Do democratic transitions attract foreign investors and how fast Do democratic transitions attract foreign investors and how fast? Philadelphia, ASSA 2018 Jean Lacroix Centre Emile Bernheim, Université Libre de Bruxelles (ULB) Pierre-Guillaume Méon Khalid Sekkat Economic Research Forum (ERF)

1. Introduction Policy-makers tend to believe that democracy attracts FDI June 2015, “Investing in Tunisia, start-up democracy”, investment forum One year before: “We are not dictators”, Thailand’s premier (in power since the May 2014 coup) Does it?... 30 papers on the effect of democracy on FDI: In 13, it is positive In 5, it is negative In 6, it is insignificant It is conditional in the last 6 See the appendix

1. Introduction The impact of democracy is difficult to measure Cross-country heterogeneity The level of democracy is difficult to measure A lesson from the growth literature Democracies do not grow faster (Barro, 1996, La Porta et al., 1999, Doucouliagos and Ulubaşoğlu, 2008) But countries that democratize grow faster than before (Rodrik and Wacziarg, 2005, Papaioannou and Siourounis, 2008, Acemoglu et al. forthcoming) => Use within country variations: democratic transitions

1. Introduction 3 questions Our paper is the first to address them Do democratic transitions affect FDI inflows? How fast? Is this relation explained by political risk? Our paper is the first to address them an event study method applied to growth (Rodrik and Wacziarg, 2005, Papaioannou and Siourounis, 2008, and Acemoglu et al., 2014) within variation in FDI net inflows over GDP around democratic transitions a panel of 115 developing countries over 1970-2014

2. Theoretical background: level of democracy Direct impact of democracy on FDI Checks and balances (North and Weingast, 1989) Political and civil rights (Harms and Ursprung, 2002) Less privileged relationships with the regime (O’Neal, 1994) Mutability of laws (Tocqueville, 1835, Dutt and Mobarak, 2015) Indirect impact of democracy on FDI Institutional outcomes (Mohtadi and Roe, 2003) Policies (Grosjean and Senik, 2011, Gwartney and Rode, 2012, Giuliano et al., 2013, or Bjørnskov and Rode, 2014) Public expenditures (Aidt and Jensen, 2013), Education (Gallego, 2010)

2. Theoretical background: transitions Reforms take time Economic freedom (Gwartney and Rode, 2012) Corruption (Mohtadi and Roe, 2003) Political risk (Sunde and Cervelatti, 2014, Méon and Sekkat, 2016) Early transitions are unstable The ousted elite may stage a coup (Acemoglu and Robinson, 2001) “Democratic capital” (Persson and Tabellini, 2009) => One must distinguish The transition to democracy The risk of autocratic reversal Political risk

5 periods around the transition year 3. Method: Event study After Transition year D = 1 5 periods around the transition year

3. Method: Event study Net FDI inflows over GDP (UNCTAD, 2015)   Net FDI inflows over GDP (UNCTAD, 2015) Lagged value of the ratio of net FDI inflows over GDP Country fixed-effect Time fixed-effect Democratic dummy variables: D1 : 5th, 4th, and 3rd pre-transition years D2 : 2nd, 1st pre-transition years, and the transition year D3 : 1st, 2nd, and 3rd post-transition years D4 : 4th, 5th, and 6th post-transition years D5 : 7th and subsequent years Autocratic reversal dummy Time-variant control variables (e.g. focus on political risk) Error term Baseline specification with D=1 from the transition year onwards

3. Method: data FDI inflows / GDP Democratic transitions UNCTAD (2015) 1970 – 2014 Democratic transitions Use Acemoglu et al. (forthcoming) database. Extend it to 2014 using the same method Based on simultaneous jumps in Polity IV index and Freedom House rating (and Cheibub et al., 2010, classification for available years)

3. Method: How to take political risk into account? Consolidated democratic transitions Stability condition: at least 5 years without autocratic reversal (Papaioannou and Siourounis, 2008) Controlling for political risk International Country Risk Guide ICRG11 : Sum of all ICRG components except democratic accountability From 1985 onwards Year average

4. Baseline findings No effect democratic transitions in general   (1) (2) (3) (4) All Consolidated 0.390 0.585** (1.234) (2.035) -0.147 -0.244 (-0.829) (-1.243) 0.187 0.355 (0.540) (0.935) 0.161 0.300 (0.436) (0.981) 0.387 0.479 (0.913) (1.171) 0.729 0.790* (1.429) (1.676) Observations 4,818 Number of countries 115 Adjusted R-squared 0.250 Positive effect of consolidated transitions: 6 years after the transition 0.585% of GDP Robust t-statistics in parentheses *** p<0.01, ** p<0.05, * p<0.1

4. Baseline findings: Controlling for ICRG   (1) (2) (3) (4) All Consolidated 0.700 1.084** (1.469) (2.246) -0.0124 0.268 (-0.0326) (0.856) 0.918 1.539* (1.066) (1.759) 0.684 1.225* (0.841) (1.844) 1.086 1.513* (1.178) (1.835) 1.178 1.572* (1.249) (1.869) ICRG11 0.0695* 0.0679* 0.0702* 0.0697* (1.884) (1.882) (1.816) (1.895) Observations 2,476 Number of countries 85 Adjusted R-squared 0.214 0.215 0.216 No effect democratic transitions in general When controlling for ICRG Positive effect of low political risk Positive effect of consolidated democratic transitions only The effect appears earlier 1,1 to 1,6% of GDP Robust t-statistics in parentheses *** p<0.01, ** p<0.05, * p<0.1

4. Baseline findings: Illustrations

5. Robustness checks Adding covariates GDP per capita secondary schooling Alternative coding of D1, D2, D3, D4, D5 Alternative controls for political risk None of the political risk component explains the difference between consolidated democratic transitions and the whole set of transitions

6. Causality? Our estimates are causal if the timing of transitions is exogenous Revolutions are to a large extent unpredictable (Kuran 1989, 1991) Bueno de Mesquita (2010) provides a model of regime changes with multiple equilibria => loosely related to fundamentals Structural factors only matter in the median run because of the mistakes of autocrats (Treisman, 2015, 2017)

6. Causality? But we address endogeneity using alternative strategies Selection in the treatment Local projections Propensity score matching IV regressions Share of democracies in the region (Acemoglu et al., forthcoming) Regional average * country’s propensity to follow the region (Qian and Nunn, 2014)

6. Causality? Propensity score matching Controlling for political risk All transitions Consolidated transitions

5. Causality ? IV regressions   (12.1) (12.2) (12.3) (12.4) (12.5) (12.6) (12.7) (12.8) IV – All IV – Consolidated IV - Consolidated IV- All 0.410*** 0.409*** 0.371*** 0.370*** 0.316*** 0.317*** 0.205** 0.209** (4.975) (4.964) (3.358) (3.356) (3.710) (3.760) (2.315) (2.328) 0.606 0.760 1.513 1.607* (1.113) (1.526) (1.346) (1.716) -0.648 -3.161 -3.647 -5.673 (-0.219) (-1.010) (-0.856) (-1.216) 0.948 2.787 12.23** 12.90** (0.413) (0.922) (2.163) (2.336) -0.603 -0.278 4.014 3.034* (-0.676) (-0.544) (1.599) (1.767) 0.0173 0.0509 4.794* 3.125* (0.0360) (0.120) (1.937) (1.796) 0.163 0.260 5.146* 4.279* (0.243) (0.391) (1.882) (1.883) 0.558 0.590* 1.054 0.947 0.0838 0.221 1.787 0.586 (1.353) (1.701) (1.089) (1.299) (0.179) (0.711) (1.497) (0.669) ICRG11 0.0711* 0.0678* 0.0958*** 0.0756** (1.952) (1.927) (2.581) (2.117) Observations 4,818 2,476 4,013 1,881 Number of countries 115 85 Hansen p-stat 0.394 0.650 0.115 0.156 0.909 0.983 0.764 0.761 First stage F stat D 79.85 139.5 23.41 45.26 D1 22.83 30.99 10.47 16.60 D2 30.34 26.71 21.20 15.53 D3 38.63 26.12 15.19 13.78 D4 19.56 15.87 14.98 15.88 D5 82.77 96.21 34.17 33.02 - IV estimate using the dynamics of regional waves of democratization - Results are consistent with previous estimates Robust z-statistics in parentheses *** p<0.01, ** p<0.05, * p<0.1

7. Conclusion Democratic transitions do not attract foreign investors on average. But two effects Higher political risk reduces FDI Intrinsic appeal of democracy The effect of consolidated transitions appears approximately ten years after the transition It appears faster once political risk is netted out Implications Democratic transitions alone are not sufficient. Need to stabilize the transition and to attract foreign investors Thank you.