How does a country’s political system affect its incentives to attract foreign investment?

“Foreign direct investment is a critical engine of economic growth. But not all countries value it equally. Dario Maimone Ansaldo Patti , Ram Mudambi and Pietro Navarra tested the assumption that more democracy equals more inward investment and found instead that both strong democracies and strong autocrats need FDI, for very different reasons. Economists Daron Acemoglu and James Robinson revolutionised our understanding of global development by arguing that a nation’s political regime exerts a systematic and profound impact on its economic growth or backwardness. At the heart of their thesis, which was awarded a Nobel prize in 2024, is the distinction between “inclusive” and “extractive” institutions. However, the underlying driver of institutional quality is the nature of political competition and the incentives it creates for those in power. Our new research extends the Acemoglu-Robinson framework to foreign direct investment (FDI), one of the most potent engines of modern economic development. In a globalised economy, the movement of capital, technology and managerial expertise via multinational enterprises has been the catalyst for unprecedented shifts in the wealth of nations. From the rapid industrialisation of China and India to the Celtic Tiger phenomenon in Ireland and the sustained employment stability in Britain, FDI is seen as a silver bullet for boosting income levels and reducing poverty. Yet, FDI does not flow uniformly. In our paper we argue that the volume and quality of these inflows are not merely functions of market size or labour costs but are the deliberate results of the political calculus of incumbent political rulers seeking to retain power. The political calculus of power retention Acemoglu and Robinson’s work suggests that types of political regimes, characterised by varying levels of political competition, provide distinct incentives to incumbent leaders. Whether a leader presides over a liberal democracy or an absolute autocracy, their primary objective, of survival, remains the same. But the mechanisms for retaining power differ across the political spectrum. In highly competitive environments, survival is tied to public approval at the ballot box. In non-competitive environments, survival is tied to the satisfaction of elite coalitions and the suppression of dissent. It is the operation of these disparate mechanisms that determines whether a ruler’s pursuit of power aligns with – or actively subverts – national economic growth. We apply this logic to FDI policy. Because FDI is a primary driver of growth, it becomes a strategic tool for incumbents. However, the incentive to attract it depends on the ruler’s time horizon and the degree of competition they face. To test this framework, we conducted an empirical analysis of 144 countries between 1990 and 2018. Our findings reveal a striking U-shaped relationship between political competition and FDI inflows. Contrary to the common assumption that “more democracy equals more investment” we found that both established autocracies (with very low political competition) and highly competitive democracies (with very high political competition) exhibit the strongest FDI inflows. For instance, both Ireland, with healthy and robust democratic institutions, and the United Arab Emirates, with absolute monarchies, have consistently attracted very strong FDI inflows. In contrast, middle-ground regimes – specifically weaker autocracies and entrenched democracies – experience significantly lower inflows. Examples include South Africa, where the democratic African National Congress government was been entrenched in power between 1994 and 2024, and the fragile autocracies in many other African countries like Sudan, Mali, Chad and Burkina Faso. All of these countries have struggled to attract FDI inflows. Highly competitive democracies wield FDI as a vital electoral tool while established autocracies use rent-extraction In countries where political competition is fierce and the margin of victory is slim, the incumbent government faces a constant threat of being unseated. In this environment, FDI is viewed as a vital electoral tool. Large-scale inflows create jobs, signal economic competence to the middle class and drive the aggregate growth necessary to secure re-election. The survival instinct of the politician translates directly into pro-FDI policies. At the other end of the spectrum, established autocracies face little to no internal threat of losing power. In these regimes, the ruling elite views FDI through the lens of economic rents. Because they are confident in their long-term tenure, they encourage FDI to grow the economic pie: not to please voters, but to increase the total volume of wealth they can extract for themselves and their supporters. The absence of competition allows them to take a long-term view of growth as a source of personal and regime enrichment. Entrenched democracies and weak autocracies exist in the “valley of weakness” The dip in the U-shaped curve occurs in two specific scenarios: entrenched democracies and weaker autocracies. Among entrenched democracies, when a government is highly confident of re-election, perhaps due to a fractured opposition or historical dominance, the fire to innovate or aggressively pursue FDI cools. The incentive to prioritise the complex, often politically sensitive trade-offs required for FDI diminishes because survival is already perceived as secure. Weaker autocracies are in perhaps the most precarious position. Rulers in weak autocracies fear imminent overthrow. Because their time horizon is short, they have little incentive to prioritise FDI-led growth. They fear they may not be in power long enough to enjoy the resulting economic rents, and in some cases they may even fear that the social changes brought by FDI, such as a rising, educated urban class, could accelerate their downfall. While we depict the quantity of per capita FDI flows in our figures, our results also hold for the total quantity of FDI inflows. They also hold in a similar manner for the quality of FDI inflows, both per capita and total. Figure 1 The inequality paradox and social voice The political calculus is further complicated by the social outcomes of investment. While FDI generates growth, it is often associated with rising income inequality . In democracies, where citizens have a stronger voice and the legal right to protest, this exacerbates political risk. Our evidence suggests an ironic outcome: democracies may occasionally offer fewer incentives for inward FDI than autocracies because democratic leaders must account for the public backlash against inequality. An autocrat can ignore the widening gap between the rich and poor to pursue growth-led rents. A democratic leader who does so may face an “inequality tax” at the polls. This highlights the necessity of evaluating FDI not just as an economic variable but as a social one that can destabilise a regime if the benefits are not broadly shared. Our empirical analysis shows that the effect of incorporating income inequality on depressing FDI inflows becomes more pronounced at higher levels of political competition. Figure 2 The dotted curve includes the “income inequality” as an explanatory variable FDI’s impact on growth In the final section of our analysis, we moved beyond the drivers of FDI to investigate its impact. It is crucial to remember that incumbent rulers are rarely interested in foreign investment for its own sake. More often they are interested in its income-enhancing effects. Our estimations reveal that the FDI inflows generated by the political calculus of incumbents in both established autocracies and competitive democracies lead to significantly higher per-capita growth rates. However, this relationship is not just a matter of quantity. The impact on growth is markedly stronger when the FDI is high quality, involving technology transfer and high-value-added activities, or diverse, spanning multiple inward investors rather than being concentrated in a handful of origin countries. These superior types of FDI grant incumbent rulers exactly what they need to satisfy their respective survival mechanisms. In autocracies, quality FDI leads to greater sustainable power and higher extractable rents. In democracies, it provides high-quality employment and modernisation that correlates with a significantly higher probability of re-election. What are the lessons for policymakers? When applied to FDI the Acemoglu-Robinson framework reveals that the global map of investment is a mirror of the internal political struggles of nations. The U-shape demonstrates that extreme stability (among established autocracies) and extreme accountability (among competitive democracies) are both surprisingly conducive to capital inflows, albeit for very different reasons. For policymakers, the lesson is clear: attracting FDI requires more than just lowering taxes – it requires an institutional alignment where the survival of the political elite is inextricably linked to the economic success of the country. This post summarises Do political systems affect economic outcomes? The geography of inward FDI and its relationships with growth and inequality , published in the Journal of International Business Studies in 2026. This article gives the views of the author, not the position of LSE Business Review or the London School of Economics. You are agreeing with our comment policy when you leave a comment. Image credit: dowjohns provided by Shutterstock. The post How does a country’s political system affect its incentives to attract foreign investment? first appeared on LSE Business Review .

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