Rent seeking, institutions, and commitment: The political economy of foreign investment in the Venezuelan oil industry

How can governments attract foreign investment to high sunk cost industries, which they have expropriated in the recent past? Foreign direct investment in high sunk cost sectors, such as mining and infrastructure, can be a significant source of economic growth in developing countries. The problem is that there are high intrinsic expropriation risks in this type of sector, as revealed by the historical precedent of recurring government reneging. As a result, investors would not deploy their capital unless the government credibly commits to respect their property rights.; The evolution of the oil industry constitutes a prototypical example of the pattern of expropriation in sunken investments. In Venezuela, as in most developing countries, the government repeatedly reneged on investment deals with foreign companies. Despite this antecedent in the 1990's the Venezuelan government successfully opened the oil sector to foreign capital, attracting more than {dollar}15 billion.; The institutional economics literature argues that without credible domestic institutions for protecting property rights (e.g. independent judiciary), either no foreign investment would be obtained or foreign investors would have to be given large short-term rents in compensation for the high expropriation risks. However, in Venezuela the government did not offer investors significant short-term rents despite the inexistence of credible domestic institutions for protecting investors' rights.; This dissertation explores an alternative type of commitment mechanism to attract foreign capital based on external enforcement of the investment deal using offshore assets and future export revenues as hostages . The key feature of this institutional arrangement is that it makes government reneging costly and provides effective third-party external enforcement to the deal.; The analytical framework is based on a simple game-theoretic model around which the political cost-benefit analysis of expropriation is developed. The historical evolution of the institutional framework for enforcement of investment deals in the Venezuela oil industry and its impact over foreign investment is analyzed. Empirical evidence showing the successful attraction of investment and the reduction of investors' perceptions of expropriation risk is evaluated. The external hostage framework offers a variety of potential applications for sovereigns to credibly commit in the absence of domestic sources of enforcement.