DETERMINANTS OF FOREIGN DIRECT

INVESTMENT IN MALAYSIA





Presented by
Yee Nee TEOH
090051064




ECM010 DISSERTATION
MSc Business Economics
Supervisor: Professor Saqib Jafarey

September 2010





CONTENTS


ACKNOWLEDGEMENTS3
ABSTRACT.4
CHAPTER 1: INTRODUCTION..5
1.1 BACKGROUND.5
1.2 PROBLEM STATEMENT..7
1.3 CONCEPTS AND THEORIES..9
1.4 RECENT TRENDS...10
1.5 OBJECTIVE OF THE STUDY10
1.6 SIGNIFICANT OF THE STUDY11
CHAPTER 2: LITERATURE REVIEW12
CHAPTER 3: METHODOLOGY...19
3.1 DATA SOURCES.19
3.2 EMPIRICAL MODEL...21
3.3 EXPECTED RESULT...22
CHAPTER 4: EMPIRICAL RESULTS..23
4.1 AUGMENTED DICKEY FULLER TEST ..24
4.2 CORRELATION MATRIX .25
4.3 ORDINARY LEAST SQUARES ESTIMATION ...26
4.4 BREUSCH-GODFREY LM TEST ..28
4.5 RAMSEY RESET TEST...28
4.6 THE WHITES TEST29
4.7 DESCRIPTIVE TEST30




CHAPTER 5: CONCLUSION.31
5.1 SUMMARY...31
5.2 MAJOR FINDINGS..31
5.3 POLICY IMPLICATIONS33
5.4 LIMITATION OF THE STUDY...34
5.5 RECOMMENDATION FOR THE FUTURE STUDY.35
REFERENCES...36


List of Figures
Figure 1: Net inflow of foreign direct investment (FDI) in Malaysia..10


List of Tables
Table 1: Data source and units of measurement...20
Table 2: ADF unit root test results...24
Table 3: Correlation matrix..25
Table 4: OLS estimation results...26
Table 5: Breusch-Godfrey LM test results...28
Table 6: Ramsey RESET test results28
Table 7: Whites test results.29
Table 8: Descriptive test results...30








ACKNOWLEDGEMENTS

With the deepest gratitude I wish to thank my supervisor Professor Saqib Jafarey, for
giving me this opportunity to involve in this Study and his superb guidance to guide me
completed this work. The project is fully supervised by him during the past 3 months.
I would also like to thank my parents for their advices, financial and moral support
throughout this academic year and help me to overcome the obstacles when the things do not
turn out as expected.




ABSTRACT

This study using quarterly time series data for the period 1997 2007 to examines the
determinants of foreign direct investment (FDI) in Malaysia. The study uses the Ordinary
Least Square (OLS) method to identify the variable in explaining the FDI in Malaysia.
Empirical results suggest that FDI flows in Malaysia are positively influenced by market size
and corporation tax rate while negatively affected by degree of openness in economy, real
exchange rate and labour cost. All variables are statistically significant except for the degree
of openness and corporate tax rate.




CHAPTER 1: INTRODUCTION


1.1 BACKGROUND

Over the past decade, foreign direct investment (FDI) has increased sharply as a major
form of international capital transfer. Economic phenomena such as globalization,
liberalization and economic integration are one of the significant outcomes from the flow of
FDI. It is widely recognized that FDI generate economic benefits to recipient country.
However, economists have no general consensus on the factors to determining the flow of
FDI. That means until now there have no independent variables able to consider as the correct
determinant of FDI. Many of the studies have shown mixed result of the determinant of FDI.
Main factors driving FDI like the rate of exchange, wages, corporate tax, and trade barriers
identified to have both positive and negative impact on FDI.
In classic form, FDI is a company from one country making a physical investment by
building a factory in another country. While according to the IMFs Balance of Payments
Manual 5
th
edition, FDI can be defined as the investment made to acquire lasting interest in
enterprises and develop a multinational corporation (MNC) together with foreign affiliate. In
line with the definition of IMF and OECD, Malaysia has chosen an arbitrary value, holding
of at least 10 per cent of the total equity in a resident company by a non-resident direct
investor. This also include a foreign direct investment relationship which connecting the non-
resident direct investor and resident companies with subsequent transactions in financial
assets and liabilities. Generally, the motive behind foreign investors is influenced by three
groups of factor. First is the resource-seeking, this might be happen when the home economy
lack of natural resources and factor of production. The second one is market-seeking which
aim to discovering the new markets or expanding the existing market. Third groups will be
efficiency-seeking by trying to develop economies of scale to improve the efficiency and
profit.
Global FDI dominated by United States after the Second World War and according to the
history, there have around 60% of the world FDI stock in this time period was in natural
resources. Availability of these kind resources especially minerals, agriculture product and



raw material become an important determinant of FDI for host country. Malaysia as a
medium-size, upper middle income developing economy, although it is largely urbanized but
the state continues to develop their cultural sectors actively. This is aided well by its rich
natural resources. In addition, a condition where politically stable is highly attractive to
foreign investment. Hence, FDI appears to a key driver underlying the strong growth
performance experienced by the Malaysian economy. Reformation of the policy to improve
the investment climate by Malaysia government with the introduction of Investment
Incentives Act in 1968 to promote manufacturing export such as exempt from company tax
and import duty. The next step follow by bring in the New Economy Policy (NEP) in 1970;
foreign investors owned 60% of the Malaysian corporate economy, with around 23 per cent
of the largest part of local share hold by the local Chinese business community. In order to
raise the Malay share of the corporate sector to 30%, state development agencies set up
subsidized Free Trade Zones in the early of 1970s. But this is not apply on individual
company basis and this is key element of the NEP attract foreign investor participation where
100% foreign ownership of export-oriented firms is allowed.
Generally, Malay upper and middle classes prefer foreign investment since under the
NEPs ethnic ownership and employment quotas, foreign investment offers them with more
opportunities for employment at all level of the workforce. On the other hand, Chinese
business community generally positioned themselves well of collaborative relationships since
foreign investment is important in technology transfer, develop new market and contributing
more to economic growth if compare with domestic investment. Chinese middle classes are
able to take advantage of getting skilled, managerial and professional jobs in foreign firm.
Nevertheless, NEP aim to remove the identification of race with economic function in
Malaysian society. Government try to restructure by imposed restrictions on foreign
investment while selectively welcoming to reserve certain percentage of employment for
Malay. But over the years, increasing of public debt by 1980s force Malaysia government to
deregulates the FDI rules to become more transparent. More of the restrictions have been
relaxed since foreign capital is able to reduce Malaysias budget and balance of payments
deficits. In the late 1980s, FDI start to flood into Malaysia depends to the Chinese connection.
Presence of significant Chinese business community in Malaysia, proximity to Singapore and
fast developing East Asia countries and also the convenient production base for relocation of
labour intensive segments in response to wage rate pressure and lack of labour force problem



success to attract investors from Taiwan, Hong Kong, Korea and also FDI from Developed-
country multinational.
Furthermore, Malaysia government recognize that foreign investment particularly in
manufacturing helped Malaysia to improve economy growth and provide benefit of
employment opportunity. Introduction the growth triangle concept, like Singapore-Johor-
Riau (SIJORI) and Northern Growth Triangle recently is to attract more FDI and bring
Malaysia into international economy. This step provides incentive for multination enterprises
by making wider production base with different factor endowments in each node of the
triangle. For instance, this concept had been attracting investment of US6.2 million from
Indonesia and US 2.51 billion from Singapore. However, there are many other factors to
drive the rate of FDI other than the determinant we mention above. It is believed that sound
macroeconomic management, well functioning financial system have made Malaysia an
attractive location for FDI. A survey of electronics companies in Japan rated Malaysia as the
best host location for foreign manufacturing investment in Asia. FDI has played a crucial role
in the countrys economic development process. However, there has been a persistent decline
in the ratio of FDI inflows to GDP since the early 1990s. While for the period of 2003 to
2007, total stock of FDI increased substantially mainly due to mergers & acquisitions of
existing multinational companys joint ventures and new investment activities. The
movement of the FDI becomes a major concern of researchers and policy maker to
investigate what are the key forces that determines FDI in Malaysia.


1.2 PROBLEM STATEMENT

Increased globalization has lead to strong growth of international economy activity and
foreign direct investment (FDI) over past two decades. Hence, there have extensive of the
studies and literatures on the phenomena of FDI and to identify the determinants and impacts
of FDI. Past studies commonly approved that FDI will promote economic growth.
Advantages of FDI always outweigh the disadvantage shown that FDI affect economic
growth positively. However, large number of studies conducted by economists to identify
determinants of FDI but end up with quite chaotic empirical findings and reflects a lack of



robustness. That means there is no general consensus has emerged and it is difficult to say
which explanatory variables can be consider as true determinant of FDI.
As the enormous increase in FDI flows across countries over past 20 years, an important
determinant among the factors that attract foreign investment are particularly the
characteristics of host country. Investment environment in host country such as political risk,
infrastructure system, regulatory framework, red tape and degree of corruption always
regarded have negative effect or maybe have mixed effect on FDI inflow. According to
Chakrabarti (2001), the relation between FDI and many of the controversial variables namely
tax, wages, exchange rate and trade balance are highly sensitive to small alterations in the
conditioning information set. Ngie and Yol (2009) concluded that determinants of FDI inflow
group into three major categories which is economic condition, host country policies and
Multinational Enterprises (MNE) strategies. Economic condition means availability of natural
resource and market size. Host country policies include macroeconomic policies and different
policies related to trade and industry. While MNE strategies will be concern about location,
sourcing and integration transfer. Large number of research has been conducted to identify
the effect of these three major categories mention above. For instance, Clegg and Scott-Green
(1999) argue that market size and growth variable have positive impact on FDI inflow. On
the other hand, Kristtjansdottir (2005) argue that FDI inflow are more significantly affect by
wealth effects if compare with the effect of market size. Past research works and studies
shown quite different empirical finding, are all of these cross-countries evidences applicable
in Malaysia case?











1.3 CONCEPTS AND THEORIES

According to Organization for Economic Cooperation and Development (OECD)s
Benchmark Definition of Foreign Direct Investment 3
rd
Edition (OECD 1999), the definition
of foreign direct investment (FDI) is the objective of obtaining a lasting interest by a
resident entity in one economy (direct investor) in an entity resident in an economy other
than that of the investor ( direct investment enterprise). An investment can be qualify as
FDI if it could afford the parent enterprise control over its foreign affiliate. In this case,
International Monetary Fund (IMF) defines this control as owning 10% or more of the regular
shares or voting of an incorporated firm or its equivalent for an unincorporated firm. There
have typical two types of direction for FDI. Inward investment is when foreign capital occurs
in local resource. The other type of FDI is outward direct investment, can also be referred as
direct investment abroad which means local capital is invested in foreign resources.
Generally, FDI classified into three components which is equity capital, reinvested earnings
and intra-company loans. While the FDI data on the other hand are normally describe in
terms of stock and flow. FDI stock includes value of capital and reserve plus net indebtedness.
FDI flow refers to a foreign investor offer or accepts capital with others FDI enterprise.
Explosion of growth in FDI over time has raised the interest of economists to examine the
question about why do companies invest abroad. Basically, there have three groups of factors
that affected FDI. Firstly, foreign investor concern about the profitability of the foreign
investment project. Second, degree of the ease with which subsidiaries operations can be
integrated into the business strategies of foreign enterprise. Lastly, depends to overall quality
of the investment environment in host country. As a result, Dunning et al. (1977) and
Dunning (1988) combined both microeconomic and macroeconomic perspectives to develop
his theory, so-called OLI paradigm. It states that FDI is undertaken if ownership (O)
advantage like proprietary technology exists together with country specific locational (L)
advantage in host country like low factor costs, and potential benefits from internalization (I)
advantage of production process abroad. The latter answer the question of why do
multinational enterprises choose to invest abroad significantly. The factors such as
availability of factor of production like natural resources, raw material, market size,
infrastructure system, factor price and certain elements of government policy are all influence



investor to selects a location for the project. This point of view provides an interesting
background in order to study the determinants of FDI.
1.4 RECENT TRENDS

According to Statistic Department of Malaysia 2003, foreign direct investment (FDI) in
Malaysia decline by 8.6% per annum from year 1997 to 2001. This is due to Malaysia
suffered a great hit from the 1997 Asian Financial Crisis. Figure 1 shows the net inflow of
FDI as U.S. dollar spanning 1997-2007. Substantial surges of FDI inflows were reported in
year 1999, 2002, 2004 and 2006. For the period of 2003 to 2007, manufacturing, financial
intermediation, mining and services become main four sectors of FDI recipients. Total stock
of FDI increased substantially in year 2006 and 2007 mainly due to mergers and acquisitions
(M&A) by multinational enterprises (MNE). The largest proportion of FDI in Malaysia
contributes by manufacturing sector and most of the FDI flow from Singapore, USA and
Japan.
Figure 1

Data source: Obtained from World Development Indicators (WDI)



1.5 OBJECTIVE OF THE STUDY




The general objective of this study is to understanding the determining factors of FDI
inflows in Malaysia from year 1997 to 2007. Specifically, the study in this paper is to
examine the determinants of FDI for Malaysia.

1.6 SIGNIFICANT OF THE STUDY

Since the 1960s, capital inflows to Malaysia have been dominated by foreign direct
investment (FDI). However, introduction of New Economic Policy (NEP) in1970 was a tool
for Malaysia government to increase the share of Malays in corporate sector and reserve a
specific percentage of employment in foreign venture for Malays. The constraints of NEP and
government intervention in almost every business level create anxiety in the mind of foreign
investors. Although government have taking step to make the policy stance towards FDI
unambiguous, the slowdown in FDI inflow since the early 1990s was due to the financial
crisis. The speculative attack on the Thai baht in 1997 results in East Asia financial crisis.
Malaysian government attempt to prevent further pressure on domestic currency by restricted
the short-term capital inflow and use of ringgit outside country had been influence economic
performance adversely. Vision 2020 then developed in order to stimulate the economy to
propel Malaysia economy by increase foreign investment.
Previous studies shown there have no consensus view about the determinants of FDI and
there is no widely accepted set of explanatory variable can regarded as true determinants of
FDI. The determinants of FDI vary across countries depending on typological characteristic
of the host country. This can explain why some countries are more successful than others in
attracting FDI with their own policies. Hence, this study will be examine which of the
variables that are truly influential and robust in term of their effect on FDI in Malaysia base
on the unique structure features and the historical settings of the Malaysia economy.











CHAPTER 2: LITERATURE REVIEW

Strong growth of international economy activity and foreign direct investment (FDI) over
the last two decades led to extensive research on this topic and become prime concern for
policy maker especially regarding the determinants of FDI inflows. This chapter aim to
provide a survey of the major theoretical and empirical studies on this issue from the past
literature review.
Early empirical studies such as Robinson (1961), Basi (1966), Wilkins (1970) and
Forsyth (1972) shown variety of factor including market factors, in particular market size,
market growth and maintaining market share, trade barriers, cost factors and investment
climate were the main determinants of FDI. Dunnings (1977) developed a theory so-called
OLI paradigm states that FDI is undertaken if ownership specific advantage (O) exist
together with location specific advantages (L) in host countries and potential benefits from
internalisation (I) of the production process abroad. (Frenkel, et al. 2004). The most
important factor is the selection of location for a project including the availability of local
input, factor prices, market size, and position of the economy and certain elements of the
economic policy of the government. This is supported by Asiedu (2002) and Edwards (1990),
they argue that an efficient environment that comes with more openness to trade is likely to
attract foreign investment. Kok and Ersoy, (2009) had been investigate whether FDI
determinants affect FDI based on both panel of data and cross section SUR (seemingly
unrelated regression) for 24 developing countries over the period 1983 to 2005 and from
1976 to 2885 respectively. Time series combine with cross sections able to enhance the
quality and quantity of data and the empirical result found that domestic policies help to
attract FDI and maximize the benefits by reduced restriction, removed obstacles to local
business. The finding also shows that foreign company pursue only the good business



environment. The other determinants have significant affect FDI inflow including trade, gross
capital formation and GDP per capita growth.
Chakrabarti (2001) argue that the relation between FDI and many of the controversial
variables such as tax, wages, openness, exchange rate, growth and trade balance are highly
sensitive to small alteration in the conditioning information set. Many potential determinants
found to be statistically significant in cross-sectional studies depend on specific variable are
included in the regression equation. Chakrabarti (2001) give the example like tariffs have
positive effect on FDI if combine with growth rate and openness but provide negative effect
when including wage rates and real exchange rate have positive effect when combine with
openness, domestic investment and government consumption. Hufbauer, Lakdawalla and
Malani (1994) use the ratio of trade to GDP as a measure of the degree of openness and test
on the relationship between trade and FDI in an UNCTAD study. On the other hand, Wang
and Swain (1995) used the tariff rate as an alternative measure of the openness in the host
country. They argued that the coefficient have insignificant effect to the FDI although it had
the expected positive sign. However, as mention above the reliable of the empirical results
are depends to some question given the small number of observations researchers work with.
There is a variety of results regarding the empirical work in area of the openness of the host
countrys economy. Thus, Bajo-Rubio and Sosvilla-Rivero (1994) examined the relationship
between the degree of openness and FDI flows by using the tariff rate as a proxy and the
result shown both have a significant coefficient and also the expected sign. Jeannie, et al.
(2000) investigates the determinants of aggregate FDI inflows into Australia since the mid-
1980s. They measure the openness of the economy by the traditional measure of the sum of
imports and exports as a percentage of GDP and the result come out with a negative
coefficient. This is contradicting with the earlier argument that greater openness of the
economy attracts capital inflow. However, it is in some extent support some of the literature
view that FDI inflows are substitute for trade and thus decreasing in trade flows or
economys openness might have to come together with an increasing in FDI inflows.
On the other hand, Moosa, et al. (2006) examines eight determining variables if FDI
inflows by using extreme bounds analysis to a cross-sectional sample cover 138 countries
over the period 1998 to 2000. The empirical evidence shows that countries which are
developed countries with large economies, high degree of openness and low country risk are
able to attract more FDI. This is also supported by Nunnenkamp, et al. (2002) and Wheeler,



et al. (1992), they find that the size of the market and the market potentiality, typically
proxies by the level of GDP and GDP growth rate affect FDI inflow significantly.
Measurement for the size of the host market in great majority of empirical studies is real GDP.
Wang and Swain (1995) found that the market size as a significant determinant of FDI flows
by using the real GDP. Nevertheless, the rate of growth of real GDP and GDP per capital can
be an alternative measure of the size of host market. Domestic market size and market
potentiality become important factor in attracting foreign investment since some of the
foreign investors invest to host countries mainly serve the market in host country. Mottaleb
(2007) examines the factor of size and growth rate of GDP in affect the inflow of FDI in the
developing countries by using the panel data from 60 developing countries. He then identified
that FDI mostly flows towards the developed country with higher per capita GDP and higher
GDP growth rate and only a small portion of FDI flows to a limited number of developing
countries. The highly significant and positive coefficient conclude that only those countries
with large market size, high market potentials and the greater contribution of industries to
GDP will more likely to increasing the FDI inflow. This argument is again consistent with the
founding from Kok and Ersoy, (2009) that GDP per capita growth has positive effect on the
flow of FDI.
Existing empirical studies focused on the role of different tax treatment as determining
the source and location of foreign direct investment (FDI). Hartman (1984) examined the
impact of corporate tax rate on FDI flows and it is largely ignored home country tax rates. He
includes the tax rate on U.S. capital owned by foreign investor relative to those owned by
local investor as the explanatory variable during the estimation of the effect to the change in
the after tax rates of return on FDI. The result had shown that dependent variable, log of the
ration of FDI to U. S. gross national product (GNP) increase when the after tax rates of return
rise and lower as the foreign investors relative tax rate decrease. This finding is supported by
Boskin and Gale (1987) where they re-examine Hartmans model with the refinement of the
data cover period from 1956 to 1984 and come with the result consistent with Hartmans
original finding, which is taxes are an important determinant of FDI. On the other side,
Newlon (1987) found the results that is away from Hartman (1984), Boskin and Gale (1987).
He extends their studies by using better data from the Bureau of Economics Analysia for
period of 1965 to 1973 and found there have no estimated coefficient that explains FDI
finance by transfer of fund statistically significant from zero. As the first study to examine the
determinant related to tax policy on the foreign direct investment (FDI) by using micro data,



Cummins and Hubbard (1994) investigate the effects of taxation on FDI using panel data on
outbound FDI by subsidiaries of U.S. multinational firms collected by Compustats
Geographic Segment file project and they find that there is a significant doubt on the simplest
notion that taxes dont matter for the FDI investment of the U.S. firms.
Foreign direct investment (FDI) determine by the potential interrelationship of the
taxation policies between home country and host country since foreign investor are subject to
corporate income tax in host country and follow by the another tax to their after-tax
expatriated profits in their home country. Furthermore, some of the countries adopt tax
exemption system and thus will be more sensitive to any changes of the taxes policies in host
country. Slemrod (1990) investigate that if FDI from exemption countries should be at least
as sensitive to U. S. tax rates as FDI from tax credit countries by using the FDI time series
data from 3 credit countries and 4 exemption countries. However, the result comes out with
no convincing evidence with the original hypothesis. The other studies like Hines (1996)
argue that foreign investors from tax exemption countries are considerably more responsive
to U.S. states tax than foreign investors from tax credit countries. On the other hand, Desai et
al. (2002) conclude that the tax sensitivity of FDI will affect by the different tax systems in
different countries. This is about same to the view of Mooji and Ederveen (2001), when
different studies put at the same format, investor from tax exemption country are more
sensitive to changes in host country tax if compare with those investors from tax credit
country. Hence, Wijeweera, et al. (2007) try to capture all significant changes in tax policies
over past two decade by using the data for nine countries over the period 1982 to 2000 to
examine the impact of corporate taxed on FDI in the U.S. They found that corporate income
tax give a significant negative impact on U.S. FDI and another finding is investors from
exemption countries are more sensitive to taxes policies than investors from credit countries.
This result is consistent with the studies from Hines (1996).
Although many empirical results shown corporate tax rate as an important determinant of
foreign direct investment (FDI), but the role of other non-tax determinants of FDI should not
be underestimate. It already well documented in the past literature that there have a
significant relationship between FDI and the bilateral exchange rate between home countries
and host countries. Wakasugi (1994) argue that the exchange rate and the relative rent
between Japan and U.S. affected the relative ratio of exports to FDI significantly in his
analysis of the determinants of production for Japanese manufacturing companies in the two



countries. Froot and Stein (1991) whose had been highly influence by Kohlhagen (1977)
about the theory of FDI and exchange rate linkages , used an imperfect capital market
approach to argue that FDI flow into the U.S. over the period of 1973 to 1988 were
negatively related to the real value of the dollar. This is because the borrowing costs become
more expensive than the internal cost of capital in firm due to the imperfect information
about capital markets. Hence, the wealth of foreigner rises automatically and they are able to
make higher bids for assets. Thus, it is expected that the depreciation of the host country will
give a positive effect on inbound FDI. This finding also consistent with the investigation
from Klein and Rosengren (1994), they examine the significant importance of the wealth
which caused by the imperfect information in capital markets across countries on to FDI from
seven industrial countries to the U.S. for the period of 1979 to 1991. The result shows that
there is strong evidence where the relative wealth is affecting the FDI significantly. While
when the exchange rate of the dollar face the appreciation, all kind of the FDI were decreased
significantly except for the acquisition of land.
According to Choi (1989), corporate international investment was aimed to diversify risk
together with operational cash flow and also the real exchange rate. Theoretically, the
covariance of exchange rates with output and input prices in a stochastic market will always
give significant result in foreign investment decision. This implies that the gains from real
exchange risk diversification attract foreign investment. To further explaining the link
between FDI and exchange rate, Baek and Okawa, (2001) examine the Japanese FDI of their
manufacturing sector in Asia by focusing on the various type of exchange rates, such as the
yen against the Asian currencies, the yen against the US dollar and also the US dollar against
the Asian currencies which cover the period from 1983 to 1992 for six countries. The study
finds that the exchange rate variables are significant factor in determining FDI in
manufacturing sector. The nominal exchange rates variable exert a significant effect on FDI
even it is decomposed in to PPP rates or convert into the real exchange rate and this results
are all consistent with the prediction before.
Past empirical and theoretical work have no consensus regarding the nature of the
relationship between exchange rate and foreign direct investment (FDI). Risk averse investors
will attempt to reduce the effect of uncertainty on profit by exploiting exchange rate
correlations between locations during decide the alternative location to do the foreign
investment. This is due to the exchange risk will come out when there have the timing



differences between investment and profit. This is so-called exchange rate volatility if the
expected return gains by foreign investors are equal to the cost plus payment for the degree of
risk. Cushman (1985) found that when a risk adjusted expected real exchange rate appreciates,
the foreign cost of capital will decreases and hence increasing the flow of FDI. Xing and
Zhao (2008) had used reverse imports as a means to shown that exchange rates can
significant affect FDI. They investigate relation between reverse imports, exchange rate and
FDI by using a two countries model (Japan and China) with oligopolistic markets. If the
exchange rate changes, the wage and cost of capital shift, then barriers due to the brand
recognition will encourage the Japanese FDI in China. Yen appreciation result in a relatively
cheap input cost in China, Japanese will then search those input through the FDI. This
appreciation will decrease thee exports from local Chinese company since the reverse imports
of Japanese will rises due to the barriers in brand name recognition in Japan. Therefore, they
show that if the exchange rate of FDIs recipient appreciates more than the rival country, this
will lead to the shifting of the relative FDI to the rival country.
Most empirical studies in the foreign direct investment (FDI) literature have found
conflicting results regarding labour cost on the direction of influence of the determinants of
FDI. In the cost reduction case, which means the foreign investors try to utilize certain host
countrys production factors, there may be a significant important determinant of foreign
investors in choosing the investment location if the host country have a low labour standards.
The wage related labour standards including regular, overtime and minimum wages in a host
country. Logically, foreign investors making their investment in developing countries are
able to take advantage of low labour cost. According to Coughlin, et al. (1991), the FDI
inflows are affected by the condition of local labour market. By using high state specific real
wages in manufacturing sector as a proxy for local labour cost are was found significantly
affect the FDI inflows. On the other hand, the rate of unemployment in host country indicates
the availability of labour also suggests to attracting the flow of FDI. The Hecksher-Ohlin
model in comparative advantage framework suggests that the location decisions are pre-
determined by natural endowments such as the relative prices for raw materials and labour.
Hence, the costs in the host country relative to those elsewhere are play as vital a role in the
investment location decision for the labour intensive foreign firms. The other studies, Swain
and Wang (1995), found that relative cheap labour costs in China are significantly attracting
inward FDI. On the other side, Zhang (2000) argued that the factor of labour cost hardly to



make any influence on the U.S. multinational companys investment decision to invest in
China.
In Mexico, Feenstra and Hanson (1997) find empirical evidence that the growth of FDI is
positively correlated with relative wages of skilled labour. This argument is due to the foreign
investors undergo the activities of outsourcing and hence follow by the increasing demand for
the skilled labour. Wage differentials between host and source country is one of the condition
to make FDI to be profitable in the host country. It is natural to expect that a rise in the host
countrys wages will have negative effect to FDI flows. Little (1978) using cross section data,
argue that there is a significant negative relationship between wage levels and the location of
FDI by foreign company with the U.S. However, the past empirical finding shown
unambiguous result since Goldberg (1972), Schneider and Frey (1985), Moore (1993) have
all found no significant effect. Caves (1974) investigate the cross section industries in Canada
and United Kingdom, the result shown the coefficients are insignificant for the proportion of
sales by foreign-owned firms which associated with the low relative labour cost in these two
host countries. Thus far, no consistently significant effects have been founded from labour
costs.





















CHAPTER 3: METHODOLOGY

In the vast majority of empirical studies, there is a distinct lack of consensus conclusion
as to which determinant has the most significant and positive impact on foreign investment
flows. The above literature review shows that there are a variety of determinants both
economic and non-economic or qualitative and quantitative play as vital a role in the foreign
investment decision. Thus, it could be conclude in this discussion of theories and empirical
work on the variables that determine foreign direct investment (FDI) by choosing base on the
basis of the literature reviewed. The five variables chosen as the determinants of the FDI
flows to Malaysia includes real exchange rate, corporation tax rate, degree of openness in
Malaysia, labour cost and also the market size. This chapter presents the methods used
throughout the analysis of the determinants of FDI in Malaysia. The data sources are obtained
to present in this section and this chapter is categorized to three parts, first part explains the
data sources that are collected in this analysis. The second part shows the empirical model of
this study while the expected result of the study will be discusses in the third part of this
chapter.

3.1 DATA SOURCES




All the data sources in this part of analysis are collected from the financial statistical
database, Thomson Reuters Datastream and the World Development Indicators database from
the World Bank. This study cover with quarterly data so that it will allows the analysis to
restricted to the more recent years and able to be more compact with an enough number of
the observations for the analysis. However, the sample period and the data frequency for the
study are largely determined by the availability of the data. Since this is a country specific
study and thus it is not using a panel model in this study.
The data of the net inflows for foreign direct investment (FDI) in Malaysia cover from
the year 1960 through 2009 but in this study it is restricted to only year 1997 through 2007.
The exchange rate was measured by the trade-weighted index (TWI). This is representing the
broad range of exchange rate associate to the trading partners weighted by the share in term
of the trade. The trade openness is defined as the sum of exports and imports over GDP. A
tax variable is measured by the quarterly corporate tax revenue in Malaysia. Since some of
the available data are not always in satisfactory stage and the proxy had to be used in the
analysis. For the market demand and market size, the variable used here is the real GDP in
Malaysia. While the average quarterly earnings are used to measure the level of wages, this is
the approximation of the labour cost in Malaysia. In this study, as all trade in Malaysia are in
terms of U.S. dollars and hence all the variables are in terms of U.S. dollars as well. Table 1
below shows details of the sources of the data and the units of measurement used in the
analysis.

Table 1: Data source and units of measurement
Variable Units of Measurement Source
Foreign Direct Investment (FDI) U.S. dollar World Development Indicators &
Global Devolopment Finance, World
dataBank
Real Effective Exchange Rate
(REER)
Percentage, Year Over
Year
Global Economic Monitor (GEM),
World dataBank
Market Size Percentage, Year Over
Year
Global Economic Monitor (GEM),
World dataBank
Corporation Tax U.S. dollar Thomson Reuters Datastream, Cass
Business School
Degree of Openness Ratio Thomson Reuters Datastream, Cass
Business School
Labour Cost U.S. dollar Thomson Reuters Datastream, Cass



Business School








3.2 EMPIRICAL MODEL

Past literature studies showed no consensus among the identification of the
determinants of foreign direct investment (FDI) as to which variable have the most important
effect on FDI flows. But in this empirical analysis, five variables have been chosen in this
study to examine the most significant factors that attract FDI flows into Malaysia. A
theoretical model suggests the relationship between FDI and its determinants had been
developed in earlier studies as below:
FDI =f (OPN, RER, GDP, TAX, WGE)
Where FDI is foreign direct investment, OPN is openness of the economy, RER is exchange
rate, GDP used as a proxy for the domestic market size, TAX are level of corporation tax in
Malaysia and WGE represents the cost of labour. Above model can be further expressed
become:
(1)
In the equation 1, the error term capture all of the variable that are not included in
the independent variables list mention above but they have the influence on the flow of FDI
in Malaysia. The empirical models that are related to the determinants of foreign investment
always consist of a generalized version of the above theoretical model. This is according to



the new growth theory derived from the international trade and economic development where
normally involves using a multiple regression model, which can be estimates in log-linear
form. Therefore, equation 1 can be written as follows:
(2)
The variables expressed in term of logarithm form in order to achieve mean-reverting
relationship and enable all the econometric tests become valid through all the procedure. Note
that the FDI inflow, tax rates and wages are expressed in logarithmic form while the rest of
the variables are expressed as ratios or percentages. The variables in the model remained as
defined above while in the equation represents K1 vector of unknown parameters and is
a random error.

3.3 EXPECTED RESULT

A distinct lack of consensus regarding to the relative importance and the direction of
the impact of the potential determinants of foreign direct investment (FDI) suggests that it is
fundamentally empirical among the exact relationship between the FDI and the factors affects
the flows of FDI. According to the majority of empirical studies, the effect of exchange rate
on FDI was less clear. There was many mixed result in explaining the link between the
exchange rate and FDI since its coefficient could be positive if foreign investors regarding it
as lower cost of capital but if they looking for a higher return on the investment project then
the coefficient will be negative. In short, there have no consensus concerning the nature of
the relationship between both variable. Likewise, there have variety of results regarding the
empirical investigation in area of the openness of the host countrys economy affected the
flows of FDI. However, most of the researchers tend to support the view that more openness
to trade and less barrier is likely encouraging the foreign investment. Hence, it is to be
expected that a significantly positive correlation between openness and FDI.
Empirical findings implicate that market size and market demand has positive effect
on the flow of FDI and its mostly flows towards the host country with higher GDP growth
rate because foreign investors prefer a big market as their investment location. It is expected
that the market size will be a significant determinant of FDI with a positive coefficient.



Corporate tax rate as an important determinant of FDI always found to give a significant
negative impact on flow of FDI in past literatures. On the other hand, most empirical studies
found conflicting results among the relationship between labour cost and FDI and there have
no consistently significant effects have been founded from the labour costs variable.
Therefore, the expected signs for the coefficient in the equation 2 based to the discussion
above should be: >0 that is OPN have positive impact on FDI; and cannot be
determined a priori since both of these variables might have positive or negative effect on
FDI. The expected sign for >0, represents GDP have positive relationship with FDI
inflow. <0, that is, TAX negatively correlated to the FDI.




CHAPTER 4: EMPIRICAL RESULTS


This chapter presents the empirical results of the determinants of foreign direct
investment (FDI) in Malaysia. Batteries of diagnostic tests are divided into seven sections and
explain the results for each of the test.
The purpose of the empirical investigation is to analyse the determinants of foreign
direct investment (FDI) in country of Malaysia. The study employs quarterly data on inflows
of FDI, gross domestic product (GDP), degree of openness (OPN), defined as the ration of
the sum of exports and imports over GDP, real exchange rate (RER), corporation tax (TAX)
and average wage (WGE). All the analysis will be conduct by using EViews 6 statistical
software.

























4.1 Augmented Dickey Fuller Unit Root Test


Prior proceedings to the estimation of the FDI equation, all the variables in the series
are subject to the augmented Dickey and Fuller (ADF) unit root test. If there have the
presence of unit root, ADF test have to proceed in the first difference. This is to avoids to
employ the non-stationary data where could result in the results obtain from the regression of
this kind are totally spurious. The ADF unit root test results are in Table 2.


Table 2: ADF Unit Root Test Results
Variables Constant Constant and trend
LEVEL t-statistic Prob. t-statistic Prob.
Log FDI -0.9651 0.7561 -1.7541 0.7074
OPN -9.6017 0 -9.62274 0
RER -1.9164 0.3219 -2.5247 0.3153
GDP -4.1189 0.0025 -5.55672 0.0002
Log TAX -1.5454 0.5007 -2.7143 0.2366
Log WGE 1.0167 0.9958 -4.9179 0.0016

FIRST
DIFFERENCE
t-statistic Prob. t-statistic Prob.
Log FDI -6.2084 0 -6.1887 0
OPN -7.1856 0 -7.0859 0
RER -3.8924 0.0045 -3.8618 0.0228
GDP -3.6830 0.008 -3.661 0.0360
Log TAX -11.4401 0 -11.5045 0
Log WGE -3.7189 0.0072 -5.5834 0.0003

Note: Denotes significance at the 5% significant level and the rejection of the null hypothesis of non-
stationarity. The critical values obtained fromthe ADF test are -2.9389 for the constant equation, -
3.5331 for the constant and trend equation respectively.

By taking into account the intercept and trend in the ADF test, the null hypothesis is
that contain unit root in the process for all cases. The unit root test shown each of the series is



non-stationary when the variable defined in levels. But the first differencing the series
removes the non-stationary components in all cases and the test reject the null hypothesis
suggesting that the series are stationary at first difference. The result indicate all the variables
are all at most I(1) as only first difference able to induce stationary except for the OPN and
GDP variable, where the test indicate that they are I(0). However, the robustness of the model
allows us to treat the variable as I (1) and proceed with the further analysis work.

4.2 Correlation Matrix

Table 3 shows the correlation among the dependent variable and the explanatory
variable. If there have the problem of multicollinearity, which is the linear relationship
among the sample values of the independent variable will leads to incorrect results on OLS
estimators.
Table 3: Correlation Matrix

LFDI OPN RER GDP LTAX LWGE
LFDI 1.000000 -0.179789 -0.368280 0.055110 -0.026221 -0.464064
OPN -0.179789 1.000000 0.162103 -0.002928 0.186713 0.156783
RER -0.368280 0.162103 1.000000 0.399538 -0.010639 0.353973
GDP 0.055110 -0.002928 0.399538 1.000000 0.084804 0.568450
LTAX -0.026221 0.186713 -0.010639 0.084804 1.000000 0.362557
LWGE -0.464064 0.156783 0.353973 0.568450 0.362557 1.000000

Coefficient of determination, >0.9 are considered to be highly correlated among
independent and dependent variable. It is generally viewed as evidence of the existence of
problematic multicollinearity. If the correlation between two of the variables is negative, it
means that there have a negative relationship among two variables. Contrarily, there is a
positive relationship between two variables if the correlation among them is positive. From
the result output of the correlation matrix above, the dependent variable (FDI) and the
independent variables where are positively correlated will be only the variable of GDP, with
a positive value of 0.0551. The rest of the explanatory variables, (TAX, OPN, RER, WGE)
have a negative effect on FDI variable with negative value -0.0262, -0.1798, -0.3683 and -
0.4641 respectively. Overall, the dependent variable has weak correlation with most of the
independent variables except for the average wage (WGE =-0.4641). In general, the linear
relationship between the independent variables is considered low. However, it could be see



that only variable of wages (WGE) and market size (GDP) have relative high correlation
(0.5685) if compare with others.
4.3 Ordinary Least Squares (OLS) Estimation

Table 4 are the output of using the OLS estimation to examine the equation (2) as
stated above.


Table 4: OLS Estimation Results

Dependent Variable: LFDI
Method: Least Squares
Date: 09/11/10 Time: 00:50
Sample (adjusted): 1997Q1 2006Q4
Included observations: 40 after adjustments


Coefficient Std. Error t-Statistic Prob.


C 75.27765 12.20297 6.168799 0.0000
OPN -8.95E-06 2.57E-05 -0.348312 0.7298
RER -0.006500 0.002670 -2.434493 0.0203
GDP 0.018917 0.004868 3.885837 0.0004
LTAX 0.451387 0.300103 1.504108 0.1418
LWGE -4.645902 1.003832 -4.628166 0.0001


R-squared 0.507004 Mean dependent var 19.43614
Adjusted R-squared 0.434505 S.D. dependent var 1.258796
S.E. of regression 0.946607 Akaike info criterion 2.865616
Sum squared resid 30.46621 Schwarz criterion 3.118948
Log likelihood -51.31232 Hannan-Quinn criter. 2.957213
F-statistic 6.993219 Durbin-Watson stat 0.505858
Prob(F-statistic) 0.000138



The result obtained above could interpret the equation (2) as below:







This equation explains the relationship between the dependent variable (FDI) and
various explanatory variables (OPN, RER, GDP, TAX, and WGE). With exception of
economys openness and corporate tax rate, the estimated coefficients of all the specified
independent variables are statistically significant at least at the 5 % significant level.
According to the EViews output table above, the results of the FDI equation can be
summarised as follows: the intercept of the equation is equal to 75.2777. This value indicates
that the inflow of foreign direct investment in Malaysia will be 75.28 when all of the
independent variables are equal to zero. On the other hand, when the degree of openness in
the host country rise by 1%, the flow of the foreign investment into Malaysia will be decrease
by 0.000009%. If the real exchange rate appreciates by 1%, the value of FDI in Malaysia will
then fall by 0.0065%. A one percent increasing of the size and demand in host countrys
market, the inflow of FDI will be goes up by 0.0189%. Also, when the corporate tax rate
raise for 1% will lead to the flow of FDI decrease by 0.4514% while for a one percent
increase of average wage will result in the value of FDI in Malaysia falls by 4.6459%.
Furthermore, the variable of market size (GDP) gain a positive and significant result
at 5% level as expected. Since the past literature shown a mixed result for the real exchange
rate and wages in determined the flow of FDI. Each of the coefficients for the real exchange
rate (RER) and labour cost (WGE) both showing a negative sign but statistically significant
in 5% significant level. This is supported by the views of Moore (1993), Love and Lage-
Hidalgo (2000) where lower wages in the host country encourages FDI. The negative sign of
RER also consistent with Froot and Stein (1991) claimed that a depreciation of host countrys
currency should increase FDI and conversely. The coefficient of corporation tax (TAX) are
negative signed while the degree of openness (OPN) shows a negative sign which is
contradict with the expected result in this study and both of them are statistically insignificant
at 10% significant level.
The regression has the p-value of the F-statistic equal to 0.0001. The almost zero
value indicates that the model is valid in examining the determinant of FDI in Malaysia and it
is substantial enough to conclude there is joint significance of the chosen explanatory
variables. In addition, the value of R-squared equal to 0.507 imply that 50.7% of the variation
in foreign direct investment (FDI) is explained by real exchange rate (RER), corporation tax
rate (TAX), degree of openness (OPN), labour cost (WGE) and market size (GDP). The
remaining of 49.3% is unexplained and it may be due to the other qualitative factors which
are not accounted within this model.




4.4 Breusch-Godfrey LM Test for Serial Correlation

After estimating the FDI regression equation above, we proceed by testing the fourth-
order serial correlation due to the fact that we have quarterly data by using the Breusch-
Godfrey LM test.

Table 5: Breusch-Godfrey LM Test Results


Breusch-Godfrey Serial Correlation LM Test:


F-statistic 0.357469 Prob. F(4,29) 0.8367
Obs*R-squared 1.832579 Prob. Chi-Square(4) 0.7665




From the results above, the values of both LM statistic and the F statistic are quite low.
If the probability of the Breusch-Godfrey LM Test is higher than 0.05 means that the model
is not able to reject the null of no serial correlation. Since the probability of the LM Test in
this result is 0.7665, higher than 0.05. This suggesting there is no autocorrelation in the
model and it could say that the model is fit to examine the determinants of foreign direct
investment in Malaysia.


4.5 Ramsey RESET Test for General Misspecification


Table 6: Ramsey RESET Test Results

Ramsey RESET Test:


F-statistic 7.393177 Prob. F(1,32) 0.0105
Log likelihood ratio 8.106412 Prob. Chi-Square(1) 0.0044




From the result above we can see that because the p-value for the F-stat is bigger than
the one percent significance level (0.01) but less than required level of significance (0.05).
Therefore, we cannot reject the null hypothesis of correct specification at 1% significant level



but able to reject the null hypothesis at 5% of the significant level and conclude that the
model is misspecified.
4.6 The Whites Test for Heteroskedasticity

Heteroskedasticity deals with unequal variances and we run the Whites Test to
detecting the presence of heteroskedasticity in the model. Below is the result of the test:


Table 7: Whites Test Results

Heteroskedasticity Test: White


F-statistic 2.434648 Prob. F(5,33) 0.0552
Obs*R-squared 10.50968 Prob. Chi-Square(5) 0.0620
Scaled explained SS 27.48483 Prob. Chi-Square(5) 0.0000



The result from Table 7 shown that the LM-stat is 10.5097 and the p-value, 0.062 is
also bigger than the level of significance where usually is 0.05. Both suggest that the model
have no evidence of the heteroskedasticitys problem because we cannot reject the null
hypothesis of homoskedasticity. Therefore, the results obtained from different diagnostic tests
above indicate no serious problem with the model estimated in the study.



















4.7 Descriptive Test


Table 8: Descriptive Test Results

LFDI OPN RER GDP LTAX LWGE
Mean 19.43614 1423.134 -20.56079 35.87568 7.095720 12.88103
Median 19.75075 909.4621 -5.504480 47.04036 7.177896 12.92128
Maximum 20.97335 34759.09 57.41440 94.96056 8.282205 13.21533
Minimum 16.40214 -15121.75 -222.2356 -89.45480 6.000424 12.28461
Std. Dev. 1.258796 6147.205 64.24002 39.81416 0.559253 0.203923
Skewness -1.312837 3.626835 -1.614804 -1.574403 0.126096 -1.106267
Kurtosis 3.971301 24.15039 5.391693 5.530385 2.660758 3.990141

J arque-Bera 13.06266 833.2576 26.91760 27.19638 0.297810 9.792804
Probability 0.001457 0.000000 0.000001 0.000001 0.861651 0.007473

Sum 777.4457 56925.35 -822.4315 1435.027 283.8288 515.2413
Sum Sq. Dev. 61.79810 1.47E+09 160944.4 61821.52 12.19781 1.621792

Observations 40 40 40 40 40 40


Table above present the descriptive analysis for the entire specified variable in the
model. All of these variables cannot be comparing to each other since they are all
independent among others. According to the result of the descriptive analysis table, variable
of economys openness (OPN) has a very large mean value which is 1423.134 while the real
exchange rate (RER) has the lowest mean with the value of -20.561. On the other hand, the
variable has the lowest median is also from variable of RER with a negative value, -5.504.
While the variable with highest median is still remain the same, which is OPN. Regarding to
the standard deviation, again OPN has a highest value with 6147.205 and the lowest is wages
(WGE) with a value of 0.204. All the variables within this model exhibit the variability and
the average distance of a set of score from the mean of each variable from the standard
deviation.




CHAPTER 5: CONCLUSION


5.1 SUMMARY

The main purpose of this study is to examine the determinants of foreign direct
investment (FDI) in Malaysia over the period 1997 to 2007. The main interest is to study how
different variables in attracting FDI in Malaysia. The analysis uses the Ordinary Least Square
(OLS) method for the model estimation to identify the variable in explaining the FDI in
Malaysia. The study considers the market size, exchange rate, wages, corporate tax and the
host countrys openness variables if they explain the inflow of FDI where the FDI in
Malaysia denoted as the dependent variable in the model. All the variables are statistically
significant except for the degree of openness in economy and the corporation tax rate. The
variables indicated a correct sign includes real exchange rate, market size, and labour cost.
The rest of the variables, degree of openness and corporate tax have a contradict result as
expected. The study clearly emphasizes the role of these policy variables in determining the
FDI inflow in Malaysia.


5.2 MAJOR FINDINGS

Past literatures and studies argued that the impact of the openness in host countrys
economy is expected to be mixed but generally this variable in the conventional findings
tends to be positively associated with the FDI inflows. According to the empirical results
above, the regression analysis shown that the ratio of exports and imports to gross domestic
product (GDP) as the indicator to measured the degree of openness (OPN) has negative effect
on the flow of foreign direct investment (FDI) in Malaysia. However, the variable is not
statistically significant in the analysis and implying it has no impact on FDI. It becomes the
weakest variable in determining the FDI inflows in Malaysia among the other explanatory
variables which have been tested in the model. There are some possible explanations for this
negative sign. The negative coefficient for degree of openness in Malaysia might be due to
the fact where FDI inflows are one of the substitutes for trade and therefore decreasing in
trade flows as an evidenced by a fall in the openness in the economy of host country. The



substitution for trading is the result of the trade barriers imposed by host countrys
government, which is Malaysia in this case. This includes the reservation certain percentage
of the share and employment for Bumiputras (Malays) in the corporate sector. Another
explanation for the negative sign could be based on the argument of Markusen and Maskus
(2002), the trade restrictions might be less important as an incentive for the horizontal FDI
which mostly catering to the host market. This means the effect on market seeking foreign
investment will be lesser when the degree of openness in host country becomes greater.
Previous theoretical findings suggest that higher tax levels of host country will deter
potential FDI. Hence, it is predicted that the corporate tax rate will have a negative
coefficient in the regression model. However, the empirical result for the TAX variable is
found to be insignificant at conventional significance level. The positive coefficient on the
TAX variable will only be statistically significant in 15% level, observed that tax rate has
little role to play in influence the FDI inflows in Malaysia. Nevertheless, this insignificant
determinant is consistent with the study of Wheeler and Modys (1992). The positive sign in
the FDI equation where contrary to the expected result in Chapter 3 might be have used an
inappropriate TAX variable. One of the possibilities is the corporation tax measure in this
study captures taxes as income rather than taxes as cost. Or the statutory tax rate does not
consider tax base effects then may be unsuitable measures of the true tax burden. Therefore,
it can be explain why the two variables, TAX and FDI would be positively correlated in the
regression model.
The importance of the market size has been confirmed in many past literatures as the
host market size represents the host countrys economic condition and the potential demand
for their output. The empirical findings in our analysis reveal that the market demand and
market size, indicated by the variable of GDP in the regression model are positively related to
the flow of foreign investment in Malaysia, as expected. The coefficient of this variable is
positive and statistically significant in 1% level, implying that increased size of the domestic
market results in more FDI inflows due to the economies of scale and efficient utilization of
economic resources once the market size reaches a threshold level. Similar evidence of a
positive correlation between GDP and flow of FDI corroborates the studies on determinants
of FDI in Malaysia (Hassan 2007; Ang 2008; Ngie and Yol 2009) that reported a positive
relationship between the two variables.
In regard to the real exchange rate (RER), the coefficient for exchange rate is
ambiguous in many studies. It is worthwhile to note that the Ringgit Malaysia was pegged



from September 1998 to July 2005 at MYR 3.80 to the U.S. dollar as a part of series capital
controls due to the Asian Financial Crisis in year 1997. The estimated coefficient of RER in
the regression equation is negatively signed and statistically significant at the 5% level,
implying that a depreciation of the Ringgit Malaysia against the U.S. dollar encourages FDI
inflows into Malaysia. This negative sign suggests that the foreign investors expecting a
higher return on their investment since their wealth position will become larger due to the
depreciated currency value able to bring in a cheaper cost of capital. The finding is consistent
with Ang (2008) but contrarily to Hasan (2007), Ngie and Yol (2009), they argued that weak
currency is likely to encourage the FDI over time in their recent study on Malaysia. The
conflicting results on the coefficient of RER reflect that the influence of real exchange rate on
FDI is quite elusive.
Average wages (WGE) as a proxy for labour cost in the analysis react negatively to
the flow of FDI in Malaysia. The estimated coefficient of WGE is negative and found to be
statistically significant could be explain as there is low level of skilled labour force in
Malaysia and only the labour intensive foreign investment would be attracted as wages are
low enough. Similar result are also obtained by Little (1978), Swain and Wang (1995).


5.3 POLICY IMPLICATIONS

The important lesson to learn from this study is the government of Malaysia should
keep an eye on the factors that have negatively influence the flows of FDI in the country
since this finding has important policy implications. Trade openness in the study react
negatively to the FDI suggested Malaysias economic system does not create globally
competitive atmosphere for the growth of foreign direct investment (FDI). Certain level of
protectionism extends in some of the industries such as the foreign ownership restriction
result in Malaysia becomes the most restrictive country in terms of financial sector openness.
Decision made by the Malaysia government to implement the relaxation of the FDI
restriction by liberalise 27 services sub-sectors in the financial sector on November, 2009 in
fact a wise decision in opening up previously protected industries. For instance, relaxation
ownership rules in Thailand and South Korea allowing foreign investors to acquire local
banks and other financial institutions motivated greater FDI inflows.



Empirical result shown cheap labour as determinant to attract FDI but the labour
intensity of FDI project in Malaysia has been decreasing in recent year indicating rapid wage
increase and depletion of surplus labour reserves in the country. Malaysia no longer has the
advantage of cheap labour cost and local people become more selective about jobs.
Furthermore, Malaysia face the competition from China where has a huge comparative
advantage in terms of cheap labour and attract large volumes of FDI from the labour-
intensive industries. Thus, Malaysia needs to make further efforts to attract FDI with
strengthen interest in human resource development and skill formation in FDI policy. For
instance, Singapore and Korea able to maintain high inflows of FDI despite the expensive
labour cost if compare with Malaysia. Hence, making appropriate investment in human
capital by provides professional training and education to improve the ability in develop the
skilled human resources base in Malaysia. The similar move had been taken by Malaysia
government in setting up the skills development centres to promote technical and vocational
training and this enhanced human resource capabilities able to attract more foreign
investment such as relocation of world class high-tech plant in Malaysia.
In view of the result from Malaysia to develop infrastructure to promote linkages with
foreign enterprises and established the Small and Medium Industries Corporation to offer
advice, and guidance to increase the competitiveness of small and medium-sized enterprises
to help deter the decline in FDI. This evident that economic policy in Malaysia orientated
towards attracting FDI and it is necessary to reform by creating an investment-oriented
climate in Malaysia to meet the demands of foreign investors and boosting all of the variables
that encourage the growth of foreign investment such as creating a larger market through
regional and bilateral cooperation.



5.4 LIMITATION OF THE STUDY

There are 44 observations in the study and it is fulfil the requirement of time series
where need at least 25 observations to ensure the result of the analysis is stable and precise.
However, some of the data from Malaysia is not up-to-date or cannot be found. Lack of
availability data in Malaysia might result in the insignificant result from the analysis of
determinant of foreign direct investment in Malaysia.








5.5 RECOMMENDATION FOR THE FUTURE STUDY

In the future study, it is suggested that association of more broadly type of the
influential factors that determine foreign direct investment (FDI) in Malaysia is needed such
as the political risk, level of corruption, total debt service or domestic gross fixed capital
formation which indicates capital stock in the host country and availability of the
infrastructure. In addition, future research should include large amount of observation by
access the data where spanning the longer time period. Hence, it would probably provide a
more accurate result in the further empirical analysis.





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