Does good governance matter for FDI inflows? Evidence from Asian economies

Abstract

This paper examines the effects of the six components of good governance on foreign direct investment (FDI) inflows in 15 Asian economies for the period 1996–2007 using a fixed effect model for panel data with heteroskedasticity corrected standard errors. The study also employs the feasible general least square (FGLS) and Prais-Winstein panel estimation methods in order to check the consistency of the results with the fixed effect model. The empirical results reveal that of the six components of good governance, political stability and absence of violence, government effectiveness, rule of law, and control of corruption are the key determinants of FDI inflows, as they exhibit consistent results under different models. However, the study finds no significant evidence with voice and accountability and regulatory quality in FDI inflows. The study reveals that human capital, infrastructure, lending rate, and GDP growth rate also have a significant influence on FDI inflows. We conclude that a country which can enhance its governance environment in general is likely to attract more foreign direct investment despite offsetting deficiencies in other dimensions of good governance such as voice and accountability and regulatory quality.

Keywords:

• FDI inflow
• good governance
• human capital
• infrastructure
• openness and market size

Notes

1. ‘Governance consists of the traditions and institutions by which authority in a country is exercised. This includes the process by which governments are selected, monitored and replaced; the capacity of the government to effectively formulate and implement sound policies; the respect of citizens and the state for the institutions that govern economic and social interactions among them’ (Kaufmann et al. 2009).

2. Kauffmann et al. (1999a, b) defines six components of good governance which are: voice and accountability, political stability and lack of violence/ terrorism, government effectiveness, regulatory quality, rule of law and control of corruption.

3. Macro-economic factors are inflation, GDP growth rate, exchange rate, life expectancy, human capital and so on.

4. Agglomeration economies are more closely associated with economies of scale and network effects. In other words, agglomeration economies are used to indicate the benefits received by the producers by industry clustering and locations.