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Economic Quarterly

Summer 2007

Barriers to Foreign Direct Investment Under Political Instability

Marina Azzimonti and Pierre-Daniel G. Sarte

In this article, we describe some stylized facts about expropriation of Foreign Direct Investment (FDI) and develop a theory that relates direct and indirect forms of expropriation to the degree of political instability (the frequency at which groups alternate in power) and concentration of power (the number of powerful groups affecting policy). Lack of commitment of a government that cannot write binding contracts with multinational corporations, together with the existence of redistributive uncertainty of the amount expropriated, result in excessive expropriation. We find that, consistent with empirical work, countries that are politically stable attract more FDI because foreign investors expect lower expropriation rates. Interestingly, this result holds as long as power is concentrated between a few number of influential groups.

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