**3.2 Trends of trade and FDI**

A number of studies investigate the major contributors of economic growth in East Asian economic transition countries, and often FDI inflows and trade liberalization are suggested as the main determinants [22–27]. Nevertheless, the relationship between FDI and trade remains one of the hottest debates as was argued in Section 2.1.

**Figure 5** shows the trend of FDI net inflows in current billion US\$ of China, Cambodia, Lao PDR, and Vietnam, and **Figure 6** shows the trend of trade in current billion US\$ of the countries during the period 1990–2019. There are two y-axis in the figure, where left axis describes the status of China, while right axis describes

**Figure 5.** *Trends of FDI net inflows. Source: World Bank.*

**Figure 6.** *Trends of trade volume. Source: World Bank.*

the rest of the countries in both figures. Also, both figures are presented in the unit of current billion US\$.

For the FDI net inflows presented in **Figure 5**, every countries show improving trends with some fluctuations. Starting economic reforms in 1978, China's FDI inflows gradually increased from \$3.49 billion in 1990 to \$235.36 billion in 2018, and reaching its record high of \$290.928 billion in 2013.

While China shows fall in FDI inflow in recent years, FDI inflow in Vietnam has gradually increased since the implementation of the *Doi Moi* in 1986. Starting from \$180 million in 1990, FDI inflows consistently increased, reaching \$9.579 billion in 2008 with a small fluctuation during the global financial crisis, and continues to increase achieving new record every year. In the figure, Vietnam stays in higher point than China in recent years, but it should be noted that China is presented in different axis and it's about 15 times larger than it is shown in the graph compared to other East Asian economic transition countries.

In the case of Cambodia, who started the reform the last in 1989, FDI inflow was \$33 million in 1992, remaining stable until the early 2000s, and rapidly increased since 2004 from \$131 million to \$3.663 billion in 2019.

Compared to other East Asian economic transition countries, FDI inflows in Lao PDR has shown relatively slow increase in the figure. Initiating economic reforms in 1986, FDI net inflows in Lao PDR started low as -\$1.62 million in 1985, rising to \$159.8 million in 1996, reaching the highest in 2017 of \$1,693 million, and sharply decreased in 2019 of \$557.2 million.

Compared to **Figure 5**, trends of trade volume of East Asian economic transition countries in **Figure 6** increase in stable pace with less fluctuation and small volatility. Every countries has shown significant increase in trade volume over the period although the trends of Cambodia and Lao PDR seem not improved notably relative to China or Vietnam in the figure. Trade volume of Lao PDR started at \$310 million in 1990, surpassing \$1 billion in 1994, reached the highest of \$13 billion in 2014, and shows a decrease afterwards.

In case of Cambodia, trade volume shows a consistently increasing trend from \$1.2 billion in 1993 to \$33 billion in 2019. During the period, trade volume decreased only in 2009 from \$13.8 billion in 2008 to \$10.9 billion in 2009 attributed to the global financial crisis, but recovered afterwards by increasing its volume by \$2 billion each year.

Although Lao PDR, Cambodia, and Vietnam had similar start in 1990, Vietnam shows the highest growth in trade volume from \$5.26 billion in 1990 to \$551 billion in 2019. Shown in the figure, it rapidly increases since 2009 similar to the case of Cambodia. Interestingly, major trading partners of Vietnam are the main foreign investors [7]. Although Vietnam shows rapid growth of trade compared to Cambodia and Lao PDR, the growth of import is faster than the export thus widening the gap between the import and export.

China's trade volume started at \$87.6 billion in the initial stage in 1990, has speed up its growth since 2000s with a decrease in 2009, 2015, 2016, and 2019. Both export and import decreased during the fluctuations, and the fluctuations are more significantly shown if demonstrated in a ratio of GDP. Interestingly, export volume accounted for 36% of GDP in 2006, but only 18.4% in 2019 although the volume increased from \$991 billion in 2006 to \$2,641 billion in 2019.

Trade and FDI data that were collected for **Figures 5** and **6** are now presented in relationship in **Figure 7** as FDI net inflows in x-axis, and trade volume in y-axis during 1990–2019. Similar to **Figure 3**, trade and FDI show proportional relationship for every four East Asian economic transition countries. Cambodia shows the best fit, following by Vietnam, and Lao PDR, respectively. China shows the worst fit with some significant outliers as the value of FDI increases.

**Figure 7.** *Relationship between FDI and trade. Source: World Bank.*

#### **3.3 FDI promotion policies**

To promote economic growth, all four East Asian economic transition countries have put significant efforts to attract FDI in various ways. Countries provide various investment incentives to foreign investors, equally treat foreign and domestic investors, and established special economic zones for further engagement. In addition, apart from Lao PDR, rest of the countries have one unified central government agency responsible for promoting FDI. For foreign investors to begin investment in these countries, they should contact the administrative control tower for FDI that are summarized in **Table 2**.

China first started to open up its economy by enacting the law for joint ventures in 1979 that granted a legal status for foreign investment and establishing four special economic zones (SEZs) in 1980. FDI promotion policies were modified several times and SEZ status were gradually extended to other industrial cities in 1984, 1985, 1990, and 1992 [29]. The *Provisions of the State Council of the People's Republic of China for the Encouragement of Foreign Investment* (22 Article Provisions) and the *Law of the People's*


**Table 2.** *Administrative control towers for FDI.*

*FDI and Its Impact on Trade in the East Asian Transition Economies DOI: http://dx.doi.org/10.5772/intechopen.97214*

*Republic of China on Enterprises Operated Exclusive with Foreign Capital* launched in 1986 enabled foreign investors to enter China as a wholly foreign-owned enterprise in some circumstances and provided strong incentives for FDI [30]. Inward FDI slowed down during the Asian financial crisis in late 1990s, but China's WTO accession in 2001 and amendment of laws to comply with WTO commitments acted as a catalyst for rapid growth in FDI inflow and expansion of types of FDI from manufacturing to tertiary sectors. The new Foreign Investment Law (FIL) was enacted in 2020 that replaced the existing investment laws on joint ventures and wholly foreign owned enterprises. The FIL includes foreign IP (intellectual property) rights and equal treatment of foreign and domestic companies regarding tax exemptions, licensing, government funds, and so on [31].

In Lao PDR, FDI promotion law was enacted in 1988 and was reformed several times, in 1994, 2004, 2009, and 2016 by the Investment Promotion Department (IPD) [28]. Reformation in 2009 has improved the foreign investment environment by equally treating domestic and foreign investors. Further, Special and Specific Economic Zones (SSEZ), where have independent investment procedures and provides one-stop-services for investors, was established in 2003 to attract more FDI in the country. The Ministry of Industry and Commerce (MoIC) and the Ministry of Planning and Investment (MPI) are the administrative control towers responsible for promoting FDI. Former operates administration process for general business activities, and the latter operates administration process for concession business activities and investment in SSEZ.

After devastating war in Cambodia, FDI promotion law was first initiated in 1994 to attract FDI to rehabilitate the destroyed infrastructure and enhance growth. The Council of the Development of Cambodia (CDC) plans, operates, inspects, evaluates, and also rehabilitates national investment system and projects. In 2005, the CDC established Cambodian Special Economic Zone Board (CSEZB) to plan and launch special economic zones that offer one-stop service, similar to Lao PDR's SSEZ [32].


#### **Table 3.**

*FDI-related laws in China, Cambodia, Lao PDR, and Vietnam.*

Vietnam started to attract FDI since enacting the Law of Foreign Investment in 1987. The law was reformed several times and was lastly revised in 2014. Export processing zones that provide special incentives were established in 1991 in accordance with the amended law of foreign investment. Anwar and Nguyen [5] argue FDI was a major factor that contributed the country transform from an agricultural based economy to an industrialized based economy. Similar to Lao PDR, MPI is responsible for promoting FDI in Vietnam, but more extensively. MPI in Vietnam not only plans, manages, and operates the national investment system, but also inspects overall investments in Vietnam. Major FDI related legislations and decrees of East Asian economic transition countries are summarized in **Table 3**.

### **4. Empirical model specification**

The empirical analysis presented in this paper is based on a long panel data set which involves four East Asian economic transition countries over the period 1990–2019. In order to examine the effect of FDI on trade in East Asian economic transition countries (China, Cambodia, Lao PDR, and Vietnam) from 1990 to 2019, this paper utilizes OLS and panel within fixed effect model to take account of unobserved time invariant country-specific effects such as languages, trade distances, and geographical borders. Referring from reviewed literatures in Section 2.2, the general panel regression equation is as follows.

$$\begin{array}{c} \ln\left(\text{TRADE}\right)\_{\text{it}} = \beta\_0 + \beta\_1 \ln\left(\text{FDI}\right)\_{\text{it}} + \beta\_2 \ln\left(\text{GDP}\right)\_{\text{it}} + \beta\_3 \ln\left(\text{HUM}\right)\_{\text{it}} + \beta\_4 \ln\left(\text{EXC}\right)\_{\text{it}}\\ + \beta\_5 \ln\left(\text{TAR}\right)\_{\text{it}} + \beta\_6 \ln\left(\text{FINA}\right)\_{\text{it}} + \beta\_7 (\text{WTO})\_{\text{it}} + a\_i + e\_{it}, \end{array} \tag{1}$$

where ð Þ *TRADE it* is the dependent variable which is measured by the sum of exports and imports of goods and service of country i at time t, expressed in a ratio of GDP. FDI is the inward FDI stock, expressed in current million \$US, HUM is the variable for human capital proxied by tertiary school enrollment, EXC is the official exchange rate, expressed in local currency per US\$, and TAR is the weighted tariff rate of all products. FINA measures bank credit to private sector as a proxy for financial development, expressed in a ratio of GDP, WTO is a dummy variable for country's WTO compliance, values 1 for country's accession, or 0 otherwise, *α<sup>i</sup>* is a time invariant error, and *εit* is an idiosyncratic error. The issue of this general equation is that there exists a time invariant component and individualspecific components of the error term that are correlated with the independent variables.

Hausman's specification test was conducted to distinguish if there is a significant bias in a random effects or fixed effects. Based on the results of Hausman test, fixed effect model is consistent and favored over the random counterpart, hence, this study uses fixed effects transformation from the above equation by subtracting off the mean over time for each country so that demeaning transformation eliminates the *α<sup>i</sup>* term and only demeaned idiosyncratic error term is left. Also, within fixed effect model was utilized as within variation of variables were greater than between variation. This modified model specification is as follows:

$$\begin{split} \ln \left( (\boldsymbol{T} \ddot{\boldsymbol{A}} \boldsymbol{\ddot{A}} \boldsymbol{D} \boldsymbol{E})\_{\mathrm{it}} \right)\_{\mathrm{it}} &= \beta\_0 + \beta\_1 \ln \left( \ddot{\boldsymbol{F}} \boldsymbol{D} \boldsymbol{I} \right)\_{\mathrm{it}} + \beta\_2 \ln \left( \ddot{\boldsymbol{G}} \boldsymbol{D} \boldsymbol{P} \right)\_{\mathrm{it}} + \beta\_3 \ln \left( \ddot{\boldsymbol{H}} \boldsymbol{\tilde{U}} \boldsymbol{M} \right)\_{\mathrm{it}} + \beta\_4 \ln \left( \ddot{\boldsymbol{E}} \boldsymbol{\tilde{X}} \boldsymbol{C} \right)\_{\mathrm{it}} \\ &+ \beta\_5 \ln \left( \ddot{\boldsymbol{T}} \boldsymbol{A} \boldsymbol{R} \right)\_{\mathrm{it}} + \beta\_6 \ln \left( \ddot{\boldsymbol{F}} \boldsymbol{\tilde{N}} \boldsymbol{A} \right)\_{\mathrm{it}} + \beta\_7 (\boldsymbol{\mathcal{W}} \boldsymbol{\tilde{T}O})\_{\mathrm{it}} + \boldsymbol{\ddot{e}}\_{\mathrm{it}} \end{split}$$

*FDI and Its Impact on Trade in the East Asian Transition Economies DOI: http://dx.doi.org/10.5772/intechopen.97214*


#### **Table 4.**

*Variable description.*

where *TRADE* € ð Þ*it* is *TRADEit* � *TRADEit*, and same for other variables as well. For this fixed effect estimator to be consistent, independent variables and the error term should not be correlated to prevent endogeneity problem and reverse causality effect [33, 34].

**Table 4** describes the utilized variables, its source and expected signs. TRADE data is collected from WDI (World Development Indicators), and is the sum of exports and imports of goods and services. FDI data has been sourced from the UNCTAD (United Nations Conference on Trade and Development). FDI stock variable was utilized instead to FDI flows to avoid time lag and multicollinearity problems between trade and investment [3].

GDP, HUM, TAR, and FINA data are sourced from WDI, and EXC data are collected from the Brugel Datasets. Country's WTO accession date is searched from the member information section of WTO website [35]. As countries have to refine its policies to comply with WTO trade principles, expected sign of WTO is positive. Further, expected impacts of FDI, GDP, HUM, and FINA on TRADE are also positive, while the expected sign of TAR is negative, and EXC can have both positive and negative impact on trade.


ln ð Þ *TAR it* 120 2.3418 .6133 .5481 3.5016 ln ð Þ *FINA it* 120 3.4407 1.2227 .5197 5.11 ð Þ *WTO it* 120 .4583 .5004 0 1

**Table 5** presents summary statistics of collected variables for China, Cambodia, Lao PDR, and Vietnam from 1990 to 2019. Missing values of data are replaced with

**Table 5.** *Summary statistics (1990–2019).* imputed values, where missing values between the collected values are replaced by its mean and missing values before and after the collected values are replaced by the first and last collected data.
