Reforming Property Rights Institutions in Developing Countries: Can FDI Inflows Help?

Reforming Property Rights Institutions inDeveloping Countries: Can FDI Inflows

Help?Abdoul’ Ganiou Mijiyawa

African Centre for Economic Transformation, ACET, Accra, Ghana

1. INTRODUCTION

INCREASINGLY, it is admitted in the economics literature that economic institutions (i.e.

rules that govern human interactions relating to economic activities) are necessary for

economic growth and economic development. More specifically, it has been shown that weak

institutions are one of the root causes of poor economic performance in developing countries

(henceforth, DC). But how can DC implement good institutions? That is, how can DC reform

economic institutions in an environment where such institutions are ineffective?

To date, very few papers have studied this fundamental question. This paper seeks to fill

the gap. I focus my analysis on property rights institutions; they are institutions whose posi-

tive effects on economic performance have been established with little controversy. Likewise,

the pioneering scholars in institutional economics focused on property rights. Along the same

vein, Rodrik (2005) considers property rights institutions as market-creating institutions with-

out which it is hard to envisage the existence of viable economic activities in a country.

These different elements comfort my interest in the analysis of the factors that can facilitate

property rights institutions reform in DC.1

Inspired by the works of North and Weingast (1989), Acemoglu et al. (2005a) and Acemo-

glu and Robinson (2008) that analyse the process of institutional reforms in England during

the seventeenth century, I analyse factors that can contribute to the reform of property rights

institutions in DC.

North and Weingast (1989) show that before the Glorious Revolution (which occurred in

1688 with the overthrow of King James II), there existed in England a system of expropria-

tion of the king vis-�a-vis the people. According to North and Weingast (1989), after the Glori-

ous Revolution, the imperfections of property rights institutions were reduced in England, and

several institutional reforms had followed the revolution. For instance, the Bank of England

was created after the Glorious Revolution. North and Weingast argue that such changes were

possible thanks to the reinforcement of the power of the parliament vis-�a-vis the king.

“I would like to thank participants of the CSAE (Oxford University) 25th Anniversary Conference on“Economic Development in Africa,” participants of the first NOVAFRICA conference on “EconomicDevelopment in Africa,” participants of the international workshop on the “Determinants and Effects ofTrade and Foreign Direct Investment in sub-Saharan Africa,” and an anonymous referee for fruitful com-ments. All errors and inaccuracies are mine. The views expressed here are those of the author and not ofhis affiliated institution.”

1 Property rights institutions define rules, which protect economic agents against the risk of expropria-tion from the state and/or other economic agents, rules guaranteeing the enforcement of contracts amongeconomic agents, as well rules which define the resolution of conflicts that could result from thesecontracts. Thus, in this paper, by economic institutions, I essentially mean property rights institutions.

© 2013 John Wiley & Sons Ltd410

The World Economy (2014)doi: 10.1111/twec.12081

The World Economy

While North and Weingast analyse much more the institutional reforms that had followed

the Glorious Revolution, Acemoglu et al. (2005a) and Acemoglu and Robinson (2008) try to

explain how these changes were introduced. According to Acemoglu and his co-authors, the

participation of England in Atlantic trade had contributed to the success of the Glorious Revo-

lution and the changes it induced. Indeed, merchants who had participated in Atlantic trade

became richer and took advantage of their wealth to increase their bargaining power vis-�a-visthe king to demand and obtain institutional reforms that they needed. According to Acemoglu

et al., Atlantic trade served as an external shock, which triggered institutional reforms in Eng-

land during the seventeenth century. Moreover, according to these authors, if Atlantic trade

had played such a role in England and not in other countries (e.g. France and Spain) that had

also participated in Atlantic trade, it is because in England the power of the king was limited

by an effective parliament.

These elements of analysis relating to the experience of England during the seventeenth

century raise a relevant question that DC face today. More specifically, the question is

whether nowadays there exist opportunities relating to international markets, and to what

extent, DC could take advantage of these opportunities to reform property rights institutions

as England had benefited from the Atlantic trade to reform its institutions during the seven-

teenth century.

Based on the aforementioned studies of Acemoglu et al. (2005a) and Acemoglu and Robin-

son (2008), I assume that nowadays DC could take advantage of their participation in globali-

sation (more specifically, capital movements across countries) to reform property rights

institutions. Among various capital flows resulting from globalisation, I particularly focus my

analysis on FDI inflows as a source of exogenous shocks to the political equilibrium, which

maintains ineffective economic institutions in DC. My assumption for a possible catalytic role

of FDI inflows in the reform of economic institutions is consistent with the paper of Kose

et al. (2006). Indeed, these authors argue that DC that participate in financial globalisation

could benefit from several collateral effects of globalisation, including the implementation of

economic institutions reform. In the same vein, Rodrik et al. (2004) and authors of the 2002World Development Report also argue that openness to international markets could constitute

an opportunity for the reform of institutions in DC.2

The mechanism for a potential role of FDI inflows in the reform of economic institutions

is as follows. When FDI inflows contribute to the enrichment of private investors who aspire

to the reform of institutions, their bargaining power vis-�a-vis the government increases. This

gives private investors the opportunity to demand and obtain the reform of economic institu-

tions that they need. However, effective institutions of constraints on the executive, that is,

effective institutions of checks and balances are necessary for FDI inflows to effectively play

a catalytic role in the reform of economic institutions.3 This assumption is consistent with the

2 Although any exchange with international markets could stimulate property rights reform, it is not pos-sible to examine the effect of all the flows related to international markets; that is why the paper focuseson FDI inflows. Moreover, later on in the paper, I explain why compared with other related globalisationflows, FDI inflows may have higher potential to contribute to property rights reform in DC.3 Based on the definition of Polity IV, by constraints on the executive, I mean the existence in a countryof a number of actors or institutions (parliament, leaders of political party, notables, etc.) that thechief of executive must consult before making decisions on the management of state affairs. Thus, insti-tutions of constraints on the executive are equivalent to checks and balances institutions vis-�a-vis theexecutive power.

© 2013 John Wiley & Sons Ltd

REFORMING PROPERTY RIGHTS INSTITUTIONS 411

arguments of North and Weingast (1989) and Acemoglu et al. (2005a), according to which

the existence of an effective parliament had crucially facilitated the process of institutional

reforms in England during the seventeenth century.

When there are effective institutions of checks and balances, the opportunities for profits

that FDI inflows offer could be seized by several investors and these opportunities are not

captured by the political and economic elite only. Likewise, in a country endowed with effec-

tive institutions of constraints on the executive, individuals who wish the reform of institu-

tions could better coordinate their actions and the increase in their negotiation power could

better be taken into account in the process of reforms.

To put it simply, my main argument in this paper is that FDI inflows could contribute to

the reform of property rights institutions in DC initially endowed with a minimum of effective

institutions of constraints on the executive. This would be the first paper that examines to

what extent FDI inflows could contribute to the reform of property rights institutions in DC.

The paper builds on three different theories. First, it is based on economic history. Indeed,

inspired by the works of North and Weingast (1989), Acemoglu et al. (2005a) and Acemoglu

and Robinson (2008) relating to institutional reforms in England during the seventeenth cen-

tury, this paper examines under which conditions DC could take advantage of FDI inflows to

reform property rights institutions. Second, the paper builds on the theory of institutional

changes ignited by exogenous shocks, as described in Acemoglu et al. (2005a) and Acemoglu

and Robinson (2008). Indeed, I consider FDI inflows as a source of exogenous shocks to the

political equilibrium, which maintains ineffective economic institutions in DC. Third, the

paper is based on the theory of collateral effects of FDI inflows, as described in Kose et al.

(2006). Indeed, neither the governments nor private investors mainly seek to reform institu-

tions through FDI inflows in DC. The analysis of FDI inflows on the reform of economic

institutions is therefore an analysis of a collateral effect of FDI inflows in DC.

In the next section, I review the existing related empirical work. Section 3 is devoted to

the theoretical analysis of the relationship between FDI inflows and property rights reform.

The empirical analysis is carried out in Section 4, whereupon the results are analysed in Sec-

tion 5. Section 6 concludes the paper.

2. REVIEW OF EMPIRICAL LITERATURE

To my knowledge, only the authors of the 2005 World Economic Outlook (IMF, 2005) had

carried out an empirical analysis comparable to the one in this paper. However, there exist

differences between my paper and that of those authors.

The authors of the 2005 World Economic Outlook did their analysis with a composite

index from the Fraser Institute, measuring the overall quality of economic institutions in a

country. In contrast, in this paper, I specifically focus my analysis on property rights institu-

tions. The use of a composite index may present some advantages, but carrying out an analy-

sis of institutional change with such an index may induce a loss of relevant information. For

instance, one cannot precisely identify which institutions witness a change. In other words, a

composite index may record a change, without that change involves necessarily all the com-

ponents of the composite index. In this case, one may conclude that countries have reformed

their institutions without being able to specify which institutions have been really reformed.

The authors of the 2005 World Economic Outlook used a sample of 105 countries, com-

prising developed and DC. In this paper, I carry out my analysis with a sample of DC only. It

is in DC that it is very important to understand factors likely to contribute to the reform of


412 A. G. MIJIYAWA

institutions, because those are countries where weak institutions constitute one of the binding

constraints to economic growth and economic development. Moreover, by carrying out the

analysis with a sample of DC, very likely, the estimated coefficients will reflect the average

situation of DC; this is not the case when data from developed and DC are pooled together.

The authors of the 2005 World Economic Outlook used a probit model with cross-sectional

data. In this paper, I use panel data, which enables me to control for time and country fixed

effects.

Finally, the authors of the 2005 World Economic Outlook empirically examined the deter-

minants of economic institutions reform without focusing on a specific factor. Indeed, these

authors analysed the effects of a number of factors such as trade openness and freedom of

press. In contrast, in this paper, although I control for the effects of other factors, I specifi-

cally examine the extent to which FDI inflows could contribute to the reform of economic

institutions in DC.

3. THEORETICAL ANALYSIS OF ECONOMIC INSTITUTIONS REFORM

Acemoglu (2003), Acemoglu et al. (2005b) and Acemoglu and Robinson (2008) argue that

difference in the quality of institutions among countries is the result of conflict of interests.

Therefore, the choice of institutions and their change can be analysed as a process of collec-

tive choice. Along the same vein, Acemoglu et al. (2005b) argue that differences in the qual-

ity of economic institutions and their evolution depend on the distribution of political power,

which in turn depends on de jure political power conferred by political institutions (e.g. con-

stitution, electoral rules) and de facto political power defined by income distribution in a

country. All the members of society are not in favour of institutional change because of

income distributive consequences induced by change in economic institutions, but individuals

who control political power at a given point of time have the final decision for the creation

and the reform of institutions. Acemoglu and Robinson (2008) argue that the occurrence of

exogenous shocks to the political equilibrium, which maintains ineffective economic institu-

tions, could trigger institutional reforms. To support their arguments, Acemoglu and Robinson

(2008) cite the example of institutional reforms implemented in England during the seven-

teenth century after the Glorious Revolution.

North and Weingast (1989) also refer to the Glorious Revolution. These authors argue that

before the Glorious Revolution, England had a system of expropriation of the king vis-�a-visthe people. This system was characterised by an excessive increase in taxes at the discretion

of the king, failures of the king to meet the deadlines for repayment of his debts vis-�a-vis pri-vate creditors and unilateral termination of the contractual obligations of the king vis-�a-vis theprivate sector. Thus, in the seventeenth century, England was characterised by weak property

rights protection, as many of DC are today. According to North and Weingast (1989), after

the Glorious Revolution, the imperfections of property rights protection were reduced in Eng-

land. The creation of the Bank of England, as well as the increase in the amounts of financing

resources borrowed by the king from the private sector, is an illustrative example of institu-

tional reforms and financial development, which followed the Glorious Revolution. According

to North and Weingast (1989), such changes were possible thanks to the reinforcement of the

power of the parliament vis-�a-vis the king. Indeed, merchants who sat in the English parlia-

ment were able to constitute parliamentary groups who defended their interests. Thus, during

that period, the English parliament was in favour of the reduction in the power of the king

and a better protection of property rights.



North and Weingast (1989) argue that the English parliament benefited from the Glorious

Revolution by introducing five main institutional changes in England. The first change was the

suppression of the archaic fiscal system, which had prevailed and had allowed the king to increase

his expenditures discretionarily and consequently induced high tax rates. The second change was

the reduction in the judiciary and parliamentary powers of the king. This reduced the capacity of

the king to change the laws without initially consulting the parliament. The strength of the power

of the parliament on fiscal issues was the third change. This reduced the capacity of the king to

increase the tax rates unilaterally. Fourth, members of parliament had reinforced their role in the

allocation of resources and the monitoring of the expenditures engaged by the king. Fifth, by cre-

ating equilibrium of power between the parliament and the monarchy, members of parliament

had reduced the risk of using their power abusively against the people.

While North and Weingast (1989) focus much more on the changes that have followed the

Glorious Revolution, Acemoglu et al. (2005a) and Acemoglu and Robinson (2008) try to

explain how these changes were made possible. According to Acemoglu et al. (2005a),

several merchants who had participated in Atlantic trade during the seventeenth century

became richer. This situation had rendered the Glorious Revolution and the changes it induced

possible. Taking advantage of their enrichment, merchants favourable to institutional change

were able to mobilise mercenaries and other sources of violence to threaten and defy the king.

Thus, King James II was assassinated and replaced by William of Orange, who was obliged

to make concessions in favour of the revolutionaries, for fear of being overthrown like his

predecessor.

These elements of analysis relating to institutional reforms in England raise the question of

whether the experience of England could inspire DC in reforming their institutions. More spe-

cifically, the question is whether there exist some opportunities relating to international mar-

kets and to what extent DC could benefit from these opportunities to reform their institutions,

as England had benefited from the Atlantic trade to reform its institutions during the seven-

teenth century.

a. FDI Inflows: A Potential Factor for Property Rights Reform in DC

Based on the aforementioned works of Acemoglu et al. (2005a, 2005b) and North and

Weingast (1989) relating to the history of institutional reform in England, I assume that DC

could take advantage of their participation in financial globalisation (i.e. movement of capital

across countries) to reform property rights institutions. I particularly focus my analysis on

FDI inflows, which could have the same effects as exogenous shocks to the political equilib-

rium that maintains ineffective economic institutions in DC. My analysis of the role of FDI

inflows in the reform of economic institutions is consistent with the work of Kose et al.

(2006). According to these authors, DC that participate in financial globalisation could benefit

from several related collateral effects, including the implementation of institutional reforms.4

I particularly focus my analysis on FDI because in terms of volume, they are the most

important foreign private financings received by DC (Kose et al., 2006), and because of this

characteristic, FDI inflows may have many collateral effects in DC. Also, contrary to other

4 For other externalities of FDI, see Moran (2005) and Moran et al. (2005). These authors have pub-lished a book in which they analyse various externalities that local enterprises in DC could benefit whenthey interact with foreign enterprises through FDI. However, Moran et al. (2005) do not analyse anyexternality of FDI in the form of contribution to the reform of economic institutions.


414 A. G. MIJIYAWA

flows relating to globalisation, FDI inflows would be more sensitive to the quality of property

rights protection in DC, because FDI inflows are long-term investments, and most of time

they occur with the physical presence of foreign investors in the host countries. Moreover, the

literature assumes that FDI inflows could be a source of managerial skills transfer to DC.

A transfer of good managerial skills could trigger property rights reform, thus FDI inflows

can contribute to that reform.

b. How Can FDI Inflows Contribute to Property Rights Reform in Developing Countries?

To analyse the contribution of FDI inflows to the reform of property rights institutions in

DC, I consider an economy where property rights institutions are weak and the population is

composed of the elite and other economic agents. The elite comprise individuals who control

political power acquired either through political institutions or economic and financial wealth.

Thus, the elite comprise policymakers, but also a minority of rich business people who have

good relations to policymakers. These good relations can take the form of monopoly posi-

tions that policymakers offer their allied, rich business people. The other members of society

constitute the majority and comprise private entrepreneurs and/or potential entrepreneurs

without any relation to the elite. In contrast to the private entrepreneurs who enjoy close rela-

tions with policymakers, the majority of private entrepreneurs do not benefit from any

favours from policymakers. Weak property rights institutions enable the elite to expropriate

and prevent the development of economic activities of the majority of private investors.

In such context, I analyse institutional reform as a game of supply and demand. The elite

are the suppliers of the reform of economic institutions, and the other economic agents (i.e.

the majority of private investors and potential investors) are the demanders for that reform.

While the other economic agents aspire to institutional changes to develop their businesses,

the elite have little interest in reforming economic institutions, as the status quo enables the

elite to preserve its economic rents. Thus, the game of supply and demand that I describe is

comparable to a framework of negotiation, where individuals with more negotiation power

have the last word in implementing or blocking property rights institutions reform.

In the model, initially, the elite have more negotiation power since they control political

power. In this case, if no change is enacted regarding the distribution of political power, it is

hard to envisage any institutional reform. Thus, my analysis is similar to that of Acemoglu and

his co-authors, which I previously discussed. Indeed, like Acemoglu et al. (2005a, 2005b),

I assume that individuals who control political power are those who make decisions on institu-

tional change, and external shocks to the political equilibrium can trigger property rights reform.

I consider FDI inflows as a potential source of exogenous shocks to the initial political

equilibrium and so to the initial distribution of negotiation power in society. FDI inflows

come from foreign countries and so can be a source of exogenous shock since DC cannot

totally control the volume of FDI inflows that they wish to receive, nor the time at which they

could receive them. In DC, FDI inflows could improve the negotiation power of private inves-

tors who wish the reform of economic institutions. The following arguments justify this

assumption:

� FDI inflows create jobs and generate tax revenues. In a globalised world, financial capi-

tal move rapidly from one country to another. In this context, investors could demand

and obtain the reforms that they need, given that a situation of non-compliance with their

demand may result in a departure of FDI from a country. To avoid such a situation, very



likely, policymakers would make concessions in favour of private investors in case of

discussions for the reform of property rights.5

� FDI inflows may improve the productivity of local enterprises and, consequently, their

profits and their fiscal contributions.6 In this case, the negotiation power of local entre-

preneurs would also increase. Local entrepreneurs could threaten not to pay or to pay

part of their taxes if the government does not implement institutional reforms supported

by the majority of entrepreneurs (see Acemoglu et al., 2005a for the case of England in

the seventeenth century). To avoid such a situation and its consequences, policymakers

may implement institutional reforms demanded by private investors.� Exchanges with foreign enterprises through FDI could enable local entrepreneurs to dis-

cover other organisational styles and institutional models. Such a situation would also

increase the negotiation power of private investors in the process of institutional reforms.

Indeed, private investors could propose a larger number of options to policymakers for

property rights reform. Such a situation would induce flexibility in the negotiations,

which would facilitate property rights reform.

c. Checks and Balances vis-�a-vis Policymakers: A Necessary Condition for a CatalyticRole of FDI Inflows in Property Rights Reform

I describe institutional change as a process of negotiation whose result depends on the

negotiation power of individuals involved in that process. I assume that FDI inflows could

increase the negotiation power of private investors who wish property rights reform. However,

the contribution of FDI inflows in changing the negotiation power in society is not automatic,

and there is an additional condition for FDI inflows to effectively contribute to property rights

reform. That is an equitable and a fair framework of negotiation, where all the opinions could

be expressed freely and could be considered. More specifically, I assume that the contribution

of FDI inflows to the reform of economic institutions would be effective when there exist

political and institutional constraints on policymakers in the exercise of their functions, that

is, when there exist checks and balances vis-�a-vis policymakers. The justifications for such an

assumption are as follows:

� When policymakers face institutional and political constraints in the exercise of their

functions, very likely, several private investors can benefit from the opportunities for

profit that FDI inflows offer. Thus, the opportunities for profit would not be limited to

policymakers and their partisans only.7 By enabling several private investors to benefit

5 Cornelius and Kogut (2003) have published a book with a series of chapters written by policymakersand practitioners. These chapters demonstrate how financial globalisation had induced in some DC thechange in corporate governance to satisfy the demand of foreign investors.6 For empirical results showing the impact of FDI inflows on the productivity of local enterprises inDC, see L�opez-C�ordova (2003), Alfaro and Rodr�ıguez-Clare (2004), Javorcik (2004) and Blalock andGertler (2005).7 North and Weingast (1989) and Acemoglu et al. (2005a, 2005b) show that before the Glorious Revolu-tion, the absence of limit of power enabled kings to offer monopoly positions to their partisans and tothe close members of their families. Likewise, De Long and Shleifer (1993) show that between 1,000and 1,800, Western European regions governed by authoritarian monarchs had experienced poor com-mercial and industrial developments and, consequently, low rates of economic growth because ofunequal repartition of opportunities.


416 A. G. MIJIYAWA

from the opportunities for profit, political and institutional constraints on policymakers

could increase the number and the negotiation power of individuals who wish the reform

of economic institutions.� In an environment where there exist institutional constraints on policymakers, the transac-

tion costs for individuals that wish the reform of economic institutions would be reduced.

More specifically, this means that the problems of collective action that may face private

investors would be less. Indeed, private investors who aspire to property rights reform

could better coordinate their actions without fearing reprisals from policymakers (for a

similar argument, see Roland, 2004). A good coordination of the actions of private inves-

tors favourable to property rights reform is necessary for the success of that reform.� An environment where the power of policymakers is limited is generally propitious for

economic reforms. Indeed, in such an environment, the potential winners resulting from

economic reforms would not abuse of their gains and the potential losers are guaranteed

to receive adequate compensation for the losses that they may bear. Such a situation

facilitates the emergence of national consensus for economic reforms.8

I assume that DC could benefit from FDI inflows to reform property rights. More specifically,

I assume that FDI inflows could contribute to the reform of property rights institutions in DC

when a minimum of effective institutional and political constraints on policymakers pre-exists.

Thus, for the empirical analysis, my variable of interest is a multiplicative variable between

FDI inflows and an index measuring the level of institutional constraints on policymakers.

4. EMPIRICAL ANALYSES

a. Measurement of Property Rights Reform

To test the main argument of the paper, I first need a measurement of property rights reform.

To do so, I take advantage of the methodology developed by Doing Business, the World Bank

annual report on the reform of regulatory and property rights institutions around the world.

More specifically, I use data from the Fraser Institute, and I apply two transformations to the

index of property rights. I initially calculate the first difference of the index.9 However, the first

difference is probably not enough to suitably identify the occurrence of property rights reform.

For instance, if the first difference of the index is negative, this would reveal deterioration

instead of improvement in the quality of institutions. To avoid such a situation, I transform the

result of the first difference into a dummy variable taking the value of one in case the result of

the first difference is strictly positive and zero otherwise. Thus, my analysis focuses on a posi-

tive variation in the index of property rights compared with its deterioration or its maintaining

status quo. However, for robustness checks of the results, later in the paper, I also run regres-

sions with the first difference of the property rights index as a dependent variable.

8 Similar arguments have been developed by Acemoglu (2003), who shows that political democratisationis a guarantee for the credibility of commitments of policymakers in the process of the reform of econ-omic institutions. Likewise, Rodrik (1999) shows that democratic countries are those which quicklyrecovered from the oil crisis in the 1970s, because thanks to democracy, the populations were guaranteedto receive appropriate compensations for the losses they bore. Such a situation facilitated the implemen-tation of the necessary reforms to overcome the crisis in democratic countries.9 For the identification of top reforming countries, authors of Doing Business calculate annual change in thecountries’ rankings based on the number of reforms that countries implement to make doing business easier.



The measurement of property rights reform is appropriate, since institutions are not tangi-

ble factors, the index of property rights should not record an increase in its value if institu-

tions are not reformed. However, one may suspect that there could be an increase in the value

of the index of property rights without reform necessarily. This may be possible in the short

term, because in the short term, the measurement of the quality of institutions could be done

with errors. However, this risk of errors is limited in the long term, where data are collected

over several years, as it is the case in this paper.

b. Econometric Model

In this paper I assume that FDI inflows could contribute to the reform of property rights

institutions in DC, if there pre-exist institutional and political constraints on policymakers in

the exercise of their functions. However, chiefs of the executive are the most decisive policy-

makers in achieving most reforms. Moreover, only data on the quality of institutions of con-

straints on the executive are available. Thus, I reformulate my hypothesis as follows: FDI

inflows are likely to contribute to the reform of property rights institutions in DC initially

endowed with a minimum of effective institutions of constraints on the executive. I therefore

estimate the following model:

Refit ¼ cþ a: log gdpitð Þ þ b:FDIit þ c:consti0 � FDIit þ ui þ vt þ eit:

As previously explained, the dependent variable is a dummy variable taking the value of

one for a strictly positive variation in the index of property rights and zero otherwise. Thus,

the econometric model is a probability model that estimates the occurrence of property rights

reform. My variable of interest is a product of FDI inflows and the initial level of constraints

on the executive; that is consti0 9 FDIit. I expect a positive effect of the variable of interest

on the explained variable.

I control for the natural logarithm of GDP per capita. As I explained in the theoretical

section, the analysis of FDI inflows on the reform of property rights institutions is an anal-

ysis of a collateral effect of FDI inflows in DC. Indeed, neither the governments nor pri-

vate investors mainly seek to reform institutions through FDI inflows. Governments of DC

seek to improve the living conditions of their populations through FDI inflows, whereas for-

eign private investors seek to maximise the returns of their financing resources by placing

them in the form of FDI in DC. Empirically, to be consistent with the idea that the effect

of FDI on property rights reform is a collateral effect, it is necessary to control for the

effect of GDP per capita in the model. GDP per capita is an indicator of the population’s

living conditions as well as an indicator of the population’s demand capacity. Therefore,

GDP per capita acts as an indicator of the potential profits, which foreign private investors

could make when settling in a country. After controlling for GDP per capita, if the vari-

able of interest continues to have a statistically significant effect on the reform of property

rights institutions, I could consider this effect as a collateral effect of FDI inflows. Indeed,

by controlling for the effect of GDP per capita, most likely the model incorporates the

main effects sought both by foreign private investors and by the governments in DC. More-

over, GDP per capita is a potential determinant of the reform of institutions, in the sense

that rich countries are those capable of affording the necessary resources for economic

reform.

I also control for the unconditional effect of FDI inflows on the reform of property rights

institutions; this is the linear effect of FDI. The unconditional effect of FDI inflows is ambig-


418 A. G. MIJIYAWA

uous. Indeed, regardless of the level of constraints on the executive, FDI inflows may contrib-

ute to the reform of property rights institutions. In this case, the unconditional effect of FDI

inflows on the probability of reforming property rights institutions would be positive. Con-

versely, when the level of constraints on the executive is low, FDI inflows may complicate

the reform of property rights institutions. In this case, the unconditional effect of FDI inflows

on the explained variable would be negative.

c. Description of the Data and their Sources

In this paper, I use panel data for econometric analysis. Thus, in the above-mentioned

econometric model, c, ui, vt and eit, respectively, stand for constant, country fixed effect, time

fixed effect and idiosyncratic error.

With panel data, the explained variable is the likelihood for a country to record a strictly

positive variation in the index of property rights over five-year intervals. The choice of five-

year period is imposed because the Fraser Institute computes data on the quality of property

rights institutions on the basis of five-year intervals over the period 1970–2000. The annual

data are available from 2001. To complete the data, I calculate the mean value of the index

of property rights over the period 2001–05 and take the first difference between this mean

value and the value of the index in 2000. The Fraser Institute database has the advantage of

covering a long period, going back to the 1970s. This is the only database on economic insti-

tutions covering such a long period.10

The index of property rights measures the degree of property rights protection by a govern-

ment, which includes respect of rule of law, quality of legal enforcement of contracts in a

country, independence and integrity of judiciary system and risk of expropriation of private

agents by the government in a country. Initially, that is, before transforming the index, the

index of property rights lies between 0 (minimum value) and 10 (maximum value). The

higher the index, the better the protection of property rights in a country.

Data on FDI inflows are annual data taken from the World Bank, Global Development

Finance data set, and cover the period 1970–2005. For the purposes of econometric analy-

ses, I calculate the five-year average values of FDI inflows over the period of analysis.

Data on FDI inflows measure the amount of investment by non-resident investors. These

are data on net FDI inflows, that is, the sum of new capital invested, profits reinvested

and inter-enterprises capital invested, all adjusted for capital transfers in the home countries

of foreign investors and debt reimbursements. Thus, FDI inflows data capture new capital

and profits reinvested, net of capital transfers in the home countries of foreign investors

and reimbursements of debt. Consequently, throughout this paper, by FDI inflows, I mean

net FDI inflows as defined above. Data on FDI inflows are expressed as a percentage of

GDP.

I assume that the effect of FDI inflows on the reform of property rights depends on the ini-

tial level of constraints on the executive. Therefore, my variable of interest is the multiplica-

tive variable between FDI inflows and the level of constraints on the executive in 1970, the

first year of the analysis period. Given that I use panel data, in the model with fixed effects, it

is not possible to control for the effect of the initial level of constraints on the executive,

10 Data and further description of the index of Fraser Institute are available at: http://www.freetheworld.com/release.html.



since this variable does not vary over time. That is why in the econometric model, I do not

control for the effect of constraints on the executive in 1970.11

Data on constraints on the executive are obtained from the Polity IV data set and lie

between one (minimum value) and seven (maximum value). The higher the index, the more

effective institutions of constraints on the executive are. Data on constraints on the executive

measure institutional and political constraints that the chief of executive faces in the exercise

of his/her function. More specifically, according to the experts of Polity IV, operationally,

constraints on the executive variable refer to the extent of institutionalised constraints on the

decision-making powers of chief executives, whether individuals or collectivities. Such limita-

tions may be imposed by any ‘accountability groups’. In Western democracies, these are usu-

ally legislatures. Other kinds of accountability groups are the ruling party in a one-party state,

councils of nobles or powerful advisors in monarchies. The concern is therefore with the

checks and balances between the various parts of the decision-making process.12

Data on GDP per capita are taken from the Pen World Table 6.2 (https://pwt.sas.upenn.

edu/). These are GDP data corrected from the purchasing power parity. I consider the value

of the natural logarithm of GDP per capita at the beginning of each five-year period.

Panel data offer several advantages for the analysis in this paper. First, using panel data

with time fixed effects, it is possible to control for the effect of covariant shocks, which

simultaneously induce institutional reforms in different countries. Second, thanks to country

fixed effects, I can control for the effects of invariant and unobservable effects that may affect

institutional reforms in a country. These invariant characteristics include among other things,

historical and cultural factors that can affect the occurrence of institutional reforms. Despite

their importance, without using panel data with country fixed effects, it would not be possible

to control for cultural and historical factors on the reform of property rights institutions. To

the best of my knowledge, this would be the first paper that uses panel data to analyse the

contribution of FDI inflows to the reform of property rights institutions in DC.

d. Econometric Techniques

(i) Endogeneity Issues and the Use of the System-GMM TechniqueLike in most empirical analyses, endogeneity issues may arise in the analysis of the effect

of FDI inflows on property rights reform because of measurement errors or omission of

important explanatory variables, for instance. Moreover, this paper introduces a new argument

in the FDI literature. Indeed, generally, this literature analyses the effect of the quality of

institutions on FDI inflows. For instance, it has been shown that countries with better property

rights protection attract more FDI (Li and Resnick, 2003; Jakobsen and de Soysa, 2006). In

this paper, I introduce the reverse argument in the sense that I analyse the effect of FDI

11 When using a multiplicative variable in an empirical model, it is generally advisable to include sepa-rately in the model the two variables used to build the multiplicative variable. If this is not the case, onemay suspect bias in the coefficient associated with the multiplicative variable. However, in this paper,because of high correlation between the level of constraints on the executive and the level of GDPper capita, the latter variable can capture the effect of the former variable, therefore reducing bias in theestimations. Also, like any institutional variable, the constraints on the executive variable are persistentover time; therefore, part of its effect can be captured by country fixed effects. Moreover, since I use aninstrumental variable technique, any omitted variables bias would be reduced.12 Data and further description of the index of constraints on the executive can be found at: http://www.systemicpeace.org/polity/polity4.htm.


420 A. G. MIJIYAWA

inflows on the reform of institutions. This situation highlights the risk of simultaneity errors

and endogeneity bias in the analysis.

However, generally, it is not an easy task to find exogenous and valid instrumental vari-

ables to deal with endogeneity issues, especially when one uses panel data as it is the case in

this paper. To deal with endogeneity issues, I use the system-generalised methods of moments

(GMM) technique. This technique has been developed by Blundell and Bond (1998) and con-

sists of combining two sets of equations: one set of equations are the differenced equations

for which suitable lagged level variables are used as instruments, and the other set of equa-

tions in the system are the levels equations, where suitable lagged first differenced variables

are used as instruments. Thus, the system-GMM uses internally generated instrumental vari-

ables to correct for the endogeneity of all the potential endogenous variables, and the quality

of the instruments can be tested using the Sargan over-identification test. The system-GMM

technique has been widely used in macro-empirical analysis to deal with endogeneity issues.13

(ii) More Discussions on Estimation TechniquesAs outlined before, the model in this paper is a probability model. In this case, I should

use probit or logit model to run regressions. However, with panel data, the current pro-

grammed versions in Stata (IBM, Armonk, NY) are probit and logit models with random

effects. But, when using panel data with random effects, the underlying assumption is the

absence of correlation between the explanatory variables and country fixed effects, which is a

debatable hypothesis.14 To deal with this weakness of random effects model, I also run regres-

sions with fixed-effect linear probability models. In this case, there is no need to assume an

absence of correlation between the explanatory variables and country fixed effects. I use two

linear probability models: the fixed-effect model and the system-GMM.

However, when using linear probability models, it is important to check the proportion of

observations for which the predicted values of the explained variable do not lie between zero

and one. In general, when one uses linear probability models, it is possible that the predicted

values of the explained variable do not vary between zero and one. This constitutes a limit of

linear probability models. However, according to Wooldridge (2000), if for the majority of

the observations the predicted explained variable lies between zero and one, the limit of linear

probability models relating to the interval of variation of the predicted values of the explained

variable should no longer be a concern.

In this paper, I run regressions using four different techniques: two probability models, that

is, logit and probit models with random effects, and two linear probability models, namely

the fixed-effect model and the system-GMM technique. The use of four different econometric

techniques enables me to check the robustness of the results. However, among the results,

those obtained with the system-GMM technique are much more convincing because if suitable

instrumental variables are used, the results would not suffer from endogeneity bias.

For the period 1970–2005, given that I use five-year panel data, normally, each country in

the sample should have seven observations. However, this is not the case, which means I use

13 The first differenced GMM could also be used to deal with endogeneity issues in panel data, but thisestimator has been proved less efficient compared with the system-GMM technique (see Blundell andBond, 1998).14 There exists in Stata, another version of logit model with fixed effects. However, this model onlyconsiders part of the observations, that is, those observations for which the explained variable alwaystakes the value of one or zero.



unbalanced panel data. My sample comprises 80 DC from Africa, Latin America and Asia.

The sample also comprises emerging countries and transition countries from the former Soviet

Union and China (see Appendix A for the list of countries).

e. Statistical Analysis

Before presenting and commenting on the results of econometric analysis, it is useful to

analyse the trend of FDI inflows and that of unconditional probability of property rights

reform. I also compare the volume of FDI inflows and the level of constraints on the

TABLE 1Statistical Description of the Main Variables

Variables Observations Mean StandardDeviation

Minimum Maximum

Reform (dummy, explained variable) 439 0.45 0.49 0 1Property rights index (first difference) 438 0.14 1.19 �3.12 4.76Constraints on the executive 546 3.05 2.11 1 7FDI inflows (% GDP) 505 1.68 2.49 �7.90 23.74Variable of interest 492 5.32 10.05 �21.13 97.10Log (GDP per capita) 556 7.68 1.08 5.11 10.39Trade openness (% GDP) 497 0.65 0.36 0.1 2.3Population with primary education (%) 411 12.13 7.54 0.5 43.7Natural resources (%) 482 29.30 31.27 0.01 98.61Dummy for trade agreement 560 0.01 0.12 0 1Dummy for WTO membership 560 0.26 0.44 0 1

Source: Author’s calculations.

3.5

3

2

1

01975 1980 1985 1990 1995 2000 2005

Years

0.5

1.5

2.5

Reform (%)FDI (% of GDP)

FIGURE 1Trends of FDI Inflows and Unconditional Probability of Property Rights

Institutions Reform in Developing Countries

Source: Author’s calculations based on data from Polity IV and the Global Development Finance data sets.


422 A. G. MIJIYAWA

executive in the sample. By unconditional probability of reform, I mean the ratio of coun-

tries that have experienced a strictly positive variation in the property rights index to the

total number of countries for which data are available to judge the situation of property

rights. I calculate the unconditional probability at every five-year point from 1970 to 2005.

I also calculate the five-year average values of the ratio of FDI inflows to GDP over the

same period. Moreover, statistical descriptions of the main variables are reported in

Table 1.

From Figure 1, it appears that the unconditional probability of property rights reform was

at its lowest value, that is, 0.18 in 1975, and it reached its highest value estimated at 0.78 in

1980. During the following five-year period, the percentage of DC that experienced a strictly

positive variation in the index of property rights shrank. Then, from 1985 to 1995, the uncon-

ditional probability of property rights reform witnessed a new increase. From 1995, the per-

centage of DC that reformed their property rights institutions decreased and reached the value

of 0.3 in 2005.

The trend of FDI inflows shows that there was a reduction in the volume of FDI inflows in

DC from 1975 to 1990, when FDI inflows reached their lowest value estimated at 0.8 per cent

of GDP. From 1990, the volume of FDI inflows in DC increased and reached the value of 3

per cent of GDP in 2005. Thus, it is only during the period 1990–95 that FDI inflows and

unconditional probability of property rights reform showed similar trends. During the period

1995–2005, the two variables have evolved in opposite directions; the same pattern appeared

during the period 1975–85. Thus, from Figure 1, it appears that FDI inflows and the uncondi-

tional probability of property rights reform have evolved in opposite directions for the major-

ity of the period of analysis.

In Figure 2, I compare the volume of FDI inflows and the unconditional probability of

property rights reform according to the level of constraints on the executive in 1970. I con-

sider countries whose level of constraints on the executive is higher than the sample average

(i.e. higher than 3, see Table 1) as countries with a high level of constraints on the executive.

1.8

1.6

1.4

1.2

1

0.8

0.6

0.4

0.2

0FDI (% of GDP) Reform (%)

High constraintLow constraint

FIGURE 2Comparison of FDI Inflows and Unconditional Probability of Property Rights Reform

according to the Level of Constraints on the Executive inDeveloping Countries

Source: Author’s calculations based on data from the Polity IV and the Global Development Finance data sets.



Conversely, countries whose level of constraints on the executive is lower than the sample

average are considered countries with a low level of constraints on the executive.

Figure 2 shows that there is no difference in FDI inflows between DC according to the

level of constraints on the executive in 1970. Indeed, regardless of the level of constraints on

the executive, on average, over the period 1970–2005, DC have received a volume of FDI

equivalent to 1.7 per cent of their GDP. However, from Figure 2, it appears that countries

with a high level of constraints on the executive have a much higher chance to reform prop-

erty rights institutions than countries with a low level of constraints on the executive. On

average, during the period 1970–2005, the unconditional probability of property rights reform

was 0.5 in the countries with a high level of constraints on the executive as compared to 0.4

for countries with a low level of constraints on the executive. Thus, Figure 2 highlights a

trend that is consistent with the main argument of the paper, but we also need the results of

econometric analyses to confirm.

TABLE 2Baseline Results

Linear Probability Models Probability Models

Fixed Effect System-GMM Probit Logit(1)Ref

(2)Ref

(3)Ref

(4)Ref

Log (GDP per capita) 0.129 (1.05) 0.010 (0.35) 0.087 (1.12) 0.140 (1.09)FDI inflows (% of GDP) �0.033 (1.91)* �0.050 (2.29)** �0.130 (2.41)** �0.212 (2.36)**Variable of interesta 0.006 (1.15) 0.014 (2.83)*** 0.022 (1.88)* 0.036 (1.88)*Constant �0.588 (0.76) 0.718 (3.21)*** 0.179 (0.29) 0.305 (0.30)

Observations 402 402 402 402Countries 74 74 74 74Sargan–Hansen testb – 0.505 – –AR (1) – 0.000 – –AR (2)c – 0.957 – –Log likelihood – – �251.202 �251.272Wald test – – 47.92*** 44.54***Percentage ofobservationsd

100 100 – –

Notes:(i) a By variable of interest, I mean the multiplicative variable between FDI inflows and the index of constraints onthe executive at the beginning of the analysis period.(ii) b Denote the p-value for the test of validity of the instrumental variables used in the system-GMM model. Theresult of the test indicates that the instrument variables are good, since the p-value associated with the Sargan–Hansentest is higher than 10.(iii) c Denote the p-value for the test of absence of second-order autocorrelation and validate the use of a minimumof second five-year lagged values of the endogenous variables as instruments in the system-GMM model. To limit thenumber of potential instruments, I only use the second and the third five-year lagged values of FDI and that of thevariable of interest as instruments.(iv)d Stand for the percentage of observations for which the predicted value of the explained variable lies between 0 and 1.(v) ***, **, * denote significant coefficients respectively at the level of 1%, 5% and 10%. The linear probability mod-els are based on panel data with fixed effects, whereas the probability models are based on panel data with randomeffects.(vi) The figures in brackets are robust t-statistics. The regressions contain time fixed effects whose coefficients are notshowed to save space.


424 A. G. MIJIYAWA

5. REGRESSION RESULTS

From Table 2, it appears that regardless of the estimation technique, the variable of interest

(i.e. the multiplicative variable between FDI inflows and the index of constraints on the exec-

utive) has a positive effect. In all the models except for the fixed-effect model, the effect of

the variable of interest is statistically significant. Thus, the data confirm my hypothesis

according to which FDI inflows can contribute to the reform of property rights in countries

where the exercise of the executive power is governed by a minimum of effective institutions

of checks and balances.

Column 2 of Table 2 reports the results obtained with the system-GMM. In this case, the

Sargan–Hansen test shows that the lagged variables that I use are good instrumental variables.

Based on the system-GMM model, the minimum level of constraints on the executive for DC

to benefit from FDI inflows to reform property rights institutions is 3.6. This is a reasonable

level; it is slightly higher than the sample average. Only 20 of the 80 countries of the sample

have this level of constraints on the executive, and among the 20 countries, only five are in

sub-Saharan Africa.15 Moreover, the result with the system-GMM model suggests that a one

standard deviation increase in the value of the variable of the interest (10.05) would increase

the probability of property rights reform by 14 per cent. From Table 2, we can also see that

hundred percentage of the predicted values of the explained variable lie between zero and

one. This is a reassuring result; it suggests that there is no observation for which the predicted

values of the explained variable do not vary between 0 and 1.

By comparing the results of linear probability models, the data reveal endogeneity bias due

to measurement errors. Indeed, a comparison of the results of the fixed-effect model with the

results of the system-GMM model shows that the coefficient associated with the variable of

interest increases after correcting for endogeneity. Measurement errors bias the coefficients

towards zero; this may explain why the variable of interest is not significant, although its

coefficient is correctly signed in the fixed-effect model.

The unconditional effect of FDI inflows on the probability of reforming property rights

institutions is negative and significant no matter the estimation technique used. This suggests

that in DC with a low level of constraints on the executive, FDI inflows may delay or compli-

cate the process of property rights reform. This result can be understood based on the theoret-

ical arguments of the paper. Indeed, an extension of the theoretical arguments of the paper

may imply that in an environment characterised by poor institutions of constraints on the

executive, very likely, FDI inflows would contribute to enrich political and economic elite

only. In doing so, the elite that wish to maintain institutional status quo would reinforce their

position and their bargaining power in society, thereby reducing the likelihood of reforming

property rights institutions.

The results in Table 2 show that the effect of GDP per capita is positive, though insignifi-

cant regardless of the technique of estimation used. Thus, after controlling for the other vari-

ables, and for the period of analysis, it appears that an increase in income is not a sufficient

condition for reforming property rights institutions in DC.

15 The following countries had in 1970 a level of constraints on the executive higher than 3.6: Bangla-desh, Botswana, Chile, Colombia, Costa Rica, Ghana, Guyana, El Salvador, India, Jamaica, Papua NewGuinea, Mauritius, South Africa, Sri Lanka, Trinidad and Tobago, Turkey, United Emirates Arab,Uruguay, Venezuela, Zimbabwe.



a. Robustness Checks

I previously explained why I preferred running regressions with a dummy variable instead

of five-year first difference of the property rights index as an explained variable. Indeed, the

first difference may not be enough to suitably capture positive changes in the index of property

rights, especially when first difference is negative. However, as a first robustness check of the

results, I run regressions using the first difference of the index of property rights as a depen-

dent variable. In this case, there is no constraint imposed on the variation of the property rights

index and the concern that some countries may be penalised if a dummy variable is used as an

explained variable would no longer be valid. When using five-year first difference of the prop-

erty rights index as an explained variable, I run regressions with the fixed-effect and the sys-

tem-GMM models only. The results of this robustness check are reported in Table 3. It

appears that with five-year first difference of the property rights index as an explained variable,

after correcting for endogeneity, I still find a positive and significant effect of FDI inflows on

property rights reform in countries with a minimum level of constraints on the executive.16

TABLE 3Robustness Check with Five-Year First Difference of the Property Rights

Index as an Explained Variable

System-GMM Fixed Effect

(1)First Difference PropertyRights Index

(2)First Difference PropertyRights Index

Log (GDP per capita) 0.038 (0.76) �0.081 (0.28)FDI inflows (% of GDP) �0.060 (3.00)*** �0.032 (1.07)Variable of interesta 0.019 (1.90)* 0.001 (0.10)

Constant �0.563 (1.52) 0.132 (0.07)Observations 402 402Countries 74 –Sargan–Hansen testb 0.363 –AR (1) 0.000 –AR (2)c 0.120 –

Notes:(i) a By variable of interest, I mean the multiplicative variable between FDI inflows and the index of constraints onthe executive at the beginning of the analysis period.(ii) b Denote the p-value for the test of validity of the instrumental variables used in the system-GMM model. Theresult of the test indicates that the instrument variables are good, since the p-value associated with the Sargan–Hansentest is higher than 10.(iii) c Denote the p-value for the test of absence of second-order autocorrelation and validate the use of a minimumof second five-year lagged values of the endogenous variables as instruments in the system-GMM model. To limit thenumber of potential instruments, I only use the second and the third five-year lagged values of FDI and that of thevariable of interest as instruments.(iv) ***, **, * denote significant coefficients respectively at the level of 1%, 5% and 10%.(v) The linear probability models are based on panel data with fixed effects, whereas the probability models are basedon panel data with random effects. (vi) The figures in brackets are robust t-statistics.(vii) The regressions contain time fixed effects whose coefficients are not shown to save space.

16 To save space, only some of the results of robustness checks are reported in the text. The results thatare not reported are available upon request.


426 A. G. MIJIYAWA

The analysis sample comprises DC from different regions and at different stages of devel-

opment. Although in the econometric models I control for country fixed effects, the results

could be sensitive to some regional characteristics. Thus, I run regressions with a subsample

that excludes former USSR transition countries and China from the initial sample. Indeed, in

recent years, China and transition countries have experienced several social and economic

mutations, including an increase in FDI inflows. Therefore, it is possible to suspect that the

results may be driven by the presence of these countries in the sample. When I run regressions

without transition countries in the sample, I find a positive and significant effect of the variable

of interest in all the models, except for the fixed-effect model. Likewise, the unconditional

effect of FDI is negative and significant in all the models. Thus, the exclusion of transition

countries from the sample does not call into question the main results of the paper.

I also check the robustness of the results by excluding emerging countries from the sample.

Compared with other DC, because of a relatively higher level of income, emerging countries

may have some advantages in building good institutions. Therefore, one can suspect that the

significant effect of the variable of interest may be driven by the presence of emerging coun-

tries in the sample. The results of regressions with a subsample that excludes emerging coun-

tries from the initial sample show that the effect of the variable of interest is positive and

significant and the unconditional effect of FDI is negative and significant.

I simultaneously exclude emerging and transition countries from the sample. The result of

this additional robustness check confirms the main result of the paper, that is, conditioned on

the level of constraints on the executive, the effect of FDI inflows on the probability of

reforming property rights institutions is positive and significant.

TABLE 4Robustness after Controlling for the Effect of Trade Openness


Fixed Effect System-GMM Probit Logit

(1)Ref

(2)Ref

(3)Ref

(4)Ref

Log (GDP per capita) 0.026 (0.18) �0.030 (1.04) �0.014 (0.16) �0.027 (0.19)FDI inflows (% GDP) �0.029 (1.65)* �0.042 (2.20)** �0.166 (2.48)** �0.272 (2.41)**Variable of interesta 0.005 (1.01) 0.012 (2.30)** 0.026 (2.02)** 0.042 (1.99)**Trade openness(% of GDP)

0.135 (1.11) 0.185 (1.00) 0.385 (1.69)* 0.626 (1.68)*

Constant 0.003 (0.00) 0.868 (3.75)*** 0.680 (1.03) 1.135 (1.04)


100 100 – –

Note:(i) The same as in Table 2.



The above robustness checks show that the main results are not sensitive to the sample

composition. I carry out additional robustness checks by considering the effects of other vari-

ables on the reform of property rights. These are variables that could simultaneously affect

the explained variable as well as the variable of interest. The omission of such variables in

the regressions could bias the results.

I control for the effect of trade openness. In a historical perspective, Acemoglu et al.

(2005a) demonstrate that the participation of England in Atlantic trade had accelerated institu-

tional reforms in the country during the seventeenth century. In addition, trade and financial

openness are interdependent and complementary. Based on these arguments, it is judicious to

control for the effect of trade openness. Indeed, it is possible to suspect that the effect of FDI

and that of the variable of interest is attributable to trade openness. To check for this possibil-

ity, I introduce in the model a commonly used indicator for trade openness, that is, the sum

of exports and imports as a percentage of GDP. I obtain this variable from the World Bank

(2006) 2005 World Development Indicators database. The results in Table 4 show that the

introduction of trade openness in the model does not affect the significance of the variable of

interest. The effect of trade openness, though positive, is significant at the 10 per cent level in

the logit and probit models only. Therefore, the main results of the paper are not driven by

the omission of trade openness in the baseline econometric model.

Another potential determinant of institutional reform is a country’s population level of edu-

cation. Indeed, countries with a high proportion of educated population are likely to better

design and implement institutional reforms. Thus, I add to the models an indicator of a coun-

try’s educational level. Drawn from Barro and Lee (2000) data sets, I include in the models a

TABLE 5Robustness after Controlling for the Effect of Natural Resources



(1)Ref

(2)Ref

(3)Ref

(4)Ref

Log (GDP per capita) 0.123 (0.88) 0.032 (0.59) 0.129 (1.44) 0.209 (1.42)FDI inflows(% of GDP)

�0.075 (2.51)** �0.125 (3.39)*** �0.170 (2.60)** �0.276 (2.52)**

Variable of interesta 0.012 (1.53) 0.032 (2.29)** 0.023 (1.72)* 0.038 (1.70)*Natural resources (%) �0.002 (0.51) �0.005 (0.80) �0.003 (1.16) �0.004 (1.12)Constant �0.451 (0.50) 0.269 (0.81) �1.338 (2.01)** �2.230 (2.01)**


95 95 – –



428 A. G. MIJIYAWA

variable measuring the share of the population of at least 15 years old who have a primary

education level. Despite taking into account the level of education, the main results do not

change, that is, the variable of interest and FDI are both significant and their coefficients are

of the same signs as I initially found. The effect of education is positive as expected, but

insignificant.

Natural resources abundance is another potential determinant of property rights reform.

Abundance of natural resources can generate significant rent revenue for policymakers,

which may render property rights reform more difficult. Moreover, countries rich in natural

resources may attract FDI aimed at exploiting the resources. To test for the effect of natural

resources, I include in the model a variable measuring the sum of metal exports, minerals

and fuel exports as a percentage of a country’s total export of merchandises. The natural

resources abundance variable is obtained from the World Development Indicators data sets.

After introducing an indicator of natural resources abundance in the model, the variable of

interest still has a positive and significant effect on the probability of reforming property

rights institutions. The effect of natural resources is negative as expected, but insignificant

(see Table 5).

According to the authors of the World Economic Outlook (IMF, 2003, 2005), other factors

that could affect the reform of institutions in DC are external anchors. The influence of exter-

nal anchors can manifest through trade agreements, World Trade Organization (WTO) adhe-

sion and the review of the pairs of chief executives. Failing to control for such factors could

bias the results.

Thus, I control for the effect of WTO membership. On the basis of information obtained

from the WTO website, I generate a dummy variable taking the value of one from the year a

country becomes a member of WTO and the value of zero for non-member years and non-

member states. Thus, on the one hand, I compare WTO members to non-members and, on the

other hand, individual member countries prior to and following WTO membership. The

results show that neither the sign nor the significance of the variable of interest has changed

after taking into account the effect of the WTO membership. In addition, the effect of the

WTO dummy variable is negative, though insignificant in all the econometric models. It

seems that membership to WTO does not necessarily contribute to property rights reform.

Membership of WTO could induce other reforms, but very likely, property rights reform is

not the priority of those reforms. This may explain the effect of the WTO dummy variable

that I find.

Another potential external influence on the reform of property rights institutions is mem-

bership to regional integration organisations, especially a trade agreement among developed

and DC. Indeed, several authors argue that the prospect of the EU membership has acceler-

ated economic reforms in the former USSR countries. The initial sample comprises Mexico,

which has signed a regional integration agreement (NAFTA) with the United States and

Canada and Eastern European countries, new members of the EU. To take into account the

effect of trade agreements among developed and DC, I generate a dummy variable taking the

value of one from the year a country signs a trade agreement either with the United States or

the EU and zero otherwise. Therefore, I compare member to non-member countries of trade

agreements and the situation of individual countries before and after signing a regional trade

agreement. After controlling for the effect of regional integration, the variable of interest still

has a positive and significant effect on the probability of reforming property rights institu-

tions. The unconditional effect of FDI is negative and significant. The regional integration

dummy variable is negative, though insignificant.



For the last robustness check, I simultaneously control for the effects of all the explanatory

variables that I add to the baseline models: trade openness, primary education, abundance of

natural resources, membership to WTO and membership to regional integration organisation.

The results in Table 6 show that the effect of the variable of interest remains positive and

significant after correcting for endogeneity.

6. CONCLUSION

In this paper, I analysed factors that can potentially facilitate property rights institutions

reform in DC. Inspired by the works of North and Weingast (1989), Acemoglu et al. (2005a)

and Acemoglu and Robinson (2008) that analysed the process of institutional reforms in Eng-

land during the seventeenth century, I assume that nowadays DC could take advantage of FDI

inflows to reform property rights institutions. I analysed FDI inflows as a source of exogenous

shocks to the political equilibrium, which maintains ineffective property rights institutions in

DC.

The main hypothesis of the paper is that FDI inflows could contribute to property rights

reform in DC that are initially endowed with a minimum of effective institutions of con-

straints on the executive, that is, a minimum of effective checks and balances institutions.

TABLE 6Robustness after Controlling Simultaneously for all the Explanatory Variables



(1)Ref

(2)Ref

(3)Ref

(4)Ref

Log (GDP per capita) �0.101 (0.48) �0.261 (1.35) �0.144 (1.16) �0.247 (1.21)FDI (% of GDP) �0.084 (2.10)** �0.085 (1.87)* �0.209 (2.19)** �0.350 (2.14)**Variable of interesta 0.013 (1.25) 0.020 (1.94)* 0.029 (1.62) 0.049 (1.62)Trade openness(% of GDP)

0.292 (1.05) 0.123 (0.35) 0.533 (1.89)* 0.875 (1.88)*

Primary education (%) 0.011 (0.95) 0.002 (0.12) 0.017 (1.33) 0.028 (1.33)Natural resources (%) �0.003 (0.79) 0.002 (0.32) �0.004 (1.24) �0.006 (1.21)WTO dummy �0.010 (0.04) �0.036 (0.12) �0.473 (0.83) �0.756 (0.84)Trade agreement dummy �0.199 (0.80) �0.164 (0.80) �0.761 (1.11) �1.222 (1.03)Constant 0.791 (0.56) 2.411 (1.63) 1.055 (0.98) 1.816 (1.04)


97 95 – –



430 A. G. MIJIYAWA

Indeed, the existence of constraints on the executive would enable several private investors to

benefit from the opportunities for profit that FDI inflows offer. Likewise, in a country with

effective institutions of constraints on the executive, individuals who wish the reform of prop-

erty rights could better coordinate their actions, and the changes in negotiation power in their

favour could better be taken into account.

Using five-year panel data over the period 1970–2005, with a sample of 80 DC, economet-

ric analysis suggests that FDI inflows have a negative and significant effect on the reform of

property rights institutions. However, conditioned on the initial level of constraints on the

executive, the effect of FDI inflows on the reform of property rights institutions becomes

positive and significant. This result corroborates the main hypothesis of the paper.

The policy implication of the paper is that FDI inflows may have several potential collat-

eral effects in DC, including a collateral effect in the form of contribution to institutional

reforms. This is consistent with the arguments of Kose et al. (2006). However, DC need to

create a minimum of favourable local conditions to benefit from the positive collateral effects

of FDI inflows. More specifically, this paper highlights that the creation or the strengthening

of institutions of constraints on the executive is a good start for DC to benefit from FDI

inflows to reform property rights institutions.

The results suggest that more efforts have to be made for the reinforcement of institutions

of constraints on the executive. Indeed, I found that 20 of the 80 DC in the sample had the

minimum level of constraints on the executive necessary for FDI inflows to be a catalyst in

the reform of property rights institutions. This minimum level of constraints on the executive

is 3.6, for an index of constraints on the executive that ranges between one and seven. Among

the 20 countries, five are in sub-Saharan Africa. Thus, the results indicate that the efforts

needed in building effective institutions of constraints on the executive are greater for sub-

Saharan African countries.

In this paper, I demonstrated that an appropriate combination of an internal factor (i.e. the

existence in DC of a minimum of effective institutions of constraints on the executive) and an

external factor (FDI flows into DC) could facilitate the reform of property rights institutions

in DC. Further researches are necessary to improve our understanding of the factors or mecha-

nisms that can facilitate property rights institutions reform in DC.

APPENDIX A

LIST OF THE COUNTRIES

The sample of analysis comprises the following countries. Countries marked with one star

are transition countries and those with two stars are emerging countries (FTSE classification).

Albania*, Algeria, Argentina**, Bahamas, Bahrain, Bangladesh, Barbados, Benin, Bolivia,

Botswana, Brazil**, Burundi, Cameroon, Central Africa, Chad, Chile**, China(**)*, Colom-

bia**, Congo Democratic, Congo Republic, Costa Rica, Cote d’Ivoire, Dominican Republic,

Educator, Egypt, El Salvador, Gabon, Ghana, Guatemala, Guinea, Guinea Bissau, Guyana,

Haiti, Honduras, India**, Indonesia**, Iran, Jamaica, Jordan, Kenya, Kuwait, Madagascar,

Malawi, Malaysia**, Mali, Morocco**, Mauritius, Mexico**, Myanmar, Namibia, Nepal, Nic-

aragua, Niger, Nigeria, Pakistan**, Panama, Papua New Guinea, Paraguay, Peru**, Philip-pines**, Romania*, Rwanda, Senegal, Sierra Leone, Singapore**, South Africa**, Sri Lanka,Syria, Tanzania, Thailand**, Togo, Trinidad of Tobago, Tunisia, Turkey**, Uganda, UnitedEmirates, Uruguay, Venezuela, Zambia, Zimbabwe.



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Reforming Property Rights Institutions in Developing Countries: Can FDI Inflows Help?