The Effect of Foreign Direct Investment on Domestic Investment (in Korean)

Recently, domestic investments in Korea have been dwindling while the outbound foreign direct investments (FDI) made by Korean enterprises have increased. This raised the issue of whether foreign direct investments replace and suppress domestic investments. The relationship between FDI and domestic investments, however, is not straightforward as many previous studies show. Some argue that the outbound FDI and domestic investments may substitute each other via the resource constraint facing a multinational enterprise. Other studies stress that the two investments can be complementary through the relatedness in the production process or through a regionally created vertical division of labor. In addition, some researchers reveal that the relationship between FDI and domestic investments can vary across countries depending on their industrial structures. Therefore, the issue is empirical rather than theoretical. This paper tries to look at the relationship between FDI and domestic investments in Korea. It turns out that the analysis of quarterly data for the economy as a whole (1990.Q1~2006.Q4) does not provide a strong case for the substituting relationship between FDI and domestic investments in case of Korea. If anything, the relationship was complementary for the whole period, although the significant positive relationship weakened after the 1997 financial crisis. The analysis of manufacturing panel data (13 manufacturing industries, 1990~2005) also confirms the complementary relationship. By region, however, the result was rather different. FDI in developed countries has no significant relationship with the domestic investments, while that in developing countries was complementary to domestic investments. This result indicates that FDI in developed countries may be decided upon rather independently from the decision making on domestic investments, and that FDI in developing countries may take place while maintaining vertical connectedness with domestic investments and production. By period, positive relationship between FDI and domestic investments was weak in the whole period, but it became significant after the crisis. This seems to be related with the fact that FDI in labor intensive industries was dominant before the crisis in Korea, while FDI in high-tech industries which require vertical connectedness with domestic production became more prevalent after the crisis.