Direct Foreign Investment and Expropriation Incentives: A Mitigating Role for Match-Specific Capital

Abstract

This paper develops a model of direct foreign investment (DFI) in a country where the government cannot commit itself (through institutions or reputational concerns) to refraining from implicit expropriation of sunk investments by transnational enterprises (TNEs). In this situation, when the government lacks the necessary resources to finance the sunk costs of investment, DFI may be possible if there exist contracts under which the investing TNE ends up with a necessary amount of surplus to cover sunk investment. We argue that such contracts may exist if there is the TNE-country match that generates specific rents. The presence of such rents is plausible because TNEs tend to have significant specific, "intangible" assets whose returns may vary across the myriad of country-specific conditions. The model helps explain the presence of uninsured foreign investment in countries with high policy risk. The model also offers predictions about the geographic and sectoral pattern of DFI across countries.

JEL Classification: G31, G38, F21