A comparison of fdi determinants in asean3 and asean5 countries new evidence from financial integretion factor analysis doctoral thesis major finance

Key words in Czech: hrubý domácí produkt HDP, infrastruktura, otevřenost obchodu, mzdové náklady, úroková sazba, index vnímání korupce, směnný kurz Key words in English: Foreign Direct

Doctoral Thesis

A comparison of FDI determinants in ASEAN3 and ASEAN5 countries: New evidence from financial

integration factor analysis

Srovnání determinant PZI v zemích ASEAN3 a ASEAN5: Nové

důkazy z analýzy faktoru finanční integrace

Zlín, January, 2020

© Ho Thanh Tri

The publication was issued in the year 2020

Key words in Czech: hrubý domácí produkt (HDP), infrastruktura, otevřenost

obchodu, mzdové náklady, úroková sazba, index vnímání korupce, směnný kurz

Key words in English: Foreign Direct Investment (FDI), Gross Domestic Product

(GDP), Infrastructure, Trade Openness, Labor cost, Interest Rate, Corruption Perception Index, Exchange Rate

Full text of the Doctoral thesis is available in the Library of TBU in Zlín

I would like to especially thank Professor Drahomíra Pavelková, Boris Popesko and

Dr Lubor Homolka, who gave me much advice for my dissertation

I am also very grateful to my family: my mother and brothers Without their support,

I could not have completed my study My deepest gratitude goes to my mother, Lê Thị Minh Nhu for her immeasurable love and encouragement

And there are also many friends that I would like to say thank you to them for their help, support and encouragement during the time I study abroad

I dedicate this achievement to all

Foreign direct investment (FDI) contributes greatly to the economic development of the receiving country by providing an important source of finance for development and acting as a channel for the transfer of capital and new technology On the one hand, FDI adds to the stock of domestic capital and increases the productivity of production factors such as raw materials and labor On the other hand, FDI also contributes to diversifying the economy by adding new economic actors and promoting competition to produce better products at lower prices in the host country The literature has indicated that FDI inflows are determined by the market size, the degree of openness, the role of institutional factors and degree of economic integration Besides, other factors such as labor costs, infrastructure, domestic tax rates, and institutional environment are correlated significantly with FDI inflows Many studies about the factors were influenced by foreign direct investment inflows

in developing countries as well as developed countries However, none of the research articles compare FDI determinants in ASEAN3 and ASEAN5 with the new issue of the financial integration factor measured by the KAOPEN index to see whether or not it has an impact, along with other factors, on attracting FDI inflows

in ASEAN3 and ASEAN5 member countries Therefore, in this study, the author conducts a "a comparison of FDI determinants in ASEAN3 and ASEAN5," focusing

on the new issue of the financial integration measure by KAOPEN index and a examination of the impact of other factors such as gross domestic product, infrastructure facility, trade openness, labor costs, interest rate, institutional stability, and exchange rate to FDI inflows The author uses the quantitative research strategies by the panel ordinary least square estimation with the method of first differencing to address the critical research question and research hypotheses of this study There are three stages of this study In the first stage, the author identifies factors influencing FDI inflows in ASEAN countries In the second stage, the author uses econometric models to give concrete empirical evidence And in the third stage, the author draws a conclusion based on findings from the econometric models The author also includes an interview conducted with experts on the impact of these factors on attracting FDI in ASEAN member countries, which can help policymakers improve the FDI attraction of ASEAN member countries as well the FDI attraction

re-of Vietnam This study collected data from eight ASEAN member countries during two financial crises from 1996 to 2016 The author divides ASEAN member countries into two groups, ASEAN3 and ASEAN5, based on their level of economic development The findings indicate that the coefficient of financial integration is positive and statistically significant at a 1% level of significance on FDI capital inflows The empirical results also support the hypothesis that foreign direct investment in ASEAN3 and ASEAN5 is positively correlated to market size and

infrastructure facilities, and negatively correlated to labor costs as well as trade openness in ASEAN3

ABSTRAKT

Přímé zahraniční investice (PZI, Foreign direct investment - FDI) významně přispívají k hospodářskému rozvoji hostitelské země tím, že poskytují důležitý zdroj financí pro rozvoj, převod kapitálu a nové technologie Na jedné straně PZI navyšují zásoby domácího kapitálu a zvyšují produktivitu výrobních faktorů, jakými jsou suroviny a práce Na druhé straně PZI také přispívají k diverzifikaci ekonomiky tím,

že vytváří nové hospodářské subjekty a podporují konkurenceschopnost s cílem vyrábět v hostitelské zemi lepší produkty za nižší ceny

Literatura naznačuje, že příliv PZI je určován velikostí trhu, stupněm otevřenosti, rolí institucionálních faktorů a stupněm ekonomické integrace Další faktory, jakými jsou mzdové náklady, infrastruktura, daňová sazba dané země a institucionální prostředí, pak s přílivem PZI vysoce korelují Mnoho studií zaměřených na tyto faktory bylo ovlivněno přílivem přímých zahraničních investic jak v rozvojových zemích, tak v rozvinutých zemích Žádný z výzkumných článků však nesrovnává determinanty PZI v ASEAN3 a ASEAN5 s novou problematikou faktoru finanční integrace měřenou indexem KAOPEN, aby se zjistilo, zda má nebo nemá dopad, spolu s dalšími faktory, na příliv PZI do ASEAN3 a členských zemí ASEAN5

Z toho důvodu provedl autor této práce „srovnání determinant PZI v ASEAN3 a ASEAN5“ zaměřující se na novou problematiku faktoru finanční integrace měřenou indexem KAOPEN a na následné přezkoumání dopadu dalších faktorů, jakými jsou hrubý domácí produkt, infrastruktura, otevřenost trhu, mzdové náklady, úroková sazba, institucionální stabilita a směnný kurz, na příliv PZI

K řešení zásadní výzkumné otázky a výzkumných hypotéz použil autor této práce kvantitativní výzkumné strategie s využitím metody nejmenších čtverců aproximací

s metodou první diferenciace Tato práce má tři fáze V první fázi autor identifikuje faktory ovlivňující příliv PZI v zemích ASEAN Ve druhé fázi autor využívá ekonometrických modelů k zajištění konkrétních empirických důkazů Ve třetí části pak autor, na základě výsledků z ekonometrických modelů, vyvodí závěr Autor také poskytuje rozhovor s odborníky o dopadu těchto faktorů na atraktivitu PZI v členských zemích ASEAN, což může politikům pomoci zlepšit atraktivitu PZI jak v členských zemích ASEAN, tak i ve Vietnamu Tato práce shromáždila data z osmi členských zemí ASEAN v průběhu dvou finančních krizí v letech 1996 až 2016 Autor rozděluje členské země ASEAN do dvou skupin, ASEAN3 a ASEAN5, na základě úrovně jejich ekonomického rozvoje Výsledky naznačují, že koeficient finanční integrace je pozitivní a statisticky významný pro příliv kapitálu PZI, při statistické hladině významnosti 1% Empirické výsledky také podporují hypotézu,

že přímé zahraniční investice do ASEAN3 a ASEAN5 pozitivně korelují s velikostí trhu a vybaveností infrastruktury a negativně korelují se mzdovými náklady a otevřeností trhu v ASEAN3

TABLE OF CONTENTS

ABSTRACT 4

ABSTRAKT 6

LIST OF FIGURES AND TABLES 10

LIST OF ABBREVIATIONS AND ACRONYMS 12

1 INTRODUCTION 14

1.1 Research background and motivation 14

1.2 Research questions and objectives 18

2 LITERATURE REVIEW 20

2.1 Theories of FDI 20

2.2 Previous empirical studies of FDI determinants 23

2.3 Financial integration 27

2.3.1 Financial integration concept 27

2.3.2 Benefits and risks of financial integration 28

2.3.3 Financial integration in ASEAN countries 30

2.4 Financial integration index of Chinn-Ito 38

3.RESEARCH METHODOLOGY 48

3.1 Stages of research process 48

3.2 Definition of variable 49

3.2.1 Foreign direct investment 49

3.2.2 Financial integration 49

3.2.3 Market size 52

3.2.4 Exchange rate 53

3.2.5 Labor cost 53

3.2.6 Infrastructure facility 53

3.2.7 Institutional stability 54

3.2.8 Interest rate 54

3.2.9 Trade openness 55

3.3 Sampling and data collection 56

3.4 Statistical method 57

4.RESULT FROM QUANTITATIVE ANALYSIS 59

4.1 Descriptive statistics 59

4.2 Correlation between the variables 60

4.3 Result from regression analysis 62

5.RECOMMENDATIONS 73

5.1 Financial integration 73

5.2 Market size 76

5.3 Monetary policy 77

5.4 Trade openness 78

5.5 Institutional stability 78

6 CONTRIBUTION TO SCIENTIFIC AND PRACTICAL KNOWLEDGE 81

6.1 Contribution to scientific knowledge 81

6.1.1 Developing and introducing models, indicators for FDI determinants in ASEAN 81

6.1.2 Providing approaches, findings, and suggestions from previous relevant studies 81

6.1.3 Acquiring a deeper understanding of FDI determinants in ASEAN 81

6.1.4 Adding theoretical contribution to studies of FDI determinants 82

6.2 Contribution to practice knowledge 82

6.2.1 Providing critical evaluation of FDI in ASEAN 82

6.2.2 Practicality of this study’s approach 82

6.3 Contribution to education 83

7 CONCLUSION AND SUGGESTIONS 84

7.1 Conclusion 84

7.2 Suggestions for future research 84

BIBLIOGRAPHY 86 LIST OF THE PUBLICATIONS BY THE AUTHOR 98 AUTHOR’S PROFESSIONAL CURRICULUM VITAE 100

LIST OF FIGURES AND TABLES

Figure 2.1: Gross domestic product: Annual average growth rate, 1995 -2015 32

Figure 2.2: Gross domestic product: Annual average growth rate in selected Asian countries, 1995 -2015 33

Figure 2.3: Exports and imports of goods and services, annual, 2005-2016 (US Dollars at current prices in millions) 35

Figure 2.4: FDI inflows and financial integration in ASEAN 1996-2015 36

Figure 2.5: Foreign direct investment in ASEAN 1996-2016 37

Figure 2.6: Financial integration measured by the KAOPEN index of ASEAN 47

Figure 3.1: The stages of the research 48

Figure 3.2: FDI inflows into Asean from 1990 to 2016 51

Figure 3.3: The theoretical framework 56

Figure 3.4: The observed and unobserved effects influencing to FDI 58

Figure 5.1: ASEAN 2025 Vision 74

Table.1.1: FDI policies of ASEAN 14

Table 1.2: FDI inflows in ASEAN3 and ASEAN5 countries (millions of USD) 16

Table 2.1: ASEAN Countries: Economic Indicators 34

Table 2.2: Summary of the features of exchange arrangements and regulatory frameworks for current and capital transactions in IMF member countries Examples are taken from Vietnam 39

Table 2.3: Regulations on cross-border portfolio investments in selected ASEAN countries 40

Table 2.4: Comparison of financial integration measures 43

Table 3.1: Top 5 according to the total FDI inflows between 1990 and 1996 50

Table 3.2: FDI inflows into ASEAN from 1990 to 2016 50

Table 3.3: Summary of the factors influencing FDI in ASEAN 56

Table.4.1: Descriptive statistics 59

Table 4.2: The correlation matrix of ASEAN3 60

Table 4.3: The correlation matrix of ASEAN5 61

Table 4.4: Variance inflation factor (VIF) of ASEAN3 and ASEAN5 61

Table 4.5: The parameter estimates of ASEAN3 62

Table 4.6: The parameter estimates of ASEAN5 63

Table 4.7: Total external debt in ASEAN5 (1996-2002) - (in millions $) 65

Table 4.8: Imports of goods and services in ASEAN5 (1996-2002) - (in millions $) 65

Table 4 9: Trade of goods and services in ASEAN3 and other economic countries (% GDP) 67

Table 4 10: The global competitiveness index 2016-2017 rankings 68

Table 4.11: Summary of empirical findings result in ASEAN3 70

Table 4.12: Summary of empirical findings result in ASEAN5 71

Table 5.1: Some recommendations towards achieving regional financial integration goals by 2025 75

Table 5.2: The focus targets of the ASEAN Community 77

Table 5.3: Four key areas and several suggested recommendations in addressing anti-corruption challenges 79

LIST OF ABBREVIATIONS AND ACRONYMS

ACAs Anti-Corruption Authorities

AEC ASEAN Economic Community

ADB Asian Development Bank

AFFTA American Fly Fishing Trade Association

APAC Asia Pacific Accreditation Cooperation

AIC ASEAN Integrity Community

AREAER Annual Report on Exchange Arrangements and Exchange Restrictions ASEAN Association of Southeast Asian Nations

CSP Cyber Security Program

FDI Foreign Direct Investment

GDP Gross Domestic Product

ICT Information & Communication Technology

IMF International Monetary Fund

ISO International Organization for Standardization

MNCs Multinational Corporations

MNEs Multinational Enterprises

NAFTA North American Free Trade Agreement

OECD Organisation for Economic Co-operation and Development

POLS Panel ordinary least square

RIA Regional integration agreements

TWMNCs Third World MNCs

UNCTAD United Nations Conference on Trade and Development

1 INTRODUCTION

1.1 Research background and motivation

Foreign direct investment (FDI) contributes greatly to the economic development

of the host country by promoting the factors of economic growth of a country, i.e transfer of capital and new technologies As a result, the attraction of foreign direct investments is getting more and more attention from economists and policymakers

On the one hand, FDI adds to the stock of domestic capital and increases the efficiency of production factors such as raw materials and labor as input Moreover, FDI contributes to diversify the economy by adding new economic actors and promotes the competition to produce better products at lower prices in the host country Consequently, the ability to produce goods and services in the host country

Table 1.1: FDI policies of ASEAN Source: Adopted from the research of

Xaypanya et al (2015)

Singapore

Reduces business expenses as part of a cost reduction package amounting to S$ 10 billion in savings and extends 30% corporate investment tax allowance to industrial projects and to several selected service industries like manufacturing, engineering, and technical services and computer-related services

Thailand Allows 100% foreign equity ownership for manufacturing

investment projects regardless of locations

Malaysia

Offer 100 % foreign-equity ownership in the manufacturing sector without imposing export conditions on new investments, expansions and diversifications With limited exceptions, foreigners have direct ownership of land and property in Malaysia

Indonesia

Offers wholesale and retail trade up to 100% foreign equity ownership to qualified investors, in addition to 100% foreign equity in the manufacturing sector, and reduces the processing time for approval of investments less than US$100 million, to 10 working days Banks are open for 100% foreign equity ownership

• Tax incentive in securities exchange: (i) 10% of tax on profit for securities companies; and (ii) 50% reduction of withholding taxes on interest and dividend distribution for public investors

promoted investment projects

Vietnam

• Offers duty exemptions for imported capital goods for all projects, on the importation of raw materials for production in encouraged investments and for projects located in mountainous

or remote regions during the first five years of operation

• The period required for the issuance of investment licenses for several types of the project has been reduced to 15 days from the receipt of the required documentation Investment licensing for projects under the US $5million in Viet Nam has been decentralized to provincial and city levels

A highlighted point, the ASEAN region is not really homogeneous, which leads

to the impact of economic factors on FDI inflows would be significant different in

each region in the area (Xaypanya et al., 2015) They found that the differences

between ASEAN3 (Vietnam, Laos, Cambodia) and ASEAN5 (Indonesia, Malaysia,

Philippines, Thailand, Singapore) raised interesting questions for both academics

and policymakers regarding why the two groups of countries performed differently

in attracting FDI inflows According to the recent data from the United Nation

Conference on Trade and Development (UNCTAD) (2019) in Table 1.2, compared

to other ASEAN nations, Singapore is the largest source of FDI Thailand, Malaysia,

Indonesia and the Philippines also continue to attract FDI inflows into their

countries Another report of UNCTAD (2018) indicated foreign investor around the

world have considered the least developed countries in ASEAN such as Cambodia,

Laos, and Vietnam their ideal investment destinations after the trade war between

China and America broke out Adopting this approach, this study divides the

ASEAN member countries into two groups based on their level of economic

development: ASEAN3 (Cambodia, Laos, and Vietnam) and ASEAN5 (Indonesia,

Malaysia, Philippines, Thailand, Singapore) Moreover, Brunei and Myanmar are

removed from this study due to data limitations

Table 1.2: FDI inflows in ASEAN3 and ASEAN5 countries (millions of USD)

Source: UNCTAD statistics online (accessed September 2019)

to study the factors that influence FDI inflow in ASEAN Based on the eclectic paradigm theory of Dunning (1988), the factors affecting FDI inflows can be separated into observable and unobservable effects This theory is based on the OLI conditions (OLI stands for Ownership, Location, and Internalization): Ownership specific advantages (‘Why’ operate in a foreign country?), Location advantages (‘Where’ do firms produce in a particular host country?), and Internalization advantages ('How' do they compete in the domestic market of the host country?) In this study, the author defined the location-specific advantages as the observable effects, and two advantages of the ownership-specific and internalization as unobservable effects, which can be time-variant or time-invariant According to OLI conditions of Dunning (1988), the observable effects are composed of macroeconomic stability (measured by the exchange rate, interest rate, institutional stability), market size (measured by GDP), infrastructure facility (measured by the fixed telephone subscriptions), level of openness (measured by the trade openness), low cost of labor (measured by labor cost) The unobservable effects, which can be time-variant or time-invariant namely government policies, licensing, law and

management skills, etc However, the outcome and conclusions in previous studies failed to address the issue of being biased, unrobust, and ungeneralized Moreover, financial integration is a new factor in the topic of FDI determinants Many studies mentioned the effect of financial liberalization policies on economic performance, however, unable to properly measure financial integration (Chinn et al., 2009) They introduced the scale of ‘Impossible Trinity’ theory and developed a set of “trilemma indexes.” namely monetary independence, exchange rate stability, and financial openness Financial integration is one of the aspects of the 'Impossible Trinity' theory This theory was developed in the field of international economics and it was formulated by Robert Mundell and Marcus Fleming in the 1960s Financial integration allows more capital flows to enter the economy It helps citizens of the host country to diversify their assets through offshore investing and it also encourages foreign investors to bring resources, experience and technology in the receiving countries To measure financial integration, there are three broad categories: de jure, de facto, and hybrid indicators KAOPEN index is a new approach, which also has been neglected in previous studies (Quinn et al., 2011) This study has used the data of financial integration measured by KAOPEN index

of Chinn et al (2009) for research purposes

This study aims to investigate the comparison of FDI determinants in ASEAN3 and ASEAN5 Firstly, identify FDI determinants in ASEAN3 and ASEAN5 based

on eclectic paradigm theory of Dunning (1988) Secondly, test the new factor of financial integration based on KAOPEN index Thirdly, compare the differences in FDI determinants between ASEAN3 and ASEAN5 The study sheds some light on what ASEAN3 and ASEAN5 should do to improve aspects of attracting higher FDI

as well as a new trend for scholars in the field of FDI

The rest of the dissertation is organized as follows Section 2 discusses the literature review and financial integration in ASEAN countries Section 3 presents the research methodology adopted in this study The results, recommendations, contributions and conclusions are in Sections 4, 5, 6 and 7 respectively

1.2 Research questions and objectives

This study will address the critical issue for FDI attraction in ASEAN3 and ASEAN5 The main research question is set out as follows:

RQ: What is the difference of FDI determinants between ASEAN3 and ASEAN5?

According to the research question above, the main research objective and three sub-objectives of this study are as follows:

RO: To identify and compare FDI determinants between ASEAN3 and ASEAN5

RO1: To identify FDI determinants in ASEAN3 and ASEAN5 based on eclectic paradigm theory of Dunning (1988)

RO2: To test financial integration defined in terms of KAOPEN index

RO3: To compare the differences in FDI determinants between ASEAN3 and ASEAN5

2 LITERATURE REVIEW

To be able to understand and answer the research question “What is the difference

of FDI determinants between ASEAN3 and ASEAN5?” this section will describe the development of FDI in emerging markets and the trend of FDI in ASEAN countries through FDI's theories Afterward, financial integration in ASEAN countries is discussed Finally, this section will present the findings of FDI determinants from previous existing studies

2.1 Theories of FDI

A significant contribution made to the literature on FDI was made by Steven Hymer (1960) and Charles Kindleburger (1969) when they developed the market imperfection theory that considered where enterprises developed coherent strategies for companies to expand their businesses through capitalizing on their clear advantages over the local firms Such overseas operations require more care, time and effort but local advantages enable the enterprises to maximize the financial returns Kindleburger (1969) proposed that it was market imperfections in the host country that provide the opportunities for FDI Rather than searching for perfect competition sites, the investor takes advantage of product differentiation, economies

of scale, advanced skill in marketing, high technology access, better management skills, positive government and their improved access to capital to take advantage of the host countries imperfections in the market Although the investor inherits the problems of operating in a new environment, these are counterbalanced by their advantages in competing

In the research of FDI theories, the eclectic theory of Dunning became a common analytical framework for understanding FDI as it successfully combined the understanding of determinants of FDI with other theories such as organizational theory, location theory, and market imperfections approach The eclectic method is based on the OLI conditions (OLI stands for Ownership, Location, and Internalization): Ownership specific advantages (‘Why’ operate in a foreign country?), Location advantages (‘Where’ do firms produce in a particular host country?), and International advantages ('How' do they compete in the domestic market of the host country?) The conglomeration of the effects of these inter-related pathways is thought to define the patterns and extent of FDI success The theory helps to analyze why, where, and how FDI enterprises operate in host countries

(Dunning, 1988) Investors grab the investment opportunity to exploit their ownership-specific advantages and to expand abroad by engaging in FDI (Dunning, 1988) The form of intangible assets of the common governance advantages provide for the overall positive advantages of the FDI enterprises and factors such as unlicensed secret technology, management knowledge advantages, and access to foreign markets make the FDI more beneficial than the one of their rivals (Xuemin and Decker, 2004) The multinational enterprises (MNEs) use their advantages in the internalization incentives to maximize their specific strengths across borders while maintaining the positions within their organization Their preference is to internalize their benefits rather than take the risks of licensing them The I factor is

a result of market imperfections and it is mainly concerned with the interrelation between ownership and internalization advantages Internalization enables the enterprise to acquire further ownership advantages such as an increase of its assets (Dunning, 1988) Location-specific advantages are the primary condition for MNEs

to expand MNEs combine their ownership-specific advantages with the positive factors of the host country in those areas, such as more substantial markets, population growth, etc., combined with infrastructure advantages, political stability and positive factors, e.g stable interest rates, beneficial tax and the balance of trade (Rugman, 1982) Thus, the macro-levels of the economy help to determine the location, size, and type of FDI

A growing body of literature has examined the structure of international trade.Ricardo (1817) and Smith (1776) put forward their approach, suggesting the theory about explanations of trade flows between nations Smith developed his method on the basis of the competitive advantage of each country Given by Adam Smith, the theory of absolute advantage stated that international trade would occur if one country that was more efficient (had an absolute advantage) in the production of one commodity or technology An absolute advantage means that one can produce more

of a good or service than its competing entities using less of a given resource However, the failure of Smith's theory is the inability to explain the absolute advantage of one country Elaborating Smith's theory to more general framework, Ricardo formulated the theory of comparative advantage This theory was based on differences in labor productivity between both countries which provide incentives for trade The academicians contended that countries would export products that utilize their relatively abundant and cheap factors of production and import products that use the scarce factors (Heckscher 1919, Ohlin 1933) However, these theories

did not provide an answer to the question concerning overseas production as these theories were based on the assumption of international immobility of factors of production In 1966, Vernon proposed his theory, successfully combining international trade and international investment

Vernon’s theory was called “Product Life Cycle Theory” and it provides an explanation for factors such as the availability of larger and cheaper capital, superior management, the discovery of new markets, etc Vernon’s theory was used to explain certain types of foreign direct investment made by U.S.-based firms in Western Europe in the manufacturing sector during the period of 1950-1970 following World War II The U.S has become an importer of many of the goods that

it had once exported The product life cycle involves three stages: (1) The invention and introduction of new product; (2) The process of bringing a product from perfect

to mature; (3) The standardization of the product itself In the first stage, new products hitting the market were not able to generate any profit as the costs of the introduction outweighed the profits In the following, the products were welcomed and consumed rapidly by the market As products matured, a certain degree of standardization took place Then there were others imitating those products There was competition between firms making the same products and pricing became the main competitive tools and cost became a more serious issue As a matter of fact, production was moved to other countries on the basis of its cost Products were then exported to the US by US based firms In brief, we can see how FDI began to appear

in the second phase of a business cycle However, the products did not improve One of the main limitations of these studies is that they neglected the structure of vertical and horizontal FDI Helpman (1984) showed a model of international trade where firms decide to invest in the domestic market and then export to other countries He believed that heterogeneity influenced every industry; thus, the productivity of firms can vary As a result, firms are organized based on their productivity The least productive firms which cannot generate enough profits will have their businesses shut down Meanwhile, low-productivity firms can only operate only in their local markets Firms can operate abroad via two ways which are through FDI and selling commodities by exports In other words, the reason that all firms choose to engage in FDI is to avoid transportation expenses According to theory of horizontal FDI, this is called "the proximity-concentration trade-off"

2.2 Previous empirical studies of FDI determinants

The factors that impact the FDI into developing countries have been presented in numerous research articles The experimental studies of Hussain and Kimuli (2012), using data collected from 57 low- and middle-income countries for the period of

2000 – 2009, showed that countries with high a GDP rate, a fast GDP growth and a favorable business environment can better attract FDI Many other researchers also focused on this topic

Hussain and Kimuli (2012) explored the different factors responsible for variation into FDI to developing countries They used a macro panel data of 57 low and lower-middle-income countries selected from a timespan of ten years (2000-2009) Their model includes seven independent factors such as market size, inflation rate, tariff rate on imports, secondary enrollment rate, money supply to GDP ratio and two dummy variables that are country- and time-specific The findings revealed that developing countries could attract FDI by focusing on increasing their market size and promoting more liberal trade policies Moreover, improving the quality of the workforce, developing financial institutions and maintaining low inflation rate can help countries to attract FDI The main limitation of their research was that only 215 observations out of a total of 570 collected in 57 countries in ten years were used In addition, 355 observations were missing

Nunnenkamp (2002) used survey data from the European Round Table of Industrialists on investment conditions in 28 developing countries since late 1980s The model included six independent factors which affected FDI inflows such as population, GDP per capita, GDP growth, administrative bottlenecks, entry restrictions and risk factors of host countries Surprisingly, the study found out that little had changed so far Meanwhile, there was a correlation between FDI and non-traditional determinants such as cost factors, complementary factors of production and openness to trade

Khachoo and Khan (2012) analyzed determinants of FDI inflows into developing countries over a long period The study was based on a sample of 32 developing countries in order to establish a panel data estimator The study considered GDP, foreign exchange reserves, wage cost, infrastructure development and trade openness to identify the factors that affect FDI inflows Empirical results showed that the coefficients of GDP, foreign exchange reserves, wage cost and infrastructure development were significant whilst trade openness was not meaningful Therefore, international investors did not consider the importance of the trade openness of the

receiving investment when deciding where to set up subsidiaries This is contradictory to some of the theories as well as to some empirical studies Garibaldi

et al (2001), Compos et al (2003), but it is suitable for the tariff jumping hypothesis, which argues that the nature of FDI into most developing countries is either market-seeking or tariff-jumping in order to avoid trade restrictions The results of the study suggested that developing countries should improve the infrastructure system, accumulate foreign exchange reserves and encourage GDP growth to attract inflows

of FDI

Tomio et al (2010) estimated a panel data model to deliver results supporting the hypothesis that FDI into Latin America is positively correlated to its economic stability, growth and trade openness, and improvement in the institutional and political environment However, a key variable failed to deliver the expected result

- the government effectiveness had a negative relation with the dependent variable Meanwhile, researchers found evidence that developing markets can offer MNCs many incentives to lessen production costs or to gain access to abundant resources FDI is an important factor in mots developing countries in South-Eastern Asia Cuyvers et al (2011) highlighted the success of Cambodia in attracting FDI with a

study, namely the Determinant Factors on Foreign Direct Investment in Cambodia

Based on the Cambodian Investment Statistics of CIB (1994–2004), Cambodia attracted FDI for about 5,313 million USD in the form of fixed assets during 1994–

2004 There are two main modes of FDI entry in Cambodia: Cambodian-foreign joint ventures and wholly foreign-owned enterprises The factors determining FDI into Cambodia included market size, international trade, labor costs, lending interest rate/borrowing costs, exchange rates, inflation rate, political risk, regional integration, and geographic distance The research paper analyzed panel data sets between 1995-2005 The results indicated that the determinants of approved and realized FDI are somehow similar GDP and exchange rate of the host country had

a positive impact on inward FDI flows into Cambodia As expected, geographical distance negatively affected the level of FDI inflows into Cambodia

Kolstad and Villanger (2008) studied a panel data considering 57 countries for the period between 1989-2000 to reach the conclusion that the service sector is dominant

in world foreign direct investment flows The 57 countries included developing, transition and developed economies The model consisted of eleven independent and dependent variables which represent logged FDI inflows per capita in the service sector as a whole and in each of the major service industries including finance,