The Politics of FDI Expropriation
25 Pages Posted: 31 Jan 2016
Date Written: January 29, 2016
This paper documents that countries with low political turnover exhibit larger inflows of foreign direct investment. This correlation is rationalized with a model of redistribution, where policymakers have access to an expropriation technology that can be used to extract resources from foreign investors. The amount collected can be transferred to a specific group of people or region in the country. Different groups compete to gain control of this instrument, and face a probability of losing the power at each point in time. Since the economy has an infinite horizon, it is not optimal for any group to extract all the investment made by foreign firms, because this would reduce future investment and hence the possibility of extracting resources in the future. The greater the government instability or political turnover, the stronger the incentives to expropriate when in power. A key force driving this result is the redistributive uncertainty, since there is a possibility that no transfers will be received in the future. The mechanism is supported by the finding that investment risk (a measure that captures the degree at which the extraction technology is used) is negatively related to FDI and government stability.
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