Growth in the Shadow of Expropriation

Joint with: Manuel Amador

In this paper, we address two questions: (i) Why do developing countries with the highest growth rates export capital; and (ii) Why are some countries unable or unwilling

to pursue the high growth/low debt strategies that has proven successful for many “miracle” economies. The model we study is a small open economy subject to political economy and contracting frictions. The political economy frictions involve polarization and political turnover, while the contracting friction is a lack of commitment

regarding foreign debt and expropriation. We show that the political economy frictions induce growth dynamics in a limited-commitment environment that would otherwise move immediately to the steady state. In particular, greater polarization corresponds to a high tax rate on investment, which declines slowly over time, generating slow convergence to the steady state. Moreover, while political frictions shorten the horizon of the government, the government may still pursue a path of tax rates in which the first best investment is achieved in the long run, although the transition may be slow. The model rationalizes why openness has different implications for growth depending on the political environment, why institutions such as respect for property rights evolve over time, and why open countries that grow rapidly tend to accumulate net foreign assets rather than liabilities.

For more information, contact Harold Cole.