Readers Question: why is political stability needed to attract FDI?
FDI = Foreign Direct investment. For example, if BP invested in Venezuela or Iraq to produce oil. This would be an example of foreign direct investment into Venezuela and Iraq.
Clearly for countries like this, the political situation is going to be important for determining whether investing in these countries is a good idea.
Investing in Iraq may have high potential returns. But BP maybe dissuaded from investing there because:
Risk of terrorist action. Cost of equipment, cost in terms of lives. Difficulty of getting workers to go and live in Iraq.
Future attitude of government cannot be guaranteed. Possibility of ultra nationalist government being formed which seeks to nationalise Iraqi oil reserves. BP could then lose everything.
Political instability can cause a run on the exchange rate. e.g. political instability contributed to collapse of Russian rouble in the early 1990s. This made investing in Russia economically difficult.
Firms require investment and good infrastructure to make FDI worthwhile. Political instability means that the country is likely to face problems raising taxes and investing in roads / communication e.t.c.
Basically, the more political instability there is the less attractive and more costly it becomes to invest in those particular countries. It doesn’t mean there won’t be any FDI, it just means firms will require a higher return to compensate for the increased risk involved.