Expropriation of foreign direct investments: Empirical evidence and implications for the debt crisis

Conclusions

The message from the empirical tests is the following. First, we were not able to support the public-interest hypothesis stating that selective expropriations are driven by a national-welfare calculus with costs and benefits directly related to the technological characteristics of foreign firms. Instead, the hypothesis that governments decide on expropriations with regard to their political self-interest seems to be more appropriate. This is true if we look at more widespread expropriations that are unspecific in terms of technological standards (industries). The main factor that drives politically motivated expropriations is the poor overall economic performance of a country, which reinforces earlier findings (e.g., Picht, 1988: 351).

Additional regressions were run for selective expropriations that included political-economy variables. The results were as discouraging as the results for the “pure” public-interest calculus. The only explanation of why overall national welfare considerations as expressed by selective rather than unspecific expropriations are not reflected at all in the empirical results we can think of is that either government illusion about its potential or ignorance prevailed. This does not seem to be totally unrealistic (Tullock, 1986: 9–11) in a world where authoritarian governments are dominant with its extreme form being the dictatorship.¹ In fact, a look at the list of countries covered by this analysis does not leave any doubts in this respect.

Second, these findings suggest also that LDC governments may face difficulties if they try to attract more FDI to compensate for limits encountered with respect to new bank loans. The same reasons that lead creditors to restrict new lending, i.e., poor economic performance (e.g., Nunnenkamp and Picht, 1989; Picht, 1988: 349) may also induce foreign investors to hesitate with new investments. Apparently, firm-specific measures of self-protection (Ehrlich and Becker, 1972) as the use of technologies that increase the cost of expropriation for the host country do not have much impact in realistic settings.

Third, LDC governments must build up a reputation that they do not succumb to the political pressures against foreign investors and lenders in case of sluggish economic performance. Otherwise the access to foreign sources of finance, in particular to loans and foreign direct investments, will be restricted just in times of emerging economic difficulties, i.e., when additional foreign financing is most urgently needed. Thus, arrangements that serve as “institutional collaterals” need to be found that specifically address the government's incentive to expropriate and willfully default when the economic performance is poor. Yet it is much more difficult to imagine how such arrangements may look like if the presumption is that one is dealing, more often than not, with non-democratic, ultimately politically unaccountable regimes. The same difficulty, of course, arises with respect to sovereign borrowing, for which FDI might substitute, where patterns of self-enforcing contracts come to bear (Picht, 1990).

It is interesting to add, fourth, that external shocks, which may eventually lead to real income losses in the future, initially seem to reduce the likelihood of an expropriation. It is perhaps here were expropriation risks differ systematically from default risks, since some empirical evidence is available that suggests that the risk of willful default increases with external strains (e.g., Nunnenkamp and Picht, 1989; Picht, 1988: 349). The difference might be that the change in the expropriation risk follows with some lag to the initial shock. In other words, the variable measuring the external shock might be taken as a leading indicator with respect to the exposure to expropriation risk.

Finally, from all that has been said it may be obvious that the present euphoria with respect to debt-for-equity swaps in LDC financing as a way of converting existing ‘old’ debt into FDIs should be looked at with caution from the sovereign-risk perspective. This aspect has largely been ignored until present.² The reason, of course, is that the international debt crisis was predominantly viewed as either a liquidity or a solvency problem, and not as a matter of government opportunism towards foreign creditors and investors alike.