Short-Term Harm, Long-Term Prosperity? Democracy, Corruption and Foreign Direct Investments in Sino-African Economic Relations

Abstract

This study examines the effect of FDI openness to China and the rest of the world (ROW) on democracy levels of African countries in the short and long terms. We propose and test the hypothesis that the nexus between FDI openness and democracy is moderated by the grabbing and helping hands of regime corruption of African countries. We argue that in the short run, FDI openness will negatively impact democracy (grabbing hand) in corrupt regimes. However, in the long run there will be a positive effect (helping hand) as the revenue spillovers from the investment projects will reach the society empowering the middle class to demand better institutional qualities. We test these theories with a unique panel dataset spanning 2003–2017. Our dataset includes gravity model and politico-economic variables not only between China and African countries but also between the ROW. Building on examples from the existing research, we test the short-run impacts with dynamic GMM model (Blundell and Bond, J Econ, 87(1):115–143, 1998), whereas we test the long-run relationships with two stage least squares fixed effects models. To account for transaction costs and endogeneity problems, in the first stage we apply instruments on openness to both China and ROW FDI. We find statistically strong yet mixed results for our expectations. While in the short-run corrupt African countries that liberalize to Chinese FDI have lower democracy levels, in the long run, the FDI openness has a positive influence. Our results are robust to alternative measurements of democracy, 3- and 5-year non-overlapping smoothed averages and exclusion of top five countries with FDI openness to China and ROW.

Appendices

Appendix A: Data

In this section, we discuss the conceptual descriptions of variables and their measurements and we also present descriptive statistics in Table 5. To preserve space, we present the results and discussions of the first-stage models for our main empirical estimations in the supplementary materials available online . In this section, we report the robustness check results using different indices of democracy, and 3- and 5-year averages of our key data frame.

Below are the definitions of the five democracy measures from the Varieties of Democracy version 10 that we use to construct the composite variable of democracy index used in our study. The scales for the five democracy indices from V-Dem dataset are coded based on expert survey responses. The scale ranges between 0 and 1.

Table 5 Descriptive statistics

Electoral Democracy

Question To what extent is the ideal of electoral democracy in its fullest sense achieved?

Clarification The electoral principle of democracy seeks to embody the core value of making rulers responsive to citizens, achieved through electoral competition for the electorate’s approval under circumstances when suffrage is extensive; political and civil society organizations can operate freely; elections are clean and not marred by fraud or systematic irregularities; and elections affect the composition of the chief executive of the country. In between elections, there is freedom of expression and an independent media capable of presenting alternative views on matters of political relevance. In the V-Dem conceptual scheme, electoral democracy is understood as an essential element of any other conception of representative democracy liberal, participatory, deliberative, egalitarian or some other.

Liberal Democracy

Question To what extent is the ideal of liberal democracy achieved?

Clarification The liberal principle of democracy emphasizes the importance of protecting individual and minority rights against the tyranny of the state and the tyranny of the majority. The liberal model takes a "negative" view of political power insofar as it judges the quality of democracy by the limits placed on government. This is achieved by constitutionally protected civil liberties, strong rule of law, an independent judiciary, and effective checks and balances that, together, limit the exercise of executive power. To make this a measure of liberal democracy, the index also takes the level of electoral democracy into account.

Deliberative Democracy

Question To what extent is the ideal of deliberative democracy achieved?

Clarification: The deliberative principle of democracy focuses on the process by which decisions are reached in a polity. A deliberative process is one in which public reasoning focused on the common good motivates political decisions—as contrasted with emotional appeals, solidary attachments, parochial interests or coercion. According to this principle, democracy requires more than an aggregation of existing preferences. There should also be respectful dialogue at all levels—from preference formation to final decision—among informed and competent participants who are open to persuasion. To make it a measure of not only the deliberative principle but also of democracy, the index also takes the level of electoral democracy into account.

Participatory Democracy

Question To what extent is the ideal of participatory democracy achieved?

Clarification The participatory principle of democracy emphasizes active participation by citizens in all political processes, electoral and non-electoral. It is motivated by uneasiness about a bedrock practice of electoral democracy: delegating authority to representatives. Thus, direct rule by citizens is preferred, wherever practicable. This model of democracy thus takes suffrage for granted, emphasizing engagement in civil society organizations, direct democracy and subnational elected bodies. To make it a measure of participatory democracy, the index also takes the level of electoral democracy into account.

Deliberative Democracy

Question To what extent is the ideal of egalitarian democracy achieved?

Clarification The egalitarian principle of democracy holds that material and immaterial inequalities inhibit the exercise of formal rights and liberties and diminish the ability of citizens from all social groups to participate. Egalitarian democracy is achieved when 1 rights and freedoms of individuals are protected equally across all social groups; and 2 resources are distributed equally across all social groups; 3 groups and individuals enjoy equal access to power. To make it a measure of egalitarian democracy, the index also takes the level of electoral democracy into account.

The Freedom House

Civil liberties Civil liberties allow for the freedoms of expression and belief, associational and organizational rights, rule of law and personal autonomy without interference from the state. The more specific list of rights considered varies over the years. Political rights: Political rights enable people to participate freely in the political process, including the right to vote freely for distinct alternatives in legitimate elections, compete for public office, join political parties and organizations and elect representatives who have a decisive impact on public policies and are accountable to the electorate. The specific list of rights considered varies over the years.

Political rights Political rights enable people to participate freely in the political process, including the right to vote freely for distinct alternatives in legitimate elections, compete for public office, join political parties and organizations and elect representatives who have a decisive impact on public policies and are accountable to the electorate. The specific list of rights considered varies over the years.

World Bank Governance Indicators

Rule of Law “Rule of Law” includes several indicators which measure the extent to which agents have confidence in and abide by the rules of society. These include perceptions of the incidence of crime, the effectiveness and predictability of the judiciary and the enforceability of contracts. Together, these indicators measure the success of a society in developing an environment in which fair and predictable rules form the basis for economic and social interactions and the extent to which property rights are protected.

Voice and Accountability “Voice and Accountability” includes a number of indicators measuring various aspects of the political process, civil liberties and political rights. These indicators measure the extent to which citizens of a country are able to participate in the selection of governments. This category also includes indicators measuring the independence of the media, which serves an important role in monitoring those in authority and holding them accountable for their actions.

See Figs. 3, 4, 5, 6, 7, 8, 9, 10 and Tables 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17.

Table 6 Results of the long-run models

Table 7 Results of the long-run models

Table 8 Results of the long-run models

Table 9 Results of the short-run models

Table 10 Results of the long-run models, second stage, 5-year averages

Table 11 Results of the short-run models, 3-year averages

Table 12 Results of the long-run models excluding the top 5 countries with FDI openness to China and ROW

Table 13 Results of the short-run models excluding the top 5 countries with FDI openness to China and ROW

Table 14 Results of the long-run models, 5-year data excluding the top 5 countries with FDI openness to China and ROW

Table 15 Results of the short-run models, 3-year averages, excluding the top 5 countries with FDI openness to China and ROW

Fig. 3

Correlation for first-stage instruments applied on Chinese FDI openness

Fig. 4

Correlation between V-Dem, governance indicators, POLITY and freedom house indices

Fig. 5

Annual averages of normalized democracy indices

Fig. 6

Correlation for first-stage instruments applied on ROW FDI openness

Fig. 7

Correlation for second-stage variables including predicted values from the first-stage FDI openness

Fig. 8

Original levels of democracy index by country and year

Fig. 9

Predicted levels of democracy index by country and year

Fig. 10

FDI stocks versus openness

Table 16 Summary of past research on the association between democracy, corruption, institutional qualities and FDI

Table 17 Summary of past research on the short- and long-run models for institutional qualities and FDI

Appendix B: Methodology

Theoretical Underpinnings of the Gravity Model

In simplest form, the gravity model is motivated by Newton’s formula of gravity which estimates bilateral interaction between two countries with the ratio of economic size and distance (Sellner, 2019). The economic size is scaled as GDP of exporter/investor and importer/recipient countries. The model takes the following form:

$$F_{i,j} = C*\frac{{G_{j} *G_{i} }}{{D_{i,j} }}$$

(4)

where F is the FDI flow from country i to j, G is the GDP of economic partners, the denominator D indicates the distance between them, and C is a constant term. The logic of this model implies that larger countries with more wealthier economies will engage in commercial activities more than emerging economies (Head and Mayer 2014). Anderson and van Wincoop (2003) elaborate on the standard gravity equation by modifying it to control for the transaction costs of trade or FDI. They show that the relative trade/FDI costs directly influence the bilateral expenditures. Those relative costs are determined by country j's inclination to import from country i and vice versa based on multilateral resistance among the partners.

$$F_{i,j} = C*\frac{{G_{j} *G_{i} }}{W}*\left( {\frac{{y_{ij} }}{{E_{i} L_{j} }}} \right){ }^{1 - \alpha } *\omega_{ij}$$

(5)

where F is the FDI flow revenue, W is the total GDP of all N countries in the world/dataset, G is the GDP of economic partners, $y_{ij}$ is the cost exporter/investor, j incurs from importing/receiving from country i, $\alpha > 1$ is the substitution elasticity term, $E_{i}$ and $L_{j}$ are the multilateral resistance terms for exporter/investor j and importer/recipient i indicating the flexibility of market access outwardly for i and inwardly for j, and $\omega_{ij}$ is the disturbance error term.

The traditional econometric practice has been to linearize the multiplicative form of the gravity model by log transforming both sides of the equation (Santos Silva and Tenreyro, 2006). Performing linear log on Eq. (2) derives:

$${\text{ln}}(F_{i,j} ) = \beta_{0} + \beta_{1} {\text{ln}}(G_{j} ) + \beta_{2} {\text{ln}}(G_{i} ) + \beta_{3} {\text{ln}}(y_{ij} ) + \beta_{4} {\text{ln}}(E_{i} ) + \beta_{5} {\text{ln}}(L_{j} ) + {\text{ln}}(\omega_{ij} )$$

(6)

where previous assumptions on G, y, E, L and $\omega_{ij}$ apply in addition to $\beta_{0}$ denoting the constant term and other $\beta_{i} ^{\prime}s$ representing the coefficient parameters of interest to be estimated with $\beta_{3} = \left( {1 - \alpha } \right)$. After linearizing Eq. (5), Eq. (6) allows to log transform both sides of the equation (except the dummy variables) to estimate the elasticities between FDI openness and a vector of control variables that will account for transaction costs and unobserved endogeneity issues in the second-stage regression.