Why does a substantial portion of FDI flow into authoritarian regimes despite their weak political institutions? I argue that foreign investors invest in autocracies and democracies in pursuit of different institutional advantages. They invest in some authoritarian countries not despite the lack of credibility, but because of the availability of flexibility. Strong institutions create a credible investment environment that protects property rights better. Weak institutions create a flexible investment environment that provides more preferential treatment and selective protection of property rights. Foreign investors’ preferences toward a more credible or more flexible investment environment depend on their firm-specific features which determine whether their bargaining power diminishes relative to host governments after their investment is made.

I conduct quantitative analyses of the effect of political institutions on both the quantity and the composition of FDI. The results indicate a significant nonlinear relationship between political institutions and FDI in developing countries. Increase in the number of veto players enhances countries’ ability to attract FDI at low level of credibility but decreases countries’ ability to attract FDI when a moderate level of credibility has been attained. In particular, strong institutions tend to attract foreign firms that are engaged in capital-intensive and domestic market-seeking production.

These quantitative findings are buttressed by an extensive case study of China based on fieldwork. I argue that China attracts massive amounts of FDI partly because of the authoritarian system that gave political elites the flexibility and capacity to initiate a set of institutional innovations, notably the special zone policy, to attract FDI. But China’s continuing success in attracting higher quality FDI owes much to the government’s credibility that has been gradually built up in the process of maintaining the special zone policy. At the sub-national level, the effect of special zones depends on how they are implemented by local governments. Local institutional factors including central-local relations, governance structure, and legal environment can explain much of the residual regional variation in FDI beyond the geography and policy effects.

This dissertation helps us understand the varieties of capitalism in developing countries and how the variation in socio-economic institutions may lead to various development patterns and policy outcomes. In particular, it suggests that authoritarian governments have the flexibility to use their discretionary authority to play a “helping hand” to promote economic growth, but whether the policy outcome is developmental or predatory largely depends on the credibility of local policy implementation.