new trends and patterns of us fdi in asia
TRANSCRIPT
New Trends and Patterns of US FDI in Asia
Shandre Mugan Thangavelu1 Department of Economics
National University of Singapore
Ramkrishnen Rajan George Mason University
And
Rasyad A. Parinduri
University of Nottingham
Preliminary Draft
Paper prepared for Global Development Network (GDN)
Ninth Global Development Network Conference Brisbane, Australia, 2008
Research Workshop Program
Emerging Trends and Patterns of
Trade and Investment in Asia
Organized by The Division of Economics
Research School of Pacific and Asian Studies College of Asia and Pacific
The Australian National University
1 Corresponding author: Shandre M. Thangavelu, Department of economics, National University of Singapore, Singapore (119750), email: [email protected]
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1. Introduction
Several studies have highlighted the importance of FDI for economic growth,
where FDI activities contributes to recipient countries through the channels of higher
exports, global networks, transfers of technology, increased government revenues and
improved job opportunities. At the aggregate level, these channels create strong and
positive externalities for domestic economic growth. For a considerable number of
developing countries, which includes those in Asia, the acceleration of output growth
has been driven by high levels of domestic and foreign investment, notwithstanding the
high savings levels of these countries (Yussof et. al 2002). For these developing
countries, the lack of indigenous technology as well as participation in global networks
has led to much dependence on foreign investments. As such, governments of these
developing countries have found it necessary to design policies to improve the
attractiveness of the economy to foreign investors, especially towards specific critical
economic sectors.
In the absence of strong domestic enterprises and technology levels sufficient to
drive economic growth entirely, developing countries in Asia have been generally
active in promoting themselves as choice destinations of FDI, with the aim of reaping
the benefits from FDI to boost growth in the domestic economy. These foreign
investments will be able to provide developing host countries with much-needed
technological know-how through knowledge transfers, such that domestic productivity
can increase. Foreign investments will also lead to more job opportunities which will in
turn increase the domestic economy�s output. In addition, foreign enterprises may invest
in the physical infrastructure in their activities, therefore improving the overall
infrastructure in the host countries.
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On the other hand, FDI has been viewed in certain situations as encroaching on
the sovereignty of a host country through a foreign control over resources, and also as a
possible danger to the promotion of domestic investment. Besides being questioned as a
threat to national security and accused of undermining national industries, FDI has also
been viewed as �good cholesterol� that promotes long-term economic development
(Kumar 2003).
This paper seeks to add on to the existing literature by examining the trends and
flow of United States foreign direct investment in Asia and in particular on the East
Asian and South Asian countries. The paper undertakes an empirical analysis of the key
determinants of U.S. foreign direct investment flows in the Asian region in a panel
gravity framework. The paper also identifies key implications for promoting FDI from
the changing decomposition of the United States FDI in Asia.
The paper is organized as follows. The next section provides a brief overview of
the recent literature on the importance of FDI for economic growth. Section 3 discusses
the trends and the changing patterns of the US foreign direct investments in Asia. We
provide the empirical model and discuss the panel gravity model in section 4. Section 5
provides the concluding remarks.
2. Literature Review: Importance of FDI and Growth
In view of the recent surge in foreign direct investments across the globe and
substantial liberalization of government policies towards FDI, a debate about the impact
and significance of FDI and transnational corporations (TNCs) on economic growth has
again rekindled in the recent years, albeit with conflicting viewpoints. There are a vast
number of empirical literatures on the impact of FDI on economic growth, with little
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conclusive empirical evidence. Recent paper by Choe (2003) asserts strong positive
relationships between FDI and economic growth, however the paper does not
sufficiently establish a causal relationship from FDI to growth.
Carkovic and Levine (2002) suggests that at the firm-level, studies generally
show that economic growth is not enhanced by FDI, and that positive spillovers do not
occur from foreign-owned firms to domestically owned ones. The firm-level study will
be able to control for firm specific and simultaneity issues much better than aggregate
level study.
Foreign affiliates� direct contribution to OECD countries� labor productivity
growth is examined by Criscuolo (2005) using the growth accounting approach. The
study decomposes the contribution to labor productivity growth by the within effect
(contribution from existing foreign affiliates to labor productivity growth) and the
between or compositional effect (contribution from the increase in foreign affiliates�
employment share in the host economy). The study highlighted that the labor
productivity differential between domestic and foreign firms is generally significant in
manufacturing industries where foreign affiliates are more labor productive, whereas
the service sector does not exhibit a similar differential. Through a sectoral analysis for
services, a negative correlation is confirmed between the size of the labor productivity
differential and the sector�s knowledge intensity level. Further analysis showed that
foreign affiliates� contribution mainly stems from the between effect, while evidence at
the sectoral level suggests that within effects determines the contribution in the high and
medium-high technology manufacturing sectors.
Borensztein et. al (1998) studied the role of FDI in the process of technology
diffusion and economic growth on developing countries. Based on a cross-sectional
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framework, their results show that FDI�s contribution to growth is more than that of
domestic investment, suggesting that FDI is important for the transfer of technology.
The empirical results from this study also suggest that FDI is more productive than
domestic investment only in instances where the host country has a minimum threshold
human capital stock. The complementary effects between human capital and FDI
suggested by the results are consistent with the idea that the ability of the flow of
advanced technology to enhance economic growth is dependent on a country�s
absorptive capability.
In Carkovic�s and Levine�s (2002) study, after joint determination of growth and
foreign capital flows are controlled for, as well as other growth determinants and
country-specific effects, results show that FDI, as an exogenous component, has no
positive, robust causal impact on economic growth. The interaction term (the product of
FDI and average schooling years of the working age population) and FDI are generally
not significant. However when they both appear significant, the FDI term is significant
while the interaction term coefficient is negative. These results thus apparently suggest
that FDI only enhances growth in countries with low education levels, and these results
may be caused by the simultaneous inclusion of FDI, schooling and the interaction
term. Their panel regressions do not support the claim that FDI flows to financially
developed economies to have a strong positive impact on growth. The results also, do
not find a robust relationship between growth and FDI when dependence on trade
openness is allowed. The interaction between economic success and FDI are also seen
as not exerting any strong independent effect on growth. As such, the authors do not
uncover any independent impact of FDI inflows on economic growth in their study.
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Ram and Zhang (2002) conducted a study of FDI�s role in host countries�
economic growth with a focus on the 1990s and a use of a large cross-country sample.
The main part of their study uses three different proxies for the FDI variable, which are
growth rate of the ratio of FDI flows to GDP, growth rate of absolute FDI inflow and
the ratio of FDI inflows to GDP. Generally, the three proxies of the FDI variable result
in generally similar implications and empirical results point to a positive nexus between
FDI and host countries� economic growth.
Nair-Reichert and Weinhold (2001) examined the possible heterogeneous
pattern of the effect of FDI on growth using a panel of 24 developing countries over a
period of 25 years. To be able to estimate across the panel a distribution of causality,
they suggest a variation of the Mixed Fixed and Random (MFR) model. Growth rates of
all variables (apart from inflation) are used in the analysis, and an examination of
contemporaneous correlation of FDI and growth of GDP, as well as a test for Granger
causality, are conducted. Using a non-dynamic fixed effects panel in a test for simple
contemporaneous correlation, FDI growth was statistically insignificant to GDP growth.
In examining a causal relationship between growths of FDI and GDP, a dynamic panel
model is used where GDP growth becomes a function of the lags of itself and other
explanatory variables. The traditional Holtz-Eakin et al. (1988) panel causality test and
the MFR causality model are then used estimate the models. Hotlz-Eakin causality test
results show that FDI growth has a strong positive effect on GDP growth, while
domestic investment and export growths are not statistically significant. In using the
MFR causality approach, the evidence provides strong support for significant
heterogeneity in the sample of 24 developing countries. Results for the MFR estimation
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and traditional panel data causality tests differ greatly, but there exists, generally, a
causal relationship from FDI to GDP growth.
The two-way relationship between growth and FDI in India is examined in
Chakraborty and Basu (2002) through a structural cointegration and vector error
correction mechanism. They found positive impact of FDI on GDP growth in India.
3. United States Trade and Foreign Direct Investment in Asia The United States adopts an open market approach to trade and investment. It pursues
both a multilateral trading and concurrently the bilateral and regional trading
agreements to achieve the free and open trading environment. Due to its open trade
policy, the overall trade in the United States has increased in 2006 and has contributed
significantly to its economic growth. The U.S. economy is also experiencing a healthy
foreign investment activity in recent years. The United States is a major investor in the
global economy and its foreign activities have increased in 2006 (see Figure 1). It
nearly accounts for around 20 to 30 percent of the total World outwards FDI flows. In
2006, the U.S. multinational corporations have increased their investment in Europe and
Asia Pacific, and in fact the United States has doubled its foreign investments in Europe
and Asia Pacific. The Unites States is also the largest host to foreign investment in the
world. In 2005, the United States attracted nearly 13 percent of the total foreign direct
investments inflows in the World (World Investment Report, 2006). The FDI inflows to
U.S. economy increased from US$53,146 million in 2003 to nearly US$99,443 million
in 2006 (World Investment Report, 2006).
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Source: Bureau of Economic Analysis, United States
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Since 1994, United States has more than doubled its investment in the Asia-Pacific
region and it is the second largest investment region after Europe in 2006. Although the
overall investment in the Asia-Pacific region might have increased, the Asian crisis was
expected to have strong impact on the relocation of its foreign investment activities to
East-Asia from South-East Asia. Thus a more disaggregated analysis of the United
States outward FDI in the region will shed more light on the changing patterns within
the Asian region. Further, we might also expect changing patterns at the industry.
Another important component for the rising global share of FDI is the number of
bilateral and multilateral trading agreements undertaken by the United States. The
United States pursues open trade and investment strategy using both the multilateral and
bilateral tracks. The United States exports and imports with its FTA completed
countries and these countries account for more than 40 percent of the total exports of
United States. Out of the total of nine bilateral and regional trade agreements completed
in 2007, most of the agreements were completed in early 2000, except for only NAFTA
that was completed in 1994. The positive complementary effects of FTA on the exports
and investment of United States is clearly indicated in the increasing trend of exports
and investment to FTA-completed countries.
Asia Pacific is becoming an important trade region for the United States as it is
the largest export destination for U.S. goods. In fact, the average share of exports to
Asia Pacific to total United States exports is nearly 27 percent in 2000-2006. The trends
indicate that United States is relying on the Asia Pacific region for its imports over the
years. The average share of imports from the Asia Pacific region is nearly 37 percent of
the total imports into United States from 2000-2006.
10
Source: Bureau of Economic Analysis, United States
It is also important to highlight that trade in services is becoming an important
component of overall trade in the United States. The share of export of services has
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increased from 27 percent in 2000 to nearly 30 percent of the total export in 2006. The
travel and other private services account for the large proportion of the exports of
services by United States in 2006 (see Figure 9). The import of services accounts for
nearly 17 percent of the total imports of United States. The importance of services in the
overall trade indicates the importance of services trade in strategic trade areas of free
trade agreements and regional trade agreements.
Source: Bureau of Economic Analysis, United States
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Source: Bureau of Economic Analysis, United States
The United States FDI in Asia-Pacific region is given in Figure 7. There are several
interesting trends emerging from the United States investment in the region since 1994.
The FDI investment by the United States to Australia and Japan has surged strongly in
2006. It surged from 4 percent in 1994 to nearly 14 percent of the total FDI flow into
the Asia-Pacific region in 2006 for Australia. We also notice a similar trend for Japan,
where the United States investment increased from 14 percent in 1994 to nearly 30
percent of the total FDI flow in 2006. Although there is a slight increase in United
States foreign investment in China in 2006, it only marginally increased to 10 percent in
2006 from 8 percent in 2000. This might indicate that the United States investment in
China might be reaching a "steady state" or a plateau that we might not see much
increase in foreign investment by United States in the future. One possible reason for
the declining United States FDI might be the depreciating US dollar to the Chinese
Yuan, thereby making United States investment to China more costly. Further, recent
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evidence suggests that the cost of production including the labour cost is rising rapidly
in China that the profitability of foreign activities might be falling over the years. Other
than Australia and Japan, we also observed some increase in United States FDI in India
rising from 0.4 percent in 2000 to 5 percent in 2006. Most of East-Asian countries of
Korea, Hong Kong, Taiwan and Singapore are experiencing falling shares of United
States FDI over the years. Hong Kong and Korea seems to have experience very drastic
fall in the share of United States FDI, where the United States to Hong Kong has
declined from 22 percent in 2000 to nearly 10 percent in 2006 and Korea has
experienced a decline to 5.3 percent in 2006 from 10 percent in 2000. The United States
foreign investment in Singapore has fallen from 16 percent in 2000 to nearly 12 percent
in 2006.
The emerging Asian countries are also experiencing falling share of United
States foreign direct investment. The most drastic fall in United States investment is by
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Indonesia where the investment has declined from 15 percent in 1994 to nearly 3
percent in 2006. Malaysia (Mal) and Thailand (Thai) have also experienced significant
decline in United States FDI.
The breakdown of the United States FDI by country and industry is given in
Tables 1 to 3. The industrial analysis indicates that the United States is shifting its
investment into services sector away from the manufacturing sector in Asia-Pacific
region. The share of services in the total United States FDI was only 41 percent in 1994,
but it has shifted to nearly 72 percent in 2006.
Table 1: United States FDI by Region and Key Sectors (1994-2006)
1994 2000 2006
Manu Services
Manu (with
Mining) Manu Services
Manu (with
Mining) Manu ServicesAsia 59.0 41.0 51.7 43.3 56.7 33.3 27.9 72.1
Australia 58.2 41.8 60.9 43.1 56.9 22.9 14.2 85.8 China 73.0 27.0 86.6 74.0 26.0 62.8 55.9 44.1 Hong Kong 22.8 77.2 7.4 7.4 92.6 15.8 15.8 84.2 India 37.7 62.3 49.2 63.6 36.4 20.0 20.3 79.7
Indonesia 62.9 37.1 86.0 5.0 95.0 77.8 13.3 86.7 Japan 60.4 39.6 26.9 26.8 73.2 28.6 28.6 71.4 Korea 44.0 56.0 49.4 49.4 50.6 53.0 53.0 47.0
Malaysia 75.5 24.5 64.7 64.7 35.3 62.4 44.3 55.7 New
Zealand 20.0 80.0 4.9 2.5 97.5 20.1 13.5 86.5
Philippines 56.2 43.8 46.5 46.5 53.5 59.7 59.3 40.7
Singapore 53.5 46.5 65.5 65.4 34.6 26.6 26.3 73.7 Taiwan 58.4 41.6 38.6 38.6 61.4 28.8 28.8 71.2
Thailand 62.0 38.0 61.0 41.9 58.1 68.5 67.4 32.6 Other 3.6 96.4 26.5 6.4 93.6 31.6 2.2 97.8
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It is interesting to observe that Australia and Japan have been attracting United
States FDI into the manufacturing sector in 1990s, but the share of the United States
investment in manufacturing sector declined drastically and share of services
investment has increased to nearly 85 percent for Australia and nearly 70 percent for
Japan in 2006. Although United States was investing in the manufacturing sector in
China in 1990s and the share in 2006 is till nearly 60 percent, services sector share is
also increasing in 2006 to 40 percent from 27 percent in 1994.
Since the India economy was liberalized in 1985, we can observe gradual
increase in United States investment in India. In 2000, the foreign direct investment
from United States was mainly invested in the manufacturing sector, where it acconts
for nearly 60 percent of the investment. In 2006, the share of United States investment
in the manufacturing sector has drastically dropped to nearly 20 percent and more than
80 percent of United States investment in India is in the services sector.
The East Asia countries of Hong Kong, Singapore and Taiwan are also
experiencing a shift in the United States investment away from the manufacturing sector
to the services sector over years. The most drastic shift is in Singapore, where the share
of United States investment in the services sector increased from 35 percent in 1994 to
nearly 72 percent in 2006. One possible explanation for the falling share of the United
States investment in the manufacturing sector might be due to the US-Singapore FTA
which basically emphasised the trade in services. We also observe similar trend with
Malaysia, with the share of United States investment in the manufacturing declining
over the years.
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Table 2: United States Foreign Direct Investment by Country and Manufacturing Industies: 1994-2006
Food Chemicals Fab. Metals Machinery Electrical
&Electronics Transport Others
Asia
1994 2.75 7.17 1.13 6.23 8.13 2.74 30.9
2000 1.23 5.27 1.83 1.38 14.58 2.45 16.5
2006 0.90 4.55 0.52 1.14 7.13 1.94 11.7
Australia
1994 4.87 13.22 1.32 2.08 1.01 2.35 33.4
2000 3.81 4.12 6.70 1.09 0.96 2.74 23.6
2006 0.92 3.51 0.62 0.77 0.72 1.20 6.5
China
1994 5.12 8.60 4.07 0.00 6.65 0.00 48.6
2000 2.57 10.07 1.41 1.96 35.53 5.85 16.6
2006 3.39 11.66 2.08 2.88 11.07 7.74 17.1
India
1994 4.66 13.50 1.46 7.67 4.08 0.58 5.7
2000 2.56 10.76 3.28 13.03 1.47 2.40 30.1
2006 0.54 5.23 0.97 5.61 3.13 0.80 4.0
Indonesia
1994 0.28 2.27 0.13 0.09 0.46 0.06 33.8
2000 0.15 4.05 0.20 0.28 0.30 0.00 0.00
2006 0.00 3.10 0.26 0.00 -0.43 -0.09 10.4
Japan
1994 2.20 6.89 1.03 13.02 5.16 6.36 25.7
2000 0.40 5.87 0.54 1.86 6.92 3.33 7.9
2006 0.18 5.09 0.19 0.56 5.17 1.22 16.2 Korea
1994 5.38 9.09 0.76 2.12 10.38 2.22 14.1
2000 3.93 8.51 0.79 2.26 21.49 5.08 7.3
2006 4.07 7.80 0.68 0.57 14.11 3.95 21.8
Malaysia
1994 0.16 4.73 0.44 2.26 53.24 0.00 14.7
2000 -0.10 3.16 0.19 0.66 55.44 0.00 5.4
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2006 0.31 6.06 0.41 1.19 26.36 0.00 10.0
New Zealand
1994 0.00 2.08 0.00 0.28 0.49 0.00 17.2
2000 -0.26 1.57 0.00 0.14 0.77 0.21 0.1
2006 0.00 1.54 0.24 0.12 2.01 0.05 9.6
Philippines
1994 11.55 12.96 0.81 0.20 13.81 0.00 16.9
2000 4.67 8.05 0.47 1.62 23.17 0.00 8.5
2006 5.67 5.66 0.37 0.00 22.87 0.00 24.8
Singapore
1994 0.23 1.83 1.34 8.02 20.05 0.70 21.3
2000 0.04 2.30 0.94 1.10 44.11 2.35 14.6
2006 0.03 2.67 0.22 1.81 16.14 3.79 1.7
Taiwan
1994 1.88 18.78 0.00 6.30 26.07 0.00 5.4
2000 0.59 15.53 0.73 1.30 15.42 0.66 4.3
2006 0.33 6.27 0.92 0.63 10.68 0.86 9.1
Thailand
1994 3.32 7.39 2.06 0.00 7.56 -0.03 41.6
2000 0.67 17.02 1.49 0.89 19.81 2.04 0.0
2006 0.44 16.67 1.48 2.73 12.11 6.02 28.0
Others
1994 0.00 3.33 0.10 0.00 0.20 0.00 0.0
2000 1.20 2.11 0.00 0.11 0.25 1.64 21.2
2006 0.00 0.92 0.19 0.06 1.07 0.00 0.0
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Table 3: United States Foreign Investment in Services Sector in Asia: 1994-2006
Trading Information Banking
Finance(other than Banking),
Insurance Other
Services
Asia
1994 0.0 6.6 15.6 4.4 0.0
2000 2.9 4.5 20.4 4.0 0.0
2006 2.4 4.1 19.3 3.6 30.3
Australia
1994 10.5 0.0 9.4 15.5 6.4
2000 3.7 3.9 12.8 2.1 0.0
2006 0.8 1.6 6.5 2.5 63.6
China
1994 0.0 2.3 10.4 2.9 0.0
2000 0.7 0.6 0.4 2.2 0.0
2006 4.6 5.5 7.0 0.6 9.0
India
1994 0.0 43.8 13.6 1.9 0.0
2000 -6.1 14.6 12.0 6.6 0.0
2006 27.3 16.1 11.7 10.9 3.8
Indonesia
1994 0.0 0.0 6.0 0.7 0.0
2000 -0.7 2.4 0.0 1.6 0.0
2006 -0.7 6.4 2.1 0.4 8.0
Japan
1994 0.0 0.9 18.1 2.8 0.0
2000 4.4 0.9 40.2 9.4 0.0
2006 2.5 0.7 48.8 8.1 2.2
Korea
1994 0.0 29.0 0.0 4.0 0.0
2000 2.8 18.8 3.0 3.1 0.0
2006 1.0 22.0 12.5 5.4 0.0
Malaysia
1994 0.0 0.0 9.2 2.4 0.0
2000 1.0 0.0 3.6 2.6 0.0
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2006 0.3 0.0 3.6 1.7 0.0
New Zealand
1994 0.0 0.0 22.2 1.5 0.0
2000 0.0 0.0 25.6 -1.9 0.0
2006 3.4 0.0 19.7 4.6 0.0
Philippines
1994 0.0 13.0 17.1 0.0 0.0
2000 0.5 5.1 0.0 0.4 0.0
2006 0.7 0.0 13.7 -0.7 0.0
Singapore
1994 0.0 3.3 15.6 12.9 0.0
2000 2.7 2.9 10.6 2.1 0.0
2006 2.3 3.4 8.5 2.2 0.0
Taiwan
1994 0.0 11.7 6.2 2.4 0.0
2000 3.9 8.2 29.7 1.4 0.0
2006 1.1 5.8 48.5 0.7 0.8
Thailand
1994 0.0 7.7 4.2 2.8 0.0
2000 0.0 7.0 7.7 0.9 0.0
2006 0.1 8.9 10.2 2.8 1.5
Hong Kong
1994 0.0 10.3 27.2 5.3 0.0
2000 2.3 8.6 24.3 2.1 0.0
2006 4.4 4.4 22.8 1.0 30.9
Among the Asia-Pacific countries, the most affected country is Indonesia by the
changing pattern of United States foreign investment. It tends to enjoy nearly 63 percent
share of the United States investment in the manufacturing sector in 1994. However,
this share has fallen to less than 5 percent and 13 percent in 2000 and 2006 respectively.
In fact, if we add the share of the United States investment in natural resources (mining
industries), the share of United States investment in both the manufacturing and mining
sector accounts for nearly 80 percent of United States investment in 2000s. This clearly
indicates that United States is basically investing in the natural resources in Indonesia.
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The sectoral investment by United States in Asia is given in Tables 2 and 3. The trend
of foreign investment by United States in China in is declining in the electrical and electronics
industry over the years and in contrast the share in the chemical, transport equipments and
machinery is increasing in recent years. In fact, the share of United States investment in the
electronics & electrical industries has drastically declined from nearly 35 percent in 2000 to
around 11 percent in 2006. We also observed that the United States investment in electronics &
electrical products is also falling for the leading electronics & electrical exporting countries
such as Korea, Taiwan, Singapore, and Malaysia. However, United States foreign investment in
the chemical and transport equipments has increased across these countries in 2006 as their
share in the electrical and electronics sector declines.
The United States foreign investment in the services sector in Asia is showing an
interesting trend for Asia. As indicated previously that the share of United States foreign
investment in services sector is rising over the years. It seems United States is investing heavily
in the services sector in India and particularly the trading, information, banking and financial
services. We also observed an increase in the share of United States investment in the trading
and banking sector for China. The share of United States investment in the financial sector for
Japan, Korea and Taiwan shows a rising trend over the years. In particular, the share of
investment by United States in the financial services sector in Japan has significantly increased
from 21 percent in 1994 to nearly 57 percent in 2006. The share of investment in the financial
sector in Taiwan also increased from 8 percent in 1994 to nearly 49 percent in 2006. We also
noticed that the share of financial and information services has increased for Korea in 2006,
where the United States foreign investment in financial sector increased to 18 percent in 2006
from only 6 percent in 2000.
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4. Empirical Analysis
To understand the dynamic trends of United States FDI in Asia-Pacific, we adopted a
standard gravity model and examined the determinants of United States foreign direct
investment in Asia-Pacific countries compared to that in the rest of the world. We
estimated a standard gravity model as follows:
+++= −− )ln()ln()ln()ln( 31211 jjtitjt AreaYYFDI βββ ∑
kkk Regionϕ
jtjtl
ljk Distance εηλδ ++++∑ (1)
where FDIjt is the value of US� FDI in country j at time t; Yit and Yjt are US� and host
country j�s GDP at time t respectively; Areaj is the land mass of country j; Distancels
are some measures of distance between US and host countries such as their
geographical distance as well as their legal system and language. Regionks are regional
dummies for Asia, South America, Africa as well as Europe and Canada; the excluded
regional dummy is Europe and Canada; λ t and η j are time-effects and country-effects
respectively; εjt is the error terms. The coefficients of interest are the coefficients of the
gravity variables and the ϕks, the coefficients of the regional dummies.
Because we want to obtain the estimates for the coefficients of the time-
invariant regional dummies, we cannot estimate the model using fixed-effect or
dynamic panel data models. Random effect model may not suitable either because the
explanatory variables are likely to be correlated with the country effect ηj, which makes
that the random-effects biased.
We decided to estimate the model using correlated-random-effects model. We
adopted the Mundlak (1978)�s specification, which allows the country-effects η j to be
modelled using the means of the time-varying explanatory variables, i.e.
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jm
mmj X ϑπη +=∑
where mX s are time-varying explanatory variables and ϕ j is iid.
4.1 Data
The sample consists of 55 countries that are major destinations of United States FDI and
the data is obtained from the Bureau of Economic Analysis (BEA), United States. The
full details of the variables and their sources are given in Appendix. We also list the
countries in our study in the Appendix. The key summary statistics of the sample is
given in Table 4.
Table 4: Summary Statistics
Variables Units Obs Mean Std. Dev.
Gravity variablesFDI Constant 2000 US$, billlion 1355 16 33GDP US Constant 2000 US$, billlion 1566 7850 1910GDP Host Constant 2000 US$, billlion 1521 294 622Land Area Host Sq. Km, thousand 1566 1068 2176Distance Km 1566 7658 4104Contiguity (=1) 1566 0.03 0.18English (=1) 1566 0.29 0.46Anglo-American Law (=1) 1566 0.43 0.50
Regional dummiesEurope 1566 0.31 0.46South America 1566 0.31 0.46Africa 1566 0.09 0.28Asia Pacific 1566 0.28 0.45
Asian-Pacific dummiesSouth-east Asia 1566 0.09 0.28South Asia 1566 0.02 0.13East Asia 1566 0.09 0.28Middle-East 1566 0.05 0.22Australia and New Zealand 1566 0.03 0.18
Developed (=1) 1566 0.38 0.49
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4.2. Empirical Results The empirical results of our model are given in Tables 5 to 9. The results by OLS,
Random Effects (RE) and Correlated Random Effects (CRE) are given below. The key
results for our study are given in column (5) and (6). The results in Table 5 support the
specification of a gravity model to examine the determinants of United States foreign
investment across the countries. The flow of foreign investments to the region is
directly affected by the output growth in the US economy and also the respective host
countries in Asia. The coefficients of GDP of United States and also the host country
are positive and also statistically significant. The RE and CRE estimation reveals that it
is not statistically significant. The regulatory framework as given by the Anglo-
American Law is positive and statistically significant at 5 percent level. Hence, a
similar and transparent regulatory framework has a positive influence on the flow of
foreign investment.
The results of the Asia-Pacific region are given in Table 6. The coefficient of
host country GDP is the only key variable that is statistically significant and tends to
have positive impact on the flow of United States foreign investment. The results of
controlling for the September 11, 2001 terrorist attack and the Asian crisis are given in
Table 7. The results indicate that host country GDP is an important component to attract
foreign investment and both the Asian crisis and September 11, 2001 terrorist attack has
little impact on the long-term flow of United States foreign investment in the region.
24
Table 5: Determinants of US� FDI (All Countries) Dependent variable: ln(FDI)
RE CRE(1) (2) (3) (4) (5) (6)
Regional dummiesAsia (=1) -0.79 -0.78 0.38 0.43 0.23 0.16
(0.45)* (0.45)* (0.82) (0.61) (0.63) (0.64)South America (=1) -1.29 -1.24 0.12 1.12 0.88 0.87
(0.52)** (0.53)** (0.88) (0.64)* (0.76) (0.76)Africa (=1) -1.80 -1.80 -0.44 -0.13 0.22 0.07
(0.50)*** (0.51)*** (0.87) (0.75) (0.74) (0.76)Australia & New Zealand (=1) -0.06 -0.04 -0.12 0.15 1.90 1.86
(0.88) (0.89) (0.89) (1.05) (1.26) (1.26)Developed (=1) 1.44 0.96 -0.30 -0.29
(0.79)* (0.57)* (0.78) (0.78)Gravity variables
Lagged ln(GDP) US 1.46 0.84 0.84(0.26)*** (0.34)** (0.33)**
Lagged ln(GDP) Host 0.57 1.11 1.10(0.14)*** (0.26)*** (0.26)***
ln(Land Area) Host -0.19 -0.46 -0.45(0.08)** (0.14)*** (0.14)***
ln(Distance) 0.25 -0.38 -0.35(0.41) (0.53) (0.54)
Contiguity (=1) 2.32 1.44 1.35(0.77)*** (1.08) (1.08)
English (=1) 1.21 0.93 0.96(0.44)*** (0.54)* (0.54)*
Anglo-American Law (=1) -0.69 -0.62 -0.63(0.40)* (0.23)*** (0.23)***
Constant 4.51 5.28 3.91 -54.68 -40.21 -53.32(0.37)*** (0.39)*** (0.81)*** (7.88)*** (8.88)*** (19.66)***
Time effect No Yes Yes Yes Yes YesMeans of time-variant No No No No No YesObservations 1355 1355 1355 1330 1330 1330Number of countries 55 55R-squared 0.13 0.24 0.28 0.58 0.52 0.53
OLS
Notes: The sample includes all countries; robust standard errors in parentheses; the excluded regional dummy is Europe & Canada; RE stands for random-effect model, while CRE correlated-random-effect model; * significant at 10%; ** significant at 5%; *** significant at 1%.
25
Table 6: Determinants of US� FDI (Includes only Asia-Pacific Countries)
Dependent variable: ln(FDI)RE CRE
(1) (2) (3) (4) (5) (6)Regional dummies
South-east Asia (=1) 0.94 0.96 1.36 -1.69 -0.27 -0.38(0.39)** (0.41)** (0.54)** (0.84)* (1.58) (1.51)
South Asia (=1) -0.34 -0.36 0.03 -1.69 0.54 0.86(0.31) (0.32) (0.47) (0.77)** (2.26) (2.20)
East Asia (=1) 1.30 1.31 1.46 0.26 -0.004 -0.08(0.56)** (0.58)** (0.55)** (0.55) (1.30) (1.29)
Australia & New Zealand (=1) 1.50 1.52 0.73 -3.25 2.06 2.22(0.87) (0.91) (1.02) (1.12)** (2.64) (2.43)
Developed (=1) 1.19 1.76 -0.09 -0.17(0.58)* (0.44)*** (1.13) (0.95)
Gravity variablesLagged ln(GDP) US 2.09 0.62 0.69
(0.37)*** (0.62) (0.60)Lagged ln(GDP) Host 0.26 1.29 1.24
(0.09)** (0.43)*** (0.42)***ln(Land Area) Host -0.01 -0.55 -0.58
(0.07) (0.29)* (0.28)**ln(Distance) 8.80 6.01 6.03
(1.82)*** (4.07) (3.91)English (=1) 0.40 -0.86 -1.33
(0.34) (1.40) (1.39)Anglo-American Law (=1) 0.06 -1.34 -1.22
(0.34) (1.01) (0.83)Constant 2.95 3.77 3.36 -147.28 -96.43 -65.10
(0.31)*** (0.33)*** (0.44)*** (23.44)*** (41.48)** (49.53)Time effect No Yes Yes Yes Yes YesMeans of time-variant No No No No No YesObservations 394 394 394 394 394 394Number of countries 16 16R-squared 0.22 0.48 0.56 0.79 0.51 0.51
OLS
Notes: The sample includes Asia-Pacific countries only; robust standard errors in parentheses; the excluded regional dummy is Middle-Eastern countries; RE stands for random-effect model, while CRE correlated-random-effect model; * significant at 10%; ** significant at 5%; *** significant at 1%.
26
Table 7: The Effect of Asian Financial Crisis and the September 11
Dependent variable: ln(FDI)
A. Allow the periods of Asian Financial Crisis and the year of September 11 to have different intercepts
Asian Financial Crisis (=1) -0.08(0.09)
September 11 (=1) -0.05(0.06)
B. Allow the periods of Asian Financial Crisis and the year of September 11 to have different slopes of GDP variables
Lagged ln(GDP) US 0.83(0.34)**
Lagged ln(GDP) Host 1.12(0.26)***
Asian Financial Crisis * Lagged ln(GDP) US 0.005(0.03)
Asian Financial Crisis * Lagged ln(GDP) Host -0.01(0.03)
September 11 * Lagged ln(GDP) US 0.003(0.04)
September 11 * Lagged ln(GDP) Host -0.01(0.05)
C. Allow Asian countries to have different slopes of GDP variables
Lagged ln(GDP) US 0.83(0.34)**
Lagged ln(GDP) Host 1.13(0.32)***
Asia * Lagged ln(GDP) Host -0.03(0.28)
D. Allow Asian countries to have different slopes of GDP variables before and after the crisis
Lagged ln(GDP) Host 1.14(0.34)***
Asia * Lagged ln(GDP) Host -0.06(0.32)
Post-Asian Financial Crisis * Asia * Lagged ln(GDP)Host 0.001(0.01)
Notes: The sample includes all countries; the regressions are estimated using correlated-random-effect models; all variables in column (6) of Table 2 are included; the number of observations is 1330; because of collinearity, Specifications A and B does not include time-effects; robust standard errors in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%.
27
We also undertake some robustness checks on our results. First, we use the share of US�
FDI in country j instead of ln(FDI) as the dependent variable. Tables A4 and A5 in the
Appendix present the results. The estimates of the coefficients of the regional dummies
of the random-effect and correlated-random-effect models do not seem to differ much
from those in Tables 5 and 6. We also add ln(Y/Pop)i and ln(Y/Pop)j as additional
explanatory variables, introduce indicators for ease of doing business and a proxy for
financial development. The estimates of the coefficients of the regional dummies does
not change much either.
5. Policy Conclusions
The paper examined the trends and patterns of United States foreign investment
in Asia. The trends indicate that the share of United States foreign investment in the
region is shifting towards the services sector. In particular, we observed this trend in
large economies such as Australia, China, India and Japan. Within the manufacturing
sector, United States is reducing its share of investment in electrical & electronics sector
in most Asian countries. In particular, we observed that the share of United States
investment in the electronics & electrical sector in China has declined, but there is an
increase in the share of the chemical and transport sectors. We also observe this trend in
the United States foreign investment in Thailand and Malaysia. Within the services
sector, we observed that the share of United States foreign investment is increasing in
the financial sector in the key Asian countries. In particular, both Japan and Australia
were the major recipients of United States foreign investment in the services sector and
this share is increasing over the years. The empirical results also indicate that the host
28
country GDP and the regulatory framework are the key factors to attract foreign
investment in the region. The empirical results also indicate that terrorist attack in
September 11, 2001 and the Asian crisis did not fundamentally change the flow of
United States foreign investment in the region.
With evidence of the benefits of FDI to host countries, the heightened global
race for FDI has led the governments to liberalize the domestic economy to attract FDI
and to maximize the benefits derived from it. There is agreement that there is no �one-
size-fits-all� strategy for governments to attract and benefit from FDI, but a general
direction for host countries, besides giving out fiscal incentives to foreign investors, is
to increase the absorptive capacities of the domestic economy in terms of human
capital, improving its institutions and the physical infrastructure.
One of the important components of the domestic absorptive capacity is the
importance of domestic companies. Thus to fully benefit from foreign direct
investment, the host country needs to increase the complementary effects between the
local and foreign companies. Governments� reliance on foreign affiliates to �solve�
competitiveness issues tend to neglect the importance of the development of domestic
companies. As such, policymakers tend to subsidize inward FDI heavily, leading to
high opportunity costs as compared to subsidies for growth industries domestically.
Besides policy to attract foreign investment, the government should also seek to
promote synergy between foreign and domestic investments, through the
encouragement of cooperative efforts, and creating and deepening linkages between
TNCs and local firms.
Our results also show that regulatory framework has a positive impact on
foreign investment in the region (Lall, 2002; Kumar, 2003). The successful
29
development of a FDI strategy that aims to attract (and keep) FDI, while benefiting host
countries, is a challenge for governments. The interventionist role of a government is
required in the presence of market failures in the process of investment and deviations
between national interests and those of TNCs. The FDI policies must also counter
coordination and information failures in the investment process, as well as the
divergence between national interests and TNCs� private interests.
Furthermore, governments hoping to attract FDI should also hold the task of
creating skilled technical manpower that is tailored to the activities that are nationally
desirable, as well as encouraging the vibrancy and technological dynamism of the
domestic enterprise sector, such that benefits from FDI can be maximized.
There are several policy implications for ASEAN countries. Generally, among
the ASEAN countries the fiscal incentives for foreign investors in terms of tax breaks
and other incentives are a major feature in the FDI promotion policies of host countries.
Such incentives are, undoubtedly, successful in attracting overseas investments as cost-
competitiveness is a large consideration for foreign investors. For example, tax breaks
and other incentives from the Malaysian government has drawn RM20 billion to the
south Johor economic zone. However, given the dynamic nature of TNCs and also to
increase the spillover of technology to the host countries, policy other than tax
incentives have to be adopted to attract foreign investment.
In general, there are four major tenets that should be addressed in FDI-
promoting policies of host countries, as well as policies to maximize the benefits
derived from FDI � firstly, that there should be a stable political regime and dependable
administration; secondly, that policies be formed in building, maintaining and
upgrading physical infrastructure available in the host country; third, that policies be
30
geared towards maintaining and upgrading human capital such that there is a ready pool
of human resource in terms of skilled professionals and managerial capacity. Combined
with high levels of physical infrastructure, the absorptive capabilities of such a
workforce will be enhanced. Lastly, that synergy between foreign investors and
domestic enterprises be fostered as a part of the promotion of FDI.
As China continues on its economic blaze, it could pose as a serious competitor
to Asian front-runners and other ASEAN members in terms of attracting inward FDI.
The Chinese government figures have shown that actual FDI to China stands at
US$5.18 billion as of January 2007, a 13.9% jump from the previous year. In addition,
India is an up-and-coming economy as well, and is also actively promoting the country
as a choice for technology-related FDI, as can be seen by the various incentives given
out to foreign investors like Intel to set up local wafer fabrication plants. As such,
ASEAN member countries need to put in serious and consistent efforts in growing their
attractive potential and aggressively promoting themselves as choice destinations for
FDI (Athukorla, 2006).
Ng (2006) mentions in his paper that China has often been likened to a vacuum-
cleaner, sucking away most of foreign direct investments at the expense of the region
whereby China�s low labor costs and abundant supply of labor competes head-on with
Southeast Asia in third country markets such as the European Union and the United
States. Wong and Chan (2002) state that, in comparison to ASEAN economies, China�s
route of export diversification, in terms of FDI, resembles that of the ASEAN
economies. However, China has a larger domestic market which allows greater
economies-of-scale advantages, and certainly a larger pool of labor, both skilled and
31
non-skilled. As such, China has a natural cost advantage over ASEAN economies and
other smaller developing countries.
On the other hand, the rise of China can be seen in a positive light.
Notwithstanding the accusation of China as a threat, its huge domestic market and large
external reserves offer plenty of opportunities for Southeast Asia to exploit. Moreover,
several studies have also produced evidence that FDI receipts in China are positively
correlated with other Asian countries� receipts. Complementarities between the region�s
countries have allowed them all to be part of the same global interconnected production
network. In addition, China�s on-going liberalization in the services sectors bodes well
for Southeast Asia, in particular for the region�s ethnic Chinese businesses in terms of
investment opportunities. Apart from that, Southeast Asian countries are now
candidates to attract Chinese investment in the region, considering that China has
become one of the largest investors globally (Wong and Chan, 2002).
As such, there is a need for ASEAN to take measures in a bid for survival and
sustained performance in attracting FDI in view of the Chinese �vacuum cleaner�. As
observed in empirical results, regional impact on economic growth is significant. To
match up better to China�s economic size, there should be a greater integrated ASEAN.
In addition, ASEAN should take a more liberal approach towards FDI from within and
without the region. Lastly, there should be consideration of information and
communications technology (ICT) in the pursuit of FDI.
Firstly, individual countries have to increase and speed up economic integration
within the region. A resulting ASEAN economy will offer a market of half a billion
people, which is close to half of China�s population; and an equivalent GDP to China�s.
Thus, in terms of economic size, ASEAN would have a better footing as a competitor
32
against China, in comparison to the individual countries. In addition, with a greater
range of resources across all member countries, an integrated ASEAN of governments
would be able to increase their bargaining power in negotiations with large TNCs, as
suggested by Lall (2002).
To facilitate economic integration, ASEAN member countries would need to
ensure commitment to designing domestic policies and regional agreements that
harmonize all member countries. Differential policy regimes may reduce the
effectiveness of a unified ASEAN representation, whereby individual member countries
or groups within the region engage in mutually-destructive competition for FDI.
Although joint-promotion of member countries such as the ASEAN-4 could be effective
in a way that all member countries are similar and thus easier to promote as a single
entity, it would be more enticing to promote ASEAN to foreign investors as a dynamic
region with the ability to house different levels of the production chain in ASEAN
locations with close geographical and cultural proximities. Thomsen (1999) had
suggested that FDI promotion should be for activities that build on the existing
comparative advantage of the host country. For the region, this would then imply the
need to highlight the comparative advantage that each member country possesses and
attract the corresponding investment activity which can build on those characteristics.
As Severino (2001) puts it, with an ASEAN of all ten countries of the region, it builds a
stronger base for stability in the region, and gives investors more choices in deciding
locations for their operations, for export production elsewhere or for the ASEAN
market that is increasingly integrated.
In addition, ASEAN should increase the region�s openness to FDI while
balancing and maintaining internal relationships between member countries. As
33
mentioned by Thomsen (1999), the incomplete openness towards FDI of the ASEAN-4
does not promote sustainable development, whereby FDI�s role in the domestic
economy is very limited and full beneficial transfers are hindered. As such, the region
as a whole should take a more liberal approach to FDI inflows, so as to benefit from a
wider impact from foreign transfers across the domestic economy. While external
relationships established with source countries of outward FDI should be pursued to
gain transfers of new and more advanced technology from the developed regions, intra-
regional cooperative measures can be undertaken based on the complementarities of
member countries� resources and niche knowledge. This is done to increase the
competitive edge of the region, as well as to build up the indigenous capabilities of each
individual country. As ASEAN countries grow as a region and improve their
capabilities in terms of human capital and infrastructure, coupled with the increasingly
outward-oriented FDI regime, their attractiveness as FDI destinations increases,
especially to FDI activities which are higher on the value chain of production.
As such, it is imperative that individual ASEAN countries be committed in
building up the absorptive capacities of the domestic economy in terms of infrastructure
and human capital. In addition, synergy between foreign and domestic sectors within
the domestic economy should be encouraged, amidst a sound political environment.
Combined with regional openness and incorporation of ICT, an integrated ASEAN can
be promoted as a region for FDI.
34
Appendix Table A1 United States: Demand, Output, External Indicators 2005 2006 2007 2008 Change from the previous year (%) Real GDP 3.1 2.9 2.2 2.0 Private consumption 3.2 3.1 2.9 1.8 Government consumption 0.8 1.4 2.0 2.4 Gross fixed investment 5.8 2.6 -2.1 -1.2 Public 0.6 3.7 2.5 2.9 Residential 6.6 -4.6 -17.2 -15.4 Non-residential 7.1 6.6 4.7 3.7 Final domestic demand 3.3 2.7 1.8 1.4 Stock building -0.2 0.1 -0.3 0.1 Total domestic demand 3.1 2.8 1.6 1.5 Exports of goods and services 6.9 8.4 8.1 8.6 Imports of goods and services 5.9 5.9 2.1 3.4 External indicators (US$ billion) Exports of goods and services 1309.4 1467.6 1642.6 1838.0 Imports of goods and services 2024.0 2229.6 2350.8 2539.0 Foreign balance -714.6 -762.0 -708.2 -701.0 Invisible, net -40.3 -49.5 -60.5 -74.0 Current account balance -754.8 -811.5 -768.7 -775.0 Source: OECD(2007)
Table A2: The Variables and Their Sources
35
Table A3: List of Countries in the Sample
1 Argentina 21 Guatemala 41 Philippines2 Australia 22 Honduras 42 Portugal3 Austria 23 Hong Kong, China 43 Saudi Arabia4 Bahamas 24 India 44 Singapore5 Barbados 25 Indonesia 45 South Africa6 Belgium 26 Ireland 46 Spain7 Brazil 27 Israel 47 Sweden8 Canada 28 Italy 48 Switzerland9 Chile 29 Jamaica 49 Taiwan
10 China 30 Japan 50 Thailand11 Colombia 31 Korea, Rep. 51 Trinidad and Tobago12 Costa Rica 32 Luxembourg 52 Turkey13 Denmark 33 Malaysia 53 United Arab Emirates14 Dominican Republic 34 Mexico 54 United Kingdom15 Ecuador 35 Netherlands 55 Venezuela16 Egypt 36 New Zealand17 Finland 37 Nigeria18 France 38 Norway19 Germany 39 Panama20 Greece 40 Peru
Table A4: Determinants of The Share of US� FDI (All Countries)
Dependent variable: Share of FDIRE CRE
(1) (2) (3) (4) (5) (6)Regional dummies
Asia (=1) -2.46 -2.46 -0.65 0.38 0.21 0.16(1.08)** (1.09)** (1.29) (1.08) (0.81) (0.88)
South America (=1) -2.33 -2.33 -0.18 -0.50 -0.76 -0.77(1.10)** (1.11)** (1.26) (0.86) (0.97) (0.97)
Africa (=1) -3.08 -3.09 -0.93 -1.01 -0.04 -0.12(1.05)*** (1.06)*** (1.22) (1.57) (1.25) (1.42)
Australia & New Zealand (=1) -1.40 -1.41 -1.53 -1.04 0.22 0.22(1.54) (1.55) (1.56) (2.43) (2.70) (2.72)
Developed (=1) Yes Yes Yes YesGravity variables Yes Yes YesTime effect No Yes Yes Yes Yes YesMeans of time-variant No No No No No YesObservations 1451 1451 1451 1377 1377 1377Number of countries 57 57R-squared 0.14 0.14 0.16 0.53 0.51 0.51
OLS
Notes: The sample includes all countries; robust standard errors in parentheses; the excluded regional dummy is Europe & Canada; RE stands for random-effect model, while CRE correlated-random-effect model; * significant at 10%; ** significant at 5%; *** significant at 1%.
36
Table A5: Determinants of the Share of US� FDI (Includes only Asia-Pacific Countries)
Dependent variable: Share of FDIRE CRE
(1) (2) (3) (4) (5) (6)Regional dummies
South-east Asia (=1) 0.46 0.47 1.15 -2.51 -2.04 -2.65(0.23)* (0.24)* (0.61)* (0.89)** (0.95)** (0.74)***
South Asia (=1) -0.12 -0.11 0.57 -1.81 -1.06 -2.94(0.08) (0.08) (0.57) (0.72)** (1.07) (0.59)***
East Asia (=1) 1.21 1.22 1.50 0.05 -0.06 0.24(0.70) (0.72) (0.70)** (0.43) (0.61) (0.26)
Australia & New Zealand (=1) 1.65 1.66 0.42 -4.69 -2.80 -6.22(1.16) (1.20) (1.57) (1.48)*** (1.74) (1.27)***
Developed (=1) Yes Yes Yes YesGravity variables Yes Yes YesTime effect No Yes Yes Yes Yes YesMeans of time-variant No No No No No YesObservations 420 420 420 407 407 407Number of countries 16 16R-squared 0.22 0.22 0.44 0.80 0.74 0.86
OLS
Notes: The sample includes Asia-Pacific countries only; robust standard errors in parentheses; the excluded regional dummy is Middle-Eastern countries; RE stands for random-effect model, while CRE correlated-random-effect model; * significant at 10%; ** significant at 5%; *** significant at 1%.
37
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