The impact of environment, social, governance performance (esg) on foreign direct investment (fdi) in asean from 2003 to 2022

ABSTRACT Environmental, Social and Governance ESG factors have become key factors in attracting Foreign Direct Investment FDI in emerging markets, especially in ASEAN.. Recognizing the i

FOREIGN TRADE UNIVERSITY FACULTY OF INTERNATIONAL ECONOMICS

000

MID-TERM ASSIGNMENT MODULE: INTERNATIONAL ECONOMICS 1

GROUP MEMBERS

TABLE OF CONTENT

INTRODUCTION

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2 Research Obfectives oo e 7

3 Object and the scope of the research + c1 22 1221112111211 12111211 181112111152 7 3.1 ObJect of the research L1 2 120112111211 1211 121112111011 1811 10111011 ng 7 3.2 Scope of the research - - - c1 20 120112111211 121112111111 1111 11111111 1111k Ha 7

4 Research methodology - - c1 20112011101 11111111 111111111111 1111 1111111111111 1111k 7

5 Content and structure of the repOFI - 5c 22 222122211131 1131 1111111111111 11111 +2 8

1 Overview of Foreign Direct Investmnent (FDI) and ESG - -::5-:+522 9

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1.2.5 Autocorrelation testIng - c2 221112111211 1211 1211121118111 33

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2 ContributIlons ofthe Research - L2 2011201121 1121 1121115111511 1111 111 111 1 ca 37

3 Limitations ofthe Research - - c1 20112011211 121 1121111111211 1111 11111811 81 xay 38

4 Policy Implications and Future Research Directions - - 22c c 22x 2552 38

ABSTRACT

Environmental, Social and Governance (ESG) factors have become key factors in attracting Foreign Direct Investment (FDI) in emerging markets, especially in ASEAN This study examines the impact of ESG performance on FDI inflows in ASEAN nations over the period of 2003 to 2022 Using annual data from 2003 to

2022 and the panel data analysis techniques, the study investigates the correlation between ESG indicators and FDI in 10 South East Asia countries, while controlling for economic, trade openness and market-specific variables Main findings are, first, the environment performance tends to have a positive and significant impact on the FDI inflows Second, social performance has a surprisingly negative impact on the FDI inflows, which can be caused by various factors Finally, the linkage between institutional indicators and FDI inflows is weak and statistically insignificant These findings highlight the importance of integrating ESG factors into strategic planning to promote sustainable development and enhance investment attractiveness in the region

Key word: environment, social, governance, ESG, FDI

INTRODUCTION

1 Reason for choosing the topic

In recent years, sustainable development has gained increasing attention worldwide, originating from concerns about climate change, social equity and transparency in governance The Environmental, Social and Governance (ESG) framework has emerged as a crucial measure to assess corporate responsibility and long-term sustainability Besides, Foreign Direct Investment (FDI) remains one of the important channels for developing countries to promote economic growth, create jobs and gain technology advancement In the Southeast Asia (ASEAN) region - where the economic structure is diverse and growing rapidly - the application of ESG principles along with FDI capital flows is opening up many opportunities and challenges

Recognizing the importance of ESG and the current state of FDI in ASEAN, our group has chosen the topic “7he impact of Environment,Social, Governance performance (ESG) on Foreign Direct Investment (FDI) in ASEAN from 2003 to 2022” for our essay This topic was selected in order to analyze the role of ESG factors on FDI capital flows in developing countries in the ASEAN bloc By researching the impact of ESG over the past 20 years, the report aims to clarify how environmental regulations, social welfare policies and governance quality influence foreign investors’ decisions, thereby helping policy makers and businesses orient their strategies in line with sustainable development goals

2 Research objectives

Analysing the impact of ESG on Foreign Direct Investment (FDI) in 10 ASEAN countries, including: Vietnam, Myanmar, Laos, Thailand, Cambodia, Philippines, Singapore, Malaysia, Indonesia, Brunei and Timor Leste

3 Object and the scope of the research

3.1 Object of the research

The primary research objects are ESG indicators and FDI flows in Southeast Asian countries The purpose is to examine the correlation between these ESG indicators and changes in FDI over time

3.2 Scope of the research

- Spatial scope: Our team focuses on Southeast Asian countries, including Vietnam, Myanmar, Laos, Thailand, Cambodia, Philippines, Singapore, Malaysia, Indonesia and Brunet

- Time scope: Our team analyzes economic data during 2003 and 2022

4 Research methodology

Our group used panel data and chose the quantitative research method: Using econometric models and testing those models on STATA software based on data collected from the World Bank and UNDP In addition, the group used the knowledge learned from the subjects of Econometrics, International Economics and others, thereby drawing conclusions and solutions from the results after running the model

5 Content and structure of the report

To accomplish the aforementioned objective, our team applied knowledge of Econometrics as well as knowledge from allied fields relevant to the economic field to study the relationship between variables in the following chapters:

IH

IV

Overview of the topic

Model specification and data

Estimation, hypothesis testing and recommendations

Conclusion

CHAPTER 1: OVERVIEW OF THE TOPIC

1 Overview of Foreign Direct Investment (FDI) and ESG

Ld FDI

Foreign Direct Investment (FDI) refers to an investment made by a firm or individual

in one country into business interests located in another country, typically in the form

of establishing business operations or acquiring business assets (OECD, 2008) The International Monetary Fund (IMF) defines FDI as an investment that grants an investor control or significant influence over a foreign enterprise, usually characterized by ownership of at least 10% of the voting power of the business (IMF, 1993)

FDI has long been recognized as a crucial driver of economic growth, technology transfer, and industrial development, particularly in emerging markets According to Dunning’s Eclectic Paradigm (OLI Model), multinational enterprises (MNEs) choose FDI destinations based on three key factors: Ownership-specific advantages (O), Location-specific advantages (L), and Internalization advantages (I) (Dunning, 1980; 2001) Southeast Asia has traditionally been an attractive destination for FDI due to its low labor costs, expanding consumer markets, and government investment incentives (ASEAN, 2022)

1.2 Environmental, Social, and Governance

The concept of Environmental, Social, and Governance (ESG) has gained significant traction in both academic and corporate discussions on investment sustainability ESG refers to a set of criteria used to measure a company’s or country’s sustainability performance in three key areas:

° Environmental: Climate change impact, carbon emissions, energy efficiency, resource usage, and waste management

° Social: Human rights, labor standards, employee welfare, diversity, and community impact

° Governance: Corporate ethics, transparency, shareholder rights, and regulatory compliance (Eccles, Ioannou & Serafeim, 2014; Friede, Busch & Bassen, 2015)

Empirical studies suggest that ESG considerations are no longer just ethical concerns but have a direct financial impact on investment returns Firms and economies with robust ESG policies tend to exhibit lower financial risk and greater long-term profitability, making them more attractive to foreign investors (Clark, Feiner & Viehs, 2015; Albuquerque et al., 2020) Furthermore, countries with stringent ESG regulations are becoming more appealing destinations for FDI A study by Ioannou & Seraferm (2019) demonstrated that firms operating in countries with strict ESG regulations experience increased investor confidence, leading to higher foreign investment inflows Conversely, economies with poor ESG frameworks often face capital flight due to rising regulatory and reputational risks (OECD, 2021)

In the context of Southeast Asia, ESG implementation varies significantly across countries Singapore and Malaysia have led the region in developing ESG-compliant investment policies, with national sustainability reporting frameworks and green financing initiatives (ASEAN, 2021) On the other hand, nations like Indonesia, Vietnam, and the Philippines still face significant ESG-related challenges, particularly

in environmental protection and labor rights compliance (ADB, 2022) As global Investors continue prioritizing ESG factors, this divergence in ESG adoption could lead to an uneven distribution of FDI across the region

As it can be concluded, the relationship between FDI and ESG has become increasingly interconnected, as sustainability considerations have begun shaping global investment trends Traditional FDI determinants such as economic growth,

infrastructure, and institutional quality remain critical, but ESG compliance is now a major factor in attracting high-quality, long-term investments For Southeast Asia, ensuring a strong ESG regulatory framework could be the key to maintaining its attractiveness as an FDI destination in the coming decades

1.3 The relationship between Foreign Direct Investment (FDI) and Environmental, Social and Governance (ESG) factors

The relationship between Foreign Direct Investment (FDI) and Environmental, Social, and Governance (ESG) factors has become increasingly important in global investment decisions Institutional theory suggests that firms prefer host countries with strong ESG regulations, as these provide regulatory stability and reduce operational risks (Meyer & Nguyen, 2005; OECD, 2023) Similarly, stakeholder theory argues that companies consider ESG commitments when expanding abroad, favoring countries that prioritize sustainability and social responsibility (Freeman, 1984; Clark, Feiner & Viehs, 2015)

Contrary to the Pollution Haven Hypothesis (PHH), which suggests firms relocate to countries with lax environmental laws to reduce costs (Copeland & Taylor, 2004), recent research shows that investors increasingly favor ESG-compliant destinations due to reputational concerns and regulatory risks (Bu & Wagner, 2016) The Porter Hypothesis further suggests that stringent environmental policies can enhance Innovation and attract high-value FDI (Porter & Van der Linde, 1995) Empirical evidence shows Singapore leveraging ESG policies to attract green FDI, while Cambodia and Myanmar face investment risks due to weak ESG governance (ASEAN Capital Markets Forum, 2023)

In addition to environmental factors, social and governance dimensions play a key role in FDI attractiveness Investors prefer countries with strong labor rights, political stability, and transparent governance structures (Alfaro et al., 2004; Javorcik & Wei,

2009) For example, Myanmar’s 2021 coup led to a decline in FDI due to governance instability (World Bank, 2023), while Malaysia and Thailand have successfully attracted investment through strong institutional frameworks (OECD, 2023)

Empirical models such as panel data regressions, gravity models, and Structural Equation Modeling (SEM) have been used to analyze the causal relationship between ESG and FDI flows, consistently showing a positive correlation between high ESG performance and increased FDI inflows (Ioannou & Serafeim, 2019; Albuquerque et al., 2020) Given the rising demand for sustainable investments, future research should explore sector-specific ESG impacts and policy interventions to enhance ESG-driven FDI

2, Literature review

2.1, Environmental impacts on FDI

Numerous environmental factors influence Foreign Direct Investment (FDI), including their impact on investment decisions, regulatory compliance and commercial sustainability The relationship between the environment and FDI is complex; strict environmental policies can either discourage or attract investment, depending on the industry concerned as well as the objectives of the investors

Environmental regulations serve a pivotal function in influencing the inflow of FDI Nations endowed with rigorous environmental policies may deter investments in industries characterized by high levels of pollution owing to elevated compliance costs, stringent emission standards, and augmented operational expenditures In contrast, countries that impose comparatively relaxed environmental regulations may entice investors in pursuit of reduced production costs; however, this scenario can precipitate environmental degradation and engender potential reputational hazards for multinational corporations The “pollution haven hypothesis" posits that corporations might relocate to jurisdictions with lenient environmental legislation to alleviate regulatory constraints (Meyer, 2004) Nonetheless, empirical findings remain inconclusive, as firms are progressively incorporating environmental, social, and governance (ESG) factors into their investment deliberations

As global environmental issues increasingly gain prominence, numerous multinational enterprises and institutional investors are placing a premium on investments that correspond with sustainability objectives The transition towards environmentally sustainable investments, especially in renewable energy, energy-efficient technologies, and initiatives promoting a circular economy, has resulted in a surge of FDI in sectors that are ecologically sound Nations that adopt robust policies endorsing clean energy and low-carbon development — such as tax benefits for green technologies and programs aimed at emissions reduction — are more inclined to draw in investors who prioritize environmental stewardship

The elevation of public consciousness concerning environmental matters has also intensified the exigency for corporations to implement sustainable business methodologies Stakeholders, including investors and consumers, are increasingly advocating for enhanced transparency and corporate social responsibility (CSR) initiatives, thereby compelling enterprises to evaluate the ecological ramifications of their FDI choices Adverse public sentiment regarding environmental negligence can result in reputational harm, legal complications, and possible financial detriment As a result, corporations are more inclined to allocate resources to regions where they can preserve a favorable corporate reputation by adhering to international environmental standards and engaging in sustainable business practices

International environmental accords and trade regulations exert substantial effects on the patterns of FDI Agreements such as the Paris Climate Accord and the United Nations Sustainable Development Goals (SDGs) incentivize countries to adopt environmentally sustainable strategies that may influence capital allocation decisions Moreover, the implementation of carbon border adjustment mechanisms and ecological tariffs has the potential to shape FDI by favoring investments in low-carbon sectors while dissuading capital flows towards high-emission industries Nations that synchronize their trade regulations with global environmental obligations are predisposed to attract FDI from enterprises endeavoring to adhere to international sustainability benchmarks (The Guardian, 2025)

2.2 Social impacts on FDI

FDI serves as a pivotal catalyst for economic advancement and globalization, exerting influence across various socio-economic dimensions within host nations Although FDI facilitates the creation of employment opportunities, the enhancement of skill sets, and the development of infrastructure, 1t simultaneously elicits apprehensions

regarding labor exploitation, disparities in income distribution, and transformations in cultural identity The social ramifications associated with FDI are intricate and contingent upon variables such as governmental policies, regulatory frameworks, and corporate conduct

One of the most profound societal ramifications of FDI is its influence on employment and labor market dynamics International investments frequently engender job opportunities within host nations, especially in developing economies where the creation of employment is pivotal for economic stability(Jenkins, 2006) The establishment of multinational corporations often culminates in enhanced wage levels, superior working conditions, and access to advanced training programs Furthermore, the enhancement of skill development is promoted as foreign enterprises introduce sophisticated technologies and managerial methodologies, allowing employees to attain new proficiencies Nevertheless, notwithstanding these advantages, apprehensions emerge concerning the quality of employment In certain instances, MNCs may prioritize cost efficiency, resulting in exploitative labor practices characterized by inadequate wages, extended working hours, and insufficient job security Additionally, the automation and technology transfer associated with FDI may precipitate job displacement, particularly among low-skilled laborers, thereby intensifying unemployment challenges in specific sectors

Another major social issue related to FDI is unequal income Overseas investments may foster some economic expansion The allocation of advantages tends to be skewed toward inequalities among varied socio-economic classes Often, in many instances, highly skilled workers in urban areas reap the advantages of FDI through increased wages as well as career growth opportunities, while low-skilled workers along with rural communities experience relatively marginal benefits This split between cities and countryside may deepen present disparities, fueling social stress coupled with unhappiness among disadvantaged people Wage gaps in the middle of local employees and expatriate personnel further compound these inequalities, igniting worries around economic exclusion along with social instability To further lessen these challenges, host governments must implement key policies that promote broader economic development and more equitable wealth distribution(Gérg & Strobl, 2001) CSR work by international firms may be quite vital when handling social problems stemming from FDI Many external investors participate in CSR programs to grow social infrastructure, such as healthcare, education, and ecological sustainability These initiatives contribute greatly to the development of the community and foster

goodwill sincerely between populations locally and investors However, the degree of effectiveness of CSR efforts typically fluctuates, as many corporations engage in somewhat superficial activities that serve mainly as public relations strategies rather than true contributions to social well-being To guarantee meaningful and sustainable effect, effective CSR policies do require strong regulatory frameworks along with active engagement with local stakeholders These policies also need active engagement with local stakeholders

2.3 Governmental impacts on FDI

The government policies, regulations, and the overall political environment of a state play a significant role in Foreign Direct Investment (FDI) The government has a fundamental impact in determining the investment environment through its economic policy, laws, tax policy, and international agreements Investment friendly policies can bring in FDI which can help in economic development whereas in case of unfavorable conditions or unstable politics, investors can be put off

Policies regarding taxation and investment incentives are one of the focal points that determine the inflow of FDI Many nations offer foreign investors tax exemptions, lower corporate taxes, and other forms of financial support(Meyer, 2004) Special Economic Zones (SEZs), tax breaks, and import duty exemptions are enticing to multinational corporations Conversely, poor tax systems or high levels of taxation on corporations tend to drive away investment, causing capital flight or the shift of businesses to more attractive areas The level to which these incentives are effective is procured from the overall constancy of fiscal policy and the clarity of its execution The political environment of a country determines its attractiveness towards FDI Countries that have secure political domains, predictable policies and low chances of government seizure are sought out by foreign investors(Jenkins, 2006) Political violence, corruption, or changes in government policies could damage the investor's trust However, countries with a firm institutional base and efficient government tend

to attract foreign investments over a long period of time Foreign investments could be negatively affected by political factors such as change of policies, expropriation of private businesses, or unexpected drastic changes to the rules and policies of business

To address these potential risks, several countries try to adopt legal frameworks, investment treaties and foreign investors guarantees by creating international arbitration tribunals

Both international treaties and foreign trade investments (FTIs) have a direct impact

on FDI inflows An open trade strategy, participation in free trade agreements (FTAs), and low tariffs also create favorable conditions for foreigners’ investment Agreements between nations or regions, such as the North American Free Trade Agreement (NAFTA) or the Comprehensive and Progresstve Agreement for Trans-Pacific Partnership (CPTPP), build investors’ trust by granting access to markets and legislative stability In contrast, sovereign restraining national economy policies, protectionist policy measures on international trade and other economic activities, especially high tariffs on imports, may economics, high operational costs, as well as minimal market opportunities for foreign industry discourage FDI.(The Guardian, 2025)

Additionally, FDIs are being provoked through the development of new infrastructure, which is frequently associated with initiatives of the government Platforms such as the public sector's requisite to deliver easily accessible services of positive quality to the population together with transportation infrastructure with established and dependable energy sources alongside digital communication and proficient logistics creates a favorable environment stimulation for increased investment These economies become more attractive when these governments improve infrastructure with the help of foreign investment through public-private partnerships (PPPs) On the flip side, certain investments can be very difficult to make-in poor infrastructure, limited public service provision, absence of appropriate transport connections especially in less developed countries

2.4, Research gap

Despite extensive research on the relationship between FDI and ESG, the findings remain inconclusive and highly context-dependent This inconsistency highlights several research gaps First, many existing studies have focused on either environment, social or governance within a country, organizations or selecting continents, but they rarely paid attention to the relationship of all three indicators with FDI in developing areas, particularly ASEAN Second, while many studies use diverse and complicated econometric techniques, there is no consensus on the most appropriate methodological approach, leading to differing results Addressing these

gaps is crucial for forming a clearer understanding of how policies influence the foreign investment across South East Asian countries

CHAPTER 2: MODEL SPECIFICATION AND DATA

1 Methodology

Id Method used to collect the data

The data identified for analysis consists of secondary data, which has been compiled and statistically processed from the database sources of the World Bank and the United Nations Development Programme (UNDP) After eliminating countries with missing data, the final dataset is structured as panel data, covering the following scope:

Temporal Scope: Data has been continuously collected over the period from 2013 to

2022

Spatial Scope: The dataset includes 10 ASEAN countries and territories, namely Vietnam, Brunei, Lao, Cambodia, Malaysia, Myanmar, Philippines, Singapore, and Thailand

1.2 Method used to analyze the data

To analyze the collected data, we employed econometric techniques to ensure the reliability of the results The following steps were taken:

e Model Selection and Estimation: The analysis began with the estimation of a regression model using both the Pooled Ordinary Least Squares (OLS) and the Random Effects Model These models were tested to determine which was more suitable for our study To decide between these models, the Breusch-Pagan Lagrange Multiplier (LM) test was conducted If the p-value obtained from the test is greater than 0.05, the Pooled OLS model will be selected as the preferred estimation approach

e Diagnostic Tests: To validate the reliability of the model, several diagnostic tests were conducted:

© Multicollinearity Testing: The Variance Inflation Factor (VIF) was used

to check for multicollinearity among independent variables

Normality of Residuals The Jarque-Bera Skewness-Kurtosis test was conducted to assess whether the residuals were normally distributed Omitted Variable Test The Ramsey RESET Test was performed to detect any omitted variable

Heteroskedasticity Testing The Breusch-Pagan test was employed to check for heteroskedasticity If the p-value obtained was greater than 0.05, heteroskedasticity was not an issue, confirming the homoscedasticity of the model

Autocorrelation Testing: To detect the presence of serial correlation in residuals, Wooldridge’s Test for autocorrelation was applied

2 Theoretical model specification

2.1 General model

Based on theoretical foundations and previous studies, our research team proposes a generalized regression model to determine the impact of ESG factors (environmental, social, and governance) on foreign direct investment (FDI) during the period 2013-2022 in the following 11 countries:

2.2 Explanation of variables in the model

Foreign Direct | InFDI Natural logarithm of - World

CO: Emissions | InCOsz Natural logarithm of + World

expectancy

Institutional inst Institutional quality, +/No World

Quality consist of control of | impact | Governance

corruption, government Index

effectiveness, political

stability and absence of

violence/terrorism,

Trade Openness _ | trade Natural logarithm of + World

percentage of GDP

Real Interest | interest rate | Lending interest rate +/- World

Infrastructure infrastructure | Index measuring the + World