Expropriation Dynamics

Many emerging market economies oscillate between periods of high and low growth (see Aguiar and Gopinath, 2007). These changes in growth regimes generate business cycles that are markedly different from the ones observed in developed countries: consumption and investment are volatile relative to output, and net exports are strongly counter-cyclical. This volatility is often accompanied by sharp changes in the policy environment as well. For example, figure 1 shows the relationship between two measures of expropriation and political risk and real GDP for Argentina between 1984 and 2007. For easy comparison to the GDP series, the risk factors are inverted so that an increase in the index corresponds to a decrease in risk, and all series are normalized to 100 in 1984.1 The risk factor series are highly correlated with output.2 When GDP is higher than average, the institutions and government policies in Argentina foster growth, as measured by increased political stability, enhanced respect for property rights, and stronger contract enforcement. In Aguiar et al. (forthcoming), we develop a framework to understand these policy reversals and the associated economic volatility. In particular, we explore the joint dynamics of sovereign debt, investment, and expropriation risk in a small open economy model. Our departing point from previous work was the introduction of two political economy frictions. ∗Prepared for the January 2009 AEA Annual Meeting. We thank Thomas Sampson for excellent research assistance. 1The measures of risk are taken from Political Risk Services (PRS). The Expropriation Risk Index is a scaled version of the PRS Investment Profile series, which summarizes the government’s attitude toward inward investment based on four risk factors: expropriation, taxation, repatriation, and labor costs. The Political Risk index assigns risk points to a group of factors, of which, the Investment Profile variable is one. Real GDP is from the World Development Indicators. 2The correlation between the inverse measure of expropriation risk and GDP is 0.68, and the political risk and GDP is 0.71.