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IDENTIFYING COMBINATIONS OF INDIVIDUAL GOVERNANCE INDICATORS ESSENTIAL FOR ATTRACTING INTERNATIONAL CAPITAL FLOWS TO ASIAN ECONOMIES

Article History Received: 27 July 2021 Revised: 30 August 2021 Accepted: 20 September 2021 Published: 12 October 2021

The role of institution and governance as part of the push factors influencing capital inflows has been increasingly studied since the 2000s. Institutional factors used in those studies include such factors as property rights, institutional quality index, country risks, and selected governance indicators (Mercado & Park, 2011). While some studies investigated the influence of governance as a component of institutional quality measurement on capital flows (Kurul & Yalta, 2017;Yakubu, 2020), some specifically measure the influence of governance (Gani, 2007).
Our study belongs to the group of studies that use governance indicators as explanatory variables to explain inward capital flows, rather than using board measures of institutions.
Measuring the impact of governance on inward capital flows, along with traditional economic factors, is important. First, some countries show varying degrees of governance quality. Most developing countries receive governance scores lower than one or fall into a negative area, while those of developed countries are positive.
Second, most countries have a policy prescription intended to attract capital flows by offering correct push and pull economic factors. However, offering the right mix of those factors may not be as effective without equal importance placed on governance reform. Therefore, offering the right combination of push and pull factors, together with improving the quality of individual governance indicators, may be vital in attracting inward capital flows.
There is some empirical evidence suggesting that not all individual governance indicators are equally important as pull factors to attract capital inflow. For example, while Gangi & Abdulrazak (2012) found government effectiveness important in attracting FDI into African countries, Aloui (2019) found that it is not significant in ASEAN countries.
This study is an explicit effort to specifically investigate the combinations of individual governance factors that play essential roles in attracting capital flows from 1997 to 2017 for seven highly interdependent Asian countries -Malaysia, the Philippines, Thailand, Indonesia, South Korea, Singapore, and Japan. It identifies two combinations; one attracts foreign portfolio investment and the other attracts FDI. Identifying the combinations of governance indicators is important as it may help policymakers make better decisions regarding improving selected individual governance indicators and provide the right economic push and pull factors to attract capital inflow.
We structure the rest of the paper as follows: Section 2 presents the review of literature, followed by the research methodology in Section 3; the analysis is contained in Section 4, followed by discussion in Section 5, and Section 6 concludes the paper with the findings and policy implications.

REVIEW OF LITERATURE
Previous studies have extensively investigated economic drivers of international capital flows. Some researchers studied push factors, such as international interest rates and business cycles, in advanced economies as primary drivers of foreign capital flows (Calvo et al., 1993;Ying & Kim, 2001). However, some argue that pull factors, which include return on domestic investments and exchange rate stability, are major determining factors of foreign capital flows (Dasgupta & Ratha, 2000;Hernandez et al., 2001). Many contend that both push and pull factors matter in attracting foreign capital (Chuhan et al., 1993;Taylor & Sarno, 1997). Mercado & Park (2011) identified factors that explain the size and volatility of various types of capital flows to Asia's developing economies.
They estimated a panel dataset and showed that per capita income growth, trade openness, and change in stock market capitalization are important determinants of capital inflows to developing Asia. Trade openness increases the volatility of capital inflows, while a change in stock market capitalization, global liquidity growth, and institutional quality lowers the volatility.
Since the ground-breaking paper "Institutions as a Fundamental Cause of Long-Run Growth" (Acemoglu, Johnson, & Robinson, 2005), a new strand of literature on drivers of capital flows has emerged, showing the roles played by institutional factors and political environments in determining growth of capital flows.
One group under the new-strand literature investigates the role of institution as a pull factor, while the other studies influence of political environment on inward capital flows. The institution scholars contend foreign agents might base their foreign investment decision not only on economic pull factors but also on institutional pull factors.
They assert that institutional quality plays a role in attracting capital flows because it influences the expected value of investment as investors take into consideration property rights and credibility of government policy (Alvarez, 2015). Therefore, an improvement in institutional quality should attract more capital flows.  found that institutional quality is positively associated with FDI, and Alvarez (2015) found that government effectiveness and regulatory quality are the most important determinants of capital flows.
From the political environment perspective, inward capital flows depend on the total productivity factor (TFP), credit market imperfections, and political conditions. Countries with a low TFP are unattractive to international investors. Differences in TFP can be because of political factors that facilitate the development of technology, institution, and human capital (Sauter & Walter, 2008). Göktan (2015) demonstrated how institutional quality explains low capital flows to developing nations.
Regarding credit market imperfections, the political environment of host countries determines credit market imperfections (Sauter & Walter, 2008). There are asymmetric information problems between borrowers and lenders. Asymmetric information causes the detrimental effects of credit market imperfections on foreign capital flows (Gertler & Rogoff, 1990). Increased transparency could ease informational friction on equity markets (Portes & Rey, 2005).
The political conditions leading to high government capacity enhances intrinsic interests of governments to attract foreign capital. Governments with high levels of political capacity with an open market policy framework send clear signals of a political environment conducive to profitability. In terms of inward capital flow, governments attract FDI when they have the political capacity to realize their commitments to open market policies (Coan & Kugler, 2008). Coan and Kugler's findings coincide with those of Feng (2003) that political capacity not only has a modest impact on domestic private investment, but it also has significant effects on attracting aggregate FDI stock.
The institutional quality and political environment perspectives imply the role of politics and institution in attracting capital flows. Politics can affect policy via governance. While politics creates governance, governance creates and implements policies in a political community. Most nations have implemented policies that attract foreign capital, and a vast majority of existing studies found supporting evidence that governance environment significantly influences capital flows.
Using data from 46 developed and developing countries from 2005 to 2008, Wu et al. (2012) found that governance environment is a significant determinant of capital inflow. Similarly, analyzing the data from 56 countries during 1996-2012, Alvarez (2015) found that countries with better governance attract more inflows. Wijethunga & Dayaratne (2018) found that foreign investors were mindful of the prevailing governance mechanism before investing in the Sri Lanka Stock Market. Biro et al. (2019) showed that good governance is a factor attracting FDI to Latin American countries. Khan et al. (2019) provided evidence from 1996 to 2012 that India attracted more FDI because of improvements in governance.
A survey done by McKinsey (2010) covering over 200 institutional investors in 31 countries showed that governance had moved to the heart of investment decisions.  studied the relationship between World Governance Indicators and foreign portfolio investment in 33 Sub-Saharan African countries (SSA). They found that quality of governance significantly attracts portfolio inflows. Wijethunga & Dayaratne (2018) found governance quality had a positive impact on portfolio investment in Sri Lanka between 1992 and 2017. Gok & Dogru (2016) showed that improvements in governance and higher GDP attract more FDI inflows into developing countries. Bouchoucha & Yahyaoui (2019) studied the interaction effects of FDI and overall governance indicators and found that their interaction effects influence economic growth. This means that overall governance enhances the impact of FDI on economic growth. Behera et al. (2020) found the existence of a long-run relationship between governance indicators and FDI inflows for South Asian countries.
While studies on the influence of governance quality on capital inflow are prevalent, studies which identify a set of essential individual governance indicators that attract capital flows are rare. Nguyen & Cao (2016) found a set of three essential factors attracting FDI to Vietnam -political stability, regulatory quality, and control of corruption.
Identifying essential combinations of governance factors influencing capital inflow is important. There are six governance indicators; however, it is likely that not all governance indicators play a crucial role in attracting capital flows.

METHODOLODY
We collected 21 years of annual data from 1997 to 2017 for seven Asian countries from several sources, Thailand and then spread to the entire region, but it affected those seven economies more than the rest of the region (Chew, 2009;Ito, 1999). However, the magnitude of the impact varied from country to country.
Those countries showed substantial improvements in governance after the crisis. We added a dummy variable representing the 1997 financial crisis to the dataset. We estimated the panel dataset using a seemingly unrelated regression (SUR) model. SUR is suitable for estimating panel data models with long time periods but small sample sizes (long T, but small N) (Zellner, 1962).

Model Specification
We built the estimation models based on the concept of, and literature on, traditional push and pull factors, which play roles in attracting foreign capital, such as return on equity, economic growth, and global liquidity.
However, governance indicators have emerged as pull factors along with traditional factors since the early 2000s. Therefore, our estimation models include both traditional economic variables as independent variables and governance indicators as explanatory variables. We used precise measurements of "governance" rather than broad measurements of "institution". Regarding dependent variables, we used three types of capital inflows: portfolio investment, FDI, and gross capital flow. The estimation models in Equations 1 and 2 are specified below.
Equation 1 estimates the impact of overall governance quality on gross capital flow. To estimate the impact of each individual governance indicator on each type of capital flow, we specify Equation 2 as follows:
The AGOVERNANCE variable in this equation is the factor extracted from factor analysis of six governance indicators: namely, rule of law, regulatory quality, control of corruption, voice and accountability, political stability, and government effectiveness. From Table 3, the coefficients of all governance variables, except voice and accountability, are statistically significant and positive. This means that the combination of individual governance indicators essential to attracting foreign portfolio investment to these seven economies comprises rule of law, regulatory quality, control of corruption, government effectiveness, and political stability. Together with those individual governance variables, stock market return and global liquidity growth are also statistically significant. Note: Dependent variable is portfolio investment. *** significant at < 1%; ** significant at < 5%; * significant at < 10%.
We then test the impact of each governance variable on FDI. From Table 4, only four out of six governance variables are statistically significant. This shows that the combination of governance indicators essential to attracting FDI are rule of law, control of corruption, government effectiveness, and political stability. Traditional economic variables, including GDP per capita growth, global liquidity, and world GDP growth, are significant.
In summary, together with traditional economic push and pull factors, we found two different combinations of factors influencing portfolio inflow and foreign direct investment into these seven Asian economies. The five-factor combination influencing portfolio inflow comprises rule of law, regulatory quality, control of corruption, government effectiveness, and political stability. The combination essential to attracting FDI comprises four indicators -rule of law, control of corruption, government effectiveness, and political stability.

DISCUSSION
The findings show that, first, together with conventional economic push and pull factors, overall governance quality positively influences gross capital flow. Second, there are two essential combinations of individual governance indicators which are essential to attracting capital flow to these seven economies. The combination influencing portfolio investment comprises five factors, namely regulatory quality, control of corruption, government effectiveness, rule of law, and political stability. The combination that influences FDI comprises four indicators, namely rule of law, control of corruption, government effectiveness, and political stability. Note: *** significant at < 1%; ** significant at < 5%; * significant at < 10%. Dependent variable is FDI.
Our findings differ from those conducted in different regions. Gangi & Abdulrazak (2012) only found three indicators -voice and accountability, government effectiveness, and rule of law -that influence inward FDI to African countries.  found a combination of four factors, comprising government effectiveness, control of corruption, rule of law, and political stability, that influence portfolio inflows to Sub-Saharan Africa.
Aloui (2019) found four factors, namely political stability, rule of law, regulatory quality, and voice and accountability, that affect FDI to ASEAN countries.
These findings imply that, first, distinct sets of governance indicators play a role in attracting international capital flows to specific regions/countries. For example, regulatory quality is significant in attracting capital flows to the seven Asian countries in our study; however, it is insignificant in other economies, such as those in African countries . Second, although overall governance quality is important, not all individual governance indicators are equally important as factors that drive portfolio inflow and FDI.

CONCLUSION AND POLICY IMPLICATIONS
Our study aims to identify combinations of individual governance indicators that influence capital flows to seven specific economies. The findings show that, along with traditional push and pull factors, improvement in overall governance quality drives inward capital flows to local economies.
We found two essential combinations of governance indicators which influence inward capital flows, one influencing portfolio inflow, the other influencing FDI. The combination that influences foreign portfolio investment includes rule of law, regulatory quality, control of corruption, government effectiveness and political stability; while the one influencing FDI comprises rule of law, control of corruption, government effectiveness, and political stability.
Our findings offer some policy implications. Policy makers should know that usual policy prescription expecting to attract capital flows into local economies by offering correct push and pull factors, such as improving the macroeconomic environment, may not be sufficient in the absence of good governance. Improving the quality of governance supplements the effects of those traditional economic factors. However, not all individual governance indicators are equally important. The two essential combinations of governance factors found in this study should be top priority for improvement if governments intend to attract more portfolio inflow and FDI.
Funding: This study received no specific financial support. Competing Interests: The authors declare that they have no competing interests.