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 increasingly restrict foreign investment, arguing that foreign participation in sensitive industries can threaten national security. We develop a dynamic model of how a host government should manage exposure to foreign firms under geopolitical uncertainty. The government benefits economically from foreign investment but faces the risk that some firms are covertly adversarial and may build capacity—through data access, supply-chain dependence, or similar channels—to inflict harm, such as espionage or economic disruption, if relations with the firm’s home country become hostile. We characterize the government’s optimal access policy, accounting for the adversarial firm’s strategic incentives to build capacity. When geopolitical relations are initially peaceful but may later turn hostile, optimal exposure is U-shaped over time: the government initially grants high access, reduces it as the period of potential hostility approaches, and raises it again if hostility does not occur. This pattern contrasts with the seemingly intuitive policy of restricting access initially and relaxing restrictions after a probationary period. We show that such a probationary policy is instead optimal when the government expects geopolitical relations to potentially turn hostile in the immediate future.

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.