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Reversal of Fortunes: Democratic Institutions and Foreign Direct Investment Inflows to Developing Countries

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  • Li, Quan
  • Resnick, Adam
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    Abstract

    Does increased democracy promote or jeopardize foreign direct investment (FDI) inflows to less-developed countries? We argue that democratic institutions have conflicting effects on FDI inflows. On the one hand, democratic institutions hinder FDI inflows by limiting the oligopolistic or monopolistic behaviors of multinational enterprises, facilitating indigenous businesses pursuit of protection from foreign capital, and constraining host governments ability to offer generous financial and fiscal incentives to foreign investors. On the other hand, democratic institutions promote FDI inflows because 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. Our argument reconciles conflicting theoretical expectations in the existing literature. Empirical analyses of fifty-three developing countries from 1982 to 1995 substantiate our claims. We find 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.We thank Steve Chan, Jim Eisenstein, Erik Gartzke, John Oneal, Andrew Sobel, Holloway Sparks, Peter Gourevitch, David Lake, Lisa Martin, and two anonymous referees for their helpful comments and suggestions. We thank Monica Lombana for research assistance. An earlier version of this article was presented at the ISA Annual Meeting, 2001, Chicago. Replication data are available from the authors upon request.

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    Bibliographic Info

    Article provided by Cambridge University Press in its journal International Organization.

    Volume (Year): 57 (2003)
    Issue (Month): 01 (December)
    Pages: 175-211

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    Handle: RePEc:cup:intorg:v:57:y:2003:i:01:p:175-211_57

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