Development stages and foreign direct investment: an analysis of Indonesia's recent experiences

Abstract

The role of foreign direct investment (FDI) in the industrial restructuring of developing countries is of concern to host countries. Nowadays, most countries compete for international investment. Every country, including Indonesia, is aggressively attracting inward FDI to further economic growth, opportunities for technology transfer and stronger exports as catalysts for prosperity and employment. Obviously, technological advance is the prerequisite for improvement in factor productivity and product innovations.

Since the impact of foreign capital on economic growth of developing countries and the relative significance of various types of foreign capital is still controversial, this study investigates the impact of FDI on Indonesia's economy.

The study empirically examines the role of FDI in Indonesia's economic development. FDI also contributed to welfare improvement as measured by increased marginal productivity of labor (MPL). Meanwhile, the main cause of exessive (speculative) investment was easy credit to investors in Indonesia due to abundant capital inflows and the emotional behavior of investors. In addition, Indonesia's economy also experienced a rapid structural upgrading. A simulation model indicates that the role of labor-intensive sector declines as per-capita income increases, and that technology-intensive industries become more important at higher levels of per-capita income. Structural upgrading is thus positively correlated to increases in the income level.