The Political Economy of FDI 589 The importance of FDI to capital accumulation is large and growing.Inter- national capital flows have increasingly become dominated by flows of private capital.In 1990,44 percent of all international capital flows were private.This rose to 85 percent in 1996,with FDI being the largest single type of capital flow. FDI has outpaced international trade,growing at an average rate of 13 percent per year from 1980-97,as compared to an annual 7 percent growth rate for exports.3 In 1998 alone,FDI flows increased 25 percent.A simple snapshot of FDI as a percentage of gross domestic investment,averaged for the 1980s,is presented in Table 1.6 In the vast majority of countries,FDI accounts for a substantial amount of domestic investment. These figures obscure an even more important element of FDI flows-the role of multinational production in transferring technology.The potential for techno- logical transfer is obvious if one examines the characteristics of most multi- national firms."Multinationals tend to be important in industries and firms with four characteristics:high levels of research and development(R&D)relative to sales;a large share of professional and technical workers in their workforce;prod- ucts that are new or technically complex;and high levels of product differentia- tion and advertising.These characteristics appear in many studies,and I have never seen any of them contradicted in any study."7 Investments by these technologi- cally advanced firms translate directly into growth-promoting technical advances for the host nation.8 Although the direct effects of FDI on capital accumulation and technological transfer are economically the most important,other economic and political effects of FDI should not be overlooked.FDI is often concentrated in export sectors,gen- erating foreign exchange for the host nation.FDI is also a means of generating employment-both directly,through the foreign firm,and through the indirect ef- fects on the economy,such as domestic industries emerging to compliment the new foreign firms.9 These material benefits of FDI force governments into a competition for scarce international capital.In this article I focus specifically on the relationship between democratic governance and FDI inflows.Drawing on the vast literature on the effects of democracy in interstate relations and democratic theory,I identify a num- 4.IFC1997,14. 5.Mallampally and Sauvant 1999. 6.Data are unweighted averages from the World Development Indicators 2000.Negative values represent disinvestment by multinationals. 7.Markusen 1995,172. 8.Wang 1990;and Grossman and Helpman 1991 provide the theoretical foundation for this.Em- pirically,Luiz R.de Mello Jr.1999 uses panel data for fifteen Organization for Economic Cooperation and Development(OECD)countries and seventeen non-OECD countries from the period 1970-90 and finds that FDI does increase growth,but the growth-enhancing effects are dependent on the level of technological backwardness.For the backward countries,FDI is more productive than domestic invest- ment.A study by Barrel and Pain 1999 finds that for four industrialized European countries,a one- percentage increase in FDI increased technological progress by 0.18 percent. 9.See OECD 1995;and Markusen and Venables 1999.The importance of FDI to capital accumulation is large and growing+ Inter￾national capital flows have increasingly become dominated by flows of private capital+ In 1990, 44 percent of all international capital flows were private+ This rose to 85 percent in 1996, with FDI being the largest single type of capital flow+ 4 FDI has outpaced international trade, growing at an average rate of 13 percent per year from 1980–97, as compared to an annual 7 percent growth rate for exports+ 5 In 1998 alone, FDI flows increased 25 percent+ A simple snapshot of FDI as a percentage of gross domestic investment, averaged for the 1980s, is presented in Table 1+ 6 In the vast majority of countries, FDI accounts for a substantial amount of domestic investment+ These figures obscure an even more important element of FDI flows—the role of multinational production in transferring technology+ The potential for techno￾logical transfer is obvious if one examines the characteristics of most multi￾national firms+ “Multinationals tend to be important in industries and firms with four characteristics: high levels of research and development ~R&D! relative to sales; a large share of professional and technical workers in their workforce; prod￾ucts that are new or technically complex; and high levels of product differentia￾tion and advertising+ These characteristics appear in many studies, and I have never seen any of them contradicted in any study+”7 Investments by these technologi￾cally advanced firms translate directly into growth-promoting technical advances for the host nation+ 8 Although the direct effects of FDI on capital accumulation and technological transfer are economically the most important, other economic and political effects of FDI should not be overlooked+ FDI is often concentrated in export sectors, gen￾erating foreign exchange for the host nation+ FDI is also a means of generating employment—both directly, through the foreign firm, and through the indirect ef￾fects on the economy, such as domestic industries emerging to compliment the new foreign firms+ 9 These material benefits of FDI force governments into a competition for scarce international capital+ In this article I focus specifically on the relationship between democratic governance and FDI inflows+ Drawing on the vast literature on the effects of democracy in interstate relations and democratic theory, I identify a num- 4+ IFC 1997, 14+ 5+ Mallampally and Sauvant 1999+ 6+ Data are unweighted averages from the World Development Indicators 2000+ Negative values represent disinvestment by multinationals+ 7+ Markusen 1995, 172+ 8+ Wang 1990; and Grossman and Helpman 1991 provide the theoretical foundation for this+ Em￾pirically, Luiz R+ de Mello Jr+ 1999 uses panel data for fifteen Organization for Economic Cooperation and Development ~OECD! countries and seventeen non-OECD countries from the period 1970–90 and finds that FDI does increase growth, but the growth-enhancing effects are dependent on the level of technological backwardness+ For the backward countries, FDI is more productive than domestic invest￾ment+ A study by Barrel and Pain 1999 finds that for four industrialized European countries, a one￾percentage increase in FDI increased technological progress by 0+18 percent+ 9+ See OECD 1995; and Markusen and Venables 1999+ The Political Economy of FDI 589