CAPITAL ACCOUNT OPENNESS, POLITICAL INSTITUTIONS AND FDI IN MENA REGION: AN EMPIRICAL INVESTIGATION

Abstract

(ProQuest: ... denotes formulae omitted.)1. INTRODUCTIONWhile global cross border capital flows have risen to reach nearly $6 trillion in 2004, only a small fraction (about 6.4 percent) flows to developing countries. Researchers cannot help but ask, doesn't capital flow from rich to poor as predicted by classical economic theory?Some academics and policy makers are seeking to provide a possible explanation for why? despite the surge in capital mobility over the last decade, FDI inflows to developed are much larger than those to developing countries. Addressing this question, an important strand of literature Kaminsky and Schmukler (2003), Kose et al. (2003), Campion and Neumann (2004) and Caprio et al. (2001) have paid special attention to the role of financial liberalization in absorbing FDI. They suggest that can attract more international capital flows by de-regulating activities in their domestic financial markets, liberalizing their capital account transactions and equity markets. Brafu-Insaidoo and Biekpe (2014) employ three explanations on how capital account liberalization affects capital inflows: Firstly, the removal or relaxation of restrictions on foreign ownership limitations can increase FDI inflows. Secondly, the de-regulation of offshore borrowing can attract more foreign private loan inflows through the removal of quantitative restrictions on overseas borrowing and the provision of tax incentives. Thirdly, the abolition of multiple exchange rate practices can enhance the foreign capital inflows by eliminating economic distortion, and reducing the uncertainties and the risks about exchange rates particularly during repatriation of capital or income from capital.Another body of literature (Chan and Gemayel, 2004; Onyeiwu, 2003; Daniele and Marani, 2006; Alfaro et al., 2008) have focused on the role of political stability and institutional quality in boosting FDI. They all suggest that low institutional quality is the leading factor in explaining the lack of capital flows from rich to poor countries. Recently, Asiedu and Lien, (2011) and Okada (2013) have examined the impact of institutional factors on the degree of association between capital control and FDI inflows show that financial openness improves FDI inflow only in with good institutional quality comparing to with poor institutional quality.In this paper, we try to give an explanation on the question why FDI does not flows from rich to poor countries by examining the role of interaction effect of financial openness and institutional quality in enhancing FDI in the MENA region. The MENA region is a particularly interesting example for this study, given that although most member have undertaken financial liberalization in the 1980's as part of the structural adjustment programs of the IMF and World Bank in order to promote FDI, it continues to attract a smaller share of FDI than all other regions except for Sub-Saharan Africa. Over the period between 2006 and 2010, the share of FDI inflows in the MENA region represented on average about 6.5 percent of the world's total FDI inflows, against 23.62 percent in East Asia and Pacific and 8.72 percent in Latin America and Caribbean. The Europe and Central Asia region have maintained the lion's share of global FDI flow (59 percent). This distribution is not only particular to this period or one year, but also of the whole previous decades (World Bank's World Development Indicators).The level of FDI inflows to MENA region is lower for two main reasons: The first one is related to the fact that multinational firms are unlikely to invest in with bad institutions even if these become more financially open. In contrast, if which have good institutions become more financially open, it is expected that international capital flows to these will increase. The second one is that, in the financially open countries, a perceived deterioration in its policy environment could be punished by the flight of capital out of the country. …