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The determinants of foreign
direct investment in ASEAN
The first differencing panel data analysis
Phonesavanh Xaypanya, Poomthan Rangkakulnuwat and
Sasiwimon Warunsiri Paweenawat
School of Economics, University of the Thai Chamber of Commerce,
Bangkok, Thailand
Abstract
Purpose – The purpose of this paper is to investigate the significant factors determining foreign
direct investment (FDI) in Cambodia, Laos, and Vietnam (ASEAN3) and Indonesia, Malaysia, the
Philippines, Thailand, and Singapore (ASEAN5).
Design/methodology/approach – This paper applies the first differencing technique to estimate the
parameters on the constructed panel data starting from 2000 to 2011.
Findings – Due to the different stages of economic development between ASEAN3 and ASEAN5,
the determinants of FDI are different. We found that there are significantly positive effects of
infrastructure facility, level of openness, and negative effect of inflation on FDI inflow in ASEAN3;
while real exchange rate, gross domestic product and net official development assistance have no effect
on its FDI. The finding in ASEAN5 showed that market size and infrastructure facility are significant
factors to attract FDI. Furthermore, even though there are an increase in inflation rate as well as
a decrease in level of openness measurement, ASEAN5 are still attractive to foreign investors.
Originality/value – The time variant and invariant unobserved effects that are ignored in the
previous studies are considered in this study.
Keywords Economic philosophy/theory, Developing countries, Philosophy of economics
Paper type Research paper
1. Introduction
Over the decades, most of the countries around the world have made their business
investment environment friendly for attracting more foreign direct investment (FDI)
into their countries. FDI has been known as a key source of income, capital flows,
business competition, innovations, job creations, technological transfer, which are
important process of economic development. The member countries of the Association
of Southeast Asian Nations (ASEAN) have also attracted FDI through various policies,
which are summarized in Table I[1].
According to the recent data from United Nation Conference on Trade and Development
(UNCTAD) (2013) in Table II, Singapore is the largest recipient of FDI compared to the rest
of ASEAN countries. Thailand, the Philippines, Malaysia, and Indonesia have also been
continuously attracting FDI into their countries. Even though some of them had been
struggled in some periods such as Indonesia during 2000-2003; however, it finally could
recover. Furthermore, the least developed countries in ASEAN including: Cambodia, Laos,
and Vietnam have recently been one of the most attractive investment destinations for
foreign investor around the world. Due to the different stages of development among
ASEAN countries, the factors determining FDI should be different. As a result, this paper
divides ASEAN member countries into two groups according to their levels of economic
development including: first, ASEAN3 (Cambodia, Laos, and Vietnam) and second,
ASEAN5 (Indonesia, Malaysia, the Philippines, Thailand, and Singapore).
####### International Journal of Social
####### Economics
####### Vol. 42 No. 3, 2015
####### pp. 239-
####### © Emerald Group Publishing Limited
####### 0306-
####### DOI 10/IJSE-10-2013-
Received 25 October 2013
Revised 9 February 2014
17 February 2014
Accepted 18 February 2014
The current issue and full text archive of this journal is available on Emerald Insight at:
emeraldinsight/0306-8293.htm
239
Determinants
of FDI in
ASEAN
Singapore
Thailand
Malaysia
Indonesia
Philippines
Cambodia
Laos
Vietnam
Reduction ofbusiness costssignificantly aspart of a cost-reductionpackageamounting tosavings of US $10billion, in additionto extending a30% corporateinvestment taxallowance on aliberal basis toindustrial projectsand to selectiveservice industries activitiesspanmanufacturing,engineering andtechnical servicesand computer-related services
Allowance of 100 %foreign-equityownership formanufacturingprojects regardlessof location
Offer 100 %foreign-equityownership in themanufacturingsector, with noexport conditionsimposed on newinvestments,expansions anddiversifications limitedexceptions,foreigners canalso own land inMalaysia
Offer qualifiedinvestors 100%foreign-equityownership inwholesale andretail tradingcompanies. 100%foreign-equityownership in allareas of themanufacturingsector. Reductionof the processingtime required forthe approval ofinvestments ofless than US$100million to tenworking days were opento 100% foreign-equity ownership
Open its retail anddistributionsectors to foreignequity, andallowance forforeign companiesto compete in thedomestic privateconstructionsector
In March 2011,Prakas No. 288was issued onauthorization touse tax removal/reductionprograms ofCambodia underthe Agreement onASEANMerchandiseTrade
Allowance forduty exemptionson importedcapital goodsrequired bypromotedinvestmentproject
Allows dutyexemptions forimported capitalgoods for all projects,on the importation ofraw materials forproduction inencouragedinvestments and forprojects located inmountainous orremote regions for thefirst five years ofoperation
Tax incentive insecuritiesexchange: (i) 10%of tax on profit forsecuritiescompanies; and(ii) 50% reductionof withholdingtaxes on interestand dividenddistribution forpublic investors
The period requiredfor the issuance ofinvestment licensesfor several types ofproject has beenreduced to 15 daysfrom the receipt of therequireddocumentationInvestment licensingfor projects under US$5million in Viet Namhas beendecentralized toprovincial and citylevels
Sources:
ASEAN Investment (AIA) Council: Agreements and Declarations. Legal text: ASEAN Investment Area. Web site: asean/communities/asean-
economic-community/category/agreements-declarations-7 and for Cambodia: Source from ASEAN Secretariat (2011)
Table I.
FDI policies of
ASEAN
240
IJSE
42,
developing countries such as financial liberalization in India (Bhaduri, 2005), business
opportunity and investment costs in Thailand (Jongwanich and Kohpaiboon, 2008),
financial sector policies in India and Malaysia (Ang, 2009), and financial development
in Turkey (Ucan and Ozturk, 2011).
In the case of FDI, after Dunning (1977, 1979) first proposed eclectic theory, which is
later developed and known as the EPT in Dunning (1988), to explain the three main
factors determining FDI including: ownership, internationalization, and location,
many studies empirically investigated various factors attracting FDI into countries.
Agarwal (1980) summarizes the main determinants of FDI, that most empirical
literatures during the pre-1980 period had focussed on, are political situation in host
countries, incentives offered by the host countries, and low cost of labor. Then, in the
late 1980s, in addition to “traditional market-related determinants” of FDI, “non-traditional
market FDI determinants”, which is skills of labors as well as trade policy of the host
countries, have become significant factors (Nunnenkamp, 2002). The government of each
country is competing by providing attractive policy regarding investment and tax
incentive to attract FDI into their countries (Wheeler and Mody, 1992; Oman, 2000).
Furthermore, recent literatures focus on the financial determinants as significant factors
for firms to undertake FDI such as credit access (Klein et al., 2002), size of financial market
(Di Giovanni, 2005), stock market valuations (Baker et al., 2009), and financial
characteristics of firms (Forssbeck and Oxelheimb, 2011).
There are several determinants affecting the FDI; however, this study will include
only the variables based on the availability of our data set. As a result, we will briefly
summarize factors affecting FDI, in which we will apply in this study:
- Market size – the size of market is usually measured by GDP or GDP per capita.
Shamsuddin (1994) found that the market size is the most significant determinant
of FDI in 36 less developed countries (LDC) in 1983. This result is consistent
of the survey of 173 Japanese firms by the World Bank (Kawaguchi, 1994).
Several studies indicated a strongly positive relationship between FDI and
market size; such as Kravis and Lipsey (1982), Wheeler and Mody (1992), Dees
(1998), Fung et al. (2000), Ismail et al. (2009), Anwar and Nguyen (2010), Azam
(2010), Vijayakumar et al. (2010).
- Infrastructure facility – Loree and Guisinger (1995), Mody and Srinivasan (1996),
Fung et al. (2000) indicated that there is a positive effect of infrastructure on
attracting FDI. In order to measure infrastructure facility, telephones per thousand
of population (Anwar and Nguyen, 2010) and telephone lines (Nasser, 2007) were
applied in the estimation.
- Macroeconomic stability – two main variables have been used as an indicator of
stability of economy affecting FDI including: first, real exchange rate (Barrell and
Pain, 1996; Erdal and Tatoglu, 2002; Tsen, 2005; Anwar and Nguyen, 2010), and
second, inflation rate (Glaister and Atanasova 1998; Wint and Williams 2002;
Nasser, 2007). The literature mostly found that high volatile of host countries’
currency and high inflation rate tend to discourage foreign investors to engage in
the activities of FDI.
- Level of openness – multinational enterprises (MNEs) will choose to invest in an
export-oriented country rather than invest in a country with closed economy
(or low level of openness) (Choong and Lam, 2012). To measure the degree of
openness in the country, Kravis and Lipsey (1982), Singh and Jun (1995), and
242
IJSE
42,
Dees (1998), Anwar and Nguyen (2010) use the ratio of value of export (or import)
to GDP; while Choong and Lam (2010) and Ismail et al. (2009) used the trade ratio
(export plus import values divided by GDP).
- ODA – there are mixed results of ODA on FDI. Rodrik (1995), Tuman and
Emmert (1999), and Kosack and Tobin (2006) stated that ODA has no impact on
FDI; while Yasin (2005), Blaise (2005), Azam (2010), and Shahmoradi and
Baghbanyan (2011) found that ODA is one of main factor and positively affects
on FDI inflows to developing countries.
3. Theoretical framework
Dunning (1988) first introduced the EPT. This theory states that the extent and pattern of
multinational operations are generally determined by three factors: ownership-specific
advantages, location-specific advantages, and internalization advantages:
(1) Ownership-specific advantages (O) include capital, technology, marketing,
organizational and management skills, and benefits of economies of scale.
This ownership-specific advantages refer to the competitive advantages of the
enterprises seeking to engage in FDI. The greater the competitive advantages
of the investing firms, the more investors are likely to engage in their foreign
production.
(2) Location-specific advantages (L) include the existence of factor endowments,
investment incentives, wages, market size, macroeconomic conditions,
infrastructure, labor condition, and special tax. Locational attraction refers to
alternative countries or regions undertaking the value adding activities of MNEs.
The more immobile, natural or created resources, which firms need to use jointly
with their own competitive advantages, the more firms choose to exploit their own
specific advantages by engaging in FDI.
(3) Internalization advantages (I) represent the advantages by own production
rather than producing through a partnership arrangement such as licensing or
a joint venture. Firms may organize the creation and exploitation of their core
competencies, or circumvent market failure such as achieving synergistic
economies, controlling supplies of inputs and market outlets, avoiding or
exploiting government intervention. The greater the net benefits of internalizing
cross-border intermediate product markets, the more likely a firm prefers to
engage in foreign production itself rather than licensing.
Based on the EPT, the factors affecting FDI can be separated into observable and
unobservable effects as shown in Figure 1. We define the location-specific advantages
as the observable effects, and the ownership-specific advantages and internalization
advantages as unobservable effects, which can be time variant or time invariant.
4. Model and data
According to the EPT, the observable effects are composed of macroeconomic stability
(measured by inflation), market size (measured by GDP), infrastructure facility
(measured by the number of telephone lines), level of openness (measured by the trade
ratio)[2], ODA, and a loan for the country development. The unobservable effects,
which can be time variant or time invariant, such as licensing, organizational and
management skills, law, government policies. We include these unobservable effects
243
Determinants
of FDI in
ASEAN
The data used in this study is annual data from 2000 to 2011. The FDI data are from
UNCTAD; while RER, INFL, GDP, T_LINE, TRD_RO, ODA, and LOAN are from the
World Development Indicators of the World Bank.
5. Results
5 ASEAN3 estimation
The data of ODA and LOAN is measured in the single form of net ODA[3] due to the
way of recording. Therefore, the final model adopted in the ASEAN3 study is adjusted
as the following form:
DFDI it ¼ a 1 þ a 2 d 2002 t þ þ a 11 d 2011 t þ b 1 DRER it þ b 2 DI N FLit þ b 3 DGDP it
þ b 4 DT_LI N E it þ b 5 DTRD_ROit þ b 6 DLODA it þ Du it (4)
where LODA it is the summation of ODA and LOAN for country i at time t.
The POLS is adopted to estimate the parameters in Equation (4); we have not found
the existence of Autocorrelation and Heteroskedasticity. Moreover, the panel unit root
of Δu it is tested by the method of Levin et al. (2002). We found that the t-statistics to test
for the existent of the unit root is −3, hence the null hypothesis of common unit root
process can be rejected at 1 percent significant level. This implies that Δuit is stationary
and spurious regression is not the problem in this case. Since some time-dummy variables
are insignificant, we develop the model by removing each time dummy variable one by
one from the estimated regression until the time dummy variables appeared in the model
are significant. The final result is shown in Table III.
The coefficient on ΔRER has been found statistically insignificant; while
the coefficient on ΔINFL is negative and statistically significant at 5 percent.
This corresponds to the hypothesis and is consistent with previous studies of Azam
(2010), Nasser (2007), and Tsen (2005). However, the coefficient on ΔGDP has been
found positive sign but not statistical significance. The coefficient on ΔT_LINE has
been found positively and statistically significant at 1 percent. That implies that an
improvement of telecommunication networks in ASEAN3 could be essential to attract
more FDI inflows. The coefficient on ΔTRD_RO has been found positive as expected
and statistically significant at 1 percent. This result is as expected in hypothesis and
similar to the previous studies of Choong and Lam (2010), Ismail et al. (2009),
Ramasamy and Yeung (2010). This confirms that FDI in ASEAN3 are significantly
Variables Coefficient SE t-statistics p-value
Constant −305 146 −2 0**
d2004 −1,067 446 −2 0**
d2007 1,452 391 3 0***
d2008 1,236 621 1 0*
ΔRER −0 0 −0 0.
ΔINFL −49 23 −2 0**
ΔGDP 0 0 1 0.
ΔT_LINE 207 63 3 0***
ΔTRD_RO 72 19 3 0***
ΔLODA −0 0 −1 0.
Adjusted R 2 0.
Notes: *,**,***Statistically significant at 10, 5, and 1 percent level, respectively
Table III.
The parameter
estimates of
ASEAN
245
Determinants
of FDI in
ASEAN
influenced by the level of openness. Finally, the effect of the LODA has been found
statistical insignificance, indicating that the LODA is not the main determinant of FDI
inflows into ASEAN3 during the period of study. This result is consistent with Rodrik
(1995), Tuman and Emmert (1999), and Kosack and Tobin (2006).
5 ASEAN5 estimation
The method of POLS is adopted to the FD model in Equation (3). There is no existence
of autocorrelation and heteroskedasticity problem in the model. The panel unit root of
Δuit is also tested using the same method as in the model of ASEAN3. We found that
the t-statistics for testing the unit root is −6, hence the null hypothesis of common
unit root process can be rejected at 1 percent significant level. This implies that Δu it is
stationary and spurious regression is not the problem in Equation (3). The insignificant
time dummy variables are removed one by one until they are all significant in the
model. The results are shown in Table IV.
The coefficient on ΔRER has been found a positive sign as expected, but not
statistical significance. The coefficient on ΔINFL has been found positive sign and
statistically significant at 5 percent, which is opposite to the hypothesis. This can be
explained by the fact that the main investors in ASEAN5 are from the USA and
Europe. When the economic recession occurred in these regions, these investors
decided to bring the fund out from their countries and move to invest in ASEAN
regardless of the high inflation rates in these host countries.
The coefficient on ΔGDP has been found statistically significant at 1 percent with
a positive sign as expected. This result is consistent with the previous studies of Azam
(2010), Vijayakumar et al. (2010), Choong and Lam (2010). The coefficient on ΔT_LINE
has been found statistically significant at 10 percent with a positive sign as expected.
This indicates that the policy regarding an expansion and an improvement in market
size as well as in infrastructure facility can build up the confidence of foreign investors
and then increase FDI inflow into ASEAN5. The coefficient on ΔTRD_RO has been
found statistical significance at 1 percent with a negative sign, which is not consistent
to our hypothesis. This might be the reason that many countries had been struggled
with the negative impacts from the global economic crisis, which leads to a lower export
and import volumes. Based on the fact, even though the trade ratios of Indonesia,
Malaysia, and the Philippines have been continuously decreased, those of Thailand and
Singapore have been stable. As a result, overall picture presents that the FDI inflows in
ASEAN5 still increase.
Variables Coefficient SE t-statistics p-value
Constant −1,418 1,303 −1 0.
d2003 5,054 2,882 1 0*
d2004 5,310 2,952 1 0*
d2008 −12,150 3,391 −3 0***
ΔRER 1 2 0 0.
ΔINFL 804 327 2 0**
ΔGDP 0 0 3 0***
ΔT_LINE 2,043 1,211 1 0*
ΔTRD_RO −271 63 −4 0***
Adjusted R 2 0.
Notes: *,**,***Statistically significant at 10, 5, and 1 percent level, respectively
Table IV.
The parameter
estimates of
ASEAN
246
IJSE
42,
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249
Determinants
of FDI in
ASEAN
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10-1108 IJSE-10-2013-0238
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The determinants of foreign
direct investment in ASEAN
The first differencing panel data analysis
Phonesavanh Xaypanya, Poomthan Rangkakulnuwat and
Sasiwimon Warunsiri Paweenawat
School of Economics, University of the Thai Chamber of Commerce,
Bangkok, Thailand
Abstract
Purpose –The purpose of this paper is to investigate the significant factors determining foreign
direct investment (FDI) in Cambodia, Laos, and Vietnam (ASEAN3) and Indonesia, Malaysia, the
Philippines, Thailand, and Singapore (ASEAN5).
Design/methodology/approach –This paper applies the first differencing technique to estimate the
parameters on the constructed panel data starting from 2000 to 2011.
Findings –Due to the different stages of economic development between ASEAN3 and ASEAN5,
the determinants of FDI are different. We found that there are significantly positive effects of
infrastructure facility, level of openness, and negative effect of inflation on FDI inflow in ASEAN3;
while real exchange rate, gross domestic product and net official development assistance have no effect
on its FDI. The finding in ASEAN5 showed that market size and infrastructure facility are significant
factors to attract FDI. Furthermore, even though there are an increase in inflation rate as well as
a decrease in level of openness measurement, ASEAN5 are still attractive to foreign investors.
Originality/value –The time variant and invariant unobserved effects that are ignored in the
previous studies are considered in this study.
Keywords Economic philosophy/theory, Developing countries, Philosophy of economics
Paper type Research paper
1. Introduction
Over the decades, most of the countries around the world have made their business
investment environment friendly for attracting more foreign direct investment (FDI)
into their countries. FDI has been known as a key source of income, capital flows,
business competition, innovations, job creations, technological transfer, which are
important process of economic development. The member countries of the Association
of Southeast Asian Nations (ASEAN) have also attracted FDI through various policies,
which are summarized in Table I[1].
According to the recent data from United Nation Conference on Trade and Development
(UNCTAD) (2013) in Table II, Singapore is the largest recipient of FDI compared to the rest
of ASEAN countries. Thailand, the Philippines, Malaysia, and Indonesia have also been
continuously attracting FDI into their countries. Even though some of them had been
struggled in some periods such as Indonesia during 2000-2003; however, it finally could
recover. Furthermore, the least developed countries in ASEAN including: Cambodia, Laos,
and Vietnam have recently been one of the most attractive investment destinations for
foreign investor around the world. Due to the different stages of development among
ASEAN countries, the factors determining FDI should be different. As a result, this paper
divides ASEAN member countries into two groups according to their levels of economic
development including: first, ASEAN3 (Cambodia, Laos, and Vietnam) and second,
ASEAN5 (Indonesia, Malaysia, the Philippines, Thailand, and Singapore).
International Journal of Social
Economics
Vol. 42 No. 3, 2015
pp. 239-250
© Emerald Group Publishing Limited
0306-8293
DOI 10.1108/IJSE-10-2013-0238
Received 25 October 2013
Revised 9 February 2014
17 February 2014
Accepted 18 February 2014
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/0306-8293.htm
239
Determinants
of FDI in
ASEAN
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