Navigating the Investment Landscape in MENA: The Role of Economic Growth, Trade, Financial Development, and Governance in FDI Attraction

doi:10.21203/rs.3.rs-5128277/v1

This paper investigates the determinants of Foreign Direct Investment (FDI) in the Middle East and North Africa (MENA) region, with a particular focus on economic growth, trade policy, financial development, and governance indicators such as effective governance and political stability. Employing a robust fixed effect panel data analysis and utilizing data for 18 selected MENA countries covering the years 2000-2022, this study examines the complex interplay between the variables and their collective influence on FDI flows into the MENA region. The analysis reveals that economic growth and trade openness are significant positive determinants of FDI, highlighting the importance of fostering a robust economic environment and maintaining open trade policies. Financial development and business freedom exhibit complex relationships in the regression models, suggesting the need for holistic reforms addressing other structural and institutional factors. Moreover, among the governance indicators, effective governance and political stability emerge as crucial elements in attracting FDI, with significant positive impacts observed in both correlation tests and coefficient estimations. Conversely, high dependence on oil revenues and high real interest rates deter FDI, emphasizing the need for economic diversification and macroeconomic stability. Based on these findings, the paper proposes a set of policy recommendations, including promoting economic growth, enhancing trade openness, improving institutional quality, diversifying the economy, and maintaining macroeconomic stability to create a favorable environment for FDI. These strategies will drive sustainable development, economic diversification, and long-term growth in the MENA region.

International Economics

Agricultural Economics and Policy

Development Economics

Economic Theory

FDI

Sustainable Development

Financial Development

Economic Growth

Institutional Quality

World Governance Indicators

Trade openness

MENA

Foreign Direct Investment (FDI) plays a significant role in the global economy, acting as a key channel for transferring capital, expertise, and technology across national borders. It is a major driver of development and integration for both developed and developing countries. Its importance can be attributed to several key factors including fostering economic growth, creating employment, improving balance of payments, facilitating technological transfer, and improving market accessibility. There is abundant empirical evidence demonstrating that foreign direct investment significantly contributes to economic growth by supplementing domestic capital in host countries. Studies have shown that the growth of national economies positively impacts FDI inflows, creating a beneficial cycle of investment and development. (Borensztein et. al.1998; Alfaro et al.,2020; Farole and Winkler, 2018; Zhang and Sun, 2019; Li and Liu,2020). Another set of empirical studies has shown FDI’s potential to create direct and indirect jobs in host countries by introducing new industries and enhancing existing sectors (Sutton et al. 2016; Farole et al., 2014) as well as its role in the development of the workforce by introducing new skills and technologies and facilitating the transfer of knowledge (Blomström & Kokko, 1998). Additionally, other literature examines how FDI can improve the balance of payments of the host countries. It can do so by boosting exports and increasing import substitution through investments made by foreign entities, thereby supporting the host country's trade balance (Li, 2010; Rahman, 2016; Juanbo, 2019; Markusen & Venables, 1999). One of the most significant benefits of FDI is the transfer of technology and innovation from developed to developing countries, leading to improvements in productivity within the host country's industries (Loukil, 2016; Xu and Li, 2021; Haq, 2022). This transfer occurs through various channels, including managerial practices, employee training, and the introduction of new processes and products. Furthermore, studies provide insights into the impacts of FDI on market access and internationalization. Jochem (2008), for example, identifies international financial competitiveness as key to attracting FDI, emphasizing the importance of stable inflation and innovation. Reyes (2017) highlights FDI's role in economic growth and technology transfer, aiding high-growth firms in developing countries to integrate into global value chains. Paris and Rhee (2011) challenge gradual internationalization, showing that rapid FDI expansion can improve firm performance in globalized industries. Iman and Nagata (2005) discuss the mixed outcomes of FDI liberalization in Indonesia, balancing increased market access against heightened competition. Mattoo, Olarreaga, and Saggi (2001) explore the balance between technology transfer and market competition, suggesting strategic government restrictions can guide foreign firms toward beneficial entry modes.

1.1. Determinants of FDI

The determinants of FDI are multifaceted and can vary with economic, political, and geographical contexts. Drawing from a range of academic literature, we can categorize the key determinants influencing FDI flow as follows: Economic factors, political and legal factors, socio-cultural factors, infrastructure and technological factors, and environmental factors. The economic factors may include market size, resource availability, trade policies, and market accessibility. Studies show that larger markets are more attractive to foreign investors as they promise higher returns on investment (UNCTAD, 2020). Similarly, abundant natural resources and cheap labor, which is particularly relevant in countries that are rich in minerals, oil, and agricultural products, as well as a skilled and educated labor force especially for investments seeking technology transfer, can attract FDI (UNCTAD, 2020). Furthermore, access to regional markets through free trade agreements may significantly impact FDI inflow while protectionist measures tend to deter FDI (World Bank, 2019; Ozturk, 2017; Chow et al. 2022; Ozturk & Radouai, 2020; Ozturk et al.2024 ). Political and legal factors such as political stability, regulatory environment, and investment incentives are critical determinants of FDI. Countries marked by political instability often experience FDI outflow (Bénassy-Quéré, Coupet, & Mayer, 2007; Ozturk & Faizi, 2023). Furthermore, a business-friendly regulatory environment that facilitates starting a business and protects property rights significantly boosts a country's investment attractiveness (World Bank, 2019). Fiscal incentives such as tax incentives and grants can attract foreign investors, while restrictions on foreign ownership, profit repatriation, and limitations on sectors accessible to foreign investment can act as deterrents (OECD, 2018). Socio-cultural factors, including cultural and linguistic similarities, can also play a role in attracting FDI as they reduce business operation costs and facilitate market entry. The quality of infrastructure, including transportation, telecommunications, and energy supply, plays a significant role in attracting FDI, especially in the manufacturing and services sectors (World Bank, 2019). Additionally, countries that demonstrate high levels of technological readiness and innovation capabilities are better at drawing FDI into high-value-added sectors (UNCTAD, 2020). Lastly, environmental regulations have emerged as a significant factor of FDI in recent years. Countries that are aligned with Sustainable Development Goals (SDGs) increasingly attract FDI from companies committed to corporate social responsibility and sustainable practices, which underscores the growing importance of environmental and social governance in investment decisions (UNCTAD, 2020). Factors influencing FDI are varied and encompass economic, political, legal, socio-cultural, infrastructural, technological, and environmental elements. Policymakers need to grasp these determinants to effectively attract and maintain FDI.

1.2. Mena Context

FDI has become a critical driver for economic growth, diversification, and sustainable development in the MENA region. Characterized by diverse economies, varying levels of natural resource endowments, and complex political landscapes, many MENA countries are actively seeking to reduce their traditional reliance on oil and gas revenues. FDI plays a pivotal role in this shift, especially in promoting non-oil sectors such as tourism, manufacturing, and services. The United Nations Conference on Trade and Development (UNCTAD) highlights that FDI not only supports the development of new economic sectors but also mitigates economic vulnerability to oil price fluctuations (UNCTAD, 2019). Furthermore, FDI is instrumental in technology transfer, and regional integration, enhancing the region’s participation in the global economy. Empirical studies underscore the multifaceted impact of FDI on economic growth, employment, skill development, and institutional quality across the MENA region. This comprehensive role of FDI shows its importance in the economic transformation and diversification strategies of these countries. For example, several studies underscore the positive impact of FDI on economic growth and development in the region (Matallah, Ghazi, and Bounoua, 2015; Abbas and El Mosallamy, 2016; Abdouli, M., and Hammami, S. 2017; El Fakiri and Cherkaoui, 2022; Abdouli, M., and Ouni, 2023) and employment and skill development (Elia, Mariotti, and Piscitello, 2009; Farzanegan & Gholipour, 2021). Moreover, FDI’s correlation with institutional quality and governance indicators has been analyzed by Abderrezak, 2008, who suggests that historical factors such as the ‘colonization memory effect’ may affect the current receptivity of FDI. Additionally, Badri and Hfiaiedh (2021), analyzing the impact of corruption, and environmental policies suggest that governance and environmental policies play significant roles in attracting FDI. Furthermore, some studies emphasize the need for MENA countries to develop policies that enhance financial development, economic freedom, and infrastructure to attract more FDI and stimulate economic growth (Ghali et al., 2018; Abdouli & Ouni, 2023).

When it comes to the factors affecting FDI inflows into the MENA region, they are not significantly different from the global trends. Recent empirical research on the region focuses on the economic and market-related factors (Alfaro and Charlton, 2019; Farole & Winkler, 2018), political stability (Asiedu and Lien, 2021; UNCTAD, 2020), technological capabilities (Iammarino, Sanna-Randaccio, and Savona, 2020), and environmental, social and governance (ESG) criteria (Kolk, Kourula, and Pisani, 2020), and along with socio-cultural factors (Cuervo-Cazurra, 2020)

However, the region faces several unique challenges when it comes to attracting FDI. Economic risk and energy endowments, for instance, significantly influence FDI inflows. Countries with high economic instability deter foreign investment due to uncertainties in market dynamics and returns. Conversely, nations rich in oil and gas often have policies that inhibit FDI, demonstrating a "Dutch disease" effect, where resource wealth hinders investment in other sectors ( Al-Khouri, 2015; Rogmans & H. Ebbers, 2013). Moreover, the "colonization memory effect" suggests that historical colonization may foster anti-MNE sentiments, perceived as exploitative, which adversely affects FDI (Abderrezak, 2008). Additionally, governance effectiveness and political stability present critical challenges in attracting FDI. Good governance practices, including government stability, investment profile, and rule of law, are essential for creating an attractive investment climate. The absence of these factors due to internal and external conflicts significantly deters foreign investment (Jabri & M. Brahim, 2015). Finally, environmental challenges pose a barrier to attracting FDI, particularly the need for alignment with sustainable development and environmental sustainability standards ( Abumoghli & A. Goncalves, 2019). Addressing these challenges through policy measures, such as improving political stability, economic diversification, enhancing digital and physical infrastructure, and fostering a positive investment climate, is crucial for enhancing FDI in the MENA region.

The determinants of FDI continually evolve with changes in the global economic landscape, technological advancements, and shifts in investors’ priorities towards sustainability and social responsibility. Understanding these determinants is crucial for policymakers aiming to create an attractive investment climate that adapts to the dynamic nature of global investment flows. The purpose of this research is to comprehensively examine the determining factors of FDI inflows into the MENA region with particular emphasis on the impact of economic growth, trade openness, effective governance, and political stability among the broader set of determinants of FDI in the MENA region. By focusing on the specific roles of these factors within the complex array of FDI determinants, this research seeks to offer nuanced insights and practical recommendations for policymakers in the MENA region. The goal is to enhance the region's attractiveness to foreign investors through informed policy measures, thereby fostering an environment conducive to economic growth, diversification, and sustainable development.

2.1. Data

The sample includes 18 MENA countries (Algeria, Bahrain, Djibouti, Egypt, Iran, Iraq, Jordan, Kuwait, Lebanon, Libya, Morocco, Oman, Qatar, Saudi Arabia, Syria, Tunis, UAE, and Yemen) and covers the period from 2000 to 2022.

Table 1: Description of Variables

Variable	Description	Measure	Exp.Sign
FDI: Net FDI Flow	Net FDI inflow as % of GDP	%
FIND: Financial Development	Domestic credit to private sector by banks (% of GDP)	%	+
ECG: Economic Growth	GDP per capita growth (annual %)	%	+
TRAD: Trade Openness	Log of Trade (% of GDP)	%	+
BUSF: Business Freedom	0-100, with 100 indicating the freest business environment	score	+
GE: Government effect.	Government Effectiveness	%	+
PS: Political Stability	Political Stability and Absence of Violence/Terrorism	%	+
RL: Rule of law	Rule of Law: Percentile Rank	%	+
INF: Inflation	Inflation, Consumer prices (annual)	%	-
IR: Interest Rate	Real Interest Rate	%
OR: Oil Rents	Oil Rents (% of GDP)	%
GFC: Global Financial Crisis	Global Financial crisis	Dummy	-
GHC: Global Health Crisis	COVID-19 pandemic	Dummy
OD : Oil Dummy	Oil Exporting Country=1	Dummy

Table 1 describes the data used in the analysis. All macroeconomic indicators (FDI, ECG, FIND, TRAD) are obtained from the World Development Indicators database. Business freedom measures the degree to which a country's regulatory and infrastructural environments facilitate the efficiency of business operations, and it is sourced from the Heritage Foundation database[1]. This quantitative score is derived from multiple factors influencing the ease of starting, operating, and closing a business. It is based on four equally weighted sub-factors: (1) access to electricity, (2) business environment risk, (3) regulatory quality, and (4) women’s economic inclusion. and the governance indicators (GE, RL, PS) are obtained from the World Governance Indicators(WGI)[2] database from the World Bank. Finally, GFC, GHC and OD are dummy variables representing the 2008 global financial crisis, the COVID-19 pandemic, and oil-exporting countries respectively.

2.2. Methodology

This study employs a rigorous process to select the most appropriate econometric model for our analysis. Our focus is on three potential models: Pooled Ordinary Least Squares (POLS), Fixed Effects (FE), and Random Effects (RE). To determine whether a homogenous or heterogeneous model is more suitable, we utilize the Breusch-Pagan LM test. The null hypothesis posits homogeneity (POLS), while the alternative hypothesis suggests the presence of unobserved heterogeneity across countries. Rejecting the null hypothesis indicates the need for a model accommodating this heterogeneity, such as FE or RE. Next, the Hausman test is used to decide between FE and RE. The null hypothesis suggests no correlation between individual effects and independent variables (RE). Rejecting the null hypothesis implies using an FE model due to a potential correlation between individual heterogeneity and the right-hand side variables. Additionally, the Wooldridge test for autocorrelation and the Modified Wald test for groupwise heteroskedasticity are used to assess the presence of autocorrelation and heteroskedasticity, respectively.

[1] https://www.heritage.org/index/explore

[2] https://www.worldbank.org/en/publication/worldwide-governance-indicators/documentation

3.1. Preliminary Analysis

Table 2 presents descriptive statistics of the variables under the study. Net foreign direct investment inflow (FDI) exhibits a positive average inflow (2.76), suggesting an overall tendency towards international capital attraction. However, significant variability (3.47) highlights contrasting periods of net outflows (-4.54) and substantial inflows (23.54), implying a dynamic and potentially volatile landscape. The positive skew (2.29) suggests that smaller inflows might be more frequent, while the heavy-tailed distribution (7.75) indicates the possibility of occasional surges.

Table 2: Descriptive statistics

Variable	Mean	Minimum	Maximum	St. Deviation	Skewness	Kurtosis	Obs
FDI	2.76	-4.54	23.54	3.72	2.29	7.75	375
FIND	43.00	1.27	138.42	26.03	0.43	-0.37	353
ECG	0.90	-25.93	18.91	4.87	-1.01	9.50	399
TRAD	91.02	32.65	320.94	44.53	2.45	11.67	399
BUSF	64.15	20.00	85.00	12.35	-1.01	4.92	399
GE	41.34	0.00	90.48	23.60	-0.04	-0.99	399
PV	30.68	0.00	92.46	25.53	0.69	-0.66	399
RL	40.43	0.48	81.43	23.29	-0.22	-1.26	399
INF	6.54	-10.07	171.21	14.49	7.68	75.34	368
OIL	17.72	0.00	65.16	17.75	0.77	-0.47	375
RIR	2.84	-20.13	60.88	11.79	1.36	4.07	226

Financial development (FIND) demonstrates a wider range (1.27 - 138.42) across countries, reflecting varying levels of financial system sophistication. While some lag, others boast highly developed systems. This diversity is reflected in the moderate average (43) and near-normal distribution, implying a relatively even spread of values around the mean.

Economic growth (ECG) presents a modest average gain (0.90%) but with substantial variability (4.87). This highlights significant fluctuations, ranging from periods of contraction (-25.93) to strong growth (18.91). The negative skew (-1.01) suggests a potential bias towards low growth periods, while the heavy-tailed distribution (9.50) indicates the possibility of more extreme growth fluctuations than expected.

Trade openness (TRAD) tells a story of interconnectedness, with a high average (91.02) indicating generally open economies. However, the wide range (32.65 - 320.94) reveals pockets of both relative closure and extreme openness. This diversity is mirrored in the positive skew (2.45), suggesting more frequent occurrences of moderately open economies compared to highly open ones. The heavy-tailed distribution (11.67) further reinforces the potential for extreme values on both ends of the spectrum.

While the average business freedom (BUSF) of 64.15 suggests a moderate level, the key lies in the variability across countries. The tight clustering around the mean indicates that most countries fall within a similar range, but the standard deviation (12.35) highlights that there are still significant differences.

Table 3. Correlation Matrix

	FDI	GE	PV	RL	ECG	FIND	INF	OIL	RIR	TRAD	BUSF
FDI	1
GE	0.16*	1
PV	0.11*	0.76*	1
RL	0.14**	0.93*	0.92*	1
ECG	0.07*	0.92*	0.03**	0.01**	1
FIND	0.33*	0.55*	0.68*	0.31**	0.65*	1
INF	-0.02**	-0.29*	-0.28*	-0.23*	-0.28*	-0.31	1
OIL	-0.3*	-0.02**	-0.03**	0.24	-0.05*	-0.07	-0.25	1
RIR	-0.07**	-0.06**	-0.02	-0.09	-0.03*	0.04	0.08	0.12	1
TRAD	0.40*	0.43*	0.39*	0.44*	0.4*	0.49*	0.17**	0.25**	-0.24*	1
BUSF	-0.02**	0.25*	0.23*	0.26*	0.05	0.32*	0.03	0.07	0.06	0.07	1

Notes: ^* p < 0.1, ^** p < 0.05,

The correlation matrix (Table 3) shows the strength and direction of the linear relationship between FDI and the economic and institutional indicators. Specifically, results show positive correlations of FDI with economic growth (ECG), financial development (FIND), trade openness (TRAD), and institutional quality variables (GE, PV, RL), while negative correlation with inflation (INF), oil rent (OIL) and business freedom (BUSF). There is a positive correlation between FDI and ECG (FDI vs ECG: 0.16), suggesting that higher GDP per capita growth is marginally associated with higher FDI inflows, possibly because growing economies present more investment opportunities. Likewise, a positive correlation exists between financial development and net foreign direct investment (FIND vs FDI: 0.33). This highlights that robust financial systems, characterized by efficient credit markets and strong institutions, create an attractive environment for foreign investors. This underscores the crucial role of investing in financial infrastructure to unlock the potential of foreign investment. Similarly, there is a relatively strong positive correlation between FDI and trade openness investment (TRAD vs FDI: 0.40). This indicates that countries with more open trade policies tend to attract more FDI. Trade openness can facilitate the entry and operation of foreign businesses, making the country more attractive to investors.

Regarding the institutional indicators, the correlation between Government Effectiveness and FDI (FDI vs GE: 0.16) shows that there is a positive correlation, suggesting that effective governance may provide a stable and efficient business environment, which can be attractive to foreign investors. Similarly, Political Stability is positively correlated with FDI (FDI vs PV: 0.11) suggesting that more politically stable countries are likely to attract more FDI as stability reduces the risks associated with investing in a country. Additionally, Rule of Law has a positive correlation with FDI (FDI vs RL: 0.14) suggesting strong legal frameworks and enforcement can protect investors' rights, making the country more attractive for FDI. On the other hand, inflation, oil rents, interest rates, and business freedom have negative correlation with FDI inflow. Oil rent has a moderate negative correlation with FDI (FDI vs. OIL: -30), indicating that countries heavily dependent on oil revenues tend to attract less FDI, possibly due to market volatility and economic risks associated with the oil sector. This is in line with the “resource curse” hypothesis. Likewise, there is a weak negative correlation between FDI and the real interest rate (FDI vs. RIR: -0.07). Higher interest rates might increase the cost of borrowing, which can deter foreign investment. Similarly, the correlation between FDI and inflation (FDI vs INF:-0.02) is also negative, which suggests that high inflation can create economic instability and uncertainty, which can deter foreign investment.Interestingly, there is a very weak negative correlation between FDI and business freedom (FDI vs. BUSF: -0.02). This could be counterintuitive, but it might suggest that countries with certain regulations may still attract FDI if other factors (like resource availability or market size) are favorable.

Furthermore, the correlation matrix highlights the strong interrelationships among the governance indicators, political stability, government effectiveness, and rule of law, indicating that improvements in one area are likely to be associated with improvements in the others. Similarly, the correlations between economic growth, financial development, and trade openness suggest that these factors are mutually reinforcing. Effective governance appears to be a common underlying factor that supports economic growth, trade openness, and financial development. Finally, it is worth noting that the negative correlation between inflation and financial development underscores the importance of maintaining low inflation for financial stability and development.

It is important to note that correlation does not imply causation. The presence of a correlation between two factors does not necessarily mean that one causes the other. To confirm cause-and-effect relationships and determine the relative importance of each factor influencing FDI, further analyses, such as regression models, are needed. This is the next step.

Table 4 presents regression results based on a fixed effects estimator with robust standard errors. Various diagnostic tests were employed to obtain more reliable estimates and valid inferences. Our initial model specification included Pooled Ordinary Least Squares (POLS), fixed effects, and random effects models. The Breusch-Pagan LM test rejects the null hypothesis (p-value <5%), indicating the presence of unobserved heterogeneity across countries. This suggests the need for a model that accounts for this heterogeneity, such as fixed effects or random effects. Further analysis using the Hausman test rejects the null hypothesis of no correlation between the individual effects and the independent variables (p-value < 5%), favoring fixed effects over random effects, as the latter assumes no such correlation. Additionally, the Wooldridge test for autocorrelation and the Modified Wald test for groupwise heteroskedasticity reveal the presence of serial correlation and heteroskedasticity within the data (p-value <5%), accordingly. This necessitates the inclusion of robust standard errors to address the potential bias in parameter estimates due to these issues.

Table 4: Empirical Results with Interactions (Fixed Effects with Robust option)

Variable	Model 1	Model 2	Model 3
FIND: Financial Development	-0.031	-0.034^*	-0.031^**
	[0.019]	[0.019]	[0.011]
ECG: Economic Growth	0.067^**	0.065^**	0.066^**
	[0.027]	[0.027]	[0.028]
TRAD: Trade Openness	0.050^**	0.052^**	0.033
	[0.022]	[0.022]	[0.025]
BUSF: Business Freedom	-0.042^**	-0.052^**	-0.068^*
	[0.017]	[0.020]	[0.039]
INF: Inflation	-0.001	-0.006	-0.003
	[0.014]	[0.014]	[0.013]
OIL: Oil Rents	-0.056**	-0.068**	-0.060**
	[0.015]	[0.016]	[0.014]
RIR: Real Interest Rate	-0.042**	-0.044**	-0.047**
	[0.009]	[0.009]	[0.008]
OD: Oil Exporter Dummy	-1.715**	-1.784**	-1.520**
	[0.717]	[0.825]	[0.604]
GE: Government Effectiveness	0.023**
	[0.011]
PV: Political Stability		0.016*
		[0.008]
RL : Rule of Law			-0.005
			[0.011]
GFC: Global Financial Crisis	1.577**	1.543**	1.653**
	[0.382]	[0.414]	[0.357]
GHC: Global Health Crisis	0.978**	0.976*	0.703
	[0.493]	[0.519]	[0.465]
TRAD x BUSF: Interactions			0.0002
			[0.000]
Constant	2.055	2.759	3.652
	[2.518]	[2.635]	[2.675]
Observations	328	328	328

Notes: Dependent variable: FDI. Model: fixed effects estimator with the robust option. Standard errors in brackets. Standard errors in brackets. * p < 0.1, ** p < 0.05. Diagnostics: BP-LM test: heterogeneous model (p-value<5%); Hausman test: fixed effects model (p-value<5%); Wooldridge test for autocorrelation: there is a serial correlation (p-value<5%); Modified Wald test for groupwise heteroskedasticity: there is a heteroskedasticity (p-value<5%). So, we use fixed effects with the robust option.

Economic growth consistently has a positive and significant impact on FDI across all models, highlighting the importance of a growing economy in attracting foreign investment. These results coupled with correlation results from Table 3 show that higher GDP per capita growth makes the country more appealing to foreign investors due to better economic prospects.

Trade Openness shows a significant positive impact on FDI in Models 1 and 2, but not in Model 3. This suggests that while trade openness is generally beneficial, its effect may be moderated by other factors such as the rule of law in Model 3.

Government effectiveness and political stability both have positive impacts on FDI, highlighting the critical role of stable and effective governance in attracting foreign investment. Correlation and regression analyses show that effective governance significantly enhances a country’s appeal to foreign investors. Similarly, political stability positively influences FDI by reducing investment-related risks, making the country more attractive to foreign investors. Improving governance and maintaining political stability are therefore essential strategies for increasing FDI inflows. On the other hand, the coefficient of Rule of law is not statistically significant. While the correlation suggests a positive relationship, the regression indicates that the rule of law alone might not significantly influence FDI when other factors are considered.

Despite the positive correlation (Table 3), regression results indicate a negative impact of financial development on FDI. This suggests that while financial development correlates positively with FDI, other factors in MENA countries might cause higher financial development to detract from FDI, possibly due to inefficiencies or the crowding out of foreign investors.

Business freedom has a consistently significant negative impact on FDI, which is counterintuitive and might indicate that in MENA countries, business freedom alone is insufficient without other supporting factors. Other structural issues might overshadow the benefits of business freedom alone. It could also be interpreted that less regulation may not always be appealing to foreign investors, possibly due to perceived risks or stability concerns. This finding challenges conventional wisdom and indicates the need for a balanced approach to regulation and business freedom.

Oil Rents consistently show a significant negative impact on FDI, indicating that higher dependence on oil revenues deters foreign investment. Estimation results are consistent with correlation results from Table 3 confirming that higher dependence on oil rents reduces FDI. This supports the resource curse theory, where reliance on oil revenues deters foreign investment in other sectors. This result also underscores the need for economic diversification as reducing dependence on oil revenues can attract more diverse foreign investments.

Real interest rate negatively impacts FDI significantly across all models, suggesting that higher borrowing costs deter foreign investors as they increase the cost of borrowing and reduce the attractiveness of investment.

Global Crises, both the global financial crisis and the global health crisis, have significant positive impacts on FDI in most models, indicating that MENA countries became more attractive relative to other regions during these periods of global instability and possibly that due to investors seeking stable environments or opportunistic investments in distressed assets. The global financial crisis increased FDI in the MENA region, possibly due to relative stability compared to other regions during the crisis.

The interaction term (TRAD x BUSF) tells us how the effect of Trade Openness on FDI changes as Business Freedom changes. A positive interaction term indicates that as Business Freedom increases, the positive effect of Trade Openness on FDI becomes stronger. The positive coefficient for the interaction term suggests that the impact of Trade Openness on FDI is more favorable when Business Freedom is higher. Essentially, the more business-friendly the environment, the stronger the positive impact of trade openness on attracting FDI. Policy Insight stemming from this is that policymakers in MENA countries can enhance the positive effects of Trade Openness on FDI by also improving Business Freedom. This means that efforts to liberalize trade should be complemented with reforms that make the business environment more open and competitive.

The analysis of FDI determinants in the MENA region reveals several important implications for policymakers. Understanding these dynamics is crucial for crafting policies that attract and sustain foreign investment, which is pivotal for economic growth and development.

Economic growth and trade openness emerge as significant positive determinants of FDI. The regression results consistently show that higher GDP per capita growth and increased trade openness are associated with higher FDI inflows. These findings highlight the need for policies that foster economic growth and facilitate trade. Growth-oriented policies should be prioritized through investments in infrastructure, education, and technology as sustainable growth creates a favorable environment for FDI. Further, continued efforts to reduce trade barriers and enhance integration into global markets are essential. This could include negotiating trade agreements, improving customs procedures, and reducing tariffs and non-tariff measures.

Government effectiveness and political stability positively influence FDI, as indicated by both correlation and regression results. Effective governance and a stable political environment reduce risks and increase investor confidence. This suggests a holistic approach to reforms. Strengthening institutions, ensuring transparency, and combating corruption are vital. Effective governance enhances the overall business climate, making the region more attractive to foreign investors. Also maintaining Political stability is critical for long-term investment. Policies should focus on maintaining social and political stability through inclusive governance and addressing socio-economic inequalities.

Interestingly, financial development and business freedom show complex relationships with FDI. While financial development positively correlates with FDI, regression results indicate a significant negative impact. This suggests a balanced financial policy. While developing the financial sector is important, it is crucial to address inefficiencies and ensure that financial services support rather than crowd out foreign investment. Similarly, business freedom shows a negative relationship with FDI in both correlation and regression analyses. This result indicates holistic reforms are needed. Simply increasing business freedom is insufficient. Comprehensive reforms addressing other structural and institutional factors are necessary to create a conducive environment for FDI.

Oil rents and the oil exporter dummy variables have significant negative impacts on FDI. This indicates that countries heavily reliant on oil revenues attract less FDI, supporting the resource curse theory. This highlights that reducing dependence on oil revenues by diversifying the economy is essential. Investments in non-oil sectors such as tourism, technology, and manufacturing can attract more FDI. Policies that incentivize investments in non-oil sectors, such as tax breaks, subsidies, and infrastructure development, can help diversify the economy.

Higher real interest rates deter FDI, while inflation shows a weak negative relationship with FDI. These findings suggest that macroeconomic stability is important for attracting foreign investment. Maintaining low and stable interest rates is crucial. Central banks should aim for monetary policies that keep inflation in check and borrowing costs low. Also, broad macroeconomic stability, including controlled inflation and fiscal discipline, enhances investor confidence and attracts FDI.

The analysis of Foreign Direct Investment determinants in the MENA region reveals a complex interplay of economic, institutional, and structural factors that influence foreign investment inflows. By combining insights from both correlation tests and fixed effects analyses using panel data of MENA countries, we have identified key areas where policymakers can intervene to enhance the attractiveness of the region for foreign investors.

Economic growth and trade openness emerge as the most significant positive determinants of FDI. These findings underscore the importance of fostering a robust economic environment and maintaining open trade policies to attract foreign investment. Investing in infrastructure, human capital, and innovation are critical steps in driving sustainable economic growth. Similarly, reducing trade barriers and enhancing trade facilitation infrastructure are essential for improving trade openness and attracting FDI.

The relationship between financial development and FDI presents a nuanced picture. While financial development correlates positively with FDI, the estimation results indicate a negative impact. This suggests that in the MENA region, financial development efforts must be coupled with measures to address inefficiencies and ensure that financial services support rather than hinder foreign investment.

Governance and political stability play crucial roles in attracting FDI. Effective governance, political stability, and adherence to the rule of law reduce risks and build investor confidence. Policymakers should focus on strengthening institutions, combating corruption, and ensuring inclusive governance to create a stable and predictable business environment. The analysis also highlights the challenges posed by dependence on oil revenues. Countries with higher oil rents tend to attract less FDI, supporting the resource curse theory. To mitigate this, MENA countries must diversify their economies by developing non-oil sectors and incentivizing investments in these areas. Reducing reliance on oil revenues will create a more resilient and attractive investment environment. Macroeconomic stability is another critical factor. Higher real interest rates deter FDI, while controlled inflation and prudent fiscal management enhance investor confidence. Policymakers should aim to maintain low borrowing costs and ensure overall economic stability to attract foreign investment. These efforts will drive sustainable development, economic diversification, and long-term growth, positioning the MENA region as a competitive and attractive destination for foreign investors.

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The authors declare no competing interests.

Appendix.docx

Navigating the Investment Landscape in MENA: The Role of Economic Growth, Trade, Financial Development, and Governance in FDI Attraction

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Version 1

Abstract

I. Introduction

1.1. Determinants of FDI

1.2. Mena Context

II. Methodology and Data

2.1. Data

2.2. Methodology

III. Discussions of the Results

3.1. Preliminary Analysis

IV. Discussion

V. Conclusion

References

Additional Declarations

Supplementary Files

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Version 1