12. Investment policy in fragile contexts

Investment can help to mitigate elements of fragility

FDI can play a pivotal role in providing necessary financing to address fragility across its different dimensions. This is especially relevant considering the macroeconomic constraints, limited domestic private investment levels, and in some cases ODA dependence, that many economies face.

Increasing foreign investment is not purely about volumes of financing to the private sector, it should also promote economic resilience and inclusiveness. The sectoral distribution of FDI is thus particularly important: FDI can increase jobs, local income and productivity, and advance social goals, including through investment into sectors such as healthcare, education, and digital services. Using data from the Social Progress Index of social and environmental health of societies, Deloitte (2015[7]) found a positive relationship between FDI per capita and social progress across a sample of 132 countries, though the nature of this relationship varies according to country and sector. Additionally, input-output linkages with the local economy, including with local SMEs, can strengthen economic resilience by promoting private sector development.

Governments should therefore concentrate their efforts on attracting investment that can have a higher development impact by targeting sectors that contribute to creating a suitably skilled-workforce, and encouraging spill overs. Foreign companies should also act responsibly to generate higher impact for the host economy. Insights from private sector activities in the most fragile and conflict-affected contexts show that there is a positive business case for responsible investment in these economies, although this requires companies to see the benefit in adapting their core operations to manage the risks fragility presents and improve their impact on society (WEF, 2016[8]). When this is indeed the case, it may generate returns for the companies, local communities, and governments alike (ibid.).

Fragility and conflict, where present, can limit FDI and encourage FDI enclaves

Instability and conflict can reduce investor confidence and further compound protracted economic and political fragilities. This is particularly, though not exclusively, relevant in economies showing relatively high fragility in the security dimension, such as Libya and PA (see Annex A). For example, based on the World Bank Group’s classification of Fragile and Conflict-Affected Situations (FCS),4 the IFC (2019[9]) found that even though the potential for FDI in FCS is lower than in more stable contexts due to small markets and low levels of trade, under conditions of peace and stability FDI flows to FCS would be at least twice as high as is currently the case.

Nevertheless, even severe fragility and conflict do not affect all investors alike, depending on the stage in the investment cycle or the sector (Barry, 2018[10]). Evidence suggests, for example, that resource-seeking FDI (e.g., in natural resource-intensive and extractives industries) is not particularly deterred by political instability or even conflict. FDI in natural resources is relatively insensitive to political instability (Chapter 2), driven in the region by a few mega-projects. Analysis using the Fragile States Index of the Fund for Peace showed that among countries with the highest level of fragility, FDI as a proportion of GDP was highest among resource-dependent countries, higher even than the average in low- and middle-income countries (Jensen, 2020[11]). Alongside natural endowments and global commodity prices, resource-seeking FDI in such situations is more likely to be determined by the extent to which production facilities and export infrastructure can be protected from current and future conflict, whether in offshore processing facilities or through onshore security measures (Jensen, 2020[11]; Multilateral Guarantee Agency, 2011[12]).

In some of these cases, however, overall positive FDI figures may hide its limited impact on resilience and sustainable development due to its structural and sectoral composition. While the employment outlook is varied and may be more positive in minerals, renewables, and agriculture, some natural resource investments – for example in mining and oil – may effectively operate in FDI enclaves with few linkages to the rest of the economy, generating relatively few jobs. This risk may be higher where investments are capital intensive rather than labour intensive (as is the case for most energy investments), require specialist training that local populations do not have access to, where they require few inputs from the local economy or local companies may not be set up to act as suppliers (UNCTAD, 2012[13]; Cordes, Östensson and Toledano, 2016[14]; Thompson, 2020[15]).

Fragility is costly for investors, even in the absence of conflict

Even in the absence of open conflict, fragility can discourage investment decisions, FDI inflows and retention by increasing the risks – actual and perceived. Studies indicate that some aspects of fragility have a greater negative impact on investment than others (Thompson, 2020[15]). Besides economic upheaval, political risk5 can heighten investor concerns, whether due to increased protectionism, regulatory instability, policy uncertainty around Covid-19, or concerns about governments’ ability to fulfil sovereign and contractual obligations or maintain currency convertibility (Kher and Chun, 2020[16]). FDI inflows also appear to be reduced by factors like low institutional quality (Alfaro, Kalemlio-Ozcan and Volosovych, 2008[17]) and high levels of corruption (Wei, 2000[18]).

Managing and mitigating these risks through, for example, political risk insurance (see below), increases the cost of doing business. Indeed, a global survey of international investors shows that political risk is the most important factor affecting investment entry decisions (Kher and Chun, 2020[16]). This includes fears on sudden political changes, uncompensated expropriations, breach of contracts, unfair treatments or discriminatory measures, abrupt regulatory changes (e.g., on licensing, tax, environmental requirements, etc.) and lack of transparency.

Recent studies show that investment in the MENA region is particularly sensitive to fragility in its political and security dimensions (Caccia, Baleix and Paniagua, 2018[19]; Dimitrova and Triki, 2018[20]). Moreover, quantitative analysis shows that higher political risk, especially in relation to conflict and institutional quality, increases the cost of equity capital for firms operating in the MENA region (Belkhira, Boubakrib and Griraa, 2017[21]).

On some occasions, investments can exacerbate risks to stability that need to be managed

The positive contributions of FDI to resilience, economic and social development are important, but not automatic. Investment is not a panacea, and its positive impact on sustainable development depends on a number of factors, including good policies, strong institutions and appropriate human resources (Li and Tanna, 2019[22]). Where State monitoring and regulatory enforcement mechanisms are weak, the possibility arises for FDI to have a negative impact on stability, whether through communal violence, poor working conditions, environmental degradation or increased corruption opportunities.

There have been cases globally where investments have been linked to increased fragility, especially in the extractives sectors. In sub-Saharan Africa, for example, (Christensen, 2018[23]) mining investments double the risk of protests and riots around the site, which are more likely when commodity prices increase, and in environments where the state is absent in negotiations between mining companies and local/host communities. In the Democratic Republic of Congo, even during conflict, the proximity of an AngloGold Ashanti mining site to a peace-keeping operation helped provide reassurance for the resumption of mining exploration. But this also involved engagement with and payments to the militia involved in the conflict, and the company was accused by Human Rights Watch of indirectly fuelling the ongoing conflict (Multilateral Guarantee Agency, 2011[12]).

Government policy and responses to fragility can help to determine whether FDI exacerbates fragility risks or reinforces coping capacities. High societal and security risks, high levels of unemployment and social instability may lead governments to adopt, willingly or not, behaviours that are even more detrimental for investors and increase this negative impact (WEF, 2019[24]). Christensen (2018[23]) argues that poor information flow can lead to mismatched expectations between the investing firm and the local population, which governments can help mitigate through greater transparency and institutions that can mediate between local communities and investors. In the case of Liberia, geo-spatial analysis supported the governments’ decision to use a ‘development corridor’ approach, whereby agglomeration affects and the provision of public goods ensured that mining concessions support positive economic growth and development in the surrounding areas, even in the face of high levels of fragility (Bunte et al., 2018[25]).

The concrete risk that international investors could exploit a lack of state capacity has inspired international efforts to promote due diligence and responsible business conduct, particularly in sensitive sectors (Chapter 10). The OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas, for example, provides recommendations on how companies can avoid contributing to conflict through their mineral purchasing operations in these contexts. Recently, the OECD Due Diligence Guidance inspired EU due diligence obligations for importers of minerals originating in high-risk areas, effective as of January 2021.6

The political dimension of fragility

The political dimension of fragility encompasses a country’s mechanisms for mediating economic and social relationships – including those relevant for investment – and its capacity to strengthen accountability and transparency. Political fragility affects other dimensions by shaping the institutions that are key to supporting a sound investment climate, as well as inclusive societies. Indicators of the political dimension of fragility include clientelism and corruption, government effectiveness, division of power, constraints against the executive, physical integrity, voice and accountability, and women’s participation in parliament. Political fragility can mean that the legal and regulatory context for international investment can be unstable and bring additional risk for investors.

The greater MENA region exhibits the highest level of political fragility among all regions of the world (OECD, 2020[2]). This is mirrored by data pointing to low trust in governments in the region. In Lebanon and the PA, for example, 80% and 50% of respondents to a recent survey reported have little to no trust in government (Transparency International, 2019[27]). Political fragility can be caused by endogenous factors, like lack of voice and accountability, social unrest, terrorism and poor institutional quality, as well as exogenous factors like conflict in neighbouring countries.

In the aftermath of the 2011 uprisings, some governments in the region have experienced major political transitions, including constitutional reforms. While some focus economies have increased their relative stability in this respect, political stability goes beyond stable and highly centralised states. The functioning of regional governance for example (i.e., the presence, level of autonomy, and effectiveness of elected public officials at the subnational level), as well as appropriate legislative and judicial constraints on the executive play, can play an important role in mitigating political fragility by promoting pluralism, local accountability, and mediating potential conflicts.

Among the focus economies, political fragility remains one of the most salient dimensions of fragility. Demonstrations of popular discontent in Algeria, Lebanon, Egypt, Morocco and Tunisia in particular have made increasingly clear that widespread corruption and territorial inequalities on the one hand, and accountability on the other, are intrinsically linked to the political dimension of fragility. Although corruption levels vary, international indicators point that none of the focus economies received a “passing grade” of 50/100 in terms of integrity (Chapter 11).

The societal dimension of fragility

The societal dimension of fragility comprises a country’s vulnerability to risks affecting social capital and cohesion, especially in relation to inequality and access to opportunity, as well as the institutional capacity to mitigate these risks. Societal fragility exacerbates economic, political, and social exclusions and contributes to worsen the situation of marginalised communities.

In this dimension again, the greater MENA region excluding high income countries presents the highest level of fragility compared to other regions (OECD, 2020[2]). Youth unemployment is particularly severe across most of the focus economies: 50% in Libya, 41.6% in the PA, 36% in Tunisia, and 36% in Jordan (World Bank, 2020[28]). Although the total unemployment rate is estimated to be relatively low in Lebanon (6.3%), this is three times as high among young people (ibid.). High levels of unemployment, especially among youth and women, represent a major threat to social cohesion (ILOSTAT, 2020[29]). Globally, poverty and a lack of socio-economic opportunities are especially common among internally displaced people and refugees, which the focus economies host in large numbers (OECD, 2019[30]).

In the greater MENA region, the proportion of young people who are not in education, employment, or training (NEET) exceeds those in all other regions of the world (OECD, 2018[31]). Low scores on women’s participation in the labour force, and on the proportion of NEET are common across the focus economies, with NEET rates among women surpassing 40% in Egypt, Jordan, PA and Tunisia (Dimova, Elder and Stephan, 2016[32]).8

The societal dimension of fragility is also exacerbated by low levels of social protection, for which public spending averages to barely 1% of GDP in the wider MENA region, against 20% in OECD countries (World Bank, 2018[33]). Low levels of social safety nets, along with low overall coverage and high informality are especially worrying factors in view of the present pandemic and economic shock it has precipitated (Box 12.2). The societal dimension of fragility affects both the economic dimension of fragility as well as political stability: popular mobilisations across the region point to the clear dissatisfaction with a lack of economic opportunities and socio-economic inclusion.

The economic dimension of fragility

The economic dimension of fragility comprises an economy’s vulnerability to shocks and its capacities to address them. Indicators of the economic dimension of fragility include GDP growth, debt, regulatory effectiveness, resource dependence, economic remoteness and labour market measures. High economic fragility negatively affects households’ ability to exit poverty and improve their socio-economic conditions. Economic fragility is closely associated with social and political challenges.

Since 2011, the greater Middle East region has been characterised by stagnating growth. The concurrent impact of the Covid-19 pandemic and oil price shocks has dramatically worsened macroeconomic outlooks, with an average GDP contraction of 5.3% projected for 2020 across the focus economies, except for Libya and Lebanon, which are expected to experience a particularly dramatic downturn in GDP growth, by -40% and 19% respectively in 2020, due to aggravated political, social and security dynamics, though forecasts are subject to high degrees of uncertainty (World Bank, 2020[36]). Current account and fiscal balances also suffered from a steep decline in both oil-importers and oil-exporters in 2020, and they are expected to remain negative in 2021 (IMF, 2020[35]).

While all of the focus economies have long faced high debt levels, the current economic contraction represents a major threat to the debt sustainability of those focus economies with particularly high debt levels. This is the case for Lebanon – which in March 2020 defaulted on the payment of a USD 1.2 billion in Eurobonds – and to a lesser extent for Jordan, whose credit rating was revised from stable to negative (FitchRatings, 2020[41]).

More generally, widening deficits will constrain the ability of governments to implement measures in support of public health and local economies, at a time when sources of private financing, including FDI and household remittances are falling globally. For countries like Algeria and Libya, resource dependence contributes to economic fragility by weighing on other issues present across the region like inflation rate fluctuations, exchange rate weakening and constrained public revenues. High dependence on oil and gas revenues contribute to creating rentier regimes, low economic complexity, lagging productivity, and limit economic diversification and innovation (Malik, 2017[42]).

Foreign aid can, for some countries, serve as an additional financial buffer but for PA, Lebanon and Jordan, aid dependence carries the risk of exposure in the event of cuts in foreign assistance. Low regulatory quality – defined as governments’ lack of capacity to formulate and implement sound policies to cope with economic fragility– also affects several MENA countries, notably Algeria, Libya and Egypt, as well as, to a lesser extent, Tunisia and Morocco (World Bank, 2019[43]). Finally, as noted above, unemployment rates in the region have remained high (ILOSTAT, 2020[29]).

The environmental dimension of fragility

The environmental dimension of fragility encompasses a country’s vulnerability to climate and health risks affecting citizens’ livelihoods, as well as the presence of the institutions that can mitigate such environmental and food insecurity risks. Environmental fragility can affect the distribution of resources, increase inequality as well as the risk of conflict.

All of the focus economies are familiar with the challenges of desertification, soil degradation and water scarcity both due to their geographical location and a variety of human factors that exacerbate these phenomena. Climate change is leading to increasing temperatures, decreased rainfall, rising sea levels and economic damage in the focus economies. For example, 96% of the territory of Tunisia is threatened by desertification, and the overall cost of environmental deterioration is estimated around 2.5% of the country’s GDP (ITES, 2017[44]). These worrying developments threaten food security across the greater MENA region, where only 5% of the land area is arable and where total agricultural production is expected to decrease by 21% by the end of the century compared to 2000 (OECD/FAO, 2018[45]). The quality and quantity of groundwater, the most important source of water in the region, has been considerably deteriorating in recent years (Hamed et al., 2018[46]).

Demographic factors, urbanisation and industrial growth will keep increasing the demand for scarce water resources, potentially weighing on social and security dynamics. There are already some indications that the densely populated Nile delta and coastlines of Algeria and Morocco are high-risk areas for climate-induced forced displacement (IOM, 2015[47]). Waste management is also a widespread issue, worsening land, water and air pollution and the associated health risks for the local population. The series of protests that took place in Lebanon in 2015 over the government’s failure to dispose over 20 000 tons of garbage in and around the capital is just one example of how these environmental and health issues can feed and trigger social discontent and instability.

The security dimension of fragility

The security dimension of fragility encompasses a country’s vulnerability to violence, crime and conflict, as well as the presence of institutions to prevent and mitigate it. The security dimension of fragility can cause societal and economic disruption, as well as damage to infrastructure and supply chains, which can be particularly problematic for investors. Insecurity can erode cohesion and social capital, cause mass displacement, and is a human and personal tragedy for millions of people globally.

The greater MENA region, excluding high income countries, exhibits the highest level of security fragility among all regions of the world, by significant margin (OECD, 2020[2]). Exposure to conflict in MENA has increased from 6% in 2007 to 19.4% in 2017, with one in five people now living in close proximity to conflict (Corral et al., 2020[48]). The 2011 uprisings led to conflicts and inter-communal violence taking an incalculable toll in Syria, Yemen, Libya and Iraq.

Some of the focus economies have been significantly affected by these security developments. Conflicts have severed trade ties, decelerated private investment and strongly affected the tourism sector. For example, studies estimate that the Libyan crisis was responsible for 24% of the deceleration of economic growth of Tunisia between 2011 and 2015 (ESCWA, 2017[49]). Lebanon, Jordan, Egypt and Tunisia have also experienced considerable inflows of forcibly displaced populations from Syria and Libya. Transnational terrorism, moreover, continues to embody a concrete threat for most of the focus economies, albeit to different degrees, forcing governments to channel public expenditures into the national security apparatus and posing a security risk to businesses, deterring investors or requiring them to incur the cost of private security. Across the region, territorial disputes represent a source of tension and instability, notably in the case of the PA and Lebanon, as well as, to a different degree, Morocco. Finally, illicit cross-border trade and smuggling of arms, drugs, oil and humans from the Sahel region into Algeria, Morocco and Libya, caused by limited or weaker state capacity in the southern regions, has historically fuelled transnational crime networks and armed clashes (Ralston, 2014[50]).

Towards a holistic approach to investment, resilience and inclusive development

The complex interaction between fragility and investment underscores that inclusive development and quality investment attraction are complementary. OECD (2019[51]) has measured the extent to which FDI can affect specific aspects of sustainable development, pointing to a broad positive impact on economic and environmental sustainability. Although further work is needed to fully understand FDI’s contribution to advancing SDGs, the institutional and policy context are pivotal in determining its eventual positive or negative economic, social and environmental impacts (ibid.). These findings suggest the adoption of holistic approaches to investment, resilience and inclusive development, where FDI is assessed against the wider framework of a country’s policy priorities and long-term development vision. In some of the more fragile contexts, this means that improving framework conditions needs to keep pace with more direct actions to increase FDI.

National development strategies can hence be a useful tool to promote economic growth and attract investment, while integrating vulnerability considerations and strengthening societal resilience. For example, efforts to increase skills of youth, women and refugees can improve the enabling environment for FDI (Purfield et al., 2018[52]). The region is progressively integrating social objectives in its strategies: e.g., Egypt’s Vision 2030 measures the achievement of sustainable inclusive growth based on an increased female labour force participation, while the Jordan National Vision and Strategy for 2025 ties together regulatory reforms of SME policy, training and rehabilitation programmes for women and youth employment. However, results on these objectives have been mixed and a renewed, long-term commitment to implement inclusiveness objectives is needed.

Laying the institutional and legal bases for a sound investment framework

In the most fragile contexts of the region, it is challenging to undertake investment climate reforms, especially when the priorities are on enhancing overall governance or de-escalating conflict (e.g. the Libyan Political Dialogue Forum). Limited state capacity and room for policy manoeuver may require careful prioritisation of specific measures that carry the largest benefits. As economies move out of conflict and unrest, additional steps can be taken towards institutional and legal reforms, serving as the basis for a future investment framework. The OECD-Iraq project provides some lessons on the importance of taking a tailored, flexible, and conflict-sensitive approach to such reforms (Box 12.3).

Improving legal stability is one of the priorities governments should consider when faced by fragility. Fragility can increase the risk, or perceived risks, of expropriation, breach of contract and capital transfer restrictions, which in turn leads investors to withdrawing existing investments or cancelling planned investments (Kher & Chun, 2020). Reforms to support solid and transparent investment provisions on non-discrimination, fair compensation for expropriation, profit repatriation guarantees and property rights could help. When designing these measures, it is crucial that governments consider concrete steps needed to ensure their adequacy to recognised international standards.

International investment agreements (see Chapter 5) may provide an additional level of protection to foreign investors engaging in fragile contexts by granting protections alongside domestic laws.9 At the same time, low implementation capacity, unforeseeable events, political and societal vulnerability and lack of inter-institutional co-ordination can potentially lead to involuntary breaches in fragile contexts (Kher and Chun, 2020[16]). In the midst of social and political turmoil in 2011, the region saw an increase of investor-state disputes, with Egypt and Libya being involved respectively in 24 and 16 known cases of international arbitration (UNCTAD, 2020[54]).

Effective implementation and enforcement of reforms aiming at improving legal stability in fragile contexts is equally relevant. This requires the establishment of bodies in charge of investment policy design and implementation, as well as co-ordination between them. For instance, a supporting institutional framework to deal with investors’ disputes is still lacking in Libya, the PA and Lebanon (Chapter 5). Overall, in contexts where state monitoring and enforcement capacities are lacking and institutions are weak, investment policy remains scattered across several institutions and agencies. This can further raise the risk for inefficiency and inconsistencies.

Development actors can support private sector development and help improve the investment environment in fragile contexts

Development partners can help improve the investment environment in fragile contexts, both through technical cooperation, for instance on how to better manage and prevent investment disputes (e.g. the World Bank Investor Grievance Management Mechanism), and financial pledges to support private sector development. Private sector development as an enabler of political, societal and economic resilience has been central to donor approaches in MENA. Various conferences (e.g., the 2016 London Syria conference, the 2017 and 2018 Brussels conferences for Syria and the region, and the 2018 Kuwait conference for Iraq, the 2020 Conference in support to the Lebanese people) resulted in financial pledges to support countries requiring post-conflict reconstruction assistance (Iraq and Syria) or facing large refugee inflows (Jordan) in the form of so-called “compacts” (Box 12.4).

More generally, development actors have been increasingly providing significant financial support to the most fragile contexts, which have limited capacity and funding. In recent years, financing for the most fragile contexts has reached record volumes: in 2018, bilateral donors spent USD 76 billion in the 57 most fragile contexts covered by the OECD fragility framework, the highest number ever recorded.

Blended finance and risk transfer mechanisms

Though not replacing wider business climate reforms, a number of concrete and temporary instruments are available to insure investors against specific types of risk, in particular political risk. They include blended finance approaches and risk transfer mechanisms like export credit and political risk insurance. However, these tools are not a panacea. They are most effective alongside, rather than instead of, policy reforms (Basile and Neunuebel, 2019[60]). They require a case-to-case analysis that needs to integrate fragility considerations and appropriate safeguards and monitoring. Avoiding engaging government institutions, or focusing only on short-term “easy wins”, could exacerbate fragility in the long run (Williams, Burke and Wille, 2014[61]).

The OECD defines blended finance as the strategic use of development finance to mobilise additional finance towards sustainable development in developing countries. Blended finance can take many forms, including the use of public guarantees, PPPs, debt instruments, equity investment, as well as innovative social-impact investment (Basile and Neunuebel, 2019[60]). OECD official statistics show that private finance mobilised by official donor interventions reached USD 48.4 billion globally in 2018, much of it concentrated in emerging markets (OECD, 2020[62]). Almost two thirds of these amounts were mobilised in economic infrastructure and financial services, mostly by guarantees, syndicated loans and direct investment in companies and special purpose vehicles (ibid.).

Blended finance can catalyse investment in fragile contexts by transferring some risks away from investors. In 2016, 15 of the largest development finance institutions (DFIs) invested a total of USD 1.3 billion in fragile contexts. IFC (2019[9]) accounted for one-third of this amount and committed to increase the share of its investments in fragile contexts and low-income countries to 40% by 2030. As for MIGA, 12% of its outstanding guarantee portfolio is in fragile contexts, accounting to USD 2.7 bn.

Interest in blended finance approaches has picked up in the last decade, including through dedicated funds and facilities. Based on recent data from the OECD’s Blended Finance Funds and Facilities Survey – which includes 198 funds and facilities managed by both public and private organisations – has captured around USD 74.5 billion of assets under management globally. Of this, an estimated around 2.7 billion targets the focus economies, the majority (USD 1.5 billion) in Egypt (Dembele, Vilalta and Bangun, forthcoming[63]).

Development finance institutions (DFIs), development partners and export credit agencies (ECAs) can support investors through risk-mitigation instruments and financing. DFIs generally mitigate risks, real or perceived, of private investment undertaken at commercial or quasi-commercial terms (Miyamoto and Chiofalo, 2015[64]). Tools offered by DFIs include financial and technical support to private companies (e.g., project preparation services), including foreign investors, and mobilisation of private investment for activities with a developmental purpose. Instruments include long-term loans, equity capital, mezzanine finance and guarantees (both full and partial), as well as investment in local banks or on-lending to private companies (ibid.). The Islamic Development Bank Group (IsDBG) is a prominent example of DFI active in 57 shareholding economies in the wider MENA, including all focus economies. The Islamic Corporation for the Insurance of Investment and Export Credit (ICIEC), within the IsDBG, offers political risk insurance (PRI) covering issues such as transfer and convertibility, expropriation, and war and civil disturbance. With the objective of facilitating FDI, ICIEC’s country risk insurance covers equity and non-equity investment under the condition that the investment is Sharia-acceptable.

Development partners can also offer a variety of risk-transferring tools to help mobilise private investment in fragile contexts. MIGA’s Conflict-Affected and Fragile Economies Facility (CAFEF), for example, issues guarantees to eligible projects that provide an initial loss layer insurance. These cover loans, equity investments and future earnings against currency inconvertibility and transfer restriction, expropriation, breach of contract, war and civil disturbance. In 2010, the IFC added fragility to its strategic priority areas and established a Fragile and Conflict-affected States Coordination Unit. In MENA, the IFC invests and provides advisory services to international private investors and public institutions through its Conflict Affected States in Africa Initiative. For example, Scatec Solar ASA, an independent solar power producer listed on the Oslo Stock Exchange, has secured guarantees with MIGA in March 2020 to cover its equity investment in six Egyptian solar power plants. The guarantees cover 90% of investments by Scatec Solar for up to 15 years against the risks of transfer restrictions and convertibility.

ECAs are financial institutions, either private or government-sponsored, that support domestic exporters through short-term trade financing in the form of credit, insurance and guarantees or project-specific long-term financing (e.g. in infrastructure). ECA support among OECD countries is co-ordinated through the Arrangement on Officially Supported Exports Credit and the Working Party on Export Credits and Credit Guarantees, which serves as an important framework for the setting of minimum interest rates, risk fees and maximum repayment terms, as well as environmental and integrity standards.

Overall, despite of the wide variety of options available, penetration of risk mitigation mechanisms in the region seems to be relatively low and could be strengthened. A recent report of the US International Development Finance Corporation (DFC) highlights that, despite the high risk for foreign companies in some MENA contexts, tools like political risk insurance remain underexploited (OPIC, 2019[65]). According to the report, when asked for the reasons why they did not make use of political risk insurance, investors responded that they either did not believe the level of risk warranted for the adoption of such instruments, that the costs of coverage were too high or that they were simply unaware of this possibility (ibid.), suggesting that additional promotion and facilitation of risk mitigation options could, to some degree, bring benefits.

Promoting linkages between foreign firms and domestic businesses

Strengthening links between international investors and domestic businesses can also play a key role in mitigating potential risks for investors. Linkages with local businesses in domestic supply chains can mitigate operational risks thanks to their knowledge of the local context and their higher risk tolerance (World Bank, 2018[66]). Joint ventures or alliances with local companies are the most common strategies chosen by international investors to mitigate political risks in emerging markets (MIGA, 2014[67]). However, this can be particularly difficult to achieve for investors in fragile contexts due to insecurity, market fragmentation, a lack of sectoral linkages and under-developed business clusters (ibid.). IPAs can play a pivotal role in developing tailored strategies or programmes in this respect, focusing first and foremost on strategic and attractive sectors (Chapter 8).

Linkages between multinational enterprises and local firms, particularly SMEs, also increase employment and training opportunities, development of human capital, as well as knowledge and technology transfers. In the case of Libya, the OECD (2016[68]) has analysed the pivotal role that SMEs can play in the reconstruction of the country, reviewing the current national framework and identifying recommendations that can contribute to pave the way for post-conflict recovery once the situation has stabilised.

Promoting integrity and responsible business conduct

Governance risks, in particular corruption, represent a major financial, legal and reputational risk for international investors (Chapter 11). Corruption, as well as poor state capacity and weak monitoring and enforcement mechanisms, reduce FDI inflows (Wei, 2000[18]). Studies specific to the region highlight that integrity improves the positive impact of FDI on economic development (Hakimi and Hamdi, 2017[69]). On the investors’ side, responsible business practices can reinforce the investment climate in fragile contexts, through accountable behaviours and increased transparency, especially in sensitive sectors such financial and extractives sectors (Chapter 10). In MENA focus economies, no IPA with the exception of the Moroccan one prioritises investors with a good RBC track record (Chapter 6).

Sectoral focus

Adopting a sectoral focus for FDI promotion in fragile contexts can help achieve two concurrent objectives: identifying and exploiting an economy’s comparative advantages, and supporting specific sectors in line with development, reconstruction and resilience strategies, as well as people and business needs. For example, research suggests that FDI in sectors like infrastructure, energy, agribusiness, retail and social services can contribute to peace consolidation and often offers high returns (WEF, 2016[8]). In post-conflict environments, evidence shows that, together with services, construction is the fastest-growing sector (World Bank, 2018[66]). Promoting FDI in infrastructure can further strengthen and support post-conflict or disaster rebuilding efforts, while also enhancing connectivity with regional and global markets (Box 12.5). For example, plans for the reconstruction of the Port of Beirut, together with a reform of the Lebanon port sector, is an opportunity to stimulate trade and economic growth.

As previously observed, most FDI in the region is channelled into capital-intensive sectors, which have contributed little to productivity and job creation, key to sustainable economic growth. Between 2003 and 2019 the majority of greenfield investment in the focus economies went to real estate and construction projects (35%) and extractive industries (26%). Investment in manufacturing has increased in recent years, but the sector attracts a relatively small amount of overall investment in the focus economies, and the service sector even less. Only 5% of greenfield FDI in Libya has gone to manufacturing since 2003 (Chapter 2).

Governments and IPAs in the region are aware of the need for diversifying the economy and prioritising investment in more productive and labour-intensive sectors. All but one IPA in the focus economies prioritise investments in certain sectors (Chapter 6). For example, the Palestinian National Policy Agenda includes the objective to attract FDI in the priority sectors of construction, tourism, agriculture and ICT. An assessment of the economy’s competitiveness, in line with the needs to address fragility, is a relevant initial strategy to target specific sectors or projects (Whyte and Griffin, 2014[76]).

Targeting investors

Investment promotion tailored to very fragile countries may be aided by a strategy targeting specific investors that are more likely to engage in such contexts. This could include investors with prior experience in fragile contexts, with the capacity to deal with potential associated risks, or investors that were present before a period of instability, who may be willing to re-engage (Whyte and Griffin, 2014[76]). Investors from neighbouring countries or from diaspora communities are also likely to have good knowledge and understanding of the national context, can build and use their networks, and potentially take advantage of underutilised value chains. They may operate at a smaller scale but build stronger business linkages with the local economy. Preliminary evidence suggests, for example, that in fragile contexts, investors are more likely to come from other developing countries than are investors into more stable developed countries (Basile and Neunuebel, 2019[60]).

Targeting regions

Identifying geographical areas with relatively higher levels of security where investors can safely operate in very fragile contexts has been identified as a potentially useful, if temporary, strategy (World Bank, 2018[66]). Special Economic Zones (SEZs), free zones and industrial clusters are increasingly common in many developing economies. They can help to partly neutralise the effects of an otherwise less favourable business climate by offering differentiated treatment or services to investors, such as through tax or administrative incentives or better infrastructure than in the rest of the country. The creation of zones is often a reflection of the need to offset a negative impact of stringent import protection on trade or challenges in accessing secured land under the inland regime (OECD, 2020[77]).

However, impact of zone-based strategies in fragile contexts has been mixed. While zones can attract FDI and help boost exports, their expected benefits in terms of economic development are not necessarily positive or automatic but are greatly contingent on the local business environment. More problematic, they may be impeding fair competition between firms inside and outside of zones, and risk creating economic enclaves. They also bear a certain cost on government revenues as the incentives, particularly corporate income tax holidays, granted to firms reduce the fiscal base. Further analysis on the impact of SEZs in MENA fragile contexts on investment attraction and enterprise activities (e.g. Tripoli Special Economic Zone in Lebanon or the Misrata Free Zone in Libya) would allow to build lessons and good practices.

In some economies, involving subnational IPAs in promotion and facilitation mechanisms may also be useful to channel investment to specific regions (see chapter 6). In principle, IPAs may contribute to ease operations at the sub-regional level in large countries, attract investment to safer areas in conflict-affected economies, balance economic development across the territory, and facilitate dialogue with local communities. For example, Iraq built a network of 15 Provincial Investment Commissions with some being proactive in attracting investment (OECD, 2016[53]).10 However, caution is once again necessary. Potentially low capacities of local institutions and lack of co-ordination with the central level may complicate administrative procedures and increase transaction costs and corruption risks.