Bullish on democracy: research notes on multinationals and the Third Wave.

• Author: Pei, Minxin

ONE OF THE most contentious issues in globalization is the international social responsibility of investors--mainly multinational corporations (MNCs)--in industrialized democracies. To be sure, the debate over how (and if) these investors can simultaneously pursue profits and global public goods has a long and contentious history, as anyone who remembers the publication of Richard Barnett and Ronald Muller's Global Reach in 1974 knows. However, as the pace of globalization accelerates (yes, it is, by the way, despite 9/11), and the backlash against globalization gains political momentum, the ethical role of international private investors has again become a divisive controversy. That controversy, which generally pits the business community against an array of international non-governmental organizations, is fueled most often by specific incidents: high-profile investment projects in countries with poor human rights record, revelations of child labor and sweatshop abuses, and allegations of environmental damag es attributed to foreign corporations. Public outrage, abetted by a media generally inclined against business, is often followed by calls for consumer boycotts or other political sanctions against the offending firms.

Over time, the accumulation of such incidents has encouraged a widespread perception that multinational corporations are irresponsible global citizens who care only about fattening their own bottom lines. Conventional wisdom even among the more knowledgeable public (and some academics) holds that MNCs, guided by profit-maximizing strategies, flock to authoritarian regimes capable of repressing demands for economic justice and the costs of meeting environmental standards. (1)

But despite the prevalence of such views, there is almost no empirical evidence that any of this is true. Indeed, a growing body of research suggests instead that foreign direct investment (FDI) (2) is generally beneficial to developing countries, creating the socioeconomic conditions conducive to the improvement of human rights and environmental quality in host countries. (3) Several studies indicate that MNCs, particularly those based in open societies, find that it makes better business sense (and enhances profitability) to "export human rights" and to implement stricter environmental regulations in the developing world. An empirical study of the relationship between foreign direct investment and human rights has produced evidence that FDI is associated with more political rights and civil liberties in developing countries. (4)

Similarly, a growing body of research shows that MNCs are not engaged in an environmental race to the bottom. Instead, scholars have found a strong connection between corporations' environmental performance and superior financial performance, and that global environmental standards and strict compliance may increase the market value of compliant firms in developing countries. (5) Others have found a link between environmental management and stock performance through both tangible economic influences and what has been termed the "reputation effect." (6) Still, other studies have found a strong correlation between environmental performance and profitability at the firm level. (7) In other words, MNCs may actually be more environmentally responsible than local competitors. (8)

CAN THE same be said for democratization? Are MNCs good for the political quality-of-life of the countries in which they invest? Our evidence, based on examining FDI patterns following democratic regime transitions in 23 countries since the mid-1970s, indicates that FDI investors--mainly MNCs--have been far more socially responsible, even virtuous, than many have supposed. (9) FDI investors have quickly embraced new democracies immediately following a regime transition; overall, the evidence shows a significant increase in FDI within the three years of regime transition compared with the three-year period prior to transition. FDI investors' confidence in new democracies has played an important role in the consolidation of many democracies since the late 1970s. Unlike international portfolio investors, who can exit a country at the tap of a few computer keys, FDI investors cannot quickly liquidate their investments (mostly factories and equipment). Ironically, the illiquidity of FDI thus becomes a better measu re of foreign investors' confidence in the long-term prospects of a given country than portfolio investments. Rising FDI investments in new democracies represent a form of economic endorsement by international investors. Such endorsement seems to carry weight, too; a striking feature of the Third Wave transitions is that no new democracy has been subsequently toppled by an economic crisis.

But how, and why, have MNCs aided democratic transitions? In theory, the prospects of the establishment and consolidation of democratic institutions should bolster the confidence of FDI investors for two reasons. First, as a general rule, private property rights are more secure in democracies than autocracies. This is because the power of the government in a democracy is more constrained, not just by electoral mechanisms and presence of opposition parties, but also by courts. Second, democratic institutions may offer long-term peaceful solutions for social and ethnic conflicts, thus contributing to political stability. In several countries, such as El Salvador, Guatemala and Nicaragua, democratic transitions also brought to an immediate end long-running civil conflicts.

But matters are not nearly...