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Economic Policy, Institutions, and Capital Flows: Portfolio and Direct Investment Flows in Developing Countries



This article is corrected by:

  1. Errata: Erratum Volume 50, Issue 4, 961, Article first published online: 13 November 2006

  • Author's note: An earlier version of this paper was presented at the 2005 Midwest Political Science Association meetings. I thank Tim Hellwing, Anthony Pezzola, the editors of ISQ and two anonymous reviewers for helpful comments on earlier drafts. I'm grateful to Margaret Levi, Aseem Prakash, Mike Ward, and Erik Wibbels for their guidance. This work was completed with the support of an NSF Graduate Research Fellowship. Data used in this analysis can be found at


Scholars examining the cross-national mobility of capital have followed two distinct paths. Economists tend to focus on the determinants and economic effects of cross-country capital movements while political scientists largely concentrate on the political impact of capital mobility. This study fills an important gap in the literature by examining the effects of economic policy outcomes on capital inflows to developing countries, explicitly comparing the reactions of portfolio and direct investors. I find that portfolio investors are in fact sensitive to past government behavior and fiscal policy outcomes; portfolio investors reallocate funds as new information about government policy becomes available. Direct investors, on the other hand, are not sensitive to macrolevel economic policy outcomes but are concerned with political institutions. Countries with more stable and democratic political institutions attract more FDI. These findings have implications for developing country governments as they consider the sequence of market liberalizing reforms.