State fragility and foreign direct investment: The mediating roles of human flight and economic decline

• Date: 01 March 2021
• Author: Belay Seyoum,Andrea Camargo
• DOI: http://doi.org/10.1002/tie.22135
• Published date: 01 March 2021

RESEARCH ARTICLE

State fragility and foreign direct investment: The mediating

roles of human flight and economic decline

Belay Seyoum

1

| Andrea Camargo

2

1

Huizenga School of Business, Nova

Southeastern University, Fort Lauderdale,

Florida

2

Lynn University, College of Business and

Management, Boca Raton, Florida

Correspondence

Belay Seyoum, International Business,

Huizenga School of Business, Nova

Southeastern University, 3301 College

Avenue, Fort Lauderdale, FL 33314.

Email: seyoum@nova.edu

Abstract

Developing countries view foreign direct investment (FDI) as a vital contributor to

economic growth by augmenting domestic capital and enhancing efficiency through

transfer of new technology, marketing, and management skills. Even though the fac-

tors that influence FDI have been examined in the context of developing countries,

the role of state fragility has been underexplored in the literature. Drawing on institu-

tional theory, we develop hypotheses on the link between state fragility and inward

FDI. Based on data from 93 fragile countries from different geographical areas, the

study shows the influence of state fragility on human flight and brain drain and the

role of the latter in causing economic decline. It also explores the mediating roles of

human flight and economic decline in the relationship between state fragility and

inward FDI flows and identifies economic decline as an important path linking state

fragility and FDI.

KEYWORDS

economic decline, foreign direct investment, human flight, mediation, state fragility

1|INTRODUCTION

The rapid liberalization of trade and investment in many developing

countries over the last few decades and increased competition among

firms has given rise to the growth in the volume of foreign direct

investment (FDI). FDI flows to developing countries are estimated at

706 billion (compared to developed countries' share of 557 billion) in

2018 (United Nations, 2019). Many studies have examined the vari-

ous determinants of inward FDI flows such as economic growth, polit-

ical stability, and other pertinent factors (Dunning, 1995; Uddin,

Chowdhury, Zafar, Shafique, & Liu, 2019; Zhao, 2003).

The role of state fragility in influencing inward FDI flows has

received limited attention in the literature. Recent studies have

focused on capacity building and reconstruction (Geda, 2011; Kedir,

2011) as well as on the role of cultural and historical factors (Coyne,

2006; S. Kaplan, 2009; Yoo, 2011). There are also a few studies deal-

ing with state fragility in the context of terrorism and potential spill-

over effects (Mair, 2008; Piazza, 2008). The only recent study on

state fragility and FDI shows that increases in political state fragility

deter FDI in Southern and Eastern Mediterranean countries

(Dimitrova & Triki, 2018). Qualitative or empirical works addressing

the link between state fragility and FDI involving many diverse coun-

tries is quite limited. Furthermore, the reasons that lead to reduced

FDI in fragile countries have not been investigated. It may be that

other variables can intervene that moderate or mediate this

relationship.

The role of state fragility in generating human flight and economic

decline has been sufficiently examined in the literature (Carment,

Stewart, & Yiagadeesen, 2009; D. Kaplan, 2008; Rotberg, 2004).

Rotberg (2004) observes that when states fail, population is displaced,

and human capital is depleted, and the nation's aggregate production

and per capita incomes decline. Even though research has provided

valuable insights into these relationships, it does not reveal any stud-

ies at how state fragility, human flight and economic decline jointly

may influence inward FDI. This newfound knowledge could help firms

focus (with the state and NGOs) on areas that will have beneficial

impact on FDI.

We theorize and test the idea that human flight and economic

decline may play a mediating role and could partially explain the influ-

ence of state fragility on inward FDI. Mediation analysis is a statistical

DOI: 10.1002/tie.22135

Thunderbird Int. Bus. Rev. 2021;63:159–174. wileyonlinelibrary.com/journal/tie © 2020 Wiley Periodicals, Inc. 159

method in which one causal antecedent (x) variable is proposed as

influencing an outcome (y) through one or more intervening variables

(m1 and m2) (Hayes, 2013, 2018). We hope that focusing on this

dimension of the analysis will bring about a better understanding of

the issues that influence inward FDI flows in fragile states through the

examination of these mediation effects. Previous research has largely

focused on the direct effects of state fragility on human flight and

economic decline (Rotberg, 2004; D. Kaplan, 2008) as well as the

direct effects of state fragility on inward FDI (Dimitrova & Triki, 2018;

Luiz & Stewart, 2014). This study provides an integrative framework

by exploring the effects of state fragility and mediators

simultaneously.

The study applies institutional theory and the theory of social

capital. Institutional theory argues that weak formal and informal insti-

tutions adversely affect not only firms but also the broader economic

progress of countries. Institutional rules provide a level of certainty

and predictability and affect transaction costs of exchange. Social and

political fragmentation in such countries impact social cohesion and

trust which is critical for engaging in productive activity and risk taking

(D. Kaplan, 2008).

The following terms “fragile states”and “weak states”are synony-

mously used in this study. The term “human flight”includes brain

drain, that is, the loss of skilled personnel and professionals.

FDI provides host countries with a wide range of benefits.

Besides its contribution to investible resources and capital formation,

FDI is a means of transferring production technology, skills, organiza-

tion, and managerial practices as well as international marketing net-

works (Cavusgil, Knight, & Riesenberger, 2020; Wang, Gu, Tse, & Yim,

2013). Given its positive contributions for economic growth and

employment, the extent to which such flows can be impacted by state

fragility deserves further investigation.

The research is driven by three key questions:

1.What is the role of state fragility in influencing human flight and

brain drain (HF) and the impact of HF in causing economic decline?

2.What is the effect of economic decline in inward FDI flows?

3.What is the role of HF and economic decline (two factors often

associated with state fragility) in mediating the main effects of state

fragility on FDI?

State fragility is a multidimensional construct and used to

describe countries that (a) have weak capacity to carry out basic gov-

ernance functions and (b) provide limited personal security to their

inhabitants due to violence and widespread violation of human rights.

Such countries are also characterized by a weak national identity or

plurality of competing identities that erodes the role and legitimacy of

the state (OECD, 2018).

Fragile states have weak and/or missing formal institutions

(legally enforceable). Informal institutions in the form of shared values

are also weak due to a plurality of competing ethnic, religious, and

political identities (Coyne, 2006; S. Kaplan, 2009). There is broad con-

sensus on the distinguishing qualities of state fragility: lack of state

legitimacy and weak capacity to provide security and public goods to

inhabitants (rule of law, independent judiciary, education, and other

basic social services) (Rotberg, 2004; Stewart & Brown, 2009). Even

though the effective delivery of a range of public services is critical

for the existence of a strong, functional state, some public goods such

as security are a precondition to the effective delivery of other

services.

This study applies Gravingholt, Ziaja, and Krebaum's (2015) core

dimensions of fragility. The three key dimensions include security

(control of violence), capacity (provision of services), and legitimacy

(acceptance of rule). Similar dimensions of fragility have been pro-

posed by Brinkerhoff (2014), Carment, Landry, Samy, and Shaw

(2015) and Stewart and Brown (2009). This approach has the advan-

tage of measuring each dimension on a continuum of values and

allows for clustering of countries across those dimensions.

There are several degrees of state fragility. In failed states, the

government does not have effective control over, nor is it able to

deliver vital services to, significant parts of its territory due to conflict.

Rotberg (2003) states that it is not the absolute intensity of violence

that identifies a failed state, rather it is the enduring character of that

violence that is directed against the government. The government also

preys on its people and corruption thrives on a destructive scale

(Carment et al., 2009). A major ingredient of this failure is disharmony

between communities that is often accompanied by sectarian/com-

munal violence. As the state is perceived as being controlled by an

exclusive group, its legitimacy plummets. The absence of social capital

that binds the inhabitants and dysfunctional state that is unable to

leverage its peoples' histories and customs to construct formal institu-

tions with wide legitimacy hinders any viable productive activity.

Examples of failed states include Burundi, Central Africa, Eritrea, Ethi-

opia, Kenya, Nigeria, Uganda, and Zimbabwe.

A collapsed state is an extreme version of a failed state. It exhibits

a vacuum of authority since there is no functioning central govern-

ment and the basic functions of the state are no longer performed.

Examples include the Democratic Republic of the Congo, Somalia,

South Sudan, Syria, and Yemen.

Failing states, however, have a functioning central government.

There is delivery of basic services to inhabitants, but the state is often

unable to control its entire territory thus opening the space for non-

state actors to fill the vacuum (Rotberg, 2004). They are weak states

on the verge of failure. The Fund for Peace (2006) that prepares the

Fragile States Index (FSI) puts failing states under “warning status.”In

failing states such as Colombia, Guatemala, or Pakistan, there is some

minimum legal order and the state provides core physical infrastruc-

ture favorable for firms. However, these conditions also attract orga-

nized crime which discourages domestic and foreign investment. Mair

states: “organized crime needs a legal order to subvert to make real

profit as well as a certain minimum of financial, economic, and physi-

cal infrastructure to flourish. For this reason, it is not the failed state

but the failing state which has the greatest attraction to international

terrorism and organized crime”(Mair, 2008, p. 53). It is important to

note that none of these designations are permanent as some coun-

tries manage to recover (Lebanon, Liberia, and Sierra Leone) while

others move to catastrophic failure (Syria, Yemen, and Zimbabwe).

The concept of fragile states includes failed, collapsed, and failing

states.

160 SEYOUM AND CAMARGO