Do Political Institutions Affect Foreign Direct Investment? A Survey of U.S. Corporations in Latin America

Article excerpt

Abstract

The political economy literature investigates the determinants of foreign direct investment (FDI) based largely on aggregate data, ignoring the actual decision makers. The authors conduct a survey of U.S. chief executive officers-the actual decision makers-of corporations that have investments in Latin America to understand FDI inflows. The authors find that investment risk related to property-rights protection, adherence to rule of law, and an effective court system weighed most heavily in U.S. firm preferences. The results suggest that rather than stress democracy itself as a determining factor, researchers might better focus on the institutions found within democracies.

Keywords

foreign direct investment, property rights, rule of law, effective courts, investment security

The past two decades have seen a revival of both democracy and foreign direct investment (FDI) in the developing world. The similar time frame led many political economy scholars to argue that political reform and foreign investment were no coincidence-that democratization promoted increased FDI in the developing world (Busse 2004; Feng 2001; Henisz 2000; Jensen 2003, 2006; Li 2006a; Li and Resnick 2003). However, not all scholars agree. Some studies find either that authoritarian regimes are more attractive to foreign investors (Huntington 1968; O'Donnell 1978; Oneal 1994; Tuman and Emmert 2004) or that regime type makes little difference for FDI inflows (Biglaiser and DeRouen 2006; Crenshaw 1991). Other researchers claim that economic factors, including macroeconomic conditions and market-oriented reforms, are the most important FDI determinants (Rummel and Heenan 1978; Baer and Miles 2001). Still others suggest that security issues (such as good relations between the host country and the home country) and geographic proximity to the home country of the investor are key considerations for explaining investment flows (Jones and Kane 2005; Biglaiser and DeRouen 2007).

The different findings reached by such excellent scholarship suggest the value of a new approach to gain deeper insights about the factors that contribute to FDI. Most previous studies use large data sets from the World Bank, International Monetary Fund (IMF), and other sources to arrive at their conclusions. Missing from these studies, however, is information from the actual decision makers-the foreign investors themselves. While imputing the motivations of investors based on broad economic and political measures is justified when there is nothing else to go on, it seems that going directly to the source is better for understanding investor motivations.

Our study does just that, by querying investors about their investment priorities. In the first study, which we are aware of, that includes questions related to political, economic, and geographic factors, we administered a survey sent to chief executive officers (CEOs) of U.S. firms with operations in Latin America to understand what influences their investment decisions.1 Latin America is an ideal setting to survey FDI determinants because not only has the region shed many of the authoritarian orientations that plagued it during the 1940s through the 1970s, but it has also witnessed a surge in its share of world FDI (Blonigen and Wang 2004). Moreover, FDI inflows vary across the region, which enriches country comparisons.

To test the investment determinants presented in previous research, our survey includes questions about the importance of macroeconomic conditions, economic reforms, regime type, investment risk, and other potential explanations. In addition, to test the validity of the survey results, we carried out panel data analysis of 138 developing countries from 1976 to 2004. Confirming findings in work by Biglaiser and DeRouen (2006), Feng (2001), Li and Resnick (2003), Globerman and Shapiro (2002), Grosse (1997, 148), Crenshaw (1991), and Tuman and Emmert (2004), the survey and panel data indicate that property-rights protection through democratic institutions weighed most heavily in deciding whether to increase investments in any given country. …