Internal vs. External Shocks in Weakening Democracies: Evidence on Migration and Foreign Investment

Assaf Razin

No 20859, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper investigates the consequences of regime change for both migration and foreign direct investment (FDI) by employing quasi-natural experiments that exploit external and internal shocks to democratic institutions. It compares evidence from Europe, which was afflicted by the “Syrian Shock†—an external institutional stress testing administrative and fiscal capacity—and Israel, which experienced the “Corruption Shock†—an internal credibility crisis that eroded judicial independence and policy predictability. These two shocks provide a natural experiment to examine how weakening democratic institutions influence both capital mobility and people mobility, using a unified econometric framework. The analysis applies Difference-in-Differences (DiD) estimation to OECD panel data spanning 1995–2023 to isolate the causal effects of institutional deterioration on FDI inflows and migration flows. The DiD approach, complemented by fixed effects at the country and year levels, captures both the short-term disruptions caused by exogenous humanitarian pressures and the long-term persistence of governance-driven uncertainty. The results demonstrate that internal shocks—such as Israel’s judicial and corruption crises—generate large and durable declines in FDI and sustained outward migration, while external shocks—such as Europe’s refugee crisis—produce more transient effect

Date: 2025-11
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