Institutional clusters and foreign direct investment flows to the Middle East and North Africa region
Empirical studies examining the relationship between institutions and foreign direct investment have examined the influence of either individual institutions or aggregate measures of institutions on FDI. The former treatment implies that individual institutions are isolated and independent of one another, while the latter treatment implies that institutions can be perceived as an (mathematical) aggregation of separate individual units. Either treatment ignores the correlation among institutions and possibly their clustering around a broader institutional theme or function. In this paper we address this conceptual shortcoming by clustering institutions based on objective statistical method – Principal Component Analysis (PCA), instead of the above treatments.
Data/Methods:
We first apply PCA to 11 International Country Risk Guide institutions (ICRG) for 16 MENA region countries (Bahrain, Egypt, Iran, Iraq, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Qatar, Saudi Arabia, Syria, Tunisia, UAE, and Yemen) for the period 1984-2011. We then estimate an empirical model of FDI flows.
The dependent variable is FDI flows normalized by GDP. The explanatory variables include market size, trade openness, the degree of infrastructure development, human capital, an Arab Spring dummy, in addition to the identified institutional clusters. To account for heterogeneity among the MENA countries, we adopt feasible GLS estimation methodology. Data are obtained from ICRG and the World Bank’s World Development Indicators database.
Results:
PCA indicates that MENA institutions can be grouped into 3 clusters. The first cluster comprises mainly government stability, internal and external conflicts and ethnic tensions, law and order, protection of property rights, and the manipulation of religion in politics. The second cluster comprises (mainly) corruption, bureaucracy quality, and the role of military in politics, while the third cluster comprises (mainly) democratic accountability. Estimation results show that the first and third clusters have a positive influence on FDI flows, while the second cluster has a negative influence in contrast.
The influence of the second and third clusters is robust to changes in the normalization of the dependent variable to FDI inflows per capita, while the influence of the first and third clusters is robust to changing the sample period to 2000-2011. Both robustness checks suggest that the influence of the third cluster, comprising mainly democratic accountability, is the most robust.
Policy Implications:
One may conclude that political reforms, which enhance democratic accountability are likely to enhance FDI flows to the MENA region. If MENA countries aim to boost FDI inflows, they should consider political reforms as a priority.