Do Civil and Political Repression Really Boost Foreign Direct Investments?

Beginning of article

I. INTRODUCTION

The globalization of the economy is an issue that continues to attract a great deal of attention in the political arena. The exchange of opinion unfortunately often does not follow civilized patterns but is articulated in street riots. The third ministerial conference of the World Trade Organization (WTO) in November-December 1999, for example, gave rise to the now-legendary Battle of Seattle, and the 55th Annual Meeting of the International Monetary Fund (IMF) and the World Bank Group (WB), which took place in September 2000 in Prague, was also accompanied by violent demonstrations.

The arguments of the demonstrating opponents of economic globalization, peaceful or violent, appear to follow a standard pattern. One of the groups demonstrating in Prague, for example, described its objectives as follows:

We will be exposing the links between the IMF/WB, the WTO and transnational corporations and the ways how they work to maximize private profits and limit the power of people to protect the environment, determine their economic destiny, and safeguard their human rights. ... Our goal is to give the proper name to what the policies of the IMF/WB really cause in the South as well as in the Central and Eastern Europe. We will be demanding an immediate suspension of these practices leading to environmental destruction, growing social inequality and poverty and curtailing of people's rights. (1)

In short, globalization is interpreted as a devious maneuver undertaken by multinational firms that, on the one hand, relocate production to undermine the tax and regulation policies of democratic nation states and, on the other hand, exploit the politically and economically repressed workers in third-world autocracies: "Essentially, the WTO, and the 'new' Global Economy, hurt the environment, exploit workers, and disregard civil society's concerns. The only beneficiaries of globalisation are the largest, richest, multinational corporations." (2)

It would be wrong to denigrate these statements as mere battle cries of street fighters because similar patterns of argumentation can be found in the extensive popular literature on globalization. The reproach that multinational enterprises have a special liking for autocratic countries in which workers are not allowed to organize themselves (with the result that the wage rates do not reflect their productivity) can be found, for example, in William Greider's 1998 bestseller One World, Ready or Not: The Manic Logic of Global Capitalism. Greider (1998, 38), in particular, argues against the hypothesis that foreign direct investment (FDI) may have a liberalizing effect in these countries:

The promise of a democratic evolution requires skepticism if the theory is being promoted by economic players who actually benefit from the opposite condition--the enterprises doing business in low-cost labor markets where the absence of democratic rights makes it much easier to suppress wages. A corporation that has made strategic investments based on the cost advantages offered by repressive societies can hardly be expected to advocate their abolition.

Greider understands, of course, that FDI decisions are influenced by balancing labor cost advantages against losses of labor productivity. However, he writes in this context:

The general presumption that low-cost workers in backward countries were crudely unproductive was simply not true. In fact, dollar for dollar, the cheaper workers often represented a better buy for employers than the more skillful workers who were replaced. Their productivity was lower but it also improved rapidly-much faster than their wages. In order to attract foreign capital, their governments often made certain this was the case. (Greider, 1998, 74)

Greider's statements echo a line of argument that has a long tradition in the political-economic literature analyzing the effect of democracy on economic growth. (3) Various authors have postulated that due to their greater ability to enact painful yet efficiency-enhancing policies, autocratic rulers provided a better environment for domestic and foreign investment than democratic governments (see, e.g., Huntington and Dominguez, 1975). Although autocratic regimes obviously also resorted to some redistribution to create loyalties and to consolidate their power, it was claimed that this redistribution usually came in the form of "measures which transfer rights over the control of labor from labor to capital" (Wintrobe, 1998, 161). As a result, regimes characterized by "bureaucratic authoritarianism" (O'Donnell, 1988) were supposed to foster domestic capital accumulation, foreign investment, and growth.

The benefits of authoritarian rule for private investors, however, are not uncontested, and a number of authors argue that the allegedly greater security of property rights offered by repressive regimes may be an illusion. Though an autocratic ruler may shield the owners of capital from the citizens' pressure for redistribution, there are few constraints that limit his or her own behavior, and though the business climate he or she currently offers to investors may be favorable, the investors face a considerable risk of policy reversals--driven either by the dictator's own distributional interests, the need to gather support by sudden turns to populism, or the violent transformation of the entire system by a revolution. This is the point brought forward by Olson (1993) and McGuire and Olson (1996), who contrast the lack of credibility of a short-sighted autocratic ruler with the longer time horizon of the average citizen and stress the importance of democratic checks and balances as a commitment device.

As Przeworski and Limongi (1993) point out, neither of the two positions is completely convincing. The view that dictatorships enhance growth by providing a better protection of property rights "fails to answer why an autonomous state would behave in the interests, long- or short-term ones, of anyone else" (Przeworski and Limongi, 1993, 57) and why an autocratic ruler should place the interests of capital above those of labor. On the other hand, Olson's (1993) more optimistic view of democracy's role in solving the time inconsistency problem does not explain why a country's citizens should have a longer time horizon than a dictator. Hence, what emerges as a conclusion of this literature is that theory does not deliver an unambiguous hypothesis about democracy's impact on investment and growth, and that empirical research has to show which of the forces described dominates.

Given the heated debate about the role of multinational firms in developing countries, it is surprising that there is almost no systematic analysis of the relationship between globalization and the respect for human rights. Do civil and political repression really boost FDI, and are multinational firms attracted by countries in which workers' rights are curtailed, or do they prefer societies in which political participation and civil liberties are guaranteed and in which an organized labor force is able to pursue its interests? In this article we try to answer these questions by systematically examining the hypothesis that multinational enterprises preferably invest in countries in which the working populations' civil and political rights are disregarded.

We find that indices of political and civil repression have a significant influence on foreign direct investment per capita and that this influence is negative. This result emerges both from a cross-section analysis that considers average values for the early to mid-1990s and from panel estimations that exploit the time series variation of the data. (4) Moreover, a greater degree of unionization among workers seems to attract rather than deter foreign investors. The results of our study thus not only support the view that the location decisions of multinational firms are influenced by the host country's political system, they also contradict the widespread perception that international investors are attracted by societies in which political rights are repressed and workers' representation is curtailed.

The rest of the article is structured as follows. The next section presents our data set and performs a cross-section regression using average data for the early and mid1990s. We then exploit the time-series dimension of our data set by performing a fixed-effects panel regression. Finally, we apply a two-step procedure, first identifying the factors that cause the time-series variation in FDI and then checking whether measures of democracy influence the time-invariant country fixed effects. The last …