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FDI and Democratic Governance, Evidence from a Panel VAR Model
Unformatted Document Text:  Theoretically, FDI, or the activities of multinational corporations, does lead to democratic improvements in less developed countries. First of all, democratic governances in less developed countries are not a constant variable. As endogenous determinants of FDI, level of democracy, transparency and good governance could be changed by the domestic governments. A new Bank report also says countries can make significant progress on governance in six to eight years (Kaufmann, Kraay, and Mastruzzi 2005). In this sense, less developed countries could develop better governance in terms of the degree of democracy, regardless of their authoritarian features or even communist political system. Secondly, FDI from democratic and developed countries has the basic requirement to demand democratic governance in the host countries. As foreign private businesses are only familiar with the rules of marketing economies, multinational corporations are greatly sensitive to the political and economic environments in less developed countries. Since the efficient operation of the market requires a peaceful and stable political environment, an enforceable system of property rights, impartial courts, and predictable rules, foreign investors apparently prefer host countries which are good at reducing excessive regulations, enforcing property rights, improving the quality of bureaucracy, and reducing corruption. They shy away from countries where governments are seen as incapable of implementing policies and enforcing contracts. Thus, foreign investors become key constituents in favor of good governance and democratic development, which reduces the cost of doing business and substantially increases the predictability of the rules of the game within which firms conduct their business. Based on the belief that lower barriers and increased flows of FDI are in the national interest, 9

Authors: Sun, Feng.
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Theoretically, FDI, or the activities of multinational corporations, does lead to
democratic improvements in less developed countries. First of all, democratic
governances in less developed countries are not a constant variable. As endogenous
determinants of FDI, level of democracy, transparency and good governance could be
changed by the domestic governments. A new Bank report also says countries can make
significant progress on governance in six to eight years (Kaufmann, Kraay, and Mastruzzi
2005). In this sense, less developed countries could develop better governance in terms of
the degree of democracy, regardless of their authoritarian features or even communist
political system.
Secondly, FDI from democratic and developed countries has the basic
requirement to demand democratic governance in the host countries. As foreign private
businesses are only familiar with the rules of marketing economies, multinational
corporations are greatly sensitive to the political and economic environments in less
developed countries. Since the efficient operation of the market requires a peaceful and
stable political environment, an enforceable system of property rights, impartial courts,
and predictable rules, foreign investors apparently prefer host countries which are good at
reducing excessive regulations, enforcing property rights, improving the quality of
bureaucracy, and reducing corruption. They shy away from countries where governments
are seen as incapable of implementing policies and enforcing contracts. Thus, foreign
investors become key constituents in favor of good governance and democratic
development, which reduces the cost of doing business and substantially increases the
predictability of the rules of the game within which firms conduct their business. Based
on the belief that lower barriers and increased flows of FDI are in the national interest,
9


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