FDI and coups

Transcription

1 Investing In Violence: Foreign Direct Investment and Coups Andrey Tomashevskiy February 28, Introduction Foreign Direct Investment (FDI) is a topic that has received wide attention from both economists and political scientists. While a significant amount of research has been produced on the determinants of FDI, very little research has been conducted on the effects of FDI. In this paper, I seek to address this lacuna in research by examining the effects of FDI on an important aspect of domestic politics, coups. A fashionable topic of research in the past, the study of coups has fallen off in the past years. Although a lack of interest in this topic would seem to be explained by the decreased prevalence of coups since the end of the Cold War, coups continue to occur with regularity, with recent coups taking place in Thailand in 2006, Honduras in 2009 and Niger in The possibility of coups continues to play an important role for many states in the developing world and is a subject worthy of renewed and continued study. Although a number of studies have used global data on coups to contribute to our understanding regarding the determinants of coups (Londregan and Poole, 1990; Galetovic and Sanhueza, 2000; Belkin and Schofer, 2003), there still remain questions regarding the impact of international economic factors on domestic events such as coups. 1

2 The influx of international capital into a state can have profound effects on the domestic political structure by shifting the distribution of resources, altering the domestic balance of power and making the central government a more attractive target for capture. Similarly, by building costly, non-mobile production facilities, multinational corporations (MNCs) have an interest in protecting their investment and thus also act as agents of change in a host country (Malesky, 2006; Dutta and Roy, 2009). International economic processes can thus significantly change the nature of domestic politics in a country. The extent of the impact of FDI on domestic politics remains understudied, however, and I attempt to address this gap in research by evaluating the relationship between FDI and coups. Although an extensive body of research has evaluated the impact of economic factors on the occurrence of civil war, similar attention has not been devoted to the occurrence of coups. Existing studies on coups have considered broader, macro-economic trends in evaluating coup risk. Studies of coups and macro-economic factors have strongly demonstrated the importance of such variables for the occurrence of coups but more detailed mechanisms and other types of capital flows have no been considered (Londregan and Poole, 1990; Alesina et al., 1996). Studies of civil war have considered more specific economic factors such as primary commodity exports but have paid no attention to FDI (Collier and Hoeffler, 2004; Collier, Hoeffler and Rohner, 2009). While evidence has been found that economic factors such as primary commodity exports influence the outbreak of civil war, many developing states do not experience this type of economic activity without the presence of FDI inflows and MNCs. Coups are conceptually related to civil war as a type of violent rebellion against the state, but are driven by different factors and considerations. There are reasons to expect that FDI may lead to increased instability and greater coup risk under certain conditions. To better explore the relationship between coups and FDI, I utilize a formal model to develop the logic of my theoretical argument and since coups are more prevalent in states without a developed mechanism for the turnover of power, I explicitly focus my analysis on author- 2

3 itarian states. A key implication of the formal model is that FDI is expected to have an inverse-u shaped effect on the likelihood of coups. At high levels of FDI, the dictator uses the gains from FDI to insulate himself from potential challenges. At middle levels of FDI, the state becomes a more attractive target for capture and the dictator is not able to deter a coup. I find evidence for these propositions with a logit model using a new dataset on coups (Powell and Thyne, 2011). 2 FDI and Coups Before examining the determinants of coups, it is important to discuss the existing research on FDI. Within political science literature, the focus of a majority of studies has been on FDI as a dependent variable. These studies have typically set out to examine the factors that determine the inflows of FDI to a given country. Much of the thinking on FDI, on the behavior of Multinational Corporations(MNCs) and on host country-mnc relations stems from the theory of the obsolescing bargain (Vernon, 1971). According to this argument, assets created by foreign investment are non-mobile and often require the investment of significant sunk costs. Costly manufacturing or natural resource extraction projects that may require the construction of complex infrastructure and the development of production capabilities are long-term projects that require considerable investment in capital and. For MNCs, moving this capital is often not an option once the investment has been made. This characteristic distinguishes FDI from other types of investments, such as portfolio investment. Since portfolio investment does not require physical presence in a foreign country, it is much more mobile and is commonly described as footloose. The initial investment decision is therefore risky and costly and MNCs commonly exercise considerable bargaining power when choosing the investment site. Host countries thus often engage in a beauty contest to demonstrate attractive characteristics, such as macro-economic and political stability, that 3

4 will lead to further foreign investments. Once the investment is made, however, MNCs lose much of their bargaining power since they are unable to credibly threaten exit (Kobrin, 1980). For this reason, political risk becomes an important factor for any investor seeking to invest in assets abroad. Investors must take into account political factors that may negatively impact the returns on investments prior to any investment decision since capital cannot be moved once the investment project goes forward. Political instability can result in significant losses for investors if a foreign government chooses to change the terms of the original contract bt directly expropriating foreign owned assets, creating a restrictive tax environment or dictating local ownership quotas (Kobrin, 1979). Furthermore, more extreme forms of instability, such as civil war, can have even more dire effects for foreign investors. Determining the extent of political risk prior to the investment decision is therefore a critical part of any investment strategy abroad. In determining the extent of FDI inflows, pull factors become important. These pull factors can include country level characteristics such as regime type and also the specific policies adopted by states designed to attract investors. Most research on FDI in the political science literature has typically focused on determining the relationship between political factors and political risk; the most common factor examined is the role of political regime in affecting political risk (Jensen, 2003, 2006; Jensen and Johnston, 2011; Li, 2009; Li and Resnick, 2003; Oneal, 1994; Asiedu and Lien, 2011). Two theoretical arguments are proposed regarding the impact of regime type on FDI. Some, like Oneal (1994) and Li and Resnick (2003) argue and provide evidence that autocratic governments attract more investment than democratic governments. The proponents of this view suggest that autocratic regimes should be viewed as more stable by investors since autocratic polities do not go through regular cycles of elections, which may be associated with increased uncertainty and increased expropriation risk. Investors may also find authoritarian regimes more attractive because of a greater opportunity to leverage monopoly advantage in an authoritarian state. Further, the ability of authoritarian states to suppress workers 4

5 ability to organize, the ability to suppress wages and the insulation of authoritarian leaders from electoral pressure are also attractive features for foreign investors. Some have also argued that institutional investors have expressed a strong preference for stability, where the preference for stability takes precedence over the political regime of a state (Haley, 2001). The ability of authoritarian states to provide stability is preferred by investors that also view democracy as associated with instability and uncertainty. Democratic states may also lack the political will and popular support to implement unpopular reforms that are may be demanded by foreign investors, whereas autocrats are able to implement such reforms without seeking the support of the population. Although Haley s arguments are focused primarily on portfolio investments, this logic can be applied to the analysis of FDI as well. Since democratic regimes are associated with higher MNC taxation, increased labor bargaining power and higher levels of consumer protection, autocratic regimes are in many ways attractive for foreign investors, and Oneal (1994) and Li and Resnick (2003) find evidence that autocratic states experience greater FDI inflows. Since autocratic states are not overlooked by international investors, there are reasons to expect that FDI will have an impact on domestic political processes in authoritarian states. FDI can impact domestic politics because MNCs often have a specific political agenda and advance it by working as agents of change. Work by scholars such as Ramamurti (2001) suggests that MNCs commonly have more bargaining power post-investment than is assumed by the obsolescing bargain. Ramamurti argues that negotiations between MNCs and host countries can be characterized as a two-step process. While theories based on the obsolescing bargain assumes that factors such as size of economy or political regime are key in affecting the decision to invest, micro-level negotiations between MNCs and host countries are in fact affected by macro-level, international factors. International institutions such as the IMF and GATT/WTO have adopted a focus on FDI where many developing countries are often pressured into liberalizing their investment environment as part of ongoing international 5

6 negotiations regarding trade agreements or IMF loans. For this reason, states lose much of their bargaining leverage before micro level negotiations with MNCs even begin. In this sense, FDI often have an impact on processes within the state and a shift in focus from FDI as a dependent variable to FDI as an independent variable may be justified (Malesky, 2006, 2009; Dutta and Roy, 2009). Thus, Egan (2010) finds that FDI may help to lock in economic reforms and Dutta and Roy (2009) find that FDI has the potential to increase media freedoms within a state. This work suggests that FDI has a noticeable impact on the domestic processes within a country and FDI should not simply be viewed as a dependent variable. Since authoritarian states lack normalized procedures for peaceful turnovers of power, a potential preference for authoritarian states by international capital may also have important effects on the likelihood of coups and domestic instability. While MNCs may attempt to advance a particular political agenda, a more important effect for the probability of coups involves the distributional and spillover effects of FDI. FDI may increase the likelihood of coups not necessarily due to any direct actions on the part of MNCs, although owners of foreign capital may certainly favor particular factions in a given state over others, but due to a shift in the balance of resources within a state. An influx of FDI may lead to increased tax revenue, greater productivity of domestic firms and spillover effects of technology transfers (Javorcik, 2004; Blomstrom and Kokko, 1996). Not only does FDI increase tax income, foreign companies may also engage in bribery and kickbacks to government officials in order to secure access to protected sectors of the economy (Hellman, Jones and Kaufmann, 2000; Gueorguiev, Malesky and Jensen, 2011). Increases in corruption as combined with conventional growth effects of FDI increase the sovereignty rents accruing to the authoritarian leader in control of the central government. Since these factors increase the value of central government control, these factors may lead to coups through what Collier and Hoeffler (2005) terms as the greed motivation for rebellion. While the greed and grievance 6

7 explanation has typically been applied to studies of civil war (Collier and Hoeffler, 2004), coups are similar to civil wars in that both are attempts to capture the state by force. Unlike civil wars, coups do not require the creation of a large army and can be carried out by a small group of conspirators (Luttwak, 1979). Since the barriers to coup feasibility are lower than civil wars, the greed motivation may apply more strongly to coups than to civil wars. Since returns from FDI will accrue to whomever takes control of the central government, and since authoritarian states lack regularized mechanisms for the turnover of power, rising FDI inflows may motivate elites in authoritarian states to attempt a coup. Where elites may have been happy enough to receive patronage from the dictator in return for loyalty, increased state revenues from taxes levied on foreign capital as well as bribes and kickbacks received by members of the government makes control of the state an attractive prize for those elites that do not have direct access to these rents. To better develop the connection between FDI and coup risk, it is necessary to examine the existing literature on coups and authoritarian regime dynamics. The literature on coups is largely in agreement that economic factors matter and that coups are more likely during poor economic times. Thus, Londregan and Poole (1990) find that the probability of a coup increases during periods of poor economic performance. Similarly Alesina et al. (1996) find that low rates of economic growth increase the likelihood of coups. Since FDI is commonly correlated with economic growth, these findings would seem to suggest that FDI would actually decrease the likelihood of coups. However, the authors cited above do not take regime type into account. While Alessina et. al. include controls for the regime type of a state, insufficient attention is paid to the micro-mechanisms of leadership survival that take place within the authoritarian regimes. Galetovic and Sanhueza (2000) go further to develop a formal model of coups and also find that coups are more likely during recessions. However, Galetovic and Sanhueza also find that the relationship between coups and incomes is less clear. Although it is possible that FDI may increase income and reduce the likelihood of 7

8 coups, FDI has been found to impact growth only in states with sufficient human capital and technological capacity (Borensztein, De Gregorio and Lee, 1998). Many authoritarian regimes are found in states with low human capital, with FDI typically going into natural resource extractive industries. Although FDI may indirectly decrease the likelihood of a coup by increasing income, this relationship is not straightforward and is conditioned by other factors, including human capital, absorptive capacity and industry type. While a connection between coups and FDI on purely economic grounds appears ambiguous, more light can be shed on this issue by examining leadership dynamics in authoritarian regimes In authoritarian state, the relationship between the dictator and domestic elites plays a key role in affecting the stability of the regime. In the selectorate model developed by de Mesquita et al. (2005), a dictator retains office by winning the support of a winning coalition that allows the dictator to remain in power. Support of the winning coalition is attained by distributing some mix of public and private goods. Similarly, Gandhi and Przeworski (2006) argue that dictators remain in office by redistributing spoils or providing policy concessions. Acemoglu and Robinson (2005) suggest that dictators provide policy concessions by choosing to democratize when rising inequality increases the threat of popular rebellion. Collectively, these works agree that dictators must please an outside group through a mix of policy concessions or material compensation. With the exception of Acemoglu and Robinson, literature on authoritarian states also tends to agree that the greatest threat to a dictator comes not from the general population but from a small circle of elites, many of whom are commonly members of the dictator s ruling coalition or group of followers Svolik (2009). This suggests that coups tend to be the greatest threat to a authoritarian leader s survival in office; thus, Svolik finds that 68% of all authoritarian leaders were removed by means of a coup. Coups are typically carried out by groups of elites that connected to the central government or the military. Since successful coups typically require a high degree of organization, secrecy and sufficient access to weaponry to swiftly remove the leadership of 8

9 a state and take its place (Luttwak, 1979), high ranking military officers or influential elites are typically in an ideal position to carry out the coup. These arguments receive support in the historical record, where coups in states like Chile, Turkey and Pakistan were carried out by members of the military who would go on to take control of the state. A successful coup thus requires either some tacit concent or direct participation of the military hierarchy in order to be successful. Since a coup represents a significant risk for a dictator s survival, a dictator hoping to avoid coups has to take steps to neutralize the military. While some leaders have sought to do so by creating parallel military structures that serve as bodyguards of the regime and that are able to counter-balance the regular military (Quinlivan, 1999), others have purchased the support of the military by providing material concessions. One example is Hosni Mubarak s tenure in Egypt, where Mubarak was able to ensure the loyalty of the military by allowing military leaders to become active in domestic business. By allowing military leaders to extract spoils from business activities, Mubarak was able to ensure their continued support. Dictators, many of whom come from the ranks of the military themselves or are indirectly controlled by the military, may also reward the military by increasing the military s budget. The military may engage in behavior similar to an extortion racket by threatening to launch a coup when faced with the possibility of reduced spending (Collier and Hoeffler, 2006). Since a dictator is commonly first among equals and relies on the support of a winning coalition to stay in power, the distribution of spoils and patronage plays an important role in any authoritarian leader s survival strategy. What does this mean for FDI? FDI has important implications for the stability of the regime because FDI changes elite expectation regarding an appropriate distribution of private goods. Since foreign companies contribute additional tax revenues and lead to increased exports, FDI increases the value of state control. Development and GDP growth taking place over a long-term time frame does have the potential to decrease the likelihood of 9

10 coups, as Alesina et al. and Londregan and Poole find. FDI, however, generates a shift in the distribution of resources in the short term and may benefit isolated groups in a polity, rather than the state as a whole. In ethnically or religiously divided states, shifts in the distribution of resources in favor of one group may increase grievances among other groups. Quoting MacBean, O Kane notes that a sudden rise in the proceeds realized from the export of an important crop may appear to redistribute income in an entirely arbitrary manner and when the government is also comprised mainly of one tribe or race and is confronted by a sudden change in the value of the particular export with which it is associated, it will run the clear risk of being accused of corrupt manipulation (O Kane, 1981, p.299). Just as O Kane argues that shifts in commodity prices cause redistributions of income, shifts in FDI produce similar effects. Similarly, shifts in FDI may also lead to instability by making the state a more attractive target for capture. If elites find that provided concessions are insufficient, elites may be motivated to launch a coup and gain full access to spoils accruing to the state. Less volatile than commodity prices or portfolio investment, FDI capital generates rents that can be appropriated by anyone capable of seizing the reins of power in a state. FDI thus increases the value of central government control and may motivate a coup by elites unsatisfied with access to patronage that may not include access to rents from FDI. This argument is related to arguments proposed by Collier and Hoeffler (2004); Collier, Hoeffler and Rohner (2009). Collier and Hoeffler argue that primary commodity exports increase the likelihood of civil war by giving rebels a resource base from which to fund an insurgency. While Fearon (2005) criticizes Collier and Hoeffler s findings, he notes that exports such as oil may still raise the value of state control. Fearon suggests that It seems more likely that high oil exports indicate a weaker state given the level of per capita income and possibly a greater prize for state or secessionist capture, both of which might favor civil war (Fearon, 2005, p. 503). Although Fearon is here talking about primary commodity exports and civil war, the essential logic of the argument applies to FDI and coups as 10

11 well. Since most developing states often cannot engage in natural resource extraction and exports without the technology and expertise provided by foreign companies, any discussion of primary commodity exports and domestic instability would need to explicate the role of FDI as well. These factors contribute to make control of the government more attractive, especially when elites feel slighted by the dictator s distribution of patronage. Developing states endowed with significant natural resource wealth but with no way to extract it may suddenly find themselves reaping the profits of lucrative exports after an inflow of FDI. A sudden shift in central government income may undermine existing agreement between the dictator and elites and increase the willingness for a coup. While leaders may find it possible to adjust and re-negotiate the patronage equilibrium under conditions of long-term growth, short-term changes caused by FDI present a more severe disruption and thus alter political elites strategic calculus. In this way, the link between FDI and coups presents a more direct relationship between the rising value of state control and domestic instability, and is a more appropriate and direct statement of the logic of Fearon s and Collier and Hoeffler s arguments. Not only does FDI increase the attractiveness of state control, FDI may also contribute to a shift in the balance of power within a particular state and make the threat of a coup more credible by providing additional resources to actors within the dictator s ruling coalition. Malesky (2008) argues that FDI can contribute to the autonomy of subnational actors, loosen central government control and lead to de-facto decentralization. FDI may provide an independent resource base to elites which can then be used to launch a successful coup. If FDI leads to increases in the productivity of domestic firms through technology spillovers and forced adjustment due to increased competition, domestic assets owned by elites or the military may increase in value and contribute to increased elite autonomy. By developing an independent resource base, elites become less dependent on patronage distributed by the dictator and more willing to pursue independent political goals. Nito Alves, the leader of an 11

12 Figure 1: Formal Model attempted coup in Angola in 1977, provides an example of this tendency. Alves hailed from the province of Malanga, an agriculturally rich region which received considerably more investment compared to other Angolan provinces, which enabled Alves to drawn upon a strong resource base to build his influence. 3 A Model of FDI and Coup Risk To better illustrate this logic, I develop a simple, two player game-theoretic model. The game is graphically presented in Figure 1 and the steps of the model are as follows. The game has two actors, dictator and elites. At start of game, dictator chooses to distribute concessions or patronage (P) to elites or not (NP). Elites observe the choice and decide to have a coup (C) or no coup (NC). Dictator then decides to back down (NF) or fight (F). At the start of the game, the dictator receives some amount of personal income. This income is a function of the dictator s domestic resources and investments, β, and income from the presence of multinationals in his country, taking the form of taxes, gains from exports, bribes and kickbacks. Income is represented by function I(y, β) where β are personal 12

13 resources and y the dollar amount of FDI invested in the dictator s country in the current period. In the first period the dictator offers some non-zero percentage of this FDI income to elites as patronage or he offers nothing. The elites observe the offered patronage and then decide whether to accept the offer or to reject it and stage a coup. If the elites accept dictator s offer of patronage, dictator shares some percentage 1 α of his personal income where α (0, 1). If the elites accept the dictator s offer of patronage, the dictator stays in power and gets to enjoy income from FDI in future periods. The function F (y 1 ) represents the dictator s utility for anticipated access to FDI income in future periods. Because multinationals often announce investment projects in advance, the dictator and the elites have an estimate of the approximate value that future investment will have, even though the actual investment project will be finished at some later time. By investing in a particular state, multinationals also open the way for further investment through the effects of agglomeration. A mining operation may also attract more investment in the form of hauling and transport infrastructure, electricity and energy systems or marketing and sales operations, bringing in more FDI over time. The dictator s anticipation of access to this future income forms a part of his utility function when elites accept the offer of patronage: U d (NC P ) = αi(y, β) + F (y 1 ). Since elites accept the offer of patronage, elites receive a percentage of the dictator s income in addition to income generated by domestic resources owned by the elites. Utility for elites is then U e (NC P ) = C(d) + (1 α)i(β, y). Since elites may own other domestic assets that are independent of FDI, C(d) is a function that captures the value of domestic assets owned by elites that is independent of foreign investment. If the dictator chooses not to distribute patronage, the dictator keeps all of his income for himself and elites only get income from domestic investments. Payoffs are then U d (NC NP ) = I(y, β) + F (y t+1 ) and U e (NC NP ) = C(d). If the elites reject the dictator s offer of patronage, they choose to launch a coup. Upon observing this decision, the dictator chooses whether to back down and flee or to fight back 13

14 and resist the coup plot. Choosing to back down, the dictator goes into exile with none of his resources and receives a payoff of 0. If the dictator backs down, elites receive complete access to future gains from FDI and payoffs are then U e (NF C) = C(d) + F (y 1). Since foreign γ investors prefer to avoid instability in FDI host countries, investors observing a coup may choose to pull out some of their assets. Gains from FDI are therefore diminished by some fraction and γ represents the loss of investor confidence from domestic instability. Assume that γ is strictly non-zero and positive. If the dictator chooses to fight and resist the coup attempt, he wins with probability p I(y, β) where p =. The dictator has higher probability of winning as income from (C(d)) + I(y, β) domestic resource and FDI increases. Authoritarian leaders can convert gains from FDI into protection by using this income to create parallel military forces that will act as bodyguards of the regime and protect the dictator from elite challenges. Increasing FDI thus increases a dictator s chances of victory in the event of a coup. Elites can only use their domestic resources and win with a probability of 1-p. Choosing to fight, the dictator gets a utility of U d (F C) = p(i(y, β)+ F (y 1) γ )+(1 p)( λ d ). If the dictator fights back the coup, he keep all of his income but loses some percentage of future FDI income because of a loss of investor confidence cause by domestic instability. If he loses, he is imprisoned or loses his life and λ d represents the cost for losing the war. For greater ease of computation, assume that λ d is equal to -(I(y, β) + F (y 1) γ ). If elites win the war, elites gain full access to future FDI but future FDI is diminished by domestic instability and loss of investor confidence. Elites get the following utility if the dictator fights back: U e (F C) = p(c(d) + F (y 1) ) + 1 p(λ) where λ e is cost to elites for γ losing the war. I again assume that λ e = C(d)+ F (y 1). Several proposition can be derived γ from this analysis that can shed light on the relationship between FDI and coups. Proposition 1: Define a value of p, p such that when p p U d (NF C) < U d (F C) and 14

15 U d (NF C ) < U d (F C ). Under this condition, the dictator always chooses to fight when faced by a coup. Since λ = (I(y, β) + F (y 1) ), p is greater than or γ equal to p when p.51. When p.49, the dictator prefers to flee rather than fight. Assume that p p and the dictator chooses to fight. If provided with patronage, elites choose between launching a coup or accepting patronage. Since (1 p).49, elites receive a negative payoff if they choose to have a coup and the dictator fights back. Since any positive payoff is preferred by elites to a negative payoff, elites choose not to have a coup whether provided with patronage or not. When these conditions hold, an equilibrium exists where the dictator provides no patronage and elites do not launch a coup. Since the probability of victory is a function of the dictator s income, this equilibrium can be generated when the dictator grows more powerful either from personal income or from FDI income. This illustrates a situation where gains from FDI can be used by the dictator to entrench his position. Proposition 2: Assume that the dictator s income is not high enough to guarantee victory and p.49. This situation occurs when the dictator s personal income is low or when income from FDI in the same period is low or both. The dictator is weak and chooses to flee when threatened with a coup. If offered patronage, elites choose between accepting patronage or launching a coup and taking control of FDI rents. Elites thus launch a coup when C(d) + F (y 1) > C(d) + (1 α)i(y, β). Solving for F (y 1 ), this γ condition is met when F (y 1 ) > (1 α)γi(y, β). If offered no patronage, elites launch a coup when C(d) < C(d) + F (y 1). This condition is not met only if F (y 1 ) is negative γ since we constrained γ to be strictly positive and non-zero. Elites thus always launch a coup when offered no patronage if they expect the dictator to back down, unless they expect FDI outflows to negatively impact their own domestic assets. Define a positive value of F (y 1 ), F (y ˆ 1 ) such that when F (y 1 ) F (y ˆ 1 ), F (y 1 ) > (1 α)γi(y, β). When this condition is met, the elites launch a coup regardless of whether the dictator offers 15

16 patronage or not. This proposition illustrates the greed outcome of the model. Here, elites are tempted by the possibility of high FDI income in the future and take advantage of the dictator s weakness to launch a coup and take control of the state. Consider a case where income is smaller than future FDI, I(y, β) < F (y 1 ). When this is the case and γ < 1 1 α, future FDI need only be marginally larger than income for a coup to be more worthwhile for the elites than accepting patronage. More formally, when γ < 1, F (y 1 α 1) > I(y, β) satisfies the inequality C(d) + F (y 1) > C(d) + (1 α)i(y, β). To satisfy this inequality γ when income is greater than or equal to future FDI, future FDI must meet the more restrictive condition of F (y 1 ) > (1 α)γi(y, β) for the elites to reject patronage and launch a coup. This proposition suggests that coup risk is highest for poorer, underdeveloped states that receive a sudden influx of FDI. In such states, the dictator is more likely to be weak and unable to defeat a coup attempt and future value of FDI is likely to exceed the dictator s current income. Proposition 3: As before, assume that p.49. As demonstrated in Proposition 2, elites have a coup when F (y 1 ) > (1 α)γi(y, β). Define γ such that when γ γ and F (y 1 ) is greater than 0, F (y 1 ) < (1 α)γi(y, β). When these conditions hold, an equilibrium exists where the dictator provides patronage and elites do no launch a coup. This equilibrium defines a situation where elites, although they are sure to win a coup, do not launch it out of fear of reducing investor confidence. When patronage is provided, the value of patronage is sufficient to placate the elites, who would rather take the provided patronage than risk conflict to take the reduced amount of FDI. However, if no concessions are provided, elites are willing to stage a coup and take the reduced amount of FDI rather than accept a status quo where no concessions are provided. This equilibrium may not hold in natural-resource rich states. As Jensen and 16

17 Johnston (2011) argue, the presence of natural resources may reduce fear of investor backlash and he authors thus find that expropriation is more common in developing, resource rich states. This would suggest that γ is less than γ in natural-resource dependent states and so elites may not be deterred by losses in investor confidence from launching a coup. Proposition4: Assume that γ γ and p.49. As seen from Proposition 3 above, these conditions ensure that dictator offers patronage and elites do not launch a coup. Now, define F (y 1 ) = where F (y 1 ) > ˆ F (y 1 ). F (y 1 ) such that when F (y 1 ) F (y 1 ), F (y 1 ) > (1 α)γi(y, β), When these conditions hold, an equilibrium results where elites launch a coup regardless of the actions of the dictator. Observationally, this equilibrium is equivalent to Proposition 2 since it suggests a situation where elites cannot be placated by concessions and launch a coup no matter the action taken by the dictator. However, this equilibrium is generated by alternative conditions than in Proposition 1. The values of γ and F (y 1 ) indicate that in this case, the prize from FDI is so great that elites are willing to risk investor backlash to take control of the state and gain access to rents from FDI. When F (y 1 ) < F (y 1 ) and γ γ, the equilibrium in Proposition 3 holds and elites do not launch a coup. Setting F (y 1 ) equal to ȳ ensures that elites are no longer deterred by fear of disinvestment and are free to launch the coup. A number of implications arise out of this analysis. These propositions suggest a inverse U-shaped relationship between FDI and the probability of coups. The model indicates that under certain conditions, FDI deters a coup, while under others, FDI increases the likelihood of a coup. Two factors are important in preventing the occurrence of a coup: the threat of disinvestment and the dictator s power. When the dictator is sufficiently powerful, no patronage is provided and no coup takes place. In this case, FDI can have a negative effect 17

18 on the likelihood of a coup since FDI contributes to the dictator s power. This enables the dictator to engage in coup-proofing and provides a deterrence against coup attempts. Similarly, when the costs of disinvestment are too high, the elites accept patronage and choose not to launch a coup, even if the elites are sure of victory in the event of a coup. However, when FDI is sufficiently high, elites ignore the effects of disinvestment and engage in a coup. Danger of a coup is thus at its highest when the promise of future FDI exceeds the dictator s current income. When FDI is increasing but is not large enough to enable the dictator to coup-proof his regime, elites are tempted to launch a coup in order to gain full access to rents from FDI. 4 Evidence To test these propositions, I use coup data by Powell and Thyne (2011) for my dependent variable. These data specifically focus on the occurrence of coups and provide wide-ranging country and time coverage. Coups are here defined as attempts by the military or other elites within the state apparatus to unseat the sitting head of government using unconstitutional means (Powell and Thyne, 2011). While data on coups discriminates between successful and unsuccessful coups, the above developed theory is interested in coup attempts more generally and so I code a binary dependent variable equal to 1 when a coup attempt, successful or unsuccessful, has taken place. Data coverage extends from 1975 to 2004 and accounts for 117 coup attempts. For my key independent variables, I use FDI data from the World Bank World Development Indicators. I use net inflow data on FDI as percentage of host country GDP. Since I expect a non-linear relationship between FDI and probability of coups, I include the FDI variable and a quadratic term, FDI squared. This specification allows a test of a concave relationship between FDI and coup occurrence and so I expect FDI to be positively and the quadratic term to be negatively correlated correlated with coups. 18

19 As controls, I include a number of variables that have been found to be related to coups in the previous literature. Since economic factors have been found to be strongly related to coup probability, I control for these factors by using variables that measure the log of per capita GDP in constant 1996 dollars and per capita GDP growth using Gleditsch (2002) expanded GDP data, where GDP growth is measured as percentage change from the previous year. These variables are designed to account for the coup inhibiting effect of income found by Londregan and Poole (1990); Alesina et al. (1996) and Galetovic and Sanhueza (2000) and I expect these variables to be negatively signed. While income may contribute to coup deterrence, coups may be more likely during periods of poor economic performance since such periods may serve to delegitimize a government. I account for this factor by including a variable for inflation, measured as an annual GDP deflator percentage, using inflation data from the WDI. Since the military often plays an important role in launching coups, I include several variables to control for factors related to role of the military in executing coups. Military size may be related to coup probability since larger militaries may exercise more influence in a polity and thus not require a coup to gain more control of a state. I use data on military personnel size from the Correlates of War data and I expect this variable to be negatively signed. Finer (1988) also argues that grievances felt by the military often contribute to a decision to launch a coup. To control for this factor, I include a variable that measures military spending per soldier. Militaries that receive more funding will be less likely to feel aggrieved and I expect this variable to be negatively related to coup probability. This variable can also account for the effects of military professionalization since a more professionalized military will be less likely to become involves in politics and launch a coup. Data on military spending also comes from the Correlates of War. Military regimes have also been found to be more susceptible to coups. Since military regimes are themselves instituted by the means of a coup, this breaks a taboo on future coups by other actors within a state and provides 19

20 any future plotters with a blueprint for a successful coup. I create a dummy variable equal to 1 for all military regimes and for outwardly civilian regimes that are controlled by military elites. Data on regime type comes from Bank s Cross-National Time Series (CNTS) data. Lastly, I include more general variables that may be associated with coup probability. Just as rising inflation serves to delegitimize a regime and may lead to a coup attempt, more general unrest can also produce the same effect. I control for the effects of unrest by using CNTS data on domestic unrest and I create a count variable that measures the number of general strikes, major government crises, riots and anti-government demonstrations occurring in a given year. I expect this variable to be positively correlated with coup probability. A leader s length of tenure may decrease the probability of coups since years spent in office allow a leader to engage in coup-proofing and secure his domestic base of support. I include a variable measuring a leader s years in office using data from World Bank Database of Political Institutions. The extent of ethnic and cultural fractionalization may also increase the probability of a coup since ethnicities or cultural groups excluded from government may be more likely to harbor grievances and desire control of the central government. Similarly, members of the military who come from such excluded groups may also be more likely to plot to overthrow the government. Using data from Fearon (2003), I include variables for ethnic and cultural fractionalization where ethnic fractionalization is measured as the probability that any two individuals drawn at random from a country will be from different ethnic groups and cultural fractionalization is the probability that any two individuals will be drawn from structurally dissimilar language groups and I expect both of these variables to be positively correlated with coup probability. Since regions like Latin America have experienced more coups compared to regions like Western Europe, I include region dummies for three of the most coup-prone regions; Latin America, Sub-Saharan Africa and Middle East-North Africa (MENA). To control for factors related to time, I include a variable that measures the time since the occurrence of a coup. Following Carter and Signorino (2010), I also include t, t 2 20

21 and t 3 in order to estimate the effects of time on coup hazard. I estimate a logit model with heteroskedasticity robust standard errors clustered by country. I use three separate specifications: first, I estimate a baseline model with factors that have been confirmed by previous work to be strongly related to coup probability, domestic unrest, years in office, military regime type, PC GDP and GDP growth, and military expenditure. I then estimate two expanded models, first adding inflation, military personnel numbers and regional dummy variables and then adding the fractionalization variables for the last model. I first estimate these three models for all states from 1975 to Since the coup theory developed in this paper is designed to specifically apply to authoritarian states, I then re-estimate the models using only states with a Polity IV score less than -5. I choose this value in order to examine the effects of FDI for strongly authoritarian states since the effects of FDI may be different in democracies, weakly authoritarian states or anocracies. The results are presented in Table 1. These results provide evidence for the hypotheses developed above. As expected, FDI and FDI squared show the expected term across all models. These results are in line within the propositions generated by the formal model in that they suggest that rising FDI inflows increase the probability of a coup of a coup up to a certain point, after which the likelihood of a coup decreases. Although these variables do not reach the.05 level of significance in the general models, these variables are significant for all three of the authoritarian models. This finding is also consistent with the theory developed in this paper since leadership dynamics between the dictator and the elites are expected to apply only to strongly authoritarian states. These initial results therefore confirm the theoretical intuition outlined above. Other variables also reveal some additional insights regarding the underlying causes of coups. The strongest results across all models are associated with PC GDP and PC GDP growth variables. The strong negative association between income and income growth confirm previous studies and further cement the finding that coups are unlikely in rich countries that expe- 21

22 rience steady economic growth. The effects of unrest are also strongly significant for the general models but not significant for authoritarian states. This also suggests that underlying coup dynamics differ across regime types. It is possible that elites or the military are more likely to launch a coup during periods of unrest in non-authoritarian regimes. Once a coup is successful and an authoritarian regime is installed, the effects of unrest appear to diminish. Military regimes also appear more susceptible to coups. This finding also appears to confirm the idea that a successful coup that installs a military regime in power opens the door to future coups as the taboo on violent regime change is broken. The effects of time suggest that coup probability is described by a decreasing hazard rate where the probability of a coup is higher directly following a previous coup, with the probability decreasing over time. Military expenditure is also a significant factor for the general models. Higher military expenditure appears to offset military grievances and decrease the probability of a coup. Consistent with arguments made by Collier and Hoeffler (2006), military spending may operate as an extortion racket where members of the military may threaten a coup in response to cuts in funding. Military personnel is also significant and suggests that larger militaries are less likely to launch coups. The effects of ethnic and cultural fractionalization are surprisingly divergent, with ethnic fractionalization serving to decrease a coup, while cultural fractionalization increasing the likelihood of a coup. It is possible that in states with multiple ethnic minorities but a common language, the different minorities act as veto players and deter members of other minorities from launching coups. This result is also consistent with arguments made by Jackman (1978), who suggested that high ethnic fractionalization serves to decrease the probability of coups because it indicates a lack of ethnic dominance, a situation where a single large ethnic groups controls the polity and dominates smaller ethnic groups. The ability to deter other groups from attempting a coup may also require a common language in order to facilitate communication among groups. Countries with several separate language groups may lack this mechanism and so are more susceptible 22

23 to coups. To more fully explore the effects of FDI, it is necessary to explore different types of FDI. Key parameters of the formal model, such as γ, may take on different values in states where FDI is focused in the extractive sector compared to states that receive primarily manufacturing FDI. As Jensen and Johnston (2011) suggests, leaders in resource rich states may be more insulated from negative reputational effects of instability and expropriation. States endowed with FDI are also likely to receive more FDI compared to non-resource endowed states, all things being equal. Resource barren states will have no possibility of receiving extractive FDI at all and extractive FDI can also contribute to further FDI growth through agglomeration effects of firms following each other into an investment destination. Resource rich states will thus represent a more lucrative investment environment where the effects of FDI may be more pronounced. To examine this possibility, I re-estimate the above models for all states that are likely to receive extractive FDI. Using World Bank data on natural resource rents 1 as a percentage of GDP, I limit the model to states that receive 8 percent or greater of their GDP from natural resource rents, with 8 percent being the observed mean value for this variable in the dataset. The results are presented in Table 2. The results observed in Table 2 provide further support for the hypothesized relationship between coups and FDI. The FDI variables continue to have the hypothesized sign and are now significant in the general models as well, not just in the authoritarian models. The coefficients are also larger in magnitude, suggesting that the effects of FDI on coups are stronger for natural-resource exporting states. Other effects remain largely the same as in the previous models, with several important differences. Although inflation was not found to be significant in Models 1-6, it is now positive and significant for authoritarian states. This suggests that elites in resource rich states may be more threatened by rising inflation and may be more motivated to launch a coup when faced with devaluing assets. Variables 1 Sum of oil rents, natural gas rents, coal rents (hard and soft), mineral rents, and forest rents 23

24 such as military expenditure, unrest and PC GDP variables retain their sign and statistical significance, while variables related to cultural and ethnic fractionalization are no longer significant. Overall, these models provide evidence for the argument that parameters such as γ may be smaller in resource-rich states, making such states more susceptible to coups as FDI inflows increase. Figure 2: Inflection Points (a) Model 4 (b) Model 10 Since the relation between FDI and coups is parabolic, it is may be useful to find the inflection point of the function in order to determine FDI levels at which coup probability begins to decrease. To do so, I plot the linear predictor, ŷ, of the logit models using the following equation: ŷ = α + β 1 F DI + β 2 F DI 2. I use α and β estimates from Models 4 and 10 and plot the linear predictors in Figure 2. As can be seen from the graph, FDI appears to increase coup risk at low amounts of FDI inflows. For all authoritarian states, the risk of coup begins to decline for values of FDI greater than 9.6, as denoted by the vertical line. For resource-rich authoritarian states, the inflection point is found at These results are consistent with the arguments developed in this paper since coup risk is increased by a disruption in the patronage equilibrium between the dictator and elites that is more likely to be short-run. It appears that the time after the initial investment of FDI carries the 24