Inequality, Institutions, and the Risks to Foreign Investment

Income inequality is frequently given a central role in explaining diverse political outcomes, but the specifics of how, when, and under what circumstances inequality really matters are far from clear. This paper addresses these questions by examining whether greater levels of inequality raise the risk of expropriation associated with foreign investment. The results demonstrate that inequality matters in two distinct ways. First, inequality elevates risk, although consistent with the argument developed herein, the effect is strongest when chief executives face high constraints on their decision making. Second, inequality mitigates the otherwise protective influence of political institutions on the risk of expropriation. The findings are robust across a variety of estimation strategies, including instrumental variable procedures that correct for error in the measurement of inequality. The findings provide new insights regarding the determinants of foreign investment while simultaneously resolving one part of the contested literature describing inequality's role in the political economy of development.