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BOĞAZİÇİÜNİVERSİTESİ
ISS/EC‐2007‐03
DoesthePerceptionofGovernanceInstitutionsMatterforPrivate
Investment:TheCaseofMiddleEastandNorthAfrica
AhmetFarukAysan
ZeynepErsoy
M‐AVeganzones‐Varoudakis
ARAŞTIRMARAPORU
RESEARCHPAPERS
BoğaziçiUniversityDepartmentofEconomicsResearchPapersareofpreliminarynature,circulated
topromotescientificdiscussion.Theyarenottobequotedwithoutwrittenpermissionofthe
author(s).
1
Does the Perception of Governance Institutions Matter for
Private Investment: The Case of Middle East and North
Africa?
Ahmet Faruk Aysan*
Zeynep Ersoy*
Marie-Ange Véganzonès –Varoudakis**
Abstract
This paper empirically shows that the perceived quality of governance is an essential determinant
of the private investment decisions in the developing countries by stressing the existence of different types
of possible measures of governance. We use three different indicators to measure the perceived quality of
governance, “Quality of Administration” (QA), “Political Accountability” (PA) and “Political Stability”
(PS). All of the three indicators were proved to be significantly –although at different levels of significance
and magnitudes of influence- contributing for private investment decisions. We also confirm that Middle
East and North Africa (MENA) region could have achieved a better private investment performance if it
had an enhanced level of perceived institutions. In particular the low level of political accountability has
been an influential factor which has been holding back the region from reaching its private investment
potential.
Keywords: Perceptions, Institutions, Governance, Private Investment, Middle East and North Africa.
JEL Classification: P4, E2, E6, D02
Corresponding Author: Ahmet Faruk Aysan
Boğaziçi University
Department of Economics
34342 Bebek, Istanbul, Turkey
Phone: 90-212-359 76 39
Fax: 90-212-287 24 53
ahmet.aysan@boun.edu.tr
* Boğaziçi University, Department of Economics, Istanbul, Turkey
** CERDI, CNRS, Université d’Auvergne, France
2
Does the Perception of Governance Institutions Matter for Private Investment: The
Case of Middle East and North Africa?
1. Introduction
The quality of governance in the Middle East and North Africa (MENA) region is
generally considered to be inadequate. Although this is true for a large number of
institutions, quality of governance is a wide-ranging phenomenon and its distinct features
may exhibit quite different paths for the same region (see Table 1). For example in terms
of the administrative quality and political stability indicators used in this paper, MENA
ranks third -with scores of 0.14 and 0.07 respectively- among the six developing regions
and is superior to Africa (AFR), Latin America (LAC) and South Asia (SAS). This basic
comparison shows that contrary to common belief, MENA is not particularly deficient in
institutional quality when measured by these indicators. On the other hand political
accountability for the MENA is the lowest among the regions with the score of -0.90. The
disaggregated governance variables in our sample of developing countries, which are
shown in Table 2, also confirm the same result. The level of the variables associated with
administrative quality –corruption, law and order, investment profile and bureaucracy
quality- and political stability –government stability, internal conflict, external conflict
and ethnic tensions- look rather satisfactory for the MENA region. The region is ranked
as the second best in the categories of bureaucratic quality and investment profile and
“the best” in the categories of government stability and ethnic tensions. In contrast, in
terms of political accountability variables –civil liberties and government stability-
MENA has the lowest score among all the regions1.
Table 1 Governance Indicators (average 1970-2002)
Region
Administrative
Quality
Political
Stability
Political
Accountability
AFR -0.38 -0.63 -0.55
EAP 0.59 0.29 -0.05
ECA 0.29 0.42 0.03
LAC -0.31 -0.09 1.16
MENA 0.14 0.07 -0.90
SAS -0.55 -0.88 0.46
Sources: International Country Risk Guide, Freedom House, and the Authors’
calculations.
The different levels of advancement displayed by the various governance
indicators in the MENA region (as well as other regions) suggest that the mechanisms
shaping each indicator can be quite different. Hence these different types of governance
institutions are also expected to exert their influences on the economic variables
differently as well. Hence, in studying the relationship between governance and
economic indicators, unique influence of each category of institution needs to be taken
into account. In this paper we focus on the various different dimensions of governance
1 Our argument supports the view presented by World Bank (2004).
3
indicators and analyze the impact of various types of perceived governance institutions
on the level of private investment in MENA.
There is an emerging literature on the quality of governance which advocates that
“good” governance institutions are needed for successful market-based economies2. The
impact of institutions on economic growth3 , GDP per capita4 and or volatility of the
economic activity5 have been studied extensively in the recent years. Although private
investment is arguably one of the main channels through which institutions exert their
influence on growth and economic development, very little research is done on the
relationship between private investment and governance institutions. The existing studies
on governance and private investment have generally concentrated on the effect of the
rule of law6. However, there is not much research done on the other types of governance
institutions. Moreover empirical link between these variables and private investment is
not strongly established. This is particularly the case for corruption and bureaucratic
administration7 as well as the quality of the democratic institutions8. In terms of political
instability and policy uncertainty there are some studies which have been successful in
proving the impact of institutions on private investment. 9
Private investment is very much responsive to the changes in the business
environment; which governance constitutes an important element. The forward looking
nature of investment also highlights the importance of a stable and secure environment –
in particular the security of property rights. High quality governance institutions reduce
uncertainty and promote efficiency10. Using a large sample of countries, World Bank
(2004) finds a strong positive link between the investment climate and private investment
2 See in particular Rodrik (1999) and Frankel (2002).
3 See for example Knack and Keefer (1995), Acemoglu, Johnson, and Robinson (2001), Rodrik,
Subramanian, and Trebbi (2002)
4 See Hall and Jones (1999), Acemoglu, Johnson, and Robinson (2001), Easterly and Levine (2003), and
Rodrik, Subramanian, and Trebbi (2002).
5 See for example Acemoglu, and Taicharoen (2003).
6 Under this category the security of the property rights is the most studied and empirically validated
component. See North (1981), Knack and Keefer (1995), Calderon and Chong (2000), Easterly and Levine
(2003), Rodrik, Subramanian, and Trebbi (2002), and Saleh (2004).
7 See Keefer (2002).
8 Pastor and Sung (1995) is among the few articles that have been able to establish a link between the
political institutions and private investment.
9 See Rodrik (1991) and Le (2004)
10 North (1990)
Table 2 Disaggregated Governance Variables (average 1970-2002)
Region Corruption
Bureaucracy
Quality
Investment
Profile
Law
and
Order
Political
Rights
Civil
Liberties
Government
Stability
Internal
Conflict
External
Conflict
Ethnic
Tensions
AFR 2.81 1.49 5.42 2.71 -5.10 -4.97 6.07 6.96 8.44 2.99
EAP 3.22 2.37 6.29 3.89 -4.29 -4.49 7.07 9.28 9.99 3.33
ECA 3.43 1.71 5.69 4.04 -4.20 -4.39 6.94 9.68 10.06 3.92
LAC 2.71 1.44 5.73 2.81 -2.72 -3.02 6.13 7.61 9.75 4.34
MENA 2.98 1.95 5.89 3.39 -5.41 -5.51 7.62 8.30 8.34 4.34
SAS 1.98 1.81 5.38 2.33 -3.38 -4.08 5.73 6.60 8.27 2.29
Sources: International Country Risk Guide, Freedom House the Authors’ calculations.
4
decisions11. In that study the reason for this observed relationship is suggested to be the
fact that better governance improves the investment climate by improving bureaucratic
performances and predictability which in turn reduced uncertainty and the cost of doing
business.
Since governance is an important determinant for investment, private investors
would want to know about the quality of the governance institutions at the time of
making investment decisions and also in the future when they will be getting their
returns. Although good institutions are beneficial for reducing uncertainty, the
perceptions about the quality of the governance institutions may themselves be a source
of uncertainty, because investors may not know the actual governance establishments
with 100% accuracy. Uncertainty associated with private investment arises both from the
unknown future factors and imperfect information about the current state of governance
variables. Investors collect information about the quality of governance institutions from
consulting firms as well as from the other sources to form their perceptions about these
institutions. Since their opinions on governance institutions are crucial in making the
investment decisions, perceived level of quality of the governance institutions needs to be
analyzed as a determinant of private investment. This paper incorporates this argument
into its estimation process.
For the governance variables we use the data obtained from International Country
Risk Guide and Freedom House. These are independent private firms that provide
consulting services to international investors. We argue that, this data set can be a good
proxy to measure the perceptions of the investors about the institutions. At this point it is
important to point out the existence of the possible distinction between the perceived and
actual institutions. Governance institutions are not expected to show abrupt changes from
one year to another, but in our data set we do observe sudden variations for certain years.
This may be due to the fact that investors have incomplete-asymmetric information about
the quality of governance institutions in the economy. At extraordinary times-like crises-
governmental bodies are forced to reveal the true quality of their institutions. With the
arrival of the crises government institutions are faced with a real examination and
information concerning the true quality of the institutions is uncovered. At regular times
investors may not be able to get healthy information about the quality of the institutions
to form their perceptions and without additional information they may not be able to
modify them. This line of argument is one explanation for the observed pattern of the
governance data.
A wide set of governance variables -which are not commonly used as the
determinants of private investment in the empirical literature- are employed in our study.
These variables are likely to be highly correlated. To account for the multi-collinearity
issue we use principal component analysis to aggregate a few broad categories of
governance institutions. Based on the existing literature, we classify governance
11 The World Bank (2004) has investigated the correlation between private investment and ICRG’s index of
“investment profile”. This index is based on measures of contract enforceability, expropriation, profit
repatriation, risk of operations, taxation and payment delays.
5
institutions in three groups as “Administrative Quality”, (QA), “Political Accountability”
(PA), and “Political Stability” (PS).
Aysan et.al. (2006a) have reexamined and updated the International Finance
Corporation (IFC) data set for private investment by consulting the national sources, IMF
and World Bank series and country economists. We use their disseminated data set
(which covers the period from 1970 to 2002) in our study. High quality data for the 63
developing countries are included in their database.
We use a simultaneous equations model to stress the joint determination of
private investment and different forms of governance institutions. The procedure of this
model is justified by the fact that private investment can have a direct effect on the
institutions. For instance, an increase in the private investment strengthens the private
sector’ incentive in lobbying12. Hence these newly-empowered corporate bodies are
likely to exert more pressure on the government and demand institutional changes for
their own well-being. Our findings show that the perceived quality of governance
institutions plays an important role in private investment decisions. “Administrative
Quality” (QA) and “Political Stability” (PS) and “Political accountability” (PA) are
crucial for the determination of private investment. This result supports the hypothesis
that different categories of governance institutions effect private investment through
different channels.
The paper is organized as follows. The second section introduces our
classification of governance institutions. The third section presents the other determinants
of private investment that will be taken into consideration in our empirical analysis and
highlights the importance of these factors for the MENA countries. The fourth section
introduces the model of private investment tested and the results of the estimations. The
sixth section uses this model to determine which reasons account for the private
investment performance of the MENA region. It also identifies the incentives to be
provided to enhance private investment in the future. The last section concludes.
2. Categorization the Governance Institutions
To study the impact of different types of governance institutions on the private
investment, we first distinguish between the various dimensions of governance. The
existing literature on the classification of institutional quality provided us the guidelines
for categorization the governance institutions.
Kaufmann, Kraay and Mastruzzi (2003) categorize these institutions under six
groups. Their measures of governance indicators are based on 194 variables drawn from
17 different sources. “Government Effectiveness” and “Regulatory Quality” summarize
the ability of the government to devise and implement sensible policies. The respect of
the citizens and the state for the institutions which govern their interactions is categorized
as “Rule of Law” and “Control of Corruption”. "Political Stability and Absence of
Violence" measure perceptions of the likelihood that government in power will not be
12 See Altmann
6
destabilized and indicate the continuity of policies. “Voice and Accountability” captures
the process by which the citizens of a country are able to participate in the selection of
governments. The World Bank (2004) constructs two indices on “Political
Accountability” and “Administrative Quality” by aggregating the existing relevant data
sets for these aspects of governance.
Taking these categorizations into account, we grouped institutional variables into
three broad units: “Administrative Quality” (QA), “Political Accountability” (PA) and
“Political Stability” (PS).
2.1. Quality of Administration
Following the World Bank (2004), we have defined the first governance indicator
as the “Quality of Administration”. This index contains four variables from the
International Country Risk Guide (ICRG): “Control over Corruption”, “Quality of
Bureaucracy”, “Investment Profile”, and “Law and Order”. These four variables are
aggregated using the Principle Components Analysis (PCA) to form a broad index for the
Quality of Administration13. This governance unit shows the capacity of the government
to provide investment-friendly and reliable conditions for the private investors.
The negative effect of corruption on the economic variables is firmly established
in a number of studies14. Mauro (1995) empirically shows that corruption reduces growth.
For private investors, corruption increases the initial and operational costs of investment
in addition to the uncertainties about the timing and application of government policies.
The “Quality of Bureaucracy” index of ICRG shows the ability of the government to
generate and implement sound policies. Also, this index indicates that “countries where
the bureaucracy has the strength and expertise, govern without drastic changes in policy
or interruptions in government services. “Investment Profile” index measures the
“government’s attitude to inward investment as determined by the assessment of four
sub-components: risk to operations, taxation, and profit repatriation and labor costs”. By
its nature investment requires people to make long-term decisions. Hence risk to
operations and other uncertainties about future policies are important for investment
decisions. In the “Law and Order” index, the law element presents an “assessment of the
strength and impartiality of the legal system”, while the order element is related with the
“popular observance of the law.” Different aspects of the business environment are
important for investment, but the security of property rights and the rule of law and their
effects on private investment are seen to be the most important ones and these are
empirically validated through a number of studies15. Investors are concerned about the
future state of the economic-social institutions in order to protect their investments.
Specifically they need institutions that preserve the right of private property, ensure
13 The variables forming the QA index is likely to be highly correlated. In order to account for the multi-
collinearity problem in using these variables in the same regression equation PCA method is used to
aggregate these variables. The other governance indicators are also formed by using this method.
14 World Bank (2005) and Mo (2001).
15 See North (1981); Knack and Keefer (1995); Calderon and Chong (2000); Easterly and Levine (2003);
Rodrik, Subramanian, and Trebbi (2002), and Saleh (2004).
7
equitable and consistent rule of law in protecting this right, as well as effective incentives
to respect and enforce it.
2.2. Political Accountability
Our second governance indicator is “Political Accountability”. This unit consists
of two indicators from Freedom House (FH): “Civil Liberties” and “Political Rights”.
Since all types of investments involve a certain degree of irreversibility, private
investment decisions are highly sensitive to the perception of the credibility and
persistence of the political regime, as well as of policies16. A participatory political
system provides the stability of social institutions and ensures a broad public support to
policies, which are in this case more sustainable in the long run. The empirical literature
on democratic participation has concentrated on the effects of transparency and
accountability on growth, using data on civil liberties, political rights, and freedom of
press. These attempts to establish causal links between democracy and growth generated
moderate success17.
2.3. Political Stability
The last indicator is “Political Stability” and is composed of the following
variables from ICRG: “Government Stability”, “Internal Conflict”, “External Conflict”
and “Ethnic Tensions”. Political instability creates uncertainty which has detrimental
effects for the level of investment. Using different measures of political uncertainty,
various studies have brought empirical evidence that institutions associated with political
instability hinder investment18.
All of the three indicators reflect the perceptions of the private investors about the
quality of the governance institutions. These perceptions are not necessarily the same as
the actual level of the quality of the institutions.
3. Other Determinants of Private Investment and Governance Institutions
In studying the private investment performance of the developing countries some
additional issues needs to be taken into account. In particular, the business environment
in these countries is not always competitive and investors face additional limitations
which are not accounted for in the neo-classical model. The debate about how to
incorporate these factors into the estimation procedure gave rise to the usage of different
types of variables as determinants of private investment by various authors19. In this
16 See in particular, Rodrik (1991) and Serven and Solimano (1993).
17 In the contex of private investment the study of Pastor and Sung (1995) is one of the few articles to find a
positive influence.
18See Rodrik (1991), Alesina and Perotti (1996), Le (2004), Brunetti and Weder (1994). In the growth
context see also Alesina et al. (1996), Svensson (1998), Olson et al. (2000).
19 See for example Greene and Villanueva (1991) and Blejer and Khan (1984)
8
paper we address some of the constraints encountered in the developing world, especially
the ones linked to economic policy and institutional quality.
In the macroeconomics literature, the neoclassical flexible accelerator model is
the most widely accepted model of investment. This model is based on the neoclassical
idea of the theory of the firm (Jorgenson, 1963), which claims that enterprises decide to
invest so as to generate more profit in the future. The investment function is derived from
the optimization problem of the firms, which maximize current and expected profits by
equating the production prices to their marginal costs. The net investment is the gradual
adjustment of the actual capital stock to its desired level, which is derived from the
maximization of profit. The determinants of investment in the neoclassical flexible
accelerator model include the expected aggregate demand (the accelerator), the user cost
of capital, the wage rate and the initial capital stock.
One of the main assumptions of this model - competitive markets- , however,
does not often hold in the developing countries. Empirical validation of the model
appears to be successful for several developed countries. However the firms in
developing countries face certain constraints that are not accounted for in the
conventional neoclassical theory20. Next, we will examine some of these constraints –
especially the ones that are more relevant for the MENA region- in detail.
One of the main constraints confronted by the investors in the developing
countries is the deficit in economic reforms. This is also the case for the MENA countries
which have lagged behind other regions in terms of reforming their economy (Nabli and
Véganzonès -Varoudakis, 2006). Structural reforms constitute an important determinant
of the actual and future profitability of private investment. These reforms are mostly
directed towards the establishment of a sound financial system and an economy that is
fully integrated to the world. Hence our structural reforms index includes trade policy and
financial development.
Financial development is an important determinant for private investment since it
creates profitable investment opportunities. A developed financial system mobilizes and
allocates resources to the projects that will create the most amount of surplus. This
efficiency in the allocation process is derived from the enhanced technological
specialization and reduced “information, transaction, and monitoring costs”21 which leads
to a better selection of projects and a more advanced diversification of risks. This allows
the firms to finance more investment projects and increases the productivity of new
investments (see Levine, 1997, for a synthesis). Financial markets are not fully developed
in the emerging economies. Hence the neoclassical assumption of flexible accelerator
model about the limitless availability of credit supply by the banking sector cannot be
taken for granted in these countries. As pointed out by Blejer et.al (1984) and Rama
(1993) the quantity of the available funds in these countries may be restricted by
government policies. One of the deriving forces behind these policies can be the public
20 See in particular Shafik (1992), Agenor and Montiel (1999) and Aysan et al. (2006b) for a discussion and
additional references.
21 See Creane, Goyal, Mobarek and Sab (2004).
9
deficits and public debt, which can lead to financial repression and to crowding out of
private investment. On the empirical side, the impact of financial development on private
investment is now well documented22. In the MENA region, reforms needs to particularly
focus on the development non-bank financial sector. The corporate bond market and
equity market are not active and the investors are forced to rely on bank credits23.
Trade reforms can also encourage private investment decisions. The link between
persistent growth and trade openness is generally acknowledged24. Trade openness
increases competitiveness and provides access to enlarged markets (Balassa, 1978; Feder,
1982) and can contribute to the productivity gains. In addition, trade openness influences
the availability of external credit -- considering the general consensus on the role of
tradable goods in providing positive externalities in the form of collateral for external
financing (Caballero and Krishnamurthy, 2001). Some countries in the MENA region are
highly disintegrated to the world trade and this has adverse consequences on foreign
investment levels in the region.25
In addition to their direct effects mentioned above, economic reforms are also
expected to affect private investment through their impact on institutional quality. For
example, there is some evidence that greater openness to trade and stronger competition
are conducive to institutional improvement26. Opening up markets may help to weaken
vested interests and reduce rents derived from prevailing economic and institutional
arrangements. Trade openness may also lead to demands for institutions more suited to an
increasingly varied and complex range of transactions (See IMF, 2003).
Human capital is an important determinant for the level of private investment. It is
generally viewed as a complementary factor of physical capital. In this study, human
capital index is composed from health and education variables. Human capital stimulates
private capital formation by raising the profitability of investment and can provide
positive externalities27. Since skilled workers are better in dealing with changes, a skilled
work force is essential for firms to adopt new and more productive technologies28
Additionally, human capital gives rise to institutions with better quality. More
educated people with higher life expectancy become more competent bureaucrats and --
in addition to better monitoring of the functioning of government officials -- demand for
better quality of bureaucracy (Galor et al., 2005). Also, educational attainment reduces
the political instability by encouraging a consensus environment. This idea constitutes the
one of the classical approaches in the literature to highlight the importance of education
in bringing better institutions (Lipset, 1959). From the democratic accountability point of
22 In his survey of investment functions in developing countries, Rama (1993) presents the positive effect of
financial development on private investment in twenty-one of the thirty-one papers surveyed.
23 See Mc Call (2004)
24 See Bisat et. al. (1996) and the references there.
25 See Bisat et.al. (1996)
26 For the positive spillover from trade openness on institutions see Berg and Krueger (2003), Islam and
Montenegro (2002) and Wei (2000).
27 See Lucas (1988) and Mankiw, Romer and Weil (1992).
28 See in particular Acemoglu and Shimer (1999).
10
view, a more educated society is more likely to be enfranchised in terms of civil rights
and liberties (Acemoglu and Robinson, 2001). These arguments support the view that in
addition to its direct effect, human capital can influence private investment decisions
through its effect on the institutions.
The improvements in the level of educational attainment experienced by the
majority of the developing countries have not been sufficient to change the perceptions of
private investors about the skills of the workers in these countries. This is the case for the
MENA region, where progress is still needed in order for the region to catch up with the
developed world as well as with some of the developing regions29. As pointed by the
World Bank (2004), to meet this challenge, MENA countries have to gear up their
educational system both to improve basic education and to equip the labor force with
skills appropriate for the enterprises to invest efficiently.
In the developing countries, the government is still the pre-dominant actor in the
economy. Hence the level of government consumption can be an important determinant
for private investment for these countries. When government spending is used to finance
projects which increase the profitability of the private investment, then the effect of this
factor on private investment will be positive. Improvements in the infrastructure system
and quality of health and education services financed through the government budget can
be shown as examples of such cases30. Also an increase in the demand for private sector
products by the government can stimulate private investment.
On the flip side government consumption can reduce the amount of funds
available to the private sector. This effect is most likely to be observed through the
increase in the interest rates (Binter 1977) and future tax burden (Friedman 1976). If the
excess amount of government spending is financed through “printing money” then this
leads to an increase in the level of the inflation which in turn increases uncertainty.
Besides using external debt for government deficit may harm the financial and political
stability, given that the country can encounter difficulties in reimbursing its debt. The
negative impact of instability and uncertainty on private investment is empirically
validated in a number of studies31. Since government consumption can have beneficial as
well as damaging effects on the private investment in theory, the overall impact of this
variable on the level of private investment needs to be analyzed empirically.
Government spending is expected to have a positive effect on governance. For
example the improvements in the living standards of the bureaucrats caused by the
increase in wages can induce them to form better governance institutions. 32
4. The Econometric Analysis
29 See Nabli and Véganzonès -Varoudakis (2006).
30 See for example Bisat et.al. (1996).
31 References for political uncertainty and instability are given in the introduction section. In addition to
those, for macroeconomic uncertainty see Serven (1997) and (2002).
32 See Azariadis and Lahiri (2002)
11
4.1. The Model Tested
The aim of the model tested is to isolate the effects of the perceived quality of the
different governance indicators on private investment. In our empirical model,
endogenous variables are the share of private investment and the various measures of
governance, namely “Quality of Administration” (QA), “Political Accountability” (PA)
and “Political Stability” (PS). The endogenous variables have the ability influence each
other and hence determined simultaneously. To incorporate this two-way causality into
our analysis, we form a system of equations to estimate the share of private investment
(PI) in GDP and quality of governance institutions (IQ) simultaneously. In the private
investment equation, perceived quality of governance institutions is expected to increase
the private investment. In the other equation in which governance is the dependent
variable, the sign of the coefficient of private investment is expected to be positive.
This system of equations is estimated using three stage least squares by
controlling for the other determinants which include variables that affect both of the
endogenous variables. Three stage least square (3SLS) estimation allows to use the links
between endogenous variables efficiently. Since endogenous variables are correlated
with the error terms, they have to be instrumented out using exclusion restrictions.
The model estimated is the following:
(A) itiitit XIQPI 11210
ε
α
α
α
+
+
+
=
(B) itiitit XPIIQ 22210
ε
β
β
γ
+
+
+
=
Where:
− it
PI is the share of private investment in GDP
− it
IQ represents the various indexes of governance (QA, PA and PS)
− i
X1 and i
X2 are the other control variables in private investment (PI) and
governance (IQ) equations respectively
− it1
ε
and it2
ε
are the error terms of each equations. i signifies the country and t
represents the time of the variable.
As mentioned before, the determinants of investment in the neoclassical flexible
accelerator model include the expected aggregate demand (the accelerator) and the user
cost of capital. The private investment equation in our model includes real interest rate
(Realr) to capture the user cost of capital and the GDP growth rate in last year (Growth)
to account for the accelerator effect33. These two variables are assumed to have no direct
effect on the level of the perceived quality of governance. Hence they are not included in
the governance equations. This detail is crucial for the identification of the system.
33 GDP growth rate enters the equation with an expected positive sign whereas the effect of the real interest
rate is expected to be negative.
12
GDP per capita, variations in the structural reforms (Struct Ref), human capital
(Human Cap) Government consumption (GCons) and oil export as a percentage of
merchandise export (Oil export) enters into both of the equations as explanatory
variables. GDP per capita is included in the private investment equation to take into
account the argument put forward by the Solow growth model; Countries with lower
GDP per capita are expected to gradually catch up with the more developed counterparts
with their higher capital investment over time. Additionally, GDP can be a proxy for the
market size for goods and services which can affect the differences in the private
investment ratios across the countries. GDP per capita variable in the governance
equation is expected to exert a positive influence because of the theoretical argument that
more developed countries can afford to have better institutions34. This argument may
influence the perceptions of the investors when they are forming their investment
decisions.
Structural reforms index is composed from trade policy (TP) and financial
development indicators. Financial development is proxied by the private credit by banks
and other depository institutions (Pcr). Trade policy indicator is formed by subtracting
the exports of oil and mining products and the “natural trade openness” (constructed by
Sachs and Warner 1997) from the commercial openness (calculated by aggregating the
export and import in total GDP). The trade policy and financial development variables
form the structural reform index after applying the principal component analysis.
Structural reform is expected to enhance the level of private investment and the perceived
quality of the governance institutions.
To form the Human capital index life expectancy at birth and average years of
primary, secondary and higher schooling35 variables are aggregated using the principal
component analysis. Human capital is widely considered to improve the private
investment and the quality of the governance institutions.
The ratio of government consumption to GDP (GCons) is used to account for the
level of government consumption and this variable is included in both of the equations.
As mentioned before the effect of this variable on private investment is not certain ex-
ante. On the other hand the expected coefficient of the government consumption variable
in the governance equations is positive.
Oil export as a percentage of total merchandise export is also included as
explanatory variables in both equations. The validity of the natural curse hypothesis is
tested by incorporating this variable in the investment equation. When a country relies
more on natural resources extraction in its export, there can be less incentives to invest
for other products36. Hence the sign of this variable in the private investment equation is
expected to be negative. The share of oil exports has also implications for the quality of
governance institutions in the economy. Countries which are less dependent on natural
resources are expected to form better governance institutions. The natural resource
34 Azariadis and Lahiri (2002)
35 For the education variables the portion of the population that is over 15 years old is considered.
36 This may stem from the increase in the cost of labor as mentioned by Rodriguez and Sachs (1999).
13
abounded countries do not need to mobilize the society to increase the overall level of
earnings. The governing body can control the economy by collaborating with a small
number of people in the society. The outcome from such a production arrangement does
not maximize the well-being of the society as a whole and hence do not lead to
governance institutions which are in favor of the society37. In these kinds of
circumstances, also the elite are not eager to provide high-quality institutions by bearing
in mind the future effects of today’s enfranchisements (Acemoglu and Robinson, 2001)
and engage in more rent-seeking activities. From the above discussion, we can draw the
conclusion that oil export as a percentage of total merchandise export is expected to have
a negative coefficient in the governance equations.
The tenure of the system (Tensys) from Keefer et al. (2001) is excluded from the
investment equation to identify the system. Tensys reports the number of years that an
administrative system -regardless of whether autocratic or democratic - lasts in the
country. Time is required for institutions to settle down. This variable is an important
determinant for establishment of high-quality institutions. Tenure of system is assumed to
exert its effect on the private investment only through the governance institutions; hence
it is not included in the governance equations. Finally, a regional dummy for the Middle
Eastern and North African countries (MENA) appears as a right hand side variable in
both of the equations. This variable is essential in understanding the position of MENA
countries among the other countries and to see whether MENA substantially differs from
the rest of the world in terms of private investment and of perceived quality of the
governance performance.
4.2. Estimation Results
Equations (A) and (B) have been estimated on an unbalanced panel of 32
developing countries over 1970-2002 using the three stages least square estimations
technique (3SLS). Three sets of regressions have been calculated, each one utilizing a
different governance indicator to account for the perceived quality of the government
institutions. Tables 3 to 5 present equations when “Quality of Administration”, “Political
Stability” and “Political Accountability” are respectively taken into consideration.
4.2.1 Administrative Quality
From table 3- column 1; where Administration Quality (QA) is used as a measure
of governance; we can conclude that the QA has a positive and significant coefficient at
the 5 percent level in the investment equation. This result supports the view that the
perception of a low level of corruption, a good quality of bureaucracy, a reliable judiciary
system, a clear security of property rights, a reasonable risk to operations, as well as a
sound taxation and regulation are primarily important for the private investment
decisions.
Our findings are robust to the introduction of other explanatory variables. In this
specification especially the structural reforms have a significant impact on private
37 Ross (2001) and Bellin (2001).
14
investment. Hence, our estimations emphasize that, although the perceived quality of
governance is a major determinant of the private sector decisions, the role of economic
policies cannot be ignored. This result confirms that firms in developing countries face
constraints that are not accounted for in more developed economies and shortcomings in
the trade policy and financial development have a long term impact on growth
performances, through private investment decisions.
The accelerator variable has the expected positive sign and it is significant. This
implies that anticipation of an increase in the overall level of demand stimulate the
investment decisions. Although not significant, interest rate appears to exert a negative
effect on the private investment, which is consistent with the user cost of capital theory.
Our model fails to verify the Solow hypothesis of decreasing return to scale of physical
capital accumulation. The coefficient of the GDP per capita variable is not significant.
The influence of the human capital variable is not significant either. Government
consumption variable has a significantly negative coefficient in equation 1 (Table 3).
This finding indicates that, for the countries that are included in our sample the crowding
out effect of government spending outweighs the crowding in effect.
The coefficient of the oil export variable as a percentage of total merchandise
export is significant and negative in equation 1. This result confirms the natural curse
hypothesis. Similarly, the regional dummy for MENA countries has a negative
coefficient. MENA countries seem to be diverging from the rest of the world in terms of
private investment. However, this dummy variable is not significant .This result is most
likely stem from the inclusion of the oil exports variable in the regressions.
On the “Administrative Quality” equation (Table 3, equation 2), our results
uncover the positive influence of several factors on the perceived quality of the
administration. For example GDP per capita-although small- has a significantly positive
coefficient which implies that countries with superior resources are able to develop better
institutions and/or investors perceive the high level of GDP as an indicator of good
institutions. Besides, private investment helps improving the administrative quality
considerably. This last result validates the usage of the 3SLSQ estimation technique in
order to account for the two way causality issue. Tenure of system is also an important
determinant for the administrative quality.
Government spending has a significantly positive coefficient for the
administration quality. Our estimations fail to confirm the negative impact of the share of
oil export in merchandise export. This result is in conflict with the argument that
countries with less reliance on natural resources form better governance institutions.
Structural reforms and human capital are not significant in explaining administrative
quality in equation (2). However, when estimating the system by excluding private
investment from equation (2), the coefficient of the structural reforms and human capital
becomes positive and highly significant38 (see Table 3 equation 4). This result seems to
38 When the private investment variable is eliminated form the QA equation results remain primarily the
same. The only important change-in addition to the ones mentioned above-is that in the second case the
coefficient of the interest rate in the private investment equation becomes significant.
15
be due to the fact that the structural reforms index is correlated with private investment.
Hence, the positive impact of private investment on administrative quality seems mainly
due to the structural reforms which stimulate firms’ decisions to invest. This result also
shows that the impact of human capital on private investment is indirect, considering that
this variable exerts its influence on private investment through its effect on the
administrative quality. On the other hand structural reforms have both a direct and an
indirect channel to exert their influence.
16
Table 3 Estimation Results –Quality of Administration Case (QA)
Endogenous Variables Endogenous Variables
Explanatory
Variables Priv inv QA Priv inv QA
(1) (2) (3) (4)
QA 2.07 2.16
(2.08)** (2.17)**
Gcons -0.27 0.07 -0.26 0.04
(-3.35)*** (4.07)*** (-3.36)*** (3.81)***
Priv Inv 0.12
(2.53)**
Struct Ref 1.71 -0.0018 1.73 0.3
(5.24)*** (-0.01) (5.28.)*** (9.11)***
Human Cap 0.25 0.05 0.2 0.09
(1) (0.95) (0.79)
(2.47)**
Oil Export -0.03 0.0025 -0.04 -0.0025
(-2.96)*** (0.85) (-3.28)*** (-1.41)
GDP per
capita 0.00009 0.0007 0.00018 0.0001
(0.38) (1.80)* (0.73) (3.12)***
MENA
Dummy -0.97 0.13 -0.83 0.02
(-0.99) (0.67) (-0.86) (0.15)
Realr -0.01 -0.03
(-1.53) (-3.18)***
Growth 0.19 0.16
(2.77)*** (2.13)**
Ten Syst 0.01 0.02
(3.55)*** (6.21)***
Constant 15.5 -2.84 15.62 -1.03
(10.13)*** (-3.85)*** (10.16)*** (-6.65)***
Numb obs 349 349 349 349
Notes: (*) indicates significance at 10 %; (**) indicates significance at 5 %; (***) indicates significance
at 1%.
4.2.2 Political Stability
Political Stability (see columns 1and 2 of Table 4) seems to have a significant and
positive impact on the investment decisions, but for this governance indicator the level of
significance is 10%. This conclusion supports the view that a stable political environment
is essential for investment.
Once again, trade openness and financial development are confirmed to be part of
a healthy investment climate and to stimulate private investment decisions, but this time
their effect is indirect. Structural reforms enhance the level of investment by improving
the political stability of a country (see Table 4 equations 1 and 2).
17
In this specification, both of the variables that are related to the neo-classical
investment model- growth and interest rate- are highly significant with the expected
signs, pointing out the fact that at the final stage, supply and demand considerations
constitute major factors for the entrepreneurs to undertake a new investment project. The
influence of human capital on the political stability is highly significant. Hence we can
say that the human capital variable is exerting its influence on political stability through
its influence on structural reforms. (See equations 1 and 2 of Table 4). Similar to the
Administrative Quality case, in this specification we are again able to verify natural curse
hypothesis. But the effect of private investment is not significant on political stability.
Table 4 Estimation Results – Political Stability Case (PS)
Endogenous Variables Endogenous Variables
Explanatory
Variables Priv inv PS Priv inv PS
(1) (2) (3) (4)
PS 3.64 3.46
(1.72)* (1.64)
Gcons -0.20 -0.01 -.21 0.01
(-2.52)** (-0.49) (-2.64)*** (0.77)
Priv Inv -.07
(-1.59)
Struct Ref 1.11 0.53 1.15 .34
(1.51) (4.36)*** (1.57) (9.29)***
Human Cap -0.42 0.25 -.35 0.22
(-0.76) (5.32)** (-0.63) (5.21)***
Oil Export -0.05 -0.001 -0.05 0.002
(-3.02)*** (-0.25) (-2.80)*** (1.15)
GDP per
capita -0.00002 0.0002 -0.0001 0.0001
(-0.06) (3.90)*** (-0.29) (3.68)***
MENA
Dummy -2.19 .34 -2.24 0.40
(-1.64) (1.81)* (-1.68 )* (2.26)**
Realr -0.05 -0.03
(-2.47)** (-1.54)
Growth 0.19 0.19
(2.53)** (3.11)***
Ten Syst 0.013 0.01
(3.66)*** (3.37)***
Constant 16.96 -0.02 17.00 -1.09
(7.09)*** (-0.02) (7.17)***
(-6.16)***
Numb obs 349 349 349 349
Notes: (*) indicates significance at 10 %; (**) indicates significance at 5 %; (***) indicates significance
at 1%.
The regional MENA dummy in the political stability equation (Table 4 equation
2) is significant with a positive sign. This result establishes a strong conclusion about the
level of the quality of the governance in the MENA region as measured by the political
stability indicator. Controlling for the other determinants of the political stability, being a
18
MENA country increases the level of stability. This result shows that MENA region is
politically quite stable compared to the other developing countries in our sample. Unlike
the administrative quality case, government consumption does not have a robust effect on
political stability (Table 4-column 2). Also the positive impact of GDP and Tenure
system on political stability are validated in this specification.
4.2.3 Political Accountability
Table 5 reports the regression results when “Political Accountability” measures
the perceived quality of institutions. We show that the coefficient of Political
Accountability in the private investment equation (See table 5 equation 1) is significant at
the 10% level. This can be viewed as an important contribution to the literature on
economic activity and democracy. This set of estimations, also confirms that structural
reforms encourage private investment decisions. This time, the link appears to be only
direct, the coefficient of the structural reforms indicator in the political accountability
equation appears insignificant (Table 5 equations 1 and 2)39. Like the political stability
case human capital has a significant influence on the political accountability but not on
private investment. Unlike the previous indicators the MENA dummy variable has
different coefficient in both of the equations. In equation (1), the coefficient of the
MENA dummy is positive, although not significant. On the political accountability
equation (equation 2) the coefficient of this variable is now significant and negative. This
last finding strengthens our claims about the low level of democratic quality in the
MENA region introduced in the first section.
39 This influence becomes both direct and indirect when the private investment is dropped from the PA
equation. See Columns 3 and 4 of table 5 for the case where private investment is dropped from the public
accountability equation.
19
Table 5 Estimation Results- Political Accountability (PA) Case
Endogenous Variables Endogenous Variables
Explanatory
Variables Priv inv PA Priv inv PA
(1) (2) (3) (4)
PA 4.74 4.67
(1.66)* (1.63)
Gcons -0.44 0.05 -0.45 0.06
(-2.45)** (2.55)** (-2.48)** (4.36)***
Priv Inv -0.05
(-0.87)
Struct Ref 3.53 -0.13 3.53 -0.25
(4.66)*** (-0.98) (4.67)*** (-5.98)***
Human Cap -0.71 0.25 -0.70 0.24
(-1.00) (4.70)*** (-0.99) (4.92)***
Oil Export -0.06 0.001 -0.06 0.003
(-3.06)*** (0.33) (-3.07)*** (1.31)
GDP per
capita -0.0008 0.0003 -0.0008 0.0002
(-0.95) (5.64)*** (-0.96) (5.85)***
MENA
Dummy 4.47 -1.15 4.37 -1.11
(1.25) (-5.27)*** (1.22) (-5.42)***
Realr -0.04 -0.03
(-2.86)*** (-3.11)***
Growth 0.23 0.19
(2.77)*** (2.75)***
Ten Syst 0.01 0.01
(2.29)*** (2.21)***
Constant 17.35 -0.25 17.63 -0.95
(6.80)*** (-0.30) (6.97)*** (-4.70)***
Numb obs 349 349 349 349
Notes: (*) indicates significance at 10 %; (**) indicates significance at 5 %; (***) indicates significance
at 1%.
Once again both of the variables that are related to the neo-classical investment
model- growth and interest rate- are highly significant with the expected signs. Like the
political stability and administrative quality cases, crowding out effect of the government
sector spending on private investment and the positive influence of government
consumption on the quality of institutions is established in this specification too (Table 5
equations 1 and 2). Finally like the previous two indicators, this one also verifies the
natural curse hypothesis along with the positive influence of the level of GDP on
governance.
20
5. Perceived Quality of Governance and Private Investment Performance of
MENA
In this section, we use the models estimated previously to uncover the
contribution of each type of governance institution to the improvement of private
investment performance in the MENA region. We evaluate, in particular, the contribution
of the “Administrative Quality”, “Political Stability” and, “Political Accountability”,
which have proved to exert primary importance in explaining firm’s decision to invest.
For this purpose, we compare private investment performance of the MENA region in
these respects to the one of the more advanced developing economies of our sample, the
East Asian economies.
We simulate which level of private investment MENA could have achieved if the
region had the same perceived governance institutions as East Asia. This is done for two
time periods – the 1980s and the 1990s respectively – which display, as we will see, quite
different characteristics. In our simulations we use the first equations obtained for private
investment in the three different specifications. (See the first columns of Tables 3, 4 and
5). The contribution of the Quality of Administration index has been calculated by
aggregating the contributions of its four sub-components and the same thing has been
done for Political Stability and Political Accountability. Hence, to get the overall impact
of the changes in each category of the governance indicators, we first had to calculate the
contribution of each initial variable in the category to the overall improvement in the
level of private investment. The calculation is based on the estimated coefficients of each
type of governance indicator in the regression (Table 3-1, Table 4-1 and Table 5-1), as
well as on the weights of each principal component in the aggregate indicator combined
with the loading of the initial variables in each principal component (Annex 2)40.
Coefficients of the initial variables are presented in Annex 3 and their contributions
appear in Tables 6, 7 and 8.
The weaknesses of MENA institutions during the 1980s are uncovered by the first
set of results. From Table 6 (top section) it can be seen that, if MENA had the same
perceived quality of administration as the East Asia in the 1980s it’s average-private
investment to GDP ratio would have reached 13.8 (compared to 11.9 per cent
observed).When the contributions of the various components of administration quality to
this result are examined, it becomes clear that deficiencies in the investment profile and
law &order were the primary reasons for the gap between the actual and potential level of
private investment (these two components are responsible for the loss of 0.6 and 0.8
points of private investment to GDP respectively). These results imply that, in the 1980s
the countries in the MENA region had difficulties in ensuring an equitable and consistent
rule of law in protecting the security rights, as well as providing an investment
environment that is free from risks to operations and excessive regulations.
40 See for example, Nagaraj et ali. (2000) for more details on the methodology.
21
Increase in private investment in this decade would have been even more if the
same level of “Political Stability” and “Political Accountability” could have been attained
as the East Asian countries. Table 7 shows that in the 1980s, private investment in the
MENA region had the potential to reach on average 15.9 per cent of GDP if the gap with
the East Asian institutions in terms of political stability was diminished. External and
internal stability components were nearly the sole contributors to this result which have
reduced private investment decisions by respectively 1.6 and 2.7 per cent of GDP on
average per year41 If MENA had benefited from the same quality political accountability
private investment would have been 15.9 percent of GDP in the 1980s (See table 8). The
lack of civil liberties and political rights has both been important factors in keeping the
region from reaching its potential level of investment.
In the 1990s, the gap with East Asia has been noticeably reduced and
improvement of the “Administrative Quality” and “Political Stability” notably helped
investments decisions. The deficit in private investment caused by insufficient quality of
administration was 0.4 points of GDP on average per year in the 1990s (see Table 6
bottom section). The gap with East Asia has nearly fully diminished in terms of
corruption, investment profile and law &order. On the other hand just like the 1980s lack
of bureaucratic quality is still responsible for the loss the private investment equaling to
0.3 points of GDP on average. In the 1990s, MENA had a superior performance –as
measured by the overall political stability indicator- than the East Asia in terms of
41 From table 7 it can be seen that in the 1980’s the level of ethnical tensions were lower in the MENA
compared to the East Asian countries.
Table 6 Private Investment to GDP – Administrative Quality (QA) Case
Increase with an improvement in
Priv. Invest.
(Actual) QA Corruption
Bur.
Qual. Invest.Prof.
Law&
Order
Priv Invest.
(Potential)
1980 11.9 1.9
13.8
0.2 0.3 0.6 0.8
1990 11.6 0.4 12.0
0.0 0.3 0.0 0.1
Source: Authors’ calculations.
Table 7 Private Investment to GDP – Political Stability (PS) Case
Increase with an improvement in
Priv. Invest.
(Actual) PS Gov. Stab.
Int.
Confl. Ext. Confl. Ethn. Tens.
Priv Invest.
(Potential)
1980 11.9 4.0
15.9
0.1 1.6 2.7 -0.4
1990 11.6 -0.7 10,9
-0.6 0.1 0.3 -0.5
Source: Authors’ calculations.
22
political stability (see Table 7). Government stability and ethnic tension sub-components
are better for the MENA region, whereas- although improved significantly compared to
the 1980- external conflict still accounts for the loss of 0.3 points of private investment to
GDP.
Things are different on the political accountability side. It seems like the gap
between the two regions did not decrease at all in terms of this variable. The low level of
perceived political accountability is responsible for the deficit in private investment
equaling to 3.9 points of GDP (See Table 8). Like 1980s the contribution of political
rights and civil liberties to this aggregate effect is 1.9 and 2.1 points.
These results confirm that the MENA region could have achieved a better private
investment performance if it had an enhanced level of perceived institutions. They also
underlie the fact that governance may exert different levels of influence on private
investment when measured by different indicators. Generally speaking, the low level of
political accountability has been a persistent factor which has been holding back the
region from reaching its private investment potential42.
6. Conclusion
Governance is a wide-ranging phenomenon and its distinct features exhibit quite
different states in terms of governance institutions for the same region. In this paper we
empirically show that the perceived quality of governance is an important determinant of
the private investment decisions in the developing countries by stressing the existence of
different types of possible measures of governance.
Investors do not have perfect information about the current and future states of the
governance institutions. Perceptions about the quality of governance are crucial for
private investment decisions. Our data set -which is obtained from independent private
firms that provide consulting services to international investors - captures this “perceived
quality of governance” phenomenon. We use a simultaneous equations model to account
for the reverse causality between the various types of governance indicators, namely
“Quality of Administration” (QA), “Political Accountability” (PA) and “Political
42 We acknowledge the fact that the lack of other types of governance indicators was also effective in the
determination of the level of private investment in the MENA region (especially some sub-components of
the indicators). But in terms of magnitude and consistency of the effect, political accountability seems to be
the most influential one among the three indicators of governance.
Table 8 Private Investment to GDP – Political Accountability (PA) Case
Increase with an improvement in
Priv. Invest.
(Actual) PA Pol. Rights Civ. Lib.
Priv Invest.
(Potential)
1980 11.9 4.0 15.9
1.9 2.1
1990 11.6 4.0 15.6
1.9 2.1
Source: Authors’ calculations.
23
Stability” (PS), and private investment. In our empirical model, endogenous variables are
the share of private investment and the various measures of governance. When using this
model we controlled for the other determinants of private investment and governance
indicators as well. Different types of governance institutions are confirmed to exert their
influence on private investment through diverse mechanisms. All of the three indicators
were proven to be significantly –although at different levels of significance and
magnitudes of influence-important for private investment decisions. “Administrative
Quality” was significant at the 5% significance level while the Political Accountability
and Political Stability were significant at 10%. The validation of the influence of
Administration quality confirms that a low level of perceived corruption, risks to
operations, taxation procedures and labor costs and the protection of security rights by the
enforcement of the laws are crucial for the investment friendly environment in the
developing countries. Also we provide empirical evidence for the view that political
stability can enhance private investment decisions by providing a stable environment and
decreasing the level of uncertainty. Moreover, we present an important piece of evidence
which can be useful for the ongoing debate about the role of democratic institutions on
economic activity. Our results confirm that an open and participatory political system
provides stability of social institutions and ensures a broad political support to policies,
which are in this case more sustainable in the long run. In particular civil liberties and
political rights can help the government to build credibility.
The weakness of MENA institutions during the 1980s was an important reason
for the observed low level of investment in this region. If MENA had the same perceived
quality of administration as the East Asia in the 1980s, its average-private investment to
GDP ratio would have reached 13.8 instead of the observed 11.9 per cent. In the
Administration Quality compartment, investment profile and law &order were the
primary reasons for the gap between the actual and potential level of private investment.
These results imply that, in the 1980s the countries in the MENA region had difficulties
in ensuring an equitable and consistent rule of law in protecting the security rights, as
well as providing an investment environment that is free from risks to operations and
excessive regulation. The impact of closing the gap with East Asia in terms of “Political
Stability” and “Political Accountability” on private investment would have been even
more. If political stability was enhanced, private investment in the MENA region had the
potential to reach on average 15.9 per cent of GDP in this decade. External and internal
stability components were nearly the sole contributors to this result. If MENA had
benefited from the same quality political accountability private investment would have
been 15.9 percent of GDP in the 1980s. The lack of civil liberties and political rights has
both been important factors in keeping the region from reaching its potential level of
investment.
In the 1990s the gap between the two regions mostly diminished in terms of the
quality of the administration and political stability. The deficit in private investment
caused by insufficient quality of administration was 0.4 points of GDP on average per
year in the 1990s compared to 1.9 in the 1980s. In this decade, MENA had a superior
performance –as measured by the overall political stability indicator- than the East Asia
in terms of political stability. Government stability and ethnic tension sub-components
24
were better for the MENA region, whereas- although improved significantly compared to
the 1980- external conflict still accounted for the loss of 0.3 points of private investment
to GDP. On the other hand the gap between the two regions did not decrease at all in
terms of the political accountability. The low level of perceived political accountability
is responsible for the deficit in private investment equaling to 3.9 points of GDP.
These results confirm that the MENA region could have achieved a better private
investment performance if it had an enhanced level of perceived institutions. They also
underlie the fact that governance may exert different levels of influence on private
investment when measured by different indicators. However, the low level of political
accountability has appeared to be the most persistent and influential factor which has
been holding back the region from reaching its private investment potential.
25
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Annex 1
List of Countries
List of Countries with High Quality Data (63 countries)
Argentina Kenya*
Bangladesh* Lithuania
Barbados* Malawi*
Belize Malaysia*
Benin* Mauritius*
Bolivia* Mexico
Brazil* Moldova
Bulgaria Morocco
Cambodia Namibia
Chile* Pakistan*
China* Panama
Colombia* Papua New Guinea*
Comoros Paraguay*
Costa Rica* Peru*
Cote d'Ivoire Philippines*
31
Croatia Poland*
Dominican Rep. Romania
Ecuador* Serbia and Montenegro
Egypt, Arab Rep.* Seychelles
El Salvador South Africa*
Estonia St Lucia
Ethiopia St. Lucia
Guatemala* St. Vincent and the Grenadines
Guinea-Bissau Thailand*
Guyana Trinidad & Tobago*
Haiti Tunisia*
Honduras* Turkey*
India* Uruguay*
Indonesia* Uzbekistan
Iran, Islamic Rep. Venezuela*
Yugoslavia (FR)
Due to the lack of corresponding data for some countries, only counties marked
with * are included in the final regressions
32
Annex 2
Principal Component Analysis
Table A.2.1: The Administrative Quality Indicator
Component Eigenvalue Cumulative R2
P1 2.23 0.56
P2 0.83 0.76
P3 0.51 0.89
P4 0.43 1
Loadings P1 P2 P3 P4
Corruption 0.49 -0.57 0.06 0.65
Bureaucracy Quality 0.54 -0.08 0.64 -0.54
Investment profile 0.41 0.81 0.08 0.40
Law and Order 0.54 -0.02 -0.76 -0.36
QA = P1*(0.5577/0.7640) + P2*(0.2063/0.7640)
Table A.2.2: The Political Stability Indicator
Component Eigenvalue Cumulative R2
P1 2.96 0.42
P2 0.97 0.56
P3 0.90 0.69
P4 0.68 0.79
P5 0.62 0.88
P6 0.57 0.96
P7 0.30 1
Loadings P1 P2 P3 P4
Gov Stability) 0.32 -0.62 -0.38 0.05
Socioeco Conditions 0.29 0.63 -0.44 -0.14
Internal Conflicts 0.51 -0.06 -0.09 -0.07
External Conflicts 0.39 -0.29 0.26 -0.6
Ethnic Tensions 0.39 -0.06 0.02 0.77
Religious Tensions 0.31 0.19 0.76 0.1
Military in Politics 0.39 0.31 -0.12 -0.11
PS = P1* (0.4253/ 0.7878) + P2* (0.1373/0.7878) + P3* (0.1280/ 0.7878 + P4* (0.0972/ 0.7878)
33
Table A.2.3.: The Political Accountability Indicator
Component Eigenvalue Cumulative R2
P1 1.88 0.94
P2 0.12 1
Loadings P1 P2
Political Rights
0.71 0.71
Civil Liberties
0.71 -0.71
PA = P1
Annex 3
Table A.3.1 : Short term coefficients of the Disaggregated
Indicators
Short and Long Term Coefficients/Elasticities
Short Term Coefficients
Standardized Level
Index Variables
Variables Variables
corruption 0,43 0,40
bureaucraty quality 0,78 0,75
QA
investment profile* 1,08 0,51
law and order 0,80 0,62
Government
Stability 1,81 0,75
PS
Internal Conflict 1,56 0,60
External Conflict 1,49 0,67
Ethnic Tensions 0,67 0,46
Political rights 3,37 1,70
Civil liberties 3,37 2,10
PA
