Democratization and FDI dynamics: Counterfactual evidence from Indonesia

Kapás, Botond (2026) Democratization and FDI dynamics: Counterfactual evidence from Indonesia. ACTA OECONOMICA, 76 (2). pp. 214-252. ISSN 0001-6373

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Abstract

This paper examines how a discrete transition from autocracy to democracy affects FDI inflows, shifting the focus from cross-country average marginal effects to within-country dynamic adjustment. Using Indonesia's 1998 democratic transition as a case study, the analysis applies low-rank panel methods – matrix completion and interactive fixed effects counterfactual estimator – to construct a counterfactual trajectory of FDI inflows under continued autocracy. The results reveal a pronounced and economically large decline in FDI inflows relative to the counterfactual in the immediate post-transition period. This negative treatment effect diminishes over time, with observed FDI inflows converging toward the counterfactual path in the long run. However, no sustained democratic premium is observed within the sample period. These findings suggest that the impact of democratization on FDI inflows in Indonesia follows a time-dependent adjustment pattern, consistent with the cross-country trajectory identified by Lacroix et al. (2021), rather than reflecting a uniform effect. A range of robustness checks supports the stability of the findings, including placebo-in-time and equivalence tests, alternative treatment timings, donor pool sensitivity analyses, and variations in the pretreatment period. © 2026 The Author(s). Open Access statement. This is an open-access article distributed under the terms of the Creative Commons Attribution 4.0 International License ( https://creativecommons.org/licenses/by/4.0/ ), which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited, a link to the CC License is provided, and changes – if any – are indicated. (SID_1)

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