FDI and Democracy: A Gravity
Analysis
Does a democratic country receive more FDI?
Final report
Client:
ECORYS Nederland BV
Eva van Etten
Rotterdam, November 2008
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MW/KB CD17500
Table of contents
Preface
8
List of abbreviations
9
Summary
11
Introduction
13
1 Literature review
1.1 Gravity analysis
1.2 The Determinants of FDI
1.3 The Determinants of the MNE
15
15
19
21
2 Democracy
2.1 What is democracy?
2.2 Link FDI and Democracy
2.3 Democracy and FDI illustrated
2.4 Kaufmann indices
2.5 Control variables
25
25
27
28
31
33
3 Empirical analysis at the aggregate level
35
4 FDI relative to trade
4.1 The importance of democracy to trade
4.2 Analysis and results
39
40
41
5 FDI and Democracy on an Industrial level
5.1 Analysis and results
45
46
6 Policy implications and conclusion
6.1 Policy implications
6.2 Conclusion
49
49
50
Annex 01: Figures 1-4 Bergstrand and Egger (2007)
53
Annex 0.2: Technical notes
57
Annex 03 Kaufmann indices quantified
59
MW/KB CD17500
Annex 04 Q-statistics
63
Annex 05 Granger causality
64
Literature list
65
MW/KB CD17500
Preface
This study is written in the context of the ECORYS Research Programme “Impact
Assessments and Industrial Competitiveness”. In Phase I of this ERP project an extensive
literature review of different ex-ante impact assessment methodologies has been created. One
category of impact assessment methodologies is gravity analysis, which is the impact
assessment covered by myself in the literature review. This also means that in the study
preceding here for you, I will use gravity analysis as a means to my empirical research in
Phase II of the ERP project.
I would like to thank prof. J. Bergstrand, an authority on gravity, for his guidance and
assistance. I would also like to thank Prof. dr. Charles van Marrewijk, Dr. K.G. Berden and
Richard Liebrechts for their assistance.
8
FDI and Democracy: A Gravity Analysis
List of abbreviations
BEA
BERI
CEECs
CEPII
CoC
Comlang off
Distwces
EIU
FAS
FDI
FTA
GATT
GDP
GDPdest
GDPsource
GE
GNP
GPC
HMNE
H-O
IC
IMF
LDC
M&A
MNE
NBQML
NE
OECD
OLI
OLS
Pop
Popdest
Popsource
PRI
PS
PTA
R&D
Rol
ROW
RQ
Bureau of Economic Analysis
Business Environment Risk Intelligence, S.A.
Central Eastern Europe Countries
Centre d’Etudes Prospectives et d’Informations Internationales
Control of Corruption
Common official language
Distance weigthed
Economist’s Intelligence Unit
Foreign Affiliate Sales
Foreign Direct Investment
Free Trade Agreement
General Agreement on Tariffs and Trade
Gross Domestic Product
GDP destination country
GDP source country
Government Effectiveness
Gross National Product
GDP per capita
Horizontal MNE
Heckscher-Ohlin
Investment Cost
International Monetary Fund
Least Developed Country
Merger and acquisitions
Multinational Enterprise
Negative Binomial Quasi Maximum Likelihood
National Enterprise
Organisation for Economic Cooperation and Development
Ownership Location and Internationalization
Ordinary Least Squares
Population
Population destination country
Population source country
Political Risk Index
Political Stability
Preferential Trade Agreement
Research and Development
Rule of Law
Rest of World
Regulatory Quality
FDI and Democracy: A Gravity Analysis
9
SMCs
TC
TSCS
VaA
WTO
10
Southern Mediterranean Countries
Trade Cost
Time-Series-Cross-Section
Voice and Accountability
World Trade Organization
FDI and Democracy: A Gravity Analysis
Summary
The main topic of this study is to research whether or not there exists a relationship between
the level of democracy in a certain country and the amount of FDI inflows into that country.
In other words; does a democratic country receive more FDI? For this research a gravity
analysis is employed, as an extensive literature review revealed that this method is not used
often. This literature review also shows that there is no consensus on the subject. Democracy
is used as a proxy for investment climate in the study. For the measurement of democracy the
Kaufmann indices are used. The gravity analysis results in a nuanced answer, as not all of the
Kaufmann indices show the desired positive sign. However, as the significance levels of all
the democracy indices are high, the inclusion of the democracy indices is a valid one. Overall,
the positive effects outweigh the negative effects, resulting in the conclusion that a democratic
country indeed receives more FDI. The study also looks at the effect of democracy on an
industry level and on FDI relative to trade.
FDI and Democracy: A Gravity Analysis
11
Introduction
Foreign Direct Investment (FDI) flows have become very important in the world economy.
Especially since the growth rates of FDI flows have exceeded those of trade flows. Also over
the last few decades the number of democracies has risen from about thirty in 1975 to more
than 120 in 20021.
It is this simultaneous development of FDI and Democracy that first sparked my interest in
the subject, and I wondered if there could to be a causal relationship.
The topics of FDI and Democracy have been well recorded in economic and politicaleconomic literature. Much has been written about for example the (economic) determinants of
FDI; Dunning (1977) and Markusen (1997). The topic of democracy has also been put down
to paper quite often, mostly in the context of economic growth, trade, economic policies, etc.
However, with the exception of a few authors and papers, little can be found about the two
topics together. Given the vast literature on FDI and democracy with respect to trade, this
void is surprising. On top of that comes that little, consensus has been reached about the
effect(s) of democracy on FDI flows, of which the example of Li and Resnick (2003) with
Jakobsen and De Soysa (2006) as a response is a striking illustration.
Due to the abovementioned void in the literature, and the actuality of the topic (see the
nationalizations in Venezuela, for example) the topic of this study is “The influence of
democracy on FDI flows” for my research. Moreover, I would like to perform my empirical
analysis on both an aggregate and disaggregate (sector) level.
The analysis will take the form of a Gravity Analysis. Of the literature that exists on the topic,
gravity has not been used often. By employing a gravity analysis, I hope to make some
contribution to the already existing empirical analyses. In the gravity analysis the democracy
indices will be incorporated in order to determine the effect of democracy on FDI inflows:
FDI = c + α 1GDP + α 2 Pop + α 3 Democracy + ... + α 4 Dist.
It is then the coefficient a4 that I will analyse further on sign and significance, across countries
and time. In the country specific case study this coefficient will be analysed across sectors.
The hypothesis I will test by analysing a3 is that the relationship between democracy and FDI
is positive and significant. In order to capture a possible causality in democracy and FDI, I
will also investigate the possible effect of FDI on democracy (see Annex 05).
Note that even at a glance, political patterns emerge out of the dataset by looking at with
whom a country does and does not maintain relationships. This is something that is
1
See for a definition of democracy chapter 3.
FDI and Democracy: A Gravity Analysis
13
considered as logical by many people. However, they do not dwell on the fact that behind
these political patterns, economic and political motives are at work.
The remainder of this paper is as follows. Section I covers a literature review of the topics that
cannot be ignored when handling a subject like FDI. Section II gives a definition of
democracy, and explains how FDI and democracy are linked to one another. In section III the
relationship between FDI and democracy is empirically analysed through gravity, using
Negative Binomial Quasi-Maximum Likelihood (NBQML) as an estimation method. In
section IV the strong links between FDI and trade are recognised. Thus the effect of
democracy on FDI relative to trade is analysed. Section V tries to meet the critique that
democracy is not meaningful enough on an aggregate level, by showing that it is important
both on the aggregate and disaggregate level. To conclude, section VI recommends some
policy implications for both gravity and democracy and ends with the conclusion.
14
FDI and Democracy: A Gravity Analysis
1 Literature review
1.1
Gravity analysis2
Gravity models are mathematical models based on an analogy with Newton’s gravitational
law. The first person to use the gravity model with regards to trade was Walter Isard in 1954
in his paper “Location Theory and Trade Theory: A Short Run Analysis” which is based on a
previous paper (Isard, W., Peck, M.J., 1954). Walter Isard had found in his research that,
although distance variables were neglected in traditional trade theories, these variables have a
great negative influence on trade flows, which resemble the same statistical regularity found
by Zipf (Zipf, G.K., 1941/1949). He posed that with regards to income potential, a country
closer to an arbitrary country i, produces a higher income potential upon country i than a
country that is further away from country i. Also, he stated that with using national income as
the dependent variable, one should bare in mind the effect of industrial structures.
In other words, Walter Isard was the first to heed the importance of distance, in the sense that
“economic activity across space is unequal, and remarkably regular”3.
The first to apply the gravity model to international trade between nations was Jan Tinbergen
(Shaping the World Economy, 1962).
With regards to economics the gravity model has found its basic form in explaining trade
flows. The gravity model is however not limited to predicting trade flows only, and has been
adjusted may times to be able to account for other trade issues.
The basic gravity model of trade takes the following form: Fij = G ∗
Mi ∗M j
Dij
, were Fij is
the trade flow, M is the economic mass of each country, Dij is the distance and G is a constant.
In order to be able to perform (econometric) tests with this model, the variables and its
underling data have to be transformed into (natural) logarithms, resulting in a linear equation
that can be estimated.
For some time the gravity equation was seen as an empirical anomaly, lacking a theoretical
foundation. There have been many economists who have posed various theoretical
explanations for the gravity model, some favouring and some opposing.
James E. Anderson (1979) posed a theoretical foundation for the gravity equation applied to
commodities. He derived the gravity equation from the properties of expenditure systems. In
2
For a more extensive literature review on gravity analysis see Structered Overview Impact Assessment Methodologies Chapter 4.2.
3
Charles van Marrewijk, 2002, chapter 14.
FDI and Democracy: A Gravity Analysis
15
this interpretation it is an alternative method of doing cross-section budget studies, and one
with potentially important efficiency properties (Anderson, 1979, pp. 114).
For a more general theoretical foundation, we turn to Jeffrey H. Bergstrand (1985). Making a
number of assumptions Bergstrand derives a gravity equation from a general equilibrium
world trade model, posing that the gravity equation can be seen as a reduced form partial
equilibrium model. These assumptions are the following (Bergstrand, 1985):
a. Small open economy assumption;
b. Identical utility and production functions across countries ensuring that parameters
are constant across all country pairings;
c. International substitubility of goods in production and consumption;
d. Perfect commodity arbitrage;
e. Zero tariffs;
f. Zero transportation costs.
The gravity equation that holds under only the first two assumptions is termed by Bergstrand
the “generalized gravity equation”. After citing evidence that in empirical data large and
persistent deviations from PPP are found by Isard (1977), Richardson (1978), and Kravis and
Lipsey (1984), Bergstrand realises that the assumption c to f are not realistic and not
supported by empirics. Thus, he concludes that these assumptions are too restrictive, giving
preference to the estimation of the generalized gravity equation. If, however, trade flows are
differentiated by origin as evidence suggests, the typical gravity equation is misspecified,
omitting certain price variables (Bergstrand, 1985, pp. 480).
From Summary (1989) it can be seen that the basic gravity model can be adjusted with several
variables, not necessarily being “pure economic” variables. In this paper the model is adjusted
by including economic and political variables. The results from this gravity model indicate
the qualitative variables like political factors are also important in explaining trade flows.
Summary (1989) is certainly not alone in adding qualitative variables to the gravity model.
Talamo (2005) for example has also performed research in which she included qualitative,
institutional variables.
That trade flows do not necessarily have to be the dependent variable, is shown by the
extensive literature covering different, although trade related, subjects.4 There have been
various authors that have used the gravity model in relation to FDI as well.
Yeyati et al. (2003) used the gravity model to assess the effects of regional integration
agreements on the location of FDI, using data on bilateral outward FDI stocks (Yeyati et al,
2003, p. 5). They found that regional integration can have a very important effect on foreign
direct investment. On average, common membership in an FTA with a source country
increases FDI. The increase in size of the market due to the regional integration agreement
also implies an imported expected gains. However, their gravity analysis also indicated that
the FDI will be distributed unevenly. Apart from the theoretical factors that attract FDI, the
overall attractiveness of a country as a location of FDI is significant in determining whether
the country benefits from the integration agreement (Yeyati et al, 2003, p. 20). The article of
Garcia-Alverez-Coque et al. (2006) deals with a similar issue. They tried to assess the effects
4
16
E.g. Bloom and Sachs, 1998
FDI and Democracy: A Gravity Analysis
of Association Agreements on agricultural trade, using a gravity analysis. They wished to see
whether the Agreements indeed bettered the position of Southern Mediterranean Countries
(SMCs) in the European Union. They focused their study on the products of fruits and
vegetables. They found that the Agreements do have a positive effect as expected trade
increases significantly. This being the case, the Agreements effect is not great enough to
compensate for the loss associated with the SMCs status of third countries (Garcia-AlverezCoque et al., 2006, pp. 10-12). The articles of Kandogan (2005), Smith (2002), and Anderson
and Van Wincoop (2001) also deal with issues related to trade liberalisation.
Borrmann et al. (2005) use the traditional core variables which are used for explaining trade
flows to explain FDI. However, they heed caution with the interpretation of these variables as
the mode of operation can be different in explaining German FDI in the CEECs. On top of
that, there is the issue of very wide confidence intervals. They estimate the gravity equation
both in-sample and out-of-sample. From the various equations they specified, they found that
the size of the host country, the market potential of neighbouring countries, and distance are
important determinants of German FDI. They found that using traditional core variables in the
gravity equation resulted in a model that seems appropriate to estimate for explaining German
FDI (Borrmann et al., 2005, pp. 16-17). Brenton and di Mauro (1999) also cover the issue of
FDI in CEECs. Others to assess the relationship between FDI and the geographical pattern of
trade flows are Africano and Magalhaes (2005). In this study the dependent variable of the
gravity equation are trade flows, and in addition to the traditional core variables FDI is added
as an independent variable. Literature states that FDI can be both a complement and a
substitute for trade. However, that literature did not focus upon the direction of causality
between trade and FDI. Africano and Magalhaes (2005) estimated four different gravity
equations and found that for Portuguese imports the gravity equation that included the FDI
variables had greater explanatory power and that the overall goodness of fit improved
(Africano and Magalhaes, 2005, p. 12). Especially inward FDI was significant, thus giving a
greater understanding of the geographical pattern of Portuguese imports. This was also he
case for Portuguese exports. Thus FDI in Portugal has a positive effect on both imports and
exports (Africano and Magalhaes, 2005, pp. 13-15).
Blonigen et al. (2004) apply a modified gravity model to test for the hypothesis that FDI
decisions rely on interdependence relationships across regions, instead of mere bilateral
relationships. In doing so the focus of their study is on so-called “export platform FDI”.
In the same line of research, although here bilateral flows are estimated, Talamo (2005) uses
the gravity equation to estimate the main determinants of FDI.
However, until recently there was no theoretical foundation for the gravity equation applied to
FDI. Since the 2007 paper of Jeffrey H. Bergstrand and Peter Egger such a theoretical
foundation does exist. They find that after adding an extra factor and country to the classical
two-country two-factor model the empirical fit of the gravity equation applied to FDI can be
explained. To come to their results, Bergstrand and Egger (2007) have employed a numerical
version of the general equilibrium model and have regressed theoretical values. This provided
them with the “visuals” referred to below.
The gravity equation implies a monotonic relationship between trade flows and economic
similarity. This is not the case if the model just considers two countries, and thus conflicts
with the empirical results of trade and FDI gravity equations which imply complementarity
FDI and Democracy: A Gravity Analysis
17
between trade and FDI with respect to GDP size and similarity. Moreover, gravity equations
applied to FDI find that home country GDP elasticities are significantly larger than host
country GDP elasticities, which cannot be explained with a two-country three-factor model.
Hence the addition of the third country – rest of the world (ROW), which is initially identical
to the other countries.
After adding this third country, Bergstrand and Egger (2007) indeed find that bilateral FDI is
a positive monotonic function of economic similarity; the numbers of both national
enterprises (NEs) and horizontal MNEs (HMNEs) increase with a larger joint size (see figures
3 and 4, Annex 01). Also, the addition of the third county shift the economic structures of all
three countries to more HMNEs and fewer NEs (see figures 2 and 4, Annex 01); NEs and
HMNEs are overall substitutes (bilateral FAS and FDI are overall substitutes of bilateral
Trade). However, the addition of the third country allows both bilateral trade flows and
bilateral FAS between i and j to reach maximums as GDP’s become similar, as empirical
results of the gravity equation implies, and FDI is positive (see figure 3, Annex 01). Bilateral
FDI is larger in the three-country world compared to the two-country world (see figure 1 and
3, Annex 01); FDI takes place even if j’s GDP is small.
One might wonder why, if FDI and FAS are over substitutes of Trade, FAS and Trade are
complements when GDP is similar. If one compares the FAS and FDI surfaces in figure 3 and
1, notice the fact the surfaces are less steep in figure 3. As the GDP’s of countries i and j
become more alike, prices of human capital tend to fall and those of physical capital tend to
rise. Comparing figure 4 to figure 2 it is obvious that the fall (rise) in price is substantially
larger in the three-country world than in the two-country world. This larger percentage fall
(rise) in price dampens the increase in HMNEs and decrease in NEs more in the three-country
world. This dampening of the increase in HMNEs contributes to the flatter surfaces of FAS
and FDI in a three-country world compared to a two-country world. The dampening of the
decrease in NEs is sufficient for bilateral Trade to be a monotonic function of GDP size and
similarity in the three-country world. These two effects combined cause bilateral FAS and
Trade to covary positively and monotonically with respect to GDP size and similarity in the
three country world. Bergstrand and Egger (2007) conclude that this is why the gravity
equation works for FDI, FAS, and trade flow simultaneously. Even more so, notice the fact
that the theoretical surface of bilateral FDI in a three-country world (figure 3) is
asymmetrical; bilateral FDI is maximized if i’s share of the combined GDP’s is larger that j’s
share. This implies that the home country GDP elasticity of FDI is larger than the host
country GDP elasticity, as is found in empirical results of the gravity equation applied to
FDI.5
Other studies not specifically related to trade, but more general to economics also apply to the
gravity model.6
18
5
Bergstrand and Egger, 2007.
6
E.g. Alam et al., 2006.
FDI and Democracy: A Gravity Analysis
1.2
The Determinants of FDI
As the influence of democracy on FDI is the focus of this study, I will only touch briefly on
the subject of determinants of FDI. Even more so, the literature reviewed here already has to
do with political determinants of FDI. For a more extensive review on FDI determinants I
refer the reader to the paper of Blonigen (2005)7.
Schneider and Frey (1985) argue that model with economic determinants of FDI alone misses
out on important influences and thus does not explain FDI well enough. But this also the case
for models with merely political determinants of FDI. In fact they estimated that these models
even explain FDI less then do the economic models.
Schneider and Frey argue that a model that combines both economic and political
determinants of FDI does fully explain FDI, if not fully then at least better then the separate
economic and political models.
Out of the models with economic determinants they derive six testable hypotheses8;
•
GNP per capita has a positive effect: the higher GNP per capita, the better a nation’s
economic health;
•
Growth rate of GNP has a positive effect: high GNP growth rates indicate good
development potential;
•
Rate of inflation has a negative effect: high inflation rates is a sign of internal economic
tension;
•
Balance of payments deficit has a negative effect: a large balance of payments deficit
increases the danger that free capital movement will be restricted;
•
Wage cost has a negative effect: it’s more profitable to invest in country with low wage
costs;
•
Secondary education has a positive effect: the larger the share of an age group with
secondary education, the more direct investment.
Out of the models with political determinants they derive four testable hypotheses;
•
Political instability, proxied by number of political strikes and riots, has a negative effect:
political instability may disrupt the economic process and increase the danger of
nationalization;
•
Dummy variable political ideology, left-wing (= 0) or right-wing government (= 1), has a
positive effect: the more left-wing the host government’s ideology, the more likely it is
for such a country to have a non-beneficial investment climate;
•
Aid from communist countries has a negative effect: the more aid a country receives from
the communistic bloc, the less FDI it will receive;
•
Aid from western countries has a positive effect: the more aid a country receives from the
West, the more FDI it will receive.
And they derive a hypothesis that incorporates elements of both economic and political
models;
•
Multilateral aid has a positive effect: the more multilateral aid a country receives, the
better its investment environment.
7
Blonigen, 2005, A review of the empirical literature on FDI determinants.
8
Schneider and Frey, 1985, pp. 165-166.
FDI and Democracy: A Gravity Analysis
19
These eleven hypotheses combined make up the political-economic model put forward by
Schneider and Frey (1985). Comparing the three models through estimation, the politicaleconomic model indeed performed better explaining 75% of the variation. The economic
model explained 51% and the political model 40%. Moreover, the signs on the independent
variables agreed with the hypotheses of the political-economic model and were significant;
the hypotheses developed thus needed not be rejected.9
Jun and Singh (1996) argued that besides the more traditional economic determinants of FDI,
there are other factors that may also be important determinants of FDI. Specifically, they
looked at the impact of socio-political variables, business operating conditions and export
orientation. But maybe even more importantly, Jun and Singh differentiated between high and
low FDI countries. By making this differentiation Jun and Singh found that estimations
differed in size but not in direction, indicating that there exists a structural difference between
historically high or low FDI countries. For socio-political variables they focused on socialpolitical instability, proxied by the Political Risk Index (PRI) developed by BERI10. Running
a regression analysis which incorporates this variable, revealed the variable to be highly
significant and positive. Only after incorporating exports relative to GDP as a control variable
did its significance weaken. After differentiating for high and low FDI countries, the variable
was found be significant for both groups, although more important for high FDI countries.
Business operating conditions were proxied by the Operating Risk Index developed by BERI.
Results for this variable were similar to those obtained with socio-political instability. This
variable too was significant and positive, and remained to be so after differentiating for high
and low FDI countries, being more important for high FDI countries. And as with the sociopolitical instability variability, the variables significance was reduced after controlling for
exports relative to GPD. Exports were used as a proxy for export orientation, and were found
to be significant and positive. Even more so, Jun and Singh found that exports is the most
important determinant of FDI flows, which was especially the case for high FDI countries
after distinguishing between the two sets of countries.11
More recently Büthe and Milner (2007) looked at the effect of international trade agreements
on FDI. The agreements under scrutiny in the paper are trade agreements such as the
GATT/WTO as well as PTAs. Of the many effects such an agreement can have, the authors
focus on the political and informational effects.
As the nature of FDI has changed over the years, the threat of expropriation, though still real,
has become less important. This threat has been replaced by more subtle government
interventions. Thus policies that imply limited government intervention should attract foreign
investors. Already in 1971 the obsolesce nature of FDI was identified by Vernon. This
required however that these liberal policies are credible in order for foreign investors to invest
in those countries. In Büthe and Milner (2007) it is argued that by entering into international
agreements governments are more credible in implementing liberal policies, since these are a
pre-requisite and commitment of an international agreement. This because, if governments
breach their commitments, consequences are not only national but more importantly also
international. Büthe and Milner argue that due to the great (international) costs involved in
20
9
Schneider and Frey, 1985.
10
As this a commercial database, which requires subscribing, no further information could be found on the BERI indices.
11
Jun and Singh, 1996.
FDI and Democracy: A Gravity Analysis
breaching international commitments, liberal policies implemented under an international
agreement are more credible than those without such an agreement. This because, although
trade agreements do not contain provisions about FDI, they can be seen as an indication of the
investment climate. If a trade agreement is in place, the host country has become more open
to international influences, which can be reflected into a more favourable investment climate.
It is the increased openness to international influences which a government has to take into
account when thinking of reneging on their commitments. Because if they do renege, this
signals to other international actors (be they foreign investors or other governments) to steer
clear of that particular country because it lacks trustworthiness.
In order to test their arguments, Büthe and Milner construct two hypotheses:
•
Being a GATT/WTO member increases inward FDI;
•
The greater the number of PTAs the country is part of, the greater the amount of inward
FDI.
After running a regression analysis they find strong empirical support for their hypotheses.
The coefficients for both variables are positive and significant.12
Taking a run towards democracy, Büthe and Milner find no significant effect that democracy
is correlated with higher FDI inflows after controlling for regime type.13 However, one could
argue that this result might be due to the simultaneous estimation of the effect of trade
agreements and regime type. This may hold because international agreements typically will
not liberalise trade as much between groups of democracies and autocracies, than would be
the case for groups of democracies.14 Thus, one might argue that to be able to meet the
minimum amount of concessions associated with membership of the WTO, the regime type is
more likely to be democracy than otherwise. Following this line of argument, in estimating
the effect of trade agreements one could implicitly also obtain an indication of regime type.
1.3
The Determinants of the MNE
When dealing with the subject of Foreign Direct Investment, or FDI, one cannot go around
the subject of multinational enterprises, or MNEs. This because the first cannot be separated
of the latter as 78%15 of FDI consists out of merger and acquisitions, or M&As. Thus we will
first review the literature about multinationals, keeping in mind that they are formulated in
relation to trade instead of FDI. Beneath are the most important developments in this area.
Dunning (1977) was one of the first to try to determine what the driving forces are behind
MNEs. Therefore he developed the well-known OLI framework. This framework states that a
firm will become a multinational firm if three conditions are met; Ownership Advantage,
Location Advantage, and Internalisation Advantage. The intangible assets that a firm owns
make-up the crux of the OLI framework. For intangible assets one has to think of assets such
as R&D, brands and reputation, intellectual property, and so on. According the OLI
framework one should look at these assets as a primary source of the abovementioned
12
Büthe and Milner, 2007.
13
Büthe and Milner, 2007.
14
Mansfield et al, 2000.
15
Van Marrewijk, 2002, fig. 15.3
FDI and Democracy: A Gravity Analysis
21
advantages, which make it possible for a firm to become a multinational and enter foreign
markets. Though the pragmatic nature of this framework is its strength, it may also be its
weakness as it lacks a theoretical foundation from which it is derived. This is where Helpman
(1984) and Markusen (1984) come into play.
Both of these authors developed a model for the formation of multinationals. Helpman did
this mostly for the formation of vertical multinationals, whereas the focus of Markusen lies in
horizontal multinationals. Both proved critical for the development of the “knowledge-capital
model”. Vertical multinationals are those firms that decide to slice up the value-chain and
produce different segments of the production process at different geographical locations. In
contrast, multinational firms are those firms that wish to supply a foreign market, and choose
to do this by setting up shop in that foreign market. Vertical multinationals thus engage per
definition in intra-firm trade, while this need not be the case for horizontal multinationals.
The Helpman (1984) theory relies on the following assumptions; (1) there are differentiated
products, economies of scale, and monopolistic competition; and (2) there exits inputs that
can serve a plant without the need to be located in that plant. Note the similarities between the
intangible assets argument of Dunning and the input assumption of Helpman. Helpman
employs a modified version of the Heckscher-Ohlin model, graphically displaying his theory
with the help of Edgeworth boxes. In his paper Helpman shows that (vertical) multinationals
arise due to differences in factor prices sourced from differences in relative factor
endowments. If there exists capital mobility, firms will use the differences in factor prices to
their advantage and establish subsidiaries in the cheaper country16. Where the Helpman
(1984) theory relies on strategic behaviour, i.e. taking advantage of factor price differences,
Markusen argues that it is the technology associated with MNEs that are the source of MNEs.
Markusen (1984) thus starts from a different outset, namely the notion of multi-plan
economies. Markusen states that the source of multi-plant economies can be found in firmspecific activities that exhibit “public goods” characteristics. Meaning that these activities can
be transferred among firms or plants without incurring additional costs. These activities are
assumed to be centralized. To neutralize H-O, Ricardian, and demand bases for trade, he
assumes that both countries are symmetrical in technology, factor endowments and
preferences. Because of the centralization aspect of the firm-specific activities, the
distribution of factors within the countries differ; the country with centralized activities has
for example less labour available for production, then the country without centralized
activities. This induces differences in factor prices. This will affect inter-sectoral allocation of
economic activity and therefore provides a basis for trade.17
Eventually, in 1998, Markusen combined all three of the abovementioned theories into a
conceptual “knowledge-capital” model, further extended upon by Markusen and Venables in
2000 with a 2x2x2 model, and in 2007 by Bergstrand and Egger with a 3x3x2 model.
Concerning the ownership advantages mentioned by Dunning (1977), Markusen derives that
multinationals intensively use knowledge capital and argues that the importance of knowledge
capital resides in two characteristics. First the fact that it can be easily transported from one
plant to another without incurring much added costs, relative to physical capital. Secondly,
22
16
Helpman, 1984.
17
Markusen, 1984.
FDI and Democracy: A Gravity Analysis
and possibly more important a “public goods” property is inherent to knowledge capital. As
proven in his paper of 1984, this property is very important for horizontal multinationals, and
might be as important for vertical multinationals as it gives direction to the vertical integration
process. Sources of location advantages differ between horizontal and vertical multinationals.
For the first the existence of transport costs and a large market in the potential host country
are a necessary condition for a horizontal multinational. For the latter transport cost need be
low and differences in factor prices are necessary. As for internalization advantages,
Markusen argues that these arise from the same sources as those that create ownership
advantages; the intensive use of knowledge capital with is specific characteristics. Firms will
internalize knowledge capital to maintain its value and protect it from ill use by licensees.18
Markusen develops a 2x2x2 model with endogenous multinationals with the following skilled
labour intensity assumptions;
•
headquarters only > headquarter and plant > plant only > other sectors economy;
•
horizontal MNEs > vertical MNEs and national firms;
•
Local vertical MNE > local horizontal MNE > local national firm > foreign plant
vertical/horizontal MNE.
Simulations run with this model lead to the following results19;
•
When transport costs are moderate or high, horizontal multinationals are dominant when
countries are similar in size and relative factor endowments;
•
National firms dominate when countries differ in size;
•
And vertical multinationals dominate when countries differ in relative factor
endowments;
•
When transport costs are low to zero, multinationals only occur when countries are
different in relative factor endowments, and only vertical multinationals occur;
•
Investment liberalisation leads to a reversal in the direction of trade when countries differ
in relative factor endowments but not so in size;
•
Investment liberalisation leads to factor price equalization because MNEs can make
location decision for headquarters and plants independently.
In 2007 Jeffrey Bergstrand and Peter Egger extended this model. They introduced a third
factor, physical capital, in the model and combined it with the assumption that the headquarter
of plant setups require human or physical capital. This way they were able to explain the
empirical fact the national exporting enterprises and MNEs coexist. Not only did they apply
the model to explain multinational enterprises and international trade flows, as did Markusen,
but they applied it to foreign direct investment as well. In particular, with the help of this
model they came to a theoretical foundation for the gravity equation when applied to FDI.
Another extension is the fact that they added not only a third factor to the model, but also a
third country, which models the rest-of-world or ROW. In adding this factor they were able to
explain the empirical regularity in complementarity of bilateral trade and FDI flows to GDP
similarity20.
A different rationale for MNEs can be found in the papers of Henizs and Williamson (1999)
and Henisz (2000). Whereas authors like Markusen and Bergstrand and Egger focus on the
18
Markusen, 1998.
19
Markusen, 1998.
20
Bergstrand and Egger, 2007.
FDI and Democracy: A Gravity Analysis
23
economic side of the investment decision of MNEs, Henisz and Williamson (1999) focused
on the institutional environment in which influence these investment decisions by extending
transaction cost theory. Henisz and Willamson (1999) differentiate between contractual
hazards and political hazards, of which the latter can be direct or indirect and thus affect the
investment decision in different ways. Contractual hazards are defined as: “Contracts that are
supported by durables investments in nonredeployable assets pose contractual hazards, in that
one or both parties can defect from the letter or spirit of an agreement.” Direct political
hazards are those “posed by opportunistic behaviour of the host country’s government”.
Indirect political hazards are those “posed by lobbying parties in the host country who
approach the government to take actions that are at the expense of the MNE”. Henisz and
Williamson argue that if the institutional environment between home and host country of the
MNE is similar, it will base its investment decision or market entry mode on contractual
hazards and the costs associated with those hazards. This changes however if the institutional
environment of the host country differs significantly from that of the home country, thus
introducing political hazards. Henisz and Williamson argue that if the MNE encounters direct
political hazards this will increase the cost of ownership independent of the level of
contractual hazards, pushing the market entry mode to minority equity control. If on the other
hand the MNE encounters indirect political hazards, the cost of contracting is increased
proportionally to the level of contractual hazards, pushing the market entry mode to majority
equity control. Thus the impact of political hazards be it direct on indirect, depends on the
level of contractual hazards associated with each individual transaction.21
Henisz empirically tested this extended version of transaction cost theory in 2000, and found
strong evidence in favour of it. Using property, plant, equipment, and R&D as proxies of
contractual hazards, he found that an increase in these proxies increased the probability of
choosing a majority owned plant as a market entry mode in countries associated with high
political hazards. In a first instance, partnering up with a host country firm can safeguard
MNEs against the threat of opportunistic expropriation by the host country’s government.
However, as independent contractual hazards increase, indirect political hazards as well.
Eventually, majority-owned plants indeed become the favoured market entry mode.22
24
21
Henisz and Williamson, 1999.
22
Henisz, 2000.
FDI and Democracy: A Gravity Analysis
2 Democracy
2.1
What is democracy?
The etymology of the word democracy has its roots in ancient Greek society and comes from
δηµοκρατια or “popular government”. This was derived from the words δηµος (people) and
κρατος (rule or strength).
The first democracy ever established is credited to Cleisthenes (570 B.C. – unknown).
Cleisthenes was a rich and aristocratic Athenian statesman in ancient Greece. Influenced by
the ideas of Solon – he created the Councel of Four Hundred men to represent the population
and encouraged the people to be responsible for their city – Cleisthenes reformed the political
landscape of Athens. Cleisthenes proposed a number of reforms to gain support of not only
the aristocrats but also of the working class of Athens. Unfortunately, his opponent in return
requested the aid of the Spartans. With the help of the Spartans, Cleisthenes was forced into
exile. But, the ideas of Solon and Cleisthenes had found fertile soil in the minds of the people
of Athens. An uprising of the people of Athens expelled the Spartans and they recalled
Cleisthenes from exile to form the first democratic government.23
A comparison of the first ever democracy of Cleisthenes and democracy as we know it now to
be is an attestation that democracy is a phenomenon that is constantly in motion.
Though the reforms established by Cleisthenes were revolutionary for ancient Greek society,
when looked upon with our modern views Cleisthenes’ democracy – women, slaves,
foreigners and the poor were not part of the political landscape of Athens - is not at all what
we would now associated with the word democracy – equality, constitutional human rights
and liberties.
Even now democracy is ever moving, though “true democracy” seems to be a utopia as events
like 9/11 and the following USA PARTIOT act and alike laws in other countries seem to
erode democracy. Still, we can detect gradations in democracy between countries (crosssection) and over time (time series). Still, the question remains; what is democracy? I have
already touched on the definition of democracy above. But to define democracy is a
conceptual problem, as also recognised by Bart Tromp in his book review of Fareed Zakaria’s
The Future of Freedom. Illiberal Democracy at home and abroad. Because democracy is a
relative concept and not an abstract one, a lot of controversy and discussion exists about what
should be considered a democracy. Thus a precise definition of democracy cannot be given as
everyone has different thoughts about and hence different definitions of democracy. What I
can give is a “scale”, citing the most minimal requirements of democracy at one end and the
23
For more info see www.pbs.org/empires/thegreeks/.
FDI and Democracy: A Gravity Analysis
25
“utopic” requirements of democracy at the other end. Understandably one wants to be as close
as possible at the right hand side of the “scale” than at the left hand side.
Minimal requirements: regular, free and (relatively) fair elections.
“utopic” requirements: regular, free and fair elections; divisions of powers (Montesquieu);
checks and balances; inalienable human freedoms and rights as those wrote down in the
Universal Declaration of Human Rights.
I will concentrate on the right hand side of the “scale” for my definition of democracy,
countries that linger near the left side of this “scale” are considered not democratic (enough),
as reflected by the Kaufman indices in the lower confidence percentiles (red, pink, and
possibly orange).
By choosing this more broader definition of democracy, I overcome the fact that the countries
that appear to be democratic – as their governments go through the motions – are not included
in my definition; they would fall in the left hand side category of my “scale”. To elaborate
this view further, consider the following:
The mere fact that governments are elected by a majority does not guaranty that it is a
majority representation of the views and feelings of its people. Elections may not truly be
considered free, e.g. just one party for which one can vote, or votes induced by the threat of
violence if voting otherwise, voting rights might be limited to certain groups, or outcomes of
voting are tampered with.
The need to exclude the appearance of democracy or, to keep it in terms of the “scale”, the
left hand side from a definition of democracy, becomes even more apparent when the
following example is considered24:
In January 2008 Morgan Tsvangirai announced that he would run for election. Though he expressed
confidence, he feared that the ZANU-PF party of president Robert Mugabe would defraud the elections.
Considering the track record of Robert Mugabe – elected president since 1980 by means of intimidation and
fraud – this fear was but all too real. With the elections of March in sight, things did not bode well as president
Robert Mugabe only allowed observers of countries that did not criticise him in the country.
Based on exit polls and preliminary counts of the votes, Morgan Tsvangirai declared himself the winner of the
elections in March. In April the results of the parliament elections were finally made public; the party of Morgan
Tsvangirai had won. Though there still were no results known of the presidency elections, Morgan Tsvangirai
again declared himself winner. This did not fare well with Robert Mugabe, who in turn demanded a recount of
the votes. The opposition did not agree, taking the case to court claiming that a recount was illegitimate.
Tsvangirai hoped that the court would pressure the Election Commission into announcing the official results.
However, the court denied the claim of the opposition. In mid-April a recount of the votes ensued on the order
of president Robert Mugabe. This was not all; (alleged government sponsored) violence erupted as opposition
members were arrested by the police after having fled from fight squads.
24
26
www.nos.nl.
FDI and Democracy: A Gravity Analysis
In May it finally became clear that Morgan Tsvangirai had indeed won the presidency elections. However, it
seemed that he did not obtain enough votes to be decleared the winner, giving rise to the need of a second
round of elections. The opposition did not agree with this result, claiming that Tsvangirai did obtain the required
50%. However, not participating in a second round of elections would automatically mean that Robert Mugabe
would win. This was not an option for the opposition; Tsvangirai agreed to a second election round. Mugabe
however decided to delay the second election round. Tsvangirai, after travelling through Europe, feared for his
live and decided not to return to Zimbabwe till the end of May.
As the election data came closer the situation escalated June; international aid organisation were ordered to
stop with their activities, Tsvangirai was forbidden to campaign and arrested several times, Human Rights
Watch ascertained that the opposition was terrorised by violence, and several opposition supported were found
dead. With the second election data of June 27th in sight, the escalation in violence caused Morgan Tsvangirai
to take himself out of the race for presidency on June 22nd. Still, elections proceeded as planned on June 27th
with Robert Mugabe as the only candidate. Voters were intimidated by supports of Robert Mugabe and
members of the paramilitary police. Since Mugabe was the only candidate he was swore in as the president of
Zimbabwe on June 30th.
That democracy is an ever moving phenomenon is also reflected by this example, if one keeps
in mind the fact that in the early years of Mugabe’s reign the people of Zimbabwe were very
happy with him as he freed the country of the British colonial influences.
2.2
Link FDI and Democracy
In this paper democracy is used as a proxy for investment climate in a country. I hypothesize
that the more democratic a country is, the better the investment climate is in said country.
In line with earlier mentioned authors, I argue that democracy gives rise to a stable policy
environment. A stable policy environment is very important for MNEs in the FDI-decision.
This due to the obsolete bargaining nature of FDI; when an MNE is in the decision making
process of engaging in FDI, it holds a certain amount of bargaining power due to the
“liquidity” of the capital. This means that if they don’t like the outlook of one country they
will move on to another country. However, after the FDI decision has been made the
bargaining power position shifts from the MNEs to the host-countries, due to “illiquidity” of
capital. “Illiquid” since the investment has now been made and capital is sunk into the host
county. This “illiquidity” of capital enables host-countries to take hostage of the FDI,
meaning that the can decide to change the FDI-friendly policies for which they were chosen.
Understandably, this opportunistic behaviour of host-country governments is not favourable
for MNEs. Which is why not only the FDI-friendliness of a policy is important, but also the
stability of this policy is taken into account by MNEs when making the FDI-decision. A more
stable policy environment will prove more attractive in the FDI-decision making process. A
stable policy environment is provided by democracy; elections and veto points make sure that
a government cannot whimsically change policies without having to take account of its
electorate. A government that reneges on its agreements, be it international or national ones,
are accountable to their electorates, and have to consider the possibility that its electorate will
react by installing a different government at the next elections; the so-called audience costs
mentioned by Jensen (2006). Due to these checks and balances inherent to a democracy, the
claim of a stable policy environment proves to be a credible one, and investing in such a
country becomes attractive.
FDI and Democracy: A Gravity Analysis
27
To be even more precise, I agree with Jakobsen (2006) and argue that democracy moderates
the obsolete nature of FDI. The abovementioned checks and balances that provide a credible
argument for a stable policy environment diminish some of the bargaining power of the host
country governments that might otherwise induce opportunistic behaviour. This argument
becomes even more powerful when one considers that in developing countries the endowment
division is in favour of FDI. In developing countries it is labour that makes up the greater part
of an economy, and has the most to gain from FDI. Hence, if a developing country
government would decide to renege on its international agreement by changing policies, they
would have to face the consequence that a large part of its electorate suffers from this decision
and will act upon that suffering. As a government would like to stay in power for more than
one election period, these audience costs are considerable enough to establish a (relatively)
stable policy environment, and thus an attractive investment climate.
The above holds not only for policy changes, but for government intervention as well.
2.3
Democracy and FDI illustrated
Democracy is a concept which has been written and spoken about for many years, one of the
first being Plato from ancient Greece. In modern history the fascination with democracy has
not stalled, in fact quite the opposite. Much has been written about democracy in a political
context, a social context, and an economic context as well. For a long time the economic
focus was on trade, and so were the papers written about democracy in an economic context.
More recently, speaking about the last two decades, FDI has become up and coming. Not only
in its economic importance worldwide, but in the academic interest as well. And so, papers
written about democracy in an economic context began including FDI. A few of these papers
will be illustrated here. What will become clear in this section is that no consensus has been
obtained about the effect of democracy on FDI. For all means there appear to be three groups
in the literature; those that claim a negative effect, those that claim a positive effect, and those
that can find no effect.
Negative Effect
Of those that claim a negative effect, Oneal (1994)25 is the most outspoken by stating that
foreign investors obtain higher rates of return in developing countries that have an autocratic
regime. This idea has been common for a long time, claiming that autocratic regimes are more
stable countries and thus offer better investment opportunities. Though Oneal (1994) is one of
the more outspoken authors by specifically stating that MNEs do better in autocratic regimes
(when considering developing countries), he does not stand alone. Another quite outspoken
paper is that of Li and Resnick26. They argue that democratic institutions have conflicting
effects on FDI inflows. On the one hand democratic constraints weaken the monopolistic or
oligopolistic position of MNEs, thus hindering FDI inflows. On the other hand, democratic
institutions strengthen property rights protection, thus promoting FDI inflows. Thus,
according to Li and Resnick (2003), the net effect on FDI relies on which force has more
strength. They find that after controlling for the positive effect democracy has through
28
25
Oneal, 1994.
26
Li and Resnick, 2003.
FDI and Democracy: A Gravity Analysis
property rights protection, democracy has a negative effect on FDI inflows. After explicitly
considering the positive effect of FDI on democracy through the variable democracy-related
property rights protection, they find that this variable is positive and statistically significant
while level of democracy is negative and statistically significant. Thus Li and Resnick (2003)
conclude that although democracy promotes FDI through property rights protection, the
negative effects of democracy – like a rent-seeking host country government – are stronger
and overrule the positive effects.
An author that cannot be missed in this listing is O’Donnell27, who also argues that there
exists a relationship between foreign investors and autocratic regimes.
Positive Effect
That there indeed exists no consensus in the academic world on the effect of democracy on
FDI becomes evidently clear when considering the response of Jakobsen and De Soysa 28 on
the paper of Li and Resnick (2003). In their 2006 paper, Jakobsen and De Soysa respond to all
papers that claim a negative effect of democracy on FDI and focus on the paper of Li and
Resnick (2003). Jakobsen and De Soysa (2006) do not agree with the theoretical foundations
and empirics of Li and Resnick (2003). They believe that the conclusions reached by Li and
Resnick (2003) are due to a sample bias and an untransformed dependent variable, and that Li
and Resnick missed the fact that host-country preferences for FDI are formed by factor
endowments, thereby lowering rent-seeking by ‘domestic capital’ in democracies in LDCs. To
counter the conclusions reached by Li and Resnick (2003), Jakobsen and De Soysa (2006)
replicate their model using a greater sample and refute the channels through which Li and
Resnick (2003) argued that democracy had a negative effect on FDI. Indeed, after enlarging
the sample the negative effect of democracy on FDI vanishes and becomes positive and
significant. And after transforming the dependent variable to account for skewness, both
democracy and property rights protection are positive and statistically significant. Thus,
Jakobsen and De Soysa (2006) conclude that democracy is a far more attractive political
system for FDI than its authoritarian counterpart.
In his 2003 paper, in 2006 extended into a book, Jensen29,30 argues that democratic constraints
imposed on political leaders could translate into a beneficial environment for MNEs. He
argues that these constraints lead to higher level of policy stability and more favourable
policies toward MNEs, making them more credible than their authoritarian counterparts.
Jensen (2003, 2006) poses that the constraints imposed consist out of veto points and
audience costs, ensuring policy stability and accountability of the political leaders. Indeed,
when estimating the effect of democracy on FDI by means of a regression analysis on a TSCS
dataset, the coefficient was positive and statistically significant.
In Jensen (2006), he takes it a step further and argues that democratic institutions are more
important than government fiscal policy; the idea that developed countries give subsidies and
developing countries exclude MNEs from taxation. The effect of fiscal policy on FDI is
formed by the Race to the Bottom hypothesis, which hinges on high capital mobility, more
precisely frictionless investment. Considering the fact that years of established research on
27
O’Donnell, 1978.
28
Jakobsen and De Soysa, 2006.
29
Jensen, 2003.
30
Jensen, 2006.
FDI and Democracy: A Gravity Analysis
29
FDI has focused itself on an imperfect market approach, and that in reality investment is more
fixed than mobile leads Jensen (2006) to the conclusion that this hypothesis is very much
overemphasized and simply wrong. To back his claim, Jensen (2006) regresses FDI flows
onto government spending or taxation to assess whether capital flows to countries with lower
levels of government spending or taxation. If this is to be the case, the coefficient should be
negative; higher levels of government spending or taxation deter FDI. Jensen’s (2006) claim
that the influence of government fiscal policy is overemphasized, is supported by his
empirics. Little evidence is found that government spending or taxation has a negative effect
on FDI.
Li (2004) approaches the subject of tax incentives quite differently, focusing on the political
determinants of tax incentive policies to attract FDI. Referring to Jensen (2003), Henisz
(2000) and Li and Resnick (2003), Li (2004) argues that democratic countries possess a
stronger bargaining position vis-à-vis foreign investors. This due to the fact that democratic
institutions provide for property rights protection and policy credibility. Li (2004) argues that
the level of tax incentives depends on the bargaining position of the country in question. A
stronger bargaining position implies fewer concessions to foreign investors. Comparing the
levels of property rights protection and policy credibility of democracies with those of
autocracies, explains why autocratic countries offer higher levels of tax incentives. Moreover,
because political risks are lower in democratic countries, the expected returns should be
higher in democratic countries, implying that lower levels of incentives in democratic
countries should be as attractive as higher levels of incentives in autocratic countries for
foreign investors. Following from the above, Li (2004) forms the hypothesis that democratic
countries will offer lower levels of incentives. On top of the already low levels of tax
incentives in democratic countries, Li (2004) argues that democratic countries that experience
greater FDI inflows will offer lower levels of tax incentives. This due to the fact that FDI
inflows posse a competitive threat for national companies, increasing forces opposing tax
incentives as tax incentives increase competitiveness of foreign capital. Li (2004) find support
for his hypotheses in his empirics; FDI inflows into democracies are negatively related to the
level of incentives.
Other authors that find a positive effect for democracy on FDI include Busse (2003), Blanton
and Blanton (2006) and Feng (2001).
No Effect
The already mentioned paper of Büthe and Milner (2007) finds no significant effect of
democracy on FDI. Also the paper of Oneal (1994) can be mentioned here because when he
considered both developed and developing countries as one sample, Oneal found the
relationship between democracy and FDI to be positive but not statistically significant.
30
FDI and Democracy: A Gravity Analysis
2.4
Kaufmann indices
Although there are various datasets to measure democracy available, the Kaufmann indices31
will act as my democracy dataset. This due to the fact that its indices correspond to my
definition of democracy as they measure six dimensions of democracy32:`
1.
2.
3.
4.
5.
6.
Control of Corruption (CoC);
Government Effectiveness (GE);
Political Stability and Absence of Violence (PS);
Rule of Law (RoL);
Regulatory Quality (RQ);
Voice and Accountability (VaA).
The above does not imply a ranking; it is merely set in alphabetical order and is also the order
that used in the empirical analysis. If one considers these indices, one thing stands out; the
similarities between them. As a result, the explanation of the indices below will not follow the
order mentioned above. Instead they will be put in an order such that the similarities between
the indices become clear.
As the positive effect of democracy on FDI inflows is the central hypothesis of this research, I
pose that all of these indices have a positive effect on FDI. Being aware of the fact that the PS
index is controversial, as the literature is still in debate about its effect on FDI, an alternate
explanation for PS is also given.
Voice and Accountability
This index represents the effect of human freedoms and rights on FDI, as well as the effect of
a democratic government on FDI. As citizens are able to participate in selecting their
government, either passively by voting or actively by running for it, they are able to influence
government policy. This is especially important in the less-developed countries, as these
countries are very labour-endowed and thus are the ones who stand to gain from FDI friendly
policies. Also, as the citizens are the ones who (indirectly) installed the government, it exists
by the favour of its citizens. This means that the government is accountable to its citizens. If a
government reneges on its agreements (regarding FDI or otherwise), the international
community loses confidence in this government and the country it resides in. This leads to a
drop in FDI, or more generally an economic downfall. To keep this situation ongoing is not in
the best interest of the citizens, who will thus install an other government. This threat (or
audience cost), enabled among others by freedom of expression, will keep a government from
reneging on its agreements, resulting in a favourable and stable investment climate as
opportunistic behaviour of the government is curtailed.
Control of Corruption
Not only can the government display opportunistic behaviour by reneging on its agreements.
Parties that are opposed to FDI, exert pressure on the government to take actions which are at
the expense of the MNE. If this merely takes the form of lobbying against FDI, this would not
quite be such a problem as both opposing and promoting parties undertake this kind of action,
31
See Annex 02 Technical notes.
32
Kaufman et al, 2007, pp. 3-4.
FDI and Democracy: A Gravity Analysis
31
balancing each other out. The problem becomes much more severe if, despite the fact that
both parties lobby, only the opposing party has the attention of the government. Whether this
is due to bribes or other means of coercion, the results remain the same; a harmful
environment for MNEs. Hence, if corruption is controlled, and pressures exerted on the
government are balanced such that it can make sensible (policy) decisions, the investment
environment is much more favourable for FDI.
Regulatory Quality
The term says it all; this index informs us about the quality of rules and regulations, which are
a result of sound policy making. It indicates whether the framework of rules and regulations is
beneficial to FDI. Not only those that are tailor-made to fit the issues concerning FDI, but the
framework of a country as a whole. After all, once the FDI decision has been made, the
investment is sunk into the host-country and thus part of its national institutional landscape.
This means that for instance national environment and safety regulations also apply. For FDI
the law of contracts and torts is one of the more important parts of the national framework of
rules and regulations. The obligations and rights of MNEs and their legal status are all very
important factors that go into the investment decision. I pose that the better the regulatory
quality of a host-country, the more FDI will flow into the country. However, to much rules
and regulations, also known as the red tape problem, could diminish the quality of a country’s
regulatory framework and with it the positive effect on FDI.
Rule of Law
Among other things, contract enforcement is part of rule of law. Contract enforcement is an
important element for the successful implementation of FDI. If a MNE cannot count on the
fact that parties abide by the courts rulings, and additionally cannot count on the judicial
process acting as prevention from a breach of contract or other deviations from contract, this
makes for an unfavourable investment climate. This due to the costs involved with a breach of
contract. If however, the courts rulings are obeyed, and the judicial process acts as prevention,
it is considered a safe environment to invest in and consequentially has a positive effect on
FDI. As the enforcement of the law by the court has to be seen as a last resort, there are
conditions attached to eligibility of a case in court. As the judicial systems differ per country,
so do these conditions.
Government Effectiveness
The index government effectiveness contains both regulatory framework effects and the
effects of (in) dependence of political pressures, making it a broad covering and a complex
index. Broad coverage, as it not only tells us something about the quality of policies
implementation by the government, but also in what degree the civil services – that are part of
the implementation of those policies – are (in)dependent from political pressures. It is also a
complex index, as it seems as though several other indices are combined in this one index.
Hence this index is a crossing between both the regulatory framework of a country and its
political culture, with low figures corresponding to a poor quality of policy implementation
and a dependent civil service and high figures corresponding to a high standard of policy
implementation and an independent civil service. What does this mean with respect to FDI? A
high quality of policy implementation with regards to national issues indicates that FDIpolicies will be implemented correctly as well. The fact that the civil services is independent
from political pressures means that once a policy is formulated and more importantly
implemented, it is not affected by the whims of politics. With regards to the issue at hand, this
32
FDI and Democracy: A Gravity Analysis
means that MNEs can trust a policy to remain and be a guideline on which they can formulate
their decisions and tactics.
Political Stability and Absence of Violence
If there is absolutely no political stability whatsoever and violence is the norm, the effect on
FDI is highly negative as the investment climate is very poor. When MNEs do not know the
political waters of a country as they are changing rapidly, and due to violence the possibility
of threats and destruction of the investment becomes a certainty, MNEs will not hesitate to
reject this country as a possible destination for FDI. As the situation becomes more stable, the
investment climate becomes more attractive and FDI is improving, indicating a positive
effect. This is due to the fact that investments are safe from threats and destructions, and
policies and regulations are there to stay as the political foundations of a country do not
change overnight.
However, some form of instability may actually have a positive effect on FDI. This has to do
with capital liquidation; if due to political instability capital is liquidated, further investments
are needed to keep the capital at a desired or optimum level. This scenario is dependent on a
number of factors, of which the characteristics of the particular investment is the most
important one. The investment has to possess certain qualities that make it worthwhile to keep
investing. Also, according to this line of reasoning, as a country becomes more politically
stable, the need to reinvest dissipates as capital liquidation becomes less severe, thus reducing
FDI.
2.5
Control variables
Economic control variables
To account for the fact that development of FDI displays a wave pattern; a lag is created by
adding a wave variable to the analysis. The variable Wave Total -1 measures the total value of
FDI for all country pairs in the previous year. This wave variable is expected to be significant.
GDP is an indication of market size. If a multinational resides in a (relatively) large market
while the host country has a (relatively) small market, it is not profitable for the MNE to set
up shop in this small market. Rather, it will decide to service this market through exports than
through FDI. Once the market size of the host country has passed a certain minimum
threshold, it will become profitable for a MNE to set up shop in the host country through FDI.
The level of GDP of the destination country (GDPdest) is expected to have a positive effect
on FDI. Not only the economic size of the host country is important, but also its population as
this can be an indication of expected turnover. Population is also an indication of market size,
more specifically of turnover. A large population equals a high turnover. Thus, a host country
for FDI will be more attractive as its population is larger. The level of population in the
destination country (POPdest) is expected to have a positive effect on FDI. GDP per capita
(GPC) is a sign of level of development. A higher level of development (GPCdest) is
expected to attract more FDI and to have a positive effect on FDI. As most FDI originates
from developed countries, the level of GDP (GDPsource) and the level of population
(POPsource) from the source countries are also included into the analysis. These are expected
to have a positive effect on FDI.
FDI and Democracy: A Gravity Analysis
33
Dummy variables
To account for the effect of former colonies, language and the border effect, the dummy
variables Colony, common official language (Comlang off), and Contig are included into the
analysis. All of dummy variables are expected to have a positive effect on FDI.
Distance variable33
The distwces variable is constructed using the following formula;


d ij =  ∑ ( pop k / pop i )∑ ( popl / pop j )d klθ 
l∈ j
 k∈i

1/θ
, where popk designates the population of
agglomeration k of country i. The parameter θ measures the sensitivity of trade flows to
bilateral distance dkl. For the distwces calculation θ is set at -1, corresponding to the usual
coefficient found in gravity relationships for bilateral trade flows.34 This variable is expected
to have a negative effect on FDI.
34
33
Distance variable is acquired from CEPII at http://www.cepii.fr/anglaisgraph/bdd/distances.htm.
34
Mayer & Zignago, 2006, p. 5.
FDI and Democracy: A Gravity Analysis
3 Empirical analysis at the aggregate level
Analysis and results
The dependent variable, FDI inflows from 1996-2005 with 124 countries of which all are
included as destination countries and 28 OECD countries as source countries, is taken from
the OECD database on International Direct Investment. The explanatory variables GDP,
GDP/CAP, and Population are taken from the IMFs World Economic Outlook October 2007
database. The distance variable is taken from CEPII.
Method used
The estimation method used is the Negative Binomial Quasi-Maximum Likelihood
(NBQML)35 method. The reason for the NBQML estimation method is the following. In
bilateral FDI-data there are many “zero” observations. An estimation method like OLS would
ignore these data entries, thus creating a bias in the results. To nullify this “zero-flow”
problem, one needs to employ the NBQML estimation method, as this method does not ignore
the zero entries. Also, in the presence of heteroskedasticity36 OLS estimation may lead to
biased results. The NBQML estimation method addresses this concern, as the negative
binomial distribution is often used when there is overdispersion, i.e. a high variance, in the
data. High variance is inherent to FDI data. Another reason to use the NBQML estimation
method is the fact that it results in robust estimators.37
Table 3.1
FDI regressions, 1997-2005, Negative Binomial Quasi Maximum-Likelihood estimation
LN(FDI)
LN (GDPsource)
LN (GDP/CAPsource)
LN (GDPdest)
LN (GDP/CAPdest)
P-values
LN(FDI)
P-values
1.763
0.0000
3.471
0.0000
-1.762
0.0000
-3.470
0.0000
0.132
0.5817
0.035
0.8647
0.097
0.6861
0.305
0.1431
-1.762
0.0000
-3.471
0.0000
LN (POPdest)
0.334
0.1634
0.445
0.0313
LN (Distance)
-0.386
0.0000
-0.407
0.0000
Wave Total-1
-0.0002
0.0023
0.654
0.0000
0.724
0.0000
Common official language
0.458
0.0000
0.199
0.0000
Contiguous
0.173
0.0676
0.428
0.0000
LN (POPsource)
Colony
Control of Corruption (CoC)
Government Effectiveness (GE)
Political Stability (PS)
0.005
0.0034
-0.013
0.0000
-0.009
0.0000
0.012
0.000
0.006
0.0000
0.006
0.0000
35
See Eviews Users Guide pp. 642-653.
36
See Annex 02 Technical Notes.
37
For more information see Eviews User’s Guide Ch. 21 p. 642.
FDI and Democracy: A Gravity Analysis
35
LN(FDI)
P-values
LN(FDI)
Rule of Law (RoL)
-0.005
0.0201
Regulatory Quality (RQ)
-0.016
0.002
Voice and Accountability (VaA)
# Observations
22734
# Zero observations
16153
P-values
-0.010
0.0000
0.0000
0.023
0.0000
0.0754
-0.003
0.0026
Kaufmann indices
Unfortunately not all of the indices have the expected effect on FDI. This does not mean
however, that democracy is not relevant for FDI as all of the indices are significant.
Moreover, one of the indices that is seen as the essence of democracy, VaA, is positive and
significant. The fact that a country respects the essential human rights and freedoms, part of
which exists out of political freedoms and rights, makes for a democratic government and
country is thus very important for the FDI decision. The analysis shows also that the quality
of the regulatory framework of a country matters, as RQ is positive and highly significant.
The political stability index (or PS), one that has proven to be controversial in the literature, is
shown to be positive and highly significant. Indicating that a stable political climate indeed
provides a safe and more attractive investment climate, as investors can trust that policies and
regulations implemented are not to be changed overnight due to changes in the political makeup of a country. Another index that is shown to be positive and significant is control of
corruption (or CoC). As mentioned in the surveys38, corruption is perceived as an impediment
to FDI. Hence, countries that make good efforts in controlling corruption should receive more
FDI. This is supported by the analysis that indicates that countries with a higher level of
control of corruption receive more FDI ceteris paribus.
Negative effect of Government Effectiveness (GE)
Due to the similarities with other indices one would expect that the positive effects of those
indices would rub off on this index. The fact this is not the case comes as a surprise. What
might explain this negative effect? The nature of the index might be key to the explanation. In
section II it was mentioned that the GE index is a broad and complex index. Several other
indices seem to be merged in this one index, which is why many effects are plugged into this
index; some of which might oppose one another. The interaction between these effects is
crucial to the resulting effect of GE on FDI.
Negative effect of Rule of Law (RoL)
Surprisingly the coefficient corresponding to RoL is negative, seemingly indicating that FDI
is reduced by higher values for Rule of Law. The hypothesis corresponding with rule of law
concentrated on contract enforcement, as the contract is often a deal-breaker or a deal-maker.
As such, contract enforcement is very important for MNEs and, in a continuation of that, FDI.
However, as the Kaufmann indices are not specifically constructed to measure democracy but
to measure governance, contract enforcement is not the only component of rule of law that is
measured. Though rule of law in general is also important for FDI, as it is an indication of
38
36
See FDI and Democracy on an Industrial level.
FDI and Democracy: A Gravity Analysis
investment climate, contract enforcement specifically is more suited to measure the effect of
rule of law on FDI. As this is not the only component measured by the index, its importance
and effect can be diluted by the other components considered, resulting in a result which goes
against intuition. This is also confirmed by the literature, which suggests that one should for
example look at property rights protection when measuring the effect of Rule of Law on
FDI.39 Because it exceeds the scope of this study, for future research I would also suggest to
look at the effect of the index for separate groups of countries by development level. This
might lead to other conclusions about this index.
Economic control variables
But for two variables, all the economic control variables have the expected sign.
Population of the source country (POPsource) however was expected to have a positive sign
and shows a negative sign. One explanation for this could be that a company is less inclined
to start with FDI, when the turnover in the home country is large. After all, this is a market the
company is familiar with and which delivers a certain turnover. Comparing this with the
inherent uncertainty of the FDI decision, a risk neutral or risk averse company faced will
require incentives that outweigh the costs of the uncertain decision. However, a company
based in a small country population wise, will be more inclined to look over its borders for
other markets to access, as its home market is easily saturated. Thus, the growth of the
company hinges on its ability to access other (foreign) markets.
GDP per capita of the source country (GDP/CAPsource) was expected to have a positive sign
and instead shows a negative sign. This might be explained by the empirical fact that
developed countries tend to invest more in developed countries than in developing countries.
A country has obtained its high(er) development level amongst other reason due to the
activities of innovative enterprises. If these enterprises were to invest in countries with a
lower development level than the one present in their home market, they become part of the
development process of said country. In order to bridge the differences between development
levels they would need more incentives than just the possibility of cheap labour as the
production process requires more than just blue collar activities. Development level and
difference between development levels of both the source and destination country matter, as is
shown by the positive effect of GDP per capita of the destination countries. With regards to
the wave variable, table 1 shows that the addition of the wave variable improves the model
with respect to the democracy indices. The wave variable is significant at a 1% level. The sign
of the wave variable is negative, which might indicate that the data period considered is in the
descending part of the wave movement.
Dummy variables and distance variable
Both colony and common official language shows the expected positive sign, indicating that
the ties formed in colonial times are now important economic channels to be considered. The
fact that a common official language has a positive effect is easily explained by the fact that
misunderstandings are avoided if one speaks the same language, thus simplifying the process
of FDI. The dummy variable Contig measures the border effect. The variable takes the value
of one if two countries are contiguous to one another and zero if otherwise. The analysis states
the expected positive and significant effect. The positive effect found corresponds with the
empirical fact that neighbouring countries tend to maintain closer relationships with one
39
Li and Resnick (2003) and Jakobsen and De Soysa (2006).
FDI and Democracy: A Gravity Analysis
37
another, than with other countries. In accordance to the gravity relationship, the distance
variable shows the expected negative sign.
38
FDI and Democracy: A Gravity Analysis
4 FDI relative to trade
Bergstrand and Egger (August 2008) have shown that the growth of FDI relative to trade can
largely be explained by the growth in outsourcing of intermediates.
In their August 2008 paper, Bergstrand and Egger identify four possible economic factors that
can explain the fact that FDI seems to be growing at a faster pace than trade among OECD
countries. First, the ratio of FDI-to-trade may grow over time if FDI barriers (i.e. investment
costs) fall relative to trade barriers over time. Second, Markusen (2002) argued in his
Knowledge-Capital model with an oligopolistic market structure that a rise in economic size
in both countries could lead to an increase in FDI relative to trade. The third possible
economic factor, the one which is central to their paper, for the growth of FDI-to-trade is the
growth of intermediates trade. Eyeballing the ratio of FDI-to-trade, one would say that a
growth in intermediates trade will actually reduce FDI-to-trade. Bergstrand and Egger
(August 2008) find the solution in the presence of outsourcing, in which presence growth of
intermediates trade should cause the ratio of FDI relative to final goods trade to grow. A
fourth economic factor that may explain the growth in FDI-to-trade is an increase in merger
and acquisition FDI.40
The economic factor that may explain the growth of FDI-to-trade of interest here, is the first
one mentioned by Bergstrand and Egger (August 2008); the fall of FDI barriers such as
investment costs relative to trade barriers.
As democracy is an investment cost for both FDI and trade, it is interesting to see what the
effect of democracy on FDI relative to trade. This due to the fact that democracy can be seen
as a cost and effect superseding all other costs and effects, as it is the foundation on which an
economy can be build. Thus democracy should be addressed first, as the crucial investment
cost that it is, influencing the investment and trade decision whether consciously or not.
Due to this knowing what the effect of democracy is on the relationship with FDI and trade is
of great importance with respect to policy recommendations, even more so as FDI grows at a
greater pace than trade. After all, both FDI and trade have a great impact on a country’s
economy. This impact of democracy on one’s economy could be positively influenced by
taking this into account when dealing with policy issues.
As the investment decision requires a more long term and committed relationship, as capital
becomes illiquid after the investment decision has been made, and more “fixed costs” as
opposed to trade, which relationship ties are more loose and easier to transpose to other
countries, the hypothesis is that democracy is more important for FDI than for trade.
40
Bergstrand and Egger (August 2008), pp. 32/33.
FDI and Democracy: A Gravity Analysis
39
One explanation at forehand in favour of this hypothesis is that trading relationships do not so
much have to do with countries and their political outset, but more with corporations.
Although this argument can also be made with respect to FDI, the crucial difference is the fact
that for an investment to work-out it has to be integrated41 into the host-country and work
within its political and economical system. As I will try to prove, this can be best achieved in
a democratic country.
4.1
The importance of democracy to trade
That democracy indeed is important for trade follows from the interest of political economist
with respect to democracy and trade. Some of these political economists and their papers will
be (shortly) reviewed here.
Milner (1999) for example argues that the more traditional arguments used to explain the rush
to free trade (i.e. preference-based theories, changes in political institutions) cannot claim to
paint the full picture. But there is one development that might be able to do that very thing;
the spread of democracy. The spread of democracy and the expansion of free trade seem to go
hand in hand. As such is the case, Milner argues that democracy, and the spread thereof, could
be the institutional change that best explains the ever more so dominant choice for free
trade.42,43 Agreeing with other authors, Milner argues that trade liberalization may foster
democratization, which in turn may promote more trade liberalization.44
This last argument made by Milner (1999), is further examined in the Mansfield, Milner and
Rosendorff (2000) paper. Central to this paper is the question whether or not democracies are
better able to liberalize trade than groups of autocracies or mixed groups. Crucial to their
model employed is the role of legislature. More specifically, the fact that in democracies
political leaders need the backing of its electorate, as opposed to autocracies in which this is
not the case.45 The authors argue that trade barriers will be lower within democratic pairs than
within autocratic pairs. This is supported by their empirics; the estimation of mixed pairs is
negative and significant, indicating that trade between democratic pairs is more open than
trade between mixed pairs.46
The observation that democracy and free trade seem to go hand in hand is also made by
Milner and Kubota (2005). In the mid-eighties preferences of political leaders of developing
countries shifted from anti- to pro-free trade. Milner and Kubota argue that this shift in
preferences can be explained by the movement toward democracy. They pose that the
movement toward democracy opened up new support for freer trade, as political leaders now
had to take into-account the opinions of pro-trade groups as these were now part of their
41
Ideally this should be the case, however there are FDI projects that work without integration into the host-country, such as Export
processing enclaves.
42
43
Milner, 1999, pp. 102-104.
As this may true, it could also be argued that countries become more democratic in preparation of WTO-accession or due to
integration into the world-economy.
40
44
Milner, 1999, p. 109.
45
Mansfield et al., 2000, p. 305.
46
Mansfield et al., 2000, pp. 310-317.
FDI and Democracy: A Gravity Analysis
electorate. In order to remain elected, the political leaders of a now (more) democratic country
had to take account of these groups by liberalizing trade policies.47 The electorate now
contains pro-trade groups, as is explained by the fact that developing countries are rich in
labour; the economic factor which is most likely to benefit of free(r) trade.48
Their claims are supported by their empirics; democracies are associated with lower tariff
rates, regime type has the expected sign and is highly significant. On top of that, increasing
democracy, increases the chance that a country openness up to trade. Thus, democracy may
have promoted the move to free(r) trade.49
4.2
Analysis and results
The dependent variable FDI inflows from 1996-2004 is taken from the OECD database on
International Direct Investment, with 25 OECD countries acting as source countries and 40
destination countries. The dependent variable Trade inflows from 1996-2004 is taken from the
OECD STAN Bilateral Trade Database, with 25 OECD countries acting as source countries
and 40 destination countries. The explanatory variables GDPsource and GDPdest, are taken
from the IMFs World Economic Outlook October 2007 database. The distance variable is
taken from CEPII. The estimation method used for analysis is the NBQML-method.
As investment requires a more long term and solid relationship than trade relations do,
investment costs (IC) are greater than trade costs (TC). With regards to democracy, this
means that democracy would have a larger effect on the FDI decision than on a decision with
regards to trade. Indeed, this relationship IC>TC is what is depicted by the results mentioned
below and in the table, for all but two indices.
COC
IC>TC
GE
PS
RoL
IC<TC
RQ
IC>TC
VaA
IC>TC
IC=TC
IC>TC
Even more so, the P-values depicted for FDI are better than those for Trade. Of the six
indices, four correspond with the results regarding the link between FDI and democracy,
while this is not the case for the PS index and the VaA index.50 Although the Rule of Law
index has the desired relationship between FDI and Trade, the sign of the index goes against
intuition, as already mentioned above in the analysis of section III. For reasons of brevity,
Regulatory Quality (RQ) and Control of Corruption (CoC) are further analysed here.
Indeed, the quality of the framework of rules and regulations in a host country matters more to
FDI than to trade according to the results mentioned in table 2. As FDI requires a long term
47
Milner and Kubota, 2005, pp. 158-163.
48
Milner and Kubota, 2005, pp. 165-168.
49
Milner and Kubota, 2005, pp. 176-188.
50
See Table 1.
FDI and Democracy: A Gravity Analysis
41
relationship, and because of that has to integrate into the host country’s economy, it has more
to do with the national landscape of rules and regulations than trade. This increases the
importance of the quality of these national rules and regulations for FDI relative to trade,
because trade has to consider only a small part of the national framework of rules and
regulations. This is due to the less intensive relationship that is required for trade.
The same line of reasoning applies to Control of Corruption (CoC). As FDI requires
integration into the host country’s economy, the effects of corruption are much more invasive
for FDI than for trade, which relationship to the host country is much less intensive. Thus FDI
is more benefited by control of corruption than trade, as reflected by the larger positive effect
of control of corruption for FDI than for trade.
42
FDI and Democracy: A Gravity Analysis
Table 4.1
Effects of democracy on FDI and Trade, 1997-2004, Negative Binomial Quasi Maximum-Likelihood estimation
FDI
P-values
Trade
P-values
FDI
P-values
Trade
P-values
LN(GDPsource)
0.418
0.0000
0.069
0.0000
0.419
0.0000
0.070
LN(GDPdest)
0.225
0.0000
0.053
0.0000
0.225
0.0000
0.053
0.0000
0.0000
LN(Distance)
-0.261
0.0000
-0.068
0.0000
-0.262
0.0000
-0.068
0.0000
Wave Total-1
-0.0001
0.0735
-0.000004
0.5775
Colony
0.282
0.0002
0.019
0.7868
0.282
0.0002
0.019
0.7769
Common official language
0.212
0.0008
0.031
0.5823
0.212
0.0008
0.032
0.5825
Contiguous
0.189
0.0377
0.027
0.7316
0.189
0.0373
0.027
0.7353
Control of corruption (CoC)
0.003
0.3899
0.001
0.8253
0.003
0.4130
0.001
0.8080
Governmentness Effectiveness (GE)
-0.008
0.0484
0.001
0.7893
-0.009
0.0382
0.001
0.8867
Political Stability (PS)
-0.001
0.4503
-0.001
0.5793
-0.001
0.3642
-0.001
0.5997
Rule of Law (RoL)
-0.003
0.3144
-0.0005
0.8777
-0.003
0.4144
-0.0001
0.9560
0.016
0.0000
0.001
0.4845
0.016
0.0000
0.001
0.4606
-0.005
0.0001
-0.001
0.1926
-0.005
0.0001
-0.002
0.1614
Regulatory Quality (RQ)
Voice and Accountability (VaA)
# Observations
FDI:
6159
Trade:
6159
# Zero observations
FDI:
2242
Trade:
29
FDI and Democracy: A Gravity Analysis
43
Why does this analysis result in different signs for the coefficients for some of the indices?
This has to do with the fact that the dataset used to analyse the relationship between FDI
relative to trade and democracy is much smaller than the one use to examine the relationship
between FDI and democracy. As the dependent variable Trade only ranged from 1997-2004,
and the FDI data used for the relationship between FDI and democracy ranged from 19972005, the data-period shrank as one year was lost. Also, the Trade data could only be found
for 27 eligible OECD countries instead of 28, losing one source country. Also, to make sure
that the datasets for both FDI and Trade were off the same length another two countries were
lost. This all resulted in a dataset much smaller than the one used for the relationship between
FDI and democracy. Hence the (somewhat) differing results.
Although the results are in favour of the hypothesis that democracy implicates greater
investment costs than trade costs, not all of the coefficients displayed the same sign as the
analysis of section III, and the P-values of both the FDI and the trade model were not up to
standard. This is due to the limited sample of data available, as mentioned above. The dataproblems encountered here are such that further research is needed to be able to make any
definite inferences regarding the relationship between FDI relative to trade and democracy.
The analysis performed in this section can be seen as a first suggestion to a more definite
conclusion.
44
FDI and Democracy: A Gravity Analysis
5 FDI and Democracy on an Industrial level
For a long time, vertical motivations for MNEs were theoretically viable, but could not be
sustained in econometric studies. Bergstrand and Egger (2008) however were able to find
vertical motivations for MNEs. Though democracy is not a vertical motivation per se, as
already stated is does effect the overall decision of investment, and is thus also important for
investment on an industrial level. This due to the fact that it are mostly monopolistic
companies, for instance in industries such as glass or automotives, for which investment costs
like democracy matter most compared with monopolies like the oil industry.
Showing that democracy matters on an industrial level just as it does on a national level is
thus the aim of this section.
That it indeed does matter on an industrial level follows also from some surveys and articles
reviewed here. Though they do not all speak specifically about the effect that democracy has
on investments on a industrial level, inferences can be made from the observations about
(political) risks.
The survey of Shinkman (2007) for the Economist Intelligence Unit (EIU) seems to suggest
that economic factors are more important than (political) risks and other considerations on the
list of forces that will have the greatest influence on global FDI. However, at the same time
there are signs of significantly heightened political risk perceptions. The (negative) influence
of political risk is believed to be greater in the coming years. This is especially the case for
emerging markets, in which political risk is deemed the greatest obstacle to investment. The
EIU has defined four forms of political risk; risk of political violence, FDI protectionism,
geopolitical risk, and government instability (all of which are defined similar to some of the
Kaufmann indices). Each of these forms of political risks is expected to increase in emerging
markets.51 For investors in developing countries, costs are the main concern. For investors in
emerging markets political risk and governance issues are the most prominent investment
barriers. Many of the participants interviewed indicated that they had experienced problems
related to political risk.52
Over half of the respondents indicated that it mattered whether or not a country in which they
would invest is a democracy. And over a third of the respondents did not agree with the
proposition that in emerging markets authoritarian may make a more stable and predictable
environment for business. Respondents to other questions indicated a great sensitivity to the
importance of types of regimes and a possible positive link between democratic host-countries
and MNE operations.53
51
Shinkman, 2007, p. 84.
52
Shinkman, 2007, pp. 87-90.
53
Shinkman, 2007, p. 91.
FDI and Democracy: A Gravity Analysis
45
In the paper of Brunetti et al. (1997) results are presented from their cross-country survey.
They find that in LDC’s investors constantly fear policy surprises and unexpected changes in
rules that can seriously affect their business. In many developing countries the business
community feels that the authorities do not adequately guarantee their personal safety and do
not reliably enforce their property rights. Unreliable judiciaries (i.e. corruption) are perceived
as a major problem in many developing countries. In all parts of the world entrepreneurs
ranked corruption as one of their top obstacles of doing business.
In the article of Kekic (2007) for the EIU, factors such as macroeconomic, regulatory and
geopolitical risks are dubbed to constrain FDI flows. Though Kekic mentions that there are
some reasons to be optimistic, downside risks as macroeconomic imbalances and a range of
political risks loom large.54 Kekic finds that FDI is very sensitive to the quality of the
business environment. And thus there are factors that are able to dampen FDI inflows. Among
these is FDI protectionism. Forces within countries that worry about threats to their security
and fear consequences of globalisation have caused some governments to review and in some
cases tighten their FDI regulations. Also, anti-foreign capital forces and other political risks
are growing and gaining the listening ear of their government in some countries.55 Also for
the EIU, Sauvant (2007) concentrates on the negative impact of changing FDI regulations. He
concludes that although there are still enough sources of FDI and host countries which want
to attract FDI, regulatory risks are increasing and forces against FDI are gaining in strength,
causing more hostile FDI environments.
5.1
Analysis and results
The dependent variables are industrial FDI inflows from 2000-2004 taken from the Bureau of
Economic Analysis (BEA) of the U.S. department of commerce with 31 destination countries.
The explanatory variables GDPsource, GDPdest, GDP/CAPdest and Popdest, are taken from
the IMFs World Economic Outlook October 2007 database. The distance variable is taken
from CEPII. The estimation method used for analysis is the NBQML-method.
To go into the results of the analysis in table 3 per industry goes beyond the scope of this
study. Only more general inferences in relation to the main research of this study (relationship
between FDI and democracy) will be made. What the results imply per industry is food for
thought for further research.
Note that the size of the dataset is restricted by data-availability. Even in the data available
some omissions were made, due to the fact that companies were unwilling to release data
regarding their investments. Yet, despite the restricted size of the dataset, four out of the
seven sectors mentioned here had two to three highly significant democracy indices, and the
number of significant indices increases if one also considers those significant at the 15%
level. The remaining three sectors had at least one highly significant democracy index, which
number also increases if those significant at the 15 % level are considered. The inclusion of
democracy indices in the analysis is thus a valid one. Democracy has explanatory power.
46
54
Kekic, 2007, p. 18.
55
Kekic, 2007, pp. 38-40.
FDI and Democracy: A Gravity Analysis
Moreover, three of the six indices display similar effects for FDI at the industry level as for
FDI at the aggregate level. These indices are VaA (five out of seven industries), RQ (four out
of seven industries) and PS (four out of seven industries). Two indices (GE and RoL) display
similar effects for but two sectors. At the disaggregate level, regulatory quality and political
stability also matter for the FDI decision, evidenced by the positive effects of RQ and PS. An
even more strong support for the fact that democracy does matter at the disaggregate level, is
found for the VaA index, which displays the same sign at the disaggregate level for five
sectors. Of this it is highly significant in three sectors. The fact that the people of the host
country have a say in their government and can hold it accountable matters also at the
disaggregate level. At the disaggregate level, control of corruption is negative, seemingly
indicating that rules and regulations regarding corruption might have a hindering effect on
business at the disaggregate level. The remaining two indices – RoL and GE – depict a picture
that was hoped to be found at the aggregate level. Keeping in mind the limitation of the data it
would be interesting to see what the results would be if the data sample would be enlarged.
However, differences between the aggregate and the disaggregate level might also be
explained by the effect of (specific) industry characteristics.
That this last explanation has some merit, can shown by the fact that the size of the effects of
the indices differ per industry. The positive effect of GE for instance is larger for the retail
industry (0,156), than it is for the wholesale industry (0,063). This seems to indicate that
industrial characteristic influence the effect of the democracy indices.
Though I stated not to go into the results per industry, one remark about the services industry.
Specifically for an industry like the services industry, one would expect the RQ and PS
indices to have a positive effect instead of the negative effects displayed here. Intuitively, this
mainly seems to be due to data-availability problems. However, one should also take into
account the fact that services data is not easily obtained or classified.
FDI and Democracy: A Gravity Analysis
47
Table 5.1
FDI regressions per sector, 2000-2004, Negative Binomial Quasi Maximum-Likelihood estimation
Chemicals
values
LN(GDPsource)
-6.999
0.0695
LN(GDPdest)
-1.434
1.435
LN(GDP/CAPdest)
Metals
Pvalues
-1.205
0.7917
0.6572
3.898
0.6569
-3.897
Wholesale
Pvalues
Retail
Pvalues
-2.036
0.5328
-4.049
0.5575
0.3122
1.194
0.9964
-3.028
0.3123
-1.130
0.9966
3.030
Finance
Pvalues
-1.144
0.0037
0.5064
3.776
0.5061
-3.774
Real Estate
Pvalues
Services
Pvalues
-3.973
0.2792
-8.947
0.0278
0.2383
6.097
0.8304
-5.840
0.8505
0.2384
-6.084
0.8308
5.841
0.8505
LN(POPdest)
1.434
0.6570
-3.896
0.3123
-1.158
0.9965
3.028
0.5063
-3.774
0.2383
-6.092
0.8306
5.848
0.8503
LN(Distance)
0.337
0.1210
-0.329
0.1655
0.224
0.2540
-0.043
0.8433
-0.279
0.1871
-0.146
0.4331
0.085
0.7247
Wave sector-1
-0.005
0.6163
-0.011
0.5398
-0.001
0.9603
0.031
0.1074
-0.006
0.4706
-0.013
0.7488
-0.010
0.5531
Control of corruption (CoC)
-0.133
0.0009
-0.123
0.0002
-0.019
0.4304
-0.050
0.1770
-0.045
0.1103
-0.051
0.0768
-0.046
0.2078
0.127
0.0023
0.045
0.2474
0.063
0.0108
0.156
0.0030
-0.016
0.5531
-0.060
0.0176
0.171
0.0008
-0.012
0.1937
0.030
0.0225
0.007
0.2788
-0.009
0.3605
0.004
0.6767
0.003
0.7320
-0.003
0.7695
Government Effectiveness (GE)
Political Stability (PS)
Rule of Law (RoL)
Regulatory Quality (RQ)
Voice and Accountability (VaA)
# Observations
# Zero observations
FDI and Democracy: A Gravity Analysis
48
P-
0.057
0.1141
0.032
0.3388
-0.040
0.1262
-0.050
0.2771
0.013
0.6660
0.045
0.1441
0.048
0.1804
-0.034
0.1584
0.002
0.9364
0.018
0.3609
-0.003
0.9162
0.026
0.2614
0.055
0.0063
-0.051
0.0425
0.036
0.0066
0.045
0.0039
0.005
0.5400
-0.003
0.8104
0.019
0.0441
-0.011
0.1921
0.005
0.6580
160
160
160
160
160
160
160
84
92
36
105
76
60
85
6 Policy implications and conclusion
6.1
Policy implications
Gravity analysis
The gravity equation, once estimated, can be used to predict values of bilateral FDI flows by
making use of the estimated coefficients. The policy use lies in the fact that one can compare
the actual values with the predicted values, and make inferences about policies by way of
deviations. Positive deviations would be indicative of strong point, while negative deviations
would be indicative of weaknesses or problems. To be more clear, consider the following
example: Country X has implemented FDI policy Y with regards to low income countries.
More specifically the policy aimed to improve FDI conditions for these countries. It now
wants to know what the effect of the policy has been, more specifically if the policy had the
desired positive. One could apply gravity to this problem. First, one need to run a gravity
analysis with bilateral FDI data between country X and the low income countries targeted by
the policy, using data prior to the policy implementation. This analysis results into some
coefficients. Now, one can use these coefficients to predict the bilateral FDI values for the
years after which the policy has been implemented. Comparing these predicted values to the
actual values, one can infer from the deviations (if present) between these values what the
effect of the policy has been. One can also use the coefficients to predict changes in the
bilateral FDI flows. If in a gravity analysis run for Austria, the GE index has a coefficient of
0,7 and in Estonia the GE index improves by 10%, we can infer that bilateral FDI between
these countries will increase with 7%.
Democracy
From the results obtained in this research, it becomes obvious that though not all indices have
a positive effect, all are highly significant. This indicates that democracy is indeed important
for the FDI decision. What does this mean for developing countries? The positive effect of the
index VaA indicates that respecting human rights and freedoms and accountability of the
government to its electorate has a positive effect on FDI. Thus a country in which human
rights and freedoms are respected and the government is accountable for its actions attracts
more FDI than a country in which this is not the case. Hence, developing countries should
work on their human rights record and should takes measures to ensure the participation, and
with that its accountability, of its electorate. More developed countries should be aware of the
quality of their policies and regulatory framework, by stimulating and maintaining a high
standard of policy and regulations. Moreover, the positive effect of the PS and RQ indices
indicate the importance of a stable political environment and sound regulatory framework.
FDI and Democracy: A Gravity Analysis
49
Box 6.1
Practical implication of democracy indices
To give a better feel of the policy implications of the democracy indices, consider the following:
Suppose you are the government of a country in East Asia and want to improve your policy with regards to the
democratic quality of your country, more specifically in the area of government effectiveness. You also happen
to know about the existence of the Kaufmann indices. As this is the case, you select a group of countries in the
same region, i.e. East Asia. By observing the various percentile ranks of the countries and the development of
these ranks over time, one can see which country has the best policy in the area of government effectiveness.
100
90
80
70
60
50
40
30
20
10
0
china
myanmar
philippines
singapore
thailand
20
07
20
06
20
05
20
04
20
03
20
02
20
00
19
98
19
96
vietnam
From the graph above it is clear that Singapore stands out as the best country in the area of government
effectiveness. As such, one can conclude that Singapore has the best policy in this area. A country could
consider to take this policy and adjust it so that it can be applied in this country.
However, as the gap between Singapore and the other countries is quite great, it might be wiser to ease into the
policy changes by mirroring oneself on a country such as The Philippines or China, as these countries
experience a rising trend.
6.2
Conclusion
Does democracy have a positive effect on FDI inflows? A simple yes or no does not justify
the complexity of the problem. From the empirical analysis it becomes clear that the answer
has to be more nuanced, as not all the indices have the desired positive effect. They are
however all highly significant. As such, democracy is very important for FDI.
As indicated by the indices CoC, PS, RQ and Via, some measures of democracy have a
positive effect on FDI. One might even argue that these indices capture some of the more
important aspects of democracy. However, the empirical analysis indicates that GE and RoL,
have a negative effect on FDI. Thus the empirical analysis results in conflicting effects. The
net effect relies on which force has more strength. Connecting the results of the empirical
analysis to the theoretical framework mentioned in “Link FDI and Democracy” in section II,
it is my opinion that the positive effects will outweigh the negative effects. In this section I
stressed the importance of a stable policy environment for FDI. As reflected by the positive
and highly significant effects of the RQ and PS indices, the theory is supported by empirics.
In this chapter I also mentioned that in order to keep a government from reneging on its
50
FDI and Democracy: A Gravity Analysis
agreements and display opportunistic behaviour, it needs to be accountable to its electorate.
As reflected by the VaA index, again the theory is supported by empirics as the effect of the
VaA index on FDI is positive and highly significant.
Theory predicts that when taking FDI relative to trade, investment costs should have a larger
effect on this relationship than trade costs. This due to the fact that investment requires a more
long term, and integrated relationship than trade. Indeed, for but two variables, the IC>TC
relationship was found. For brevity only RQ and CoC were further analysed. The inference
made for the RQ index was that national landscape of rules and regulations matters more for
investment than it does for trade. For the CoC index the conclusion was that due to the more
intense relationship of FDI with regards to the host country, effects of corruption are more
invasive and thus FDI stands the most to gain from control of corruption. However, due to
data limitations this positive result can only be seen as a sign into the right direction. Thus
further research is needed to reach more conclusive answers about the relationship between
investment cost and trade costs in relation to democracy.
The aim of the section of “FDI and Democracy on an Industrial Level” was to show that
democracy matters on an industrial level just as it does on a national level, as several surveys
indicated. Sadly, again data-problems were encountered, leaving little room to make any
conclusive inferences from the results. Yet, despite these data-problems the results indicated
that democracy does matter on an industrial level as the indices were significant and a similar
pattern as that displayed on the aggregate level emerged.
Again, further research is needed.
FDI and Democracy: A Gravity Analysis
51
Annex 01 Figures 1-4 Bergstrand and Egger
(2007)
Fig. 1. a. Foreign affiliate sales of i’s Plants in j (2 countries). b. Goods exports from i to j (2 countries). c. Foreign direct
investment from i to j (2 countries).
FDI and Democracy: A Gravity Analysis
53
Fig. 2. a. Number of national firms in i (2 countries). b. Nomber of 2-country HMNEs in i (2 countries). c. Price of human
capital in i (2 countries). d. price of physical capital in i (2 countries).
54
FDI and Democracy: A Gravity Analysis
Fig. 3. a. Gravity equation flow from i to j (3 countries). b. Foreign affiliates sales of i’s plants in j (3 countries). c. Goods
exports from i to j (3 countries). d. Foreign direct investment from i to j (3 countries).
FDI and Democracy: A Gravity Analysis
55
Fig. 4. a. Number of national firms in i (3 countries). b. Number of 3-country HMNEs in i (3 countries). c. Price of human
capital in i (3 countries). d. Price of physical capital in i (3 countries).
56
FDI and Democracy: A Gravity Analysis
Annex 0.2 Technical notes
Kaufmann dataset:
The Kaufmann indices dataset is the only dataset the gives the margin of errors associated
with each indicator for each country.56 Despite these margins of error, the aggregate indicators
are sufficiently informative that many cross-country comparisons of governance can result in
statistically (and practically) significant differences.57
Serial correlation:
The assumption that errors corresponding to different observations are uncorrelated often
breaks down in time-series studies. When the error terms from different (usually adjacent)
time periods are correlated, we say that the error term is serially correlated. Serial correlation
affects the efficiency of the regression estimators, but does not affect the unbaisedness or
consistency if the estimators.58
Q-statistic:
A test to see whether or not there is serial correlation present in the data is the Q-statistic test.
If there is no serial correlation in the residuals, the autocorrelations and partial correlations at
all lags should be nearly zero, and all Q-statistics should be insignificant with large Pvalues.59 Most often the critical 10% level (or P-value 0.1) is just as the cut-off level.60
Heteroskedasticity:
Heteroskedasticity means that the assumption of constant error variance cannot be held. In a
cross-section study the presence of heteroskedasticity is very likely. A country which is
considered democratic and thus has a more stable policy environment will be associated with
smaller variances than a country that is considered to be undemocratic. When
heteroskedasticity is present OLS is biased in favour of the larger variances.61 This bias is
addressed by the Negative Binomial Quasi-Maximum Likelihood estimation method.
56
The inclusion of these margins of errors indicate that the authors of the Kaufmann indices are aware of the fact that the
measurement of the indices rely upon underlying variables and the considerations of the governments, enterprises, citizens and
experts groups surveyed for the development of the Kaufmann indices.
57
Kaufman et al, 2007, p. 2.
58
Pindyck and Rubinfeld, 1998, Ch. 6, p. 159.
59
Eviews 5 User Guide, p. 479.
60
61
Pindyck and Rubinfeld, 1998, Ch. 16, p. 496.
Pindyck and Rubinfeld, 1998, Ch. 6, p. 146
FDI and Democracy: A Gravity Analysis
57
Granger Causality:
The Granger approach to causality between FDI and Democracy is to se how much of the
current democracy values can be explained by past values of democracy and then to see
whether adding lagged values of FDI can improve the explanation. Democracy is said to be
Granger caused by FDI if FDI helps in the prediction of democracy. Note however that the
result “FDI Granger caused democracy” does not imply that democracy is the effect or result
of FDI. Granger causality measures precedence and information content but does not by itself
indicate causality in the more common use of the term. 62
62
58
Eviews 5 User Guide, p. 376.
FDI and Democracy: A Gravity Analysis
Annex 03 Kaufmann indices quantified
Voice and Accountability
Country
Year
Political Stability
Percentile Rank
Country
Year
(0-100)
(0-100)
2006
Percentile Rank
59.6
2006
40.4
1996
26.4
2006
34.6
1996
35.1
2006
62.0
1996
76.4
2006
77.9
1996
92.8
2006
17.8
1996
14.9
2006
59.1
1996
61.1
2006
86.1
1996
76.0
2006
22.1
1996
16.3
2006
64.9
1996
76.9
2006
60.1
1996
78.4
BRAZIL
BRAZIL
1996
54.5
2006
5.8
CHINA
CHINA
1996
5.3
2006
91.3
FRANCE
FRANCE
1996
78.9
2006
95.7
GERMANY
GERMANY
1996
90.9
2006
59.1
INDIA
INDIA
1996
52.6
2006
85.1
ITALY
ITALY
1996
75.1
2006
76.0
JAPAN
JAPAN
1996
74.2
2006
20.7
RUSSIA
RUSSIA
1996
34.9
2006
94.2
UNITED KINGDOM
UNITED KINGDOM
1996
79.4
2006
84.1
UNITED STATES
UNITED STATES
1996
FDI and Democracy: A Gravity Analysis
91.4
59
Government Effectiveness
Country
Year
Regulatory Quality
Percentile Rank
Country
Year
(0-100)
2006
2006
53.2
1996
58.0
2006
42.0
1996
50.7
2006
85.4
1996
77.6
2006
92.7
1996
89.3
2006
46.8
1996
39.5
2006
76.6
1996
73.2
2006
86.3
1996
64.9
2006
30.2
1996
28.3
2006
99.5
1996
97.1
2006
93.7
1996
94.6
BRAZIL
1996
58.0
2006
42.0
CHINA
CHINA
1996
50.7
2006
85.4
FRANCE
FRANCE
1996
77.6
2006
92.7
GERMANY
GERMANY
1996
89.3
2006
46.8
INDIA
INDIA
1996
39.5
2006
76.6
ITALY
ITALY
1996
73.2
2006
86.3
JAPAN
JAPAN
1996
64.9
2006
30.2
RUSSIA
RUSSIA
1996
28.3
2006
99.5
UNITED KINGDOM
UNITED KINGDOM
1996
97.1
2006
93.7
UNITED STATES
UNITED STATES
1996
60
(0-100)
53.2
BRAZIL
Percentile Rank
FDI and Democracy: A Gravity Analysis
94.6
Rule of Law
Country
Control of Corruption
Year
Percentile Rank
Country
Year
(0-100)
2006
(0-100)
44.8
RAZIL
Percentile Rank
2006
53.4
1996
51.5
2006
35.4
1996
52.4
2006
91.7
1996
89.8
2006
93.2
1996
95.1
2006
51.5
1996
39.3
2006
69.4
1996
73.3
2006
90.3
1996
85.4
2006
21.4
1996
23.3
2006
93.7
1996
96.1
2006
89.8
1996
92.2
BRAZIL
1996
49.0
2006
43.8
CHINA
CHINA
1996
46.7
2006
89.5
FRANCE
FRANCE
1996
89.0
2006
94.8
GERMANY
GERMANY
1996
95.2
2006
56.2
INDIA
INDIA
1996
61.9
2006
60.5
ITALY
ITALY
1996
82.4
2006
90.0
JAPAN
JAPAN
1996
91.0
2006
17.1
RUSSIA
RUSSIA
1996
24.8
2006
93.8
UNITED KINGDOM
UNITED KINGDOM
1996
96.7
2006
91.9
UNITED STATES
UNITED STATES
1996
FDI and Democracy: A Gravity Analysis
94.3
61
Annex 04 Q-statistics
Serial correlation is present. This comes as no surprise as the dependent variable, FDI, is also
regressed on lagged values of FDI by means of the Wave Total -1 variable.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
FDI and Democracy: A Gravity Analysis
AC
PAC
Q-Stat
Prob
0.114
0.098
0.120
0.087
0.098
0.080
0.073
0.098
0.101
0.088
0.106
0.083
0.089
0.125
0.055
0.098
0.089
0.079
0.085
0.073
0.084
0.054
0.083
0.079
0.050
0.044
0.063
0.057
0.053
0.051
0.048
0.039
0.069
0.054
0.070
0.047
0.114
0.087
0.102
0.058
0.068
0.044
0.036
0.061
0.061
0.045
0.060
0.032
0.039
0.074
-0.004
0.046
0.031
0.024
0.025
0.016
0.028
-0.009
0.030
0.022
-0.009
-0.012
0.010
0.003
0.004
-0.001
0.000
-0.012
0.025
0.008
0.025
0.002
274.67
480.99
790.10
950.08
1154.4
1292.4
1404.6
1607.9
1823.8
1990.6
2228.4
2375.0
2544.6
2877.3
2941.0
3146.8
3317.3
3448.8
3601.4
3715.1
3864.3
3925.7
4074.2
4206.9
4260.8
4301.3
4387.0
4456.7
4516.2
4572.6
4621.9
4653.9
4755.3
4817.6
4921.5
4969.4
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
63
Annex 05 Granger causality
The Granger causality test for the different indices indicate the following:
Null Hypothesis:
Obs
Probability
FDI2005$ does not Granger Cause COC
21234
12.5737
0.0000035
FDI2005$ does not Granger Cause GE
21299
9.36178
0.000086
FDI2005$ does not Granger Cause PS
21299
14.2104
0.00000068
FDI2005$ does not Granger Cause ROL
21299
15.9461
0.00000012
FDI2005$ does not Granger Cause RQ
21299
5.02411
0.00659
FDI2005$ does not Granger Cause VAA
21299
3.67032
0.02548
Out of these results the following can be concluded:
•
FDI does not Granger cause Control of Corruption;
•
FDI does not Granger cause Government Effectiveness;
•
FDI does not Granger cause Political Stability;
•
FDI does not Granger cause Rule of Law;
•
FDI does not Granger cause Regulatory Quality;
•
FDI does not Granger cause Voice and Accountability.
64
F-Statistic
FDI and Democracy: A Gravity Analysis
Literature list
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•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
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