The Political Economy of FDI 599 on economic growth rates,42 little work has been done on the size of government and FDI.Proponents of the 'race to the bottom'thesis argue that governments in a world of capital mobility are forced to roll back the state and limit intervention into the economy to a minimum.43 More recent scholarship on new growth theory has stressed the potential positive role of governments in providing public goods that are undersupplied by the market,which will have positive effects on macro- economic performance.44 To test this,I employ the variable GOvERNMENT CON- SUMPTION from the World Bank's World Development Indicators 1999,which is the average general government consumption as a percentage of GDP for 1980- 90.The prediction that stems from both the theoretical work of neoclassical eco- nomics and the empirical work on economic growth suggests that government consumption should have a negative effect on FDI inflows.45 Most literature on international financial transactions highlights the negative ef- fects of government deficits on macroeconomic performance.High deficits have been linked to poorer long-run economic performance,and also have immediate negative effects on interest rates and exchange rates.In international capital mar- kets,budget deficits can be financed by inflows of foreign capital.FDI flows may be attracted to countries with high budget deficits.I control for this by using BUD- GET DEFICIT,overall general government deficit as a percentage of GDP averaged for the period 1980-90.46 The role of human capital in macroeconomic performance has recently gained tremendous attention from economists and political scientists.The concept of hu- man capital has become a buzzword in the economics literature,linking higher levels of human capital to higher growth rates and directly to higher levels of FDI.47 I have employed the Barro and Lee measure for HUMAN CAPITAL,which is defined as the average number of years of school of the workforce for the 1980s.48 The clear prediction is that higher levels of human capital should have a positive effect on a nation's ability to attract FDI. Controls on inflows and outflows of foreign capital can have dramatic effects on FDI inflows.Countries with controls on inflows may seriously limit the aggre- gate amount of FDI inflows.Countries with controls on outflows of retained earn- ings of foreign firms could potentially increase FDI inflows through these added retained earnings,and potentially decrease the attractiveness of investments in the country.The measure of controls on FDI inflows,FDI INFLOWS CONTROLS,is taken 42.Barro1996. 43.See Garrett 1998 for a review of the literature. 44.See Lucas 1988;Romer 1990;and Barro 1990. 45.Jensen 2002 argues that there are important theoretical reasons why the levels of government consumption (and taxation)would not be directly related to FDI inflows. 46.All empirical results on democracy are generally unchanged when this variable is dropped. 47.Mankiw,Romer,and Weil 1992. 48.Barro and Lee 1993.on economic growth rates, 42 little work has been done on the size of government and FDI+ Proponents of the ‘race to the bottom’ thesis argue that governments in a world of capital mobility are forced to roll back the state and limit intervention into the economy to a minimum+ 43 More recent scholarship on new growth theory has stressed the potential positive role of governments in providing public goods that are undersupplied by the market, which will have positive effects on macro￾economic performance+ 44 To test this, I employ the variable government con￾sumption from the World Bank’s World Development Indicators 1999, which is the average general government consumption as a percentage of GDP for 1980– 90+ The prediction that stems from both the theoretical work of neoclassical eco￾nomics and the empirical work on economic growth suggests that government consumption should have a negative effect on FDI inflows+ 45 Most literature on international financial transactions highlights the negative ef￾fects of government deficits on macroeconomic performance+ High deficits have been linked to poorer long-run economic performance, and also have immediate negative effects on interest rates and exchange rates+ In international capital mar￾kets, budget deficits can be financed by inflows of foreign capital+ FDI flows may be attracted to countries with high budget deficits+ I control for this by using bud￾get deficit, overall general government deficit as a percentage of GDP averaged for the period 1980–90+ 46 The role of human capital in macroeconomic performance has recently gained tremendous attention from economists and political scientists+ The concept of hu￾man capital has become a buzzword in the economics literature, linking higher levels of human capital to higher growth rates and directly to higher levels of FDI+ 47 I have employed the Barro and Lee measure for human capital, which is defined as the average number of years of school of the workforce for the 1980s+ 48 The clear prediction is that higher levels of human capital should have a positive effect on a nation’s ability to attract FDI+ Controls on inflows and outflows of foreign capital can have dramatic effects on FDI inflows+ Countries with controls on inflows may seriously limit the aggre￾gate amount of FDI inflows+ Countries with controls on outflows of retained earn￾ings of foreign firms could potentially increase FDI inflows through these added retained earnings, and potentially decrease the attractiveness of investments in the country+ The measure of controls on FDI inflows, fdi inflows controls, is taken 42+ Barro 1996+ 43+ See Garrett 1998 for a review of the literature+ 44+ See Lucas 1988; Romer 1990; and Barro 1990+ 45+ Jensen 2002 argues that there are important theoretical reasons why the levels of government consumption ~and taxation! would not be directly related to FDI inflows+ 46+ All empirical results on democracy are generally unchanged when this variable is dropped+ 47+ Mankiw, Romer, and Weil 1992+ 48+ Barro and Lee 1993+ The Political Economy of FDI 599