Doorways to Development: Foreign Direct Investment Policies in Developing Countries

Foreign direct investment (FDI) is a key option for economic growth in most, if not all, developing countries. However, not all developing countries are equally open to foreign investment. Some restrict foreign equity, while others encourage multinational corporations to enter their markets. Because FDI involves outsiders entering national markets and profits, it is very political. FDI can bring economic benefits, such as jobs and new technology, but it may also entail economic costs, such as increased competition for national businesses. FDI may also bring political costs, as governments that open to foreign equity may see a popular backlash. Most governments have policies to control FDI's entry into their markets. These policies have been inadequately explored in quantitative studies of FDI because of a lack of available data. This study seeks to rectify that problem by introducing a new set of data: The Foreign Equity Index. I develop a theory and model of FDI in developing countries framed by the logic of two-level games. FDI requires agreement between developing states and international firms, and therefore agreements are reached with influence from domestic-level political and economic factors, as well as international-level factors. FDI policies are an indication of developing countries win-sets, or range of agreements they are willing to accept when dealing with foreign multinational corporations. I test this theory quantitatively using the Foreign Equity Index, which covers 55 developing countries from 1976-2004. I first estimate the international and domestic factors that influence the degree of openness to FDI indicated by FDI equity policies in developing countries. I then test the effect these policies have on FDI inflows. I find that both domestic and international factors affect developing countries’ FDI policies, and in turn, policies are a significant factor determining the flow of FDI into national markets. I also explore the ways in which FDI policies have played a role in economic development strategies of El Salvador and Nicaragua. This research and the Foreign Equity Index should aid in a better understanding of foreign direct investment and growth in developing countries in general.