Attracting Foreign Direct Investment in ASEAN: The Impact of Institutional Quality and Macroeconomic Drivers

Abstract

Institutional quality (IQ) stands as a cornerstone in shaping foreign direct investment (FDI), influencing both the confidence and commitment of international investors in any nation's economy. This research empirically explores the influence of IQ variables, along with other important macroeconomic factors, on inward FDI in nine countries of the $\text{Association of Southeast Asian Nations}$ (ASEAN) using quarterly data from 2002Q1 to 2022Q4. Appropriate estimation techniques, including Robust Least Squares, Fully Modified Ordinary Least Squares (OLS), and Dynamic OLS estimators, are implemented in the current work to estimate the parameters. The study finds that IQ variables, namely corruption, rule of law, political stability, and government effectiveness, are significant in determining FDI inflows in the ASEAN economies, in addition to macroeconomic variables such as trade openness, urbanization, market size, financial sector development, tourism development, and inflation rate. The findings reveal that political stability and the rule of law positively influence FDI inflows, and corruption and government effectiveness show significant negative effects. Most variables showed significance at the 1% level. Findings suggest that policymakers should prioritize strengthening institutional governance, reducing corruption, and improving regulatory frameworks to create a more secure and attractive investment environment. Also, the stakeholders and development agencies must support institutional reforms to enhance legal certainty and administrative efficiency to boost FDI growth.