Globalization, Democracy, and FDI

• Economic globalization and the spread of political democracy are key aspects of today's international political economy.
• FDI inflows have increased faster than global income since the 1960s.
• Multinational enterprises (MNEs) account for about 70% of global trade.
• Sales by foreign affiliates surpass total global exports.
• Foreign production capital has spread to almost all developing countries since the 1980s
• The number of foreign affiliates in developing economies has reached 129,771, compared to 93,628 in developed countries.
• Liberal democracy has also spread, with less-developed countries (LDCs) seeing increased political participation, open elections, and expanding civil societies.
• The percentage of democratic and partly democratic countries rose from 31% in 1975 to 73% in 1995.
• The effect of democracy on FDI is understudied and poorly understood.
• Explaining the effect of democratic institutions on FDI is important for both theory and policy.

Understanding the Democracy-FDI Relationship

• Democratic governance may hurt a country's attractiveness to foreign investors, the developing country has to consider competing for limited FDI vs democratization
• Deepening democratic governance may enhance a country's ability to attract FDI, helping to deliver economic benefits from foreign capital.
• The stakes for leaders in LDCs are high because of the consequences.
• There’s a gap in how scholars explain interactions between economic globalization and political democracy.
• Article focuses on the causality from democratic institutions to FDI inflows.

Conflicting Answers From Previous Theories

• Olson argues that independent judiciaries and electoral challenges in democracies help guarantee property rights, securing investments.
• Investors favor these regimes, protecting assets from dictators.
• Higher levels of democracy should lead to more FDI inflows.
• O'Donnell argues investors and autocrats share a relationship.
• Autocrats protect foreign capital from pressures for higher wages, labor protection, or less capital-friendly taxation, due to political leaders' interest in economic benefits from FDI.
• Both Olson and O'Donnell suggest contradictory answers to the democracy-FDI relationship.
• Olson associates stable democracies with fertile investment territory through property rights.
• O'Donnell illustrates investor-state collusion favoring foreign capital in autocratic countries.
• Other scholars have contrasting arguments.
• Because democracy receives support, avoids changes, and institutionalizes redistribution, democratic developing countries tend to have less property rights violations and more private investment
• Haggard argues authoritarian rule attracts investors where there’s strong pressure from labor to their economic viability or basic property rights.
• Autocrats, in some contexts, may protect property rights rather than practicing banditry.
• Authoritarian regimes offer elites autonomy from pressures, broadening economic policy options.
• An alliance of state, local, and multinational capital is likely in autocratic countries where leaders prefer repression due to fear of diluted control.

Theoretical Synthesis and Extension

• Democratic institutions have conflicting effects on FDI inflows.
• Democratic institutions hinder FDI inflows through three avenues:
  • Constraints on elected politicians weaken the positions of multinational enterprises.
  • Constraints prevent host governments from offering financial and fiscal incentives to foreign investors.
  • Access to elected officials and political participation offer ways for businesses to seek protection.
• Increased pluralism ensured by democratic institutions generates policy outcomes that reduce the MNE's degree of freedom in the host developing country.
• Democratic institutions promote FDI inflows by strengthening property rights protection.
• Representation of citizen interests in the legislature prevents the state from predatory rent-seeking.
• Constraints over elected politicians guarantee contract enforcement for businesses.
• These effects generate credible property rights protection, reducing risks for foreign investors and encouraging foreign investment.
• The net effect of democratic institutions on FDI inflows to developing countries relies on the relative strength of these competing forces.
• Existing empirical work explores the effect of democracy on FDI.
• Oneal stands out as the first quantitative study of how regime characteristics affect FDI, whether foreign firms invest more and collect more profit in authoritarian countries than in democracies.
• Oneal finds the relationship between regime type and FDI flows is not statistically significant. Returns on investment are best in developed democracies but are greater in authoritarian countries among LDCs.
• Oneal does not consider the competing effects of democracy and focuses on FDI from the United States to LDCs dyadically, covering a different time frame.
• Resnick analyzes how democratic transition affects FDI but does not consider the role of property rights outside of democratic institutions, statistically significant negative effect on FDI.
• Theory identifies causal avenues through which democratic institutions promote or hinder FDI inflows. Assesses quantitatively positive and negative effects of democratic institutions on FDI inflows with testing covering fifty-three developing countries from 1982 to 1995.
• It is found that property rights protection and democracy related property rights protection encourage FDI inflows and democratic institutions improve private property rights protection
• When focusing the positive effect of democracy through property protection, results support initial theoretical claims when democratic institutions reduce FDI inflows.

A Theory on How Democratic Institutions Affect FDI Inflows

• The effects of democratic institutions on FDI inflows is based on the logic of why firms invest abroad.
• The level of FDI inflows hinges on the interactions between MNEs and host countries.
• By impacting these interactions, democratic institutions encourage or deter foreign direct investors.

Firm Advantages

• Dunning explains international production is motivated by advantages perceived by firms.
  • The first set is a firm's ownership-specific advantages, which include intangible assets and common governance of cross-border production.
  • Intangible assets are product innovations, management practices, marketing techniques, and brand names.
  • Diversification across borders allows a firm to exploit economies of scale and to develop monopoly power based on its size and established position.
  • The foreign investor's advantages are tied to property rights protection in the host country.
  • An is tied to security of its intellectual and physical property in multiple countries.
• The second set of advantages concerns a firm's internalization advantages.
  • Internalization refers to a firm's direct control over its value-added activities in multiple countries, as opposed to outsourcing, trade, or licensing.
  • The size of a firm's advantages correlates with the degree of transnational market failure.
  • The economic incentive to claim hierarchical control of cross-border production exists where economic advantage is likely from exploiting oligopolistic or monopolistic market structures or large-scale production.
• The third refers to location-specific advantages, which are perceived by firms or the characteristics of host countries. -The advantages are of host countries economic environment and governmental policies, including labor and natural resources.
  • Government policies on tariffs, taxation, regulation of corporations, royalties extracted, etc.
• The connection between politics and FDI hinges on the interaction between host governments and MNEs. Firms select investment sites based on how well their advantages mesh with location-specific benefits. Host government policies create location-specific conditions that affect how well a firm can exploit its advantages.

Suppressive Effect of Institutions on FDI Inflows

• First, the MNE's advantage result from or are enhanced by, the oligopolistic or monopolistic market structures. Host government regulatory policies may limit the use of these advantages, particularly through antitrust and other competition-oriented legislation.
• Second, endowed with the advantages, the MNE is more competitive than, and often displaces, indigenous firms in the host country, government may adopt industrial policy that either protects indigenous businesses from the MNE or favors the MNE.
• Third, expecting FDI managerial skills, the host government may offer investors financial and fiscal incentives, affect the choice of FDI location, but also strengthen the competitiveness of foreign investors.
• The MNE must rely on the host government for protection of its property rights in proprietary assets.
• Good and bad investment climates for MNEs differ:
  • A good climate facilitates the MNE's exploitation of its ownership-specific and advantages, including government regulation and property rights protection.
• Domestic political institutions, because they define the policymaking environment, have effects on the quality of the investment climate.
• Domestic political institutions are defined by relative strength of democratic versus autocratic characteristics of a country's political system.
• It depends on the degree to which citizens are able to choose how and by whom they are governed.
• Democratic institutions typically include free and fair elections of the executive and legislative offices, the right of citizens to vote and compete for public office, and institutional guarantees for the freedom of association and expression such as an independent judiciary and the absence of censorship.
• Institutions supply regular constitutional opportunities for changing the governing officials, and a social mechanism that permits the largest possible part of the population to influence major contenders for political office.
• Politicians have incentives to develop public policies reflecting the sentiment. Representative democracy also allows various interests to be represented in the legislature, constraining executive power.
• The stronger a country's democratic characteristics, the more likely its social interests are to get organized and participate in political competition.
• Democratic political processes are characterized by the influence of diverse opinions over electoral and public policymaking.
• Autocratic characteristics derive from limited pluralism, including co-option of civil society leadership or legal limitation of pluralism, a single leader or small ruling clique, and weak political mobilization.
• Autocratic politics are biased in favor of narrow elite control over public policy.
• Relative strength of democratic and autocratic characteristics defines the nature of political institutions.

Hindering FDI Inflows

• Democratic institutions attenuate many MNEs' ability to exploit and enhance their monopolistic or restricted positions.
• Firms invest abroad to take advantage of their advantages that often result from, and further result in, market structures.
• MNEs constitute the bulk of FDI, possess market power, and have shaped trade patterns in the global economy.
• In the host countries, such MNEs seek to create and strengthen their restricted positions that result in higher returns.
• Imperfect market structures, lead to less optimal allocation of resources in the host economy than perfection competition.
• MNEs desire to create, maintain and increase their position sets them at odds with host country governments, particularly democratic ones.
• In more democratic host governments, elected politicians encourage investment to improve economic performance.

Competition and Motivation

• That many MNEs may decrease market competition motivates elected politicians to limit the monopoly or position of the relevant MNEs through public policy.
• Democratic characteristics of the host country constrain the pursuit by many MNEs of restricted power.
• Conversely, autocratic host governments are less likely to clash and more likely to collude with the MNEs.
• Definition, the size of the winning coalition for autocratic leaders is smaller than for democratic leaders because autocratic rulers depend less on popular support to stay in power.
• Host primary focus is to generate more revenues for the ruling clique.
• Narrow elite control allows rulers to subdue dissenting voices with results in better conditions for the host governments overall.
• Industrial policy is another arena in which country degrade conditions for MNEs.
• Country advantages increase their competition leading to more loss with indigenous firms and their government support.
• New jobs and resources do not go to the displaced capital and workers. -Have multiple avenues to influence policy-making in democratic countries but their actions are discounted within them and not always beneficial due to their own country concerns.

Generosity Limits

• Institutions limit fiscal and financial incentives host often offer to attract investors.
• Factors include choice of location and type of inducement which include tax holidays, exemptions from import duties, deductions from social security contributions, accelerated depreciation allowances, investment grants, subsidized loans, donations of land or site facilities, and wage subsidies.
• Domestic players have ways to pressure executives and legislators and influence making in strong domestic constitutions. FDI stock, inflows, and associated openness tend to increase income inequality. FDI also concentrates in certain sectors, industries, leading to dual economies unlikely to take advantage of the beneficial spillovers.

Negotiated Lack of Transparency

• The process inherently lacks transparency and accountability in strong and often leads to graft, corruption, and rent seeking.
• Critics have greater access to the political participation and more able to limit the generosity because their governments has greater latitude.
• The "veto" office-holders inhibit in more autocratic companies through election.

Positive Effects of Institutions on FDI Inflows

• Democratic institutions lead to representation of a wide range of social interests and facilitate mobilization, government encroachment on private rights is minimized.
• Property rights protection is extended by MNEs investors and encourages FDI inflows.
• Security, regulatory stability transparency, and legal processes imply lower risks.
• Regime type and protection.

Securing Rights

• Democratic institutions are more effective at securing private rights than autocratic institutions.
• Typically, the state supports the property in exchange for taxes.
• The state monopolized the rights protections while endangered credibility states.
• Protection by state is not self-enforcing, it cannot abide for agreement later.
• In the British parliaments had to increase and secured private rights by a larger set to create veto players.

Additional Effects

• An independent judiciary increased costs of supplies to secure benefits.
• Able autocracies offered rights with integrity limited to a ruling elite and exerted the power of volition.
• The set of institutions served to lower risks of corruptions of law for citizens and investors.
• Our theory suggests institutions have conflicting effects in the direction to limit behaviors of multinationals, facilitate domestic industry protection and constrain host government. On the other hand, countries better protect reducing risks and attracting FD inflows.

Testing and Design

• Test covering data of 1982 - 1995 with democratic characteristics through time-series designed because arguments applied comparisions with each individual.
• Variable level each measured current USD.

Separated Effects

• To get negative and positive factors.
• Two different methods: The first with a composite measure of democracy and the second used different component institutions and separate variables.

Measurements

• Composite measurement drawn and updated annually from 1800 – 1999, Polity 4 Database. It consist of: Competitiveness of participating regulations and executive confinement with selection for leaders of politics.
• One of essential inter-related concepts: institution and procedures which cite the policies and constitution with the executive actions. All three are measured as executive and restriction components.

Positive Effects Measurements

• Positive effect through the causal with protection, one model of variables captures effects. The index based on component or regulations of business with the index and same to applied growth and development.