Political instability as an impediment of FDI. Case of the South Caucasus region

 Author: Irakli Barbakadze

Broadening linkages of national economies into a worldwide market of goods, services and especially capital is one of the key features of globalization. Growth of Foreign Direct Investment (FDI) is the most visible consequence of this process. On the other hand, FDI as a source of economic growth for transition countries seems to have recently acquired the status of stylized fact. Positive interdependence between FDI and economic performance arises the following important question, what countries can do to attract more FDI.


This paper focuses on the host country characteristics, in particular on political instability as an impediment of FDI in the South Caucasus region. South Caucasus is a strategically located region, on the border of Europe and Asia, with heterogeneous countries (Georgia, Armenia and Azerbaijan). Region has all possibilities, such as oil resource, cheap labor force, good location to become a hub of investment in SEE (South East Europe) region while political stability still remains as a main obstacle for foreign investors. This makes it a good case for identifying the role of political stability in attracting FDI.

The main contribution of this paper is not just filling the research gap in FDI literature in case of the South Caucasus region, but also analyzing business environment based on the perception data. Despite skepticism among economists about reliability of subjective perception data, it has been used in various studies across disciplines and provides useful information. There is a growing interest of using such subjective measure in the area of economics, especially in firm level analysis.

This paper assesses the relationship between affiliate firms’ perception of political instability and their headquarters’ investment decision in the South Caucasus region. Results based on the BEEPS (Business Environment and Enterprise Performance Survey 2009) data suggest that affiliate firms’ perception of political instability do not have a significant effect on the headquarters’ decision to invest or not (propensity of FDI) in this region. On the other hand, headquarters which have already made an investment prefer to reduce the volume of FDI (intensity of FDI) if their affiliate firms face the problem of political instability. This negative effect disappears when affiliate firms perceive high corruption together with political instability. Presence of oil resources is a significant determinant of FDI in the South Caucasus region but there is no significant difference between non-oil and oil industry in case of sensitivity to political instability.