Do political systems affect economic outcomes? The geography of inward FDI and its relationships with growth and inequality

Abstract

This paper explores the complex interplay between political systems, foreign direct investment (FDI), and income inequality. Building on Acemoglu and Robinson’s Nobel Prize-winning work on institutions, we develop a framework to analyze governments’ political incentives to attract FDI. We argue that highly entrenched autocracies, facing little internal competition for rents, and democracies with strong political competition, eager to secure growth for electoral advantage, exhibit strong incentives to attract FDI. In contrast, weaker autocracies with internal competition for rents and entrenched democracies, where rulers face less pressure to deliver growth, have lower incentives to do so. Rising inequality introduces an additional layer of complexity: while democracies may encounter public resistance to FDI when its benefits are perceived as unevenly distributed, autocracies remain less constrained by public opinion. We analyze data from 144 countries spanning 1990–2018, assessing how political incentives shape FDI inflows and their subsequent impact on economic growth. Our findings suggest that in democracies, robust political competition underpins a country’s incentive to remain attractive to investors, while autocracies require regulatory stability and credible long-term commitments to achieve this outcome. Ultimately, our research underscores a paradox—democratic freedoms, though vital, may at times hinder economic competitiveness relative to autocratic regimes.