Governance, Development, and Foreign Direct Investment

Abstract

Less-developed countries and transition economies wish to attract foreign direct investment (FDI), but are often handicapped by their weak governance structures, i.e. by insecurity of property rights and contracts. Potential investors and governments therefore attempt to devise alternative special arrangements and institutions that imperfectly substitute for good overall governance. The volume and form of investments adapts to the conditions and institutions of governance. Moreover, firms that have experience of coping with poor governance in their home country enjoy some advantage when investing in other host countries with similarly weak governance; this helps explain the emergence of outward FDI from developing countries. This lecture presents an overview of these issues and the related literature, and develops a simple theoretical model to improve our understanding of the emergence of multinational firms from developing countries.