The focus of this study is to examine whether FDI inflows contribute to economic growth of the Solomon Islands, identify the main factors that attract FDI inflows, and whether FDI inflows have productivity effects on the primary, manufacturing and services sectors. Chapter One introduces the key issues underlying the FDI-led growth nexus, growth driven-FDI nexus, and FDI-productivity nexus, which provides the basis, motivation and
objectives for this research, its relevance to the Solomon Islands’ development context and
a brief outline of the chapters.
Chapter Two presents the literature review on the theoretical and empirical FDI-led growth nexus, growth driven-FDI nexus, and FDI-productivity nexus including the direction of causal relationship between the selected variables in these nexus. The literature notes that while there is no firm conclusion on the relationships of the afore mentioned, the majority of recent studies appear to suggest a positive relationship depending on the level of
‘absorptive capacity’ of the host nation. This includes having the right level of human
capital, infrastructure development, domestic investments, trade openness, high economic growth, sound macroeconomic climate, and political stability to maximise the benefits of FDI inflows. These pre-requisites in turn are also key factors to attract FDI inflows. While, the impacts of FDI inflows and the growth enhancing factors have been largely successful in developed and large developing countries, little is known for small island economies such as the Solomon Islands. Other than the issues of domestic economic climate noted above, the lack of detail FDI data and other vital information on FDI is not reported
however it is noted that due to confidentiality of firm based data it’s not possible to get that.
Chapter Three presents an overview of the Solomon Islands economy, the flow of FDI and its contributions towards employment, revenue and development prospects in the pre-and post-independence period including the macroeconomic and foreign investment policies. The analysis suggests that FDI inflows play a major role in these growth factors although the level of inflows has been low until 2000. The slowness in attracting FDI inflows may have been hindered by weak inherent organisational and structural disadvantages, and inadequate absorptive capacities such as lack of adequate infrastructure and skilled manpower, poor public service delivery, weak financial institutions and limited access to
land. These drawbacks in turn promoted leakages, corruption, and other illegal practices that affected Solomon Islands of not fully maximising the benefits of foreign investment. Furthermore, the lack of appropriate policies also led to the country relying more on exploitation of natural resources than investment and production to increase export earnings, growth and development.
The recent civil unrest and political instability experienced by the Solomon Islands have
further impeded FDI’s inflows and its contributions to the economy. More recently, in the
post-civil unrest, the Regional Assistant Mission to Solomon Islands (RAMSI) has been implemented and with the assistance of RAMSI it brought some normalcy to Solomon Islands economy. This restored investor confidence, financial and development support by other key stake holders and the FDI inflows rose rapidly representing nearly 36 percent of GDP in 2010. The government also implemented foreign investment and macroeconomic policies. Thus the importance of FDI inflows to improve economic growth depends largely on the environmental conditions of the host country. In particular, Gounder (2002) notes that a stable political environment is vital for Solomon Islands long-term growth prospects. Chapter Four estimates the FDI-led growth nexus and the direction of causal linkages between economic growth, FDI inflows and domestic investment. The ARDL methodology has been utilized in preference of its advantages for allowing testing for short and long-run impacts of the variables when the sample size is small. The ARDL Bounds F- test suggests an existence of a long-run relationship amongst the variables in the FDI-led growth models. The results for the FDI-led growth models show that FDI inflows, domestic investment, labour force, and trade openness increase economic growth. On the other hand, civil unrest and political instability adversely affect economic growth. The Granger causality tests show that economic growth has a large influence on FDI and in turn they both stimulate domestic investment. Thus, this confirms that economic growth is the main mechanism in attracting FDI and in influencing domestic investment. A bi- directional causality between FDI inflows and domestic investment suggests that FDI inflows affect domestic investment and domestic investment itself exerts a major influence on the level of FDI inflows. A bi-directional causality between domestic investment and economic growth further suggests that higher levels of domestic investment promotes higher economic growth and vice versa. Thus, the results provide support for the FDI-led growth nexus and that FDI is complementary to domestic investment and economic growth in the Solomon Islands.
Chapter Five presents the results of the growth driven-FDI nexus or the determinants of FDI inflows and the direction of the causal linkages between FDI inflows, exports and per capita income. The estimated Bounds F-test statistics suggest the existence of a long-run
cointegration amongst the variables. The results indicate that economic growth, domestic investment, degree of openness and export orientation, and providing an enabling environment through the provision of infrastructural facilities are important determinants of FDI inflows. On the other hand, high inflation rate, civil unrest and political instability factors have an adverse effect on FDI inflows. Thus, civil unrest and on-going frequent changes of government, lack of resources and initiatives have further impeded the impact of major reforms initiated since 1998. The Granger causality results indicate a bi-direction causality between FDI inflows and per capita income providing support for the FDI- income growth nexus. This re-affirms the claim that FDI inflows and income growth are complementary to export expansion. A bi-directional causality has also been found between FDI inflows and exports which further support the FDI-trade nexus in that FDI and exports are complementary to income growth. Thus, increase in FDI inflows encourages exports and this confirms the view that FDI provides greater opportunities and access for the host economy into the global market.
The results for the FDI-productivity nexus are presented in Chapter Six. The stepwise procedure has been selected to evaluate these relationships given its simplicity. Using both backward elimination and forward selection, the results find strong support for a positive FDI effect on the primary and services sector while no support for the effect of FDI on the manufacturing sector. The positive spillover effects of services FDI inflows on primary productivity suggest that the availability of infrastructure, particularly transportation and
communication are important for this sector’s productivity. Furthermore, the positive effect
of institutional quality and education on the productivity of the services sector re-affirms the importance of these factors in enhancing growth in this sector. The insignificant effect of each sector exports on productivity reflects the low absorptive capacities such as inadequate infrastructure, weak export linkages and a low value-added type of foreign investment, which negate the potential benefits of exports. The direction of causality is also from primary productivity to primary FDI inflows than in the opposite direction, providing evidence that primary productivity induces FDI inflows. The Uni-directional causality also runs from services productivity to services FDI inflows, showing evidence that services productivity encourages FDI inflows to this sector.
Overall, FDI inflows, domestic investment, labour and trade openness are crucial to improve economic growth. The presence of these factors in addition to export orientation, telecommunication and infrastructure facilities, higher economic growth are key factors in influencing foreign investors and FDI inflows. On the other hand, high inflation, low skilled labour force and the presence of civil unrest and political instability all have an adverse effect on the flow of FDI and economic growth. FDI inflows are growth-enhancing in the primary and service sectors productivity with productivity in both sectors driving the inflows of FDI. Services FDI spillover is important for primary productivity whilst the level of institutional quality and human capital all play an important role in the growth of the service sector. Therefore, in the Solomon Islands, FDI plays a significant role in promoting trade and stimulating domestic activities to achieve higher level of economic growth and these provide important policy implications for the policy makers.