Relative institutional quality and FDI inflows in ASEAN countries

Abstract

PurposeForeign direct investment (FDI) inflows into any country, especially ASEAN countries, is affected by any improvement in the institutional quality (IQ) of competitors such as China. As generally investors make decisions by comparing two countries’ IQ, the ratio of two countries’ IQ matters more than a single country’s IQ. The purpose of this paper is to re-examine the role of IQ on FDI inflows in ASEAN countries for the period 1996-2013.Design/methodology/approachWith limited information on IQ, this study pools eight ASEAN countries as the sample for analysis from 1996 until 2013. A panel dynamic approach – namely, dynamic ordinary least square and fully modified ordinary least square – is utilized.FindingsThis study confirmed that relative IQ significantly affects FDI inflows into ASEAN countries. The low effect is more reflective of the small portion of world FDI inflows into the ASEAN region.Research limitations/implicationsThis study observes the crucial relationship between IQ and FDI – that the relative effectiveness of IQ in attracting FDI inflows depends heavily on the changes in both countries’ IQ. Hence, the effort of ASEAN countries to improve IQ and use it as a means to lure FDI inflows should go beyond a mere improvement. Focus should be on significant improvement of IQ so that multinational corporations will comfortably remain or inject new FDI into the country.Practical implicationsEvery ASEAN country should double their efforts toward improving their IQ in order to attract future FDI.Originality/valueSeveral studies have confirmed the role of IQ on FDI inflows. However, the majority of these studies have investigated the effect of IQ exclusively for a specific country even though some of them have used a panel of several countries’ data. On the other hand, investors normally evaluate their decision on whether or not to invest based on the relative terms, comparing several potential locations of investment at once. This study can be considered the first to explore the potential effect of IQ after taking into account the possibility of each ASEAN country’s IQ being easily offset by changes in the IQ of China.