Mode of International Investment and Endogenous Risk of Expropriation

This paper analyzes the relationship between the mode of international investment and institutional quality. Foreign investors from a capital-rich North can either purchase productive assets in a capital-poor South and transfer their capital within integrated multinational firms or they can form joint ventures with local asset owners. The South is ruled by an autocratic elite that may use its political power to expropriate productive assets. The expropriation risk lowers the incentive to provide specific capital in an integrated firm and distorts the decision between joint ventures and integrated production. We determine the equilibrium risk of expropriation in this framework and the resulting pattern of international production. We also analyze as to how globalization, which is reflected in a decline in investment costs, influences institutional quality.