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Regime changes and FDI: A tale of two countries

In the wake of recent political shifts, democratic institutions are being eroded, giving way to a consolidation of governmental power through autocratic means. This column highlights the effects of the up-and-down transformations in the liberal characteristics of a regime on foreign direct investors, comparing the experiences of Poland and Israel. Liberalisation significantly enhanced both countries’ attractiveness to foreign investors, but recent illiberal policies have led to a decline in foreign venture capital inflows. Changes in the liberal characteristics of regimes can have profound effects on foreign direct investors.

In the wake of recent political shifts, democratic institutions are being eroded, giving way to a consolidation of governmental power through autocratic means and thereby weakening minority rights, including foreign investor rights.

Acemoglu et al. (2019) argue that a judicial overhaul that undermines the liberal legal system weakens the protection of investors’ rights and triggers corruption. The latter encourages businesses to divert economic resources to ‘integrate’ into the corrupt system, instead of directing their efforts to productive activities. In his contribution to a recent CEPR eBook on the transition to illiberal democracy (Razin et al. 2024), Eichengreen observes that democratisation and economic growth are positively correlated but that correlation does not necessarily indicate causality or direction: the relationship between the various measures of democracy and economic growth is ambiguous (Eichengreen 2024). In contrast, the relationship between measures of judicial independence and economic growth is clearer. His survey of the literature finds a strong, positive, and highly significant effect of de facto judicial independence on economic growth, both when levels of growth and judicial independence are considered, and when the effects of changes in the level of judicial independence are the focus.

There is robust evidence that foreign direct investment (FDI) is a significant driver of growth in an open economy. As foreigners, investors, like any minority, are the first targets of protective national policies of the illiberal regime. Foreign direct investors are excessively sensitive to changes in the judicial-regulatory-tax regime and the liberal characteristics of the regime. 1   Multinational enterprises are the main vehicle of FDI, which has been assuming an increasingly pivotal role. Historically, the bulk of FDI has been concentrated in highly developed countries, predominantly targeting human capital-intensive industries within the services sector.

For economies such as the former communist countries of Europe, the FDI surge can be attributed to the liberalisation and internationalisation of these economies, coupled with substantial reductions in transportation costs, communication costs, and the costs associated with cross-border business operations.

In this column, we explore regime changes in Poland and Israel and their impacts on developments in the two countries and on their attractiveness for FDI. We start by describing Poland’s emergence since the early 1990s as a globalised economy and the turning point towards illiberal democracy in the last decade and a half, and discuss the role of multinational enterprises. The next section traces Israel’s ascendance to a high-tech economy and its attractiveness to foreign investors, followed by a section focusing on foreign venture capital in Israel. We then infer common patterns.

Poland’s liberalisation and FDI

Poland’s economic liberalisation in the 1990s was marked by a series of radical reforms designed to transition the country from a centrally planned economy to a market-oriented one.

However, the Law and Justice Party (PiS) introduced a radical regime change:

  • Judicial reforms: The government enacted laws that increased political control over the judiciary, undermining judicial independence.
  • Media control: State influence over public media increased, leading to concerns about press freedom and biased reporting.
  • Constitutional changes: Attempts to alter the Constitution and other legislative measures weakened checks and balances.
  • Centralisation of power: The government centralised power, reducing the autonomy of local governments and other institutions.

The illiberal policies under the PiS regime had mixed effects on FDI. While Poland remained an attractive destination for investors due to its economic fundamentals, the political instability and legal uncertainties posed challenges. Specific impacts included:

  • Investor confidence: Concerns about the rule of law and property rights affected investor confidence. Unpredictable regulatory changes made the investment climate less certain.
  • EU relations: Strained relations with the EU, due to issues like rule-of-law disputes, led to potential funding cuts and increased scrutiny of Poland’s compliance with EU standards.
  • Economic resilience: Despite these challenges, Poland’s strong economic performance and strategic advantages continued to attract FDI, though the growth rate was potentially tempered by the political environment.

Figure 1 illustrates the development of Poland’s FDI inflows as a percentage of GDP from 2005 to 2012, compared to OECD inflows. The figure shows that Poland was catching up with OECD countries until 2015, before experiencing a decline in FDI inflows relative to OECD countries following a regime change.

Figure 1 Foreign direct investment: Poland and OECD countries (% of GDP)

Figure 1 Foreign direct investment: Poland and OECD countries
Figure 1 Foreign direct investment: Poland and OECD countries
Source: UNCTAD

Multinational enterprises in Poland

In the subsequent decade, the number of foreign capital companies began to systematically decline. This decline is attributed to worsening global macroeconomic conditions and the instability of Poland’s legal environment, which was a consequence of the illiberal institutional changes initiated by the populist government. The change over time in the number of companies operating in Poland with foreign capital participation since the mid-1980s is illustrated in Figure 2. It broadly describes the ascent of FDI following 2015, and on.

Figure 2 The number of firms with foreign capital in Poland, 1985–2022

Figure 2 The number of firms with foreign capital in Poland, 1985–2022
Figure 2 The number of firms with foreign capital in Poland, 1985–2022
Source: Statistics Poland.

Changes in the distribution of companies with foreign capital by percentage share of foreign capital in 1993–2022 are presented in Figure 3.

Figure 3 Forms of ownership of companies with foreign capital participation in Poland, 1993–2022

Figure 3 Forms of ownership of companies with foreign capital participation in Poland, 1993–2022
Figure 3 Forms of ownership of companies with foreign capital participation in Poland, 1993–2022
Source: Statistics Poland

Israel’s hi-tech surge

Israel is the most tech-dependent economy in the world, with 13% of the country’s GDP and 31% of all exports originating in the high-tech sector. The global high-tech slowdown has therefore hit Israel harder than other advanced economies. Pointedly, the domestic legal system is key to entrepreneurship, innovation, and the securing of steady flows of venture capital to finance such endeavours (Razin 2018).

In recent decades, foreign capital in the form of FDI, including venture capital, has provided crucial funding for investment in Israel’s showcase technology sector. Until the proposed judicial overhaul in January 2023, Israel had been solidly established as a high-tech powerhouse – a place where budding venture capitalists from developed countries flocked to learn how to develop an innovation ecosystem (see Loungani and Razin 2001 and Razin 2018 on the role of FDI and venture capital in promoting the hi-tech sector). Israel pulled in the fourth highest level of FDI in relation to the size of its economy: its FDI comprises about 4% of GDP, well above the OECD average of 1.4%. Israel’s inward FDI flows accelerated in the 1990s and 2000s, and the country’s venture capital development exhibited a remarkable increase as a proportion of total inward FDI, demonstrating the sharp increase in funding to high-tech startups.

 Foreign venture capital has been crucial to the rise of Israel’s high-tech sector to an elite position in the world economy: Israel’s domestic market alone is far too small, with its homegrown capital formation being inadequate to foster innovation.

Figure 4 demonstrates the attractiveness of Israel to foreign direct investors, compared with other developed economies. FDI, in the form of venture capital in the initial phase of a startup and foreign acquisition of the developed innovation, has been essential.

Figure 4 Foreign direct investment: Inward FDI flows, annual, 1980–2014

(a) Percentage of GDP

Figure 4a
Figure 4a

(b) Percentage of gross fixed capital formation

Figure 4b
Figure 4b

Israel’s foreign venture capital

Foreign venture capital firms bring more than just capital; they bring valuable mentorship, strategic guidance, and global networks – resources that help Israeli startups navigate the complexities of scaling their businesses and accessing new markets. Furthermore, the presence of high-profile international investors often serves as a validation of a startup’s potential, attracting additional investment and talent.

Several factors make Israel an attractive destination for foreign venture capital. First, Israel boasts a high concentration of tech talent, particularly in cybersecurity, biotechnology, and artificial intelligence. This talent pool is supported by world-class universities and a culture of innovation fostered by mandatory military service, which often involves technical training and problem-solving skills. Second, Israel’s robust legal framework, which protects intellectual property and encourages entrepreneurship, further enhances its appeal to foreign investors.

In 2023 there were illiberal changes on the way. Figure 5 illustrates the surge in FDI and venture capital investment in the 1990s up to 2002. A sharp drop in FDI inflows in Figure 4 shows the effect of Israel’s 2023 judicial reform: following the January 2023 announcement of the judicial overhaul, inward FDI dropped sharply from $23,029 to $16,423, a drop of 29% for the full year.

Figure 5 FDI in Israel between 2007–2023: Inflows and outflows (US$ billions)

Figure 5 FDI in Israel between 2007–2023: Inflows and outflows
Figure 5 FDI in Israel between 2007–2023: Inflows and outflows
Note: This figure demonstrates the large drop in Israel’s FDI inflows after the 2023 judicial reform. Source: Bank of Israel and UNCTAD.

While part of the drop in FDI is attributable to the global recession in high-tech industries, in Figure 6 we compare the changes of the exchange-traded fund that tracks the Nasdaq 100 index (abundant with high-tech companies) to the funding amounts for Israeli tech on a monthly scale and see that both bottomed out at the end of 2022 and then started moving up towards the beginning of 2023 when the Israeli government announced its judicial regime-change programme. The exchange-traded fund shows a much quicker and larger surge than Israeli tech funding.

Figure 6 Nasdaq 100 vs Israeli funding amounts, 2018 to H1/2023, monthly scale (US$ million)

Figure 6 Nasdaq 100 vs Israeli funding amounts, 2018 to H1/2023
Figure 6 Nasdaq 100 vs Israeli funding amounts, 2018 to H1/2023
Source: Israel’s Venture Capital (IVC).

Common patterns

The liberalisation of the Polish economy and the successful implementation of market reforms in the late 1980s and early 1990s significantly enhanced Poland’s attractiveness as a destination for international companies. In 1991, legislation regulating the establishment and operation of companies with foreign capital was liberalised, forming a foundation for foreign business activities that remains relevant today, despite subsequent amendments. However, recent illiberal policies under the PiS regime, which altered minority rights and favoured domestic companies, have diminished Poland’s appeal to foreign investors.

Innovation requires scale, and scale necessitates trade. A small, isolated economy cannot serve as a hub of innovation. Entrepreneurs’ incentives to invest in creating valuable services are linked to their ability to leverage the resulting knowledge repeatedly, on a large scale, and over an extended period. FDI is crucial in facilitating economies of scale, enabling the transition from precarious innovation stages within a small economy to effective execution by accessing global markets. Additionally, the innovation sector in small, open economies often relies on suitable financial support, such as venture capital, which frequently originates from abroad.

Israel, starting in the 1990s and all through the 2010s, witnessed an increase in immigration, which elevated the workforce’s skill level, education, and human capital stock, along with a global information technology surge. This period saw unprecedented growth in Israel’s high-tech sector. Over the past three decades, the increasing globalisation of the Israeli economy has been vital for the development and prosperity of its nascent high-tech industry.

However, Israel’s growth trajectory has been significantly disrupted by recent illiberal regime changes. As a result, foreign venture capital inflows have dramatically declined.


This column underscores the significant common patterns in the effects of FDI under liberal versus illiberal regime changes by examining the experiences of Poland and Israel, two dissimilar open economies. The liberalisation of the Polish economy and market reforms in the late 1980s and early 1990s significantly enhanced Poland’s attractiveness to international companies. However, recent illiberal policies under the PiS regime have diminished Poland’s appeal to foreign investors. Similarly, Israel’s high-tech sector experienced substantial growth from the 1990s to the 2010s, driven by factors such as immigration, workforce skill enhancement, education, liberalisation of capital and finance flows, and the global IT boom. Globalisation played a crucial role in the development of Israel’s high-tech industry. However, recent shifts towards illiberal policies have disrupted Israel’s growth, leading to a sharp decline in foreign venture capital inflows. This analysis highlights the profound impact that changes in the liberal characteristics of regimes have on foreign direct investors.

Source : VOXeu



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