In a recent working paper, my co-author Kartikeya Singh and I looked at foreign direct investment (FDI) flows to a sample of 29 developing economies over a period of 20 years (1980-2000). Many of these economies have chosen to adopt the democratic roadmap, not only because they believe that it is the right thing to do, but also in many cases because they believe that it is the right template for economic growth.

Unfortunately, our results suggest that the map may not be so clear-cut. Like the growth literature in economics which suggests a marginally negative effect of democratization on economic growth, our empirical analysis indicates that more democratic countries receive less foreign investment than less democratic countries do.

Democracies try to guarantee political rights and civil liberties, but the provision of economic freedoms is often at odds with these goals.

What could account for this pattern of investment? One major factor is China. In 2006, China received almost 67 percent of all FDI to low income and developing countries. The average FDI flow to China over the entire period of study in our sample was nearly 17 times that of India (14 times after controlling for India’s smaller GDP), and nearly 3 times that of other developing democratic countries like Mexico and Brazil. But even with the exclusion of China, the list of largest recipients includes several countries that have a poor record of upholding democracy, such as Singapore, Indonesia and Malaysia. Why are investors rewarding the “wrong” sort of behavior? Along every social and political dimension that one can think of, for example, Chinese society is repressed and people’s democratic freedoms are constrained. On a scale of 0 to 1, Freedom House has consistently ranked China less than 0.2 every year between 1980 and 2005. The country ranks poorly on both indices of political rights and civil liberties.

So what is China doing right?

Our results suggest that the one dimension along which China is doing relatively well today is in the provision of economic freedoms. China opened up its economy in the 1980s and since then has aggressively attracted FDI by offering low rates of corporate taxation, tax holidays, and secure property rights for foreign investors inside special economic zones.

Along various measures of economic freedom, as compiled by the Fraser Institute’s Economic Freedom of the World Index, China does relatively better than other developing economies. For instance, for the entire period of study, on a scale of 1 to 10 with 10 representing the highest score, China received an average score of 6 for property and legal rights protection, compared to 4.9 for other emerging, developing market economies, which included countries in South America, South Asia, and Africa. This was even higher than the average for all democratic economies in the sample, around five.

Another measure of interest to investors is the corporate tax rate. The Economic Freedom index ranks countries as economically free if they have lower rates of corporate taxes, since high taxation can be viewed as a barrier to the entry of foreign capital. Over the sample period, China has maintained an average statutory corporate tax rate of 30 percent, lower than the average for all other developing economies, including democratic economies. This is even lower than the rate set by the U.S. Of even more significance, foreign firms receive preferential treatment in China, often enjoying an effective tax rate of only 15 percent and being exempt from taxation the first two years of operation.

A more striking example of a country ranking poorly on the democracy index but high on the economic freedom index is Singapore. Over the entire period, Singapore has averaged less than 0.4 out of 1 on the index for political and civil rights, but it scored a high 8 on a scale of 10 on the property rights index, has maintained a low corporate tax rate similar to China’s, and has imposed few restrictions on capital mobility and the trading of goods and services. Singapore has consistently received more than twice the FDI flowing to other developing economies, and nearly 3 times the FDI flows to democratic developing economies.

China taxes corporate earnings—especially those of foreign firms—much more lightly than the U.S.

Why are democracies doing badly? A look at the cases of Brazil, India and Mexico, some of the largest recipients of FDI after China, Hong Kong and Singapore, provides a clue. Between 1980 and 2000, India barely averaged 5 on the property rights index, it has had consistently high rates of corporate taxation which have only now been lowered to 35 percent, and it does poorly on the capital mobility index. Brazil has done relatively well on the property rights index, averaging close to 6 over the entire period, but it has kept corporate taxes high and capital mobility low. Mexico does well with property rights, and in recent times, capital mobility. But it has had high rates of corporate taxation throughout. The provision of economic freedoms thus does not seem to be a priority for these economies. Why is that?

In a democratic country, the system of political participation and representation of interests of multiple parties puts political constraints on governments. These constraints may often prevent governments from pursuing the kind (or keeping the pace) of economic liberalization that they may want, since they have to balance the interests of the majority while pushing ahead with any major reform.

For instance, in India, foreign capital is still viewed among certain sections as being antagonistic to the interests of the poor. The process of opening up sectors to foreign investment has therefore been very gradual and successive governments have had to appease the working classes and the farmers in order to move the process forward. In countries that have pushed through reforms, economic crises have often led to a reversal of liberalization. For instance, in the early 1990s, Argentina went in for wholesale privatization and a peso peg to the dollar, reversing decades of state intervention. International capital was allowed to flow in freely. But by the late 1990s, the building up of foreign debt and the South East Asian crisis plunged the economy into a recession and foreign investment dried up. This led to massive protests by the working classes and caused the government to revert to intervention and protectionism. Another example is Ecuador, where in 1993-1994 there were major protests against the privatization of power, not only by the labor unions and working classes, but also by the army who objected to the sell-off on grounds of national security. Hence governments obviously face a more complex task in countries where people enjoy the right to be heard.

Democracies try to guarantee political rights and civil liberties, but the provision of economic freedoms is often at odds with these goals. The successful resolution of these conflicts rather than their suppression, are milestones towards becoming a mature, economically and politically free democracy. The example of China, on the other hand, shows that the provision of economic freedoms may often come at the cost of political and human rights and the expression of public opinion.

Iran may choose the economic model offered by China. But at the heart of every economic model is the ability of economic agents to make rational and free choices, a right that China is unwilling to provide. I doubt that the internal tensions present in this model will allow it to survive.

Aparna Mathur is a research fellow at the American Enterprise Institute.