Foreign Direct Investment, the Rule of Law, and the New Institutionalism: Explaining FDI in the Developing World

Abstract

This papers examines the relationship between the rule of law and foreign direct investment (FDI) in the developing world. It combines statistical analysis with the results of an original survey of U.S.-based investors. I find protecting physical integrity rights and contract and property rights are related to FDI. Given the importance of the rule of law for attracting FDI, why do countries with a weak rule of law still attract significant investment? The survey analysis shows investors perceive strong personal relationships as potentially mitigating the uncertainty found in contexts where the rule of law is weak. That is, investors seem to believe personal relationships can offer guarantees similar to those provided by the formal rule of law. Drawing these findings together, I argue that mechanisms for mitigating uncertainty such as the two identified here – a strong rule of law and robust personal relationships – are important factors affecting FDI levels across the developing world.