Do Institutions Matter for FDI? A Comparative Analysis for the MENA Countries

1. Do Institutions Matter for FDI?A Comparative Analysis for the MENA Countries Vittorio Daniele * Ugo Marani** * Università Magna Graecia di Catanzaro. E-mail: v.daniele@unicz.it **Università Federico II di Napoli. E-mail: marani@unina.it

2. Summary In the last decade, the performance of the MENA Countries in the attractions of FDI has been very low. Despite the geographical proximity to the European Union, and a relative low labour cost, FDI inflows in the MENA were notably inferior to that recorded in other economies, such as Eastern European Countries, China or India. There are several reasons that can explain such a poor performance. Economic factors include the small size of local markets and the low level of development. The recent changes in the global scenario (in particular the EU enlargement and the growth of China and India) could have an important role as well. The MENA region, in particular Mashrek, suffers for political and social instability and conflicts that discourage investors. These factors, together with a deteriorate business climate, increase risks and reduce the profitability of investment. In the MENA Countries, TFP growth has been low and even negative. This papers focus on the role of institutions on FDI inflows. We use the Kauffman, Kraay and Mastruzzi (2005) dataset to estimate the role of some institutional variable on FDI. By using the Principal components analysis we calculate a variable that measure institutional quality. Regressions show as institutions play an important role for FDI. All the indicators of governance and institutions show the relative disadvantage of the MENA, in particular in comparison with the East European Countries. Our analysis suggests that institutions matter for FDI. So, some institutional and legal reforms seem to represent an important step to improve the degree of attractiveness of the MENA.

3. FDI inflows: The relative low performance of the MENA Source: Calculation on Unctad

4. FDI inflows in % of gross capital formation: The relative low performance of the MENA

5. Turkey and Israel are the main FDI recipient

6. FDI inflows in the MENA and East European Countries: The low degree of attractiveness of the MENA.

7. 6000 5000 4801 3898 4000 UE-15 EEC 3000 Mena China+India 2214 2066 2000 1756 1593 1432 873 831 1000 776 719 600 571 243 219 138 0 2002 2003 2004 Cumulated The lack of incentives to localisation: greenfield FDI projects. Figure 6. Number of greenfield FDI projects 2000-04 Source: Calculations on Unctad data.

8. Some macroeconomic indicators Table 2. MENA basics indicators 2003 Source: World Bank, World Development Indicators, 2005.

9. Growth in the MENA in comparison with the UE. Figure 7. GDP per capita (PPP constant 2000). MENA average (left scale) and in percentage of UE15 1980-2003 (right scale). Calculation on World Bank, World Development Indicators, 2005.

10. Total factor productivity growth in the MENA, in the Industrialized Countries and in China. Why TFP growth is low or negative in the MENA?

11. Conflicts on Middle-East and Maghreb (2005) *) Level of intensity in 2005: Non violent conflicts: 1): Latent conflict; 2) Manifest conflict; Violent conflicts: 3) Crisis; 4) Severe crisis; 5) War. Source: Heidelberg Institute on International Conflicts Research (2005).

12. Conflicts on Middle-East and Maghreb (2005) *) Level of intensity in 2005: Non violent conflicts: 1): Latent conflict; 2) Manifest conflict; Violent conflicts: 3) Crisis; 4) Severe crisis; 5) War. Source: Heidelberg Institute on International Conflicts Research (2005).

13. Risk index and FDI Inflows Figure 9. Risk index and FDI inflows (in log) Source: Calculation on Political Risk Service Group and UNCTAD data (2005).

14. Measuring institutional quality World Bank Governance Indicators: The WB Governance Indicators have been developed by Kaufmann, Kraay and Mastruzzi (2005). These indicators cover the period 1996-2004 and six dimensions of governance: 1) voice and accountability - measuring political and civil rights; 2) political instability and violence: measuring the likelihood of violent threats or changes in government; 3) government effectiveness: measuring the competence of bureaucracy and the quality of public service delivery; 4) regulatory burden – measuring the incidence of market-unfriendly policies; 5) rule of law: measuring the quality of contract enforcement, the police and the courts, as well as the likelihood of crime and violence; 6) control of corruption – measuring the exercise of public power for private gain, including both petty and grand corruption and state capture. The six governance indicators are measured into units ranging from about -2,5 to 2,5, with higher values corresponding to better governance. For the year 2005, this index was available for 209 countries and territories.

15. Correlation among FDI and governance indicators. For governance indicators (Kaufman, Kraay and Mastruzzi, 2005)

16. The role of institutions in the host country OLS. Observation 129. Detected multicollinearity with VIF calculation. T-statistic in parentheses. * Significant at 5% level.

17. Computing Institutional quality as synthetic variable. We use Principal Components Analysis to compute a new variables: institutional quality. Figure 11. Correlations circle variable-axes F1-F2 Factorial plane Table 7. Variable’s weight in FPC

18. Estimating the role of institutional quality for FDI. Table 8. Regression on Institutional quality Adj. R2 0,51. Obs. 129. OLS. Schwarz criterion: 484,084

19. MENA governance indicators. Rank on 209 Countries and Territories Table 9. MENA governance indicators (ranked) Rank on 209 countries and territories. Year 2004. Source: Calculation on Kaufmann, Kraay and Mastruzzi (2005).

20. A deteriorate business climate: easy of doing business in EEC and MENA. Rank on 145 Countries Source: World Bank.