Liberalize or Not? Societal Conflict, Plural Political Competition, and the Political Economy of FDI Liberalization

Abstract

While the existing literature suggests political liberalization enhances the freedom of foreign direct investment (FDI), the observation that some countries with more liberal political regimes have more restrictive policies toward direct investment than others remains unexplained. With a theoretical model of plural political competition and empirical evidences gathered from panel data, I argue that the liberalizing effect of political liberty on foreign direct investment hinges on the local factor endowment of the country experiencing democratization. I develop a theory of investment policy formation that takes into account the strategic response from domestic societal actors to redistribution of political power and its impact on FDI liberalization. Consistent with the theoretical prediction, the empirical results show political liberalization is more likely to lead to liberalization of foreign direct investment when the capital–labor ratio in the economy is relatively low.