Foreign Direct Investors as Agents of Economic Transition: An Instrumental Variables Analysis
Quarterly Journal of Political Science, Vol. 4, pp. 59-85, 2009
27 Pages Posted: 1 Sep 2010
Date Written: August 1, 2009
Previous empirical analysis has noted a correlation between Foreign Direct Investment (FDI) and economic reform in Eastern Europe and the Former Soviet Union, but has attributed the relationship to investors rewarding countries after reform decisions. Little attention has been paid to the fact that investors’ lobbying efforts may actually influence reform choices. This paper finds a positive effect of FDI on reform progress through a panel analysis of investor influence in 27 transition states (1991-2004). To address endogeneity bias, the exogenous portion of a country’s exchange rate movement is used as an instrument in a two-stage procedure. The underlying counterfactual comparison that results from this approach is between two similarly situated countries, but where one country experienced a large shift in the share of FDI in its economy as a result of changes in the international economy and the other did not. Further analysis reveals that the relationship is particularly strong in the manufacturing and service sectors, but does not hold for construction, utilities, or natural resource based projects.
Keywords: Foreign Direct Investment, Transition, Economic Reform, Eastern Europe, Instrumental Variables
JEL Classification: F23
Suggested Citation: Suggested Citation