The Relevance of Political Stability on FDI: A VAR Analysis and ARDL Models for Selected Small, Developed, and Instability Threatened Economies

Petar Kurecic,Filip Kokotovic

doi:10.3390/economies5030022

Abstract

This paper studies the relevance of political stability on foreign direct investment (FDI) and the relevance of FDI on economic growth, in three panels. The first panel contains 11 very small economies; the second contains five well-developed and politically stable economies with highly positive FDI net inflows, while the third is a panel with economies that are prone to political violence or targeted by the terrorist attacks. We employ a Granger causality test and implement a vector autoregressive (VAR) framework within the panel setting. In order to test the sensitivity of the results and avoid robust errors, we employ an ARDL model for each of the countries within every panel. Based upon our results, we conclude that there is a long-term relationship between political stability and FDI for the panel of small economies, while we find no empiric evidence of such a relationship for both panels of larger and more developed economies. Similarly to the original hypothesis of Lucas (1990), we find that FDI outflows tend to go towards politically less stable countries. On the other hand, the empiric methodology employed did not find such conclusive evidence in the panels of politically more developed countries or in the small economies that this paper observes.

Highlights

Foreign direct investment (FDI) is considered an important motivator of economic growth.There are various studies that address the issue of the relevance of FDI to economic growth, comprising numerous other macroeconomic variables
Based upon the conducted quantitative analysis methods, it is possible to conclude that there is a significant difference in the significance of political stability in countries based upon their respected economic size and levels of development
We determine that political stability is only relevant to FDI in the panel of smallest economies, while we find no such causality in larger economies

Summary

Introduction

The approaches to identifying key trends are increasingly interdisciplinary, while intuitive claims and policy discussions should be accompanied by adequate quantitative analysis and empirical proof. This was especially obvious during the time of the 2008 crisis, as noted by Krugman (2009), who claims that investor confidence and their perceptions or prejudice currently are the key economic elements. In these times, perhaps, the issues of perception and investor’s confidence are becoming increasingly important in maintaining stable economic growth. Perhaps a key element to the issue of public awareness is the media coverage, as indicated in several studies that point out the so-called “CNN effect”

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Conclusion