The Impact of Political Stability on Economic Growth in Libya

Prepared by the researcher : Dr. Hosein A. Elboiashi – Department of Economics, Faculty of Economics, University of Zawia – Al-Zawiya, Libya

Democratic Arabic Center

International Journal of Economic Studies : Twenty-Eighth Issue – February 2024

A Periodical International Journal published by the “Democratic Arab Center” Germany – Berlin

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 Abstract

The purpose of this paper is to analyse the impact of political instability on Libya’s economic development. For the period 1986 to 2017, an autoregressive dependent lagged model (ARDL) was used. The results of this technique show that political instability has hindered Libya’s economic development in both the short and long term. Through the results of this paper, the impact of economic policy can be formulated by strengthening policies to overcome political instability in the country. Such a policy would likely involve strengthening cohesion among various political, military, tribal, and regional groups, the absence of which could lead to distrust among them. This distrust may lead to internal instability, accompanied by conflicts and armed conflicts, and raised violence, which will lead to the collapse of Libya’s production system, at the end will lead to a decline in Libya’s economic growth and development. Likewise, strengthening democracy, and improving social and economic conditions would significantly increase the level of political stability, and help achieve the Sustainable Development Goals (SDGs).

Introduction

The main objective of economic policy is to improve the living conditions of the population by helping to reduce unemployment, provide employment opportunities and reduce poverty, while economic development and economic well-being or welfare remain the main concerns of economic policymakers (Loots, 1988; Bakaboukila and Hakizimana, 2021).

The United Nations stipulates that developing countries must achieve a target economic growth rate of at least 7% to achieve the Sustainable Development Goals (SDGs). The World Bank’s economic indicators show that the Libyan economy achieved a negative GDP growth of 50.3% in 2011 and a negative growth of 23.9% in 2020, which is not in line with the country’s target growth rate expectations and focuses on achieving the United Nations’ national sustainable development goals. While the October 2021 World Bank report titled “Libya: Economic Prospects” suggests that the Libyan economy will post positive GDP growth of 31.4% in 2021, this growth is dependent on a positive political start-up process and the President’s And parliamentary elections are held in the near future. Reintegration of public institutions, continuation of oil production and stabilization of the security situation. These facts confirm that one of the most important factors that can explain economic development is political instability, as demonstrated in ((Ndokang and Tsambou, 2019 ; Gurgul and Lach, 2013 ; Alesina et al., 1996).

Since Libya became an independent state on December 24, 1951, it has witnessed various periods of political instability resulting from coups and political changes (1969 September regime; 2011 February regime; 2014 two governments and two legislative institutions); constitutional changes (1975 Jamahiriya system; 2012 National Congress elections; 2016 the creation of a presidential council, a state council, and a parliament); unstable social and economic conditions; civil wars; armed conflicts; political and institutional division; the cessation of oil production and export; and the closure of oil ports. All these events of instability were accompanied by a sharp drop in the rate of economic growth. As a result of these conditions, despite its slowness, the economic development achieved in the last few decades has been eroded. This could be one of the most significant factors influencing sustainable development in the country, impeding the Libyan government’s efforts to implement the SDGs. Taking these characteristics into account, the hypothesis of an important relationship between growth and political instability can be reinforced in the Libyan case. For these reasons, it is interesting to study the impact of political instability on economic development in Libya. In the economic literature, the impact of political instability on economic development is a controversial topic, both theoretically and empirically. On the theoretical level, although most researchers agree that the effects of political instability on economic development cannot be denied, there are differences regarding the mechanisms of transmission of political instability to economic development. At this level, two sets of ideas are identified. The first group considers the doubt as the means by which political instability affects economic development (Barro, 1996; Mauro, 1995; Cukierman et al., 1989). On the other hand, the second group asserts that in a state of instability; productive expenditures (investors) that can promote economic development are diverted from their objectives and channelled towards non-productive military expenditures.

At the empirical level, the results are still controversial regarding the effects of political instability on economic development. Some studies indicate a contrary relationship between economic development and political instability (Tabassam et al., 2016), while other studies show an encouraging effect of political instability on economic development (Nadia & Mouna, 2017; Londregan & Poole, 1990).

Due to the low and fluctuating level of the economic development rate in Libya, as we explained above, the lack of agreement between practical studies on the effects of political instability on economic development, and at almost non-existent studies and research examining the relationship between political instability and economic development in Libya. This paper search for an answer to the following question: What is the impact of political instability on Libyan economic development? To this end, the goal of this paper is to analyse the effect of political instability on economic development in Libya, under the hypothesis of political instability has undesirable impact on Libya’s economic development.

Political Instability and Economic Development in the Economic Literature

This quarter of the paper focuses on three main points of literature review an ideal, a theoretical, and an empirical review. The conceptual review is casting to review the different delineations that allow for a better understanding of the conception of political instability. Numerous experimenters in the current literature have tried to define political instability, but they have not been suitable to agree on a universal accepted description. According to Fosu (1992), political instability can be defined by conforming to the change in political power through violence and changes in legal forms. Which is understood in three aspects the instability of the leading or the administrative regime, which includes accomplishments that corresponds to social movements similar as strikes; and armed or violent instability, which includes civil war and violent political action (Gupta, 1991; Gouenet, 2009). At the equal time, Alesina (1996), considers political instability to be the tendency to change government, given the unconstitutional variations. Barro (1991) adds that political instability corresponds to the composition of political instigations, including the number of military accomplishments. While the International Country Risk Index (ICRG) considers that political instability includes government stability, internal conflicts, external conflicts, military presence in politics, religious and ethnical pressures, social and profitable conditions, investment profile, corruption, law and order, popular responsibility, and regulatory quality. Along the same lines, Gakpa (2020) explains that political instability is what corresponds to government instability, internal and external conflicts, and the presence of the military in politics. Barro (1991) asserts that numerous political instigations, including the number of military accomplishments, significantly and negatively affect economic development.

Theoretical perspectives on how political instability affects economic development generally concur that political instability has detrimental consequences on economic development. Differences of opinion still exist, nonetheless, about the ways in which political instability affects economic development. According to this viewpoint, Cervantes and Villasenor (2015) contend that political instability has an impact on economic development through savings, investments, labour market unrest, productivity levels, and monetary and fiscal policies of the government. According to Munoz (2009), political instability has an impact on economic development through three different channels: investment (reduced accumulation of physical and human capital), social and political conflict (reduced productivity due to disruption of repetitive economic activities), and substandard economic policy performance (poor political performance). Baklouti and Boujelbene (2020), on the other hand, show that political instability causes interruptions in productive activity and increases in transaction costs, which may prevent a country from optimizing its true potential, which is required for achieving economic development goals. Bakaboukila and Hakizimana (2021) argue, on the other hand, that the transition to a more democratic political system may be accompanied by political instability manifested in strikes, demonstrations, and unexpected changes in government, all of which have an adverse impact on investment and economic development.

Mixed outcomes have been found in applied research that illustrate how political instability affects economic development. While some have adverse effects, others have favourable ones. In a group of 98 countries, Barro (1991) looks into the connection between political instability and economic development and growth. The number of political conflicts and military takeovers is used in the cross-sectional regression model as a proxy for political instability. The findings of this investigation show that political instability has a major detrimental impact on these countries’ economic progress. In addition, Barro and Lee (1994) investigated how political instability affected economic development and growth in 116 economies from 1965 to 1985. They discovered that political instability had a detrimental impact on economic development and growth. Similar to this, Haan and Siermann (1996) examined whether political instability was associated with slower economic development for 96 countries from 1963 to 1988. They came to the conclusion that one of the biggest barriers to investment in Asia and North America is political instability. In a similar vein, Alesina et al. (1996) used a sample of 113 nations, spanning the years 1950–1982. In their study, they measured political instability by the likelihood of governmental change, including non-constitutional reforms (such as coups). Their study’s findings suggest that economic development is less pronounced during periods of high political reform propensity than it is at other times. Aisen and Vega (2011) discovered that a high level of political instability adversely linked with GDP using the propensity for government change as a measure of political instability. They did this by applying the GMM system of dynamic models for the period 1960–2004 in a sample of 169 nations. Their findings showed that political instability hinders the growth of productive components, which has a detrimental impact on the building up of physical and human capital.

Gurgul and Lach (2013) also looked at panel data for ten EAC nations between 1990 and 2009 to examine the connection between political stability and economic development. The researchers used two criteria to characterise political instability: a change in the prime minister (a significant change) and a change in the government. According to the report, political instability is bad for economic growth. Farjallah and Abdelhamid (2017) discovered that political stability by using a set of three political risk indices, democratic accountability, law and order, and ethnic tensions, drawn from the International Country Risk Guide (ICRG) database, and annual data on the Tunisian economy covering the period from 1984 to 2014, have positive effects on economic development. Similarly, Makrem and Faycel (2018) investigated whether political stability was necessary for development in a sample of 79 countries from 1984 to 2008 in order to determine the nature of the relationship between democracy and development, using the dynamic models of GMM system. They discovered that one of the most important factors influencing economic development is political stability. Indeed, in the absence of a stable political environment, the impact of democracy on development is statistically inconsequential.

Gakpa (2020) examines how political instability and foreign direct investment interact to affect economic development in 31 sub-Saharan African nations. Using a panel data model and the triple least squares method for model estimates for the years 1984–2015, an aggregate index of political instability was created using a collection of political risk indicators taken from the International Country Risk Guide (ICRG) database. The model’s findings show that political instability has an impact on economic development both directly and indirectly by affecting foreign direct investment. The findings demonstrate that political instability may impede economic development and growth brought on by foreign direct investment. Similar to this, Bakaboukila and Hakizimana (2021) analyse how political instability affects economic development in the Democratic Republic of the Congo. They found that political instability significantly impedes economic development, using an aggregate index of political instability derived from a set of six political risk indices taken from the International Country Risk Guide (ICRG) database and applied the ARDL model for the period from 1986 to 2017. They were able to offer a series of recommendations that improve political stability, which promotes economic development, based on the findings of their study.

In contrary, Ndokang and Tsambou (2019) want to evaluate how the political instability in the Central African Republic has affected Cameroon’s economic development and growth. They achieve this by analysing the effects of political instability on Cameroon’s economic growth performance using a Solow Model for Economic Development enhanced by human capital. Using the OLS methodology, the findings revealed that political instability in one country has favourable effects on the economic efficiency of another country by diverting foreign direct investment from one country to another. This effect is dependent upon the degree of integration and economic interdependence between the regional countries themselves.

According to a previous analysis of the economic literature, there is no evidence to support an inverse association between political instability and economic development. There are still differences of opinion regarding how political instability affects economic development and growth. On the empirical side, there is a different relationship, and there are also distinct methodologies and measurement techniques. While some claim the results demonstrate positive impacts, others claim the contrary. Political instability as a concept has also been handled in many ways. We are unaware of any research connecting Libya’s political instability with its economic development. The value of this research paper thus lies in the fact that it will significantly contribute to the enrichment of the economic literature by studying and applying ARDL techniques in evaluating the impact of political instability on economic development, in the case of the Libyan economy.

Methodology

The purpose of this paper is to analyse the impact of political instability on economic development in Libya. To achieve this goal, the paper proposed an economic development model based on the model proposed by Farjallah and Abdelhamid (2017), Gakpa (2020) and Bakaboukila and Hakizimana (2021), as following, after adapting it according to the state of the Libyan economy:

Data Sources and Variables Description

The data used in this paper are temporal data covering the period from 1986 to 2017, according to the availability of data, especially for the political stability index. Adapted from the World Bank’s World Development Indicators (WDI) database: gross domestic product (GDP), total exports of goods and services (EX) and total imports of goods and services (IM) for the calculation of the net trade balance (CA=EX-IM), Total Public Expenditures (GX), Total Public Revenues (GR), Consumer Price Index (CPI). While the variable exchange rate of the Libyan dinar against the US dollar (EXCH) was obtained from the International Food and Agriculture Organization (FAOSTAT).

As for the data used to calculate political instability (POL), refer to the International Country Risk Guide (ICRG). The political instability variable used in this paper, as in Gakpa (2020) and Bakaboukila and Hakizimana (2021), is an aggregate variable obtained by averaging the collection of seven indicators, while Gakpa (2020) and Bakaboukila and Hakizimana (2021) used six Indicators, in order to take into account the peculiarities of the Libyan state, which are the stability of the government, internal conflict, external conflict, military presence in politics, religious tension, ethnic tension, and democratic accountability, provided by the ICRG. This indicator has been ranked numerically from lowest to highest in an ascending manner, and it is interpreted as follows: The closer the indicator is to the highest numerical rank, or greater than one, this indicates a decrease in political instability, and when the indicator value is close to the lowest numeric rank, or close to zero, this indicates a state of strong political instability.

Table 1 presents a summary of the variables used, their expected signal, and sources

Table 2 shows that all the study variables do not contain a large dispersion around their mean, as well as the standard deviation of the values of the study variables, which do not exceed one value, except for GDP variable. With regard to the normal distribution of the series of variables used, the descriptive statistics show that all the variables used are distributed normally, according to the (Jarque-Bera) test, except for CA variable, which means that it does not follow the normal distribution. However, based on the law of large numbers, we can assert that all series tend towards a normal distribution with respect to the number of observations (n > 25).

Table 2 presents a summary of the statistical description of the variables used

Estimation Procedures

In addition to the requirement for a normal distribution of time series, another necessary and mandatory requirement in studies using time series data is the stationarity of data. In fact, an unstationary data series, if not addressed, can lead to biased results (false regression).

In the context of time series, several tests are used to test stationarity (presence or absence of a unit root). These tests include the Modified Dickey Fuller (ADF) and the Philippe-Perron (PP) test, which are the two most common tests used. In this paper, the PP test is used, because there is no significant difference in its results from the ADF test, and the results are summarized in Table 3.

Table 3 presents the PP unit root test results for the variables used

From analysing the results of PP test, which presented in Table 3, we note that the LGDP and LCA variables are stable in the level (absence of a unit root) at least according to the PP test, which indicates that they are integrated in the level. By integrating them with the rest of the variables in the first difference, we notice that all variables are stationary and integrated of (I(1)).

Since the time series of the variables showed clear differences in stationarity, including what is stationary in the level, and what is stationary in the first difference, the application of the ARDL autoregressive model test is justified. Compared to other models, the ARDL model has the advantage of being able to estimate the short-term dynamics and long-term effects of combined or even integrated time series. Moreover, it is suitable in the case of small sample series. In the ARDL model, the cointegration test of terms has two steps, the first being the determination of the optimal lag time by the Akaike criterion (AIC) and using the Fisher test.

Graph 1 shows the optimal ARDL model among the first twenty models selected according to Akaike’s criterion

According to the above graph, the ARDL (2, 1, 0,0,1, 2, 2) model is the best among the presented models, which shows the smallest value of AIC, which indicates that this model has less information loss than other models tested.

Table (4) shows the statistical summary of the F-bounds tests for the limits of critical values at the various degrees of significance suggested by Pesaran. The results indicate that the value of the F-statistics, the cointegration test, which is equal to (9.86), is greater than the upper limit of the critical values at different levels of significance, and therefore we reject the null hypothesis and accept the alternative hypothesis of the existence of a cointegration relationship or a long-term equilibrium relationship between the economic development variable and independent variables used in the standard model. This allows us to estimate the short-term dynamic effects of political instability on economic development.

Table (4) presents the results of the F-statistics test and the F-bounds test for the ARDL model

Results Discussion

Before discussing the results of this paper, it is important to ensure the validity of the estimated model. This validity is analysed through the results of various post-assessment tests. The results of the diagnostic tests presented in Table (5) indicate that the series of residuals are distributed normally, as indicated by the (Normality test for Jarque-Bera), as well as the (Breusch-Godfrey) test confirming that there is no serial linear correlation problem for the series of residuals, while the (Arch) test for heteroscedastic test indicates the constancy of residual variance. Also, the Ramsey Reset test for identifying the suitability of the design of the model in terms of the functional form of the proposed model, which indicates that there is no problem of inappropriateness of the functional form of the model, and thus the conditions for applying the ARDL model are fulfilled according to the proposed model to measure the relationship between political instability and economic development, in addition to a number of macroeconomic variables associated with the economic development function according to economic theory.

Table 5 presents a summary of the diagnostic statistical tests of the model

Model Results in the Short Run:

The results presented in Table (6) indicate that the independent variables can explain about 82% of the changes that occur in economic development. The results also indicate that the error correction coefficient (CointEq (-1)) is statistically significant, with a significant degree of up to 1%, and has a negative sign. This result confirms the existence of an equilibrium relationship from the short term to the long term at a rate of convergence of about 36% annually, which was confirmed by the statistical F-bounds tests. All the estimated short-term parameters were statistically significant, with a significance level of 1%.

In short, all the different tests show that the model is of high quality, and therefore the results that come out can be discussed. The analysis of the results in Table (6) highlights a key lesson: political instability impedes economic development in Libya. This statement is justified by the fact that the coefficient associated with the indicator of the variable POL in the first difference is positive and significant at the 1% level, and at 10% in the lagged one period. This indicates that an increase in the political stability index by 1% is accompanied by an improvement in economic development by about 0.69 and 0.53 points in the level and the lagged one period, respectively, ceteris paribus, in the short run. This can be explained by the fact that the impact of improvement in political stability can be noticed directly in the same period on economic development in Libya, and does not need a long time to be noticed.

Table (6) presents the short-term results of estimating the ARDL model

Model Results in the Long Run:

Table (7) shows the parameters of estimating the ARDL model in the long run for the independent variables. All estimated variables carried the expected sign, and had significant statistical significance up to a significant degree of 1%, except for the variable of government spending (LGX) and the variable of the consumer price index (LCPI). which were significant with a degree of 10%. Table (6) shows that the coefficient of the political stability variable (POL), the subject of this paper, was as expected. An increase in the improvement in the political stability index by 1% will lead, ceteris paribus, to an increase in the economic development rate by 165%.

Table (7) presents the long-term results of estimating the ARDL model

In general, the results of the estimation of the economic development model in Libya, whether in the short or long term, indicate the relative importance of the variable of political stability in explaining the changes that occur in economic development, and thus the ability of the Libyan economy to meet the needs and requirements of achieving real economic development, and SDG goals.

Conclusion and Implications for Economic Policies

The aim of this paper was to analyse the effects of political instability on economic development in Libya. The paper applied Autoregressive Model (ARDL), with annual data covering the period from 1986 to 2017, taken from the World Development Indicators (WDI), and Food and Agriculture Organization (FAOSTAT) database of macroeconomic variables and from the International Country Risk Index (ICRG) for the variable used in constructing the political instability index. The results of ARDL model showed that political instability has a significant negative impact on economic development in Libya, which delays achieving real economic development, and SDG goals.

In light of this result, the effective economic policies can be formulated by strengthening measures to reduce political instability in Libya. Such measures could include strengthening cohesion between the various political, military, tribal, and regional groups, the absence of this cohesion may lead to mistrust among them. This mistrust could lead to internal unrest, accompanied by conflicts and armed conflicts, and an increase in violence, which would result in the collapse of the productive system, and thus lead to a decline in economic development in Libya. Similarly, strengthening democracy and improving social and economic conditions would greatly reduce the level of instability.

Since there is no internationally agreed concept or definition that reflects political instability, rather it is a set of indicators provided by the ICRG, which may not provide sufficient information on the transmission mechanisms or reflection of those indicators on economic development. These used indicators can somehow limit the results obtained in this paper, especially in the case of Libya, despite the attempt to adapt the development model used in line with the Libyan case.

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