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The Rule of Law and Foreign Direct Investment in the Developing World


Foreign direct investment (FDI) is an increasingly important part of the world economy. Foreign investment is especially important in developing countries where it can make up for a lack of domestic capital, increase tax receipts, improve employment, and hopefully lead to economic development. Given the potential importance of foreign direct investment it is important to understand why some countries receive more foreign investment than others. This dissertation examines the role a country's respect for the rule of law plays in its ability to attract FDI. Using regression analysis I find investors prefer countries that protect contract, property, and physical integrity rights. At the same time, countries with a weak rule of law are still able to attract FDI. Using the results of an original survey of U.S.-based CEOs, phone interviews, statistical analysis, and a case study of China, I argue investors use personal relationships with business partners and government connections to reduce the uncertainty created by a weak rule of law. Furthermore, investors prefer personal relationships more than formal rule-of-law substitutes like bilateral investment treaties and special economic zones.

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