High FDI inflows drive economic expansion in emerging Asian economies

A new study reveals that foreign direct investment (FDI) plays a pivotal role in accelerating economic development across South Asia and Southeast Asia. The study, titled "The Impact of Foreign Direct Investment on Economic Development in South Asia and Southeastern Asia", was published in Economies in June 2025 and uses robust econometric methods to evaluate the impact of FDI on growth across 16 countries between 2006 and 2022.

The research, authored by Darlington Chizema, employs Feasible Generalized Least Squares (FGLS) as the primary estimation technique, along with Fixed Effects with Driscoll-Kraay standard errors, Common Correlated Effects Mean Group (CCEMG), and Two-Stage Least Squares (2SLS) as robustness checks. The findings offer consistent evidence that FDI and gross capital formation significantly promote economic growth, while variables such as human capital, trade openness, inflation, and government spending show mixed or adverse effects.

How does FDI influence growth in the region?

The study finds a strong and statistically significant positive correlation between FDI inflows and economic growth in both South and Southeast Asia. By injecting capital, facilitating technology transfer, and improving productivity, FDI has enhanced the absorptive capacity of host economies. Countries that have managed to attract consistent FDI, such as India, Indonesia, Vietnam, and the Philippines, benefited from expanded industrial bases, improved infrastructure, and greater access to international markets.

Gross capital formation, representing investment in physical assets such as machinery and infrastructure, also emerged as a significant contributor to growth. This underscores the importance of stable investment environments that can sustain capital accumulation and modernize production systems. In tandem, FDI and capital formation create a foundation for higher productivity and long-term development.

Conversely, the analysis highlights inefficiencies in how some governments manage public expenditures. Government spending was negatively associated with growth across multiple model specifications, suggesting that fiscal outlays are not effectively converted into economic value. The study suggests that performance-based budgeting and transparency reforms, such as independent audits, could improve the effectiveness of public investments.

Why do some variables have limited or negative impact?

While FDI and capital formation support growth, the study observes that other factors commonly associated with economic development perform unevenly. Notably, the Human Capital Index (HCI), which measures education and workforce skill levels, was found to have a limited or even negative association with growth. This indicates that the region's human capital may not be sufficiently aligned with the needs of modern, investment-driven economies.

Trade openness, typically viewed as growth-enhancing, had minimal positive impact in this study, suggesting that trade liberalization alone is not sufficient without corresponding improvements in logistics, regulatory efficiency, and technological adoption. Inflation also showed a negative correlation with growth, reinforcing the importance of macroeconomic stability.

One of the most important implications is that FDI alone is not a silver bullet. Without supportive policies, absorptive infrastructure, and skilled labor, countries cannot fully leverage the benefits of foreign investment. The interplay between these variables determines whether FDI will lead to structural transformation or simply capital inflows with limited multiplier effects.

What are the policy recommendations for sustainable growth?

Drawing on comparative case studies and empirical modeling, the study offers several actionable policy recommendations aimed at improving economic resilience and long-term growth outcomes in the region.

First, governments are urged to invest in education systems that better align with the skill demands of FDI-intensive sectors. Expanding technical and vocational education through public–private partnerships, such as Singapore’s SkillsFuture model, is proposed as a solution to bridge the skills gap.

Second, the study calls for greater transparency and efficiency in public spending. This includes performance-based budgeting and independent audits, inspired by Malaysia’s anti-corruption and audit reform programs. Ensuring that government resources are used productively will complement private investment and stimulate domestic economic activity.

Third, the study emphasizes the importance of improving the trade and investment climate. Digital platforms like Indonesia’s Online Single Submission (OSS) system are cited as examples of how regulatory bottlenecks can be reduced. Infrastructure upgrades that cut trade costs are essential for improving competitiveness and attracting more sustainable forms of FDI.

Finally, the study advocates for deeper regional economic integration through harmonized regulations under frameworks like the ASEAN Comprehensive Investment Agreement (ACIA). Developing cross-border special economic zones (SEZs) can also enhance regional connectivity and spread the benefits of FDI more evenly.