Liberalization and FDI performance: EEvidence from ASEAN and SAFTA member countries

Ullah, Muhammad; Inaba, Kazuo Article Liberalization and FDI performance: EEvidence from ASEAN and SAFTA member countries Journal of Economic Structures Provided in Cooperation with: Pan-Pacific Association of Input-Output Studies (PAPAIOS) Suggested Citation: Ullah, Muhammad; Inaba, Kazuo (2014) : Liberalization and FDI performance: EEvidence from ASEAN and SAFTA member countries, Journal of Economic Structures, ISSN 2193-2409, Springer, Heidelberg, Vol. 3, pp. 1-24, https://doi.org/10.1186/s40008-014-0006-z This Version is available at: https://hdl.handle.net/10419/147196 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. http://creativecommons.org/licenses/by/4.0/ Journal of Economic Structures (2014) 3:6 DOI 10.1186/s40008-014-0006-z RESEARCH ARTICLE OpenAccess Liberalization and FDI Performance: Evidence from ASEAN and SAFTA Member Countries Muhammad Shariat Ullah ·Kazuo Inaba Received: 7 April 2014 / Revised: 16 October 2014 / Accepted: 20 October 2014 / © 2014 Ullah and Inaba; licensee Springer. This is an Open Access article distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/4.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly credited. Abstract The developing and least developed countries in the South and Southeast Asia have emerged as dynamic hosts of foreign direct investment; and inbound FDI growth surpassed that of the developing world during the decade 2001–2010. Yet foreign investment continues to flow quite unevenly into individual countries in the region, although majority of the Asian countries do emphasize liberalization unilaterally, bilaterally under the bilateral investment treaty (BIT) and the bilateral trade agreement (BTA), and regionally under the regional trade agreement (RTA). Under such scenarios, this study empirically assesses FDI determinants with a specific focus on the FDI effects of BIT, BTA, and RTA as well as of factors pertaining to institutional quality. Gravity-type econometric results of unbalanced panel data uncover that BIT, BTA, and RTA promote FDI insignificantly. It appears that the role of bilateral instruments in stimulating the inflow of foreign capital diminishes if liberal FDI policies already exist in the host country. Under such circumstances, the quality of the host country’s legal and regulatory environment exerts a profound influence on firms’ investment decisions. Nonetheless, core gravity variables are found to be important determinants of FDI. Keywords FDI ·ASEAN ·SAFTA ·BITs ·BTAs ·Institutional quality JEL Classification C33 ·F21 ·F23 M.S. Ullah University of Dhaka, Dhaka, Bangladesh e-mail: [email protected] K. Inaba (B) Ritsumeikan University, Kusatsu, Shiga, Japan e-mail: [email protected] Page 2 of 24 M.S. Ullah, K. Inaba 1 Introduction South and Southeast Asian countries are integrated under two distinct regional trade blocs, namely the South Asian Association for Regional Cooperation1(SAFTA) and the Association of Southeast Asian Nations2(ASEAN). Owing either to a perception of bolstering economic prosperity or to overcoming an economic crisis by injecting foreign capital and technology, developing and least developed participants3 of these trade blocs’ undertook unilateral opening to international investments over recent decades. Consequently, FDI policies—i.e., national treatment, equity ceiling, sectoral opening, profit repatriation, and foreign exchange control—were gradually softened. Nonetheless, ASEAN and SAFTA members have maneuvered a wide range of fiscal incentives so as to remain more competitive and to feature attractive investment locations. Alongside the unilateral opening to FDI, these economies have signed an extensive number of bilateral investment treaties (BITs) over time.4In addition, some countries have attempted to complement the investment liberalization process by forming bilateral trade agreements (BTAs); these are like free trade agreements (FTAs) that also contain provisions for stimulating investment at a bilateral level. In the wake of the speedy liberalization of restrictions on FDI, coupled with a rising trend in the dislocation of operations by multinational enterprises (MNEs) to access locational advantages, South and Southeast Asia emerged as key destinations for inbound FDI. The Asian Development Bank (2007) reported that the liberalization of investment barriers by developing countries in Asia resulted in an upward trend of FDI flow into the region in recent years. Furthermore, the FDI flows to South and Southeast Asia exceeded FDI growth in developing countries in other regions (UNCTAD 2010). Although the developing and LDC members of ASEAN and SAFTA actively invite FDI by formulating investment-friendly policies, by offering incentives as a way to deliver higher competitiveness to the foreign firms, and by 1Regional cooperation in South Asia began with the formation of the South Asian Association for Regional Cooperation (SAARC) in 1985 by seven South Asian countries. Subsequently, the SAARC members signed the South Asian Preferential Trade Arrangement (SAPTA) in 1993 and transformed the SAPTA into the South Asian Free Trade Agreement (SAFTA) in 2004. Some of the SAARC members also belong to the Asia Pacific Trade Agreement (APTA). See Ullah and Inaba (2012) for details on the regionalization of South Asian countries. 2Member states of ASEAN have instituted far-reaching liberalization to facilitate and coordinate investment liberalization within the region since the late 1990s. In particular, the creation of the ASEAN Investment Area (AIA) in 1998 was a milestone initiative in the area of regional cooperation through investment liberalization. Plummer and Cheong (2009) provide a comprehensive literature on liberalization initiatives under the ASEAN. 3By referring to developing and least-developed participants of ASEAN and SAFTA, this research indicates nine countries, i.e., Bangladesh, Cambodia, India, Indonesia, Myanmar, Pakistan, the Philippines, Thailand, and Vietnam. This study selects these nine sample countries because it aims to unveil the determinants of FDI from the perspective of receiving countries that stand at a similar stage of economic development, offer comparable degree of liberalization but exhibit noticeable variation in hosting FDI. Countries like Singapore and Malaysia simultaneously receive and undertake FDI and therefore have been excluded from the analysis. In addition, some countries like Sri Lanka and Laos could not be included in the sampling frame because of non-availability of data. 4The total number of BITs implemented by the nine sample countries increased remarkably from 24 to 281 between 1990 and 2011. Journal of Economic Structures (2014) 3:6 Page 3 of 24 entering into a growing number of BITs, the performance in FDI attraction differs substantially among them. Hence, the critical question is what factors govern MNEs’ decisions in choosing locations for investment. Analyzing the FDI data of eight Asian countries—Hong Kong, Taiwan, Republic of Korea, Singapore, Malaysia, the Philippines, Indonesia, and Thailand— Chantasasawat et al. (2010) report that openness and corporate taxes are the driving forces of inward FDI in the East and Southeast Asian host countries. Their results further indicate that institutional characteristics—i.e., corruption, government stability, and rule of law—have no significant influence on FDI. Plummer and Cheong (2009) investigate ASEAN integration and its effects on FDI. Their findings demonstrate that BITs have insignificant positive effects on FDI inflow to the ASEAN countries. Vogiatzoglou (2007) unveil that the volume of bilateral trade between host and home countries, bilateral vertical production specialization links between them, international integration, degree of openness, growth rates, labor cost, and macroeconomic instability in the host country are the main determinants of FDI inflows from the selected OECD countries to the nine East Asian host countries (i.e., China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan, and Thailand). While some studies addressed many aspects of FDI determinants, the role of investment treaties has been inadequately explored. Therefore, the present research attempts to examine FDI effects of BITs in the nine Asian countries in which a growing momentum in signing BITs has been prevalent. Apart from that, we discern the impact of bilateral investment agreements (BTAs) on firms’ choices for investment locations. Developing and LDC member states of ASEAN and SFTA primarily attract vertical FDI, in which the investing firms tend to export the output from the host country. In this case, FDI and trade act as complements to one another. Owning to a complementary relationship between vertical investment and trade (Gast and Herrmann 2008), BTAs are likely to constitute an integral determinant of inward FDI. In particular, BTAs between the Southern and Northern countries can stimulate FDI from the latter to the former. Furthermore, we assess the role of institutional quality in attracting inward FDI by examining law and order as well as corruption and internal conflict. Effects of these factors in the context of ASEAN and SAFTA countries have rarely been addressed in past studies. Because the sample hosts have already implemented an open-door policy toward foreign investment and they have maneuvered competitive incentive packages, institutional development might act as the driving force of future FDI inflows. Therefore, we aim to contribute by ascertaining the required institutional reforms to benefit from investment-friendly policies and incentives. The rest of the paper is structured as follows. Section 2compares FDI policies and performance of the sample countries. Section 3presents literature on FDI determinants. Section 4outlines the econometric model and analyzes the empirical results. Finally, Sect. 5gives the conclusion. 2 FDI Policy and Performance 2.1 Evolution of Investment Policies FDI policies in the developing and LDC countries of SAFTA and ASEAN have undergone far-reaching changes in recent decades. These capital-deficient countries still Page 4 of 24 M.S. Ullah, K. Inaba strive for FDI by lowering barriers to capital inflows. Nonetheless, countries competing for inward FDI also grant fiscal stimuli to allure foreign investors, which has resulted in a “proliferation of incentives” (OECD 2004). In order to keep pace with the changing business environment and global business rules, FDI-seeking countries amend their investment statutes quite frequently. Alongside the current investment provisions, Tables 1and 2exhibit a brief summary of FDI policy evolution in selected countries.5It is evident that investment liberalization at the country level began at different points of time and at varying degrees. Overall, the phase of liberalization in Southeast Asia preceded that of South Asia. In particular, three Southeast Asian countries—Indonesia, Thailand, and the Philippines—relaxed some of their regulations on FDI in the 1960s and 1970s. Thailand pioneered the introduction of the tax holiday in 1960, followed by Indonesia in 1967.6Indonesia moved first in some areas including eliminating the ceiling on foreign equity holding, granting national treatment, guaranteeing against expropriation, and allowing concessional duty on import. By the 1970s, Thailand and the Philippines also instituted liberal FDI policies, similar to Indonesia. Vietnam joined the club of liberal economies in the late 1980s and adopted a liberal FDI policy regime by the early 1990s. In South Asia, the liberalization of FDI policies commenced prior to the implementation of broad-based economic reforms. In particular, Bangladesh and Pakistan opened the door to foreign investors in the early 1980s, although these countries have changed their direction from import substitution to an export-led growth strategy since the early 1990s. India was relatively restrictive to FDI until the beginning of the 1990s. Although India opened the first export processing zone (EPZ) in Asia in 1965, the FDI policy of the country at that time was highly restrictive, and industrialization was controlled by protected domestic sectors with a focus on import substitution strategy. Although the initial journey of softening FDI policies in South and Southeast Asia ranged from the 1960s to the 1990s, investment policies gradually converged, and the current state of the policies and incentives mostly demonstrates similar attributes.7 Table 2shows that SAFTA and ASEAN countries compete head to head in relation to offering generalized investment incentives and concessions. In some cases, even, smaller countries, like Bangladesh and Vietnam, offer more a liberal atmosphere than the bigger markets. 2.2 FDI Trends in ASEAN and SAFTA Countries Table 3compares the growth trends of inward FDI in developing countries across the globe, in the Asian countries as a whole, and in the nine sample countries that belong to either ASEAN or SAFTA. It is evident that during the 1990s, the aggregate growth of FDI in the nine selected hosts in Asia lagged behind FDI growth in the developing 5The FDI policy of Cambodia and Myanmar could not be compared due to data limitation. 6Indonesia revoked tax holiday on FDI from the year 1984 under the Law Number 7 passed in 1983. Since then, the government usually grants some tax concessions that ease tax burden of investors. 7In addition to the policies and incentives summarized in Table 2, every country designs some sectorspecific policies and incentive packages. Journal of Economic Structures (2014) 3:6 Page 5 of 24 Table 1 Commencement of investment liberalization FDI policy aspects Countries Bangladesh Pakistan India Indonesia Thailand Philippines Vietnam 100% equity investment in most sectors 1980 1989 1990 (some sectors) 2005–2006 (most sectors) 1967 (some sectors for a span of 30 years); 2007 (except few sectors) n/a 1972 (within EPZ), 1991 (outside EPZ) 1987 Introducing tax holiday n/a n/a 1991 1967 1960 n/a 1987 Ensuring national treatment 1980 1992 1991 1967 n/a n/a 2005 Granting repatriation of capital 1991 1976 (by industrial sector) 2000 2000 1977 1967 1987 Permission to import capital machinery/Reduction of import duty on machinery and raw materials 1980 (by EPZ firms) 1983 (by EPZ firms) 1991 (with limits) 1967 1977 1967 (only machinery), 1972 (raw materials by EPZ firms) 1992 Right of foreign investors to appoint foreign nationals n/a n/a 1991 (only foreign technicians) 2000 1977 (only skilled workers and experts) n/a 2005 (managers, technicians) Implementing first BIT 1980 1981 1995 1992 1973 1981 1991 Opening first special investment zone 1980 1980 1965 1973 1978 1972 1991 Guarantee against nationalization 1980 1992 n/a 1967 1977 1967 1987 Source: Authors’ compiled from various official documents of the sample countries Note: n/a indicates not available data Page 6 of 24 M.S. Ullah, K. Inaba Table 2 Current state of FDI policies FDI policy aspects Countries Bangladesh Pakistan India Indonesia Thailand Philippines Vietnam Tax holiday (i) 5–7 years in most sectors; (ii) 15 years in power sector; (iii) 10 years (in EPZ) Tax cut (50% of plant, machinery, and equipment cost) (i) 10 years in the power sector; (ii) 5 years in infrastructure sector n/a 8 years (in priorities activities) 3∼8 years 2∼8 years Corporate tax rate 25% 35%∼25% 40∼42% (higher than local investors) 25% 30% 30% 25∼10% Ceiling on equity holding No ceiling No ceiling (in manufacturing sector); 60% (in service and agriculture) Ceiling on few sectors 45–95% (ceiling on 17 sectors) No ceiling (in manufacturing sector); 49% (maximum in some specified sectors) 20% (5 sectors), 30% (one sector), 40% (19 sectors) No ceiling Number of restricted sectors 4 4 2 25 n/a 11 12 Repatriation provisions Full repatriation of capital, profits, and dividends Full repatriation from manufacturing; 60% from service sector Repatriation of profit after tax without any restriction Full repatriation Free to repatriate investment funds, profits, and dividends and to repay overseas loans Free to repatriate investment, earnings, and funds for loan payment Full repatriation Number of BITs (until 01 June 2012) 29 46 83 63 39 35 60 Source: Authors’ compiled from various official documents of the sample countries Journal of Economic Structures (2014) 3:6 Page 7 of 24 Table 3 Comparison of net inward FDI growth (period average) Regions Period 1991–1995 1996–2000 2001–2005 2006–2010 Developing World 27.817.98.613.5 South, East, and Southeast Asia 31.414.26.113.0 9 sample countries of ASEAN/SAFTA 20.7−7.836.816.3 Source: Authors’ calculations from the UNCTAD’s data Table 4 Inward FDI as % of total inflows in nine countries (period average) Host country Period 1991–1995 1996–2000 2001–2005 2006–2010 Bangladesh 0.23.82.81.4 Cambodia 0.81.61.01.1 India 8.124.537.348.4 Indonesia 28.9−3.11.213.0 Myanmar 2.53.71.61.1 Pakistan 5.83.85.56.5 Philippines 13.914.15.43.9 Thailand 26.337.935.013.7 Vietnam 12.613.69.711.1 Source: Authors’ calculations based on the UNCTAD’s data set world as well as the growth achieved by the entire Asian region. In particular, the sample countries suffered from a negative flow during the last half of the 1990s, which was primarily due to the Asian financial crisis. The negative growth of FDI during the second half of the 1990s was greatly related to the substantial outflow of FDI from Indonesia. However, FDI growth of those economies during the first decade of the present century surpassed the growth achieved by the developing world and also by the developing Asian region. In particular, during the period 2001–2005, SAFTA and ASEAN countries witnessed spectacular growth in hosting FDI. Although the rate of FDI growth in these developing countries declined from 36.8% during 2001–2005 to 16.3% between 2006–2010, their achievement was better than that of developing world and of South, East, and Southeast Asia. 2.3 Relative Share in Regional FDI Inflows Even though developing Asia witnessed an FDI boom over the past decade, few countries hosted the lion’s share. Table 4presents country-specific FDI share during 1991– 2010. The salient features of FDI share can be summarized as follows: (1) India’s share of inward FDI in Asia consistently rose at a remarkable rate, while that of the Philip- Page 8 of 24 M.S. Ullah, K. Inaba pines shrank constantly; (2) recent FDI inflows tended to be more concentrated on India, Indonesia, and Vietnam; (3) India, Indonesia, Pakistan, and Vietnam’s share increased during 2006–2010 over the preceding period’s share; (4) Bangladesh, Cambodia, and Myanmar accounted for a marginal share of the total regional FDI inflows; (5) Thailand hosted a dominant portion of total inward FDI until 2005, but its share substantially dropped during the subsequent period; (6) over time, the share of FDI for the Philippines worsened more than all of the remaining countries. 3 Literature on FDI Determinants Empirical analyses of FDI determinants have been a key area of research for a long time. Since the 1990s, the rapid expansion of MNEs’ operations has led to a substantial growth of FDI in the world that has outpaced the growth of world trade and output. For instance, during the period of 1990 to 2010, the average growth rate of inward FDI in the world was 13.2 percent, as compared to 8.1 and 2.6 percent average growth rates of world trade and output, respectively.8A healthier growth rate of world FDI for decades has provided the impetus for exploring the reasons that firms undertake FDI. Research in this area is still advancing at a rapid rate, owing to the increased orientation of FDI from developed countries to developing ones that have heterogeneous characteristics. Some empirical studies focus on country case, while many others analyze FDI by pooling together developed countries (DCs) and less-developed countries (LDCs). Nonetheless, studies that aim to ascertain factors affecting FDI and its effect on specific economies are still in their infancy (Blonigen 2005). This is particularly true with respect to LDCs (Blonigen and Wang 2004). Caves (1996) and Blonigen (2005) provide authoritative surveys of various strands of literature on FDI determinants. Besides, Chakrabarti (2001) presents a list of potential factors available in a vast array of cross-country studies on the determinants of FDI, and the research shows further examination of robustness of partial correlations between the level of inward FDI and a wide range of economic factors. Overtime, the analytical focus of empirical models on the factors determining FDI has shifted from traditional determinants of locational advantages to policy-oriented issues, like exchange rate and openness as well as to the governance and human development areas and lately to liberalization under BITs, BTAs, and RTAs. Nevertheless, “the empirical literature on determinants of FDI is still young enough that most hypotheses are still up for grabs” (Blonigen 2005, p. 398). Essentially, there is scanty and variant evidence of the FDI effects of BITs, more so in the context of developing and LDC countries, although starting from the 1990s, the world witnessed a rapid proliferation of BITs. As such, the number of BITs in the world reached 2,756 as of May 2010, up from 385 at the end of the 1980s (UNCTAD 2000,2010).9Busse et al. (2010) and UNCTAD (2009) find that participation in BITs by developing economies 8Growth rates were calculated by the authors based on UNCTAD data for global FDI and trade and World Bank data for GDP. 9UNCTAD (2005) reported that 40% of the world’s total BITs were signed between developed and developing countries, followed by 25% among developing countries and 13% between developed countries. Journal of Economic Structures (2014) 3:6 Page 15 of 24 Table 5 Correlation matrix GDPiGDPjGDPPCiGDPPCjDISTij HDjRAILPCjBTAij BITij ASEANij ASEANJPNij SAFTAJPNij LAWjCORRUPjCONFLICTj GDPi1 GDPj−0.03 1 GDPPCi0.03 0.65 1 GDPPCj0.32 0.11 0.03 1 DISTij 0.55 0.17 0.42 0.07 1 HDj0.05 0.27 −0.04 0.57 −0.06 1 RAILPCj−0.10 −0.20 −0.06 −0.25 −0.01 −0.52 1 BTAij 0.14 0.14 0.10 0.18 0.12 0.08 0.07 1 BITij −0.05 0.12 −0.17 0.13 0.03 0.17 −0.19 −0.13 1 ASEANij −0.43 −0.09 −0.34 0.04 −0.56 0.15 0.01 −0.07 −0.04 1 ASEANJPNij 0.33 −0.06 0.22 0.01 −0.00 0.08 −0.02 0.12 −0.20 −0.10 1 SAFTAJPNij 0.25 0.10 0.17 −0.09 0.06 −0.17 0.03 −0.03 −0.02 −0.08 −0.05 1 LAWj−0.11 −0.04 −0.12 −0.05 −0.04 −0.05 0.32 −0.00 −0.05 0.03 0.01 −0.04 1 CORRUPj−0.02 0.36 0.03 0.26 0.06 0.19 −0.27 0.03 0.13 −0.07 −0.03 0.03 0.48 1 CONFLICTj−0.05 −0.18 −0.12 0.05 0.06 0.23 0.09 −0.01 0.02 0.07 0.03 −0.09 0.66 0.39 1 Page 16 of 24 M.S. Ullah, K. Inaba Table 6 Descriptive statistics Variable Mean Std. dev. Min. Max. lnFDIij Overall 3.64 2.21 −4.60 9.55 Between 1.69 −0.20 7.49 Within 1.47 −3.75 8.56 lnGDPiOverall 27.08 1.60 21.96 30.09 Between 1.59 22.31 29.95 Within 0.19 26.41 27.82 lnGDPjOverall 24.72 1.40 21.67 27.60 Between 1.38 22.23 27.06 Within 0.29 24.01 25.44 lnGDPPCiOverall 9.62 1.06 5.73 10.64 Between 1.05 6.16 10.55 Within 0.15 9.01 10.32 lnGDPPCjOverall 6.47 0.75 4.70 7.91 Between 0.72 5.35 7.70 Within 0.24 5.83 7.22 lnDISTij Overall 8.33 0.82 6.28 9.70 Between 0.82 6.28 9.70 Within 0.00 8.33 8.33 lnHDjOverall 3.93 0.39 2.77 4.44 Between 0.36 3.36 4.38 Within 0.18 3.35 4.41 lnRAILPCjOverall 1.26 0.83 −0.67 2.40 Between 0.83 −0.52 2.34 Within 0.07 1.11 1.54 BTAij Overall 0.03 0.16 0.00 1.00 Between 0.12 0.00 1.00 Within 0.11 −0.35 0.96 BITij Overall 0.46 0.50 0.00 1.00 Between 0.44 0.00 1.00 Within 0.25 −0.47 1.40 ASEANij Overall 0.15 0.36 0.00 1.00 Between 0.34 0.00 1.00 Within 0.12 −0.78 0.47 ASEANJPNij Overall 0.06 0.24 0.00 1.00 Between 0.24 0.00 1.00 Within 0.02 0.00 1.00 SAFTAJPNij Overall 0.03 0.17 0.00 1.00 Between 0.17 0.00 1.00 Within 0.00 0.03 0.03 Journal of Economic Structures (2014) 3:6 Page 17 of 24 Table 6 (Continued) Variable Mean Std. dev. Min. Max. lnLAWjOverall 1.18 0.30 0.04 1.61 Between 0.19 0.80 1.47 Within 0.24 0.41 1.71 lnCORRUPjOverall 0.66 0.36 0.00 1.39 Between 0.20 0.18 0.91 Within 0.30 0.05 1.40 lnCONFLICTjOverall 2.12 0.22 1.41 2.48 Between 0.14 1.95 2.38 Within 0.17 1.56 2.50 This research indicates that investment liberalization by entering into BTAs and BITs fails to promote FDI in developing countries in Asia. Plummer and Cheong (2009) also report a similar result for the BITs of ASEAN countries. Although this research has produced the desired positive signs of the estimated coefficients of both variables, the results lack statistical significance at any level, even with two years of lag from the year of implementation. This finding discloses the fact that BTAs and BITs have no beneficial effect on firms’ FDI initiative. Like bilateral liberalization, integration under ASEAN promotes intra-ASEAN investment at an insignificant rate. Hence, ASEAN countries are yet to gain a worthy effect of creating AIA. Similarly, the investment relationship between Japan and ASEAN countries lacks statistical significance. On the contrary, the investment effect of Japan on SAFTA countries is negative and highly significant. This result reveals that SAFTA countries are less integrated with Japan than that ASEAN countries. As a result, countries in South Asia receive a significantly lower flow of FDI from Japan than that of countries in East Asia. Because Japan is a dominant source of FDI, SAFTA countries need to foster relations with Japan.13 Among the three indicators pertaining to institutional quality, the law and order situation has a profound impact on inward FDI. This result is consistent with the literature (Busse and Groizard 2008; Morrissey and Udomkerdmongkol 2012) and proves that the host countries possessing higher levels of institutional strength will benefit from the increased flow of FDI. In other words, countries with a vulnerable law and order situation are less likely to benefit from booming FDI in Asia. The extent of corruption in the FDI-receiving country shows no statistical implication, although the expected sign is evident. Chantasasawat et al. (2010) also report an insignificant effect of corruption on FDI inflow to Latin America, East and Southeast Asia, and China. Finally, empirical results show that a firm’s decision to implement 13The estimated results with additional dummies for examining the role of China and Korea as a supplier of FDI to the ASEAN and SAFTA countries evidence that FDI linkage between ASEAN and China is positive significant while such relationship is absent in case of SAFTA. In fact, China does not appear at all as a supplier of FDI to the SAFTA countries. On the contrary, FDI effect of Korea is insignificant in the case of both ASEAN and SAFTA. Page 18 of 24 M.S. Ullah, K. Inaba Table 7 Empirical results Variables I II III IV V VI VII VIII IX lnGDPi0.33∗∗∗ 0.34∗∗∗ 0.33∗∗∗ 0.34∗∗∗ 0.33∗∗∗ 0.40∗∗∗ 0.43∗∗∗ 0.43∗∗∗ 0.43∗∗∗ (0.003) (0.001) (0.002) (0.001) (0.004) (0.001) (0.000) (0.000) (0.000) lnGDPj0.78∗∗∗ 0.76∗∗∗ 0.78∗∗∗ 0.79∗∗∗ 0.79∗∗∗ 0.87∗∗∗ 1.14∗∗∗ 1.19∗∗∗ 1.19∗∗∗ (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) lnGDPPCi0.40∗∗∗ 0.41∗∗∗ 0.41∗∗∗ 0.42∗∗∗ 0.41∗∗∗ 0.44∗∗∗ 0.67∗∗∗ 0.66∗∗∗ 0.66∗∗∗ (0.007) (0.004) (0.005) (0.004) (0.006) (0.002) (0.000) (0.000) (0.000) lnGDPPCj−0.39 −0.44∗−0.43∗−0.45∗−0.45∗−0.52∗∗ −0.93∗∗∗ −0.96∗∗∗ −0.95∗∗∗ (0.102) (0.068) (0.077) (0.067) (0.066) (0.032) (0.001) (0.000) (0.000) lnDISTij −0.72∗∗∗ −0.73∗∗∗ −0.73∗∗∗ −0.68∗∗∗ −0.65∗∗∗ −0.75∗∗∗ −0.67∗∗∗ −0.70∗∗∗ −0.69∗∗∗ (0.002) (0.001) (0.001) (0.003) (0.006) (0.002) (0.007) (0.005) (0.006) lnHDj0.78∗∗ 0.66∗0.63∗0.62 0.53 1.61∗∗∗ 1.86∗∗∗ 1.76∗∗∗ (0.039) (0.085) (0.099) (0.104) (0.163) (0.005) (0.001) (0.004) lnRAILPCj0.62∗∗∗ 0.65∗∗∗ 0.65∗∗∗ 0.64∗∗∗ 0.66∗∗∗ 0.76∗∗∗ 0.88∗∗∗ 0.86∗∗∗ (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) BTAij (−2)0.68 0.69 0.68 0.66 0.60 0.54 0.55 (0.184) (0.182) (0.183) (0.200) (0.232) (0.289) (0.278) BITij (−2)0.28 0.29 0.29 0.30 0.28 0.29 0.28 (0.132) (0.128) (0.121) (0.115) (0.162) (0.144) (0.153) ASEANij 0.26 0.27 0.31 0.59 0.54 0.56 (0.462) (0.450) (0.390) (0.153) (0.195) (0.173) ASEANJPNij 0.23 0.01 0.09 0.11 0.12 (0.708) (0.991) (0.886) (0.862) (0.850) Journal of Economic Structures (2014) 3:6 Page 19 of 24 Table 7 (Continued) Variables I II III IV V VI VII VIII IX SAFTAJPNij −1.52∗−1.61∗∗ −1.65∗∗ −1.65∗∗ (0.062) (0.039) (0.036) (0.034) lnLAWj0.70∗∗ (0.023) lnCORRUPj−0.07 (0.791) lnCONFLICTj0.17 (0.723) Constant −19.46∗∗∗ −23.11∗∗∗ −22.92∗∗∗ −23.83∗∗∗ −23.53∗∗∗ −26.20∗∗∗ −39.08∗∗∗ −40.08∗∗∗ −40.03∗∗∗ (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) TD Chi 2(14) 46.1∗∗∗ 41.4∗∗∗ 41.4∗∗∗ 41.4∗∗∗ 41.5∗∗∗ 41.5∗∗∗ 28.2∗∗∗ 30.3∗∗∗ 32.6∗∗∗ AR(1), F41.4∗∗∗ 42.6∗∗∗ 44.6∗∗∗ 44.5∗∗∗ 44.5∗∗∗ 44.5∗∗∗ 43.0∗∗∗ 42.9∗∗∗ 43.2∗∗∗ Wald Chi 145∗∗∗ 162∗∗∗ 165∗∗∗ 167∗∗∗ 167∗∗∗ 173∗∗∗ 168∗∗∗ 160∗∗∗ 162∗∗∗ RESET test pvalues 0.914 0.314 0.267 0.229 0.247 0.150 0.456 0.140 0.148 R20.36 0.43 0.44 0.45 0.45 0.47 0.52 0.52 0.52 Mean of VIF 1.9 1.9 1.9 1.9 1.9 1.9 2.0 2.1 2.1 N1,266 1,230 1,157 1,157 1,157 1,157 1,024 1,024 1,024 Note:iand jindicate home and host country, respectively. TD implies Time Dummies. AR(1) stands for the Wooldridge test of autocorrelation. Due to significant autocorrelated errors, estimations are carried with AR(1) corrections Page 20 of 24 M.S. Ullah, K. Inaba FDI projects in Asian developing countries is not significantly impacted by the host country’s index of internal conflict. 5 Conclusion Developing and least developed members of ASEAN and SAFTA have implemented far-reaching initiatives to liberalize FDI policies, and they are still advancing toward a more competitive opening to trigger economic growth through technology transfer, employment generation, and productivity boosts. Over time, they have designed closely matched policy environments and fiscal incentives to attract foreign investors. However, the performance in FDI attraction is quite uneven and also disappointing for some countries. We, therefore, attempted to empirically examine the role of liberalization on capital inflow. The main focus of the study was to unveil the effect of BIT, BTA, and RTA on FDI. This study also discerns Japan’s role as a source of FDI in ASEAN and SAFTA countries, which, in turn, discloses the degree of integration between the source and recipients of FDI. Furthermore, we assess the criticality of some factors pertaining to the institutional strengths of the host countries. In this paper, the econometric results provide evidence that neither BITs nor BTAs constitute a strategic instrument for inducing foreign investment in the developing countries in Asia. Such estimates bring to light the fact that extensive engagement in bilateral agreements has less opportunity to foster the inflow of foreign capital if liberal FDI policies already exist in the host countries and they compete for vertical investment. Because the developing countries in Asia have long been practicing competitive liberalization of FDI regulations, there is less room for them to design convincing and customized incentives under BITs and BTAs. Therefore, some of the sample host countries have failed to stimulate their performance in hosting foreign investment, although they have signed a substantial number of investment agreements over time and even with dominant homes of FDI. For instance, an investment agreement between Japan and Bangladesh went into force in August 1999 and between Japan and Pakistan in May 2002. In spite of a long period of existence of those BITs, Bangladesh and Pakistan host a very negligible portion of their annual FDI from Japan. On the contrary, Thailand received a healthy part of its total annual foreign investment from Japan, although they implemented a bilateral free trade agreement only in November 2007.14 Above all, SAFTA countries exhibit a significantly lower degree of integration with Japan via FDI, although bilateral investment agreements are prevalent, except between India and Japan.15 In this circumstance, countries in South Asia may explore other possible avenues for increasing economic and cultural cooperation with Japan. Like in ASEAN countries, intensifying the extent of integra14Milner et al. (2004) provide evidence that FDI from Japan to Thailand generally takes the vertically integrated nature, in which case Japanese investors locate part of the production process in Thailand and export back home. In this case, the motive for Japanese investment is to avoid higher labors costs at home. The authors further argue that Japanese firms seek to utilize the advantage of the US preferential trade policy toward Thailand and fiscal incentives granted by the Thai government. 15India and Japan signed a bilateral FTA that came into force in August 2011. Journal of Economic Structures (2014) 3:6 Page 21 of 24 tion and cooperation within the SAFTA region might also contribute to improving FDI performance of South Asian countries. Our findings suggest that a host country’s economic growth, development of human capital, improvement of infrastructure, and better law and order situation positively affect firms’ investment decisions. Therefore, developing countries need to prioritize their funding in the fields of education, training, transport, communication systems, and institutional capacity building in order to strengthen their attractiveness as potential hosts of FDI. Owing to the negative effect of distance and the positive outcome of ASEAN integration on inward FDI, intra-ASEAN investment is likely to increase in the future. Furthermore, ASEAN and SAFTA countries possess comparable comparative advantages and compete for labor-intensive FDI by granting similar kinds of incentives and treatments. Under this circumstance, the inability to institute desirable states of legal and regulatory environments act as a major stumbling block to FDI growth. Competing Interests The authors declare that they have neither any financial nor any non-financial competing interests. No organization has financed this manuscript and no organization will gain anything from the publication of this paper. The authors neither hold any patents nor currently apply for any patents relating to the contents of the manuscript. Authors’ Contributions The main idea of the paper was proposed by KI and MSU designed the manuscript initially. Both the authors contributed to the collection and analysis of data and performed all the steps of the proofs in this research. Both the authors also read and approved the final manuscript. Acknowledgements The authors are thankful to the two anonymous referees for their judicial comments and suggestions. Earlier versions of this paper were presented at the 2013 Spring Conference of the Japanese Economics Association; the 2013 Spring Conference of the Japan Association for Applied Economics; 2013 Asia Pacific Conference: Revitalization and Development, Asia Pacific University, Beppu, Japan; and the Advances in Business-Related Scientific Research Conference, Venice, Italy, 2013. The authors express thanks and gratitude to the discussants and participants of conferences for their insightful comments and suggestions. Appendix: Variable Explanation and Data Sources •FDIij t : Annual inflow of FDI from country ito country jat year tcame from the UNCTAD World Investment Report. •GDPit (GDPjt): Real GDP of home (host) country at year twere taken from the World Bank’s World Development Indicators (WDI). Missing data were collected from the UN statistical database. Nominal GDP was converted to real GDP by using the GDP deflator (2005 =100). •GDPPCit (GDPPCjt): Real GDP per capita of home (host) country at year twere obtained from the World Bank’s World Development Indicators (WDI). •DISTij : Geographic distance between capital cities of country iand jwas taken from the CEPII’s distance database. Page 22 of 24 M.S. Ullah, K. Inaba •OPENjt: Openness of country jat year t. It measures total trade (export +import) as a percentage of GDP. Export and import data were supplied by the IMF’s Direction of Trade Statistics (DOT) CD-ROM. •HDjt: Human development of the host country is proxied by gross secondary school enrollment rate, and the data came from the WDI database. •RAILPCjt: Rail line per 100,000 people of country jat year t. Total length of rail line network of each host country was generated from various sources, including the World Development Indicators (WDI), the ASEAN Statistical Year Book, and the country-specific government database on transport and communication. •BTAij t : Bilateral trade agreements between countries iand jat year t.TheWTO list of trade agreements provided the data. •BITij t : Bilateral investment treaties between countries iand jat year tuntil the June 2012 were obtained from UNCTAD’s country-specific lists of bilateral investment treaties. •ASEANij t : It takes the value 1 if countries iand jbelong to the ASEAN at time t; otherwise, it is zero. This variable measures intra-ASEAN investment flows, and the expected sign is positive. •ASEANJPNij t : Dummy variable that takes the value 1 if the host country belongs to ASEAN and the source country is Japan. This variable intends to reveal the extent of integration between Japan and the ASEAN countries via FDI. •SAFTAJPNij t : Dummy variable that takes the value 1 if the host country belongs to SAFTA and the source country is Japan. This variable measures the extent of integration between Japan and the SAFTA countries via FDI. •LAWjt: Index of law and order of country jat year twas provided by the International Country Risk Guide (ICRG). The “law” element measures the strength and impartiality of the legal system, while the “order” element is an assessment of popular observance of the law. Altogether, the value of this index ranges from 0 to 6 points. A higher score indicates better law and order and is expected to induce FDI positively. Thus, the index of law and order is expected to show a positive sign. •CORRUPjt: Index of corruption of country jat year t, which comes from the International Country Risk Guide (ICRG). The total value of the index ranges from 0 to 6. The lower the score, the lower the risk and vice versa. Thus, the index of corruption is likely to show a negative sign. •CONFLICTjt: Index of internal conflict of country jat year twas also taken from the International Country Risk Guide (ICRG). This is an assessment of political violence in the country and its actual or potential impact on governance. The score of this index ranges from 0 to 12 and is summed up from three subcomponents: (a) civil war/coup threat; (b) terrorism/political violence; and (c) civil disorder. A higher score represents a lower intensity of internal conflict, while a lower score indicates a higher intensity of conflict. The expected FDI effect of internal conflict index is positive. 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