Nonlinear Effect of Financial Development and Foreign Direct Investment in Integration… DOI: http://dx.doi.org/10.5772/intechopen.86104

among the ASEAN countries including Malaysia, Thailand, Indonesia, Singapore, and the Philippines. The study covers 38 years for the period of 1980–2017. The sources of the data are World Development Indicators, UNCTAD Database and Financial Structure Dataset.

The last few decades, the ASEAN-5 economies have witnessed an increasing economic freedom and financial integration implies a strong interdependence between these countries. To measure the existence of economic integration among ASEAN-5 countries, the cross-sectional dependency (CD) test is used for all variables [9]. The existence of cross-sectional dependency among ASEAN-5 countries are proven in Table 1 indicated by the p-value of CD statistics which are lower than 0.01 for all variables that against the null hypotheses of cross-sectional independence among countries, CD N(0,1). Consumer price index is the highest absolute correlation among ASEAN-5 countries at 0.976, means the changes of price of one country closely affected price the other countries. Meanwhile, liquid liabilities are the highest absolute correlation in ASEAN-5 region among other proxies for financial development. This may involve the integrated economic process especially when the countries are neighbors. Furthermore, the cross-sectional dependence can arise for several reasons, such as spatial spillovers, financial contagion, and socioeconomic interactions [19].

Table 2 shows the descriptive statistics of the variables. Jarque-Bera for normality test shows that all variables are not normally distributed. The median for


#### Table 1.

market, through the financial reporting can reduce the asymmetric information that

absorb and efficiently manage FDI inflows and take advantage of potential FDI benefits [18]. Although recent studies discover that financial development influences FDI performance to be realized, the long run relationship between the variables including FDI, financial development and macroeconomic variables need adequately addressed in the field of study. This study is therefore attempting to contribute to the existing literature in the dimensions of nonlinearity and crosssectional dependency dimensions. The investigation on the effects of financial development on the FDI inflows employs both linear and quadratic models in the estimations. Incorporating the cross-sectional dependency due to economic integration, financial openness, economic freedom and spillover effects among ASEAN-5 countries over the period 1980–2017, the panel cointegration for second generation is used and the long-run coefficient estimated by considering the

Accounting and Finance - New Perspectives on Banking, Financial Statements and Reporting

The development of strong financial market can increase an economy's ability to

The effect of the financial development on foreign direct investment is investigated by using ASEAN-5 countries panel data with the econometric model specified

where, the FDI in Eq. (1) represents foreign direct investment, and FinDev indicating financial development. The domestic credit of private sector, liquid liabilities and private sector credit to deposit money are used as a proxy for financial development. Parameter X comprises with the vector of control variables: real gross domestic product per capita (RGDPPC) and consumer price index (CPI). The crosssections are denoted by subscript i (i = 1, 2, …, N), the time period by subscript t (t = 1, 2, …,T), ω<sup>i</sup> is the country fixed effect and ε is the stochastic random term. Incorporating the nonlinear effect of financial development on FDI, Eq. (1) has

it þ α<sup>0</sup>

it is a square term for financial development that indicates the

Xit þ ω<sup>i</sup> þ εit (1)

Xit þ θ<sup>i</sup> þ μit (2)

FDIit ¼ β<sup>0</sup> þ β1FinDevit þ β<sup>0</sup>

been extended by using a quadratic specification as expressed in Eq. (2):

the turning point of financial development can be calculated as �α1=2α2.

This study uses FDI inflows as the percentage of GDP. Real GDP per capita in constant of US dollar (US\$) is used to measure economic development. Domestic credit to private sector by banks as a percentage share of GDP (DCPS), liquid liabilities as a percentage of GDP (LL) and private credit to deposit money (PCDM) are used as proxies for financial development. Five countries have been selected

nonlinearity of the relationship between financial development and FDI inflows. The focal parameters in the quadratic model in Eq. (2) are α<sup>1</sup> and α2. If there exists a nonlinear relationship between financial development and FDI, an anti-Kuznets curve is anticipated since higher the financial development indicating the financial health that can assist the foreign entrepreneur and thus attracting the FDI inflows in ASEAN-5 countries. The anti-Kuznets curve is verified by significantly negative sign in parameter α<sup>1</sup> and significantly positive in α2. The threshold level is computed by first order derivation (δFDI=δFinDev). Based on the quadratic model in Eq. (2),

FDIit <sup>¼</sup> <sup>α</sup><sup>0</sup> <sup>þ</sup> <sup>α</sup>1FinDevit <sup>þ</sup> <sup>α</sup>2FinDev<sup>2</sup>

attracts the FDI inflows into the host countries.

cross-sectional dependence in this study.

as follows:

where FinDev<sup>2</sup>

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3. Econometric model and data description

Result of cross-sectional dependency test for ASEAN-5 countries.


#### Table 2.

Descriptive statistics of variables.

