ASEAN nations face sustainability setback as shadow economy expands ecological footprint

Economic expansion in Southeast Asia continues to carry hidden costs, with new research pointing to the shadow economy and foreign direct investment (FDI) as major contributors to environmental degradation. The study investigates how informal economic activities, energy consumption, and cross-border capital inflows intersect with sustainability challenges in the region.

Published in Economies, the study “Shadow Economy and the Ecological Footprint Nexus: The Implication of Foreign Direct Investment in ASEAN Countries” evaluates nine member states of the Association of Southeast Asian Nations (ASEAN) over the period 1993 to 2017. The authors employ advanced econometric techniques to test long-term patterns, moving beyond traditional carbon dioxide emission studies to focus on ecological footprint, a broader measure of environmental impact.

Does economic growth lead to sustainability?

The study assesses whether ASEAN economies conform to the Environmental Kuznets Curve (EKC) hypothesis, a widely studied model that suggests environmental pressure initially rises with growth but later declines after a certain income threshold. The findings challenge this assumption.

Instead of the expected inverted U-shaped trend, the analysis reveals a U-shaped relationship. Economic expansion in ASEAN countries does not improve environmental quality over time but intensifies ecological degradation. This outcome reflects the reality of middle- and low-income nations where industrial development and manufacturing are still heavily dependent on traditional, cost-saving technologies that generate substantial ecological harm.

The evidence underscores a key policy dilemma: economic progress in the region remains tied to outdated and resource-intensive production models. Without decisive intervention, growth will continue to compound environmental pressures rather than alleviate them.

How do energy and shadow economies shape environmental impact?

Energy consumption emerges as the most significant driver of ecological degradation. The study shows that even modest increases in energy use sharply elevate ecological footprints across ASEAN states. Heavy reliance on petroleum, natural gas, and inefficient biomass systems keeps the region locked into unsustainable pathways. Despite discussions of renewable adoption, poor technological efficiency and weak regulatory frameworks limit the benefits of alternative energy sources.

The shadow economy is identified as another destabilizing factor. Informal and unreported economic activities, often accounting for up to 40 percent of GDP in some ASEAN states, operate beyond the reach of environmental regulation. The research confirms that an expansion of the shadow economy directly increases ecological footprints. Informal enterprises frequently invest in short-term, high-return ventures with little regard for sustainability. They also evade oversight, using outdated technologies and ignoring waste management and emissions standards.

This link between the hidden economy and environmental strain highlights an institutional weakness across the region. Weak fiscal capacity, poor enforcement of environmental laws, and reliance on outdated monitoring systems allow shadow activities to flourish unchecked. As a result, a significant portion of ASEAN’s economic engine continues to operate outside the accountability structures necessary for sustainability.

What role does foreign investment play?

Foreign direct investment is often promoted as a tool for accelerating economic development, but the study shows it also carries ecological costs. The analysis finds a positive and statistically significant relationship between FDI inflows and the ecological footprint of ASEAN countries.

This trend aligns with the “pollution haven hypothesis,” in which multinational firms shift operations to countries with weaker environmental regulations in order to cut compliance costs. In ASEAN, FDI inflows are concentrated in traditional manufacturing and resource-intensive industries, sectors that often rely on outdated and polluting technologies. These investments entrench unsustainable industrial practices, further amplifying the region’s environmental challenges.

While FDI can theoretically bring technology transfers and green innovations, the reality in ASEAN suggests the opposite. Without clear governance and environmental safeguards, capital inflows have largely reinforced extractive and polluting activities. The study’s findings stress the need for strong policy intervention to transform FDI from a liability into a driver of sustainable development.

Policy recommendations and the path ahead

The research concludes with urgent calls for ASEAN governments to realign growth strategies with sustainability objectives. Strengthening governance is identified as a priority, particularly in addressing the shadow economy. Measures such as tax incentives, simplified registration procedures, and access to credit tied to compliance with environmental standards could incentivize informal businesses to transition into the formal sector. This would expand fiscal space for environmental protection while improving oversight.

On the investment front, the study advocates for stricter regulatory frameworks that link incentives to measurable sustainability outcomes. Governments should prioritize FDI in clean technologies and renewable energy while discouraging polluting industries. This requires the adoption of robust environmental, social, and governance (ESG) standards, transparent reporting mechanisms, and clear penalties for non-compliance.

Energy reform is also central to the recommendations. ASEAN countries are urged to reduce dependence on fossil fuels by promoting high-efficiency renewable systems through subsidies, tax breaks, and technology transfers. The long-term shift toward sustainable energy production is portrayed as critical for breaking the link between growth and environmental harm.

A coordinated ASEAN-wide framework for environmental monitoring, transparency, and enforcement could strengthen collective resilience. By acting together, member states can prevent the race-to-the-bottom dynamics that encourage polluting industries to exploit weaker jurisdictions.