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The Politics of Investment: Partisanship and the Sectoral Allocation of Foreign Direct Investment

by Pablo M. Pinto and Santiago M. Pinto. Reading for Tuesday, 14 August.

This paper analyzes how foreign direct investment (FDI) reacts to changing political conditions in host countries. More specifically, we explore the existence of partisan cycles in FDI investment performance. We develop a model that predicts that the incumbent government’s partisanship -i.e.: its allegiance to labor or capital- should affect foreign investors’ decision to flow into different sectors. Next, we analyze the pattern of direct investment to OECD countries disaggregated by sector from roughly 1985 through 2000. We find evidence of the existence of such partisan cycles in the patterns of direct investment performance across countries and over time at the industry level. In particular, we observe that in countries that are governed by parties of the left, FDI tends to flow into industries associated with the production of food, textiles, machinery, and vehicles, financial intermediation, mining and quarrying, and utilities, and out of sectors such as construction and transportation. We also find preliminary evidence of a positive correlation between foreign investment and economy wide change in wages under left-leaning incumbents, which is consistent with the assumptions around which our model is built. Our tentative conclusion is that foreign investors do seem to respond to partisan cycles: when parties of opposite ideologies alternate in power, FDI flows into those sectors where foreign capital is a complement of the factor of production owned by the core constituent of the incumbent party, and out of those sectors where it substitutes for the factor owned by that constituent.

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