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

28 Pages Posted: 5 Jul 2006

See all articles by Jo Jakobsen

Jo Jakobsen

Norwegian University of Science and Technology

Indra De Soysa

Norwegian University of Science and Technology

Abstract

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.

Suggested Citation

Jakobsen, Jo and De Soysa, Indra, Do Foreign Investors Punish Democracy? Theory and Empirics, 1984-2001. Kyklos, Vol. 59, No. 3, pp. 383-410, August 2006. Available at SSRN: https://ssrn.com/abstract=914246 or http://dx.doi.org/10.1111/j.1467-6435.2006.00338.x

Jo Jakobsen (Contact Author)

Norwegian University of Science and Technology ( email )

Department of Sociology and Political Science
Trondheim NO-7491
Norway

Indra De Soysa

Norwegian University of Science and Technology ( email )

Høgskoleringen
Trondheim NO-7491, 7491
Norway

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