Does Foreign Aid Mitigate the Adverse Effect of Expropriation Risk on Foreign Direct Investment?

Abstract

We construct a model of FDI, risk and aid, where a country loses access to FDI and aid if the country expropriates FDI. We show that: (i) The threat of expropri- ation leads to under-investment; (ii) The optimal level of FDI decreases as the risk of expropriation rises; and (iii) Under certain conditions, aid mitigates the adverse e¤ect of expropriation risk on FDI. The empirical analysis employs data for 35 low- income countries and 28 countries in Sub-Saharan Africa, over the period 1983-2004. We ?nd that risk has a negative e¤ect on FDI, aid mitigates the adverse effect of risk on FDI, and that bilateral and multilateral aid are roughly equivalent at achieving these results. We also provide an estimate of the level of aid that would eliminate expropriation risk, and ?nd that for low-income countries, the amount of aid would need to at least double in order for aid to completely offset the effect of risk.Expropriation, Foreign Aid, FDI, Risk, Sub-Saharan Africa.