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ABSTRACT
This article compares different measures of democracy to determine how they impact breach of contract risk, especially in postcolonial states that are more likely to suffer from neopatrimonialism with their imported state apparatus. By demonstrating how the normative measure of democracy, which emphasises respect for civil liberties, is more impactful in reducing breach of contract risk than the procedural measure that emphasises institutions, this article highlights the nonoptimal consequences of institutionalised democratisation without the normative dimension. The main findings are that while there is significant variation between the normative and procedural measures of democracy, it is increases in the normative measure of democracy that better promote accountability and the rule of law, thereby more effectively reducing breach of contract risk. We conclude that democratic norms must parallel progress in democratic form so to enable better (lower) breach of contract risk.
Acknowledgments
The authors thank Samaila O. Adelaiye and Lisa Blaydes for their comments and feedback on an earlier draft of this research.
Disclosure statement
No potential conflict of interest was reported by the author(s).
Correction Statement
This article has been corrected with minor changes. These changes do not impact the academic content of the article.
Notes
1 Mathur and Singh (Citation2013, 992, 1001), for example, demonstrate that “more democratic countries receive less FDI flows than less democratic countries” because democracy “is not an automatic guarantee of economic freedoms, such as personal property protection […]”. Desbordes and Verardi (Citation2017), in contrast, show a positive association between democracy and FDI inflows because of the strong protection of property rights associated with democracies.
2 Foreign direct investment (FDI) contributes to economic growth because FDI provides capital and new technology to the host state, and both technology transfer and capital flow serve as vehicles for improving economic growth (See Li and Liu (Citation2005)).
3 For the debate on how elections weigh on capital flight in the developing world, see Frantz (Citation2018) and Goldsmith (Citation2020).
4 Political risk can be broadly defined as a measure of the likelihood that returns on investment will worsen because of adverse political or economic developments in the host country (Bouchet, Clark, and Groslambert Citation2003, 10). Haendel et al. describe “country risk,” which is a term frequently used interchangeably with “political risk,” as the “probability of occurrence of political events that will change the prospects for profitability of a given investment” (cited in Bouchet et al: 10). Political risk would include more specific risk measures, such as expropriation and BoC risk. Of course, countries pursuing an increase in local and foreign investment should aim to create an appropriate environment to attract investment and would therefore want to ensure the reduction of political risk.
5 While there are many factors that can help attract capital, senior executives of multinational enterprises have explained that the high political risk associated with a territory is one of the main reasons behind their decision to refrain from investing in that territory. For five years, from 2009 to 2013, the World Bank conducted annual surveys of several hundred “senior executives from multinational enterprises” to find out what they consider to be the greatest constraint on investing abroad. The 2013 report summarizes the results of the surveys to illustrate that political risk usually emerged as the most important reason for refraining from investing abroad. See World Investment and Political Risk report 2013. p. 7. States wishing to attract investment and guard against capital flight would therefore benefit from a low-risk environment, because high risk repels foreign investors and forces domestic capital to seek out other countries. See also Le and Zak (Citation2006, 32).
6 Jensen (Citation2008) finds a negative relationship between democracy and political risk, with the operational variable within the Polity IV democracy indicator of institutional constraints on the executive (XCONST) driving the result. Li (Citation2009) also finds that the risk of expropriation increases with weak political constraints on the executive.
7 See for example Danilovic and Clare (Citation2007), and Maoz and Russet (1993).
8 See Fearon and Wendt Citation2002 “rationalism and constructivism in international relations theory” and Wendt Citation1999 “Social theory of international politics.”
9 Although the term postcolonial can mean any post-independence state, distinguishing between settler-colonies and other territories that were under foreign control is important because the difference between the two can explain the territory's post-independence development pace. Settler-colonies like the United States, Canada, Australia, and New Zealand were able to function as an extension or “fragment” of the British metropole during the colonial period (see generally Hartz Citation1964). In these extensions, settler societies sought to “replicate European institutions, with strong emphasis on private property and checks against government power” and were able to demand political rights by claiming they were citizens of the metropole (Naidu et al. Citation2014, 1370). The metropole, in turn, “bowed to local pressure,” allowing such rights and institutions for their migrating population (Cain and Hopkins Citation1993, 237).
10 As Heldring and Robinson (Citation2018, 316, 320) explain, “there is a clear case to be made for colonialism retarding development [and that once] the Europeans left, much of what was positive was ephemeral and went into reverse, while many of the negatives endured”. See Reza (Citation2007, 535), for the case of how emergency rule in Egypt was colonial legacy.
11 Badie (Citation2000, 7) explains how “for two centuries at least, political thought, institutions, and practices, as well as legal codes and economic theories, have migrated from the shores of Europe and North America toward the south and east” to shape the political systems there in the present – essentially making the postcolonial state an “imported” state.
12 As Przeworski (Citation1991, 136–138) explains, countries in democratic transition may have difficulty “traversing the valley of transition” to “climb higher hills.”
13 Data was available for Credendo's expropriation risk (my main DV) for those years only.
14 They add “[…] for the purpose of analysing the expropriation risk, events of embargo, change of (legal) regime and denial of justice are included.” The quantitative model “combines an assessment of the economic and financial situation, an assessment of the political situation and a payment experience analysis for each country.” See Credendo (https://www.credendo.com/rating-explanation#riskofexpropriation (8 May 2023)).
15 The panel data were obtained from www.TheGlobalEconomy.com
16 We reverse code the ICRG risk indicator, to have higher measures indicate greater risk. For methodology of ICRG data, see “International Country Risk Guide Methodology”, PRS Groups. Accessed March 26, 2023. https://www.prsgroup.com/wp-content/uploads/2012/11/icrgmethodology.pdf.
17 See Freedom House Methodology (https://freedomhouse.org/reports/freedom-world/freedom-world-research-methodology). Unlike the Polity IV data, the Freedom House data evaluates through survey questions for analysts whether there is an independent judiciary, if due process prevails, if there is protection against the illegitimate use of violence, and whether there is equal treatment of different segments of society.
18 Originally, higher scores indicated less respect for civil liberties and political rights, as can be found in the original dataset; however, we reverse score the data by subtracting eight from it and then multiplying it by negative 1, making larger figures indicate greater civil liberties and political rights.
19 See V-Dem codebook. pp. 43–44. Available at: https://www.v-dem.net/static/website/img/refs/codebookv111.pdf
20 Tobler’s (Citation1970) first law of geography is relevant in this case because it can help explain why the Western colonization of Africa, Asia, and Oceania was different from colonial efforts by non-Western states during the “new imperialism.” While Japan and Russia expanded into proximate territories in Asia that may have had something in common with them, such as religion, culture, or ethnicity, the Western European colonization differed in that it reached remote territories around the globe with little or nothing in common with the metropole.
21 We consider the Western powers to comprise the European settler colonies, in addition to the northern, southern, and western sections of Europe, as defined by the UN, and therefore excluding the eastern part.
22 The setter colonies excluded are New Zealand, Australia, Israel, Canada, South Africa, Algeria, and the United States. In addition to the settler-colonies, territories previously controlled by the Portuguese and Spanish empires in South and Central America are also excluded, because the colonization of these territories occurred before the New Imperialism (from circa 1870 to the decolonization period). Although some smaller territories in the Americas were controlled by Western powers during the New Imperialism, we focus on Africa and Asia for a parsimonious classification. The geographic focus for the postcolonial category is, therefore, limited to Africa, Asia, and Oceania. We relied on the maps in Butlin (Citation2009) that describe the colonial status of different territories during the New Imperialism, in addition to Encyclopedia Britannica for individual cases not covered by Butlin. See Appendix 1 for a table showing postcolonial and other states.
23 According to the codebook, the “index is formed from […] a Bayesian factor analysis model of the indicators” that include vote buying, the extent the executive respects constitution, executive oversight, high and low court independence, and compliance with judiciary. See Coppedge et al. (Citation2018, 273).
24 The (1) Middle East and North Africa, (2) Western Europe, (3) Eastern Europe and the Former Soviet Union, (4) Latin America, (5) Subsaharan African, (6) Asia, (7) Oceania. Same regions used as control by Jensen (Citation2008).
25 This model examines how the operational variables within the democracy indicator weighs on BoC.
26 For controlling for the postcolonial dummy, see Appendix 5.
27 This positive coefficient, when controlling for neopatrimonialism, can also help explain the “leakage” of capital with elections in the developing world as described by Frantz (Citation2018). In this case, investors would value the certainty associated with benevolent autocrats over the uncertainty associated with the election process.
28 Appendices 2 and 3 show that the V-dem liberal democracy measure is a better predictor of risk estimates (both ICRG and Credendo) when compared to the electoral democracy measure, irrespective of the type of state. As for Appendix 4, it re-estimates some of the main models in table 5 with the inclusion of both the normative (FH) and procedural (Polity IV) democracy dimensions in the same model to show how the normative indicator remains negative and significant. Appendix 6 displays the results of sensitivity analysis for the different V-dem indicators, and it shows that confounders “would need to explain at least 1.76% of the residual variance of the treatment to fully account for the observed estimated effect” in the case of the v2x_polyarchy measure, while confounders “would need to explain at least 4.03% of the residual variance of the treatment” for the same effect with the v2x_libdem measure. Appendix 7 also shows a sensitivity analysis between a small control subset of consolidated democracies (UK and Canada) vs. countries considered backsliding in Europe (Hungary and Ukraine). All coefficients remain negative in this case. Models 36 and 37 in Appendix 8 use GDP to create a binary category of developed vs. developing states, to examine how the different democracy measures weigh on risk estimates among them.