Does Polarized Political Environment Hamper Foreign Investors? The Evidence from Parliamentary Democracies

Abstract

The socio-political characteristics of the host environment influence investment decisions. The complexity of the political setup strengthens the need for advanced research in the field. The main contribution of this article is to identify the party polarization as a separate dimension of the political system. This paper examines the relationship between the foreign direct investment (FDI) inflows and the host country political factors: the party polarization and the political stability. Besides constructing the political polarization index in a traditional way, authors also formulate a novel measure, which explicitly shows the divergence of political parties on economic actions. By using the manifesto data of 50 parliamentary democracies based on fixed effects model, authors conclude that political polarization is an important socio-political factor which has been previously neglected in literature while addressing the determinants of foreign investments. The paper shows that the effect of political polarization on FDI inflows changes for country groups of different institutional and development indicators. Authors underline the importance of political instability in tackling the polarization impact on capital flows. Accounting together the two variables, the authors find a negative significant effect on FDI.