Board of Governors of the Federal Reserve System

August 2013

Policy Uncertainty, Irreversibility, and Cross-Border Flows of Capital

Brandon Julio and Youngsuk Yook

Abstract:

We examine the effects of government policy uncertainty on cross-border capital flows. FDI flows from US companies to foreign affiliates drop significantly during the period just before an election. The election effect for FDI is larger than election cycles in domestic investment. The electoral patterns in FDI flows are more pronounced in countries with higher propensities for policy reversals and when election outcomes are more uncertain. Our identification strategy compares variation in different types of capital flows into the same country around the timing of national elections. The electoral cycles are present in relatively irreversible FDI flows but not in foreign portfolio investment flows, suggesting a likely causal link from political uncertainty to and capital flows.

Keywords: Foreign direct investment, political uncertainty

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