The Dynamics of Democracy and Direct Investment: An Empirical Analysis

Why do foreign direct investment (FDI) inflows largely bypass the developing world? The objective of this article is to study this question by focusing on the effect of an increase in the level of democracy on FDI inflows into developing countries. An increase in the level of democracy provides the right macro and micro conditions for larger FDI inflows. The econometric results indicate that a one standard deviation increase in the level of democracy is associated with increased FDI inflows. My empirical findings support a direct relationship between enhanced levels of democracy and FDI inflows, and the results call into question the idea that developing countries receive less capital inflows if they choose to democratize. Moreover, a reanalysis of Li and Resnick's influential 2003 paper essentially overturns their findings in support of a direct association between an increase in the level of democracy and greater FDI inflows.