Optimal Resource Extraction Contracts under Threat of Expropriation

Abstract

The object of this chapter is to propose an environment in which expropriations cannot be ruled out because of ex post political pressures. General conditions are derived that characterize the optimal ex ante contract, in the sense that the government maximizes social welfare under the threat of expropriation. Here, it is also shown how the optimal contract can be implemented using a competitive auction. In the model utilized in this chapter, the government has a natural resource project that requires up-front sunk investment, as in the case of a mining or oil extraction project. Since the problem of expropriation usually arises with foreign investment, profits are not included in the welfare function of the planner, and because the good is not consumed at home but exported, the government only cares about the revenues it can obtain from the project.

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