Policy Uncertainty, Irreversibility, and Cross-Border Flows of Capital

Abstract

We examine the effects of political uncertainty on cross-border capital flows using election timing as a source of fluctuations in political uncertainty. FDI flows from US companies to foreign affiliates drop significantly during the period just before an election and increase after the uncertainty is resolved, consistent with the view that political uncertainty deters foreign investment. The electoral patterns in FDI flows are more pronounced when elections are more competitive. The impact of political uncertainty on FDI flows depends on the level of institutional quality. Countries with higher levels of institutional quality experience significantly less variation in FDI around election cycles.

Keywords: Political Uncertainty, Foreign Direct Investment

JEL Classification: G15, G31, G38