Political Parties and Foreign Direct Investment Inflows among Developing Countries
| Date | 01 August 2019 |
| DOI | 10.1177/0032321718799015 |
| Published date | 01 August 2019 |
| Subject Matter | Articles |
research-article2018
Article
Political Studies
2019, Vol. 67(3) 712 –731
Political Parties and Foreign
© The Author(s) 2018
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Direct Investment Inflows
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https://doi.org/10.1177/0032321718799015
DOI: 10.1177/0032321718799015
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among Developing Countries
Nisha M Bellinger1
and Byunghwan Son2
Abstract
This article focuses on the nature of party systems to explain variations in foreign direct investment
inflows within developing democracies. We hypothesize a positive relationship between the
effective number of parliamentary parties and foreign direct investment inflows. Large effective
number of parliamentary parties is indicative of the expropriation risks as well as stability of the
political environment of host countries. We thus argue that expropriation risks are low when the
presence of multiple parties makes drastic, impulsive changes in economic policies difficult. We
also suggest that a larger number of parties represent diverse societal interests better, reducing the
chances of underrepresented social groups driving political instability. The relationship between
effective number of parliamentary party and foreign direct investment inflows is tested on a sample
of 56 developing democracies from 1985 to 2011. The evidence presented lends strong support to
the argument and is found robust to a number of alternative empirical scenarios.
Keywords
foreign direct investment inflows, effective number of parliamentary party, party systems,
democratic regimes
Accepted: 15 August 2018
Introduction
Firms operating across borders assign significant weight to political risks when con-
sidering hosts for their investments. Assessing political risks, however, often turns out
to be a daunting challenge. Policymakers of host countries typically have a hard time
credibly signaling their commitment to property rights protection to foreign investors
(Büthe and Milner, 2008) and as such a commitment is ultimately their private infor-
mation. Literature on foreign direct investment (FDI) implies that good governance
1Boise State University, Boise, ID, USA
2George Mason University, Fairfax, VA, USA
Corresponding author:
Nisha M Bellinger, Boise State University, Boise, ID 83725, USA.
Email: nishabellinger@boisestate.edu
Bellinger and Son
713
alleviates this commitment problem and, subsequently, renders national economies
conducive to foreign capital inflow. A swath of empirical studies in recent years find
empirical regularities between investment and quality of governance in the realm of
strong judicial systems and rule of law (Staats and Biglaiser, 2012), effective corrup-
tion control (Barassi and Zhou, 2012), and the protection of civil and political rights
(Harms and Ursprung, 2002), to name a few.
While this line of research significantly advances our understanding of how potential
investors assess political risks of host countries, we suggest that the analytic utility of
quality of governance indicators is limited. These indicators are predicated on relatively
subjective and opaque coding decisions, delivering noisy signals of the host governments’
commitment (Michener, 2015). We instead propose that the FDI literature can benefit
from utilizing a core institutional trait of democratic politics, party systems of host coun-
tries 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 inves-
tors, 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 leg-
islative processes. Moreover, the foremost analytical advantage of tapping into ENPP in
host countries lies in its high observability to potential investors. Unlike the performative
indicators of quality of governance, ENPP is easily observable and not subject to arbitrary
coding decisions.
We test the relationship between ENPP and FDI inflows on a sample of 56 developing
democracies. Our empirical analysis is twofold. We first show the direct relationship
between ENPPs and FDI through simple panel regression models. We, then, complement
these models with a causal mediation analysis where we demonstrate that the effect of
ENPP indeed runs through our two mediating factors, namely, expropriation risks and
political stability. The result of our empirical analysis lends strong support to our argu-
ment and is found robust to alternative empirical scenarios.
The findings of this article make a distinct contribution to the research on FDI inflows
as well as ENPP. First, our focus on party systems enables us to highlight the heterogene-
ity of developing democracies in terms of FDI inflow, thereby advancing the literature
beyond its traditional focus on regime type and quality of governance. More specifically,
we link an important institutional feature, namely, ENPP, to governmental policy stability
and low expropriation risk, both important attributes for potential investors especially in
the context of developing countries. Second, the use of ENPP goes beyond the purview of
studies on FDI and offers a fresh look at the importance of simple institutional configura-
tions in the broader field of the political economy of development. Unlike traditional
studies seeking traits of quality of governance such as corruption control (e.g. Johnson
et al., 2002) or those relying on empirical instruments such as settler mortality (Acemoglu
et al., 2001), we suggest that the structure of political institutions clearly represents the
limits of core policy makers’ influence over the governing environment in a straightfor-
ward manner. Finally, we expand the scope of the studies on ENPP. A growing body of
research focuses on the consequences of party systems where the significance of ENPP
has been linked to crucial outcomes such as welfare expenditures (Crepaz, 1998) and
health outcomes (Mukherjee, 2013; Wigley and Akkoyunlu-Wigley, 2011a). We contrib-
ute to this literature by highlighting that the role of ENPP is not just restricted to domestic
political economic outcomes but extends to international political economic outcomes
such as FDIs.
714
Political Studies 67(3)
Our article is comprised of six sections. In the section following this introduction, we
explore existing studies on FDI inflow and point out that the current FDI scholarship can
benefit from more contextualized insights on the effect of political party systems of host
countries in the developing world. In the third section, we offer our argument that fills this
lacuna and derive testable hypothesis from it. The fourth section outlines the empirical
strategy, and the fifth section presents the findings. The last section reviews these findings
and discusses policy implications and our contribution to the existing literature.
Literature Review
Extant literature on the politics of FDI inflows can be summarized into two broad strands of
research, where the first focuses on differences between political regimes (e.g. Jensen, 2003;
Li, 2006; Mathur and Singh, 2013; Oneal, 1994) and the second analyzes institutional deter-
minants (e.g. Barassi and Zhou, 2012; Blanton and Blanton, 2007; Harms and Ursprung,
2002; Moon, 2015; Staats and Biglaiser, 2012) that transcend a regime-type explanation. The
first strand of research, which preceded the second, was in a nutshell an attempt to encapsu-
late political determinants of FDI into political regime types. Focusing on the relative advan-
tages of democratic versus non-democratic regimes in their ability to attract greater FDI
inflows, this line of research is composed of two contending perspectives. One perspective
postulates that non-democracies are able to attract higher levels of foreign investment pri-
marily because non-democratic leaders are sheltered from societal pressure and are thereby
able to provide foreign investors with better benefits and inducements as compared to
democracies (Huntington, 1968). Fewer institutional constraints make leaders more likely to
pursue policies that could advance the interests of potential investors. Democratic officials,
on the other hand, cannot permit foreign investors to function unrestrained in the domestic
market, especially if domestic interests are likely to be compromised.1 Frequent leadership
changes via popular elections amplify this limitedness of democracies (Li, 2009).
Empirical evidence supporting the advantage of non-democratic regimes is abound. For
instance, Oneal (1994) demonstrates that returns to investments are higher among non-
democracies than democracies, while Resnick’s (2001) findings indicate that democratic
transitions push away foreign investors. Pinto (2012) provides a more nuanced analysis,
suggesting that democracies raise the expropriation risks of foreign investors when, but
only when, the investors’ interests are incompatible with that of their core constituents.
An alternative theoretical perspective postulates that democracies have a more advan-
tageous position as compared to non-democracies for two primary reasons. The first is
that they are able to provide formal and legal channels through which foreign investors
can approach host governments and...
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