Foreign Direct Investments and trade in agriculture: an incomplete contracts approach

Some firms invest abroad in land, while other firms procure raw materials from food or energy importing countries by means of an outsourcing arrangement with farmers in land-abundant countries. Few studies have investigated the pattern of recent Foreign Direct Investment (FDI) in agriculture and the ones that have are mostly focused on the locational drivers of FDI. This paper explores how the contractual features of transactions of agricultural products affect the "internalization" decision of firms, that is, the choice trade/FDI. The paper develops a partial equilibrium model incorporating incomplete contracts and asset specificity, which is used to address a number of questions: What is the impact of the quality of the institutions on the choice trade/FDI? How may the bargaining power of the downstream and upstream firms affect the outcome? How is the choice FDI/trade affected by the presence of a state-owned firm? The model provides some unconventional results, such as the finding that when the investor is private, better institutions may lead firms to choose outsourcing, while weak institutions may be a driver of FDI.