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Foreign Direcyt Investment and the Risk of Expropriation

When an investor, for example a transnational corporation, invests abroad it runs the risk that its investment will be expropriated for the simple reason that international contracts are practically impossible to enforce. Any agreements or contracts then undertaken by the transnational company and the host country must be designed to be self-enforcing. It could be possible for the host country and the transnational corporation to find such self-enforcing agreements if there are future gains from trade. Thus although the host country might have a short-term incentive to expropriate, it has a long-term incentive to foster good relations with potential investors to attract more investment in the future. This conflict between short-term and long-term incentives determines the type of investment contracts agreed. This paper extends previous work on the general underprovision of investment when contracts are incomplete or only partially enforceable (see e.g. Grout (1984)) to a dynamic context. It is likewise shown that investment is initially underprovided but it increases over time and for certain parameter values it tends to the efficient level. The expected future discounted returns to the transnational company decline over time, extending Vernon's observation of the obsolescing bargain (Vernon (1971)). The model is also extended to allow for capital accumulation and consideration is given to renegotiation-proof contracts.

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Paper provided by Tilburg - Center for Economic Research in its series Papers with number 9126.

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Length: 35 pages
Date of creation: 1991
Date of revision:
Handle: RePEc:fth:tilbur:9126
Contact details of provider: Postal:
TILBURG UNIVERSITY, CENTER FOR ECONOMIC RESEARCH, 5000 LE TILBURG THE NETHERLANDS.

Phone: 31 13 4663050
Fax: 31 13 4663066
Web page: http://center.uvt.nl/
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  1. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  2. Jeremy I. Bulow & Kenneth Rogoff, 1988. "Sovereign Debt: Is To Forgive To Forget?," NBER Working Papers 2623, National Bureau of Economic Research, Inc.
  3. Kobrin, Stephen J., 1980. "Foreign enterprise and forced divestment in LDCs," International Organization, Cambridge University Press, vol. 34(01), pages 65-88, December.
  4. Abreu, Dilip & Pearce, David & Stacchetti, Ennio, 1986. "Optimal cartel equilibria with imperfect monitoring," Journal of Economic Theory, Elsevier, vol. 39(1), pages 251-269, June.
  5. Long, Ngo Van, 1975. "Resource extraction under the uncertainty about possible nationalization," Journal of Economic Theory, Elsevier, vol. 10(1), pages 42-53, February.
  6. Asheim, G.B. & Strand, J., 1989. "Long-Term Union-Firm Contracts," Memorandum 08/1989, Oslo University, Department of Economics.
  7. Farrell, Joseph & Maskin, Eric, 1989. "Renegotiation in repeated games," Games and Economic Behavior, Elsevier, vol. 1(4), pages 327-360, December.
  8. Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, vol. 56(5), pages 1153-75, September.
  9. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  10. Kobrin, Stephen J., 1987. "Testing the bargaining hypothesis in the manufacturing sector in developing countries," International Organization, Cambridge University Press, vol. 41(04), pages 609-638, September.
  11. Hart, Oliver D & Moore, John, 1988. "Incomplete Contracts and Renegotiation," Econometrica, Econometric Society, vol. 56(4), pages 755-85, July.
  12. Jean Tirole, 1985. "Procurement and Renegotiation," Working papers 362, Massachusetts Institute of Technology (MIT), Department of Economics.
  13. Jonathan Eaton & Mark Gersovitz, 1982. "A Theory of Expropriation and Deviations From Perfect Capital Mobility," NBER Working Papers 0972, National Bureau of Economic Research, Inc.
  14. Williams, M L, 1975. "The Extent and Significance of the Nationalization of Foreign-owned Assets in Developing Countries, 1956-1972," Oxford Economic Papers, Oxford University Press, vol. 27(2), pages 260-73, July.
  15. Crawford, Vincent P, 1988. "Long-term Relationships Governed by Short-term Contracts," American Economic Review, American Economic Association, vol. 78(3), pages 485-99, June.
  16. Chris Doyle & Sweder Wijnbergen, 1994. "Taxation of foreign multinationals: A sequential bargaining approach to tax holidays," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 1(3), pages 211-225, October.
  17. Jonathan Thomas & Tim Worrall, 1988. "Self-Enforcing Wage Contracts," Review of Economic Studies, Oxford University Press, vol. 55(4), pages 541-554.
  18. Bond, Eric W & Samuelson, Larry, 1986. "Tax Holidays as Signals," American Economic Review, American Economic Association, vol. 76(4), pages 820-26, September.
  19. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, vol. 52(2), pages 449-60, March.
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