Autocracy,Democracy, and FDI Inflows to the Developing Countries

Abstract

This paper investigates the relationship between political regimes and Foreign Direct Investment (FDI) inflows to the developing countries for a sample of 134 countries over the 1983–2002 period. Using two categorical measures of regime type and three different measures of FDI, this study finds that, regardless of the measures of regime type, democracies are not significantly associated with either FDI in level or FDI as a ratio to GDP; democracy is positively related to a higher level of per capita FDI, but this result is not robust to alternative measures of political regime. Taken as a whole, there is no evidence of a systematic relationship between democracy and FDI inflows. This result suggests that being a democracy does not help attract higher levels of FDI.     

How important is employment protection legislation for Foreign Direct Investment flows in Central and Eastern European countries?1

In this article we investigate empirically the importance of labour market conditions and in particular the role of employment protection legislation as determinants of bilateral Foreign Direct Investment (FDI). We find that FDI flows are significantly higher in countries with relatively low unit labour costs. We also find that employment protection legislation does not exert a statistically significant impact on FDI flows. Our results are consistent with the interpretation that transition economies attract FDI via low production costs whereas indirect costs related to the rigidity of the labour market are less relevant.     

Democracy and Economic Growth: Optimal Level and Transmission Channels

After evening out all the benefits and costs, the overall optimal level of democracy is about 3.2, on a scale of 1 to 7. On average, fully dictatorial countries have a conditioned growth rate of –1.113 percent, fully democratic countries have a conditioned growth rate of 1.146 while countries with the optimal level of democracy/autocracy have a conditioned growth rate of 2.665. In the case of a fully dictatorial country, moving one unit towards democracy can raise the GDP growth rate by about 1.725 points; while for a fully democratic country, moving towards autocracy by one unit can raise the growth rate by about 0.885 points. This study provides useful information for many developing countries which are experiencing substantial pressures to restructure their political system.     

Risky business: Institutions vs. social networks in FDI

Political economy scholarship on foreign direct investment (FDI) emphasizes variation in host country political risk but overlooks variation in investors' sensitivity to political risk. We show that relational contracting, relationship‐based contract enforcement, is more efficient for high‐risk, human capital‐intensive activities for which the costs of writing legally enforceable contracts are prohibitive. We disaggregate FDI into two distinct varieties: mergers and acquisitions (M&A) and venture capital (VC). We propose that VC flows are less sensitive to host institutions but correlate strongly with skilled migrant networks that monitor compliance and impose reputational costs. Our empirical analysis of dyadic VC and M&A flows covers over 100 countries during 1980–2009. We address other mechanisms through which migrant networks facilitate FDI and verify our results hold at the country‐industry level. These findings suggest that relational contracting facilitates global integration of dynamic, knowledge‐intensive industries even when formal institutions are weak.     

The effect of remittances on democratic institutions

Do remittances promote stronger democratic institutions in developing countries? We study the effect of workers’ remittances on the quality of democracy in developing countries, and examine how government spending mediates the effect of workers’ remittances on the quality of democratic institutions. Using a dynamic panel estimator on data from 133 developing countries over 1972–2012, we find that workers’ remittances improve the quality of democratic institutions. We also find that workers’ remittances are more effective in promoting democratic institutions in developing countries with low government spending.     

When does more aid imply less democracy? An empirical examination

Foreign aid flows have increased considerably during the last decades, targeting, apart from development objectives, goals related to democracy. In this paper we investigate whether aid has affected the political regime of recipient countries. To this end, we use annual data on Net Official Development Assistance covering 64 aid-recipients. Because of data limitations, we cover the 1967-2002 period. We find that aid flows decreased the likelihood of observing a democratic regime in a recipient country. This effect is sensitive to economic and social conditions. The negative relation between aid and democracy is moderated when aid flows are preceded by economic liberalization. Aid from the U.S. has a non-significant effect on the political regime of recipients.     

Political Institutions, Capital Flows, and Developing Country Growth: An Empirical Investigation

The paper examines the real per-capita growth effects of the quality of democracy, the rule of law, and capital flows in developing countries. The direct growth effects of democracy are positive and often statistically significant. Moreover, the estimates from a three-stage least-squares regression offer evidence that democracy has indirect growth effects that work by encouraging schooling and that the rule of law influences growth indirectly by encouraging foreign direct investment. A higher FDI to GDP ratio is associated with a faster growth rate. The estimated growth effect of the FDI to GDP ratio is several times higher than the estimated growth effect of the domestic investment to GDP ratio. By contrast, this study does not find a clear asso-ciation between other types of capital flows and growth.     

THE IMPACT OF TRADE AND INVESTMENT AGREEMENTS ON AUSTRALIA'S INWARD FDI FLOWS

International trade and investment agreements are one of the primary instruments of global financial liberalisation. They are enacted to enhance the flows of foreign direct investment (FDI) between signatories by reducing regulatory barriers to investment; promoting stable host investment environments; and guaranteeing investors against non‐commercial risk. As a net capital importer, Australia has sought to attract FDI through participation in such accords since the early 1980s. This paper examines the determinants of Australia's inward FDI flows—focussing specifically on the effects of trade and investment agreements. Using panel data, we find that both bilateral trade and bilateral and multilateral investment agreements attract FDI flows into Australia, thereby indicating that the policy of enticing FDI through participation in these accords is quite possibly effective.     

FDI from the south: The role of institutional distance and natural resources

Using a novel dataset of bilateral FDI flows, we analyze location choices of investors from emerging economies, with an emphasis on institutions and natural resources. We show that FDI from the South has a more regional aspect than investment from the North. Institutional distance has an asymmetric effect on FDI depending on whether investors choose countries with better or worse institutions. In the latter case, large institutional distance discourages FDI inflows, but this deterring effect is diminished for destination countries with substantial resources. We also find a complementary relationship between capital flows from the North and the South in developing recipient countries, which we attribute to different FDI patterns of these investors.     

The Effect of Terrorist Incidents on Capital Flows

Previous work has shown that terrorism has significant negative impact on countries' economies. We explore this relationship in more detail. Using an unbalanced panel of more than 160 countries for up to 25 years and the Global Terrorism Database (GTD) we show a decrease in foreign direct investment (FDI) as a consequence of terrorism. We also find evidence that FDI flows are more sensitive to terrorism than either portfolio investments or external debt flows. Finally, we test the hypothesis that terrorism has negative spill‐over effects on FDI flows into neighboring countries and find evidence that cultural, but not geographical, closeness matters.     

The determinants of foreign direct investment into European transition economies

Using a panel dataset of bilateral flows of foreign direct investment (FDI), we study the determinants of FDI from Western countries, mainly in the European Union (EU), to Central and Eastern European ones. We find the most important influences to be unit labor costs, gravity factors, market size, and proximity. Interestingly, host country risk proves not to be a significant determinant. Our empirical work also indicates that announcements about EU Accession proposals have an impact on FDI for the future member countries. Journal of Comparative Economics 32 (4) (2004) 775–787.     

Do remittances improve political institutions? Evidence from Sub-Saharan Africa

Do remittances represent a significant positive determinant of democratic institutions in Sub-Saharan Africa? In this paper, we estimate the effect that remittances have on democratic institutions in Sub-Saharan Africa over the period 1975–2014. Using a 5-year non-overlapping panel sample and controlling for country and time fixed effects, we find that remittances are positively associated with democratic institutions. Our baseline system-GMM estimates indicate that a one standard deviation increase in remittance flows improves democratic institutions by around 0.32 standard deviations. Furthermore, we find that remittances improve democratic institutions by increasing schooling and reducing poverty.     

U.S. foreign direct investment in Latin America and the Caribbean: a case of remittances and market size

This article investigates the effect of remittances on U.S. foreign direct investment (FDI) flows to Latin America and the Caribbean (LAC). It covers 26 countries for the period 1983–2010. The results show a positive and significant impact of remittances on U.S. FDI flows. However, this effect depends upon the level of gross domestic product (GDP) per capita of the host country. On average, the results show that increasing remittances by one standard deviation increases U.S. FDI flows by 0.44 percent a year. Also, host country demand positively affects U.S. FDI flows, which supports the market size hypothesis.     

Ethnic Networks in FDI and the Impact of Institutional Development

Ethnic Chinese entrepreneurs are known for their active business networking practices, particularly in Southeast Asia. This paper empirically investigates the role of ethnic Chinese networks in promoting foreign direct investment (FDI). We further evaluate whether the effectiveness of networking activities are affected by the level of economic and institutional development of the source and the host countries. Using a standard gravity model, we find that ethnic Chinese networks are significant in facilitating cross‐border investment between countries. The strength of ethnic Chinese networks between country pairs, approximated by the product of the numbers of ethnic Chinese in both countries, is positively correlated with the cumulative amount of their reciprocal FDI. More importantly, this significant relationship is not limited to countries in Southeast Asia, but is applicable to other country pairs included in the study as well, regardless of whether the investment is originated from industrial countries or developing economies. Finally, the analysis finds no evidence that ethnic networks are only effective in countries where economic and legal institutions are under‐developed. Ethnic Chinese networks have played a significant role in promoting FDI to countries with a relatively higher bureaucratic quality, much more so than to countries with a lower bureaucratic quality.     

Does direct democracy make for better citizens? A cautionary warning based on cross-country evidence

It has been shown that both formal existence and actual use of direct democratic institutions have effects on a number of variables such as fiscal policies, quality of governance but also economic growth. Further, it has been argued that direct democratic institutions would not only have an impact on policy outcomes but influence citizen participation and attitudes toward politics. For the first time, these conjectures are tested in a large cross-country sample here. Overall, we do not find strong effects and some of the significant correlations are rather small substantially. In contrast to previous studies, voter turnout is not higher when direct democracy is available or used. Further, and also in contrast to previous studies, citizens do not express a greater interest in politics in countries with direct democracy institutions. Finally, they display lower trust in government and parties but not in parliament. These results shed some doubt on the hope that direct democracy would make for better citizens.     

DEMOCRATIC AID AND THE DEMOCRATIZATION OF RECIPIENTS

We investigate whether democratic aid flows, which are directed toward the democratization of recipients by covering democracy‐related programs and government and civil society activities, affect the future political regime of recipient countries. We introduce a multinomial multivariate logit model and we use 5‐yr averaged data covering the period 1972–2004 for 59 democracy aid‐recipient countries categorized into three broad classes according to the prevalent political regime. We find strong evidence that democratic aid flows are positively associated with the likelihood of observing a partly democratic or a fully democratic political regime in democratic aid‐recipient countries and that this result is robust to the potential endogeneity of democratic assistance.(JEL D70, F35, C25)     

Competing to Outsource in the South

This paper analyzes foreign direct investment (FDI) competition in a three‐country framework: two Northern countries and one Southern country. We have in mind the competition of Airbus and Boeing in a developing country. The host‐country government endogenizes tariffs, while Airbus and Boeing choose domestic output and FDI. Wages and employment in the home countries are negotiated. We find that in the unique equilibrium, both Airbus and Boeing compete to undertake FDI in the developing country. This arises because the host country can play off the multinationals, which in turn stems from three factors: (a) oligopolistic rivalry; (b) quid pro quo FDI; (c) strategic outsourcing—FDI drives down the union wages at home if the host‐country wage is sufficiently low. However, if the host‐country wage is sufficiently high, the union wage increases under FDI. In such cases, FDI competition benefits the multinationals, the labor unions, as well as the host country.     

Government Spending and Taxation in Democracies and Autocracies

The paper develops a theoretical rationale for a non-linear relationship between the level of democracy and government spending. A model is presented showing why and how political participation influences the spending behavior of opportunistic governments that can choose an optimal combination of rents and public goods to attract political support. If the level of democracy remains low, governments rationally prefer rents as an instrument to assure political support. With increasing democratic participation, however, rents become an increasingly expensive (per unit of political support) instrument while the provision of public goods becomes more and more efficient in ensuring the incumbent government's survival in power. As a consequence, an increase in democracy, which drives a country from a pure autocracy to a semi-participatory system, tends to reduce government spending, while an increase in political participation from a semi-participatory country to a full democracy tends to raise the size of the public sector.     

Shaken,Not Stirred: The Impact of Disasters on International Trade

This paper examines the impact of major disasters on import and export flows using a gravity model (170 countries, 1962–2004). As a conservative estimate, an additional disaster reduces imports on average by 0.2% and exports by 0.1%. Despite the apparent persistence of bilateral trade volumes, we find that the driving forces determining the impact of disastrous events are the level of democracy and the geographical size of the affected country. The less democratic and the smaller a country the greater is its loss due to a catastrophe. In autocracies, exports and imports are significantly reduced. Had Togo been struck by a major disaster in 2000, it would have lost 6.2% of its imports and 3.7% of its exports. While democratic countries' exports suffer identical decreases, imports increase.     

Foreign direct investment: the role of institutional and cultural determinants

Using panel data for 29 source and 65 host countries in the period 1995–2009, we examine the determinants of bilateral FDI stocks, focusing on institutional and cultural factors. The results reveal that institutional and cultural distance is important and that FDI has a predominantly regional aspect. FDI to developing countries is positively affected by better institutions in the host country, while foreign investors prefer to invest in developed countries that are more corrupt and politically unstable compared to home. The results indicate that foreign investors prefer to invest in countries with less diverse societies than their own.