Trading Spaces: The Political Economy of Foreign Direct Investment Regulation Sonal S. Pandya Department of Government Harvard University

FDI Central to International Economy Single largest source of global capital flows Generates 20% of world trade flows Promotes economic development

Research Question Why do countries regulate foreign direct investment?

Restrictions Vary By Industry Industry-Level Foreign Ownership Restrictions 25 Latin American Countries, Two-digit Industry Categories # Restricting Countries 64 Post and telecommunications Recreational, cultural and sporting activities 9 40 Electricity, gas, steam and hot water supply 8 66 Insurance and pension funding 8 12 Mining of uranium and thorium ores 7 62 Air transport 7 05 Fishing, operation of fish hatcheries and fish farms 6 11 Extraction of crude petroleum and natural gas 6 60 Land transport; transport via pipelines 6 10 Mining of coal and lignite; extraction of peat 5

Existing Explanations Insufficient Nationalism can’t account of multiple dimensions of variation Scholarly literature makes assumptions re: governments preferences for FDI No Microfoundations

Political Economy Approach Identifies Sources of Variation FDI inflows redistribute income Political cleavages between winners and losers Politicians negotiate tradeoffs

Vertical FDI Home Country Host Country FDI Inflow Finished Product

Politics of Vertical FDI Vertical FDI’s Economic Effect Increases labor demand Political cleavage Labor vs. Capital Local wages & production costs increase Salient Political Institution Partisanship

Horizontal FDI Home Country Host Country FDI Inflow Finished Product

Politics of Horizontal FDI Horizontal FDI’s Economic Effect Increases market competition Political cleavage Producers vs. Consumers Local firms’ profit & prices decrease Salient Political Institution Electoral Competition

Alternate Explanation: Nationalism FDI increases foreign ownership Foreign ownership threatens national identity

Hypotheses Left governments are less likely to restrict vertical FDI Electoral competition reduces the probability of restrictions on horizontal FDI Nationalist governments more likely to restrict FDI

Measuring FDI Regulation Foreign ownership restriction 1 = banned, only minority share allowed 0 = no limit Data coded from US Commercial Guides 119 countries, 58 industries, 1990s (pooled) Approx. 30% of country-industries restricted

Measuring Propensity Vertical FDI Restrictions Interaction of Host Labor Supply and Industry Labor Demand Data: Average Schooling Industry per worker value-added for US- based multinational firms Partisanship

Left Party x (Low Skill) # (1.64) Right Party x (Low Skill) (0.58) Support for Vertical FDI at Low Skill Levels # = significant at.1 level Logit Model Estimates

Measuring Industry’s Propensity to Receive Horizontal FDI Restriction Incentives to enter market via horizontal FDI Data Host country GDP Gravity model estimates of trade barriers Degree electoral competition

Expected Probability of Foreign Ownership Restrictions at Varying Levels of Democracy Level of DemocracyE (Foreign Ownership Restriction | Level of Democracy) No executive/legislature 1 Unelected executive/legislature 1 Elected, one candidate 0.99 One party, multiple candidates Multiple parties legal but only one won seats Multiple parties compete and won seats but one party holds more than 75% of seats 0.89 Largest party received less than 75% of seats 0.50

Nationalist Governments Less Likely to Restrict Shift to executive from nationalist party decreases expected probability of ownership restriction by 24 percentage points*. *standard deviation =.08

Summary of Results Left parties less likely to restrict FDI in lower skilled industries Weak democracies use FDI restrictions as substitutes for trade restrictions; in stronger democracies restrictions less sensitive to market entry barriers Governments led by nationalist executives less likely to restrict FDI