FOREIGN DIRECT 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. The host country although it might have a short-term incentive to expropriate has a long-term incentive to foster good relations to attract more investment in the future. This conflict between short-term and long-term incentives determines the type of contracts agreed by transnational corporations and host countries. In a model of the manufacturing industry with a continuous flow of investment it is shown that investment is initially underprovided, increases over time, tending, for certain parameter values, to the efficient level