MBA_LOCATION CHOICE OF FIES THE CASE OF ASIA

Over the last 6 decades or so of globalization, foreign direct investment (FDI) has played an important role in stimulating international trade, facilitated the global integration and growth of many developing and emerging economies. FDI is considered as one type of investment funds contributing to the growth of a country in general and the development of economy in particular because of some key reasons. For instance, FDI generates a huge number of impacts on all sectors in the national economy relating to financial development of various industries, the level of economy’s openness and so on. Beginning in the mid1980s, world foreign direct investment (FDI) flows increased rapidly with a growing number of multinational enterprises (MNEs) as the engine of the increased international economic activities. Both industrialized and developing countries are becoming more receptive to FDI flows such that a majority of FDI policy changes in these countries are in the direction of more liberalization of FDI inflows (United Nations, 1992) as there are various benefits which FDI brought for economic growth. Asia, in particular has benefited enormously from FDI flows into the region. According to UNCTAD’s World Investment Report 2014, Asia was the worlds top recipient region of foreign direct investment (FDI), accounting for nearly 30 per cent of global FDI inflows. Total inflows to developing Asia (excluding West Asia) amounted to 382 billion in 2013, 4 per cent higher than in 2012. FDI flows to developing Asia in 2017 remained at the level of 2016 (476 billion), according to UNCTAD’s World Investment Report 2018. The region regained its position as the largest recipient of FDI in the world as its share in global inflows rose from 25% in 2016 to 33% in 2017. Worldwide investors have long been interested in Asia as an investment destination thanks to the growth of local and regional markets, the region’s enormous natural resources and its strategic location for exportoriented production.

FOREIGN TRADE UNIVERSITY

MASTER THESIS

LOCATION CHOICE OF FIES: THE CASE OF ASIA

Specialization: Master of Research in International Economics

FULL NAME: DAO THI NGOC LAN

Hanoi – 2019

MINISTRY OF EDUCATION AND TRAINING

FOREIGN TRADE UNIVERSITY

MASTER THESIS

LOCATION CHOICE OF FIES: THE CASE OF ASIA

Major: Master of Research in International Economics

Specialization: International Economics

Code: 8310106

Full name: Dao Thi Ngoc Lan

Supervisor: Ass Prof, Dr Nguyen Thi Tuong Anh

Hanoi – 2019

Considered as one of the most important factors in one country’s economygrowth, Foreign Direct Investment (FDI) is properly appreciated in both developedand developing countries Especially developing Asia, already the largest recipientregion of FDI flows, registered an FDI rise of 4 per cent to $512 billion in 2018,with positive growth occurring in all subregions, according to the World InvestmentReport 2019 (UNCTAD, 2019) This study, therefore, analyses the determinants offoreign-invested enterprises’ (FIEs) locational choice in Asia region over a period of

10 years from 2008 to 2017 The estimation is for a panel of 30 Asian countries andbased on the random fixed effect model The results highlight that a country’smarket size and regulatory quality of a government have a large positive impact onthe on the Asian FDI inflow attractiveness Also, the research reaffirmed theprevious literature that a country with higher corruption index is less attractive interms of locational investment decision of FIEs Surprisingly, results indicate thatworking population, infrastructure, inflation, openness to trade, economic growth,natural resources and political stability are not significant determinants of FDIinflows in Asia during 2008 and 2017

1

STATEMENT OF ORIGINAL AUTHORSHIP

I, Dao Thi Ngoc Lan, confirm that this Master's Thesis has been written solely

by the undersigned and contains the work of no other person or persons exceptwhere explicitly identified to the contrary

I also state that said Master's Thesis has not been submitted elsewhere for thefulfilment of any other qualification

I make this statement in full knowledge of and understanding that, should it befound to be false, I will not receive a grade and may face disciplinary proceedings

I would like to express my deep gratitude to people who supported andassisted me in completing my dissertation Firstly, I would like to thank mysupervisor sincerely, Ass Prof, Dr Nguyen Thi Tuong Anh This thesis hasbenefited substantially from her guidelines, suggestions, comments andencouragements Without her help, it could have been impossible for me to finish

my research

Secondly, I would like to sincerely thank my lecturer in Econometrics, Dr.Chu Thi Mai Phuong, who has made many value comments and suggestions in theformulating of the research model and estimation method

Besides, I also would like to show my appreciation to the whole of staff in theDepartment of Graduate Studies, Foreign Trade University throughout our studyprocess, especially Dr Cao Thi Hong Vinh for her thoughtful administrativearrangements, patience and tremendous encouragement during our thesis writingprocess

Moreover, I desire to show my heartfelt appreciation to my parents, mybrother and my family as well They always stand by me to strongly encourage incompleting my whole study

Finally, I feel very thankful for my friends even if they are my classmates inthe Master of Research in International Economics or not, since they supported mesincerely and enthusiastically in many ways when I was embarking on this toughyet beneficial higher education path

Dao Thi Ngoc Lan

July, 2019

TABLE OF CONTENTS

ABSTRACT i

STATEMENT OF ORIGINAL AUTHORSHIP ii

ACKNOWLEDGMENTS iii

LIST OF ABBREVIATIONS vi

LIST OF TABLES AND FIGURES viii

CHAPTER 1: INTRODUCTION 1

1.1 Rationale of the thesis 1

1.2 Objective of the thesis 3

1.3 Methodology 3

1.4 Scope of the thesis 5

1.5 Structure of the thesis 5

CHAPTER 2: LITERATURE REVIEW 6

2.1 Theoretical foundation 6

2.1.1 What is FDI? 6

2.1.2 Why should countries encourage FDI inflow? 10

2.2 Background of Economy and FDI Inflows in Asia 13

2.2.1 The Asian economies 13

2.2.2 The facts of FDI flows into Asia 16

2.3 Determinants of FDI Inflows 30

2.3.1 Market size 31

2.3.2 Working population 32

2.3.3 Infrastructure 32

2.4.4 Inflation 33

2.3.5 Openness to Trade 33

2.3.6 Economic growth 34

2.3.7 Corruption index 34

2.3.8 Natural resources 35

2.3.9 Political Stability 35

2.3.10 Regulatory quality 36

CHAPTER 3: THE MODEL 38

3.1 Model research 38

3.2 Description of variables 42

3.2.1 Dependent variable 42

3.2.2 Independent variables 43

3.3 Data collection 49

3.4 Estimation method 50

CHAPTER 4: FINDINGS AND DISCUSSION 53

4.1 Results of the regression model 53

4.2 Discussions on the outcomes of model 56

4.3 Summary 59

CHAPTER 5: POLICY IMPLICATIONS 61

CONCLUSION 63

REFERENCES 66

APPENDICES 70

LIST OF ABBREVIATIONS

BCC: Business Cooperation Contract

BEA: Bureau of Economic Analysis

BI: Brownfield Investment

CLMV: Cambodia, Laos, Myanmar and Viet Nam

FDI: Foreign Direct Investment

FEM: Fixed effect model

FIEs: Foreign Invested Enterprise

GDP: Gross Domestic Product

GI: Greenfield Investment

IIP: Index of industrial production

IMF: International Monetary Fund

M&A: A merger and acquisition

MNE: Multinational Enterprise

REM: Random effect model

WTO: World Trade Organization

LIST OF TABLES AND FIGURES

Table 1: Asia: Real GDP 15

Table 2: Top 10 Global and Asian Foreign Direct Investment Recipients in recent years (Millions of dollars) 18

Table 3: Expected effects of explanatory variables on FDI inflow into Asia 48

Table 4: Descriptive statistics of variables in model 52

Table 5: Correlation matrix of the explanatory variables 54

Table 6: Results of analysis 55

Table 7: Descriptive statistics of variables in model 69

Table 8: Correlation matrix of the explanatory variables 70

Table 9: OLS model 71

Table 10: Random effect model 72

Table 11: Breusch and Pagan Lagrangian multiplier test for random effects 73

Table 12: Fixed effect model 74

Table 13: Results of Hausman Test 75

Table 14: Robust regression for random effect model 76

Table 15: Results of analysis 77

Figure 1: Top 10 recipients of FDI flows in developing Asia in 2017 (millions of US dollars) 2

Figure 2: FDI inflows, 2012–2018 17

Figure 3: FDI trend for China during 2008 – 2018 comparing to East Asia and Asia 19

Figure 4: FDI trend for Hong Kong (China) during 2008 – 2018 comparing to East Asia and Asia 20

Figure 5: FDI trend for Republic of Korea during 2008 – 2018 comparing to East Asia and Asia 20

Figure 6: FDI trend for Singapore during 2008 – 2018 comparing to South-East Asia and Asia 21

Figure 7: FDI trend for Indonesia during 2008 – 2018 comparing to South-East Asia and Asia 22

Figure 8: FDI trend for Thailand during 2008 – 2018 comparing to South-East Asiaand Asia 23Figure 9: FDI trend for CLMV countries during 2008 – 2018 comparing to South-East Asia 24Figure 10: FDI trend for India during 2008 – 2018 comparing to South Asia and Asia .25Figure 11: FDI trend for Bangladesh during 2008 – 2018 comparing to South Asiaand Asia 25Figure 12: FDI trend for Sri Lanka during 2008 – 2018 comparing to South Asiaand Asia 26Figure 13: FDI trend for Pakistan during 2008 – 2018 comparing to South Asia andAsia 27Figure 14: FDI trend for Turkey during 2008 – 2018 comparing to West Asia andAsia 28Figure 15: FDI trend for Saudi Arabia during 2008 – 2018 comparing to West Asiaand Asia 29Figure 16: FDI trend for Saudi Arabia during 2008 – 2018 comparing to West Asiaand Asia 29

CHAPTER 1: INTRODUCTION

1.1 Rationale of the thesis

Over the last 6 decades or so of globalization, foreign direct investment (FDI)has played an important role in stimulating international trade, facilitated the globalintegration and growth of many developing and emerging economies FDI isconsidered as one type of investment funds contributing to the growth of a country

in general and the development of economy in particular because of some keyreasons For instance, FDI generates a huge number of impacts on all sectors in thenational economy relating to financial development of various industries, the level

of economy’s openness and so on Beginning in the mid-1980s, world foreign directinvestment (FDI) flows increased rapidly with a growing number of multinationalenterprises (MNEs) as the engine of the increased international economic activities Both industrialized and developing countries are becoming more receptive toFDI flows such that a majority of FDI policy changes in these countries are in thedirection of more liberalization of FDI inflows (United Nations, 1992) as there arevarious benefits which FDI brought for economic growth Asia, in particular hasbenefited enormously from FDI flows into the region According to UNCTAD’sWorld Investment Report 2014, Asia was the world's top recipient region of foreigndirect investment (FDI), accounting for nearly 30 per cent of global FDI inflows.Total inflows to developing Asia (excluding West Asia) amounted to $382 billion in

2013, 4 per cent higher than in 2012 FDI flows to developing Asia in 2017remained at the level of 2016 ($476 billion), according to UNCTAD’s WorldInvestment Report 2018 The region regained its position as the largest recipient ofFDI in the world as its share in global inflows rose from 25% in 2016 to 33% in

2017 Worldwide investors have long been interested in Asia as an investmentdestination thanks to the growth of local and regional markets, the region’senormous natural resources and its strategic location for export-oriented production.The following figure 1 presents the top 10 Asian recipients of FDI inflows in

2017 which shows increasing amounts of FDI invested into Asia region by

worldwide Foreign-invested Enterprises (FIEs) The data are in millions of USdollars.

as economic growth, trade and energy consumption (Apergis et al., 2006; Tang etal., 2008; Lee, 2013; Omri, 2014; Tang and Tan, 2014; Bhattacharyaa et al., 2016).The FDI inflow differential among developing countries has also generated muchresearch interest among researchers As a result, a largely amount of empiricalliterature has concentrated on investigating the factors attracting FDI inflow into thedeveloping regions such as infrastructure, trade openness, human capital, politicalstability, etc Still, the determinants of FIEs’ location choice in Asia are under-researched while it is important to design the effective policies in order to achievehigh economic growth.

In this context, this paper is to provide a systematic study on the determinants

of FIEs’ location choice and policy implications for Asian countries

1.2 Objective of the thesis

This paper examines the determinants of foreign direct investment (FDI) intoAsia in range of 2008-2017 Policy makers can then use the findings to channel FDI

to the targeted regions or countries

Using Ordinary Least Square method (OLS), random effects model (REM)and fixed effects model (FEM), this paper investigates the effects of market-size,labor force, infrastructure, inflation, trade openness, economic growth rate,corruption perceptions index, total natural resources rents, political stability andregulatory quality on FDI inflows in thirty Asian countries in the period from 2008

to 2017

1.3 Methodology

Two methods have been used to estimate the panel data model including PoolOLS and Random effects and finally the Random effect technique was chosen toestimate the model We ran some tests to select the methods as the Breusch andPagan Lagrangian multiplier test for random effects to select the panel data’sestimation method out of Pool OLS or Random effects technique, and Hausmantests for choosing between fixed and random effects In all model, the time-variantindependent variables use the first-order lag to reduce endogenous problems

Gravity-type models can be estimated by both standard and more advancedeconometric methods A simple and widely used method is OLS, applied to thelinear regression derived by taking logarithms of the gravity equation However,estimation results are biased and inconsistent because of missing data implied bythe logarithmic transformation 2, heteroskedasticity and unobserved heterogeneity.Despite not being applicable to the gravity model estimation, OLS is used in manyresearch papers at both country and regional level.

The other standard estimation approach is panel data estimation, both withfixed effects (FE) and random effects (RE) By dealing with country specificeffects, the panel FE method solves the inconsistency problem of the OLSestimation in the gravity model The presence of the distance variable in the gravitymodel might make it inappropriate to use either FE method (because there are timeinvariant variables in the regression) or RE method (because the individual effectscould correlate with some explanatory variables) To solve this problem, theysuggest using the Hausman test At the regional level, the method of panel dataestimation with fixed and random effects was used

Time lag involved in decision making of FIEs on investment location into Asiahas been taken account of in this study given that investment decision is normally atime-consuming process and is made in advance before the actual investment takesplace Therefore, current values of the explanatory variables might not have muchimpact on the FDI inflows In contrast, if sudden change in host countries’economic factors makes them less attractive than at the time the initial investmentdecision is made, the planned investment might not be realized (Faeth, 2005) Asone-year time lag is logical to take an informed decision, the time-variantindependent variables use the first-order lag in all models to reduce endogenousproblems (Blattner, 2006)

As regards a research data collection, the dissertation would like to utilize twodifferent data sources – primary and secondary data The primary information iscollected from reports of FDI projects and the government’s official websites whilethe secondary data is gathered from research books, journals, articles and websites

1.4 Scope of the thesis

This paper examines the possibility of cointegration and causality among FDI,market-size, labor force, infrastructure, inflation, trade openness, economic growthrate, corruption perceptions index, total natural resources rents, political stabilityand regulatory quality in Asian countries in the period of 2008 - 2017

1.5 Structure of the thesis

The remainder of this study is structured as follows Section 2 provides theliterature review of FDI and the factors affecting FIEs’ geographical investmentdecision The data sources, model researcher and strategic estimation are presented

in Section 3 Then, section 4 analyses and discusses the regression results Lastly,the conclusion and policy implications are presented in Section 5

CHAPTER 2: LITERATURE REVIEW

The literature review section attempts to illustrate the fundamentalknowledge involving in the aim and objectives of the study First of all, theliterature will concentrate on analyzing the fundamental of FDI concept and thereasons why countries want to attract FDI inflows, what are the benefits of FDI.Next, the background of the Asian economy and its current FDI inflow trend arepresented in this chapter for a better understanding of the Asian countries’ economicsituation in correlation with how FDI is distributed in the region In addition, theauthor will review the previous literature on the determinants of FDI inflow in order

to identify a number of appropriate independent variables for the model estimation

2.1 Theoretical foundation

2.1.1 What is FDI?

Foreign Direct Investment (FDI) implies an investment made with an intent

of obtaining an ownership stake in an enterprise domiciled in a country by anenterprise situated in some other country The investment may result in the transfers

of funds, resources, technical know-how, strategies, etc There are several ways ofmaking FDI i.e creating a joint venture or through merger and acquisition or byestablishing a subsidiary company

The investor company has a substantial amount of influence and control overthe investee company Moreover, if the investor company obtains 10% or moreownership of equity shares, then voting rights are granted along with theparticipation in the management Below are some popular definitions widely usedfor FDI

According to the International Monetary Fund (IMF) and the Organizationfor Economic Cooperation and Development (OECD) definitions, FDI is defined as

a category of international investment that reflects the aim of obtaining a lastinginterest by a resident entity of one economy (direct investor) in an enterprise that isresident in another economy (the direct investment enterprise) The lasting interestimplies the existence of a long-term relationship between the direct investor and the

direct investment enterprise, and a significant degree of influence by the investor onthe management of the enterprise A direct investment relationship is establishedwhen the direct investor has acquired 10 percent or more of the ordinary shares orvoting power of an enterprise abroad Direct investment involves both the initialtransaction establishing the relationship between the investor and the enterprise andall subsequent capital transactions between them and among affiliated enterprises,both incorporated and unincorporated It should be noted that capital transactionswhich do not give rise to any settlement, like an interchange of shares amongaffiliated companies, must also be recorded in the Balance of Payments and in theIndex of industrial production (IIP).

The fifth Edition of the IMF’s Balance of Payment Manual defines the owner

of 10 percent or more of a company’s capital as a direct investor This guideline isnot a fast rule, as it acknowledges that smaller percentage may entail a controllinginterest in the company (and, conversely, that a share of more than 10 percent maynot signify control) But the IMF recommends using this percentage as the basicdividing line between direct investment and portfolio investment in the form ofshareholdings Thus, when a non-resident who previously had no equity in aresident enterprise, purchases 10% or more of the shares of that enterprise from aresident, the price of equity holdings acquired should be recorded as directinvestment From this moment, any further capital transactions between these twocompanies should be recorded as a direct investment When a non-resident holdsless than 10 per cent of the shares of an enterprise as portfolio investment, andsubsequently acquires additional shares resulting in a direct investment (10 per cent

of more), only the purchase of additional shares is recorded as direct investment inthe Balance of Payments The holdings that were acquired previously should not bereclassified from portfolio to direct investment in the Balance of Payments but thetotal holdings should be reclassified in the IIP

According to the World Trade Organization (WTO), foreign directinvestment (FDI) occurs when an investor based in one country (the home country)acquires an asset in another country (the host country) with the intent to manage

that asset The management dimension is what distinguishes FDI from portfolioinvestment in foreign stocks, bonds and other financial instruments In mostinstances, both the investor and the asset it manages abroad are business firms Insuch cases, the investor is typically referred to as the “parent firm” and the asset asthe “affiliate“ or “subsidiary” (WTO, 1996).

In conclusion, it can be understood that FDI is a form of investment whereforeign investors invest the whole capital or a partial capital which is large enough

to gain the control over or to participate in controlling enterprises in the hostcountry

In terms of FDI categories, there are 3 main investment categories of FDIwhich is discussed as bellows

a Following FDI penetration method: FDI is categorized into 2 types

Greenfield Investment (GI) and Brownfield Investment (BI)

In economics, a greenfield investment refers to a type of foreign directinvestment where a company establishes operations in a foreign country In agreenfield investment, the company constructs new facilities (sales office,manufacturing facility, etc.) cross-border from the ground up According to theBureau of Economic Analysis (BEA), a greenfield investment is a project “whereforeign investors establish a new business or expand an existing business on U.S.soil.”

A greenfield investment is a form of market entry commonly used when acompany wants to achieve the highest degree of control over foreign activities Itcan be compared to other foreign direct investments such as the purchase of foreignsecurities or the acquisition of a majority stake in a foreign company in which theparent company exercises little to no control over daily business operations Apartfrom potential tax breaks or subsidies in establishing a greenfield investment, theoverarching goal of such an investment is to achieve a high level of control overbusiness operations and to avoid intermediary costs

Meanwhile, a brownfield investment (BI) is a type of foreign directinvestment where a company invests in an existing facility to start its operations Inother words, a brownfield investment is the lease or purchase of a pre-existingfacility in a foreign country A brownfield investment is often undertaken when acompany wants to invest and start operations in a new country but does not want toincur high start-up costs associated with a greenfield investment The underlyingrationale behind a brownfield investment is to enter into a new foreign market In abrownfield investment, the company either invests in existing facilities andinfrastructure through a merger and acquisition (M&A) deal or leases existingfacilities in the foreign country.

b Based on the level of capital participation in investment projects

A 100% foreign-owned enterprise is an enterprise owned by foreign

investors, newly established, purchased, self-managed by the investors, who areself-responsible for the business results

A foreign-invested joint-venture enterprise is established on the basis of

capital contribution by foreign investors and at least one domestic investor

Business Cooperation Contract (BCC) is a cooperation agreement between

foreign investors and at least one Vietnamese partner in order to carry out specificbusiness activities This form of investment does not constitute the creation of anew legal entity The investors in a BCC generally share the revenues and/orproducts arising from a BCC and have unlimited liability for the debts of the BCC

Public and Private Partnership (PPP) Contract is an investment form

carried out based on a contract between the government authorities and projectcompanies for infrastructure projects and public services PPP contracts includeBuild-Operate-Transfer (‘BOT’), Build-Transfer (‘BT’), Build-Transfer-Operate(‘BTO’), Build-Own-Operate (‘BOO’), Build-Transfer-Lease (‘BTL’), Build-Lease-Transfer (‘BLT’) and Operate-Manage (O&M) contracts

c Based on the strategic purpose of the investor, FDI can be vertical(investing in suppliers, distributors, retailers) or horizontal (investing in the sametype of firm), or conglomerate

In case of horizontal FDI, the company does all the same activities abroad as

at home For example, Toyota assembles motor cars in Japan and the UK

In vertical assignments, different types of activities are carried out abroad Incase of forward vertical FDI, the FDI brings the company nearer to a market (forexample, Toyota buying a car distributorship in America) In case of backwardvertical FDI, the international integration goes back towards raw materials (forexample, Toyota getting majority stake in a tyre manufacturer or a rubberplantation)

In the type of conglomerate investment, the investment is made to acquire anunrelated business abroad It is the most surprising form of FDI, as it requiresovercoming two barriers simultaneously – one, entering a foreign country and two,working in a new industry

With regards to the FDI motives, there are a variety of motives for a firm toengage in FDI:

 Resource-seeking (location-specific) Resource seeking FDIs are aimed atfactors of production which have more operational efficiency than those available inthe home country of the investors

 Market-seeking (more about responding to market need than reducing costs).This FDI is undertaken to strengthen the existing market structure or explore theopportunities of new market

 Efficiency-seeking FDI which is carried out to ensure optimization ofavailable opportunities and economies of scale

 Strategic asset-seeking (created assets) FDI which involves the transfer ofstrategic asset

 Trade/import substituting (requiring FDI to direct trade to avoid customsetc.)

2.1.2 Why should countries encourage FDI inflow?

Trade has always been a vital part of economy and with the concept ofglobalization it reaches to the international level Foreign direct investment (FDI)has proved to be resilient during financial crises and the role of FDI in the economydevelopment is very crucial It is widely recognized that FDI produces economicbenefits to the recipient countries by providing capital, foreign exchange,technology and by enhancing competition and access to foreign markets ForeignDirect Investment take place when an investor based in one country acquires asset

in another country in this process, the company investing in the host country alsotransfers assets such as technology, management and marketing

In addition to this the investing company also get chances of power to exercisecontrol over decision making in a foreign land enterprise to the extent of which itheld equity control such investment could also be in the form of reinvestment ofearning in the shape of retained earnings by the host country‘s enterprises that alsostrengthen the control of foreign investors

According to Kurtishi-kastrati (2013), there exists a variety of benefits of FDI

as a key component for successful and sustainable economic growth and also as apart of a method to social improvement

Resource – Transfer Effect

Foreign direct investment can make a positive contribution to a host economy

by supplying capital, technology and management resources that would otherwisenot be available Such resource transfer can stimulate the economic growth of thehost economy (Hill, 2008) According to Jenkins and Thomas (2002), FDI cancontribute to economic growth not only by providing foreign capital but also bycrowding in additional domestic investment; so it increases the total growth effect

of FDI In addition, technologies that are transferred to developing countries inconnection with foreign direct investment tend to be more modern, and

environmentally ‘cleaner’, than what is locally available Moreover, positiveexternalities have been observed where local imitation, employment turnover andsupply-chain requirements led to more general environmental improvements in thehost economy (Kurtishi-kastrati, 2013) And by transferring knowledge, FDI willincrease the existing stock of knowledge in the host country through labour training,transfer of skills, and the transfer of new managerial and organizational practice.

Employment Effects

According to Kurtishi-kastrati (2013), the effects on employment associatedwith FDI are both direct and indirect In countries where capital is relatively scarcebut labour is abundant, the creation of employment opportunities, either directly orindirectly, has been one of the most prominent impacts of FDI The direct effectarises when a foreign multinational enterprise (MNE) employs a number of hostcountry citizens Whereas, the indirect effect arises when jobs are created in localsuppliers as a result of the investment and when jobs are created because ofincreased local spending by employees of the MNE

Balance of Payments Effects

FDI’s effect on a country’s balance of payment accounts is an important policyissue for most host governments There are three potential balance of paymentsconsequences of FDI (Kurtishi-kastrati, 2013)

First, when an MNE establishes a foreign subsidiary, the capital account of thehost country benefits from the initial capital inflow However, this is a one-timeonly effect

Second, if the FDI is a substitute for imports of goods or services, it canimprove the current account of the host country’s balance of payment Much of theFDI by Japanese automobile companies in the US and UK, can be seen as substitutefor imports from Japan

A third potential benefit to the host country’s balance of payment arises whenthe multination enterprise (MNE) uses a foreign subsidiary to export goods andservices to other countries The evidence based on empirical research on the balance

of payments effect of FDI, indicates that there is a difference between developedand developing countries, especially with respect to investment in themanufacturing industries.

International Trade

FDI can have a great contribution to economic growth in developing countries

by supporting export growth of the countries According to Kurtishi-kastrati (2013),output resulting from efficiency-seeking FDI is typically intended for export, andtherefore the impact of such FDI is likely to be an increase in exports from the hostcountry If local firms provide inputs to affiliates producing goods for exports, thelocal content of value-added exports would be much greater In cases whereintermediate goods are imported from outside the host economy, efficiency-seekingFDI will increase export as well as import

Effect on Competition

According to an OECD report (OECD, 2002) the presence of foreignenterprises may greatly assist economic development by spurring domesticcompetition and thereby leading eventually to higher productivity, lower prices andmore efficient resource allocation Increased competition tends to stimulate capitalinvestments by firms in plant, equipment and R&D as they struggle to gain an edgeover their rivals FDI’s impact on competition in domestic markets may beparticular important in the case of services, such as telecommunication, retailingand many financial services, where exporting is often not an option because theservice has to be produced where it is delivered And according to an OECD study,

“Like trade, foreign direct investment acts as a powerful spur to competition andinnovation, encouraging domestic firms to reduce costs and enhance theircompetitiveness” (OECD, 1998)

2.2 Background of Economy and FDI Inflows in Asia

2.2.1 The Asian economies

Asia is the world’s largest continent, in addition to being the most diverse interms of geography, ethnicity and so on It stretches from the Mediterranean, Black

and Red Seas in the West to the Pacific Ocean in the East, and from the Siberianglacial Arctic Ocean in the North to the Indian Ocean in the South.

The second half of the 20th century was characterized by various waves ofspectacular economic growth among countries of the Asian Pacific Rim, first inJapan, then in South Korea, Singapore, Hong Kong, Malaysia and Indonesia, amongothers In more recent decades, the rapid growth of China and India has also beenbreathtaking Broadly speaking, the economic development of these countries hasbeen based on exporting manufactured goods In the case of the Middle East and theformer Soviet Union republics of Central Asia, prosperity has been largely due tothese countries’ vast reserves of oil and other forms of non-renewable energy, inparticular gas According to the International Monetary Fund (2018), economicgrowth in Asia is forecast at 5.6 percent in 2018 and 2019 (see Table 1), whileinflation is projected to be subdued China’s growth is projected to ease to 6.6percent, partly reflecting the authorities’ financial, housing, and fiscal tighteningmeasures Growth in Japan has been above potential for eight consecutive quartersand is expected to remain strong this year at 1.2 percent And in India, growth isexpected to rebound to 7.4 percent, following temporary disruptions related to thecurrency exchange initiative and the rollout of the Goods and Services Tax Thesegood prospects for the Asian economies have ensured that FDI has continued toflow into these countries

Moreover, since Asia accounts for 60% of the world’s population and thusoffers concentrations of cheap labor, some FDI source countries, including Japan,the United States and European Union (EU) member-states, have invested strongly

in labor-intensive industries, such as textiles and clothing and so on In many Asiancountries great emphasis is placed on creating and maintaining a highly educatedand skilled workforce, which is essential for producing cutting-edge electronics and

IT goods and services With the improvements in the quality of education andfavorable policies, FDI inflows are likely to continue to increase

Table 1: Real GDP in Asia

(Year-over-year percent change)

Source: International Monetary Fund, 2019.

1 EMDEs excluding Pacific island countries and other small states.

2 India’s data are reported on a fiscal year basis Its fiscal year starts April 1 and ends March 31.

3 ASEAN comprises Brunei Darussalam, Cambodia, Indonesia, Lao P.D.R., Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam.

4 ASEAN-5 comprises Indonesia, Malaysia, the Philippines, Singapore, and Thailand.

2.2.2 The facts of FDI flows into Asia

According to the statistics reported in the UNCTAD database, during theperiod from 1970 to 2011 the least developed Asian countries attracted the leastamount of FDI, accounting for less than 1% on average, while the more advanceddeveloping countries welcomed the main share, more than 90% Furthermore,among the latter group, the Eastern and South-Eastern Asian countries absorbed theoverwhelming majority of FDI FDI inflows into the former did not exceed thoseinto the latter until 1984 With the implementation of an open-door policy and thestart of a programme of structural reforms, China began to flourish and itsgovernment entered into the competition to attract FDI As a result, since 1992,China has been the Asian country attracting the largest amount of FDI and has heldthe world’s fourth largest stock of FDI since 2003 (UNIDO, 2005; BenoîtMercereau, 2005) As already remarked, FDI inflows into Asia are not evenlydistributed Another issue that has been raised is whether FDI attraction is a zero-sum game Benoît Mercereau’s (2005) concluded that it is not

Nowadays, Asia remained the largest recipient of foreign direct investment(FDI) in 2017, attracting 32.9% of global FDI, up from 24.7% in 2016 (UNCTAD,2019) However, it varies greatly from country to country and region to region (seeFigure 2 and Table 2) The People’s Republic of China (PRC) remained the topdestination While the region continues to benefit from inward FDI, helping driveeconomic growth and rising incomes, it has also cemented its position as a majorsource of FDI, as Asian firms continue to internationalize both within and outsidethe region In 2017, Asia’s share of global outward FDI increased to 34.1%, up from33.6% in 2016 Japan reemerged as top Asian investor, followed by the PRC andHong Kong, China

Figure 2: FDI inflows in the world, 2012–2018

(Billions of dollars and percent) Source: UNCTAD, 2019.

Table 2: Top 10 Global and Asian Foreign Direct Investment Recipients in recent years (Millions of dollars)Global

Asia

Source: UNCTAD, 2019.

As can be seen in the above Figure 2 and Table 2, FDI inflow into Asiavaries greatly from country to country and region to region.

East Asia’s FDI inflows increased by 4% to $280 billion in 2018 but stayed far below their highest record of $318 billion in 2015 Inflows to China

rose by 4%, achieving a peak of $139 billion of all time which is more than 10% ofthe world’s total FDI inflows

Figure 4: FDI trend for Hong Kong (China) during 2008 – 2018 comparing to

East Asia and Asia

Source: UNCTAD, 2019.

FDI inflow to the Republic of Korea decreased by 19% to $14 billion in

2018, partly because of a significant drop in intracompany loans

Figure 5: FDI trend for Republic of Korea during 2008 – 2018 comparing to

East Asia and Asia

Source: UNCTAD, 2019.

FDI flows to South-East Asia increased by 3% to an all-time peak of

$149 billion in 2018 Consequently, the subregion’s share in global inflows

increased from 10% in 2017 to 11% in 2018 The FDI growth was mostlyinfluenced by an investment rising trend in Singapore, Indonesia, Viet Nam andThailand Manufacturing and services, particularly finance, retail and wholesaletrade, including the digital economy, continued to underpin rising inflows to thissubregion Strong intra-ASEAN investments and robust investment from otherAsian economies also contributed to the trend However, inflows to some countries(Malaysia and the Philippines) declined (UNCTAD, 2019)

Singapore remains the subregion’s largest FDI recipient with inflows of $78billion in 2018, a 3% rise from 2017

Figure 6: FDI trend for Singapore during 2008 – 2018 comparing to

South-East Asia and Asia

Source: UNCTAD, 2019.

FDI inflow to Indonesia increased by 7% to $22 billion Intra-ASEANinvestments, mainly from Singapore, accounted for more than 50% of the country’sFDI inflow China and Japan investments also further added to the record

Figure 7: FDI trend for Indonesia during 2008 – 2018 comparing to South-East

Asia and Asia

Source: UNCTAD, 2019.

Inflows to Thailand increased by 62% in 2018 to $10 billion - the steepestFDI growth in ASEAN After the uptick registered in 2017, this indicates thatThailand’s FDI inflow is recovering from its downward trend earlier in the decade.This growth was due to significant inflows from Asia, led by investors from Japan,Hong Kong (China) and Singapore Reinvestment by MNEs already present inThailand doubled to $7.4 billion, which contributed significantly to FDI flows

Figure 8: FDI trend for Thailand during 2008 – 2018 comparing to South-East

Asia and Asia

Source: UNCTAD, 2019.

FDI inflows into the CLMV countries (Cambodia, Laos, Myanmar and VietNam) remained strong Nevertheless, inflows into Laos and Myanmar declined.Active investment flows from intra-ASEAN sources and other Asian economies(China, Japan, the Republic of Korea) continued to be the highest FDI inflowsource into these countries The shift from China of labour-intensive industries,such as garment and footwear production, is increasing investment in thesecountries The participation of Chinese firms in infrastructure development is alsoaffecting these countries’ FDI inflows

Figure 11: FDI trend for Bangladesh during 2008 – 2018 comparing to South

Asia and Asia

Source: UNCTAD, 2019.

Inflows to Sri Lanka also achieved a peak of $1.6 billion, boosted by robustAsian investments, including from China, India and Singapore Infrastructure,particularly ports and telecommunication, attracted a large portion of the country’sFDI inflows.

Figure 12: FDI trend for Sri Lanka during 2008 – 2018 comparing to South

Asia and Asia

Source: UNCTAD, 2019.

Pakistan, the fourth largest FDI recipient in the South Asia, experienced a27% decrease in investment to $2.4 billion This was significantly due to thecompletion of some projects related to the China−Pakistan Economic Corridor, and

a balance-of-payments challenge that may have delayed new inflows

one third of their $85 billion highest point in 2008 The small rise in FDI can be due

to higher inflows to Turkey and a pickup of FDI in Saudi Arabia, which offset fordownward investment in other countries FDI flows in the West Asia remaineduneven Turkey, the United Arab Emirates, Saudi Arabia and Lebanon togetherattracted approximately 90% of FDI inflow in the subregion

Turkey was the largest FDI recipient, with inflows increasing by 13% to $13billion, although slower than usual economic growth

FDI flows to Saudi Arabia increased from $1.4 billion in 2017 to $3.2 billion

in 2018, still largely lower than the 2008 peak of $39 billion Political factors andlower oil prices were significantly responsible for lower than usual FDI inflow toSaudi Arabia

Figure 15: FDI trend for Saudi Arabia during 2008 – 2018 comparing to West

Asia and Asia

Source: UNCTAD, 2019.

FDI inflow to the United Arab Emirates remained almost unchanged in 2018,

at $10 billion Investment targeted a wide range of sectors, from oil and gas todigital technologies

Figure 16: FDI trend for Saudi Arabia during 2008 – 2018 comparing to West

Asia and Asia

Source: UNCTAD, 2019.

2.3 Determinants of FDI Inflows

There is a variety of theoretical models explaining FDI and a wide range offactors that can be experimented within empirical studies in order to find thelocational determinants of FDI However, there has been only a small number ofempirical studies on determinants of FIEs’ locational choice so far Hasli, Ho andIbrahim (2015) has analyzed the determinants of FDI inflow in Asia and found thatthat lending rate, trade openness and money supply have a positive significance toFDI per capita whereas debt, unemployment rate and environmental pollution have

a negative significance to FDI per capita However, the time period under study wasalready the last decade which ranged from 1993 to 2013 A more updated research isthen needed

According to Fedderke and Room (2006), the literature on the determinants offoreign investment has identified both policy and non-policy factors as drivers ofFDI Non-policy factors include market size, distance, factor proportions andpolitical and economic stability Policy factors include openness, product-marketregulation, labour market arrangements, corporate tax rates and infrastructure

Kim, Soyoung, Sunghyun Kim (2013) meanwhile investigate the role of push(external) and pull (internal) factors in determining the magnitude and directions ofinternational capital flows in Korea during 1980-2010 Push factors includeeconomic conditions outside the host (capital-importing) country such as worldinterest rate and growth rate, while pull factors include various economic andfinancial conditions of the host country, for example, domestic interest rate andfinancial strength, inflation, exchange rate volatility, domestic GDP growth rate, thecurrent account balance and policies on financial account liberalization

Asiedu (2002) documents that the variables, that is, openness, return oninvestment, GDP and market size are significant for FDI promotion andinfrastructure development Using the Least Square Method, he found political risk

as insignificant