Mitigating Effect of Official Development Assistance on Political Risks to Foreign Direct Investment: Limits of Measurability

Abstract

Mitigating political risk is a critical condition for mobilizing private capital need to achieve the Sustainable Development Goals. However, the issue of measuring the mitigating effect of various financial and non-financial instruments has not yet been conceptually or technically elaborated. This article aims to reveal the problem of measuring the effect of official development assistance (ODA) in minimizing political risks to foreign direct investment (FDI) and to provoke an academic discussion on the key limitations that complicate such measurement, as well as ways to overcome them.

Research has demonstrated that private businesses and government authorities in donor countries share a mutual interest in using development cooperation toolkit to manage political risks associated with investment in developing countries. For this purpose, home country governments can use both conventional development assistance instruments and guarantees, for which the OECD Development Assistance Committee has recently authorized the calculation of grant equivalents and their reporting as ODA.

The mitigating effect of traditional forms of development assistance can theoretically be measured by correlating data on the volume of funding for certain relevant sectors with the values of the relevant components of the most authoritative political risk ratings. However, the implementation of this idea is impeded by the reciprocal influence of the explanatory and dependent variables. A high degree of political instability in the recipient country inherently constrains the allocation of aid. Furthermore, both parameters are influenced by a multitude of endogenous and exogenous factors, which can be expressed only through dummy variables.

In the case of guarantee instruments, there is a theoretical possibility of assessing the strength of both their catalytic effect and the “halo effect,” which additionally protects investments from political risks of “legal-governmental” origin. The catalytic effect could be measured based on the exact conditions of the guarantee coverage and the amount of private capital mobilized, and the “halo effect”—based on the total number of projects supported by guarantees against political risks and the number of projects where this effect did not work. However, the practical realization of this idea is hampered by a fundamental lack of statistical data of adequate quality.

The aforementioned limitations underscore the necessity of employing qualitative methods when investigating the stated topic. This approach necessitates the utilization of a diverse array of complementary sources of various types.