Foreign investment and expropriation under oligarchy and democracy

Abstract

We study the incentives to expropriate foreign capital under democracy and oligarchy. We model a two-sector small open economy where foreign investment triggers Stolper-Samuelson effects through reducing exporting costs. The incentives to expropriate depend on the distributional effects associated to the investment. How investment affects the incomes of the different groups in society depends on the sectors where these investments are undertaken and on structural features of the economy such as factor intensity, factor substitutability, and price and output elasticities. We characterize the equilibria of the expropriation game and show that if investment is undertaken in the sector that uses labor less intensively then democratic expropriations are more likely to take place. We test this prediction and provide strong evidence of its validity.