Research

Political risk and coordination failure are major barriers to investment and growth in developing countries. We show that political risk can itself induce coordination failure and propose a subsidy scheme to mitigate miscoordination. The program guarantees investors a minimum return while clawing back returns above a threshold. By leveraging strategic complementarities, the clawback screens out investors who would have invested absent subsidies, while the guarantee attracts those deterred by political risk and strategic uncertainty. Program costs per unit of capital are single-peaked in available capital for investment, implying economies of scale in subsidy programs.

Governments are increasingly restricting foreign investments on “national security” grounds, yet we lack a clear framework for how governments manage their exposure to foreign firms when geopolitical conditions can deteriorate abruptly. This paper develops a dynamic model in which a host government values foreign investment, because it raises economic output, but also faces the risk that some firms are strategic: during “peace,” a strategic firm can quietly build latent capabilities (e.g., data access, supply-chain dependence) that becomes harmful if relations turn hostile. A geopolitical shock can trigger hostility, so policy must balance the economic gains from greater exposure to foreign firms against the possibility of future weaponization. I characterize the government’s optimal exposure path and the firm’s incentives to build capabilities, and show why governments may restrict access to foreign firms even before hostility arrives. In particular, the equilibrium exposure path features a distinctive bang-bang segment in which the government cuts access back down to the minimum for a period even before hostility arrives. Lowering access slows the buildup of strategic firm’s capacity and leaves the government in a better position if relations turn hostile.

This paper studies dynamic screening when a bad agent chooses how harmful to become before the relationship begins. A higher harm level makes future undermining more valuable, but also increases the probability of detection during pre-relationship vetting. Conditional on no warning signal during vetting, the principal is uncertain about both the agent’s loyalty and the damage potential of a disloyal agent. I first characterize the optimal contract offered by the principal for an arbitrary distribution over harm levels. With a continuum of harm levels, the optimal stakes path is given by a screening rule summarized by a moving cutoff: lower-harm bad agents are induced to undermine earlier, while higher-harm bad agents wait until stakes are higher. I then solve the full game in which the bad agent’s harm choice generates the posterior screened by the principal. In equilibrium, the bad agent mixes over harm levels, placing an atom at the lowest on-path harm level and spreading remaining probability mass over higher levels uniformly. The principal’s optimal contract screens this distribution over harm levels in an increasing order.

Why do governments adopt investment screening mechanisms? This paper distinguishes three possible reasons: economic protectionism, sectoral security, and rivalry-based security. The key challenge is that each logic can produce similar aggregate outcomes making it difficult to infer the motives driving the adoption of such regulations. I use evidence from the Foreign Investment Risk Review Modernization Act (FIRRMA) of 2018 to address this question. Using deal-level data on acquisitions of U.S. firms by foreign acquirors, I show that Chinese acquisitions decline, relative to acquisitions by other foreign firms, after FIRRMA, and this relative decline is concentrated most clearly in data/network/surveillance sectors, with additional evidence for critical infrastructure on the count margin. Event-study estimates show that the decline in these sectors is connected to the adoption of the screening regulations. The evidence provides limited support for economic-protectionist or broad sectoral-security explanations. It is more consistent with a rivalry-based logic in which screening effectively blocks acquisitions when rival-country acquirors target sectors where ownership can grant access, surveillance capacity, disruption risk, or future leverage.

To what extent does global economic exchange deter conflict between countries? This paper re-examines the pacifying effect of economic ties by examining investment behavior in the presence of geopolitical risks. While investments can deter conflict by raising its opportunity cost, the risk of war also affects firms’ willingness to invest. The central finding is that deterrence depends not on the total volume of investment but on how capital is distributed across firms. When capital is concentrated in a few large investors, an individual commitment can be pivotal in tipping a government toward peace. By contrast, when the same amount of capital is dispersed across many smaller firms, individual contributions have negligible influence on government decision. In both cases, firms must coordinate to deter conflict, but the coordination problem increases greatly when capital is dispersed across many investors, limiting the pacifying effect of investments.