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Do democratic transitions attract foreign investors and how fast?

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  • Jean Lacroix
  • Pierre-Guillaume Méon
  • Khalid Sekkat

Abstract

This paper investigates the evolution of foreign direct investment net inflows (FDI) around democratic transitions, in a panel of 115 developing countries from 1970 to 2014, using an event-study method. We find no effect of democratic transitions on FDI net inflows on average. We then distinguish the effect of democratic transitions per se and the effect of its consolidation. To do so, we specifically focus on consolidated democratic transitions, defined as transitions that did not reverse during five years at least. We find that consolidated democratic transitions do increase FDI net inflows. The bulk of the improvement appears ten years after the transition. Furthermore, the effect of consolidated democratic transitions on FDI is not limited to their impact on political risk. When controlling for the political risk index of the International Country Risk Guide, the intrinsic effect of consolidated democratic transitions appears immediately after the transition, suggesting that higher political risk accompanying the early years of democratic transitions offsets the positive intrinsic effect of democratictransition on FDI. The results are robust to controlling for GDP per capita and schooling, to alternative codings of the variables capturing the transition, disaggregating the political risk measure into several sub-components and the exclusion of outliers. Moreover local projections, propensity score matching, and IV estimates lend credence to a causal interpretation of our results. Furthermore the longer the democratic history of a country is, the fewer FDI this country may expect to attract thanks to a new democratic transition.

Suggested Citation

  • Jean Lacroix & Pierre-Guillaume Méon & Khalid Sekkat, 2017. "Do democratic transitions attract foreign investors and how fast?," Working Papers CEB 17-006, ULB -- Universite Libre de Bruxelles.
  • Handle: RePEc:sol:wpaper:2013/246943
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    Keywords

    FDI; Democratic transitions; Institutions; Development;

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development

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