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.