Party system structure and its consequences for foreign direct investment

Abstract

Studies of foreign direct investment’s (FDI’s) determinants focus on irreversibility as the main source of governments’ credibility problems. Here, we highlight an underexplored source of time-inconsistency dilemmas: geographic agglomeration within a country. FDI’s tendency to agglomerate creates visible inequalities in the country and generates demands for geographic income redistribution. Unchecked, such redistributive pressures can dissuade investors from entering the country altogether. Not all political systems are equally vulnerable, however. Countries with regionalized party systems are relatively unattractive to investors because regionalism increases the probability that investment returns from one region will be appropriated by the national government and used for geographic-based income redistribution. Countries with national parties, however, are less likely to engage in such behavior. Thus, we predict higher FDI inflows in countries with nationalized party systems and lower inflows in countries characterized by regional parties. Evidence from democracies between 1975 and 2007 supports our argument and its posited causal mechanisms.

Party determinants of FDI: Evidence from governing party fractionalization in government

“…It is well documented in the literature that a country's political uncertainty is a critical factor considered by foreign investors (e.g., Buckley et al, 2007;Chakrabarti, 2001;Moosa, 2002). In line with this, FDI is particularly sensitive to economic policy uncertainty in host countries (Bellinger and Son, 2019;Simmons et al, 2018). Both transaction cost theory (Williamson, 1975(Williamson, , 1985 and real options theory (Dixit and Pindyck, 1994) help to understand the effects of economic policy uncertainty.…”

“…However, the impact of the party system, an important political factor, on FDI has not been sufficiently researched. Prior studies argued that the party system is an important consideration for potential investors (Bellinger and Son, 2019; Simmons et al, 2018). As suggested by the “parties-do-matter hypothesis” (Schmidt, 1996), parties have economic consequences due to their involvement in policy making (Dutt and Mitra, 2005).…”

Economic Geography, Politics, and Policy

“…Such large geographic inequalities generate difficulties for the formation and functioning of political institutions. They set the stage for regional conflict over trade and taxes (Beramendi & Rogers 2018) and may discourage foreign direct investment (Simmons et al 2016). Measuring economic geography and testing its effects in developing countries are therefore important and pressing objectives.…”

Political Parties and Foreign Direct Investment Inflows among Developing Countries

“…Parties function as competitive agents of societal actors and provide an opportunity for societal preferences to influence legislation. Hence, the number of political parties is a useful indicator of the diversity of societal interests (not) effectively represented in legislation, providing investors with general insights into the economic policy making of a host country (Simmons et al, 2018). As Lijphart (2012) demonstrates, the fact that very few political parties exist in the parliament suggests that the interests of diverse political groups are likely excluded from public policy making.…”

“…We instead propose that the FDI literature can benefit from utilizing a core institutional trait of democratic politics, party systems of host countries in general and effective number of political parties (ENPPs) in particular. Parties serve as political representatives, are involved in policy making, and consequently play an important role in influencing FDI inflows (Simmons et al, 2018). For potential investors, how many actors hold the reins of power is an important consideration and ENPP is indicative of the number of actors who can influence policies at critical junctures of legislative processes.…”