Investing in the Shadows: The Impact of the Informal Economy on FDI

• In Event: Poster Session: International Political Economy I

Abstract

Does the informal economy enlarge or diminish the likelihood of a country receiving foreign direct investment? We examine the effects of the informal economy on greenfield foreign direct investment (FDI) throughout the continent of Africa. We first use estimates of the informal economy, constructed via the Multiple Indicators, Multiple Causes approach as the main independent variable. Then we test various hypotheses, including our central hypothesis: a higher informal economy will lead to lower levels of foreign direct investment. We base our argument on the theory that foreign investors reduce or withhold investment in countries with larger informal economies because of a lack of property rights protection. We use only the greenfield, job-creating portion of FDI that would be reactive to differences in the size of a country’s informal economy. The relationship between a country's informal economy and its level of greenfield foreign direct investment has not been studied until now and can help policymakers better understand the mechanisms that make investment, and therefore economic growth, more likely. By engaging in policies whereby economic growth filters down through the population, the effects that populist political movements have on a country may be curtailed. Utilizing exogenous variation in informal economic activity, we find strong support for our hypothesis.

Authors

• Les Stanaland, University of Texas at Dallas

• Paulo Cavallo, The University of Texas at Dallas