Reversal of Fortunes: Democratic Institutions And Foreign Direct Investment Inflows To Developing Countries

Overview: The article argues that democratic institutions have conflicting effects on FDI inflows. On the one hand, democratic institutions hinder FDI inflows. They tend to limit the oligopolistic or monopolistic behaviors of multinational enterprises, facilitate indigenous businesses’ pursuit of protection from foreign capital, and constrain host governments’ ability to offer generous financial and fiscal incentives to foreign investors. On the other hand, democratic institutions promote FDI inflows since they tend to ensure more credible property rights protection, reducing risks and transaction costs for foreign investors. Hence, the net effect of democracy on FDI inflows is contingent on the relative strength of these two competing forces. The argument reconciles conflicting theoretical expectations in the existing literature. Empirical analyses of 53 developing countries from 1982 to 1995 substantiate the claims. It is found that both property rights protection and democracy-related property rights protection encourage FDI inflows; after controlling for their positive effect through property rights protection, democratic institutions reduce FDI inflows. These results are robust against alternative model specifications, statistical estimators, and variable measurements. Implications of the research are also discussed in this paper.

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Format: PDF | Size: 259KB | Date: Jan 2003 | Pages: 60