The relationship between political instability and financial inclusion: Evidence from Middle East and North Africa

Published date01 January 2021
Date01 January 2021
DOIhttp://doi.org/10.1002/ijfe.1793
RESEARCH ARTICLE
The relationship between political instability and financial
inclusion: Evidence from Middle East and North Africa
Abidin Alhassan | Leon Li | Krishna Reddy | Geeta Duppati
Waikato Management School, University of
Waikato, Hamilton, New Zealand
Correspondence
Leon Li, Waikato Management School,
University of Waikato, Hmilton. New
Zealand.
Email: leonli@waikato.ac.nz
Abstract
What is the effect of political instability on financial inclusion (FI) in the Middle
East and North Africa region? Using data for 2011, 2014, and 2017, from the
Global Findex database, we test the asymmetry relationship between political insta-
bility and FI using the probit model with sample selection and a multiplicative
interaction test of the asymmetric model. We also propose and test a political sta-
bility threshold model that may trigger FI. We find that (a) political instability posi-
tively correlates with lower degrees of FI with higher levels of persistence; (b)
higher incomes and higher education are associated with higher degrees of FI; (c) a
lack of documentation required by formal financial institutions proves to be a major
barrier to FI; and (d) inefficient mechanisms to determine real interest rates, corrup-
tion, oil reliance, unemployment, and religious tensions also negatively affect FI.
Further, we calculate the political stability threshold level that will trigger FI to be -
0.960 for the Middle East and North Africa region. The policymakers could
enhance and promote FI and economic well-being by targeting the minimum
threshold value of political stability.
KEYWORDS
Barriers, financial inclusion; MENA, political instability
JEL CLASSIFICATION
G21; C21; G30; O16
1|INTRODUCTION
Financial inclusion (FI) was adopted by the G20 as a policy
goal in 2010 Global Partnership for Financial Inclusion
(GPFI). The G20 seeks to provide poor people with effec-
tiveaccess to credit, savings, payments, and insurance ser-
vices through formal financial institutions (Demirguc-Kunt
& Klapper, 2013) with the expected benefits of increased
national growth, efficiency, and welfare. To this end, the
World Bank has encouraged FI as an economic emancipa-
tion tool for the global poor. The starting point of FI is
owning an account in a formal financial institution, as a
gateway for other financial services such as saving,
borrowing, or purchasing an insurance policy. The benefits
derived from FI include wealth creation, consumption
smoothing, and increased entrepreneurship productivity
(Demirgüç-Kunt, Honohan, & Beck, 2008; Dupas, Green,
Keats, & Robinson, 2012); investment in education for
future employability (Bruhn & Love, 2014; Demirguc-Kunt
& Klapper, 2013); female empowerment (Swamy, 2014);
and financial stability (Han & Melecky, 2013). However,
many individuals are still not financially included (Cole,
Sampson, & Zia, 2011; Demirguc-Kunt, Klapper, Singer,
Ansar, & Hess, 2018; Osei-Assibey, 2009). The question is,
why are individuals not financially included despite the
many potential benefits available to them?
Received: 19 February 2018 Revised: 6 November 2018 Accepted: 13 September 2019
DOI: 10.1002/ijfe.1793
Int J Fin Econ. 2019;122. wileyonlinelibrary.com/journal/ijfe © 2019 John Wiley & Sons, Ltd. 1
Int J Fin Econ. 2021;26:353374. wileyonlinelibrary.com/journal/ijfe © 2019 John Wiley & Sons, Ltd. 353
The literature highlights that political instability and other
reasons
1
contribute to the differences in financial and eco-
nomic development in the world (Cole, 2009; Honohan,
2008; Roe & Siegel, 2011). For example, Roe and Siegel
(2011), who study political instability and its effects on
financial development and economic inequality, report that
political instability leads to financial backwardness. The data
used by Roe and Siegel (2011) are for the period 19652003
and do not include the recent waves of political instability
that have erupted in the Middle East and North Africa
(MENA) countries since 2011. Political instability involves
political protest and antigovernment activities that, if
persisting for long periods, tend to disrupt productive activi-
ties and consequently erode economic gains.
Our research examines how political instability affects
people's ability to own accounts, save money, and access
credit in formal financial institutions in MENA and in
selected Organization of Islamic Cooperation (OIC) coun-
tries. As a result, a political stability value that can trigger FI
is proposed. Olson (2008) argues that governments become
easy prey for interest groups the longer they remain in office.
Following Olson (2008), we argue that people in the MENA
region may have been financially excluded partly because
the regimes in these countries have held power for long
periods. In such situations, the regimes assume authoritative
power, where only those within the inner circles of power
control both the resources of the nation and the institutions
and policies that regulate economic sectors. The argument
is that these policies discourage internal and external
investment institutions in making funds available for lending
to clients. Consequently, the financial sector becomes under-
funded and underdeveloped because interest groups lobby
governments to make policies that benefit only a few (Dang,
So, & Yan, 2017) and weaken institutional capacities (such
as regulatory frameworks). The persistence of such leads to
weakening financial systems and growing popular disaffec-
tion. Eventually, antigovernment activities erupt.
To the best of our knowledge, our paper is the first to
examine the link between political instability and FI in the
MENA region and selected OIC countries, using the Global
Findex data. Demirgüç-Kunt, Klapper, Singer, and Van
Oudheusden (2015) report on the Global Financial Develop-
ment and indicate that poverty and youth unemployment in
the MENA region is increasing partly due to inadequate
financial intermediation, which leads to lower degrees of FI.
We investigate whether political instability in the region
leads to lowered degrees of FI using the 2011 to 2017 Global
Findex data. We use the multiplicative interaction test of the
asymmetric model proposed by Clark, Gilligan, and Golder
(2006) and lagged variables to overcome the asymmetry and
endogeneity problems identified in the study. To provide a
deeper understanding of FI in the sample countries, we also
examine the individual characteristics that determine FI and
identify the barriers individuals face in their quest to become
financially included. We further propose and test a threshold
model following Balke and Fomby (1997) by determining a
minimum political stability threshold value necessary to trig-
ger and promote FI in the MENA region. The results indicate
that political instability is positively associated with lower
degrees of FI indicators: formal account, formal savings, and
formal credit. Lack of efficient mechanisms to determine
interest rates is also found to impede the development of the
financial sector. Finally, historical antecedents in land tenure
systems (Kuran, 2008) that effectively deny legal ownership
rights to property owners has affected the level of engage-
ment in access to finance, where banks require documentary
proof of legal ownership of properties as collateral.
The paper is organized as follows. Section 2 reviews the
related literature. Section 3 provides the details regarding
data, variables, and method used. Section 4 reports the
results. Section 5 discusses the results and the robustness
test. Section 6 concludes the paper.
2|LITERATURE REVIEW
2.1 |Effects of political instability on financial
development
Political instability refers to the incidence of political vio-
lence in society, such as demonstrations, assassinations, acts
of terrorism and anti-governments activities. Alesina, Özler,
Roubini, and Swagel (1996) define political instability as the
propensity of a change in executive power through constitu-
tional or unconstitutional means. They contend that political
instability results in lower economic growth. However, East-
erly (2007) finds that low economic growth could also lead
to political instability. In other words, both political instabil-
ity and lower economic growth, measured by inequality and
other indicators, could have reverse causality (Engerman &
Sokoloff, 2002; Roe & Siegel, 2011).
In his theory of institutional sclerosis, Olson (2008)
argues that political stability offers opportunities for special
interest groups or institutions to become corrupt over time,
as they tend to practise rent seeking. This slows the ability
of governments to reform as they feed on the wealth of soci-
ety and fail to adapt to competitive markets. Resistance to
change can lead to instability, as people become impatient
for political and institutional change. In a stable environ-
ment, governments build relationship with banks by financ-
ing and funding them. This leads to less risk-taking and
eventually less stability in the banking system when these
governments become unstable (Jou, Chen, & Tsai, 2017).
A number of empirical studies focus on political instabil-
ity and its relationship with economic growth and
2ALHASSAN ET AL.
354 ALHASSAN ET AL.

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