The effect of political instability on capital flight and foreign direct investment

Abstract

Nowadays, Political instability is the major problem for almost every region. All of financial markets throughout the world are inevitably affected by uncertainty in politics. The political instability impacts many functions in financial market especially flows of fund. It is not only normal capital flow, foreign direct investment but also abnormal capital flow, capital flight that have been affected by political instability. This paper examines the effect of political instability on capital flight and foreign direct investment. The effect is observed in emerging market, developed market, Asian emerging market and non-Asian emerging market. To investigate the effect, panel data analysis is applied and three measured methods of capital flight, residual, dooley, and hot money method, are used. In addition, five political variables are applied to capture the political effects in different aspects. This paper finds that political instabilities discourage capital flight and foreign direct investment inflow in emerging market. However, the magnitude of the political instability is higher in developed market than in emerging market. Besides, the magnitude of political instability on FDI is higher in non- Asian emerging than in Asian emerging markets.