Foreign Direct Investment in Infrastructure Projects: Taxonomy of Political Risk Profiles in Developing Countries

Abstract

Political risk is a recognized deterrent to foreign direct investment in infrastructure (FDII) in developing countries. The sensitivity of FDII to political risk is amplified above that of common foreign direct investment (FDI) as a consequence of the distinguishing characteristics of FDII: larger capital commitments, longer payback periods, and greater dependency on government stability. Moreover, developing countries experience political risk at higher levels than developed countries. Nevertheless, the literature remains conflicted as to the exact impact of political risk on FDI and infrastructure investment. Some studies reported the impact of political risk as considerable, whereas others reported it as marginal when corrected for other factors. This study seeks to resolve the uncertainty surrounding the effect of political risk on FDII. It draws on a database of 90 developing countries from 2006 to 2015. The hierarchical cluster method and general least-squares regression are applied to analyze this database against further FDII moderators identified in the literature: gross domestic product (GDP), GDP per capita, GDP growth rates, macroeconomic conditions, and infrastructure stock, as well as 12 political risk indicators. Findings reveal that in about half of the countries, FDII is indeed sensitive to political risk, whereas in the other half, it is less sensitive. Moderating these outcomes are economic factors. In countries with higher GDP but lower GDP growth and higher stocks of infrastructure, political risk plays a stronger role in deterring FDII. However, when countries have lower GDP but higher GDP growth and lower stocks of infrastructure, political risk plays a lesser deterrent role in FDII. The identification of this duality of developing country infrastructure investment profiles will be of practical interest to both capital investors and those seeking investment.