Academic journal article Romanian Journal of Political Science

Foreign Direct Investment and Civil Rights: Testing Decreasing Returns to Civil Rights

Academic journal article Romanian Journal of Political Science

Foreign Direct Investment and Civil Rights: Testing Decreasing Returns to Civil Rights

Article excerpt

Overview

This study addresses the relationship between quality of democracy and the level of inflows of foreign direct investment (FDI inflows). In particular, it examines how effective improvements in political and civil rights are to attract inflows of foreign direct investment for democracies. I contend that advances in the quality of democracy--specifically in the area of civil rights--present positive but decreasing marginal returns for attracting FDI inflows. In other words, as the quality of democracy progresses, the marginal returns to civil rights decline. I empirically prove this regularity in polities with recent democratization experiences--more precisely by using panel data regressions within the Latin American and Eastern European contexts from periods following their democratization (1991-2003).

Due to the evidence of decreasing returns to civil rights, I conclude that 1) countries that boost the scope of civil rights after democratizing (despite its diminishing but positive returns) are relatively more successful in attracting FDI inflows than those with extreme levels; 2) politicians and policy-makers should expand the provision of civil rights selectively if the maximum impact in terms of foreign investment (and eventually more economic development through foreign direct investment) becomes a priority; and 3) despite the existence of diminishing returns, the impact of any increase in the scope of civil rights is almost always positive on the amount of FDI inflows.

In order to extend the literature on the role of political variables in attracting FDI inflows, I estimate the impact of changes in the quality of democracy during the first stages of democratic consolidation on the behavior of foreign investment inflows. After verifying the existence of decreasing returns to the quality of democracy--measured by the scope of civil rights--new venues for further research are suggested to explore why and how different components of civil rights can produce such a property (decreasing returns to civil rights).

Politics and Foreign Direct Investment

Previous studies on the role of good governance or other political variables (concerning democratic quality) in attracting FDI inflows have mainly concentrated on the relationship between FDI inflows and 1) type of regime (whether democratic or not); or 2) only one aspect of democratic consolidation or political condition (e.g., corruption, tests of expropriation, political risks insurance, tax incentives, and property rights).

Using the first approach, several scholars have focused on determining the link between regime type and investor confidence (Jessup 1999; Jensen 2003; Li and Resnick 2003; O'Neal 1994). For example, O'Neal (1994) finds that authoritarian regimes provide investors with higher returns of profitability in developing countries. However, overall investment flows are not generally related to regime type. Likewise, Jessup (1999) argues that authoritarian regimes in developing nations attract more international investment. On the other hand, Jensen (2003) concludes that democratic governments attract higher levels of FDI. Between these divergent views, Li and Resnick (2003) were perhaps the first to suggest that democratic institutions can affect FDI inflows both positively and negatively. However, Li and Resnick mainly focus on the role of property rights, arguing that increases in democracy improve property rights protection, thus encouraging FDI inflows. Like Li and Resnick, another group of scholars tested the hypothesis that enforcement of property rights can increase the attractiveness of a host country for foreign investors (Biglaiser and Danis 2002; Jensen 2003).

The second approach has more recently incited debate among scholars. This research has tended to move away from aggregate FDI flows. Traditionally, these studies were focused on the role of corruption in explaining FDI inflows. …

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