The Politics of Investment: Partisanship and the Sectoral Allocation of Foreign Direct Investment

Abstract

This paper explores the existence of partisan cycles in foreign direct investment performance. Our theoretical model predicts that the incumbent government's partisanship should affect foreign investors' decision to flow into different sectors of the host country: pro-labor governments would encourage the inflow of the type of investment that complements labor in production; pro-capital governments would promote the entry of investment that substitutes for labor. Empirical evidence from a sample of OECD countries reveals a pattern of foreign investors' response to partisan cycles consistent with the predictions of the model. First, foreign investment systematically flows into different sectors of the host economy under left and right leaning incumbents. Second, we find a positive correlation between foreign investment and changes in average wages under left-leaning incumbents, but no effect on wages under right-leaning governments.

Keywords: foreign direct investment, partisan governments

JEL Classification: F21, F23, D72, D78