Effects of Economic and Political Risks on Foreign Direct Investment: A Panel Data Analysis in MENA Region

Effects of Economic and Political Risks on Foreign Direct Investment: A Panel Data Analysis in MENA Region

Souhaila Kammoun (IHEC, CODECI, University of Sfax, Tunisia), Youssra Ben Romdhane (University of Sfax, Tunisia) and Marwa Ben Salem Fakhfakh (University of Sfax, Tunisia)
DOI: 10.4018/978-1-7998-1730-7.ch012


The chapter identifies the main determinants of FDI and the factors that constitute the main obstacles to foreign investment attractiveness in a region affected by economic and political instability and even conflict and where investors may face a multitude of political, economic, and security risks. The sample includes 14 Arab countries over the period of 2003-2017. To determine the factors that explain the probability of attracting investment inflows in MENA countries, the study uses a multiple regression model to estimate data in a time series. The authors also use the World Bank's governance indicators to assess the quality of the Arab institutional framework. The results of the panel data estimates through three different regressions reveal that macroeconomic instability combined with political instability constitutes an obstacle to investment. On practical implications, the study suggests that, in general, economic managers should take some economic policy measures to reduce or mitigate risks to encourage foreign investors to invest in MENA countries.
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Since the 1980s, foreign direct investment (FDI) flows have become a key growth driver for developing countries. In this context, several studies have focused on the determinants of foreign direct investment and several questions have arisen to provide some clarification on this matter.

Many researches on the subject show that FDI has a positive overall effect on the economy (Alfaro, Chanda, Kalemli-Ozcan, & Sayek, 2004; Borensztein, De Gregorio, & Lee, 1998; Erokhin, 2016a, 2016b, 2017; Prabhakar, 2016, 2017, 2018; Gupta, Kangur, Papageorgiou, & Wane, 2014; Li & Liu, 2005). Indeed, the role of FDI is becoming increasingly important, since it contributes significantly to host countries’ economic growth and development. Large flows of FDI are now a feature of the globalized economy and policymakers are competing to attract long-term investment. In recent decades, FDI flows to host countries have increased, particularly, in countries that have undertaken economic and political reforms and have seen their economies become more open to international trade. More specifically, FDI provides recipient countries with the capital flows, technological know-how, human capital development, and management skills necessary for sustainable economic development. FDI provides valuable capital to stimulate economic growth and development and thus enables the transfer of technology and knowledge to host countries.

Nevertheless, if several researchers have explained the determinants of FDI in stable and developing countries, only few studies have examined the relationship between FDI and macroeconomic aggregates in a context of political uncertainty, an issue which remains underexplored. In this context, some scholars have shown that there is a negative correlation between incoming FDI flows and the number of strikes, corruption, political stability and the quality of legislation (Schneider & Frey, 1985; Wheeler & Mody, 1992). Further, other studies have shown that political uncertainty has negative effects for some countries by discouraging savings and foreign direct investment by destroying trade with other countries (Ades & Chua, 1997). From the perspective of Arunatilake, Jayasuriya, and Kelegama (2001), political instability has economic costs such as lost income due to reduced domestic and foreign investment. Fosu (1992) also studied the effect of political instability on growth in Sub-Saharan African countries and the results of the study confirmed that political instability has a negative impact on economic growth. In the Franco-Prussian example of Devereux and Smith (2007), the effect of wars on production and consumption movements was considered mandatory to adapt to German and French macroeconomic history between 1871 and 1873.

Key Terms in this Chapter

Regression: A technique for determining the statistical relationship between two or more variables where a change in a dependent variable is associated with, and depends on, a change in one or more independent variables.

MENA Countries: An acronym for the Middle East and North Africa region, an extensive region extending from Morocco in Northwest Africa to Iran in Southwest Asia. It generally includes all the Arab Middle East and North Africa countries, as well as Cyprus, Iran, Israel, and Turkey.

Developing Economy: A country with a less developed industrial base and a low Human Development Index relative to other countries.

Correlation: A connection or relationship between two or more facts or numbers.

Foreign Direct Investment: An investment in the form of a controlling ownership in a business in one country by an entity based in another country.

Macroeconomic Stability: A national economy that has minimized vulnerability to external shocks, which in turn increases its prospects for sustained growth.

Risk: A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through preemptive action.

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