Pecunia Non Olet: Financial Flows into Illiberal European Countries

• In Event: New Patterns in Foreign Direct Investment

Abstract

Many scholars have argued that investors reward countries whose governments uphold the rule of law and maintain democratic commitments. Such theories would predict that when governments violate democratic norms, markets would punish them by withdrawing their investment or demanding a higher price for loans. Yet in Eastern Europe, where many newly democratic governments have reversed course, investment still flows in. What explains this pattern, which contradicts many of our theories of credible commitment? Under what conditions do firms not only remain but actually seek to invest in in illiberal countries? We argue that firms will still invest into countries whose governments violate democratic and rule of law norms, so long as EU membership offers investors seamless access to the EU’s single market. Moreover, we argue that larger firms will be more eager to invest in (and less inclined to leave) the markets of such democratic backsliders, as they will be less vulnerable to predation by the government than smaller firms. We test these arguments using investment data from 2000-present on East Central European EU member states and neighboring countries, and data on firm entry and exit into East Central Europe since 2007. We supplement our empirical analysis with original fieldwork from Hungary.

Authors

• Julia Gray, London School of Economics

• R. Daniel Kelemen, Rutgers University, New Brunswick

• Terence K. Teo, Seton Hall University