📈 economics

Energy Price Volatility and Digital Capability in Shaping FDI Location Decisions: Evidence from Central and Eastern Europe in the Post-Pandemic Era

This study reveals that while energy price volatility does not uniformly deter foreign direct investment in Central and Eastern Europe, its negative impact is significantly mitigated by high levels of digital capability, which acts as a strategic resilience mechanism that allows economies to better internalize energy risks and sustain capital inflows.

Original authors: Abdulgaffar Muhammad, Smith Maxwell Ogbotor, Ezie Israel Omoye, Edirin Jeroh, Michael Tonbraladoh Sinebe, Chukwugoziem Tom Ezi, Fatima Adam Labaran, Bernard Osahon Odiase, Emmanuel Osarowenyeke Ogbebo

Published 2026-07-06

📖 5 min read🧠 Deep dive

CC BY 4.0

Original authors: Abdulgaffar Muhammad, Smith Maxwell Ogbotor, Ezie Israel Omoye, Edirin Jeroh, Michael Tonbraladoh Sinebe, Chukwugoziem Tom Ezi, Fatima Adam Labaran, Bernard Osahon Odiase, Emmanuel Osarowenyeke Ogbebor, Maryam Isyaku

Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). ✨ This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer

The Big Picture: A High-Stakes Game of "Where to Build?"

Imagine you are a giant multinational company (like a massive construction firm) looking for the best place to build a new factory. You have a list of 40 potential spots in Central and Eastern Europe. You need to decide: Where is the safest and smartest place to park your money?

This paper investigates two main things that influence your decision:

The "Stormy Weather" of Energy Prices: How much do electricity and fuel costs jump around unpredictably?
The "Super-Computer" of Digital Skills: How good is the local country at using data and technology to understand the world?

The researchers wanted to know: Does bad energy news scare investors away? And does having a "super-computer" (digital skills) help investors handle that bad news better?

The Main Characters

Energy Price Volatility (The Storm): Think of this like the weather. Sometimes the sun shines (cheap energy), and sometimes a hurricane hits (sky-high prices). The paper looks at how unpredictable the weather is, not just how bad it is.
Digital Adoption (The Weather App): This is the country's ability to use data, analytics, and technology. Think of this as a high-tech weather app that tells you exactly when the storm is coming, how hard it will hit, and how to prepare.
FDI (The Investment): This is the money foreign companies bring in to build factories and businesses.

The Big Discovery: It's Not Just About the Storm

The researchers found a surprising twist. They expected that "Stormy Weather" (unstable energy prices) would always scare investors away, like a storm warning keeps people from going to the beach.

But that's not exactly what happened.

Here is the analogy:

In a country with low digital skills (No Weather App): When energy prices jump around, investors are confused. They don't know if the storm is real or just a glitch. They can't calculate the risk accurately. So, the "storm" doesn't change their decision much because they are flying blind.
In a country with high digital skills (The Super Weather App): When energy prices jump around, these investors have a crystal-clear view. They see the storm coming, they know exactly how much it will cost, and they can calculate the risk perfectly.

The Result: In the high-tech countries, the "storm" actually does scare investors away more effectively. Why? Because they are smart enough to realize, "Oh, this energy volatility is a real, expensive problem, and I need to avoid it."

The Metaphor:
Think of energy volatility as a leaky roof.

If you have a dull axe (low digital skills), you chop at the roof but don't really see the leak. You might keep building anyway because you don't fully grasp the danger.
If you have a laser-guided saw (high digital skills), you instantly see the leak, measure exactly how much water is coming in, and decide, "Nope, this house is too risky to buy."

So, the paper concludes that digital capability doesn't "fix" the leaky roof; it just makes you realize the roof is leaking. It makes investors more sensitive to the risk, not less.

The "Tipping Point" (The Threshold)

The study found a specific "tipping point" in digital skills.

Below the line: Countries are so digitally behind that energy chaos doesn't seem to matter much to investors (they are too busy with other problems).
Above the line: Once a country crosses a certain level of digital maturity, the relationship changes. Suddenly, energy price swings become a major deal-breaker for investors because the data makes the risk undeniable.

What Else Matters?

The paper also looked at other factors, like a checklist for a perfect vacation spot:

EU Membership: Being part of the "VIP club" (the EU) makes the spot more attractive.
Trade Openness: How easy is it to ship goods in and out? (The more open, the better).
Inflation & Exchange Rates: If the local currency is unstable or prices are rising too fast, investors get nervous.
Post-Pandemic Era: The world changed after 2020. Investors are now more focused on "resilience" (surviving shocks) than just cheap costs.

The "Cheat Code" (Machine Learning)

To make sure their math was right, the researchers used a "cheat code" called Machine Learning (specifically Random Forest and XGBoost). They didn't use this to find new rules, but to double-check their work.

The Result: The computer agreed with the human mathematicians. It confirmed that Energy Volatility and Digital Skills are indeed the two most important factors in predicting where money will go.

The Bottom Line

The paper tells us that in the modern world, you can't just look at how cheap energy is. You have to look at how unpredictable it is and how smart the country is at handling that unpredictability.

For Investors: If a country has great digital tools, they will see energy risks clearly and might avoid it if the energy is too volatile.
For Governments: Just trying to keep energy prices low isn't enough. You also need to build a "digital super-structure" so that investors feel confident and transparent about the risks. If you are too chaotic in your data, investors might not even notice the risk (or they might notice it too late).

In short: Digital skills act like a magnifying glass. They don't stop the storm, but they make sure everyone sees exactly how wet their shoes are getting.

Technical Summary: Energy Price Volatility and Digital Capability in Shaping FDI Location Decisions

Problem Statement
This study addresses the evolving determinants of Foreign Direct Investment (FDI) location decisions in Central and Eastern Europe (CEE) within the post-pandemic era. While existing literature extensively documents how macroeconomic instability and energy price levels affect investment, there is a critical gap regarding energy price volatility as a forward-looking risk factor and its interaction with digital capability. Specifically, the authors note that prior research often relies on linear specifications and fails to model how business analytics and digital adoption might condition (moderate) the transmission of energy risk into investment decisions. The central problem is whether digital infrastructure acts merely as a direct attractor of FDI or as a strategic resilience mechanism that alters how firms perceive and price energy uncertainty.

Methodology
The research employs a quantitative longitudinal design using a balanced panel of 40 CEE countries observed annually from 2010 to 2025 (640 observations). The empirical strategy is unified and multi-layered to address endogeneity, dynamic persistence, and nonlinearity:

Core Estimator: A dynamic system-Generalized Method of Moments (system-GMM) framework is used to estimate the baseline relationship. This approach controls for FDI persistence (lagged dependent variable), unobserved country heterogeneity, and potential endogeneity of regressors.
Moderation Analysis: The study tests for linear moderation by including an interaction term between Energy Price Volatility (EPV) and the Digital Adoption Index (DAI).
Nonlinear Threshold Analysis: To formally test for regime dependence, a panel threshold model (Hansen, 1999) is applied. This endogenously identifies a critical threshold level of digital adoption ( $\tau$ ) above which the sensitivity of FDI to energy volatility structurally changes.
Structural Adjustment: A post-pandemic dummy (2021–2025) and its interaction with EPV are embedded within the dynamic model to assess whether the pandemic induced a structural shift in risk transmission.
Robustness and Validation:
- Alternative Volatility Measures: EPV is reconstructed using GARCH(1,1) conditional volatility.
- External Instruments: Global oil price volatility and gas supply disruption indices are used to strengthen causal identification.
- Machine Learning Validation: Random Forest and XGBoost models are employed strictly for predictive validation (not causal inference) to confirm that EPV and DAI remain dominant predictors under non-parametric assumptions. SHAP values are used to rank feature importance.

Key Results
The analysis yields several nuanced findings regarding the energy–digital–FDI nexus:

Conditional Impact of Volatility: Energy price volatility does not uniformly deter FDI across the region. Its direct linear effect is statistically insignificant once dynamic persistence and moderation are controlled for.
The Role of Digital Capability: Digital adoption (proxied by the Digital Adoption Index) does not act as a standalone linear driver of FDI. Instead, it functions primarily as a conditioning mechanism.
Regime-Dependent Sensitivity: The interaction between energy volatility and digital capability is statistically significant. The study identifies a critical digital adoption threshold of 0.843.
- Below the threshold: In low-digital environments, energy volatility has a negative but statistically insignificant effect on FDI, suggesting firms may already operate under structural inefficiencies where marginal risk pricing is opaque.
- Above the threshold: In high-digital environments, energy volatility exerts a negative and statistically significant deterrent effect. This implies that digitally advanced economies internalize energy uncertainty more transparently and efficiently into capital allocation decisions, making them more sensitive to risk signals.
Control Variables: Exchange-rate volatility, trade openness, renewable energy share, post-pandemic conditions, and EU membership significantly influence FDI. Notably, institutional quality promotes FDI in high-digital regimes but discourages it in low-digital regimes, indicating a complementarity between governance and digital infrastructure.
Machine Learning Confirmation: Non-parametric models (Random Forest and XGBoost) confirm that Energy Price Volatility and Digital Adoption are the top two predictors of FDI intensity, validating the robustness of the econometric findings beyond linear functional forms.

Key Contributions
The paper claims three primary contributions to the Financial Innovation and FDI literature:

Reconceptualization of Risk: It reframes energy price volatility not just as a cost shock, but as a financial risk channel that influences international capital allocation through conditional mechanisms.
Digital Resilience Mechanism: It identifies digital capability as a structural moderator that conditions how energy risk is transmitted into investment decisions, rather than simply acting as a pull factor.
Post-Pandemic Evidence: It provides empirical evidence from a strategically important European region (CEE) where energy security, digital transformation, and FDI competitiveness intersect in the post-pandemic context.

Significance and Claims
The authors assert that their findings offer policy-relevant insights for sustaining FDI inflows under persistent energy uncertainty. The study concludes that stabilizing energy markets alone is insufficient to attract or retain investment. Instead, policymakers in CEE economies must simultaneously strengthen digital infrastructure, enhance institutional credibility, and maintain macroeconomic stability.

The paper emphasizes that digital infrastructure serves as a "strategic resilience mechanism." By improving information processing and risk transparency, high digital adoption allows firms to more accurately price energy risks, thereby altering the investment landscape. The study positions itself as a bridge between energy economics and digital transformation, demonstrating that the impact of energy volatility is not static but is fundamentally reshaped by a host country's digital readiness.