The Determinants of Foreign Direct Investment in

Southeast Asian Transition Economies

*
Wen-Jen Hsieh and Min-Ching Hong

The paper investigates the determinants of foreign direct investment (FDI) in four Southeast Asian
transition economies: Cambodia, Laos, Myanmar, and Vietnam. These four countries have started
their respective economic reforms since the late 1980s and attracting FDI inflow has become an
essential economic policy. A dynamic panel data model with fixed effect is employed to analyze the
locational determinants of FDI inflows in these four countries for the period of 1990 to 2001. The
determinants are grouped into three categories: macroeconomic factors, cost-related factors, and
investment environment improving factors. Additionally, a dummy variable to proxy the 1997 Asian
financial crisis and a lagged dependent variable to illustrate agglomeration effects are included in the
model. The estimated results suggest the key determinants are the agglomeration effects, GDP per
capita, and degree of openness, all of which have significantly contributed to attracting FDI, while the
Asian financial crisis has deterred FDI inflows in these countries. The adverse impact of the Asian
financial crisis on FDI inflows in these four indirect crisis-hit countries, clearly demonstrates the
importance of attracting appropriate FDI, from well diversified sources and destined for diversified
industries, to mitigate any possible damage from regional crises. Moreover, the only category of
determinants found to be significant in attracting FDI is the fundamental macroeconomic factors.
The findings indicate that the governments should explore the agglomeration or self-supporting
economies, enlarge GDP per capita, and adopt open-door policies to successfully attract FDI.

. Introduction

One of the key components in the movement towards economic globalization is

international capital flows, of which primarily are portfolio investment and foreign
direct investment (FDI). The definition of FDI used in this paper is an investment
involving a long-term relationship and reflecting a lasting interest of a resident entity
in one economy in an entity resident in an economy other than that of the investor
(Lindblad, 1998: 1). Cambodia, Laos, Myanmar and Vietnam all have actively
welcomed FDI activities since the late 1980s. FDI inflows are seen as one method
of boosting economic growth and assisting in the transition process, including
economic reforms and business liberalization measures, underway in these four
countries. The still evolving laws and regulations pertaining to FDI activity are
relatively liberal. For example, 100% foreign-owned business ventures across a
fairly wide range of business sectors are generally permitted. As FDI inflows have
accrued, and confidence has grown, the foreign investment regimes have continued to
improve in these host countries. There is little doubt that considerable progress has
been made over the last decade in the field of FDI activity in Cambodia, Laos,
Myanmar and Vietnam.
The term transition economies often refers to central and east European countries,
especially the Commonwealth of Independent States. In this paper, we employed a

*
Hsieh: Dept. of Economics and Graduate Institute of Political Economy, National Cheng Kung
University, One University Road, Tainan [70101], Taiwan, R.O.C. Fax: (+886) 6-276-6491, Tel: (+886)
6-275-7575 ext. 50260, E-mail: whsieh@mail.ncku.edu.tw.. Hong: Graduate Institute of Political
Economy, National Cheng Kung University, One University Road, Tainan [70101], Taiwan, R.O.C.
The original manuscript was presented at the International Symposium on Foreign Trade, FDI, and
Industrial Development at National Chung Cheng University, Chia-Yi, Taiwan, on March 27, 2004. We
are grateful to Professor P.C. Li of National Sun Yet-Sen University for exceptionally helpful
comments. The usual disclaimer applies.

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broader definition of transition economies by emphasizing two main characteristics:
1) movement from a command-based to a market-oriented economic system and 2)
most of the countrys capital stock in industrial sector is obsolete prior to the reforms
taking place. Hence, in this paper, transition economy is defined as a nation that has
initiated a process of gradual sequencing or rapid comprehensive reforms and
consequently resulted in major economic structural changes; whether the nation is a
socialist economy is not a major concern. In other words, the term transition
economies is simply used here as a short hand collective noun to depict the four
countries of the sub-region of Southeast Asia, without particular political, historical or
other connotation intended. The four transition economies were socialist regimes
after the mid-1970s, however, peacefully transformed into more market friendly in the
late 1980s. In the transition process, FDI is perceived as a catalyst as it can bring not
only less volatile capital flows but also the technology and managerial know-how
necessary for restructuring firms.
The objective of this paper is to investigate the determinants of FDI in Cambodia,
Laos, Myanmar and Vietnam. These transition economies present an extremely
valuable, but so far little utilized object of empirical research, at least, partly owing to
the availability of data. Much of the detailed data of the four countries are missing
from international economic organizations or institutes. A dynamic panel data
model is constructed utilizing data from 1990 to 2001 from the four transition
economies to make an empirical study of the locational determinants of FDI inflows
in the four transition economies. This paper is organized as follows. In the next
section, we describe the FDI experience of the four transition economies in Southeast
Asia. Section 3 reviews major findings from literature related to FDI determinants.
A dynamic panel data model with fixed effect and the variables to be tested as the
determinants of FDI inflows are discussed in section 4. Section 5 reports
econometric results, and section 6 concludes the paper.

. FDI Experience in Cambodia, Laos, Myanmar and Vietnam

When looking at FDI activities in the four transition economies in Southeast Asia,
one tends to focus on the inflow of foreign capital that has occurred over
approximately the last decade, as part of the economic transition process that these
countries have undergone since the late 1980s. Since foreign private capital was
generally not permitted into the four countries in the years preceding their opening
up, the governments of these countries have experienced a steep learning curve;
learning how to attract, retain, sustain, manage, harness, and monitor FDI inflows.
Cambodia, Laos, Myanmar and Vietnam have similar experiences with FDI inflows.
There are similar experiences with FDI inflows among the four countries. These
countries broadly opened up to foreign investment at roughly the same time, issuing
and subsequently improving quite liberal foreign investment laws and implementing
regulations. FDI was relatively quick to respond to the promulgation of foreign
investment laws in the four countries, and aggregate FDI inflows have been quite
admirable. Table 1 illustrates the sizes of FDI inflows and their shares of gross
domestic product (GDP) in Cambodia, Laos, Myanmar and Vietnam; FDI peaked in
the period of 1996-7 and has not yet returned to the pre-crisis peaks. All four
countries are members of the Association of Southeast Asian Nations (ASEAN) and
are committed to various initiatives relating, directly or indirectly, to foreign
investment activity, including the ASEAN Free Trade Area (AFTA) and the ASEAN
Investment Area (AIA). These regional initiatives will have some influence, to a

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 Table 1The sizes of FDI inflows and their respective shares of GDP
Unit: Million US$, %
Year Cambodia Laos Myanmar Vietnam
1989 109.0 (7.57) 4.0 (0.56) 7.8 (0.29) 100 (1.60)
1990 94.2 (6.58) 6.0 (0.70) 161.1 (6.20) 120 (1.85)
1991 20.0 (1.05) 6.9 (0.68) 238.1 (11.22) 220 (2.88)
1992 33.0 (2.19) 7.8 (0.67) 171.6 (7.30) 260 (2.64)
1993 54.1 (2.81) 35.8 (2.74) 104.7 (3.68) 300 (2.28)
1994 69.0 (2.89) 59.2 (3.90) 126.1 (3.01) 1048 (6.44)
1995 150.7 (5.16) 88.4 (5.11) 277.2 (5.44) 1780 (8.58)
1996 293.7 (9.38) 128.0 (7.00) 310.4 (6.26) 2395 (9.71)
1997 168.1 (5.14) 86.3 (5.04) 387.2 (8.31) 2220 (8.27)
1998 108.0 (3.60) 45.3 (3.58) 314.5 (6.39) 1671 (6.14)
1999 131.0 (3.98) 51.6 (3.57) 253.0 (3.88) 1412 (4.92)
2000 126.0 (3.77) 33.9 (1.97) 254.8 (3.67) 1298 (4.14)
2001 115.0 (3.38) 23.9 (1.38) 217.7 (4.63) 1300 (3.92)
Note: The ratios of FDI inflows to their respective GDP are listed in parentheses.
Sources: Cambodia: Asian Development Bank, Key Indicators: Cambodia. Website: http://www.adb.
org/Documents/Books/Key_Indicators/2002/CAM.pdf. Laos: Asian Development Bank, Key
Indicators: Laos. Website: http://www.adb.org/Documents/Books/Key_Indicators/2002/LAO.pdf.
Myanmar: Asian Development Bank, Key Indicators: Myanmar. Website: http://www.adb.org/
Documents/Books/Key_Indicators/2002/MYA.pdf; and Economist Intelligence Unit, Country Report
November 2002: Myanmar (London: EIU, 2003), p18. Vietnam: Asian Development Bank, Key
Indicators: Vietnam. Website: http://www.adb.org/Documents/Books/Key_Indicators/2002/VIE.pdf.

greater or lesser extent, on the overall FDI profiles of the four transition economies
and partially drive future FDI policies, such as the issue of national treatment.
Another similarity in these four countries FDI experience relates to the foreign
investment data itself. Although great strides have been made to improve the
accounting of foreign investment data in these countries, it remains quite difficult to
get an accurate and up-to-date profile of FDI activity. The disparity between the large
amount of approved or pledged FDI inflow figures and the more humble disbursed or
committed FDI inflow figures are quite considerable (particularly in Laos, where a
handful of mega-projects have been approved but not yet implemented). The kinds
of data limitations are by no means unique to these four transition economies, but they
are common to many less-developed countries (LDCs), and make it quite difficult to
get anything more than a broad impression of FDI patterns (Table 2). The four
transition economies have also found it quite difficult to attract foreign private capital
into major infrastructure projects. Among all FDI receiving industries, the hotel and
tourism industry stands out as one of the main attractions; however, due to poor
infrastructure in rural areas, this industrys development will remain limited. Some
FDI activity has been oriented towards serving the domestic market, particularly in
the early part of the 1990s, but a considerable element has been attracted to these
countries as platforms for export-oriented production. The FDI inflows in these
countries are not supported by foreign (equity) portfolio investment in the host
countrys stock markets. Cambodia, Laos and Myanmar have never had an equity
market, whilst Vietnams young equity market remains small.
However, the business sectors in which FDI activity has been most prominent have
differed in the four countries and are largely conform to the perceived resource

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 Table 2Major FDI receiving industries
Unit: %
Cambodia Laos Myanmar Vietnam
Rank
(1994-2001) (1988-2001) (1990-2001) (1988-2001)
Hotel & Tourism Hydro Power Oil & Gas Heavy Industry
1
(44%) (53%) (33%) (19%)
Garment Telecommunication & Transportation Manufacturing Hotel & Tourism
2
(11%) (6.8%) (22%) (12%)
Cement Hotel & Tourism Real Estate Development Light Industry
3
(6.7%) (6.5%) (14%) (11%)
Wood Processing Industries-Handicrafts Hotel & Tourism Oil & Gas
4
(6.5%) (5%) (12%) (10%)
Agriculture Wood Industries Mining Construction
5
(5%) (2%) (7%) (9%)
Note: The ratios of cumulative FDI to the total FDI inflows are indicated in parentheses.
Source: ASEAN Promotion Centre on Trade, Investment and Tourism, ASEAN-Japan Centre. Website: http://www.asean.or.jp/eng/index.html.

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strengths and comparative advantages of the respective host economies. In Laos, for
example, less than ten individual FDI projects related to energy generation (primarily
hydropower) have dominated the countrys aggregate FDI inflows. As shown in
Table 2, the energy generation sector has accounted for 53% of cumulative FDI
inflows since 1988. In Cambodia, the hotel and tourism industry counted for as high
as 44% the countrys cumulative FDI since 1994. Nevertheless, due to large
garment quotas for some export markets, more than one-third of the FDI projects in
the manufacturing sector relate to garment projects. In Myanmar, the oil and gas
sector has accounted for 33% of cumulative FDI inflows since 1990. In contrast,
Vietnams FDI activity is more widely distributed across sectors, with fairly
substantial foreign investment activity recorded in such areas as: heavy industry,
tourism, light industry, oil and gas, and construction.
The home country sources of FDI in these four transition economies have also
differed substantially. Table 3 lists the top five home countries of FDI sources in the
four countries. As the major capital exporter in Southeast Asia, it is no surprise
that Singapore features in the top ranking of FDI sources for three out of four
countries under study (as indicated by cumulative FDI inflows from the home country
as a percentage of total FDI inflows in the host country): Cambodia (5%), Myanmar
(19%) and Vietnam (15%). Malaysia and Thailand are also top FDI sources in
Cambodia, Laos and Myanmar. Particularly, Cambodia and Laos cumulative FDI
inflows have been dominated by Malaysia and Thailand, both accounting for 51% of
total cumulative FDI inflows into each of the two countries. The other principal FDI
sources in the region are Taiwans investments in Cambodia and Vietnam, the USs
investments in Laos and Myanmar, South Koreas investments in Laos and Vietnam,
and more recently, mainland Chinas investments in Cambodia and Laos. It is worth
noting that not only are there relatively few business synergies among these four
transition economies but that the four countries are competing with each other to
attract FDI inflows in certain business sectors.
Tables 1-3 clearly illustrate that Vietnam has outperformed the other three countries
since 1992. For Vietnam, improvements in international relations, such as the ending
of the investment embargo in February 1994 and the granting of normal trade
relations in June 1995 by the U.S. and accession to the Association of Southeast Asian
Nations (ASEAN) in July 1997, as well as the improvement in domestic hard and soft
infrastructure, attracted FDI inflows. The FDI inflows in Vietnam is not only more
widely distributed across sectors, but also more diversified in terms of home country
sources. This more diverse spread makes Vietnams aggregate FDI inflows less
vulnerable to an economic downturn occurring in just one or two countries or
production sectors. In marked contrast to Vietnam, such FDI inflow diversity is not
apparent in the other three countries.

. Literature Review

What specific host country characteristics attract FDI? The emerging consensus is
that the answer crucially depends on the motives of foreign investors in undertaking
investment projects. According to the eclectic theory of Dunning (1993), there are
three types of FDI. The first is market-seeking FDI whose purpose is to serve local
and regional markets. Second, when firms invest abroad to acquire resources not
available in the home country, FDI is said to be resource- or asset-seeking.
Resources may be natural resources, raw materials, or low-cost inputs such as labor.
Especially in the manufacturing sector, when multinationals directly invest in order to

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 Table 3Major home countries of FDI sources in each host country
Unit: %
Cambodia Laos Myanmar Vietnam
Rank
(1994-2001) (1988-2001) (1990-2001) (1988-2001)
Malaysia Thailand Singapore Singapore
1
(51%) (51%) (19.4%) (15%)
Taiwan United States United Kingdom Taiwan
2
(12%) (26%) (19.2%) (13)
China South Korea Thailand Japan
3
(8%) (11%) (17%) (9%)
Singapore Malaysia Malaysia Hong Kong
4
(5%) (5%) (8.4%) (8%)
Thailand China United State South Korea
5
(4%) (1%) (8.1%) (8%)

Total 80% 94% 72.1% 53%

Note: The ratios of cumulative FDI received from individual home countries to total cumulative FDI inflows into each of the host country are shown in parentheses.
Source: ASEAN Promotion Centre on Trade, Investment and Tourism, ASEAN-Japan Centre. Website: http://www.asean.or.jp/eng/index.html.

136
export, factor cost considerations become important. Third, the foreign investment
is said to be efficiency-seeking when the firm can gain from the common governance
of geographically dispersed activities in the presence of economies of scale and scope.
All these suggest that countries possessing a large market, low-cost labor, abundant
natural resources, and are close to the major Western markets should be able to attract
large amounts of FDI inflows. FDI would thus go to countries with favorable initial
conditions.
Gastanaga, et al. (1998) adopted John Dunnings eclectic theory to examine the
effects of FDI related policies for forty-nine LDCs during the period of 1970 to 1995.
The estimated results vary with different models utilized; however, the authors
claimed the importance of policy and institutional factors on FDI inflows. Billington
(1999) investigated the locational determinants of FDI inflows in Britain. The
explanatory variables included the size and the potential of the market, the
expenditure on infrastructure, unit labor cost, trade balance, interest rates, population
density, unemployment, and corporate tax. The estimated results suggested that the
size of the market, unit labor cost, interest rates, population density, unemployment,
and corporate tax are relevant to FDI inflows.
Cassou (1997) utilized panel data to examine the linkage between tax rates and FDI
inflows to six advanced economies. He demonstrated that the corporate tax and
income tax are the most dominant factors on FDI. Nevertheless, other variables such
as the relative unemployment rates, GDP, and real exchange rates between the host
and home countries are also influential on FDI inflows. Bevan and Estrin (2000)
also employed a panel data model to investigate the determinants of FDI inflows into
eleven transition economies during the period of 1994 to 1998. The estimated
results suggested that FDI inflows are related to four categories of determinants:
country risks, unit labor costs, sizes of local markets, and gravity factors.
Furthermore, the findings indicated that the announcement of EU accession and the
one-period lagged country credit rating have a positive impact on FDI inflow.
Lucas (1993) investigated determinants of FDI inflows in seven East and Southeast
Asian economies. Using data from 1960-87, he found FDI inflows are dominantly
determined, by the prices of capital and product for five out of seven countries.
Yang et al. (2000) studied the determinants of FDI inflows in Australia by using
quarterly data for the period of 1985 to 1994. The determinants were the interest
rate, real wage rate, GDP, degrees of openness and industrial competitiveness,
exchange rate, and inflation rate. They found the interest rate, real wage rate, degree
of industrial competitiveness are positively related to FDI; while the degree of
openness is negatively related to FDI inflows in Australia.
Bende-Nabende et al. (2000) established a vector autoregression (VAR) model to
study the locational determinants of long-term FDI inflows in five East Asian
economies during the period of 1986-1996. They grouped the potential determinants
into four categories: macroeconomic and political ideological changes, cost-related
factors, and investment environment improving factors. The estimated results
suggested that cost-related factors, especially, the real wage rate and semi-skilled
labor, play a dominant role in determining FDI inflows. In a recent paper,
Bende-Nabende (2002) utilized co-integration analysis to examine the determinants of
FDI inflow in nineteen Sub-Sahara African nations for the period of 1981 to 2000.
The regression results found the economic growth rate, export-oriented policies and
liberalization of FDI are the dominant factors on FDI inflows. Moreover, the real
exchange rate and the size of the market also play roles in determining FDI.
Nguyen and Haughton (2002) employed a dynamic panel data model to study the

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relationship between trade liberalization and FDI in Vietnam. For the period of 1990
to 1999, panel data from 16 Asian countries were utilized to forecast the magnitude of
the impact of the bilateral trade agreement (BTA) signed by the U.S. and Vietnam in
December 2001. The estimated results suggested that the BTA would attract 30% of
FDI for the year 2002 and contribute an additional 0.6% to the growth rate annually
starting from 2002. Moreover, the lagged FDI, real exchange rate, export as a
percentage of GDP, government budget balance, and output-capital ratio all play
significant roles in determining FDI inflows.
In summary, the empirical investigations on the determinants of FDI inflows vary
with different models and variables specified according to different host countries and
time periods under study. In order to understand the determinants in the four
transition economies in Southeast Asia, it is crucial to specify an empirical model that
allows for a combination of cost-related, macroeconomic as well as investment
environment improving determining factors.

V. Empirical Model and Variable Specification

Limited by the data availability in Cambodia, Laos, Myanmar and Vietnam, the
variables and hence the model specified in this paper are very restrictive. The
classification of the locational determinants made by Bende-Nabende et al. (2000 and
2002) is modified into three categories: macroeconomic factors, cost-related factors,
and investment environment improving factors; each category, in turn, is measured by
several indicators. According to the literature reviewed, indicators such as GDP per
capita, real GDP growth rate, and the degree of openness can be grouped as the
macroeconomic factors; real exchange rate and real wage rate can be classified as the
cost-related factors; and human capital and government budget balance can be
categorized as the investment environment improving factors. Additionally, a
dummy variable to proxy the 1997 Asian financial crisis and a lagged dependent
variable of FDI to demonstrate agglomeration effects are included in the model.
A dynamic panel data model is utilized to incorporate the time-series aspect (to
reveal the agglomeration or self-reinforcing effects of FDI and take into account
structural changes of the variables) and the cross-sectional aspect of the four countries
under study.

ln FDIi,t = ai + 1 ln FDIi,t 1 + 2CRISISi,t + 3 ln ERi, t + 4 lnWAGEi,t + 5 ln gdpi, t 1

+ 6GDPGWi,t 1 + 7OPENi,t 1 + 8GEi, t 1 + 9 ln HCi,t 1 + i, t .

Where
FDI foreign direct investment,
CRISIS Asian financial crisis,
ER market exchange rate,
WAGE real wage rate,
gdp GDP per capita,
GDPGW real economic growth rate,
OPEN (exports + imports) / GDP,
GE government budget balance / GDP, and
HC government expenditure on education / population.

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 In the equation, the subscript i indicates the four transition economies in Southeast
Asia; while t and t-1 are the time period from 1990 to 2001 with the latter denotes a
one-period lag. The one-period lagged explanatory variables are FDI, gdp, GDPGW,
OPEN, GE, and HC. A one-period lagged dependent variable is included as one of
the explanatory variables to reveal the dynamic process. Furthermore, in the
presence of agglomeration economies, newly made investment would be an increasing
function of the past investment already in place. The larger the ln FDIi,t 1 (in
natural logarithm), thereby, generates a positive impact on FDI for the period to come.
The dummy variable CRISIS represents a possible structural change and may lead to a
negative impact on the FDI inflow after the Asian financial crisis. Hence, CRISIS =
1, for the period 1997-2001; and CRISIS = 0, otherwise. The other explanatory
variables are discussed in order. The rise in market exchange rate, ER, expressed as
local currencies per US dollar, indicates a depreciation of the local currency. Hereby
foreign investors acquisition cost of assets in the host country could be reduced, and
FDI inflows may increase. The wage rate reflects labor cost as well as labor
productivity. Hence, low real wage rate may or may not attract FDI, depending on the
nature of FDIs relative labor intensity. GDP per capita, denoted by gdp in the
equation, is incorporated to indicate the consumption capacity of the people or the
size of the market, therefore, a positive relation with FDI inflows is anticipated. The
variable GDPGW indicates the growth potential of the host countries, and thereby
generates positive impact on FDI inflows. Whether the degree of openness of an
economy is positively or negatively related to FDI inflows, again, depends on the
objective of the FDI, i.e. market-seeking or tariff-jumping. The ratio of government
budget balance to GDP, denoted as GE, is utilized as a proxy for government
efficiency (IMD, 2002) and should be positively related to FDI inflows. The variable
HC denotes per capita (government) education expenditure, which is viewed as a
proxy for the quality of education and, in turn, human capital and therefore should be
positively related to FDI inflows.
The above discussed explanatory variables are incorporated into a dynamic panel
data model to find key determinants of FDI inflows in Cambodia, Laos, Myanmar and
Vietnam.

V. Estimated Results

Due to the difficulty of obtaining sufficient FDI data prior to 1990, past studies on
FDI in the four Southeast Asian transition economies were often limited to qualitative
analyses. This study employs panel data from Cambodia, Laos, Myanmar and
Vietnam to gain preliminary insights on the determinants of their FDI inflows. The
data used in this study is a panel of four transition countries between 1990 and 2001.
The number of observations in the complete panel is 48. The dependent variable is
the absolute magnitude of FDI in natural logarithm. The data of dependent and
explanatory variables are primarily from various publications of the Asian
Development Bank.
In this section, estimated results of the determinants of FDI inflows in the four
Southeast Asian transition economies are discussed. Table 4 reports the regression
results of the dynamic panel data model with fixed effect to analyze the locational
determinants of FDI inflows for all four countries in our sample. The introduction of
an agglomeration and partial adjustment mechanism lends itself to straightforward
econometric implementation by the inclusion of a lagged dependent variable. (Cheng
and Kwan, 2000)

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 Table 4Estimated results of the determinants of FDI inflows
Variables Estimated coefficients (t-statistics)
ln FDIt-1 0.582703 ( 4.9917)**
CRISIS -0.853528 (-3.5390)**
ln ER 0.175675 ( 1.1628)
ln WAGE -0.426886 (-0.9835)
ln gdpt-1 0.879875 ( 2.5475)*
GDPGWt-1 0.023365 ( 0.7569)
OPEN t-1 1.358083 ( 2.0357)*
GEt-1 -3.053784 (-0.7787)
ln HCt-1 0.188457 ( 0.9896)
Fixed effect
Cambodia -4.270267
Laos -5.147182
Myanmar -2.451348
Vietnam -2.803465

R-squared 0.947757
Adjusted R-squared 0.927534
Durbin h statistic 0.698843
Notes: * and ** denote p-value<0.05 and p-value<0.01, respectively. Durbins h statistic lies between
-1.96 and +1.96. Therefore, do not reject the null hypothesis that there is no first-order autocorrelation.

In Table 4, the estimated adjusted R2 is as high as 0.9275 indicating the models

significant explanatory power on the variations of the dependent variable lnFDIi,t.
Durbins h test is employed to examine the existence of autocorrelation when the
lagged dependent variable is included in the model. The test statistic can not reject
the null hypothesis that there is no first-order autocorrelation (Gujarati, 1995). As
for the individual explanatory variables, the estimated results indicate that the impact
of lagged FDI inflows, GDP per capita, the degree of openness, and Asian financial
crisis on the current FDI inflows are significant in the four transition economies.
Hence, as expected the agglomeration and partial adjustment mechanism of FDI
inflows exists as suggested by the estimated coefficient of lagged FDI inflows.
Additionally, the domestic market consumption capacity is also important, as
demonstrated by the GDP per capita. The significant positive impact of the openness
on FDI inflows suggests that foreign investors are more inclined to market-seeking
rather than tariff-jumping investment. The findings also show that the Asian
financial crisis has a significant adverse impact on FDI inflows. These four
economies are not crisis hard-hit countries; nevertheless there is a significant portion
of FDI sources from the hard-hit neighboring countries, such as Thailand, Malaysia,
and, to a lesser extent, Singapore. Hence, well diversified sources of FDI and FDI
destined industries are very important to mitigate any possible threat from regional
crises.
The estimated coefficients of the cost-related factors (real wage rate and market
exchange rate), macroeconomic factors (such as real GDP growth rate), and
investment environment improving factors (per capital government education

140
expenditure and government budget balance as a share of GDP) are statistically
insignificant. The findings could serve as a useful reference for the governments of
developing countries in attracting market-seeking FDI inflows by focusing on the
agglomeration effects and open-door trade policies.

V. Conclusions

A dynamic panel data model with fixed effect, using data from the four Southeast
Asian transition countries between 1990 and 2001, is utilized to incorporate the
time-series aspect and the cross-sectional aspect of the four countries under study.
These four countries have transitioned from socialist to market-friendly economies
starting in the late 1980s, but foreign investors were cautious in the beginning. Due
to difficulties in obtaining sufficient FDI data prior to 1990, past studies on FDI in
Southeast Asian transition economies were often limited to qualitative analyses.
This study employs panel data from Cambodia, Laos, Myanmar and Vietnam to gain
preliminary insights on the determinants of their FDI inflows.
In this paper, the size of FDI inflows, the major FDI destined industries and home
countries of FDI sources in four transition economies are discussed. The key
determinants of FDI inflows are then examined. The locational determinants are
grouped into three categories: macroeconomic factors, cost-related factors, and
investment environment improving factors. Additionally, a dummy variable to
proxy the 1997 Asian financial crisis and a lagged dependent variable of FDI are also
considered to reflect, respectively, possible structural change and agglomeration
effects. Using the fixed effect model, the four countries FDI inflows are modeled as a
function of the abovementioned variables.
The estimated results suggest that the most important determinants are the
one-period lagged FDI inflows, GDP per capita, and the degree of openness, all of
which have significantly contributed to attracting FDI; additionally, the Asian
financial crisis is shown to have deterred FDI inflows in these countries. The
adverse impact of the Asian financial crisis on FDI inflows in the four indirect
crisis-hit countries clearly demonstrates the importance of attracting appropriate FDI
from well diversified sources and destined for diversified industries to mitigate any
possible damage from a regional crisis. Moreover, two out of three broad categories
- the cost-related factors (real wage rate and market exchange rate) and investment
environment improving factors (per capital government education expenditure and
government budget balance as a share of GDP) are statistically insignificant. The
only category found to be significant in attracting FDI is the fundamental
macroeconomic factors. The findings indicate that the governments of the four
Southeast Asian countries should explore the agglomeration or self-supporting
economies, enlarge GDP per capita, and adopt open-door policies to successfully
attract appropriate FDI.

REFERENCES

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