Quarterly Journal of Political Science > Vol 4 > Issue 1

Foreign Direct Investors as Agents of Economic Transition: An Instrumental Variables Analysis

Edmund J. Malesky, Assistant Professor, University of California-San Diego, Graduate School of International Relations & Pacific Studies, USA, emalesky@ucsd.edu
Suggested Citation
Edmund J. Malesky (2009), "Foreign Direct Investors as Agents of Economic Transition: An Instrumental Variables Analysis", Quarterly Journal of Political Science: Vol. 4: No. 1, pp 59-85. http://dx.doi.org/10.1561/100.00008068

Publication Date: 19 Mar 2009
© 2009 E. J. Malesky
International political economy,  Comparative politics,  Interest groups


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In this article:
Data, Measurement, and Specification 
Naïve Models Without Accounting for Endogeneity 
Identification Strategy—Predicted Exchange Rates as an Instrument for FDI 
Exploration of the Local Average Treatment Effect 


Previous empirical analysis has noted a correlation between Foreign Direct Investment (FDI) and economic reformin Eastern Europe and the Former Soviet Union, but has attributed the relationship to investors rewarding countries after reform decisions. Little attention has been paid to the fact that investors' lobbying efforts may actually influence reform choices. This paper finds a positive effect of FDI on reformprogress through a panel analysis of investor influence in 27 transition states (1991–2004). To address endogeneity bias, the exogenous portion of a country's exchange rate movement is used as an instrument in a two-stage procedure. The underlying counterfactual comparison that results from this approach is between two similarly situated countries, but where one country experienced a large shift in the share of FDI in its economy as a result of changes in the international economy and the other did not. Further analysis reveals that the relationship is particularly strong in the manufacturing and service sectors, but does not hold for construction, utilities, or natural resource based projects.