Contribution of Official Development Assistance to Mitigation of Political Risks for Foreign Direct Investment: Measurability Constraints

Abstract

A mitigation of political risks is a pre-requisite for an effective mobilization of private capital which is expected to play an important role in financing Sustainable Development Goals. However, the issue of measuring the effect of various financial and non-financial tools on such risks has not been addressed properly on a conceptual or technical level. This article examines the question of measurability of the official development assistance (ODA)’s contribution to mitigation of political risks for foreign direct investment (FDI) and aims to stimulate an academic discussion about the constraints and the ways to overcome them.

The article shows that private businesses and official authorities of donor countries are mutually interested in using development cooperation toolkit to mitigate political risks for investments in developing countries. They can achieve this objective with both conventional ODA instruments and guarantees which have been proclaimed measurable in terms of donor effort on a grant-equivalent basis by the OECD Development Assistance Committee.

Theoretically, the risk mitigation effect of conventional ODA can be measured by correlating the volume of aid allocated to relevant sectors (with distinctive purpose codes) with the correspondent subcomponents of the most authoritative political risk indices. However, an operationalization of this idea is hindered by a strong interdependency between explanatory and response variables: high political risks in a recipient country limit considerably its aid receipts. Moreover, both parameters are influenced by various endogenous and exogenous factors, many of which can be operationalized only as dummies.

As for the guarantees for development, theoretically it might be possible to measure their direct catalytic effect (knowing the exact conditions of the guarantee coverage and the amount of private capital mobilized) and an indirect “halo” effect (calculating the share of projects covered by political risk guarantees which did not incur losses). However, both paths are hindered by the lack of statistical data of a decent quality.

All these measurability constraints point at the importance of the use of qualitative methods in exploring the article’s topic using as broad spectrum of complementary sources as possible.