1. 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)

2. 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

3. 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

4. 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

5. 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)

6. 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

7. 5 periods around the transition year
3. Method: Event study
After
Transition year
D = 1
5 periods around the transition year

8. 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

9. 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)

10. 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

11. 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

12. 4. Baseline findings: Controlling for ICRG
(1)
(2)
(3)
(4)
All
Consolidated
0.700
1.084**
(1.469)
(2.246)
0.268
( )
(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

13. 4. Baseline findings: Illustrations

14. 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

15. 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)

16. 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)

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

18. 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

19. 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.