Political Risk and Firm Experience

Political risk deters foreign direct investment (FDI) and deprives developing countries of much needed capital. However, the negative effect of political risk on FDI in the aggregate masks important variation across different types of risk and different types of multinational firms. I argue that some risks, particularly bureaucratic risk, can be effectively mitigated by firms with the right experience. This leads countries with high levels of bureaucratic risk to attract entry primarily by firms with experience managing bureaucratic in other host countries. Other risks, particularly policy risk, are more difficult to mitigate, and these risks have less effect on the average experience level of entering firms. I test this theory on confidential data from the U.S. Bureau of Economic Analysis that cover the full universe of U.S. outward foreign direct investment from 1990-2009. I find that bureaucratic risk, but not policy risk, is associated with entry by more experienced firms. Both types of risk deter investment, but one does so more selectively. By disaggregating both different political risks and different types of direct investors, we can uncover how different political risks (and therefore different institutions and policies) affect both the pattern and pace of development.