This research paper investigates whether the political style of nations has an impact on drawing foreign direct investment (FDI). A review of literature was conducted and research findings suggested that there is a relationship between mechanisms of government and foreign investment. This study sought to investigate these variables.
The following questions guided the research:
1. Is there a difference between groups representing free nations, partially free nations, and not free nations regarding political rights and civil liberties?
2. Do political rights and civil liberties predict foreign direct investment?
The hypotheses for the study are as follows:
Hypothesis 1. Free nations will draw more FDI than non-free nations.
Hypothesis 2. Higher levels of political rights and civil liberties will result in higher levels of FDI.
Archival research was used to examine the variables for this study. Political rights and civil liberties were operationally defined by the Freedom in the World survey used to gather data for this study. The Foreign Direct Investment database was also used to gather data. ANOVA was used to test the first hypothesis and regression analysis was used to test the second hypothesis. Following this, conclusions are presented.
Review of Literature
The International Monetary Fund (IMF) (2003) defines foreign direct investment (FDI) as a category of international investment reflecting the objective of a resident in one economy (the direct investor) obtaining a lasting interest in an enterprise resident in another economy (the direct investment enterprise). The lasting interest implies that a long-term relationship between the parties is desirable and that there will be a significant degree of influence by the investor on the management of the enterprise. A direct investment relationship is established when the direct investor acquires 10 percent or more of the ordinary shares or voting power of an enterprise abroad.
In recent decades, relations between multinational corporations (MNCs) and host governments in developing countries that are typically recipients of FDI have changed from being predominantly adversarial and confrontational to nonadversarial and cooperative (Ramamurti, 2001). This may be due in part to the overarching effects of globalization and the emergence of new trade relationships, both of which are understood as important catalysts for economic growth in developing countries. Further, as Makki and Somwaru (2004) have pointed out, FDI is an important vehicle of technology transfer from developed to developing countries that stimulates domestic investment and facilitates improvements in human capital and institutions in the host countries.
This review of literature will first, offer a general overview of FDI patterns and targets in recent years. It will then move to an examination of FDI flows with respect to specific regions and countries and the effects of these flows. Only FDI to developing countries are considered.
Trends in FDI
Ramamurti (2001) has stated that FDI flows into developing countries had a discontinuity in the 1990s. From only $20 billion in 1980, and $23.7 billion in 1990, FDI inflows rose to $166 billion in 1998, a 7-fold increase. In this same period, the stock of FDI in developing countries rose from 5 percent of gross domestic product (GDP) to 20.5 percent of GDP whereas imports and exports rose only slightly from 51.5 percent to 56.6 percent of GDP. FDI liberalization has been quite broad in the past 10 years (Ramamurti, 2001).
In discussing global FDI flows, Globerman and Shapiro (2002) commented that governance infrastructure is an important determinant of both FDI inflows and outflows. Investments in governance infrastructure not only attracted capital, they also create the conditions under which domestic MNCs emerge and invest abroad. These researchers believe, however, that investments in governance infrastructure are subject to diminishing returns, so that the benefits in terms of inflows are most pronounced for smaller and developing countries.
Overall, Makki and Somwaru (2004) believe that FDI and trade together have a positive impact on economic growth but the size of such impact varies across countries depending on the level of human capital, domestic investment, infrastructure, macroeconomic stability, and trade policies. These researchers believe that a combination of FDI, trade, human capital, and domestic investment are important sources of economic growth for developing countries. They identify a strong positive interaction between FDI and trade in advancing growth and that FDI stimulates domestic investment.
Neumayer and De Soysa (2005) noted that FDI has many artifacts, including the development of labor market regulations that improve workers’ income and quality of life. Hassan (2004) also suggests that FDI benefits developing countries by diversifying the sources of external finance, increasing the risk-bearing by investors, reducing the cost of capital, improving incentives for managing the investment process, assisting in the development of domestic capital markets, and enhancing the mobilization of domestic resources.
Similarly, Makino, Lau, and Yeh (2002) also found that a major trend in FDI is the decision of many investing firms to invest in developing countries with actual or perceived pre-existing relationships to the direct investor and its country. For example, these researchers noted that in a sample of 328 Taiwanese firms engaged in FDI, well over 70 percent of these firms tended to seek out investment opportunities in the Peoples Republic of China and other developing countries in the Pacific Rim. Such investment is also facilitated, said Janeba (2004), by the responsiveness of host country governments to FDI overtures initiated by MNCs.
Levels of FDI were identified by the IMF (2003) for the period from 1990 through 2001. As of 1990, an average of $59.9 billion in FDI inflows to developing countries was recorded. By 2000, this amount had increased to $248.3 billion and as of 2001, had declined slightly to $215.4 billion.
Regionally, there were significant differences in FDI flows during this time period. The IMF (2003) reported that overall, Africa averaged $2.7 billion in FDI from 1990 through 1994 and as of 2001, received $17.7 billion in FDI. Asia, in contrast, received an average of $33.5 billion in FDI between 1990 and 1994 and $91.4 billion in 2001 (down from $128.2 billion in 2000). The developing countries of Europe experienced an increase in FDI from $4.4 billion in 1990 to $31.2 billion in 2001. The IMF (2003) also noted that Western hemispheric developing countries increased their share of FDI from $15.7 billion in 1990 to $69.5 billion in 2001 (down from the 1999 peak of $88.0 billion).
In an effort to better understand how host country and industry characteristics impact on FDI choices and inflows, Nunnenkamp and Spatz (2004) analyzed FDI stocks in major sectors and specific manufacturing industries in a large number of developing economies that originated from the United States. Their goal was to determine which host-economy and industry characteristics are most likely to lead to increases in FDI. A cross-country analysis was undertaken in a study which revealed that host-economy characteristics and industry characteristics such as technology intensity, factor requirements, linkages to local and foreign markets, and the degree of vertical integration of foreign affiliates are likely to shape the growth impact of FDI. Openness to trade, an established government regulatory and oversight system, and adequate human capital were also identified as variables likely to facilitate larger inflows of FDI.
Richards, Gelleny, and Sacko (2001) analyzed another determinant of FDI inflows. These authors looked at the relationship between foreign economic capital and the level of government respect for two types of human rights in developing countries. These rights were physical integrity rights and political rights/civil liberties. Using ordered logit analysis on a cross-national sample of 43 developing countries from 1981 to 1995, Richards, et al (2001) discovered systematic evidence of an association between foreign economic penetration and government respect for these two types of human rights. Of particular interest was the finding that both FDI and portfolio investment are reliably associated with increased government respect for human rights, with such respect further associated with democratization.
Generally, the research reviewed thus far suggests that a number of variables have influenced FDI choices and inflows. Noorbakhsh, Paloni, and Youssef (2001) stated that despite the dramatic increase in total FDI flows to developing countries in the last few years, the bulk of FDI has been directed to only a limited number of countries. Human capital is a statistically significant determinant of FDI inflows and may be an increasingly important determinant over time. While many investors seek FDI investment climates that maximize profitability and return on investment (ROI), there is a growing sense that a developing country with limited human capital does not have the capacity to generate the level of profitability that MNCs seek. Such considerations are also seen by Noorbakhsh, et el (2001) as linked to democratization processes.
Examples of FDI Inflows
The literature on FDI inflows by region and/or country is both broad and deep. This section of the review will examine general patterns with respect to key regions of the world. For example, data generated by the United Nations reported that the 49 least developed countries remain marginal recipients of FDI with only 2 percent of all FDI going to those countries (“FDI in least developed countries….,” 2003).
The United Nations Conference on Trade and Development (UNCTAD) (2004a) reported on FDI inflows to Latin America and the Caribbean and noted a decline for the fourth consecutive year. This region experienced a decline of 3 percent in 2003, down from $51 billion to $50 billion. The largest recipients of FDI in this region were Brazil and Mexico, which nevertheless received 39 percent and 26 percent less in FDI respectively.
UNCTAD (2004a, p. 2) offered the following statistical data on the region (Table 1):
LAC: economy distribution of FDI inflows, by range, 2003
Further, UNCTAD (2004, p. 4) delineated specific recipients of FDI in the region as follows (Figure 1):
Figure 1. The Top 10 recipients of FDI inflows in LAC, 2002-2003
(Billions of dollars)
UNCTAD (2004b) also provided data regarding FDI inflows into Asia. Specifically, FDI flows to Asia and the Pacific rose from $94 billion in 2002 to $107 billion in 2003. Some 34 economies received higher inflows whereas 21 economies received lower inflows. Presented below is a table illustrating the range of FDI in selected Asia Pacific economies (Table 2).
Asia and the Pacific: economy distribution of FDI inflows, by range, 2003
UNCTAD (2004b) also identified the top ten recipients of
FDI inflow in this region for both 2003 and 2002. China topped
the list, followed by Hong Kong, Singapore, and India. According to UNCTAD (2004b), intraregional investment is also growing in this area partly because of the shift of production from higher to lower cost locations within the region and also due to regional integration arrangements. China and India are becoming sources of FDI and Asian companies now dominate the list of the 50 largest transnational corporations (TNCs) from developing countries, with 32 of the total. Presented below is UNCTAD’s (2004b, p. 4) listing of top ten country FDI recipients (Figure 2).
Figure 2. The top 10 recipients of FDI inflows in developing Asia, 2002 and 2003 (Billions of dollars)
African FDI inflow was also analyzed by UNCTAD (2004c). Some 36 African countries registered an increase of FDI inflows in 2003 while 17 saw a decline. Morocco was the region’s largest FDI recipient thanks to its privatization program. Resource-rich African nations, including Angola, Equatorial Guinea, Nigeria, and the Sudan, received inflows in excess of $1 billion. Presented below is UNCTAD’s (2004c, p. 2) depiction in tabular form of 2003 FDI inflows by country in Africa (Table 3).
Africa: country distribution of FDI inflows, by range, 2003
Presented below is UNCTAD’s (2004c, p. 4) breakdown of the
top ten African country FDI recipients in this time frame (Figure 3).
Figure 3. The top 10 recipients of FDI inflows in Africa, 2002 and 2003 (Billions of dollars)
In a discussion of FDI to developing countries in Africa, Asiedu (2002) noted that in sub-Saharan Africa (SSA) and non-SSA countries, there are some significant differences with respect to this factor. Higher return on investment and better infrastructure had a positive impact on FDI to non-SSA countries, but no significant impact on FDI to SSA countries. Openness to trade is seen by this researcher as promoting FDI inflows to both SSA and non-SSA countries, whereas the marginal benefit from increased openness is less for SSA countries. Asiedu (2002) suggests that the endemic poverty, ethnic conflict, and lack of adequate governance in SSA may account for these differences.
Stoner-Weiss (2000) considered FDI in Russia, which remains an attractive developing market possessed of abundant natural resources and a well-educated population which comes from a talented and relatively underpaid labor force. Despite these inherent advantages, in comparison to other transition economies, countries in the Russian Federation have a rather dismal record in attracting FDI. Accounting for this lack of FDI are a weak legal framework, an underdeveloped financial sector, corruption, a nontransparent taxation system, and the absence of legislation regulating clear property rights. Both economic structure and the lack of adequate democratic institutions of governance are seen by Stoner-Weiss (2000) as negatively impacting upon FDI inflows to this region.
Erdilek (2003) examined inward and outward FDI in Turkey, hypothesizing that the country’s negative business climate, caused by both economic and political factors, is a major determinative of both. Compared to many developing countries that have benefited from and attracted significant FDI inflows, Turkey is conspicuous as a country that has not done so despite its increasing openness to trade. The failure of Turkey to attract FDI is seen by Erdilek (2003) as a function of such economic variables as high transaction costs of entry and operation for foreign investors due to excessive bureaucracy and widespread corruption, chronic high inflation, increasing economic instability, lack of protection of intellectual property rights, and lack of internationally acceptable accounting standards and failed privatization.
Erdilek (2003) stated that chronic political instability, internal conflicts, fear of foreign political domination, historical animosity towards foreign economic presence, and a fledgling democracy are also among the reasons why FDI inflows are not being directed toward Turkey. Erdilek (2003) notes, however, that the government of Turkey is structuring reforms that will hopefully increases FDI flows into the country.
In looking at FDI to non-poor nations over the period from 1980 to 1996, Shandra, Ross, and London (2003) noted that a number of variables appear to be determining what developing or what Third World/Southern countries receive FDI. FDI is an artifact of global capitalism, which seeks investment opportunities in those climates where capitalism itself has been adopted as a market system. Further, Shandra, et al (2003) believe that democratizing or democratized less developed countries are more likely to be FDI recipients because they are likely to have put into place or are creating the kinds of infrastructure and governance systems that are conducive to capitalist business activity. These researchers observed this pattern over a 16-year period and have predicted that future FDI inflows will also be based on similar variables.
The final article selected for analysis presents South-South FDI flows and their impacts. Aykut and Ratha (2004) noted that it is commonly believed that the recent surge in FDI to developing economies in the South originated in the developed countries of the North. However, the South is increasingly home to a number of TNCs who are an increasingly significant, largely intraregional source of FDI. Aykut and Ratha (2004) note that by 2000, South-South FDI inflows accounted for more than one-third of these funds reported by developing countries. This suggests that the model of North-South FDI flows is not necessarily as dominant as it once was. Countries that have recently moved from less developed status to developing status are now accounting for an increasingly significant portion of all FDI received by the countries of the South. In such instances, however, factors specific to national economies and trade relationships may be more likely to determine FDI inflows than variables related to governance mechanisms.
Conclusion to Review
This review of literature provides insight into changing levels of FDI in recent years as well as the direction of these capital inflows in specific regions of the world and in selected developing countries as well. The literature suggests but does not confirm that there is a relationship between mechanisms of government and the interests of MNCs and TNCs to invest in a host country’s economy. Other factors, such as openness to trade, human capital, and accountability are equally influential in facilitating an FDI decision.
The literature reveals that Africa, which remains the poorest region of the world, is the region least likely to receive FDI. Political instability may well play a role in shaping this particular phenomenon. Given the necessity of ROI, FDI inflows are undoubtedly linked to a broad assortment of factors.
Archival research was used for this study. Archival research includes the collecting and reviewing of data that already exists in a natural setting such as government research documents. This information is reviewed with the purpose of testing a hypothesis or answering a research question. This method is useful when there is reliable information already available that can be used to study a problem. Archival research is a nonexperimental design. Although an experimental design allows for the control over variables and threats to validity, and the nonexperimental design does not, both yield empirical results. Empirical research includes the collection of data and the analysis of the data to answer a research question or test a hypothesis. For this study, hypotheses were stated, the literature relevant to the topic was reviewed, data were gathered and statistically analyzed, and conclusions were drawn based on results. The archival research design is a method used to gather scientific information related to a topic.
The sample for this study included 89 nations, 27 not free, 38 partly free, and 24 free.
Freedom in the World. Freedom in the World survey data for the year 2000 were used for this study. This survey represents an annual evaluation of global freedom. Analytical reports and numerical ratings of countries are provided. For this survey, freedom is measured by degrees of political rights and civil liberties. Efforts were made to define freedom with no culture-bound view of the term. Instead basic standards from the Universal Declaration of Human Rights were used and applied to all countries and territories. Thus, geographical location, economic development level, and ethnic or religious composition were not factors in the definition of freedom (Freedom in the World, 2003).
Political rights are defined as people being able to participate in the political processes freely. They have the right to vote and run for public office and they have the right to elect office representatives that vote on public policies. Civil liberty is defined for this survey as including freedom to develop opinions, personal autonomy, and institutions, with no state interference. Further, countries are defined for the survey as independent states internationally recognized whose governments reside in the state. The survey rates countries and territories with a sum total of 0 to 4 points for each 10 questions grouped into three subcategories related to political rights and 15 questions grouped into four subcategories related to civil liberties. Two final numerical ratings of 1 to 7 correspond to the total raw points. Ratings are averaged to determine the status category for the country: Free (rating of 1 to 2.5), Partly Free (rating of 3 to 5.5), or Not Free (rating of 5.5 to 7) (Freedom in the World, 2003).
Characteristics of political rights and civil liberties ratings are provided. Checklists for political rights and civil liberties are used to determine ratings for each nation. With regard to political rights, a rating of one refers to countries or territories that come closest to ideals such as free and fair elections, competitive parties for electing those who rule, with opposition or minorities having power (found on checklist). A rating of tow goes to those nations who are less free and include factors such as political corruption, violence, discrimination against minorities, and military or foreign influence on politics. A rating of three to five is given to countries that have additional conditions, which undermine freedom, such as civil war, military involvement in politics, royal power, unfair elections, and one-party dominance. A rating of six is given to nations with political rights ruled by military and one-party dictatorships, autocrats, or religious hierarchies. A rating of seven is given to nations in which political rights are nonexistent due to oppression and/or civil war (Freedom in the World, 2003).
With regard to civil liberties a rating of one is given to countries and territories that have most of the ideals sought (on the checklist) such as freedom of expression, association, education, assembly, and religion. A rating of two is given to those nations who are deficient in three or four of these aspects but remain relatively free. A rating of three to five is given to nations with part of the ideals but with a level of oppression that increases at each rating level in areas such as censorship, political terror, or prevention of association. A rating of six is given to countries that are severely restricted in areas such as rights of association and expression due to political terror. A rating of seven is given to nations with no freedom and fear of repression (Freedom in the World, 2003).
Foreign Direct Investment
Data from Foreign Direct Investment were also used for this study. United Nations Conference on Trade Development (http://stats.unctad.org/fdi/eng/ReportFolders/Rfview/Explorerp.asp?CS_referer=UNCTAD) compiles statistics regarding foreign direct investment (FDI). The data are presented as an interactive database for the aggregate figures and data are presented in an electronic publication that includes detailed information for each country. This database presents information for 196 reporting economies (aggregate inflows, outflows, inward stocks, and outward stocks of foreign direct investment). The FDI database is available with free access (UNCTAD, 2002).
Procedures for Data collection
Data were collected from existing information related to the Freedom in the world survey and the Foreign Direct Investment, a measure from the World Bank. All data were from the year 2000. The experimenter gathered the data from existing data bases and computed the statistical results.
For the comparison of means for the free, partly free, and not free nations with regard to FDI levels, a one-way analysis of variance (ANOVA) was used to statistically analyze data. ANOVA is used to analyze variability and determine whether or not population means could be equal. The t-Test comparing the means for two samples was not used since the research question involved more than two groups of means. The one-way ANOVA was used since there was only one grouping factor involved (Minium, King, & Bear 1993). ANOVA was used to test the first hypothesis.
To calculate the predictive ability of civil liberties and political rights with regard to levels of FDI, a regression analysis was used. Multiple regression allows for one response variable and several explanatory variables and their predicted relationship. For example the presence of grade point average and high school grades in science and mathematics can be used to predict college grade performance. Assumptions are the same as for bivariate regression. Bivariate regression assumptions are that the underlying relationship is linear. Dots in the scatterplot tend to be dispersed equally about all parts of the prediction line referred to the assumption of homoscedasticity (Minium, King, & Bear 1993). Multiple regression was used to test the second hypothesis.
Results for Hypothesis 1
The first hypothesis stated that free nations will draw more FDI than non-free nations; free, partly free, and not free nations were compared to demonstrate differences between these groups on FDI in the year 2000.
An ANOVA compared the means for three groups, not free, partly free, and free. The mean for the not free group (n = 27) was 1.68E+09 and the standard deviation was 7348433142.4, the mean for the partly free group (n = 38) was 1.20E+09 and the standard deviation was 5384824782.1, and the mean for the free group (n = 24) was 2.28E+09 and the standard deviation was 4124229640.7 (Table 1).
Means and Standard Error for Three Groups
ANOVA demonstrated non-significant results with a total of 89 subjects, a df of 2 and 86, F = .259, not significant at p = .772 (Table 2).
ANOVA for Three Groups
Results for Hypothesis 2
The second hypothesis stated that higher levels of political rights and civil liberties will result in higher levels of FDI.
A regression analysis showing the predictability of political rights and civil liberties on FDI demonstrated that 2 percent of the variance in the dependent variable was explained by civil liberties and political rights. The effects were not significant at p = .80 (Tables 3 and 4).
Percent of Variance
Further Results of Individual Group Comparisons
Post hoc analysis demonstrated that comparisons of means for each of the groups were not significant: partly free compared to free was not significant at p = .743 and p = .710; not free compared to free was not significant at p = .743 and p = .474; and not free compared to partly free was not significant at p = .710 and p = .474 (Table 5).
Post Hoc Analysis
In summary, findings showed that neither of the hypotheses were supported. There were no significant differences between free, partly free, and not free nations with regard to FDI in the year 2000. Higher levels of political rights and civil liberties did not significantly predict higher levels of FDI.
Conclusions are as follows: whether a nation is free or not has no significant effect on FDI and political rights and civil liberties do not predict FDI levels.
Findings were not consistent with predictions that there is a relationship between government mechanisms and foreign direct investment. For example, Shandra et al. (2003) noted that democratizing or democratized less developed countries are more likely to be FDI recipients, but findings from this study did not find significantly higher levels of FDI in countries with higher levels of political freedom and civil liberties. Findings from the current study are also not consistent with views presented by Erdilek (2003) for example, who noted that variables such a political instability, internal conflicts, fear of foreign political domination, and fledgling democracy are related to low FDI inflows toward Turkey.
Erdilek (2003) also pointed out however, that low FDI inflows toward Turkey may also be due to economic variables such as high transaction costs of entry, corruption, inflation, economic instability, lack of accounting standards, and lack of protection of property. Findings from the current study may be consistent with the conclusion that factors related to economies and trade relationships may be more influential in FDI inflows than governance mechanisms (Aykut & Ratha, 2004).
Implications of the study findings are that while political rights and civil liberties are thought to be factors in FDI levels, this may not be the case. In fact FDI levels may be more related to factors such as economy, openness to trade, higher return on investments, better infrastructure, strong legal framework, and lack of corruption, legislation regulating property rights (Asiedu, 2002; Aykut & Ratha, 2004; Stoner-Weiss, 2000).
This study was limited by the factors studied, which only included political rights and civil liberties. While findings added to the knowledge base regarding factors related to FDI, a future study is needed to explore additional factors. A future study is required to determine if factors such as economy and trade agreements are predictive of FDI and how these factors compare with political rights and civil liberties.
In summary, this study sought to examine whether the political style of nations has an impact on drawing FDI. Existing data from the Freedom in the World survey and the Foreign Direct Investment were compiled and statistically analyzed to test the hypotheses. Findings did not support the hypotheses. Conclusions were that political rights and civil liberties were not significant factors related to FDI in free, partly free, and not free nations. Implications of findings are that future studies need to explore other factors such as economic and trade factors for their predictive ability related to FDI and compare these factors with civil liberties and political rights.