Foreign Ownership Restrictions: A Numerical Approach

Abstract

In this paper, we analyze the reason behind the use of foreign ownership restrictions on inward Foreign Direct Investment (FDI). We extend the results developed in Karabay (2005) by changing the condition on share distribution in the model. Due to this change, we are able to analyze the political economy aspect of this restrictive policy, i.e., we can study the effect of the host government,s welfare preference on the optimal foreign ownership restriction. Since the analytical solution to the optimal share restriction policy cannot be specified in general, we use a numerical approach based on collocation to approximate the solution to the problem. Within this framework, under certain conditions, it turns out that the rent extraction-efficiency trade-off is sharper the less the host government favors the local firm. We show that not only economic factors but also political factors play an important role in the determination of the foreign ownership restrictions.