Investment and Instability

Abstract

Although recent research has repeatedly found a negative association between investment and socio-political instability (SPI), the existence and direction of causality between these two variables has not yet been investigated. We construct an index of SPI for non-overlapping five-year periods between 1960 and 1995 for a sample of 98 developing countries. We use the Granger causality framework and report Anderson-Hsiao-Arellano instrumental variable estimates. Our main finding is that, for the full sample, there is a robust causal relationship going from SPI to investment, and it is positive. In other words, we find that an increase in the level of SPI Granger causes an increase in investment. We argue that three reasons may explain this result: one is that SPI delays investment, another is that it destroys at least part of the capital stock, and the third is that SPI causes changes in government policies that are beneficial in the long run.

Keywords: political instability, aggregate investment, Granger causality

JEL Classification: 040, E23, D72