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Poverty Reduction In India:The Role of Foreign Direct Investment

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DOI: 10.17492/focus.v6i1.182828

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 FOCUS: Journal of International Business
Volume 6, Issue 1, January-June, pp. 48-71
doi: 10.17492/focus.v6i1.182828

Poverty Reduction in India: The Role of Foreign Direct Investment

Komal* and Madan Lal**

ABSTRACT

Developing economies like India, China, and various African nations have increasingly
been looking at foreign direct investment (FDI) flows as a source of economic growth,
raising per capita income, reducing unemployment, and thus finally alleviating poverty.
However, the positive impact of such openness remains a matter of debate. Hence, this
paper aims to ascertain whether FDI flows play a role in reducing depth as well as
intensity of poverty using time series data spanning from 1981-2012 for India. The
regression analysis reveals that increased FDI inflows are associated with a lower
poverty count, in both the measures that are Headcount Poverty as well as Poverty Gap.
In the second model of (OLS), agricultural incomes seem to elevate households out of
poverty but fail to bridge the divide between the incomes of the people below poverty line
and the average incomes. Thus, the study suggests that bringing more FDI flows is no
perfect recipe for alleviating poverty, but it can have a positive impact on poverty
reduction, provided that desired mechanisms are in place in the host country to have
these positive effects.

Keywords: Economic growth; Exports; FDI; Poverty; Inequality.

1.0 Introduction

Developing economies like India, China, and various African nations have
increasingly been looking at foreign direct investment (FDI) flows as a source of
economic growth, rising per capita incomes, reducing unemployment, and thus finally
alleviating poverty. This is evident from the economic policies being followed globally
by the developing nations, which seem to focus on a premeditated strategy of attracting
FDI flows and to capitalize on such flows.
______________________________
*Corresponding author; Research Scholar, Department of Commerce, Delhi School of
Economics, Delhi University, New Delhi, India. (E-mail: komichhikara@gmail.com)
**Professor, Department of Commerce, Delhi School of Economics, Delhi University, New Delhi,
India. (E-mail: Madanfms@gmail.com)
 Poverty Reduction in India The Role of Foreign Direct Investment 49

Over the past three to four decades, these nations have employed wide ranging
economic reforms like opening up their foreign trade and investment regimes. India,
especially since the BOP crisis in 1991, has become much more liberal in its economic
policies to attract more FDI to increase its economic growth and hence to assuage the
impact of poverty in the country. However, to what extent such openness is beneficial
for India remains a matter of debate.
Against this backdrop, it would be interesting to analyse the linkage between
openness in capital flows and poverty reduction in India. India has been specifically
chosen for the study; since according to the Millennium Development Goals Report
(2015), the majority of world’s poor reside in developing regions of the world, lead by
India. Though poverty levels have come down substantially, the pace of poverty
reduction in India has been very slow. In fact, the slow poverty reduction has resulted in
increase in India’s share of the world’s extremely poor population. Further, among the
many types of capital flows, the focus in this paper will be on FDI flows, as these are
likely to have the maximum impact on poverty. It is contended that FDI flows help in
perking up economic growth as well as sustainable development in emerging economies.
Higher growth is channelled through increased employment, diffusion of information,
technology transfers and knowledge spill-over effects, etc. And these higher levels of
growth, in turn, are likely to help in poverty reduction. However, the impacts of FDI on
poverty depend on many factors including the host countries’ institutions and policies,
the quality of the labour market, the economic environment, and the investment itself
(Mayne, 1997).
Although the FDI effects on the reduction of poverty have been identified,
empirical research on the impact of FDI on poverty reduction in India has been limited.
Thus, the main aim of this study is to ascertain whether FDI flows play a role in reducing
depth as well as intensity of poverty in India. By assessing the impact of openness on
poverty while controlling for other variables like education and government expenditure,
the study seeks to shed light on appropriate policies to be pursued in order to encourage
higher volumes of FDI and to reinforce its impact on poverty reduction.
The rest of the paper is organized as follows. In Section 2, the authors conduct a
literature review on the relationship between poverty and FDI flows. Here, the author
also outlays the conceptual framework describing the Poverty-growth-FDI nexus.
Section 3 describes the historical background as well as long term growth trends and
magnitude of FDI flows in India. Section 4 deals with data, variables and econometric
methods. In Section 5 the paper analyses the poverty-FDI linkage with the help of
empirical analysis. Section 6 explores the impact of growth in agriculture and
manufacturing sector on poverty reduction followed by conclusion in Section 7.
50 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

2.0 Objectives

 To empirically examine the impact of India’s FDI flows on poverty outcomes.

 To examine the impact of macroeconomic variables on FDI-poverty relationship.
 To study the linkages between growth, openness and poverty.
 To analyze the impact of ‘Make in India’ scheme on FDI flows in India.

3.0 Literature Review

3.1 Definitions of FDI

FDI is regarded as the ownership or control of 10 percent or more of an
enterprise's voting securities or the equivalent interest in an unincorporated business
(Griffin & Pustay, 2007). Farrell (2008) defined FDI as a package of capital, technology,
management, and entrepreneurship, which allows a firm to operate and provide goods
and services in a foreign market. Whereas World Bank define FDI as investment made to
acquire a lasting management in an enterprise operating in a country other than that of
the investor. Theoretically FDI can be classified into two types i.e. Horizontal FDI and
Vertical FDI. Horizontal FDI (HFDI) is defined as a type of investment which is in the
same industry operating abroad as a firm operate in its home country or offers the same
services as it does at home, with the objective of production for foreign market rather
than exporting the produce to home (Maskus, 2002); (Haile & Assefa, 2006). On the
other hand, vertical FDI occurs when a company invests in a business that plays the role
of a supplier or a distributor.

3.2 FDI and poverty linkage

The empirical literature on poverty-FDI relationship can be divided into three
different parts. The first is in the context of the determinants of economic growth. The
supposition is that, ceteris paribus, rising FDI flows are correlated with a faster economic
growth which decrease unemployment, thus ultimately alleviating poverty. The second
part of literature focuses on diffusion of technology and other spill-over benefits from
MNC’s to local firms. The third way is through utilization of tax revenues collected from
foreign firms towards economic activities which directly or indirectly benefit the poor.

3.2.1 Through “labour-intensive” economic growth

Theory suggests that FDI has the potential to directly affect economic growth
through increased investment in domestic firms as well as through introduction of
 Poverty Reduction in India The Role of Foreign Direct Investment 51

advance technologies and innovation. Empirically, neoclassical models have been used
to test those theoretical benefits of FDI. Firstly, the FDI’s impact on existing human
capital in host countries has been explored in numerous studies. One such study is by
Borensztein, De Gregorio, & Lee (1998) where they analyze the impact of FDI on
human capital in a cross-country regression analysis of 69 developing countries in the
period 1970-89. They concluded that inward FDI has positive effects on growth through
its interaction with human capital. Similarly, in a panel data framework for a sample of
20 Latin American countries for 30 years, Bengoa & Sanchez-Robles (2003) deduced
that economic growth as reflected by GDP per capita is a necessary , but not sufficient,
means of attaining raised standards of living for the poor or lower poverty levels. The
most important mechanism by which trickle down occurs is thus, via, economic growth
led employment creation as shown in Figure 1.

Figure 1: Relation between FDI and Poverty Reduction through Economic Growth

FDI Labour intensive Employment Poverty

economic growth creation reduction

Source: Author

The first part of this chain i.e. the linkage between FDI and economic growth has
been studied by Nair-Reichert and Weinhold (2001) in a cross-country regression
framework. They conclude that though local investment speeds up economic growth, it
does not emerge as a strong determinant. The study also reveals that there exist no
significant relationship between human capital and economic growth, however these
findings need to be evaluated with a word of caution, since the impact of human resource
is too vast to be captured by a linear model. Similar studies by Taylor (1998), Blomstrom
(1990), Levine (1992), and Wacziarg (2001) reveal similar conclusions indicating that
FDI flows play a significant role in establishing clear linkages between open trade and
economic growth, and thus conclude that poor investment policies which discourage FDI
could undermine trade benefits. However, there are studies which dispute the positive
relationship between FDI and economic growth. One such study is by Carkovic and
Levine (2002), where they contend that most of the studies which find positive linkages
between FDI and growth, fail to control for endogeneity issues, country specific effects
as well as including the lagged values of dependent variables while regressing the
growth equations. They stress that, once all these factors are taken into consideration,
FDI inflows no longer show significant relationship with growth.
52 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

Another route through which economic growth can be spurred is through

encouraging exports from developing nations to advanced economies. Also, FDI can
play a pivotal role in supporting exports from developing economies and contribute in
raising per capita incomes, thus reducing the poverty burden. Komal and Lal (2017)
reviews the relevance of trade in reducing poverty in India and promoting pro-poor
growth through a survey of the existing literature and concludes that a strong
performance on the international market can help reduce domestic poverty in developing
countries. Via a review of the literature on this topic, they posit that there is strong
empirical evidence in favor of the growth enhancing effects of exports and trade in
general. Thus they conclude that exporting can lead to productivity, growth and directly
reduce poverty through wage and employment effects. Another study by
Balasubramanyam et al. (1996) hypothesized that countries which promote their exports
are better able to exploit the FDI gains, since increased domestic resources viz. labour
and capital can be easily funded through FDI inflows. They contend that being the
primary source of innovative technologies and better skill-sets in developing economies,
the FDI variable captures the externalities, learning by watching, and spillover effects.
Studying the latter part of the chain describing poverty- growth relationship,
Deininger and Squire (1996) summarizes that there was no established linkage found
between economic growth and inequitable distribution, however, they found that
economic growth was positively associated with poverty reduction. Similar confirmation
is given by Ravallion and Chen (1997). They use household survey data for 67
developing nations, over a time period of 15 years spanning from 1981-95. They deduce
that virtually every time, poverty decreased with increasing growth and living standards
of households, while it increased with falling economic growth. Dollar and Kraay (2001)
examined the impact of trade volumes on the poorest sections of society and deduced
that since there is little systematic evidence of a relationship between changes in trade
volume and changes in income share of the poorest, the increase in growth rates that
accompanies expanded trade leads to proportionate increases in incomes of the poor.
Hence, from the literature it appears that, increased FDI flows are not a sure-shot recipe
for reducing poverty and raising employment in all the poor nations. Different countries
need to customize the policies according to their own local conditions, in order to gain
maximum poverty reducing benefits provided by capital flows.

3.2.2 Through transfer of new technology, knowledge, and other intangible assets
The FDI inflows not only help in setting off the chain for economic growth but
also spearhead the diffusion of advanced technologies, innovative ideas, practices and
management skills from the advanced nations to the technologically backward nations
 Poverty Reduction in India The Role of Foreign Direct Investment 53

like India. The transfer of such intangible assets helps in raising wages for production
workers and is a much less volatile form of international investment than portfolio
investment flows (Bhorat and Poswell, 2003).

Figure 2: Relation between FDI and Poverty Reduction through Transfer of New
Technology, Knowledge, and Other Intangible Assets

Diffusion of Increased
advanced International
technology, competitiveness
Economic Poverty
FDI innovative ideas, growth reduction
skills, best Increase in
practices & other productivity and
intangible assets wages

Source: Author

Klein, Aron and Hajimichael (2001) studied the impact of FDI on development
and economic growth using cross country regression analysis. The paper shows that FDI
inflows contribute towards technological innovation and economic growth in countries
having skilled human resources. Further, Saravanamuttoo (1999) explores the
theoretical, conceptual and empirical literature on the relationship between FDI and
economic growth in both the host as well as home countries. A significant finding from
the literature review is that spillover gains from FDI inflows not only benefits the
domestic firms financially but also enriches the skill set of poor labour working in such
organizations. However, Aaron (1999) in his study on the financial impact of diffused
technologies through FDI inflows contends that FDI spillovers tend to benefit the skilled
and semi-skilled workers, as compared to the unskilled labour. This indicates that though
FDI lifts the skilled workforce out of poverty by raising their productivity and incomes,
it makes the unskilled worse off because of meagre wages and rampant unemployment.
Also, Hung (2005) demonstrates that FDI benefits large scale domestic firms more as
compared to smaller ones. Since large firms have better financial and human resources,
they are able to benefit through diffusion and spill over of technologies and innovation.
When coming to country specific studies, a lot of work has been done in Africa
regarding the diffusion benefits of FDI flows to the poor African economies. These
studies reprove the findings that FDI plays a significant role in technological
advancement of FDI recipient nations. One such study is by Cockcroft and Riddell
54 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

(1991) which insinuates that FDI made an insignificant impact on the development status
of African countries in 1980’s. They show that the advanced technology brought in by
MNC’s was not suitable for low-skilled labour, both in terms of difficulty of usage as
well as the abundance of cheap labour. Since most of the multinational firms were
capital intensive, they failed to create employment for the local population. Thus, their
results reiterate the belief that innovative technology improves economic growth at the
expense of unskilled and poor sections of the society.
Since, a lot of other developing and under-developed nations lie in Asia,
studying the impact of FDI flows from advanced nations to third world countries become
imperative. Agarwal and Atri (2016) in their case study on India find that FDI inflows
contribute to increases in poverty in India whereas for other SAARC countries they
significantly reduce poverty. The impact of FDI outflows in India too is in complete
contrast with other SAARC countries. While FDI outflows significantly reduce poverty
in India, they turn out to be insignificant for other regional countries. Another such study
is by Bende-Nabende (1998) where they study the spill over impact of FDI on ASEAN
countries over a time span of 25 years starting from 1970 to 1995. They posit that
ASEAN member countries have experienced spur in economic growth because of FDI
inflows from developed nations. This growth is led by innovative technology, enhanced
skills of the workforce, learning effects, better management expertise and finally through
training of workforce.

3.2.3 Through the allocation of tax revenue collected from foreign firms
Finally, the third way through which FDI positively impact poverty reduction is
through taxing the foreign subsidiaries of domestic firms which help in raising the
government revenues (Figure 3). Since, Government Final Consumption Expenditure
(GCE) is a major source of funding for poverty alleviating projects like infrastructure
and public utility, the taxed revenue indirectly helps the weaker sections of society. But
this indirect impact can be materialized only when the economic conditions in host
country are favourable. For instance, the tax rates in host countries should be competitive
enough to attract foreign investments. If the tax rates are not conducive for the foreign
investors, they might get engaged in transfer pricing, ultimately reducing the revenues
for the host governments. Also, the host countries need to ensure that the tax revenues
actually get collected because usually the MNC’s use measures like transfer pricing in
order to avoid their tax burden in the host countries. A study by Jenkins and Thomas,
(2002) highlights that 82% of respondent developing nations blamed the MNC’s for
shifting the profit base to parent firms in order to avoid tax payments, thus severely
impacting the revenues for host governments.
 Poverty Reduction in India The Role of Foreign Direct Investment 55

Further it needs to be ensured that the tax revenues are actually being utilized by
the government for poverty alleviating programs like employment generation,
infrastructure expenditure, development of MSME sector, generating goods of public
utility rather than using the funds for the benefits of already rich business houses.

Figure 3: Relation between FDI and Poverty Alleviation through the Allocation of
Tax Revenue Collected from Foreign Firms

Expenditure on
Human resource Increase in
development like productivity
education.

FDI Tax Financing labour- Employment Poverty

(foreign revenue intensive job generation reduction
subsidiary) collected creation

Source: Author

4.0 Historical Background

After Independence, the major challenge for the Indian government was to lift
up the sluggish economy as well as to protect the domestic market from the competitive
industrialized nations. Thus, India was torn between opening up the economy for growth
and development on one hand and protecting its small and infant businesses from outside
competition, on the other. Indian government followed the policy of control and
regulation, whereby exports were promoted and imports were substituted. As far as
capital flows are concerned, Indian economy was heavily restricted or rather closed. But
the situation was drastically changed, when in 1991 India had to undergo a Balance of
Payment crisis, thereby demanding major policy reforms in the form of Liberalization,
Privatization and Globalization (LPG) of Indian economy. Thus, by and large, India’s
attitude towards capital flows can be categorized in three main phases. The first phase,
beginning from independence and spanning up to the middle 1980’s, saw huge
restrictions on foreign capital flows, which were only limited to concessions and foreign
aids. In the second phase, the oil as well as non-oil imports increased, coupled with
unsustainable borrowings and high Government expenditure, ultimately widening the
current account deficit. Thus, India had to support the economy with external
56 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

commercial borrowings (ECBs) as well as deposits from NRI’s. The third phase saw the
BOP crisis of 1991 and the introduction of LPG reforms. (Mohan, 2008).

4.1 Trend and magnitude of FDI flows

The capital flows have increased steadily since 1980’s. This increase has been
more evident after the LPG policies in 1991. Interestingly, not only inflows but FDI
outflows are also increasing, even at a higher rate than the inflows. The gap between FDI
inflows and outflows seems to be decreasing from 1995 onwards till 2005. From 2005,
the FDI inflows increase suddenly till 2008, when global financial crisis hit the world
economy. Thus, after 2008 the FDI inflows and outflows show a downward trend. In
terms of magnitude, FDI inflows amount to roughly 11% of GDP in 2011 and FDI
outflows amount to 6% of national GDP, which is fairly high for a capital scarce
economy like India. It is because of these significantly different trends revealed by the
FDI flows that the inclusion of both, FDI inflows as well as outflows become imperative.

5.0 Data and Methodology

5.1 Model specification

This study investigates the link between FDI and poverty using time series data
spanning from 1981-2012 for India. Explanatory variables like FDI inflows, FDI
outflows and other control variables have been used to determine the poverty in India.
Thus, the model is specified as:
The structural form of the model is: Y = f(X1, X2, X3, X4, X5)
The mathematical form of the model is: Y = ß0 + ß1X1 + ß2X2 + ß3X3 + ß4X4
+ ß5X5
The econometric form of the model is: Y = ß0 + ß1X1 + ß2X2 + ß3X3 + ß4X4 +
ß5X5 + µi - (1)
where, Y= Poverty measured as Headcount Poverty Ratio and Poverty Gap
X1= FDI Inflows (% GDP)
X2= FDI Outflows (% GDP)
X3=Total Fertility Rate
X4= Log of School Enrolment (% gross)
X5= General Government Final Consumption Expenditure (% of GDP)
µi= Error term

5.2 Variables – definition/measurement

Poverty: One of the key decisions is to decide which variables should be used to
express poverty, since the literature review suggests poverty being measured as
 Poverty Reduction in India The Role of Foreign Direct Investment 57

Headcount ratio, poverty gap, average monthly consumption expenditure of people

living below poverty line, income shares of the bottom 20% of total population etc. In
order to measure the extent as well as depth of poverty, the author uses two indicators
that are Head Count Ratio (HCR) and Poverty Gap Index (PGI). HCR is defined as the
percentage of people living in households with consumption or income per person below
the poverty line whereas Poverty Gap is defined as the mean shortfall from the poverty
line (where the non-poor have a zero poverty gap) expressed as a percentage of the
poverty line. Both HCR and PGI are measured using the international poverty line of
$1.25/day given by the World Bank (2013).
FDI inflows: The main independent variable is FDI flows. Typically,
developing economies like India receive FDI inflows from the developed ones. The
major driver for inward flows is cheap and abundant labour force in developing nations.
The other factors significantly affecting the FDI inflows could be economic growth and
development, liberal trade regimes, exchange rates, political stability, corruption,
bureaucratic ease, macroeconomic indicators like inflation, industrial development,
solvency of the economy, and market size. Since, FDI inflows generate capital
accumulation in the host economy; it sets forth the production chain, finally leading to
economic development. Further, inward flow of FDI brings advanced technology from
the developed economies, thus causing spill-over benefits. Hence, it is contended that
one of the ways FDI inflows could facilitate poverty reduction is by promoting higher
levels of economic growth (Bhaskaran et al., 2010).
FDI outflows: Since, different patterns exist for FDI inflows and FDI outflows;
it becomes essential to study the impact of both the flows individually. FDI outflows can
be traced from developing economies like India to other developing economies like
Singapore, Mauritius etc. rather than channeling to advanced nations. This is primarily
because advanced economies have highly competitive markets and the cost of production
is also high in developed countries owing to high labour costs. Thus, developing nations
channel their flows to economies with similar levels of development to neutralize the
costly labour effects as well as to get greater access to natural resources, channels of
production and distribution and circumvent highly regulated domestic markets. Further,
it is also asserted that after FDI investments abroad extra jobs need to be created at home
in order to serve the investments (Masso et al., 2007).
Control Variables: Apart from FDI flows and poverty, other control variables
impacting poverty are also included in the model.
a) Fertility rates: Since India is the most populous country in the world, next
only to China, it is often asserted that the decent GDP and economic growth does not get
reflected in per capita incomes owing to huge population acting as the denominator. It is
58 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

because of this reason that nearly 30% of Indian population is still below poverty line
(BPL). The impact of population can be measured through fertility rates in a country.
Thus, the author uses Total fertility rate (TFR) defined as number of births per woman.
TFR is expected to have a positive relationship with poverty since larger households are
more prone to fall under BPL.
b) Education: It is evident from the literature that human development is critical
for raising labour productivity and thus reducing intensity of poverty. To control for this,
the author uses school enrolment rate (per cent gross). School enrolment is expected to
have a negative sign as higher levels of educational attainment reduce the chances of
unemployment as well as poverty. c) Government support: The underprivileged sections
of society depend a lot on government subsidies as well as public goods and
infrastructure. In order to control for this impact, General Government Final
Consumption Expenditure (per cent gross), GCE is used. The impact of GCE cannot be
straight forwarded stated as positive or negative. This is because of varied distributional
aspects of additional government expenditure on different sections of the society. Shared
prosperity and equitable distribution are usually a far-fetched dream in developing
economies like India.

5.3 Data sources

Poverty is measured as poverty headcount and poverty gap, the data for which is
taken from World Bank database created by three researchers Ravallion, Datt and
Murgai (2016). The data for FDI inflows and outflows is obtained from UNCTAD state
and rest of independent variables is sourced from World Development Indicators, 2017.

5.4 Method of data analysis

The econometric technique employed in the study is the ordinary least square
(OLS) using STATA 13.Ordinary Least Squares (OLS) technique gives consistent,
efficient and unbiased coefficient estimates if and only if the following assumptions of
the Classical Linear Regression Modelling (CLRM) are satisfied – explanatory variables
are strictly exogenous, linearly independent, errors are homoscedastic and they are
serially uncorrelated.

5.5 Evaluation based on econometric criteria

In order to find out whether OLS is an appropriate technique or not for the
model, the author test the data for Heteroskedasticity and Auto-correlation.
 Poverty Reduction in India The Role of Foreign Direct Investment 59

5.5.1 Test for heteroskedasticity

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity is done which has
the null hypothesis stating that Ho: Constant variance. When the Dependent variable is
Headcount Poverty, the value of chi square is 4.35 with Prob > chi2 =0.4996 and in case
of poverty gap the chi square is 2.94 having Prob > chi2 =0.7085. Since the p values are
>0.05, therefore the null hypothesis of constant variance cannot be rejected. Hence the
data is homoskedastic in nature.

5.5.2 Test for autocorrelation

The data is tested for autocorrelation using Breusch-Godfrey LM test, having the
null hypothesis as H0: no serial correlation. When the Dependent variable is Headcount
Poverty, with lag (1) the value of chi square is 3.470(1 df) having Prob > chi2= 0.0625.
Whereas, when the Dependent variable is Poverty gap, with lag (1) the value of chi
square is 0.322(1 df) having Prob > chi2= 0.5706. Since the p value is >0.05, the null
hypotheses that there is no serial correlation of any order up to p cannot be rejected.
Hence the data is not auto-correlated. Since, the preliminary tests confirm the absence of
autocorrelation and heteroskedasticity hence OLS is used for regressing the model.

6.0 Results

In total the sample covers time series data for India over the period 1981 – 2012.
Table 1 shows the summary statistics for the whole sample. From this Table, it can be
seen that the average headcount of poverty, i.e. the average share of a population living
below the international poverty line of $1.90 a day, is 44%. The mean value of second
poverty measure, the poverty gap, is 12%, meaning that the average gap between the
income of those living below the poverty line and the poverty line is on average 12%.

Table 1: Summary Statistics

Variables Observation Minimum Maximum Mean Std. Deviation

Headcount 32 21.236 64.444 44.157 11.873
Poverty gap 32 4.270 22.360 12.133 4.796
GCE 32 9.847 12.455 11.147 .703
Fertility rate 32 2.475 4.766 3.587 .698
FDI outflows 32 -.004 1.622 0.296 .495
FDI inflows 32 .002 3.656 0.782 .907
Logschl enrolment 32 4.432 4.748 4.566 .088
Source: Author’s computation.
60 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

The researcher now takes a look at the scatter plots which compare the FDI–
poverty relationship. Hence in order to give a first-hand indication of the relation
between FDI flows and the occurrence of poverty, Figure 1 shows the linear prediction
of the relationship between both poverty measures and FDI flows across the whole
sample.

Figure 1: Poverty and FDI Flows

70 25.00
60
20.00
Headcount Poverty

50
Poverty Gap

40 15.00

30 10.00 y = -4.2195x + 15.437

20 R² = 0.6367
y = -10.711x + 52.542 5.00
10 R² = 0.6695
0 0.00
0 0.5 1 1.5 2 2.5 3 3.5 4 0 2 4
FDI (% of GDP) FDI (% of GDP)
Source: Author’s computation.

In both plots there is a strong downwards trend, indicating that poverty falls as
FDI inflows increase. This could be because FDI inflows lead to increased economic
growth via capital accumulation. Moreover, it also depends on the domestic environment
of the country as FDI inflows can cause widespread diffusion of technology and spill-
over investment benefits.

6.1 Baseline results using regression analysis

Now, to control for other poverty determinants, the model is tested through an
econometric analysis. Hence in order to test this further by accounting for interaction of
other variables, the researcher turns to the regression estimates obtained. Thus by
regressing individually, the National Headcount poverty and National Poverty Gap as
dependent variable on Government consumption expenditure GCE , Log of school
enrolment, FDI outflows, FDI inflows and fertility rate using STATA13, the researcher
obtains following results. The equation 1 can be reinterpreted as:
Pov,t = β0 + β1fdi inflow t + β2fdi outflow t + β3fert t + β4logsch t+ β5gengovt
t+ε t …..(1)
which is used to compute the OLS results.
 Poverty Reduction in India The Role of Foreign Direct Investment 61

Table 2 shows the baseline results using both the poverty headcount and poverty
gap as the measure of poverty. The negative coefficient of FDI inflows indicate that
increased FDI inflows are associated with a lower poverty count, in both the measures
that is Headcount Poverty as well as Poverty Gap. These results confirm with the
literature which suggests that FDI inflows help in poverty reduction by promoting higher
levels of economic growth (Bhaskaran et al., 2010). However, the variable is
approximately significant for poverty ratio but not statistically significant for the
intensity of poverty measured by poverty gap.

Table 2: Baseline Results

Dependent Headcount Poverty Poverty Gap

variable (1) (2) (3) (4)
Variable Coefficient P>|t| Coefficient P>|t|
_cons 577.6478 0.031 216.2228 0.021
GCE -3.278849** 0.040 -1.61764*** 0.005
Fertirate .3204162 0.954 1.088403 0.574
FDIout 5.289723 0.515 1.791246 0.527
FDIin -4.600311* 0.053 -1.224997* 0.080
Logschlenr -108.618** 0.039 -41.50071** 0.025
Observations 32 32
R-squared 0.812 0.847
Source: Author’s computation
Note: *** p<0.01, ** p<0.05, * p<0.1 respectively. The dependent variable is the headcount of poverty in
column (1) and (2) whereas it is poverty gap in column (3) and (4).

As expected, the coefficient of Government consumption expenditure (GCE) is

negative which means that as Government consumption expenditure increases, poverty
decreases. Thus, on average the researcher finds statistically significant relation between
GCE and poverty outcomes, whether measured as the head count or poverty gap. This
further implies that the additional expenditure by Government of India is allocated
among the poor income groups in the economy as well as supports the belief that
government expenditure is essential for poverty reduction.
Also, the results in columns (1) and (3) show a strong negative relation between
school enrolment rates and poverty rates which indicate that higher access to
education/Human development leads to poverty reduction and should therefore be
included in the model. In terms of magnitude, the results suggest that a 1% increase in
the school enrolment rate is associated with an approximate decrease of 108% in
62 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

Headcount poverty and 42% decrease in National Poverty Gap. The other explanatory
variable, FDI outflows have a positive coefficient implying that poverty increases as FDI
outflows increase, however the relationship is not statistically significant. The literature
review, in this regard tells us that after FDI investments abroad, extra jobs need to be
created at home in order to serve the investments which facilitates poverty reduction
(Masso et al., 2007). But, since the coefficient of FDI outflows is positive, it can be
posited that FDI outflows from India does not help in generating employment
opportunities for the poor and unemployed sections of the society.
Further, Fertility rates show a positive coefficient, reinforcing the popular belief
that higher population leads to higher poverty rates, since the number of people coming
below the poverty line increases. Also, the p value for the coefficient term is statistically
significant, thus justifying its inclusion in the model. The R-square values in the
regression are relatively high. Thus, it could capture and explain largely the change in
the explanatory variables effect on the dependent variables. From the regression analysis,
it is observed that all the variables conform to the a priori expectation of the study. Table
3 summarizes the a priori test of this study.

Table 3: Summary of Economic a Priori Test

Variables Expected Observed

Parameters Conclusion
Relationships Relationships
Regressand Regressor
ß0 Poverty Intercept +/- + Conform
ß1 Poverty FDI inflows - - Conform
ß2 Poverty FDI outflows +/- + Conform
ß3 Poverty Fertility rates + + Conform
ß4 Poverty Log School enrolment - - Conform
ß5 Poverty GCE +/- - Conform
Source: Author’s computation

7.0 Sectoral Impact of FDI on Poverty Reduction

7.1 Farming out of poverty: FDI in Indian agriculture sector

The author next examines the impact of agricultural growth on poverty
reduction. The relevance of studying this linkage can be traced down to the fact that 74
per cent of the households and 76 per cent of population live in rural India and more than
50% of them are employed in agriculture. Since poverty in India is essentially an
agricultural phenomenon, the Government of India has been focusing on the
 Poverty Reduction in India The Role of Foreign Direct Investment 63

development of agriculture in order to enhance the productivity and raising the real per
capita income of the farmers as well as other agricultural labourers. It is in this regard
that the role of FDI in agricultural development should be analyzed. In comparison to
other developing nations like China, Indian agriculture is still underdeveloped, which is
depicted by low productivity and declining competitiveness. The major reasons for
declining productivity and competitiveness, as shown in Figure 2, are due to shortages in
technology, human resource, infrastructure, supporting industries, and other necessity
inputs (Tambunan, 2011).

Figure 2: Relation between Development of Agriculture and Poverty Reduction

Productivity
growth in
Growth
Agriculture
determinant
factors in
agriculture:
Land Development Output Increase in Poverty
Human Resource in Agriculture growth in farmer’s reduction
Technology Agriculture income
Infrastructure
Supporting
Improvement in
Industries
quality and
competitiveness
in agriculture
Investment
including FDI
Increase in
market share of
agriculture

Source: Adapted from “The impact of Foreign Direct Investment on poverty reduction: A survey of literature
and a temporary finding from Indonesia.” by (Tambunan, 2011).

7.2 Results including agricultural growth: Regression analysis

Since more than 60% of Indian population still depends upon agriculture as its
primary source of income, it becomes imperative to study the impact of agriculture on
poverty and the linkages among FDI, agriculture and poverty reduction. Thus, the new
model includes agriculture as well as non-agricultural growth rates in order to control for
their impact on poverty reduction. The equation becomes:
64 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

Pov, t = β0 + β1 fdi inflow t + β2 fdi outflow t + β3 fertility rate t + β4 log

school enrolment t+ β5 GCE t+ β6 agriculture growth t+ β7 non
agriculture growth t+ ε t …..(2)
The above equation is regressed using Headcount poverty as well as Poverty gap
being the explained variables and following results are obtained:
Table 4 shows the regression results using the agricultural and non-agricultural
growth rates as explanatory variables. Since, the coefficient for agriculture growth rate is
negative and approximately significant; it implies that the growth in agriculture is
contributing to reduction in Poverty Headcount in India. The explanation for this lies in
the fact that growth in agriculture leads to increasing farmer incomes, thus ultimately
reducing poverty. However, the reduction of poverty incidence based on agricultural
growth rate is not statistically significant. Thus Agricultural incomes seem to elevate
households out of poverty but fail to bridge the divide between the incomes of the people
below poverty line and the average incomes. Also, in this model as well, the FDI inflows
variable is approximately significant for poverty ratio but not statistically significant for
the intensity of poverty measured by poverty gap. The results coincide with other similar
studies like Agarwal and Atri (2016). Table 5 summarizes the a priori test of this study.

Table 4: Results Including Agricultural and Non-Agricultural Growth.

Headcount Poverty Poverty Gap

Dependent Variable
(1) (2) (3) (4)
Variable Coefficient P>|t| Coefficient P>|t|
_cons 639.051 .021 233.755 .017
GCE -3.087* .055 -1.567*** .008
Ferti rate -.232 .967 .920 .644
FDIout 4.359 .598 1.560 .593
FDIin -3.568* .051 -.957* .094
Logschlenr -122.927** .025 -45.560** .019
Agrigrowth - .070* .054 -.015 .134
Non agrigrowth -.464 .208 -.131 .313
Observations 32 32
R-squared 0.843 0.873
Source: Author’s computation
Note: *** p<0.01, ** p<0.05, * p<0.1 respectively. The dependent variable is the headcount of poverty in
column (1) and (2) whereas it is poverty gap in column (3) and (4).
 Poverty Reduction in India The Role of Foreign Direct Investment 65

Table 5: Summary of Economic a Priori Test

Variables Expected Observed

Parameters Conclusion
Regressand Regressor Relationships Relations
ß0 Poverty Intercept +/- + Conform
ß1 Poverty FDI inflows - - Conform
ß2 Poverty FDI outflows +/- + Conform
ß3 Poverty Fertility rates +/- - Conform
ß4 Poverty Log School - - Conform
ß5 Poverty enrolment +/- - Conform
ß6 Poverty GCE +/- - Conform
ß7 Poverty Agriculture growth +/- - Conform
Non-agri growth
Source: Author’s computation

7.3 Making in India: Reducing poverty and attracting capital inflows

After analysing the impact of agriculture growth on poverty reduction, some
attention needs to be directed to the manufacturing sector as well. According to a report
by McKinsey and Company, India’s manufacturing sector could leave behind services
sector, capturing more of global market and thereby touch US$ 1 trillion by 2025. There
is potential for the sector to account for 25-30 per cent of the country‘s GDP and create
up to 90 million domestic jobs, by 2025. In order to make these fancy facts a reality, the
Government of India has taken certain initiatives like Make in India. This is not only
aimed at making India a global manufacturing hub but also target at poverty alleviation
through employment generation on a large scale. Moreover, FDI flows in India have
received a thespian development in the aftermath of ‘Make in India’ scheme. According
to the Department of Industrial Policy and Promotion, FDI inflows, under the approval
route (which requires prior government permission) increased by 87% during 2014-15
with an inflow of $2.22 billion. More than 90% of FDI was through the automatic route.
Also in 2014-15, foreign institutional investment rose by an unparalleled 717% to $40.92
billion. In a major boost to the ‘Make in India’ initiative, the Government of India has
received investment proposals of over Rs 1,10,000 Crore (US$ 16.56 billion ) during
2014-15 from various companies including Airbus, Phillips, Thomson, Samsung , LG
and Flextronics among others. There was a tremendous increase in FDI inflows from
October, 2014 to June, 2015, of almost 40% (Economic Survey of India 2015, Vol.1, ch
7). Further, the Government of India is in talks with stakeholders to further ease foreign
direct investment (FDI) in defence under the automatic route to 51 per cent from the
66 FOCUS: Journal of International Business, Volume 6, Issue 1, Jan-Jun, 2019

current 49 per cent, in order to give a boost to the Make in India initiative and to
generate employment (Union Budget of India, 2017-18).
Hence, the twin goals of achieving greater poverty reduction and a double digit
growth rate can be materialized only when all the three sectors viz. primary, secondary
and tertiary perform with high productivity and efficiency. FDI inflows, in the areas like
agriculture, manufacturing, infrastructure, transport, technology, services, etc. can act as
an enabler for both of the above mentioned economic goals of India.

8.0 Conclusion

The study provides empirical evidence on the impact of FDI in both direct and
indirect ways on the reduction of poverty in India from the period 1981 to 2012. Time
series data analysis is used in the form of two regressions, which is represented in the
basic model and the model including agriculture growth rates and the findings of the
regressions are discussed. The major findings derived from the study are:
(a) The inflows of FDI are found to have an approximately significant and positive effect
on poverty reduction, both in terms of headcount as well as intensity.
(b)High school enrolment and more Government consumption expenditure (GCE) show
a significant and positive impact on poverty alleviation, whereas high fertility rates and
increased FDI outflows seem to be negatively related with poverty reduction in India.
(c) The agricultural incomes seem to elevate households out of poverty but fail to bridge
the divide between the incomes of the people below poverty line and the average
incomes.
The above findings of the research highlight the importance of the inflows of
FDI to the reduction of poverty in India. Based on the finding of the positive and
significant impacts of inflows of FDI on poverty reduction in the paper, the government
policies should promote and encourage FDI flows to the accomplishment of the
Millennium Goals in India by 2025. To promote economic growth and poverty
reduction, there are some possible policies which the government should follow. First,
due the significant and positive impact of FDI and employment on poverty reduction, it
reflects the fact that labour-intensive industries can reduce poverty rapidly. Moreover,
India, like other developing nations, has a competitive advantage in labour-intensive
production. Thus, the government should encourage more FDI inflows in labour-
intensive industries. The policies should include giving tax incentives, training courses
for people especially at the rural level where people are not highly educated. However,
the paper does not analyse the impact of human capital as well as skilled and unskilled
workers on the reduction of poverty. Thus it will be out of the scope of this paper, to
 Poverty Reduction in India The Role of Foreign Direct Investment 67

comment about that. But, in general the government should have a policy to support the
improvement of human capital because it is hoped to enhance the country’s
competitiveness especially in global economic integration.
Second, parts of the revenues from FDI, which are collected through tax
revenue, rental fees, and export and import activities, should be used to promote further
economic activities, safety nets as well as investment in infrastructure. These are
believed to have significant and positive effects on the reduction of poverty.
Furthermore, with the participation of foreign companies in social welfare, this could
reduce the burden of the government budget to build the safety nets as well as improve
other social welfare. Furthermore, government spending has a large impact on poverty.
Although the paper does not analyse the effects of government spending on poverty
alleviation programs alone, the positive effects of government spending, as a whole are
significant. To enhance the effects, the government should spend more on poverty
alleviation program as well as infrastructure because it has a direct and significant
impact on poverty.
Hence, through the literature review and empirical analysis, it can be
summarized that given the appropriate host-country policies and a basic level of
development, numerous benefits that accrue from FDI flows include employment
creation, the acquisition of new technology and knowledge, flows of ideas and global
best practice standards and increased tax revenues from corporate profits generated by
FDI. All of these forms of benefits are expected to contribute to higher economic and
employment growth, which is the most effective tool for alleviating poverty in
developing countries. However, this is only one side of the story. The other side of the
story is the possibility of negative effects of the presence of foreign firms on local
economic activities in the form of ‘crowding out’ impact on local firms by superior
foreign firms.
Thus, it can be concluded that bringing more FDI flows is no perfect recipe for
alleviating poverty, but it can have a positive impact on poverty reduction in developing
countries, provided that mechanisms are in place in the host country to have these
positive effects. In other words, the impacts of FDI on poverty and other social goals of
development depend principally on many factors, such as host country policies and
institutions, the quality of investment, the nature of the regulatory framework, the
flexibility of the labour market, and many others (Mayne, 1997).

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