Democracy and FDI in Developing Countries – A Critical Assessment and a Complementary Research Direction

Abstract

The relationship between democracy and FDI inflows in developing coun-tries has been extensively investigated in empirical research, yielding mixed and sometimes contradictory results. This paper aims to provide a system-atic review and critical assessment of this literature. Two principal strands are identified: one links democratic institutions to increased FDI inflows via stronger property rights and policy credibility, while the other highlights the potential “costs” of democracy, including redistributive pressures, regulatory constraints, and policy uncertainty. These contradictions are attributed not only to theoretical differences but also to variations in empirical specifica-tion, measurement, and sample composition. Most existing studies employ regression analyses to estimate the average marginal effects of democratic levels. This research argues that the existing studies should be complement-ed by analyses of regime changes to observe how FDI responds to political transitions. This proposed research agenda should primarily employ coun-terfactual analysis to reveal how FDI might have evolved in the absence of regime change, thereby distinguishing short-term adjustment effects from longer-term investment dynamics.