A signaling model of foreign direct investment attraction

Abstract

Foreign direct investors face uncertainty about government's type of the host country. In a two period game, we allow the host country's government to mitigate such uncertainty by sending a signal through fiscal policy. Our main finding states that a populist government may mimic a conservative one in order to attract foreign direct investment (FDI), and this choice depends mainly on its impatience degree and the originally planned FDI stock. We highlight the role of the government's reputation in attracting foreign capital and thus provide some policy implications. Moreover, our model explains why some governments considered to be populist adopt conservative policies in the beginning of its terms of office.