (1) and the neoclassical theory of growth (2) .
Theory of endogenous designation of FDI and Economic Growth
According to Wang & Swain (1995), Schneider & Frey (1985) studies, market size, population size, rapid economic growth and per capita income generate conditions for growth for multinational companies. Countries that borrow more from abroad should be willing to spend more, because domestic saving is less restricted, so they should rise rapidly. There are financial and other systemic barriers that hinder a poor country's tendency to process foreign capital. They are described as too ambitious for FDI as far as the SEE countries are concerned.
Their value is an additional function of endogenous growth models. According to certain models, economic policies can influence long-term growth. A policy of openness to the outside world and thus the promotion of FDI, which is justified by the constant increase in the rate of growth. Therefore, if the determinants of growth are endogenous and FDI is seen as a combination of resources, know-how and Balasubramanyam et al. (1996) technology, there are several channels by which FDI contributes to economic growth in the host country by describing each of these channels, which we will attempt to present a theoretical model.
Using an endogenous growth model, Borensztein, De Gregorio and Lee (1998), highlighted the role of FDI in economic growth, where the rate of technological progress is regarded as the key determinant of the long-term growth rate. In this model, the adoption of new FDI- generated technologies and the existence of a sufficient level of human capital in the host country tend to be two determinants of economic growth, and the human growth mechanism requires complementarity between FDI and capital.
Studies by Borensztein, Alafaros and Lesnik have shown that the host country should have at least the minimum threshold of the requisite infrastructure, capital, schooling, a functional banking system and good governance to attract FDI and better management practices.
Although there are proposals that include the use of the FDI system if a developing country seeks economic development and the welfare of its citizens, economic policies, the regulatory system for the promotion and security of investors and several other goals should be tried to be clear and favorable. There are counterarguments, however, from the pragmatic nationalist theory that opening to FDI is seen as sacrificing national sovereignty. This idea's proponents point out that there is no link between FDI and growth and vice versa. FDI is mistakenly seen as a remedy for developed countries, they add3. They see FDI as an entrepreneurial kit in pursuit of continuous profitability and the host country's cheap labor market. Such investments do not come as a matter of charity, but rather are against small businesses. The
"open doors" to the FDI policy should therefore not exist. They must be permitted by national agreement and in line with certain performance criteria (Yash Tandon, 2002).
Ozturk conducted a literature survey based on Endogenous model of FDI and Economic Growth where the cause on economic growth by the induction of FDI and, according to statistics, 90% of the studies, mostly in developing countries, showed a positive relationship, while samples from developed countries highlighted an unimportant or neutral correlation.
Neoclassical Theory of Economic Growth
“The theory of growth certainly did not start with my scientific articles of 1956, it probably started with “the Wealth of Nations” by Adam Smith probably even by his predecessors”
4says Solow. Solow embraced the course outlined by Harrod and Domar, who, by saying that
"savings make economic growth," arrived at a classical answer to the increasing problem.
But higher growth rates do not provide this forever. Solow's implementation of a kind of technical versatility gave the growth theory new possibilities. The pioneer of the neoclassical theory of growth is considered Solow. In the sense that it begins substantially from the
3Seatini, 2002
4 Pano & Angjeli, 2004, pp. 404-405
classical view of its theoretical approach, which puts great emphasis on mathematical techniques, it is "neo." The growth rate is exogenous and does not involve only work (L) and capital (K) in its development, but also the level of technology. None of the original growth trends, however, did not regard FDI as determinants of economic growth from the 1950s to the 1990s, even though it was very clear that they were a significant factor. After the 1990s, researchers strongly acknowledged the growth trend and during their study, each one found the models to match their count's requirements.
According to neoclassical growth models, long-run per capita income growth is zero or equal to the exogenous pace of technological development. Only short-term economic growth can be influenced by the FDI, given that the decline in marginal capital productivity, the host economy converges to a stable state and the FDI does not have a lasting effect on economic growth. FDI impacts the host country's economic growth only through permanent technology shocks.
Throughout the 1990s, foreign capital flows were more targeted to developing countries. This phenomenon has not been clarified by the neoclassical theory of growth because it implies capital can move from rich to poor countries. The theory of endogenous growth (Lucas, 1990), which attempts to clarify the reality of the return of human capital and illustrates that capital will not be moved from rich countries to poor countries. As part of an empirical verification of the FDI-growth relationship in China, Wang (1990) noted that there are two possible routes by which FDI influences economic growth, namely: the rate of accumulation of physical capital and the growth of productivity. FDI is thus not only an additional source of financing development, but also helps to increase productivity, according to Wang (1990).
De Mello (1997) observed that the host country's effect of FDI on economic growth depends on the degree of efficiency of domestic companies. The long-term growth rate determines the rate of time preference, the competitiveness of domestic resources, and the extent to which domestic and foreign technologies complement each other.
1.1.1. Effect of FDI on Domestic Savings and Economic Growth
It is important to understand the relationship between economic growth and other macroeconomic measures and the path of causality, as it offers economies the ability to identify their changing policies. A wide field of application has also been found in the literature on the relationships between economic growth and FDI and economic growth and DS. The beginning of the 1990s was correlated with higher foreign capital flows to developing countries, which led to empirical studies on the causes and effects of these transfers on the recipient countries' macroeconomic factors5 . Over the past decade, FDI has become essential as a tool to facilitate the growth and development of emerging markets (Janicki et al., 2004).
Models supporting the DS-economic growth relationship have various causal consequences.
The fundamental presumption of the growth model of Solow (1956), for instance, is that higher saving precedes and triggers economic growth. This means that by growing spending, which is a source of capital accumulation in the economy, high savings economies can grow faster. Furthermore, the multiplicity of forms of FDI determines the large-scale and multilateral influence that it might have on Domestic Savings through real GDP growth indicator.
For the relationship between FDI and DS, literature studies provide blended data. In the early 1990s, the revival of foreign capital flows to less developed countries revived empirical studies on the causes and effects of these flows on recipient economies' DS. An acknowledged fact in the current literature is the negative relationship between foreign investment and savings in less developed countries. Edwards (1995) concludes that there are no major variations between Asian and Latin American countries in the response of the DS to changes in capital inflows. He notices that international and domestic savings can be replaced in both regions: a 1 percent rise in foreign savings is correlated with a decrease in DS of around 0.5 percent to 0.63 percent. This outcome, however, is practically based on standard econometrics, which excludes the non-stationarity of the parameters discussed.
5 Borensztein et al., 1998; Bosworth and Collins, 1999
Hachicha (2003) considers unidirectional causal relationship running from DS to capital inflows in the long-run by using time-series data of the Tunisian economy. In the short term, the author considers between these two aggregates a two-way causation. Gruben and Mcleod (1996) used annual data to assess the impact on macroeconomic output of various forms of capital inflows and vice-versa. They have found strong evidence of a two-way causation between FDI and growth in production. According to these two writers, saving rates are also positively influenced by foreign investment, thus rebutting conventional wisdom. To assess the path of causality between national savings and international capitals, Bowles (1987) used Granger's causality test for 20 developing countries on time series data from 1960-1981.
Bowles (1987) established a causal relationship for 10 countries, either from domestic savings to capital inflows or vice versa, or a bi-directional causality. By using the Johansen cointegration and error correction models, Salahuddin et al. (2010) explores the causal relationship and finds a bidirectional relationship between FDI and DS.
In case of the Kazakhstan economy, Katırcıoğlu and Naraliyeva (2006) used Johansen’s multivariate co-integration model6 to detect short-term bidirectional causality between DS and FDI with quarterly data of DS, FDI and real GDP growth for the period of 1993 and 2002. Moreover, they used VAR and the VECM models in Kazakhstan to test the orientation of the causal relationship between DS and FDI variables. As a result, they proved that there is a long-run balance relationship with one co-integrated vector between GDP and DS, and between GDP and FDI. The normalized coefficients calculated in this study indicate that a 1% rise in DS and FDI would cause real income to adjust by 0.28 % and 0.62 %, respectively.
Bidirectional causation between DS and FDI is observed in the economy of Kazakhstan according to the VAR model they analyzed.
As shown by the results outlined above, the economic growth driven by DS and FDI in Kazakhstan is significant for the country's development policy. In order to make the environment attractive for foreign investors, government should pay more attention, as well as growing domestic savings with courage.
6 Kremers et al. (1992) and Gonzalo (1994) and the notes about ddrawbacks of Engel and Granger (1987) procedure compared with Johansen and Juselius (1990) cointegration technique.
3.1.Negative effects caused by FDI
Despite the fact that the multiplicity of forms of FDI determines the large-scale and multilateral influence that it might have on the socio-economic development of the countries that receive investments, we can't ignore the existing problems and contradictions happening because of FDI instability and crowding out effect.
FDI is mostly concentrated in prosperous and large cities. Several factors, including FDI policies and regional variations in the investment climate, arise from this unequal regional distribution of FDI. It indicates that FDI is leading to widening income disparities between regions. Competition is also exacerbated by the increasing involvement of international companies. Most businesses do not have all the benefits of international companies, such as sophisticated technology, management expertise, easy access to credit, government priorities, etc. Therefore, competitive pressure is rising, leading to the exit from the market of local firms. This foreign company policy poses a range of social and economic issues, such as market distortions, wealth losses and differences in regional income.
The negative effects of FDI include the following: crowding out of national capital and companies; removal of capital from the country through transfer pricing, as well as in the event of benefit repatriation; advanced technology combined with cheap production factors leading to unemployment; reduction of the costs associated with foreign companies; transfer of electrical emissions from the environment and government debt increase due to FDI instability. In the event of conflict with such state criteria, international companies exploit the issue of closing a branch in the host country. Reluctance by the largest investors to invest in long-term and less lucrative manufacturing ventures, in mechanical engineering as well as in telecommunications and social services, is the key problem with the domination of international investors in the commodity market.
While using the country's preferential tax policies for foreign-funded firms to legally minimize taxes, foreign-funded firms may also use the convenience of foreign-funded firms to "reasonably" escape taxes, thus lowering national tax revenues. Nowadays, the "long-term
losses" and "the more losses the more investment" phenomena of many companies have been investing in foreign-funded businesses in Kazakhstan, which is incompatible with conventional business processes. Data also show that, although the amount of foreign investment in Kazakhstan is gradually growing, the average loss of foreign companies investing in Kazakhstan has now exceeded half of the average loss of foreign investment in a region. Accomplishing tax avoidance by producing fake losses is self-evident of ours.
Since, for instance, the starting date of the preferential 'partial tax exemption' period is the year in which corporations begin to make profits, some large multinational companies also take advantage of various forms of tax authority, tax types and tax rates in different countries in order to escape cross-border taxation via price transfers. Profits are distributed as far as possible to similar businesses in other countries in terms of imports and revenues, capital markets, labor technology, and other factors, and high inputs and low outputs are used to raise costs and minimize profits to fulfill the aims of spending less or exempting corporate income tax.
Despite the governments' effort to curb the redistribution mechanism of corporate income to escape taxation, the study shows that the share of phantom 'foreign direct investment' in the overall indicator continues to rise. According to 2010 results, the overall figure is 31 per cent of foreign direct investment. By 2017, it had reached 38% of total FDI inflow in Kazakhstan.
Another negative impact caused by FDI is involuntary unemployment. The effect on employment is first reflected in the loss or loss of employment opportunities caused by the streamlining of personnel in the process of reintegration and reorganization after FDI and mergers and acquisitions of Kazakhstani enterprises. In the case of leveraged transactions of international companies, this form of loss of jobs impact not only occurs but is also extreme.
Furthermore, international companies are primarily represented in the manufacturing, distribution, and wholesale sectors, mainly based on oil reprocessing. These sectors are alienating more and more highly skilled employees who do not want to join them. This also led to the rise of a massive army of unemployed people in Kazakhstan.
Kazakhstan did not take environmental concerns into account in the development expense of the process of creation and development in the investment sector. Local governments also aim to attract more foreign investment and increase local GDP at the expense of the environment due to weak environmental knowledge in Kazakhstan, imperfect laws and regulations on environmental protection, lack of strict accordance with global legislation, as well as considerations of political efficiency and worship of GDP. Therefore, Kazakhstan only appeals to certain developing countries that need to move emission projects at heavy price to protect the atmosphere. The pollution and harm to the environment of our country by foreign-funded corporations has reached a very huge extent, rendering this form of investment activity followed by the emergence of certain elevated environmental costs of pollution. Direct evidence is shown by National Stata where top 3 most polluted regions are Atyrau, Almaty and West-Kazakhstan region that are also found to be most invested regions.
1.2.1. Kazakhstan under conditions of FDI instability
In terms of maintaining economic stability and defense, the crisis era turned out to be very difficult for Kazakhstan. The resumption of economic growth was mainly attributed to the rise in demand in the extractive industries and the favorable situation in the world raw materials markets. This inevitably caught the attention of investors from other countries, but Kazakhstan could lift the level of FDI in GDP from the current 1.975 percent to 12.545 percent, as it was in 2016, with the aid of government economic programs that led to an increase in productivity in the manufacturing industries. However, government anti-crisis initiatives have somewhat increased the risk to the economy, by rising the size of the budget deficit. It also showed a negative impact on FDI inflow as external debt of the Kazakhstan is growing together with the budget deficit. No model has been introduced to show the relationship between FDI and Government Debt, as in most cases it appears due to financial instability of the country, however data shown by National Bank of the Republic of Kazakhstan outlined that the state budget execution in 2010 in Kazakhstan reached a level of 11% of the budget revenues and GDP growth rate slowed down to 1.1%, partially because of the 6.31 billion USD decline in FDI very same year (world bank). Unfortunately, in the
economy of the Kazakhstan this is not the first case where FDI inflow downturn and increase in Government Debt emerged at the same time. Similarly, in 2014 FDI dropped by 4.1 billion USD, whereas GD increased to 5.018% making the central country debt to be 12.064% of GDP respective year.
1.2.2. Effect of FDI on Domestic Investment
FDI has contributed to the economy of Kazakhstan significantly in the last decade, however the fact that it caused a decline in the export competitiveness of domestic products to a certain extent cannot be ignored. Exports of goods from the Republic of Kazakhstan amounted to USD 36,87 billion at the end of 2016. In the same year, Kazakhstan's FDI was about $17 billion, which was 68% of the country's total exports supplied by foreign companies, at the time discouraging the productivity of domestic firms and their commodities. It is evident from the above statistics that the composition of existing export goods is closely linked to foreign-funded undertakings and their products. Since almost 60% of Kazakhstan's import and export goods are manufactured and exported by foreign-financed businesses.
A competitive digital barrier strategy that can reduce the technology gap between Kazakhstan and developed countries over a period is being followed by multinational corporations.
Further innovations, however, are low after FDI implements technology and often remains at a superficial localization level. It's going to stagnate, and the distance could expand even more. Therefore, as multinational companies with technical monopoly advantages enter the market, depending on the Kazakhstan government's strong resources, technical strength and preferential policies, a policy of "first capturing the market, then seeking maximum profit"
would be adopted to concentrate on the field of distribution. In some domestic industries, it also contributes to a monopoly. Competitive position will be lost by local companies, and certain small and medium-sized firms in the same sector will go bankrupt. Consequently, Kazakh local enterprises mainly export basic-needed products. These export companies tend to favor low-price tactics, often selling at lower prices than the same domestic goods, prompting international anti-dumping litigation, because these products lack segregated
7 National Bank of Republic of Kazakhstan(2019)
market space. The fall in the export competitiveness of the domestic products of my country has further exacerbated this. At the same time, the introduction of foreign direct investment has increased the level of domestic market rivalry. Domestic companies have to reduce employment to increase efficiency and performance in order to cope with multinational businesses, or, because of fierce exposure to international enterprises, domestic enterprises have gone bankrupt, causing many workers to lose their jobs.
FDI inflows inevitably make future economic growth reliant on foreign capital. The country may experience many issues as a result of the crisis, which implies the need for more measures towards structural reforms. The possibility that the attractiveness of investment is one of the key drivers of economic growth places the country in a position dependent on external factors. Thus, the dedication of the State to "transparency to the outside world" may have a substantial effect on the structural changes in the economy, even though the stimulation of international economic operations is of great importance.
1.1.Comparison of Foreign Investment flows in Kazakhstan with other Transition Economies
Countries with transitional economies rely on capital inflows to fund economic growth by attracting foreign direct investment. Therefore, CIS8 countries are providing as more opportunities to foreign investors as they could to get a higher share of FDI inflow. Among them Kazakhstan was rated in top 3 most attractive investment locations by 32 %9 of respondents ranked Kazakhstan in the top three most favorable CIS investment locations, and 88 % of investors surveyed in Kazakhstan were ranked as the most attractive CIS investment venue. The only country in which Kazakhstan is inferior in terms of the amount of FDI is Russia, however if we consider that it is territorially 4 times larger than Kazakhstan, and in 2015 FDI of the two countries was almost identical. The evaluation of the attractiveness of country-specific investment depends primarily on the sector of the industry. Russia is often the first choice for industries that depend on the consumer market, considering the scale of
8The Commonwealth of Independent States: Armenia, Azerbaijan, Belarus, Kazakhstan, Kirghizstan, Moldavia, Uzbekistan, Russia, Tajikistan, Turkmenistan, Ukraine.
9 Ernst&Young investment opinion survey
its consumer base. However, Kazakhstan is perceived to be more advanced in its implementation of best foreign practices compared to Russia. Russia started to draw increased investment volumes from its neighbors: the FDI stock grew by 61.1 percent - to
$6.1 billion. Only in 2010-2012 has the indicator been higher. However, in terms of FDI imports from CIS countries, Russia is behind Kazakhstan.
In the structure of mutual investments of the CIS countries, the traditional sector of specialization of Kazakhstan - the fuel complex (at the beginning of 2017, its share was 27%) dominates. Non-ferrous metallurgy (5.9%) and infrastructure networks (6.4%) followed by a wide margin. If Kazakhstan is compared to other transition economies, a strong superiority can be seen, as government policies favor foreign investors, minimize taxes, provide subsidies and inexpensive property, as well as a large reserve of natural resources.
Table 1 below shows the annual FDI net inflows of CIS transitionary countries in US$
billions for the period from 2014 to 2018. If 2018 stock marked collapse would be ignored, Kazakhstan did great in terms of foreign capital inflow. In 2015 total inflows of international capital were almost equal for Kazakhstan and Russia (6.853 billion USD for Russia and 6.578 billion USD for Kazakhstan) and in 2016 Kazakhstan’s FDI inflows were more than a half of Russia’s. Azerbaijan and Ukraine are also in a great favor of investors from abroad, however Azerbaijan’s oil and gas supplies are 2 times less than Kazakhstan’s and Ukraine has lost almost 35%10 of their capital reserves by 2018 making FDI shrink by almost 20 times comparing to what it was in the beginning of the decade. Most economists tend to assume that this sharp decline happened due to unsolved political issues inside country. Following the example of Ukraine, Belarus has also lost more than 40 percent of FDI from the original figure amid political problems within the country. Foreign investors arrived in Belarus primarily in three sectors: manufacturing of 24.4% of all FDI net, trade 17.3% and finance 17.2%11 .Those sectors had the highest level of labor productivity in Belarus in 2015 (along with manufacturing, transport, and real estate operations). However, Kazakhstan has total
10 Dnipropetrovsk State Investment Agency
Available at: http://dia.dp.gov.ua/ru/pryamye-inostrannye-investicii-v-ukrainu-dinamika-2015-2019-godov/
11 National Statistical Committee of the Republic of Belarus.
Available at: https://www.belstat.gov.by/en/
dominance in two out of three industries, because Kazakhstan has a large stock of land and labor in the industrial sector and the trade sector is advanced due to investment from Russia and China. In addition, considering the larger customer base of some of Ukraine, Kazakhstan is seen as more appealing to new entrants in some industries, such as the services sector, because it provides substantial untapped opportunities.
Turkmenistan and Uzbekistan’s competitiveness are slowly but surely continuing to grow.
Despite the 2018 financial crisis, Turkmenistan managed to receive more FDI than Kazakhstan, the figure exceeds Kazakhstan by more than US$ 1 billion. Hydrocarbons and associated industries continue to be highly dependent on economic development of Turkmenistan. However, the economy and the formal labor market continue to be dominated by the public sector and state monopolies, so FDI remains confined outside the hydrocarbon sector, severely diminishing Turkmenistan's chances of attracting large numbers of investors.
Uzbekistan had the highest growth rate from 2017 to 2018 of total 288%12 in FDI net inflows comparing to other Central Asia countries. The main sectors of investment in Uzbekistan are electrical engineering, metallurgy, textile production, leather and footwear and oil and gas sectors. However, due to the unfavorable location of the country, the country's investment is not at such a competitive level. According to the survey made by Ernst&Young (2010) Uzbekistan got less than 1% in investors’ location preference, whereas Kazakhstan got 32%.
Tajikistan and Armenia are least popular destination for foreign capital inflow, due to the poor socio-economic situation in these countries. Most of investment goes to the oil and gas industry in a few regions plus manufacturing in Tajikistan, that has a higher share of FDI inflow than natural resource sector by 1.23%.
Georgia has also strengthened its qualifications as a favorable country for investment over the years. This is all due to the improved market climate implemented in 2008 by tax reforms, globalization, privatization and public sector reforms. Over the past four years, however, the amount of foreign direct investment (FDI) in Georgia has decreased by 54 percent. The
12 The World bank, FDI inflow in Uzbekistan (BoP, current USD)
decrease is attributed in part to the completion of the TANAP13, the termination of the extension of the pipeline in the South Caucasus, and the completion of other railway infrastructure projects funded by foreign countries. TANAP gave the country $ 2 billion in the mid-2010s, according to the Georgian Investment Promotion Agency. Unsurprisingly, after construction was finished, FDI dropped sharply.
Table 1: FDI net inflow in transition economies, US$ billions
Source: The World Bank, Foreign Direct Investment, net inflow (BoP, current US$)
Available at:https://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD?end=2019&locations = KZ&start=2014
Kazakhstan has shown strong success, especially in extractive industries, in attracting FDI.
But if the government is to achieve its ambitious plans to diversify the economy, it has to attract FDIs, which will not only bring financial transfers, but also transfer of technology, elevated equipment and human capital growth opportunities.
Many indicators alongside with statistical data prove that Kazakhstan is among top 3 destinations for investors. Its borderline with China provides a chance for prospective investors to supply China with oil reserves. For other industrial investors, for instance, the proximity of China could be more of a hazard than an advantage, given China's current competitiveness and cost-efficiency levels. Even so, the exposure to fast-growing markets in Russia, China and other parts of Asia has been seen by many investors, not only in manufacturing and natural resources, but also in financial services, as a real opportunity. For
13 Trans-Anatolian Gas Pipeline, 2010
Kazakhstan to fully realize its ability beyond the extractive industries, ongoing efforts to improve the investment environment need to complement its geographical advantages.
1.1.Investment attractiveness in different regions of Kazakhstan
There are different areas for investment projects in each zone of Kazakhstan. Mostly preferred to buy foreign capital suppliers are oil and gas, manufacturing, trade, natural resources, and mining industries.
The highest FDI went to the mining and quarrying industries by industry in 2018 - USD 13.6 billion. Investments in the manufacturing, wholesale and retail sectors amounted to USD 3.4 billion and USD 3.3 billion, respectively. At the same period, financial and insurance operations ($ 1.3 billion), transport and warehousing ($ 786 million) were included in the TOP-5 industries.
Over the past years, the most lucrative industry for FDI has been oil and gas production. In addition, its share in the overall investment volume has risen - 17.6%; 26.9%; 45.9%; 49.8%
respectively - since 2015. Thus, the value of FDI in the oil and gas sector amounted to over
$12 billion at the end of 2018, which is 26% more than $9.6 billion a year earlier. Wholesale and retail trade is the second most attractive sector - 13.5% . Last year, the volume of FDI amounted to $3.27 billion, a rise of 4%. In 2017, the metallurgical industry took second position, which fell one line lower in 2018 - 11.3% and $2.75 billion combined.
For the past five years, the top 3 FDI recipients have remained unchanged. Therefore, in 2018, the gross inflow of FDI into the region of Atyrau oil and gas amounted to $ 10.02 billion (41.3% of the total volume) which is by 28.2% more than in 2017, in Almaty - $ 5.43 billion (22.4%), in the region of East Kazakhstan - $ 2.39 billion (9, 8% respectively). In addition, the indicator hit record values within five years in the first two areas. FDI in Nur- Sultan - $ 965 million, Pavlodar - $ 854 million and Karaganda area - $ 647 million also showed a five-year cap. The regions of Almaty, Zhambyl and North Kazakhstan earned the
least direct foreign investment - 94.4 million dollars, 94.7 million dollars and 1 million dollars respectively. Last year, FDI in North Kazakhstan increased by 7 times, but in terms of volume, this is still a low figure in Kazakhstan - $ 17.8 million, lower only in Kostanay region with an outflow of $ 120.3 million.
The government of Kazakhstan is working to diversify the economy aimed at reducing dependence on raw materials. The country's policy had a positive effect on investment flows:
in 2018, the share of investments in financial and insurance activities went from 1.9% to 5.4%, in the professional, scientific, and technical spheres from 0.9% to 2.8% , construction from 1.6% to 2.4%.
Figure 1: FDI inflow indifferent regions of Kazakhstan
Source: OECD, “Local Strategies Forming Links FDI & SMEs in Kazakhstan Final Report” by Stuart Thompson (Policy Analyst), OECD, André-Pascal, 75775 Paris Cedex 16, France, 2014.
For the first half of 2018 , the Atyrau region received the largest amount of foreign capital inflow: 5.7 billion US dollars, which was 47.3% of the country's total value. The share of the oil and gas sales area in the country's trade turnover rose from 30.9% in 2018 to 35.9% (1st place) in 2019. This is $26.68 billion, of which $23.73 billion comes from exports, or 43.1%
-2,000.0 0.0 2,000.0 4,000.0 6,000.0 8,000.0 10,000.0 12,000.0
Akmola Aqtobe
Almaty Nur-Sultan
Atyrau East Kazakhstan
Zhambyl West Kazakhstan
Karaganda Kostanai
Kyzylorda Mangystau
Pavlodar North Kazakhstan
Turkestan Shymkent
Almaty city
FDI inflow in different regions of Kazakhstan (millions of USD)
2014 2015 2016 2017 2018 2019 Q1 2019 Q2
of the country's overall exports (1st place). According to the Financial Times14, one foreign project worth $ 51.6 million was announced in the Atyrau region, following the results of nine months of this year, with the creation of 40 jobs. “Blue Water”, a multinational shipping and logistics company from Denmark, is the project's investor. The Atyrau region is ranked sixth in the country in terms of ease of doing business in the World Bank's Doing Business report.
In terms of FDI inflows, Almaty ranks second: $ 2.5 billion, or 21 percent of the total. Almaty ranked first in the country in the World Bank's Doing Business 2019 classification in terms of ease of doing business, which is another reason for such high prices. According to the Financial Times, 5 international ventures in the megalopolis were announced in January- September of 2018 for a total of $ 296.9 million, with the development of 2600 jobs. The Carlsberg Kazakhstan and Phoenix Group ventures were the biggest ones (UAE). On 27th of November 2019, the “Almaty Investment Forum 2019” was held in Almaty, according to the Kazakh Invest press center. The forum's main objective is to increase Almaty's investment attractiveness. More than 700 members of business circles, of which foreign- 142, representatives of international companies in Kazakhstan - 126, have registered to participate in the forum. The forum signed 31 agreements and memorandums of cooperation and understanding between government bodies and business communities worth $ 2.3 billion. In general, 46 international projects in Kazakhstan were announced in January-September of this year, according to the Financial Times, with an investment volume of USD 2.1 billion.
There were 2.9 thousand jobs generated as a result.
The region of East Kazakhstan is among the top three in terms of FDI inflows: USD 1 billion, 8.4% of the Republic of Kazakhstan’s total FDI net inflows. Foreign direct investment inflows to the country amounted to $2.93 billion in 2017 which is third position after the region of Atyrau and Almaty, in grand total of 469.1 million (second in absolute growth after the region of Aktobe), or 19.1 percent, higher than the previous year.
14 FDI Intelligence
The TOP-5 regions in terms of foreign direct investment inflows also included the regions of West Kazakhstan and Aktobe: US$ 589.4 million and US$ 534 million, respectively. 85.9%
(US$10.4 billion) of all FDI in Kazakhstan was consolidated by the five regions listed. By 2018 the export share of the West-Kazakhstan region is 10.9 percent, the second largest after the Atyrau region. The city holds an 8.4 percent stake in the country's overall turnover and is fourth after the capital. The amount of trade rose by 29.6 percent over the year and reached
$ 6.25 billion, of which $ 5.98 billion was exported. Foreign direct investment inflows have decreased marginally over the year, from $1.2 billion to $1.17 billion, but this is the fifth highest after the Atyrau, Almaty, East Kazakhstan and Mangystau regions in terms of value.
Foreign investment amounted to nearly $ 1.53 billion in 2016 (4th place), but in June 2017, in the oil and gas condensate field "Karpovsky Severny" in FDI, the Hungarian MOL15 sold its 49% of shares to KMG16, decreasing FDI in the region to $ 1.2 billion. In 2017, for the first time, the region of West Kazakhstan reached the top 5 of the country's regions' competitiveness ranking. West Kazakhstan region's processing industry grew 14.3 percent in the five months of 2017 compared to the same span of the previous year - this is the best dynamic in the world. In the World Bank's Doing Business study, West Kazakhstan region is in 11th place in the country in terms of ease of doing business.
Actobe is the last in top 5 investment attractive regions’ list. In 2012, 430 billion tenge of investments were attracted to the Aktobe region, half of which is foreign direct investment.
74 projects worth 633.8 billion tenge have been introduced at the beginning of 2013, including the development of glass, rail and girder, gas processing and ferro-alloy plants because of foreign investment. The area is one of the three leaders in terms of fixed asset investments, showing a rise of 15% in 2013 compared to 2012. In 2016, in terms of foreign investment growth dynamics, the region ranked fourth: it grew from $367.3 million in 2015 to $1.1 billion. Regarding FDI growth in absolute terms, the region became the leader. Their volume rose by $ 631.2 million during the year. The FDI volume amounted to $ 1.8 billion in 2017, which is the fourth best result after the area of Atyrau, Almaty and East Kazakhstan.
15 Magyar Olaj és Gázipari Részvénytársaság LLC
16 KazMunaiGaz JSC
Capital city Nur-Sultan is not as popular as regions listed above, however it also showed great results in past 7 years. In 2016, the inflow of foreign investment decreased by 53.4%, from $ 424 million to $ 197.5 million (14th place), even though Gross Regional Product growth was 2.5% - the third result after the same Atyrau region and Almaty. In 2018, gross FDI inflows were $964 million (6th place), which is $377.4 million higher than in 2017. In terms of the growth of trade turnover, Nur-Sultan showed the best result in the country - 66%, its volume amounted to $ 6.93 billion, or 9.3% of the share of the country's total trade turnover.
2. Practical section
Practical part of this thesis will analyze the relationship FDI net inflows and real GDP growth as well as the relationship between DS and FDI of Kazakhstan. Data used in this paper are yearly figures covering the 1993-2019 period. The data base is the World Bank (2019), National Bank of Republic of Kazakhstan (2019) and Agency of Statistics of Kazakhstan (2019). FDI and DS are expressed in absolute values. GDP growth is express in both absolute and percentage (natural logarithmic form) forms. All results shown in this work were assessed with statistical data analysis and table-chart overview.
2.1.Methodology
Methodology of practical part will partially include analyses the model of “FDI, DS and Economic Growth in Kazakhstan: co-integration and causality model” run by A. Naraliyeva and S.T. Katirciouglu, 2006. As a main tests ADF17 and PP18 unit root tests were employed.
Also, “FDI and Economic growth in Malaysia” by M.S. Karimi and Z.Yusop (2009) who tested same connection but with the sample of Malaysia.
17 The Augmented Dickey-Fuller, tests the null hypothesis that a unit root is present in a time series sample.
18 Philips-Perron used in time series analysis to test the null hypothesis that a time series is integrated of order.
The Augmented Dickey-Fuller (ADF) and Root Tests of the Phillips-Perron unit are used to test the degree of integration and potential co-integration between the variables (Dickey and Fuller, 1981; Phillips and Perron, 1988). To test the existence of unit root process in the series the general model was used,
∆𝑦!= 𝑎"+ 𝛾𝑦!#$+ 𝑎%𝑡 + ∑(')%𝛽&∆𝑦!#'#$+∈!, (1)
Where 𝑦- is time series, t- time (trend factor), 𝑎- constant term, ∈!- Gaussian white noise19, p-the lag order. The Akaike Information Criterion (AIC) has chosen the number of 'p' lags in the dependent variable to ensure that the errors are white noise. One problem with the inclusion of the extra calculated parameters is that the degrees of freedom and test power are decreased.
The null hypothesis of a unit root (𝛾=0) might fail to reject due to misspecification regarding the following part of the regression. Consequently, when the type of the data generation method is uncertain, Doldado, Jenkinson and Sosvilla-Rivero (1990) also suggest starting from the most general model to test for a unit root. The basic principle is to select a configuration which, under both null and alternative hypotheses, is a plausible explanation of the data. The power of the test will go to zero if the intercept or time pattern is wrongly omitted. "Reduced power means the researcher will conclude that when, in fact, none is present, the process contains a unit root."20 If the variables are stationary, a linear combination of integrated variables is said to be co-integrated. Such co-integrating partnerships require multiple economic models.
Kwiatkowski Phillips, Schmidt and Shin's test (1992) (KPSS) is proposed to remove a potential low power against stationary close unit root processes that occur in the ADF and PP tests to validate the test results obtained from the ADF and PP tests. The KPSS test complements the ADF and PP tests, where the KPSS test's null hypothesis is that a sequence is stationary. The KPSS test is built on the presumption that, in the following equation, a sequence can be investigated in three parts: a time trend, a random walk, and a stationary error:
19 Any two values of GWN are statistically independent now matter how close they are in time.
20 Enders, 1995: p. 255.
𝑦!= 𝜌𝑡 + 𝑟𝑤!+ 𝜀!, (2)
Where 𝑟𝑤!= 𝑟𝑤!#$+ 𝑣! and 𝑣! is i.i.d. (0, 𝛿*%). The above regression can essentially be performed in two ways: first with a constant in the case of the stationary phase, second with both a constant and a trend in the case of the stationary trend. In the following equation, we then use the 𝜀! residuals from the regression and calculate the LM statistics:
𝐿𝑀 = 𝑇#%5 𝑉!%
!
')$
∕ 𝑉+%!
Where 𝑉!% is the estimate of the variance of 𝜀! and 𝑉! is defined this way:
𝑉! = 5 𝜀'
!
')$
As in the following equation, 𝑉!% can be constructed to be a more robust estimator because of the implications of 𝜀! ‘s behavior, as in Phillips and Perron's (1988) paper:
𝑉!(𝑝) = 𝑇"#' 𝜀$!
%
&'#
+ 2𝑇"#' 𝑤(𝑣, 𝑝)
(
)'#
' 𝜀$
%
&')*#
𝜀$"+
Where w(v,p) is a variable function. According to Newey (1987) it is possible to use the Bartlett window as w(v,p)=1-v/(v+1). After this observation, the test statistics of KPSS test is:
𝑡 = 𝑇#%5 𝑉!%
,
')$
∕ 𝑉%(𝑝)
Once the integration order is determined and if the array is in the same integration order, it is then important to evaluate co-integration between the variables to identify any long-term (3)
(4)
(5)
(6)
