But Most of All We Love Each Other: Does Social Cohesion Pay off? Evidence from FDI Flows to Middle Income Countries

The World Bank (2013) argues that social cohesion shapes the context in which entrepreneurs make investment decisions and therefore job creation. In this paper, we focus on FDI as one link of primary importance in this argument, and empirically examine the relationship between social cohesion and FDI flows. Using panel data on 52 middle income countries for the period 1984-2012, we first identify social cohesion-related institutions using principal component analysis and then examine the influence of those institutions individually and as a principal component on FDI flows. PCA identifies religion in politics, internal and external conflicts, and ethnic tensions as institutions with highest loadings. Adopting dynamic panel estimation methodologies - FE, IV and system GMM, the paper finds that religion in politics stands out with its positive influence on FDI inflows. A one percentage point improvement in religion in politics increases FDI flows by about 0.5 percentage point. The positive influence is robust to the estimation methodology adopted and to the sample size. The novelty of the paper lies first in identifying social cohesion-related institutions and principal component and second in discovering the positive influence of less religion in politics on FDI flows to middle income countries.