Foreign Direct Investors: Agents of Economic Transition

Previous empirical analysis has noted a correlation between Foreign Direct Invest-ment (FDI) and economic reform inEasternEurope and theFormer SovietUnion, but has attributed the relationship to investors rewarding countries after reform decisions. Little attention has been paid to the fact that investors ’ lobbying efforts may actually influence reform choices. This paper finds a positive effect of FDI on reformprogress through a panel analysis of investor influence in 27 transition states (1991–2004). To address endogeneity bias, the exogenous portion of a country’s exchange rate movement is used as an instrument in a two-stage procedure. The underlying counterfactual comparison that results from this approach is between two similarly situated countries, but where one country experienced a large shift in the share of FDI in its economy as a result of changes in the international economy and the other did not. Further analysis reveals that the relationship is particularly strong in themanufacturing and service sectors, but does not hold for construction, utilities, or natural resource based projects. ∗ Earlier iterations of this paper were presented at the Annual Meeting of the American Politica