BARES: 10036University of International Business and Economics HE FPL The Impact of Institution Quality and Business Environment on Trade Flows: The Evidence of the Regional Comprehensiv
Concepts of Institution Quality(IQ) and Business Environment (BE)
Border and Transport Efficiency Indicators . . c5 5c s22 ++s+ssxssvrssxs 10
Border and transport efficiency significantly impacts the business environment, influencing international trade and foreign direct investment (FDI) in a country (Borojo, 2019) This efficiency encompasses various dimensions, including the necessity for advanced logistics supported by adequate physical infrastructure and technological advancements Roads must accommodate container transport, while inland and maritime infrastructures should be aligned Ports need to efficiently handle containers, and just-in-time inventory systems require timely information exchange facilitated by modern ICT infrastructure Additionally, favorable legal and regulatory frameworks, along with efficient customs operations and harmonized trans-border transportation, are crucial, particularly in developing nations Scholars often assess border and transport efficiency using indicators related to global trade, such as import/export time, cost, and documentation requirements (Nordas et al., 2006; Borojo & Yushi, 2019).
Literature Review of the IQ, BE and Trade FÌows -. - 2-5 22c +<2<cc++sccses 11
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Since the global economy has opened up, many less developed countries have initiated crucial policy reforms, acknowledging the role of institutional quality (IQ) in economic development and trade Research indicates that strong institutions can enhance trade by reducing production and transaction costs, thereby facilitating international trade gains Studies show that factors such as bureaucratic quality, political stability, and property rights positively correlate with economic growth and trade flows Efficient institutions are vital for sustained economic growth, as evidenced by findings that improved institutional transparency can significantly boost import volumes Moreover, enhanced institutional quality in Latin America could lead to a substantial increase in trade, comparable to levels seen in the European Union Ultimately, high-income countries with robust institutions engage in more trade with each other, as their lower security-related transaction costs foster a more favorable trading environment.
Institutional differences play a crucial role in determining trade flows, as highlighted by Levchenko (2007), who argues that trade can lead to institutional improvements due to foreign competition By analyzing the impact of institutional quality (IQ) on trade flows and utilizing a model of international trade with incomplete contracts, the study reveals that North-South trade dynamics favor Northern countries with superior institutions, while Southern countries may face adverse effects, including the decline of high-paying sectors Furthermore, the importance of rule of law, contract enforcement, and property rights is emphasized as essential for mitigating risks in international trade Yu (2010) posits that democratic exporters tend to have better institutions, enhancing consumer rights and product quality, which ultimately lowers trade costs by fostering trust Mengistae (2010) supports this by indicating that successful exporters are generally more open to trade and face lower costs and regulatory barriers, aided by reliable public utilities and reduced corruption Heo (2015) finds a positive relationship between the IQ of foreign markets and ASEAN countries' exports, particularly concerning intellectual property rights Lastly, Maruta (2019) examines the interaction between IQ, trade aid, and trade, revealing that trade aid significantly boosts trade when coupled with higher IQ measures.
Research indicates that weak institutions negatively impact trade flows Hall and Jones (1999) explore this by assessing social infrastructure, which they define through two indices: the first measures government anti-diversion policies (GADP) encompassing bureaucratic quality, expropriation risk, law and order, corruption, and contract repudiation The second index evaluates openness to international trade To address endogeneity in the institutional quality variable, the study incorporates factors such as the percentage of the population that speaks English, the proportion speaking other major Western European languages, geographical distance from the equator, and the Frankel-Romer predicted trade share as instrumental variables Findings reveal that weak institutions contribute to diminished total factor productivity.
Acemoglu, Johnson, and Robinson (2005) demonstrate that countries with poor economic institutions tend to experience declining per capita incomes over time, despite initial wealth Their research highlights that the disparities between rich and poor nations largely stem from differences in economic institutions, using European mortality as an instrument for current property rights enforcement Additionally, Levchenko (2007) notes that trade flows can adversely affect national welfare, particularly in countries with weak institutions, which may suffer from “institutional comparative advantage driven trade.” Anderson and Marcouillier (2013) further emphasize that such nations face hidden transaction costs due to the insecurity of international exchanges, where customs officials may extort bribes, contracts may lack enforceability across jurisdictions, and shipments are at risk of hijacking.
Companies often express dissatisfaction with taxes, but the more pressing issue is corruption, which stands out as the top challenge for global businesses Additionally, theft and crime pose significant threats to operations Ultimately, inadequate institutional frameworks hinder trade just as much as tariffs do.
Recent research by scholars examining trade flows in Asian countries highlights significant findings regarding the impact of intellectual capabilities on exports Feenstra (2013) utilizes cross-provincial IQ differences in China alongside export data that differentiates between processing and ordinary trade, as well as foreign and domestic exporters By employing the two-stage least squares (2SLS) method with colonial rule and Christian missionary primary school enrollment in 1919 as instrumental variables, the study reveals that higher IQ levels are crucial for boosting exports of various goods, particularly in processing trade and among foreign firms This underscores the importance of institutional factors, which lead to a greater reliance on contracts in these contexts Similarly, Heo (2015) investigates the influence of intellectual property rights (IPR) protection on the export performance of ASEAN countries, utilizing system GMM with dynamic panel data, further emphasizing the role of intellectual assets in international trade dynamics.
Between 2005 and 2010, a study demonstrated that improved intellectual property rights (IPR) protection in foreign nations positively influences ASEAN's export performance, effectively addressing issues of autocorrelation, heteroscedasticity, and endogeneity The findings revealed that IPR protection is most robust among high-income trading partners, followed by middle-income and least effective with low-income partners Huyen (2017) analyzed panel data from 115 countries from 2000 to 2012, concluding that higher quality institutions (IQ) in ASEAN's trading partners significantly enhance the bloc's export performance Key indicators such as the legal structure, property rights protection, and trade freedom positively impact trade flows, while the size of government and international trade freedom are crucial for exporters in boosting trade from the ASEAN bloc.
Economic freedom is defined as the fundamental right of individuals in a free society to manage their own labor and property with minimal government intervention, as highlighted by Seyoum and Ramirez (2019) It includes institutional and infrastructural elements that lower transaction costs in international trade, according to Naanwaab and Diarrassouba (2013) Notable scholars, such as Depken and Sonora (2005), have examined the impact of economic freedom on trade flows, specifically analyzing the asymmetric effects between the United States and its trading partners through the study of import and export volumes with 119 countries.
Between 1999 and 2000, research by the Fraser Institute and the Heritage Foundation revealed that the economic freedom of trading partners significantly boosts U.S exports, demonstrating a strong correlation between economic freedom and trade flows Additionally, findings indicate that the impact of economic freedom is more pronounced on U.S exports compared to imports Improved economic freedom not only elevates the levels of both exports and imports to and from the U.S., but it also suggests that while trade in capital goods increases with economic freedom, trade in consumer goods may have a more immediate effect on consumer well-being.
Recent literature on the relationship between IQ and trade highlights two key aspects: the impact of trade liberalization on institutional quality and the role of IQ in trade performance Cheptea (2007) suggests that trade openness may negatively affect institutional quality, while Feenstra (2013) emphasizes that IQ influences the organization of trade and production Furthermore, Anderson and Marcouiller (2002) argue that weak institutions can hinder trade as significantly as tariffs, with bilateral trade volumes benefiting from higher IQ in trading countries Levchenko (2007) identifies institutional differences as a crucial factor in trade dynamics, and Y Heo (2015) assesses how the quality of institutions in foreign markets affects ASEAN countries' exports Huyen (2017) also finds that stronger IQ among ASEAN partners is vital for enhancing the bloc's export performance.
The difference in trade data used by these researches classified several types, that are industry-level trade data (Feenstra, 2013; Y Heo and NK Doanh, 2015; Alvarez, 201 8), by trade volumes data (Levchenko, 2007).
The Relationship between Business Environment and Trade Flows
Research in the relationship between business environments and trade flows is relatively underexplored Mengistae (2010) highlights how differences in business environments significantly impact international trade among Southern African countries The study reveals that successful exporters tend to be more open to trade and benefit from lower trade costs due to favorable geography, reduced transport and regulatory expenses, and improved access to long-term finance Additionally, these exporters experience fewer inefficiencies linked to disparities in access to essential services and governance, underscoring the critical role of a conducive business environment in enhancing trade performance.
Athukorala (2012) analyzes the evolving trends in merchandise trade across twelve developing Asian economies (DAEs) over the past forty years, projecting future trade patterns through 2030 The study includes economies such as China, India, and Indonesia, and relies on investor surveys to build a comprehensive database of the business environment, particularly focusing on the doing business index Utilizing the gravity model of international trade, the research forecasts an annual growth rate of 8.2 percent in total real non-oil trade among DAEs, with a significant alignment of individual country growth rates to the regional average Additionally, the proportion of intra-regional trade in total non-oil trade is expected to increase from 53 percent in 2010 to 58 percent by 2030, while the trade-to-GDP ratio is projected to rise from 39.4 percent to 74.4 percent during the same period.
Khan (2020) examined the link between governance and trade flows, highlighting the mediating role of business regulations Utilizing a partial least squares structural equation model (PLS-SEM) and data from 181 countries, the study revealed that governance indirectly influences international trade through business regulations The findings suggest that enhancing governance and the regulatory environment can significantly promote international trade.
Yushi (2019) analyzes the influence of border and transport efficiency, institutional quality, and information and communication technologies (ICT) on the bilateral trade of 44 African countries with 173 trade partners from 2000 to 2014 Using principal component analysis, the study derives aggregate indicators for institutional quality, communication, physical infrastructure, transport, and border efficiency The results indicate that Africa's trade flows are significantly affected by these factors, with border and transport efficiency having a notable impact on GDP per capita Conversely, the effects of institutional quality and ICT on trade flows appear to increase alongside GDP per capita.
Ismail and Mahyideen (2015) investigate the effects of soft and physical infrastructure on trade flows among Asian countries, revealing that enhancements in transport infrastructure—such as roads, logistics, air transport, railways, and ports—significantly boost trade volume for both exporters and importers Their findings also indicate a strong and positive influence of soft infrastructure on trade flows, with ICT infrastructure playing a crucial role in enhancing trade in the region Similarly, Bankole (2015) emphasizes the importance of ICT infrastructure in intra-Africa trade, demonstrating through archival data from 28 African countries that both ICT infrastructure and institutional quality positively impact trade efficiencies Overall, the studies underscore the vital role of both hard and soft infrastructures in facilitating trade across regions.
Technological advancements in transport and communication, alongside the reduction of international trade barriers, are key factors driving trade flow expansion (Luttermann, 2020) As production of intermediate goods occurs across various countries, robust logistics infrastructure becomes essential for nations engaged in global value chains Outsourcing production to countries with inadequate transport infrastructure poses risks, particularly regarding the timely delivery of goods to international markets Efficient border and transport systems not only enhance the safety and speed of goods transportation but also lead to significant cost reductions in international trade Conversely, inefficiencies in these areas can escalate costs, negatively impacting company performance and potentially isolating a country from global markets.
Literature Review of the IQ, BE and Foreign Direct Investment (FDI)
The Relationship between Institution Quality (IQ) and Inward FDI iz
The significance of IQ in attracting inward Foreign Direct Investment (FDI) lies in the critical role that institutions play in fostering economic growth and international trade Since the late 1990s, research has increasingly focused on the relationship between institutions and FDI, highlighting two primary channels of influence Firstly, effective governance and robust institutions create a conducive environment for foreign investment, enhancing economic prospects and productivity Strong institutions lead to higher returns on FDI by facilitating private investment and reducing political instability Additionally, an efficient institutional framework minimizes transaction costs—covering production, logistics, business information, and risk management—thus making a country more appealing to foreign investors Ultimately, a well-developed institutional environment, characterized by a skilled labor force and effective property rights protection, is essential for attracting FDI and driving economic development.
Research by Gwartney and Lawson (2006) highlights the significant impact of economic freedom (EFW) ratings on private investment and GDP growth, revealing that a one-unit increase in EFW correlates with a 2.59 percentage point rise in private investment as a share of GDP and an 18.9% increase for each additional point in EFW rating They argue that enhanced EFW makes countries more appealing to investors Similarly, Daude (2007) emphasizes the role of various institutional sub-indicators, such as government effectiveness and political stability, in attracting inward foreign direct investment (FDI), finding that stronger institutions positively influence FDI while factors like regulatory burdens and government instability deter it Mishra (2007) further examines how host country institutions affect outward FDI, utilizing data from the International Country Risk Guide (ICRG).
Research indicates that the institutions of host countries have a significantly positive impact on the outward foreign direct investment (FDI) stocks of source countries Key factors such as the impartiality and strength of the legal system, the quality of bureaucracy, adherence to law, and government stability in host countries directly influence these FDI stocks Additionally, findings from two-stage least squares regressions (2SLS) reveal that bilateral trade loses significance and reverses its expected effect Notably, the relative labor abundance of source countries compared to host countries becomes insignificant in determining their outward FDI stock.
Mina (2012) investigates the influence of IQ on inward foreign direct investment (FDI) in Arab countries from 1990 to 2008, utilizing the GMM technique The study reveals that enhanced government stability, reduced investment expropriation risks, and bilateral investment treaties significantly boost inward FDI Additionally, it highlights that political religion, conflicts, and ethnic tensions positively affect FDI inflows Similarly, Viet (2014) evaluates the role of provincial IQ in attracting FDI in Vietnam, finding that local enforcement institutions greatly impact FDI attraction, while support institutions show no significant effect These insights are crucial for local governments, particularly in provinces with a history of low FDI attraction, as they can develop effective policies to improve the institutional environment and synchronize FDI flows nationwide.
Aziz (2017) examines the influence of institutional quality (IQ) on foreign direct investment (FDI) in the Arab region, revealing that factors such as the International Country Risk Guide (ICRG), economic freedom, and ease of doing business positively affect FDI inflows He recommends that Arab nations reform their economic policies, emphasizing trade liberalization and privatization to enhance IQ and attract more FDI Similarly, Sabir (2019) assesses the relationship between IQ and FDI, finding a significant positive impact across all country groups, with FDI inflows being notably higher in developed countries compared to developing ones.
Weak institutions negatively impact investment levels by increasing transaction costs and uncertainty Investors often face the burden of bribing officials for licenses and permits, which raises the cost of doing business and deters investment For instance, if Singapore's corruption levels matched those of Mexico, it could lead to a tax rate increase of over 20 percentage points for multinationals Additionally, poorly protected property rights, lack of regulation, and undeveloped financial markets contribute to these transaction costs, making it challenging for enterprises to adapt to changing conditions Ultimately, these factors restrict businesses' ability to operate efficiently and manage risks, significantly hindering investment growth (Daude & Stein, 2007; Aziz, 2017).
Research by Baek and Qian (2011) indicates that high political risks in host economies deter Foreign Direct Investment (FDI) due to increased volatility, which leads to reduced profits for investors Utilizing the ICRG 12-component political risk index, their findings reveal that various political risk factors influence FDI inflows into developing economies differently Ultimately, a stable political and policy environment is essential for attracting FDI.
Poor institutional frameworks can increase investment costs in foreign countries, primarily due to corruption, which hampers effective business operations Foreign Direct Investment (FDI) often involves high sunk costs, making companies hesitant to invest in markets characterized by high uncertainty and risk (Gwartney et al., 2006) Additionally, transaction costs play a crucial role in how enterprises assess business environments and evaluate subsidiary performance, particularly in adapting to changing conditions These transaction costs can negatively affect investment levels by restricting a company's operational capacity, risk diversification, problem-solving abilities, and optimal organizational structure selection (Aziz, 2017).
New firms often hesitate to reinvest profits in areas with weak property rights, particularly in technology-intensive sectors, leading to a focus on distribution rather than establishing production facilities that could yield foreign direct investment (FDI) spillovers The lack of robust property protection makes investors reluctant to risk their capital, fearing that their returns may be appropriated by others Additionally, the uncertainty stemming from inadequate physical and financial infrastructure, along with poorly enforced regulations and ineffective legal systems, compels companies to be increasingly selective about their investment locations.
Research by Johnson, McMillan, and Woodruff (2002) highlights the critical role of financial institutions in fostering investment, particularly in former communist countries Their survey reveals that weak property rights hinder foreign companies from reinvesting profits, while inadequate intellectual property protections deter foreign investors, especially in technology-driven sectors This situation leads to a preference for investments focused on distribution rather than establishing manufacturing operations that could generate foreign direct investment (FDI) spillovers In environments with fragile financial institutions, entrepreneurs are reluctant to reinvest retained profits, even when bank loans are accessible, as evidenced by new firms facing the least secure property rights.
32 percent of their profits, while those reinvest 56 percent of their earnings with the most secure perceived property rights.
According to Daude (2007), uncertainty surrounding corruption significantly deters foreign direct investment (FDI) by increasing investment costs and reducing potential profits Corruption complicates business operations and can even result in investment withdrawal Countries with high political risks, such as the threat of expropriation and military involvement in politics, create an unsafe business environment, making investors wary This heightened uncertainty ultimately raises costs for foreign investors, as they must navigate a landscape fraught with potential losses.
Research suggests that weak institutions can sometimes attract foreign direct investment (FDI), as highlighted by Janeba (2002), who notes that high-political-risk environments often offer low factor costs, creating an appealing risk-reward balance This allows foreign firms to operate more cost-effectively, lowering business expenses and enhancing profitability Consequently, multinational enterprises (MNEs) may target high-political-risk markets to sidestep competition from other MNEs that are hesitant to invest in such uncertain conditions.
Research on foreign direct investment (FDI) inflows in Asian countries, particularly within ASEAN, highlights significant findings by Masron (2017) Analyzing panel data from 1996 to 2013 for ASEAN-8 countries and China, the study reveals that factors like regulatory quality, control of corruption, and rule of law significantly influence FDI The findings emphasize the urgent need for enhanced intelligence quotient (IQ) and improved governance structures across ASEAN nations to foster effective public sector decision-making and promote robust private sector development.
Borojo (2019) analyzes the influence of business environment (BE) and institutional quality (IQ) on Chinese foreign direct investment (FDI) inflows to African countries The study highlights the significance of various sub-indicators of IQ and BE Ultimately, it concludes that enhancing the IQ and BE of African economies is crucial for increasing Chinese FDI in the region.
In the context of IQ research, Seyoum (2019) examines the indirect relationship between economic freedom and trade flows, utilizing FDI inflows as a mediator and government stability as a moderator The findings reveal that the positive effects of economic freedom on trade and FDI intensify with higher levels of government stability Similarly, Luttermann (2020) explores the role of government stability as a mediator in the relationship between logistics performance and trade flows, concluding that increased government stability correlates with enhanced trade levels.
The Relationship between business environment (BE) and FDI Inflows
The business environment of a country is influenced by various factors, with the World Bank's Doing Business Index (DBI) serving as a key metric for assessing business regulations Scholars widely recognize the DBI as crucial for evaluating a country's business climate, which has garnered significant interest from multinational companies, academics, and policymakers aiming to attract foreign direct investment (FDI) Research, such as that by Piwonski (2010), has explored the relationship between DBI indicators and FDI inflows, identifying several independent variables that impact these inflows, including overall DBI scores, GDP per capita, GDP growth rate, years of schooling, population growth, and public sector corruption levels Findings suggest that an improvement in a country's DBI ranking can lead to an increase of over $44 million in FDI inflows.
Shahadan (2014) investigates the link between business indicators and foreign direct investment (FDI) net inflows, utilizing a random effects method to identify key factors influencing FDI attraction The study finds that enforcing contracts is inversely related to FDI inflow, highlighting the importance of improving legal frameworks, reducing corruption, and ensuring government stability to enhance FDI Similarly, Singh (2015) analyzes the relationship between the ease of doing business index and FDI using time series data and six specific business indicators The findings reveal a long-run equilibrium relationship, indicating that while these indicators do not Granger cause FDI in the short term, there is a significant long-term connection established through Johansen co-integration tests.
Aziz (2017) examines the relationship between the regulatory environment and FDI inflows in Arab economies using seven out of ten Doing Business indicators: starting a business, registering property, dealing with construction permits, paying taxes, getting credit, trading across borders, and resolving insolvency By applying principal components analysis (PCA) to derive a composite index of these regulations, the study finds that strong institutions significantly enhance FDI attractiveness by fostering a favorable business climate for multinational enterprises (MNEs) In contrast, Jovanovic (2018) investigates the ease of doing business as a factor in attracting bilateral FDI from 22 OECD countries to 27 ex-socialist countries, employing an instrumental variable Bayesian model averaging (IV-BMA) method This research utilizes six Doing Business indicators, including starting a business and trading across borders The findings reveal uncertainty regarding the impact of these indicators, with most proving insignificant, except for the robustness of the ease of trading across borders Consequently, Jovanovic recommends that ex-socialist governments prioritize improvements in the ease of doing business to effectively attract FDI inflows.
Hossain (2018) examines the impact of five Doing Business Indicators (DBI) on Foreign Direct Investment (FDI) inflow, including starting a business, registering property, getting credit, paying taxes, and enforcing contracts The study reveals that starting a business has an insignificant positive effect on FDI, while enforcing contracts significantly boosts FDI inflows Conversely, the indicators for getting credit and registering property negatively affect FDI, and paying taxes shows a negative but insignificant impact on inward FDI.
Khan (2020) explored the role of business regulation in the relationship between political governance and international trade, utilizing a partial least squares structural equation model (PLS-SEM) with data from 181 countries The findings revealed that business regulations significantly influence a country's trade, while governance has an indirect effect Additionally, border and transport efficiency emerged as crucial indicators affecting foreign direct investment (FDI) inflows Nordas (2006) highlighted that logistics services and import-export timelines negatively impact trade volumes, particularly for time-sensitive products Borojo (2019) assessed the business environment in African countries, identifying key factors such as import/export costs and documentation requirements The study concluded that improving border and transport efficiency could enhance Chinese FDI flows to Africa by facilitating cross-border trading activities.
Many scholars recognize the critical role of infrastructure in attracting foreign direct investment (FDI) For instance, Halaszovich (2018) examines how transport infrastructure systems impact inward FDI, utilizing robust GLS estimators and data from 22 developing Asian countries and 10 major investing developed nations The findings reveal that well-developed transport infrastructure positively influences inward FDI, enabling regions with superior national transport systems to mitigate the costs associated with geographic distance, thereby enhancing trade and investment opportunities.
Luttermann (2020) investigates the role of logistics infrastructure in attracting foreign direct investment (FDI) by analyzing World Bank Logistics Performance Index (LPI) indicators Utilizing a panel data analysis of secondary data from 20 Asian countries over 12 years (2006-2017), the study reveals that four out of ten logistical infrastructure variables significantly impact FDI Notably, road and water infrastructure are particularly influential at the 1% significance level, underscoring the critical role of transport infrastructures in developing countries and highlighting the substantial effects of logistics infrastructure on FDI.
The Literature Review of Trade Flows and FDI Inflows Nexus
Foreign direct investment (FDI) significantly influences trade between nations, playing a crucial role in the globalization process by facilitating the movement of capital and goods This interaction fosters economic interdependence among different economies The relationship between FDI and trade remains complex, with theoretical and empirical studies suggesting that they can either complement or substitute each other Factors such as a firm's access to production resources, market operations, and the size of the domestic market can determine whether FDI and trade work together or against each other, highlighting the nuanced dynamics of international economic relationships.
Trade allows countries to import goods instead of relying solely on domestic production (Krugman, 1979) There is a significant complementarity between foreign direct investment (FDI) and trade, particularly in vertical foreign investment models, where multinational enterprises (MNEs) optimize their production processes across borders to minimize costs and seek resources The potential synergy between trade and FDI is heightened when multinational affiliates import inputs from their home countries, especially in the context of FDI from developed nations into developing economies (Blonigen & Slaughter, 2001).
Foreign Direct Investment (FDI) often serves as a substitute for trade, particularly in horizontal investments where multinational enterprises (MNEs) produce the same goods and services across different countries Research indicates that while FDI can replace trade at the product and industry levels, it simultaneously encourages imports at the gross manufacturing level (Blonigen & Slaughter, 2001) This prevalent form of FDI typically involves bilateral investments between developed economies Traditional literature views FDI and trade as alternative methods for entering foreign markets, as illustrated by Dunning's OLI paradigm, which suggests firms may opt for FDI over exports when they possess ownership advantages Notable scholars like Blonigen (2001) emphasize the importance of analyzing foreign investment patterns to understand their impact on trade flows, advocating for a detailed disaggregation of investment variables to capture both complementary and substitution effects Additionally, Makki (2004) explores the interplay between FDI, bilateral trade, and economic growth, utilizing data from sixty-six developing countries over three decades.
Between 1971 and 2000, research indicates that trade, foreign direct investment (FDI), and human capital are crucial drivers of economic growth in developing nations A notable positive interaction between trade and FDI enhances economic advancement, with FDI fostering domestic investment, especially when supported by human capital and stable macroeconomic policies Tadesse (2004) highlights how a host nation's market maturity influences its FDI inflows and the interaction between bilateral trade and FDI The study reveals a positive correlation between market maturity and FDI but an inverse relationship concerning trade-FDI interaction Magalhaes (2007) explores the connection between FDI and international trade in Portugal, finding a complementary relationship between trade and inward FDI stocks Dhingra (2017) assesses the UK’s economic role post-Brexit, concluding that Brexit may reduce the UK's economic standing by diminishing trade and investment flows from the EU, with future economic performance hinging on new trade relations Lastly, Festus (2021) examines macroeconomic indicators affecting trade flows, identifying a positive link between income and imports, while noting that relative import prices inversely impact imports and other factors like FDI and exchange rates show insignificant effects on exports.
Multinational Enterprises (MNEs) play a crucial role in the relationship between Foreign Direct Investment (FDI) and international trade, significantly influencing globalization and the mobility of factors in global commerce The organization of MNEs' international business operations affects this dynamic, with some theories suggesting that production by foreign affiliates and imports can serve as substitutes Notably, research by Blonigen (2001) supports this perspective, highlighting the intricate connections between MNE activities, FDI, and trade patterns.
US imports from Japan have decreased as Japanese foreign direct investment (FDI) establishes a manufacturing presence in the US Scholars highlight the indirect relationship between institutional quality and trade flows, suggesting that FDI plays a mediating role For instance, Seyoum (2019) investigates the positive correlation between economic freedom and trade, using FDI inflow as a mediator This study integrates moderation and mediation in a model utilizing data from 1995 to 2005, with parameters estimated through OLS techniques The findings indicate that the influence of economic freedom on trade and FDI intensifies with increased government stability in a country.
The Literature Review of Research Models .- ¿5555 <S+<c<scsssesrrs 28
Gravity Model oo
The gravity model of international trade, first introduced by Tinbergen in 1962, initially relied on the constant elasticity of substitution (CES) framework Over time, the model has been enhanced by incorporating additional variables, such as dummy variables to signify membership in economic areas, as noted by Anderson and Marcouiller in 2002 This evolution has allowed for a more comprehensive analysis of the factors influencing international trade dynamics.
IQ on trade flows between countries, many scholars use gravity model in analyzing this impacts.
In recent decades, gravity models have emerged as a valuable tool for analyzing empirical international trade (Naanwaab C and M Diarrassouba, 2013) These models typically exist in absolute and relative forms, with the absolute model being favored by researchers due to its simplicity and ease of application.
Several scholars, including Filippini and Molini (2003), Yu (2010), Naanwaab and Diarrassouba (2013), Huyen (2017), and Borojo and Yushi (2019), have examined absolute models Notably, Huyen (2017) utilized the gravity model to analyze the impact of IQ on trade flows among ASEAN countries and their trading partners.
Ln TRADE; j, = Bo + BylnGDP;, + B2InGDP;, + B3lnPOP;, + BylnPOP;, +
BsInDIST;; + BeLANG;; + 6;COLONY;; + BgCOMCOL,; + 6ạADJACENCY;; + tolmINST¡¿ + By lnINST jp + tị;; (2.1)
In this analysis, we denote the exporter as 'i' and the importer as 'j,' with 't' representing the year of trade The variable TRADEjjx reflects the export volume directed from country i to country j during year t Additionally, GDP signifies the gross domestic product of the countries involved, while POP represents the total population of each country DIST indicates the geographical distance between the capitals of countries i and j, which may influence trade dynamics.
J LANG,;, COMCOL¡;,ADJACENCY,j are dummy variables that equals to unity if both countries are the same common language, colonizer after 1945, shares a common border, respectively INST institutional quality The results of the fixed and random effects estimation methods indicate that if ASEAN’s trading partners have better IQ It will increase the bloc’s export performance to their partners.
Research shows that improved intellectual quality (IQ) among ASEAN's trading partners enhances the bloc's export performance Key factors influencing this relationship include the legal framework, protection of property rights, and the freedom to trade internationally in importing countries Additionally, the size of the government and international trade freedom in exporting nations are crucial for increasing trade from ASEAN countries.
A recent study by Alvarez (2017) employs the gravity equation to examine how institutional conditions in importing countries and the institutional gap between nations influence bilateral trade In addition to traditional gravity model variables like cultural proximity, colonial ties, and geographical distance, the analysis incorporates six key indicators of institutional quality (IQ) from worldwide governance metrics The research further introduces novel variables related to exporter labor competitiveness, importer price indices, and sectoral incomes to evaluate the impact of IQ on trade Findings reveal that both the destination country's institutional conditions and the institutional gap significantly affect bilateral trade, with the influence of destination institutions increasing over time, particularly for raw materials and agriculture compared to manufacturing and services Additionally, Borojo (2019) applies the gravity model to assess China's foreign direct investment (FDI) flows to African countries, utilizing aggregate indicators of IQ.
Principal component analysis reveals that factors such as economic freedom, governance institutions, transport efficiency, and the doing business index significantly influence Chinese foreign direct investment (FDI) flows to Africa Additionally, several researchers, including Daude (2007), have utilized the gravity model to examine the relationship between institutional quality (IQ) and FDI, highlighting the impact of IQ on investment decisions.
In(FDI)ij = Bo + Bi SumGDP; + B2SQDIFGDP, + B3;ADGDP, * ADIFSKILL; +
B,ADIFSKILL, + BsLnDistancei + Bg; TARIFF; + B7TARIFF, * SQDIFSKILL +
The study defines key variables influencing foreign direct investment (FDI), including the outward FDI stock from a source country to a host country, the sum of the logs of GDPs, and various measures of GDP and skilled labor differences It also considers factors like the great circle distance between capitals and trade costs, represented by average tariff levels To address the challenge of zero FDI stocks in the dataset, the research employs instrument variables such as ethno-linguistic fragmentation and homicide rates for assessing voice and accountability and political stability Additionally, it uses the population fractions speaking English and Western European languages, along with legal system dummy variables, to enhance estimation accuracy The IV estimation results indicate that government efficiency significantly boosts FDI inflows, with a one standard deviation improvement correlating to an average increase of 2,482 million USD in FDI stocks, while political stability and economic freedom show no significant impact.
In addition, Poisson regression is used to corrects for the potential bias of the log-linearized model under heteroscedasticity.
The method proposed by Baron and Kenny in 1986 has evolved and found applications across various fields, including marketing and consumer science (Zhao et al., 2010; Pieters, 2017), supply chain management (Rungtusanatham, 2014), and foreign direct investment inflows (U, 2021) This model illustrates how an independent variable X affects a dependent variable Y through the mediating variable M, represented by three key equations.
In which, indirect effect of X on Y through M is a x b in part | (MacKinnon, 2008), the total effect of X on Y in part 2, that is C = €' + ab , When mediation occurs, the C path in Part
2 is larger than C’ path in part 1 (Shrout, P E., and Bolger, N.,, 2002) (See figure 2.1).
Figure 2.1 Path Models Show Mediated Effect (part 1) of X On Y and Total Effect (part 2)
Various techniques exist for managing intermediate variables, as highlighted by different authors Two widely used techniques demonstrate distinct approaches to understanding intermediate variables and their relationships Baron and Kenny (1986) outline three essential conditions that must be met for a variable to be considered an intermediary.
Condition 1: The independent variable has an impact on the intermediate variable (a # 0). Condition 2: The intermediate variable has an impact on the dependent variable (b # 0). Condition 3: When conditions 1 and 2 are satisfied, the presence of an intermediate variable will reduce the impact from the independent variable on the dependent variable (c' < c) Where c is the regression coefficient from X to Y, when there is no intermediate variable M if one of the above three conditions is violated, the variable M does not play an intermediary role in interfering with the effect from X to Y.
Building on the aforementioned theory, Zhao (2010) conducted a detailed evaluation of the intermediary relationship using the Sobel z-test, which assesses the statistical significance of the difference between c and c' The Sobel z-test specifically analyzes the indirect path represented by the product of coefficients a and b, as illustrated in Figure 2.1.
In the context of regression analysis, Sq represents the un-normalized regression coefficient, while its standard error for variable X is denoted as the standard error of X in simple regression equation 1 Similarly, in multiple regression equation 2.10, b signifies the unnormalized regression coefficient, with sp indicating the corresponding standard error for variable M.
If the sig value (p-value) of the Sobel test (Sobel, 1982) is less than 0.05, so M is an intermediate variable that affects the relationship from X to Y.
Scholars highlight the indirect relationship between IQ and trade flows, particularly emphasizing the mediating role of Foreign Direct Investment (FDI) For instance, Seyoum (2019) investigates the hypothesis that economic freedom positively influences trade flows, utilizing FDI inflow as a mediator The findings reveal that the impact of economic freedom on both trade and FDI intensifies with greater government stability in a country.