Sovereign Risk, FDI Spillovers, and Growth

Lilia Maliar, Serguei Maliar and Fidel Pérez Sebastián

Review of International Economics, 2008, vol. 16, issue 3, pages 463-477

Abstract: This paper studies the effect of sovereign risk on capital flows from rich to poor nations in the context of a two-country model, where Foreign Direct Investment (FDI) creates positive externalities in domestic production. We show that if externalities are large, a developing country never expropriates foreign assets, and behaves as under perfect enforcement of foreigners' property rights, jumping to the steady state in one period. If externalities are absent, a developing country always expropriates foreign assets and, then, there are no capital flows in equilibrium, as occurs in autarky. If externalities are of a medium size, our model can account for scarce capital flows from rich to poor nations, as well as other key features of the data, such as rising-over-time patterns of foreign capital and FDI in developing countries. In addition, the model offers an economic rationale for the FDI restrictions observed across nations. Copyright © 2008 The Authors. Journal compilation © 2008 Blackwell Publishing Ltd.

Date: 2008

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