Does foreign direct investment (FDI) increase the quality of democracy or facilitate democratic backsliding? An instrumental variable analysis

Despite multiple crises and attempts to impose protectionist measures, capital continues to circulate around the globe with minimum restrictions at an increasing speed. Most scholars have remained optimistic about the implications of these densely networked circuits, implying that capital inflows have positive economic and political repercussions on the communities that welcome them. Of particular significance is the discussion on the role of FDI. Yet, we know very little about the impact of FDI on the quality of political regimes over time. Do these investments improve or worsen democratic consolidation processes in the long run? This paper makes an important contribution to this debate by unpacking this relationship using a global sample of 117 countries for the period between 1980 and 2018. Based on an instrumental variable analysis, we find evidence that a rise in the inward FDI stock substantially increases the probability of negative shocks to the quality of democracy. These shocks persist over time, and affect all major dimensions of democratic quality – electoral democracy, liberalism, deliberation, egalitarianism, and participation. The findings further reveal that probability of a negative change is consistent, strong and robust. By contrast, we find no evidence for a linear effect of FDI stock on democratic quality.