Political stability and foreign direct investment inflows in 25 Asia-Pacific countries: the moderating role of trade openness

The study investigates how trade openness (TO) and political stability (POL) shape foreign direct investment (FDI) inflows across 25 Asia-Pacific (APAC) countries from 1990 to 2020. Motivated by the region’s large and rapidly growing economies, significant global trade participation, varied political governance, and substantial share of global FDI inflows, the paper asks: (1) Does trade openness promote FDI? (2) Does political stability affect FDI? (3) Does trade openness moderate the POL–FDI relationship? The authors posit three hypotheses: H1, TO positively relates to FDI; H2, POL positively relates to FDI; and H3, TO moderates the POL–FDI link. The study aims to provide robust empirical evidence using advanced econometric methods to guide policymakers in APAC on fostering sustainable FDI inflows.

The literature documents mixed effects of trade openness on FDI. Some studies (Bhasin and Garg, 2020; Mudiyanselage et al., 2021; Khan and Hye, 2014) argue higher openness can reduce FDI in emerging markets due to heightened risk, regulatory tightening, or policy uncertainty. Others (Gnangnon, 2018; Hashmi et al., 2020; Kurul and Yalta, 2017) find openness encourages FDI through reduced tariffs/quotas, lower cross-border costs, and enhanced efficiency and resource access, consistent with market-, efficiency-, and resource-seeking theories. Evidence on political stability is also mixed: institutional and governance theories suggest stability attracts FDI via better property rights and contract enforcement (e.g., Elish, 2022; Ciesielska-Maciagowska and Koltuniak, 2021), yet other work (Kurecic and Kokotovic, 2017; Shan et al., 2018; Chen et al., 2023) shows stability can deter certain FDI when paired with restrictive or interventionist policies, aligning with regulatory risk theory. Prior research further suggests that openness and stability together can be complementary in attracting FDI by improving institutional quality and market access (Blomstrom et al., 2001; Hashmi et al., 2020; Wei, 2000), motivating the moderation hypothesis that TO conditions the effect of POL on FDI.

Data: Panel of 25 APAC countries from 1990–2020 with 463 annual observations constructed from World Bank data. Outliers were winsorized at the 5% and 95% levels. Observations with insufficient data were excluded. Measures: FDI is net FDI inflows as a percentage of GDP. Trade openness (TO) is (exports + imports)/GDP. Political stability (POL) is the World Bank governance indicator (−2.5 to 2.5). Controls: consumer price index (CPI), control of corruption (COC), and real GDP growth rate (GDP_GROWTH). Empirical strategy: The authors estimate panel models via OLS, fixed effects (FEM), and random effects (REM), using Hausman and Lagrange Multiplier tests to select among them. Autocorrelation and heteroskedasticity were assessed with Durbin–Watson and Laplace Likelihood Ratio tests. To address endogeneity, heteroskedasticity, and autocorrelation, they implement dynamic system GMM (Arellano–Bond framework), instrumenting with FDI lags and endogenous regressors (FDI(−1), TO, POL, TO×POL). Model specifications include: (i) FDI on lagged TO plus controls; (ii) FDI on lagged POL plus controls; (iii) FDI on TO×POL plus controls; and (iv) a full model with TO, POL, TO×POL and controls, including country and year fixed effects. Moderation is analyzed using an interaction term (TO×POL), complemented by the Johnson–Neyman technique to identify regions of significance for POL’s effect on FDI across levels of TO and a simple-slopes analysis at low/mean/high TO. Robustness checks: (1) Two-Stage Least Squares (TSLS) estimation; (2) re-estimation excluding tax-haven countries (per related literature). Model diagnostics include J-statistics for instrument validity and AR(2) tests for higher-order serial correlation.

- Trade openness increases FDI: Dynamic system GMM shows a positive and significant TO effect (e.g., coefficient ≈ 0.0330 with t ≈ 15.40; alternative model ≈ 0.0276 with t ≈ 3.27). Interpreted, a 1% increase in TO is associated with about a 0.033% increase in FDI inflows (as % of GDP). - Political stability reduces FDI in GMM: POL is negative and significant (e.g., −0.1571, t ≈ −3.09), rejecting Hypothesis 2 and supporting regulatory risk theory. - Moderation by trade openness: The interaction TO×POL is positive and significant in moderated regression analysis (β ≈ 0.0224, p < 0.001; Table 5), indicating that higher TO strengthens the (conditional) effect of POL on FDI. Johnson–Neyman analysis shows the moderation effect is significant when TO support is lower than 67.116 and higher than −24.743 and nonsignificant when TO is between −67.116 and −24.743. Simple slopes indicate the POL–FDI association is stronger at high TO (one SD above mean) than at low TO (one SD below mean). - Controls: CPI shows mixed significance (positive in some models), COC (control of corruption) positively relates to FDI, and GDP growth is consistently positive and significant, indicating macroeconomic strength attracts FDI. - Robustness: TSLS confirms the positive TO effect on FDI; POL remains negative but often statistically insignificant in TSLS, while the TO×POL moderation remains. Excluding tax havens, TO and POL effects persist, but the interaction becomes statistically insignificant. - Additional context: The moderating role of TO was robust prior to the 2008 financial crisis (per abstract). Diagnostics (J-statistics, AR tests) support instrument validity and absence of second-order serial correlation in GMM.

The results address the research questions by demonstrating that trade openness robustly attracts FDI to APAC economies, consistent with market-, efficiency-, and resource-seeking motives as openness reduces trade costs and expands market access. Contrary to Hypothesis 2, higher political stability is associated with lower FDI in the preferred GMM framework, aligning with regulatory risk theory: in some settings, stable regimes may impose restrictive regulations or interventionist policies that deter foreign investors. The significant TO×POL interaction in moderated regression and the Johnson–Neyman regions suggest openness conditions the stability–FDI nexus: greater openness enhances the capacity of countries to attract FDI even when political stability alone is not favorable, effectively leveraging trade integration to offset adverse regulatory or governance perceptions. Positive effects of institutional quality (COC) and macroeconomic performance (GDP growth) reinforce that an enabling environment and strong fundamentals complement openness in attracting FDI. These findings are relevant for policy in the APAC region, indicating that deepening trade integration can be a powerful tool to boost FDI, particularly when paired with regulatory reforms that mitigate the deterrent aspects associated with political stability in some contexts.

The study finds that, across 25 APAC countries (1990–2020), trade openness has a strong and positive impact on FDI inflows, political stability negatively correlates with FDI in the preferred GMM estimates, and the interaction between trade openness and political stability is positive—indicating a meaningful moderating role of openness on the POL–FDI relationship. This implies that while investors favor open economies for cost and market advantages, the effect of political stability on FDI is context-dependent and can be enhanced by greater openness. Policy recommendations emphasize pursuing free trade agreements, streamlining customs and regulatory procedures, strengthening legal frameworks, and curbing corruption to bolster investor confidence. Future research should address limitations by employing panel ARDL or related methods to disentangle short- versus long-run dynamics and explore broader samples and alternative institutional measures.

- Econometric limitation: The dynamic system GMM framework is not well-suited to separately identify short-run versus long-run effects of regressors on FDI; future work should apply panel ARDL or related approaches. - External validity: Although covering 25 APAC countries over 1990–2020, findings may not generalize beyond the region or to different periods characterized by distinct global shocks. - Measurement constraints: Reliance on aggregate indicators (e.g., POL, COC) and FDI as % of GDP may mask heterogeneity across sectors, FDI types (greenfield vs. M&A), and institutional sub-dimensions. - Moderation robustness: The TO×POL interaction loses significance when excluding tax-haven countries, indicating sensitivity of the moderation effect to sample composition.