Federalism\u27s Impact on Foreign Direct Investment Inflows

Many developing countries are actively seeking Foreign Direct Investment (FDI) because it they enjoy the transfer of skills, knowledge, and capital. Multinational corporations (MNCs) are more likely to invest in countries with lower political risk. Knowing this, what forms of governance will help a country attract FDI by lowering its political risk? Will being a democracy help; will being federal help? This study attempts to add to inconclusive existing literature on this topic. It utilizes the governance classifications of 71 countries made by Dr. Robert Inman’s in his paper “Federalism’s Values and the Value of Federalism”. Countries are classified as one of the following: constitutionally based federal democracy, an administratively based federal democracy, a unitary democracy, a federal dictatorship, or a unitary dictatorship. Then it studies the impact of the governance structures on the total investment in a country, the FDI inflows as a percentage of GDP, the net FDI inflows as a percentage of GDP, and the FDI inflows per capita in $US. The conclusions are as follows: 1) Democracy is the most importance governance factor in attracting greater FDI. 2) Federalism does not improve upon democracy in attracting more FDI. 3) Federalism does not help nondemocratic countries attract FDI. 4) Federalism is still important because it impacts economic rights, which in turn help attract greater FDI