Mardi | 2019-09-12
Salle des thèses 16h – 17h20

Gerhard TOWENS – Radoslaw STEFANSKI – Marta TROYA MARTINEZ

International contracts are difficult to enforce, especially in countries with weak institutions. Thus, oil rich countries can hold up international oil firms by renegotiating taxes once the investment is sunk. If future gains from trade exist, countries can devise a self-enforcing agreement instead. We use elections to show that governments in countries with weak institutions indeed face a binding self-enforceability constraint, while countries with strong institutions do not. We show that only in countries with weak institutions, incumbent governments, facing a non-zero probability of losing power, increase taxes by 10pp in the year of the election to satisfy the self-enforceability constraint. A self-enforcing agreement would require investment and taxes to be backloaded (Thomas and Worrall (1994)). We explore this empirically and show that contracts in countries with weak institutions seem to be relatively more backloaded than those in countries with strong institutions.