Democracy and FDI in Developing CountriesA Critical Assessment and a ComplementaryResearch Direction

Abstract

The relationship between democracy and FDI inflows in developing countries has been extensively investigated in empirical research, yielding mixed and sometimes contradictory results. This paper aims to provide a systematic review and critical assessment of this literature. Two principal strands are identified: one links democratic institutions to increased FDI inflows via stronger property rights and policy credibility, while the other highlights the potential “costs” of democracy, including redistributive pressures, regulatory constraints, and policy uncertainty. These contradictions are attributed not only to theoretical differences but also to variations in empirical specification, measurement, and sample composition. Most existing studies employ regression analyses to estimate the average marginal effects of democratic levels. This research argues that the existing studies should be complemented by analyses of regime changes to observe how FDI responds to political transitions. This proposed research agenda should primarily employ counterfactual analysis to reveal how FDI might have evolved in the absence of regime change, thereby distinguishing short-term adjustment effects from longer-term investment dynamics.