Political Instability, Foreign Investment and Growth in Proprietary Economies

Developing country leaders typically resemble proprietors more than benevolent social planners, i.e., they are powerful individuals pursuing their own interests while they remain in power. We model growth in a "proprietary economy" facing each period an endogenous probability of "political catastrophe" that would hurt foreign investors and extinguish the proprietor's wealth extraction ability. We provide theory in which domestic capital exhibits a bifurcation point determining economic growth or shrinkage. With low initial domestic capital the proprietor plunders the country's resources and the economy shrinks, even when shrinkage is not socially optimal. With high initial domestic capital the economy grows faster than is socially optimal.