This paper addresses the question of what explains capital inflows. In so doing, it makes several contributions to the literature on political risk and the determinants of foreign investment. First, I clarify the relationship between capital flows and democracy’s constituent parts in a way that takes arguments beyond aggregate democracy indicators and static political institutional structures. Specifically, I argue that fair elections signal government respect for democracy and the rule of law in a highly visible manner that investors can access. I show how investors use the fairness of elections as a way to assess political risk and to inform their investment strategies. Furthermore, I show how the type of investment and the kinds of evidence of electoral misbehavior condition elections’ influence on capital flows.
I also disaggregate capital flows into foreign direct investment (FDI) and portfolio investment. I argue that the logic of investing is different in the short-term (portfolio) vs. the long-term (FDI). When it comes to political risk, I provide evidence according to which portfolio investment is much more sensitive to risk factors than FDI due to the relative ease with which portfolio investors can extricate themselves from an increasingly risky market and seek safer returns elsewhere.
This is an Accepted Manuscript of an article published by Routledge an imprint of Taylor & Francis Group in International Interactions: Empirical and Theoretical Research in International Relations on March 2016, available online at doi: 10.1080/03050629.2016.1093475
Available at: http://works.bepress.com/michael_touchton/17/