Legal systems as a determinant of foreign direct investment : the case of Sri Lanka.
Foreign direct investment (FDI) is widely considered to be an essential source of capital for
developing countries. A broad consensus is developing amongst academics, multilateral
development organisations and bilateral aid donors that a states' legal system is an
important factor affecting the location of FDI; that predictable and efficient legal systems
are the most effective in attracting FDI; and that efficiency and predictability are best
achieved by adopting a Western- style legal system (Ideal Paradigm).
A case study is presented of foreign investment in Sri Lanka, which is reforming its legal
system to attract FDI. Interviews with the wider community, and a survey of foreign
investors are used to test (1) whether the legal system is a factor in investment decisions in
Sri Lanka, and (2) whether investors react negatively to a legal system which is not of the
The research findings indicate that, in the case of Sri Lanka, the legal system is probably
not a factor in the investment decisions of many investors in the sample, and many
investors generally; that most investors do not react negatively to legal systems which are
not- of the Ideal Paradigm;-and that the role-of the legal-system as -a-determinant of FDI
may be affected by investors' characteristics, such as their size or nationality.
It is concluded that current legal reform recommendations may be flawed, in that they
reflect misconceptions about foreign investors' expectations of host state legal systems.
These misunderstandings may result from a lack of research, and an excessive emphasis
upon an international liberal economic agenda. A better understanding of the expectations
of different types of investors is required if the costs of legal reform are to be rewarded
with adequate benefits.