Capital Account Openness, Institutional Quality and European FDI: Empirical Evidence From North Africa

ABSTRACT

This paper analyzes the role of capital account openness and institutional quality in attracting European foreign direct investment (FDI) to North Africa over the period 2009–2023. Relying on a panel of five countries and instrumental‐variable estimations using the two‐stage least squares (2SLS‐IV) method, the study shows that financial liberalization can foster FDI inflows only when it is supported by a strong and credible institutional environment. The results indicate that institutional dimensions related to economic and legal governance play a central role in transforming capital account openness into an effective driver of European FDI. By contrast, financial development and trade openness are associated with negative effects, suggesting that, in institutionally imperfect contexts, these mechanisms may act as substitutes rather than complements to foreign capital inflows. Robustness checks confirm the stability of the main results, while also indicating that the interaction effect between financial openness and institutional quality is sensitive to the estimation strategy. Overall, the findings suggest that FDI‐attraction strategies based solely on financial liberalization are insufficient. Instead, they suggest that institutional strengthening may constitute an important precondition for achieving a beneficial and sustainable integration into international financial markets, although the estimated interaction effect remains sensitive to the econometric specification.