The impact of two way fdi and environmental regulation on green innovation in 10 asean countries from 2009 to 2019

ABSTRACT This research study investigate and assess the green innovation in ASEAN. The object is to estimate the change in green innovation in 10 ASEAN countries from 2009 to 2019 through the relationship between green innovation with other factors such as twoway foreign direct investment (FDI) and environmental regulation. Data from reputable sources, such as the World Bank, Statista and Our World in Data, were collected and analyzed using econometric methods, including ordinary least square regression analysis. The findings of the study indicate that inward FDI (IFDI) has a positive impact on green innovation (GI), suggesting that higher levels of FDI contribute to the development and implementation of environmentally friendly technologies and practices. Environmental regulation (ER) is found to have a negative impact on GI, indicating that stricter regulations can hinder green innovation. Additionally, government support (GS) is positively associated with GI, highlighting the importance of creating an enabling environment for sustainable businesses and technologies. The paper recommends streamlining bureaucratic processes associated with environmental regulations while maintaining their effectiveness. Investing in green infrastructure and promoting sustainable practices can further foster green innovation.

FOREIGN TRADE UNIVERSITY FACULTY OF INTERNATIONAL ECONOMICS

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MIDTERM ASSIGNMENT

THE IMPACT OF TWO-WAY FDI AND

ENVIRONMENTAL REGULATION ON GREEN INNOVATION IN 10 ASEAN COUNTRIES FROM

This research study investigate and assess the green innovation in ASEAN The object is toestimate the change in green innovation in 10 ASEAN countries from 2009 to 2019 through therelationship between green innovation with other factors such as two-way foreign directinvestment (FDI) and environmental regulation Data from reputable sources, such as the WorldBank, Statista and Our World in Data, were collected and analyzed using econometric methods,including ordinary least square regression analysis The findings of the study indicate thatinward FDI (IFDI) has a positive impact on green innovation (GI), suggesting that higher levels

of FDI contribute to the development and implementation of environmentally friendlytechnologies and practices Environmental regulation (ER) is found to have a negative impact

on GI, indicating that stricter regulations can hinder green innovation Additionally,government support (GS) is positively associated with GI, highlighting the importance ofcreating an enabling environment for sustainable businesses and technologies The paperrecommends streamlining bureaucratic processes associated with environmental regulations whilemaintaining their effectiveness Investing in green infrastructure and promoting sustainablepractices can further foster green innovation

INTRODUCTION 1

SECTION 1 LITERATURE REVIEW 4

1.1 Review of previous studies 4

1.1.1 Two-way FDI 4

1.1.2 Green Innovation 5

1.1.3 Two-way FDI and Green Innovation 6

1.1.4 Environmental Regulation and Green Innovation 8

1.2 Research gap 9

SECTION 2 METHODOLOGY AND DATA 10

2.1 Methodology 10

2.2 Empirical Model 10

2.2.1 Model specification 10

2.2.2 Variables definition 11

2.3 Data 13

2.3.1 Data source 13

2.3.2 Descriptive statistics and variables interpretation 15

2.3.3 Correlation matrix between variables 16

SECTION 3 MODEL ESTIMATION AND STATISTICAL INFERENCES 17

CONCLUSION AND RECOMMENDATION 21

REFERENCES 23

1 Context

The word “green'' has never been as omnipresent as it is nowadays After the detrimentaleffect of the Covid-19 pandemic on the environment, many governments as well as citizenshave acknowledged the importance of nature protection It is common that the term appears inthe latest articles as “green growth”, “green product”, “green economy”, and “greentechnology”, and became one of the most popular phrases after the epidemic It also projects anew trend in the macroeconomic outlook in the near future

In today's world, many nations have progressively shifted to a green economy - aneconomy that cares about happiness, social justice, and the environment in addition to economicbenefits, in response to the negative social and environmental effects of establishing the browneconomy This pattern is not exclusive to ASEAN countries Recently, a series of strategies andpolicies across sectors and fields have also been updated, revised, and promulgated

In order to achieve green economic objectives, green innovation (GI) is of significance

as it provides a number of benefits to the countries Xu L et al (2021) noted that in the hosteconomies, green innovation may reduce CO2 emissions and create a clean environment.According to Yin et al (2018), green innovation appears to have a major influence on creating asociety that is resource- and environmentally friendly for sustainable development Fromanother perspective, green innovation has a "double externality", which benefits businessesfinancially as well as in terms of the environment and society (Grekova et al., 2013; Feng &Chen, 2018; Rennings, 2000) Green innovation is a practical way for businesses to comply withenvironmental laws, absorb and lower environmental management costs, and capitalize on newdevelopment opportunities (Hamamoto, 2006)

In other words, developing nations should look for green innovation and environmentallyfriendly industrial methods because of how effectively green innovation can addressenvironmental concerns This paper will study the factors affecting green innovation in 10ASEAN countries (except for Timor-Leste since this country was only officially accepted tojoin ASEAN in 2022), namely inward and outward FDI and environmental regulation.

2 Significance

a Theoretical significance

This paper contributes newly to the discussion by examining the effect of both inwardand outward FDI, and environmental regulation on green innovation in 10 ASEAN countries(Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, andVietnam), through the model in Figure 1, using the hypothesis-driven approach

b Practical significance

The biggest expectation of developing countries in attracting foreign investment is totarget economic growth for two main reasons First, foreign investment is considered animportant source of capital to supplement Second, foreign investment creates opportunities forpoor countries to access more advanced technology, facilitate technology transfer, promotethe dissemination of knowledge, and improve skills This effect is considered as a spillovereffect of foreign investment, contributing to increasing domestic enterprises' productivity andultimately to economic growth in general

So the spillover effect is an indirect effect that occurs when the presence of FDIenterprises causes domestic enterprises to change their behavior such as changing technology,changing production, and business strategies…

3 Research questions, aim, and objectives

The aim of this research is to investigate and assess the effects of two-way FDI andEnvironmental regulation on green innovation in ASEAN In order to achieve the research

aim, the objectives of this study are to (1) investigate and analyze the relationship between way FDI and environmental regulation on green innovation in ASEAN and (2) propose possiblesolutions and policies for the government Therefore, the following research questions wereformulated to support the paper’s objectives: Do inward FDI and outward FDI encourage theimprovement of green innovation in ASEAN? What is the impact mechanism of environmentalregulation on green innovation in ASEAN? What part does environmental regulation play in thetwo-way FDI process affecting green innovation in ASEAN? The effective answers to theabove questions will be discussed in this paper.

two-4 Scope

The scope of this study is limited to the following industries in 10 ASEAN countries:Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand,and Vietnam Furthermore, in order to collect enough observations to generalize the sample andpropose the most reliable result, this research will be studied in the time span of 11 years, from

2009 to 2019, before the outbreak of the Covid-19 pandemic

SECTION 1 LITERATURE REVIEW

1.1 Review of previous studies

1.1.1 Two-way FDI

According to UNCTAD (2017), Foreign Direct Investment (FDI) is defined as aninvestment involving a long-term relationship and reflecting a lasting interest and control by aforeign direct investor or parent enterprise in one economy but not the economy of the foreigninvestors OECD Benchmark Definition of FDI (2008) recommended that FDI data can bepresented under the directional principle to reflect the direction of influence underlying thedirect investment Directionally, FDI is divided into inward foreign direct investment (IFDI)and outward foreign direct investment (OFDI)

1.1.1.1 Inward FDI

When FDI flows inward, it means that its influence originates abroad and results in theestablishment of a direct investment company in the host country (OECD, 2008)

Therefore, inward FDI can be defined as the direct investment made by non-resident investors

in the reporting economy Inward FDI includes all liabilities and assets transferred betweenresident enterprises and their direct investors It also covers transfers of assets and liabilitiesbetween resident and non-resident fellow enterprises, if the ultimate controlling parent is not aresident of the compiling economy (The World Bank)

1.1.1.2 Outward FDI

In contrast to inward FDI, when FDI flows outward, it indicates that the influence givingrise to it originated within the compiling economy, and that it resulted in the establishment by aresident direct investor of a direct investment enterprise abroad (OECD, 2008) Thus, outwardFDI can be defined as direct investment made by residents of the reporting economy to externaleconomies, including assets and liabilities transferred between resident direct investors and theirdirect investment enterprises Moreover, OFDI

also covers transfers of assets and liabilities between resident and non-resident fellowenterprises, if the ultimate controlling parent is resident (The World Bank).

1.1.2 Green Innovation

Despite its positive influence on economic growth, FDI is concerned to have a potentialnegative environmental impact due to increased CO2 emissions In such a context, businessinnovation must be accompanied by sustainable development goals (Chang, 2011; Huang & Li,2015) For this reason, Chen et al (2006) proposed the term "green innovation", which refers todesigning green products or services that use natural resources to decrease environmentaldamage, save energy, prevent pollution, or enable waste recycling Green innovation can also bedefined as a process that contributes to the creation of new products and technologies in order tominimize environmental risks such as pollution or resource exploitation (Castellacci and Lie,2017) It ensures that natural resources are used in the most effective way possible

Therefore, green innovation appeared to be a key impact factor in maintainingenvironmental management (Aguilera-Caracuel and Ortiz-de-Mandojana, 2013) as well asaugmenting resource efficiency and creating an environmentally friendly society for sustainabledevelopment (Yin et al., 2018) Besides, green innovation can help achieve competitiveadvantages (Zimmerling et al., 2017), support strategic goals (Yang et al., 2016), and enhancepositive performance in an organization (Roy and Khastagir, 2016)

Undoubtedly, developing green innovation is vitally important for firms, especially in recentyears ASEAN’s economy and enterprises are also accelerating towards green production forsustainable development For instance, in Vietnam, CIO (2018) reported that Vietnam’sinvestment in green technology has significantly improved the air quality

1.1.3 Two-way FDI and Green Innovation

1.1.3.1 Inward FDI and Green Innovation

The relationship between FDI and green innovation has been paid attention to not only

by environmental scientists but also by economic researchers; however, there is no consistentresult The Pollution Halo Hypothesis claims that IFDI can improve the green innovationefficiency of a host country through green technology spillovers as the resident enterprises canimprove their technological levels and therefore enhance their green innovation ability (Zarsky,1999) Several empirical studies show that the greater the IFDI, the higher the technical andknowledge base of domestic firms, contributing to the development of green innovation Instudying the influence of FDI on China‘s green innovation in manufacturing system (Bi et al.,2013), it is concluded that FDI inflows have a beneficial impact on green innovationcompetence, but have a negative impact on manufacturing green innovation people resources.Moreover, Song et al (2015) found that not only has IFDI contributed to the rapid growth ofChina‘s economy, but also promoted the green innovation capability of Chinese enterprisesthrough technology spillovers

On the other hand, the huge inflow of foreign capital accompanied by environmentalpollution and resource depletion seriously restricts the green development of the local economy(Singhania and Saini, 2021; Zhang and Zhou, 2016) The Pollution Haven Hypothesis (Walter andUgelow, 1979) indicated that developed countries implement stricter environmental regulationsthan developing countries, resulting in the transfer of polluting industries among them Thatwould further exacerbate the environmental pollution in developing countries (Güvercin,Handbook of Research on Economic and political implications of Green Trading and energy use2020)

Lifeng Chen, Fuxuan Guo, & Lingyan Huang (2023) investigate the impact of foreigndirect investment (FDI) on green innovation in 31 provinces in China from 2003 to 2020

Results show that FDI has a positive and dynamic evolution feature, increases green

innovation in eastern and western regions, and can positively moderate the impact of FDI ongreen innovation.

Based on the above literature, we propose the first hypothesis as follows:

(H1) IFDI has a positive impact on green innovation.

1.1.3.2 Outward FDI and Green Innovation

In the analysis of green technology innovation, Jia et al (2014) found that China’s OFDIhas promoted the knowledge and development of green technology in the home country.Similarly, Gong et al (2017) found that OFDI might increase the efficiency of green industrialinnovation through three mechanisms: agglomeration scale economic impact, agglomerationstructure lightening effect, and agglomeration resource allocation effect In the same year, Chengand Yang also arrived at the conclusion that OFDI has contributed to technologicalimprovement in China During the process of investing in developed and developing countries,Chinese enterprises can bring certain green innovation resources to the home country throughpurchases, mergers and acquisitions and thus, enhance the capability of green innovation inChina

As Borensztein et al (1998) and Görg and Greenaway (2004) found that OFDI canpromote technological development in the home country, they also claimed that there is athreshold effect related to the absorption capacity in the home country, specifically, humancapital In addition, in their research on outward FDI and domestic innovation performance usingdata from China, Strange & Ning (2016) stated that in order for OFDI to generate technologyspillovers to utilize new knowledge and turn it into usable one for application, human capital ofthe host country is required to reach a certain threshold

Based on the above literature, we propose the second hypothesis as follows:

(H2) OFDI has a positive impact on green innovation.

1.1.4 Environmental Regulation and Green Innovation

P McManus (2009) defined environmental regulation as the imposition of restrictions orobligations on people, businesses, or other organizations in order to protect the environment orimprove deteriorated conditions in the environment The impact of environmental regulationhas attracted attention from researchers as it became increasingly important in the context ofenvironmental complexity in business

Research results on the impact of environmental regulation on the promotion of greeninnovation are varied Some argue that environmental regulation may reduce innovationcapability as it can provoke additional production costs through the internalization process, whichmay spur firms to change their behavior towards production Some scholars even claimed that therelationship between environmental regulation and green innovation is nonlinear For instance,Ouyang et al (2020) found that there was a U-shaped relationship between environmentalregulation and green innovation

However, there exists a converse viewpoint which is mainly supported, that is ifenvironmental regulation is well-designed and operated efficiently, firms can develop theirtechnology innovation in an environmentally friendly way, which may not only minimize thecarbon dioxide emission but also improve production efficiency The Porter (1991) hypothesispostulates that environmental regulation actually improves economic performance by promotingeconomic competition among firms Porter and Van der Linde (1995) claimed that properenvironmental regulation can promote green innovation capability in enterprises An empiricalstudy using German panel data sources by Horbach (2008) also suggested that environmentalregulations do promote green innovation or cleaner technologies production Baumol and Oates(1988) even propose that, if the host country that is still a developing country set lowenvironmental standards for FDI, it will become a prime location of polluters Furthermore,Ambec & Barla (2006) believed that if the government can balance the intensity

of environmental regulation and economic development level, environmental regulation canstimulate technological innovation Hamamoto (2006) studied the Japanese manufacturing industriesand he found that carrying out green innovation can help enterprises cope with environmentalregulation as well as reduce environmental control costs, and promote economic growth.

Based on the above literature, we propose the third hypothesis as follows:

(H3) Environmental regulation has a positive impact on green innovation.

Referring to the relevant literature and the above hypotheses, the theoretical modelconstructed for this paper is illustrated in Figure 1 below

Figure 1 Proposed model

1.2 Research gap

There have been many studies on the impact of FDI and environmental regulation ongreen innovation Nonetheless, the determinants and impact level of green technology varyamong different countries, therefore, taking different countries and regions as research objectsmay lead to different conclusions There is a critical need to consider environmental issues inASEAN because more than 600 million citizens live in urban areas and that number is steadilyrising (Kheng-Lian, Robinson, & Lin-Heng, 2016) No previous research has been conducted inASEAN countries leading to the necessity for research on the subject in this

region Moreover, most of the previous studies analyzed the impact of two-way FDI andenvironmental regulation on green innovation separately except for studies in China.

Bringing two-way FDI and environmental regulation into the same research framework, andsystematically analyzing their impacts on ASEAN’s green innovation make the conclusion morescientific It is also worth mentioning that data in existing studies in China used data by regionswhile this paper attempts to examine the relationship among variables using data by industries,which may offer a new and innovative perspective

2.1 Methodology

This research uses quantitative methods by running Stata software to assess the impact

of two-way FDI and environmental regulation on green innovation Secondary data about Green

innovation (GIi), Outward FDI (OFDIi), Inward FDI (IFDIi), Environment regulation (ERi), Capital intensity (CIi), Government support (GSi), Degree of economic openness (OPENi) is

collected from the database of World Bank and several other source from 2009 to 2019.Afterward, the data is rearranged, cleaned, and prepared for analysis To control effects that cannot be observed separately for each nation, the authors use panel data regression model with REand FE models to quantify the two-way impact of FDI and environmental regulation on greeninnovation Diagnostic tests of heteroskedasticity and autocorrelation are performed to evaluatethe reliability of the model

2.2 Empirical Model

2.2.1 Model specification

In this research, inheriting from the past paperwork and combining different sources ofdata, we used quantitative methods and then built up our model from the two-way impacts ofFDI and environmental regulation variables on green innovation This model is built based on

the research “Environmental Regulation, Two-Way Foreign Direct Investment, and Green Innovation Efficiency in China’s Manufacturing Industry” (Feng, Z., Zeng, B and Ming, Q.,

2018) Finally, with the aim of systematically examining the effects of environmental regulationand two-way FDI on the green innovation of industries in ASEAN countries from 2009 to 2019 asfollows:

𝑙o𝑔𝐺𝐼i𝑡 = 𝛽0 + 𝛽1 ∗ 𝐼𝐹𝐷𝐼i𝑡 + 𝛽2 ∗ 𝑂𝐹𝐷𝐼i𝑡 + 𝛽3 ∗ 𝐸𝑅i𝑡 + 𝛾 ∗ Xi𝑡 + 𝑢i𝑡

In which: i represents the country, t represents the period, and 𝑢 represents the random

error term; 𝐺𝐼i𝑡 represents green innovation of countries; 𝐼𝐹𝐷𝐼i𝑡 represents inward foreigndirect investment; 𝑂𝐹𝐷𝐼i𝑡 represents outward foreign direct investment; 𝐸𝑅i𝑡 representsenvironmental regulation; and Xi𝑡 represents a series of control variables including capitalintensity, government support, and degree of economic openness

2.2.2.2 Independent variables

The core independent variables of this research are environmental regulation, IFDI, andOFDI

Environmental regulation (ER) The "Porter Hypothesis," which was formally put forth

in the 1990s, proposed that reasonable environmental regulation has the effect of innovativecompensation, which is the appropriate environmental regulation, which may cover the cost ofthe regulation's implementation while also fostering innovation Based on the “PorterHypothesis”, environmental regulation has been used by both domestic and foreign scholars

as an important factor affecting green innovation and promoting green transformation There

is no unified standard for the quantitative indicators of formal environmental regulation Singleindex method, comprehensive index method, classification inspection method, and evaluationscoring method are the four categories into which the measuring techniques in the existingliterature can be separated Integrating the advantages and disadvantages of various indicatorsand data availability, our research uses the expenditure on waste management to measureenvironmental regulation This indicator is measured in current US dollars

IFDI and OFDI We aim to examine the impact of two-way FDI flows on greeninnovation so we use the IFDI and OFDI flow data to measure inward FDI and outward FDI ineach country as two core independent variables These indicators are measured by the netoutflows and inflows of foreign direct investment

2.2.2.3 Control variables

In line with previous studies and in order to obtain unbiased estimation results, some othercontrol variables are chosen in this research as follows:

 Capital intensity (CI): In general, if the rate of capital increase is faster than the

increase in labor, the green innovation efficiency in the industry would be higher

(Feng at al 2018) Capital intensity is expressed by dividing the total stock of capital

by the total hours worked This is measured by $ per hour unit

 Governmental support (GS): Innovation activities have a certain “externality”,

which characterizes green innovation activities as high cost and high risk Due tothe allocation of government spending on R&D investment, the cost of greeninnovation is compensated, thereby decreasing the risk of green innovation.However, regardless of the benefits, this phenomenon has also brought a crowding-out effect to the green innovation of countries and hindered innovation performance(Feng et al 2018) Government support is calculated by the percentage ofgovernment funds in the intramural expenditures on R&D Moreover, R&Dinvestment denoted by the R&D capital stock is used to reflect the impact ofindigenous innovation input on GI (Y Luo et al., 2020)

 Degree of economic openness (OPEN): Previous studies have shown that

economic openness is closely related to FDI inflow attraction, more open countriestend to attract more FDI in particular (Qin et al 2022) We thus adopt the degree

of economic openness as a control variable and measure it as the ratio of totalimport and export volume to GDP (unit %)

2.3 Data

2.3.1 Data source

To investigate the impacts of different environmental regulations on green innovation,panel data from 10 ASEAN countries (Brunei, Cambodia, Indonesia, Laos, Malaysia,Myanmar, Philippines, Singapore, Thailand, and Vietnam) is collected from 2009 to 2019.Therefore, the final data will consist of approximately 110 observations over 11 years The raw

data on green innovation (GI) is obtained from the OECD database Two-way FDI (IFDI and OFDI), and environmental regulation (ER) are collected from the World Bank open data.