What attracts foreign direct investment into autocratic states? Regime time horizon and institutional design

• Date: 01 October 2020
• DOI: http://doi.org/10.1111/twec.12956
• Published date: 01 October 2020
• Author: Chungshik Moon,Lin Cui

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wileyonlinelibrary.com/journal/twec World Econ. 2020;43:2762–2784.

© 2020 John Wiley & Sons Ltd

Received: 16 June 2019

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Revised: 21 February 2020

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Accepted: 24 March 2020

DOI: 10.1111/twec.12956

ORIGINAL ARTICLE

What attracts foreign direct investment into

autocratic states? Regime time horizon and

institutional design

LinCui1

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ChungshikMoon2

1Research School of Management, The Australian National University, Canberra, ACT, Australia

2Political Science and International Relations, Chung-Ang University, Seoul, Korea

KEYWORDS

autocratic state, foreign direct investment policy, institutional design, International political economy, regime time horizon

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INTRODUCTION

The comparative institutional analysis (CIA) has been increasingly adopted in international business

research (Hotho & Pedersen, 2012; Jackson & Deeg, 2008, 2019). Focusing on the diversity of institu-

tional configurations that characterise the systematic differences across countries (Ahmadjian, 2016;

Hall & Soskice, 2001; Whitley, 1999), the CIA approach reveals how national diversity influences

cross-border business activities, such as the inflow of foreign direct investment (FDI; Cui, Fan, Liu,

& Li, 2017; Witt & Lewin, 2007). This study further develops this stream of research by contributing

new insights that address both theoretical and empirical limitations in the current literature.

There are two main limitations in the current literature that applies the CIA approach to inter-

national business research. Theoretically, while emphasising path dependency in the formation of

national institutional configurations (Jackson & Deeg, 2008), the international business literature has

not highlighted the active agency of powerful institutional actors, such as state authorities. It deviates

from the political science origin of the CIA approach, which emphasises the role of state in designing

formal institutions governing economic activities (Abbott & Snidal, 2000; Blake, 2013; Koremenos,

Lipson, & Snidal, 2001; Stevens, Xie, & Peng, 2016), giving rise to the varieties of business systems

(Carney, Gedajlovic, & Yang, 2009; Spencer, Murtha, & Lenway, 2005). As a result, we do not know

what alters states’ incentives of institutional designs for facilitating international business. This is

despite the observation that effective institutional design for attracting and managing FDI are critical

for the economic, political and social objectives of states in an increasingly integrated global economy

(Choi & Samy, 2008; Globerman & Shapiro, 2009; Jensen, 2003). Empirically, the application of CIA

approach in international business research has followed primarily on the popular typologies devel-

oped for institutional settings which feature a democratic state and an advanced capitalist economy

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(Hall & Soskice, 2001; Whitley, 2005). These models do not necessarily apply to other national set-

tings (Carney et al., 2009), especially nations that feature an autocratic state.

The current study aims to address these theoretical and empirical limitations by examining the

variations in autocratic states’ institutional design for attracting FDI. We focus on the novel context

of FDI inflow of autocratic states because the political structure of these states poses a conundrum

for foreign investors. On the one hand, many autocratic countries present substantial market poten-

tials and strategic importance to multinational corporations (Moon, 2015). Some countries such as

China and Singapore have continuously attracted large amount of FDI inflow (see data released by

UNCTAD in its World Investment Report series). On the other hand, due to lack of political checks

and balances on autocratic states, these countries also present institutional uncertainties that under-

mine the credibility of their economic policies concerning FDI (Choi & Samy, 2008; Jensen, 2003).

Hence, it is a puzzling question—what influences autocratic states’ institutional design that leads to

variation in their performance of attracting FDI?

We approach this research question by explicating the commitment mechanism underlying auto-

cratic states’ institutional design for attracting FDI, both domestically and internationally. We observe

that domestically, autocratic states can align their long-term interests with those of foreign investors by

developing commitment-institutions that will protect the property rights of foreign investors (Clague,

Keefer, Knack, & Olson, 1996). Internationally, states can sign bilateral investment treaties (BIT) to

make a credible commitment to foreign investors by increasing the costs of negative differentiation

between foreign and domestic businesses (Dolzer & Schreuer, 2008).

Not all autocratic states can afford the commitment-institutions that are friendly to market play-

ers including foreign investors. For instance, domestic market-supporting institutions are costly to

autocratic regimes because the regimes have to render their power of economic coordination to the

market, and such economic liberalisation may trigger political democratisation which threatens the

survival of the regime (Boix & Stokes, 2003; Inglehart & Welzel, 2005). As such, only those autocrats

with confidence in their long-term survival can afford such domestic institutions which align their

incentives with those of foreign investors (Moon, 2015). Moreover, when designing BITs, a long time

horizon leads autocrats to be more concerned about their autonomy in developing policy responses

to unforeseeable future changes in the economic, political and social environments, and therefore,

they tend to seek more carve-outs in BITs (Blake, 2013). Such carve-outs reduce the costs of com-

mitment breaches (i.e., sovereignty costs), which compromises the effectiveness of BITs as a credible

commitment device to foreign investors. Therefore, drawing on recent research in political economy,

we anticipate that the time horizon of autocratic states, that is, how far into the future they expect to

govern (Blake, 2013; Moon, 2015), will alter their incentives for institutional design (Abbott & Snidal,

2000; Clague et al., 1996; Pierson, 2000). Specifically, we hypothesise that that regime time horizon

will positively influence the inflow of FDI into autocratic states through the development of domestic

market-supporting institutions and that it will negatively moderate the positive effect of BITs on FDI

inflow. We found empirical support for these arguments from analyses of a time-series cross-sectional

data set which included 80 autocratic countries within the time period 1970–2003.

Bridging research on the CIA approach in international business with political economy, this

study builds synergy between these two literatures which advances their respective frontiers.

Insights from political economy research support CIA approach to re-focus on the design element

of country institutional configurations—especially the role of the state. Existing CIA models are

aimed at understanding the overall economic position of the state (Witt & Redding, 2013) and/or its

overarching role of economic coordination (Hancké, Rhodes, & Thatcher, 2007), but not the design

of specific institutions by the state with the aim of facilitating international business. Informed by

political economy research, this study establishes the time horizon of governments as an important