Do Foreign Investors Punish Democracy? Theory and Empirics, 1984–2001

Abstract

SUMMARY Some claim that when level of property rights protection is controlled, democracy lowers foreign direct investment (FDI) to developing countries (Li and Resnick 2003). We critically examine the theoretical claims of the pessimistic arguments and show that FDI responds to preferences of countries and that democracies have a clear preference for FDI given that the scarce factor – capital – will find it harder under democracy to seek rents by raising barriers to entry. On the other hand, labor (the abundant factor in developing countries) should profit from lower barriers to capital importation. We demonstrate conclusively that the most prominent pessimistic result on democracy in the literature is simply an artefact of sample size and testing procedure. We establish robust evidence suggesting that developing country democracies actually receive higher inflows of FDI, net of a number of control variables. Consistent with our view that host nations' attitudes are shaped by factor endowments, which in turn determine rent‐seeking, we demonstrate that governments controlled by ‘leftist’ political parties also receive more FDI than ‘centrist’ or ‘rightist’ governments among democracies. Why this should be true is not obvious from a theory based on property rights risk alone. An extended sample of LDCs and a better operationalization show that property rights and democracy positively affect FDI. Our results suggest that globalization advances the fortunes of democracies in the developing world.

Political risk and foreign direct investment in Nigeria: New empirical evidence

“…Studies in the past have used the ICRG classification of investment profile of host nations to examine the level and extent of how payments, repatriation of profits and expropriation or viability of contracts are affected (Bandyopadhyay et al, 2013;Jakobsen & & Soysa, 2006;Mohamed & Sidiropoulos, 2010). We hypothesized that investment profile of host nation is expected to favor the inflow of FDI despite the discouraging effect of political risk (H1).…”

Political environment and foreign direct investment: Evidence from OECD countries

“…Practical difficulties of corruption aside, Li and Resnick (2003) present empirical results that seem to be consistent with the notion that the existence of democracy is a dissuading factor for foreign investors who prefer to engage with autocracies. However, in a follow-up study, Jakobsen and de Soysa (2006) demonstrated that Li and Resnick's findings are very sensitive to the sample selection and the choice of modeling approach.…”

“…Schneider and Frey (1985) presented a model, which linked FDI inflows to a binary variable for a leftist executive, but the relationship proved to be statistically insignificant. In a more recent examination, Jakobsen and de Soysa (2006) used a similar measure and found a strong positive influence, indicating that pro-labor governments may welcome FDI due to their potential to reduce unemployment. The current investigation employs a different classification of political ideology compared to that used in Schneider and Frey (1985) and Jakobsen and de Soysa (2006).…”

“…In a more recent examination, Jakobsen and de Soysa (2006) used a similar measure and found a strong positive influence, indicating that pro-labor governments may welcome FDI due to their potential to reduce unemployment. The current investigation employs a different classification of political ideology compared to that used in Schneider and Frey (1985) and Jakobsen and de Soysa (2006). Instead of relying on the traditional dichotomy, the political spectrum is divided here into right, left and center.…”

Political Regime and Vertical vs. Horizontal FDI

“…For example, Li and Resnick (2003) show that when the level of property rights protection is controlled for, democracy reduces FDI to developing countries. Jakobsen and Soysa (2006) examine the same question and find that such negative relationship between democracy and FDI is fully dependent on sample size and estimation methodology. Their results support a strong positive relationship between democracy and FDI in developing countries.…”