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Investment with insecure property rights: Capital outflow openness under dictatorship

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Abstract

Governments have two mechanisms through which to secure the rights of investors: protecting property rights and allowing capital mobility. This article develops a formal theoretic framework that demonstrates how dictators use capital outflow openness as a substitute for poor property rights protection to attract more investment. They do so for two related reasons. First, more capital outflow openness increases the pool of capital dictators can expropriate from. Second, more capital outflow openness increases domestic wages, preventing working class revolts. When the working class is not too strong, the dictator would be able to retain workers’ support by relying on capital outflow openness alone. However, when the working class is strong, the dictator would be forced to improve property rights protection to prevent a working class revolt, constraining the dictator’s ability to expropriate in the future.

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Notes

  1. “Paris begins investigation into Ben Ali’s assets”, RFI (Internet ed.), 24 January 2011.

  2. Note that, because the working class revolt destroys all of the existing onshore capital, the investors will have no onshore capital if a revolt occurs, i.e., Kin,0 = 0.

  3. We can think of the payoffs in the second period as the present value of the expected future payoffs when the game has infinite periods.

  4. Note that the corner solution is primarily due to the Cobb-Douglas production function, which is the standard form of production function used in the literature. To see that a general expropriation function cannot avoid corner solutions, suppose we now use the general functional form f(η; 𝜃t), then the cases that correspond to the original cases in the paper would become the following:

    • η > α becomes f(η; 0) > 2α, in which case the dictator’s rent-maximizing level of capital outflow openness is still 0;

    • η ∈ [2α − 1,α] becomes f(η; 0) ∈ [2α − 1, 2α], in which case the dictator’s rent-maximizing level of capital outflow openness is defined implicitly: f(η; 𝜃) = 2α − f(η; 0);

    • η < 2α − 1 becomes f(η; 0) < 2α − 1, in which case the dictator’s rent-maximizing level of capital outflow openness is still 1.

    Thus, a general expropriation function unfortunately cannot avoid corner solutions.

  5. “Foreign Companies Face New Clampdown for Getting Money Out of China”, YaleGlobal Online, December 8 2016.

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Acknowledgements

I thank Randall Stone, Jack Paine, Sandro Brusco, Amy Pond, Brenton Kenkel, Robert Gulotty, and Arthur Silve for valuable comments on the paper.

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  1. Department of Political Science, University of Rochester, 280 Hutchison Road, Rochester, NY, 14620, USA

    Jacque Gao

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Gao, J. Investment with insecure property rights: Capital outflow openness under dictatorship. Rev Int Organ 17, 569–595 (2022). https://doi.org/10.1007/s11558-021-09444-y

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