How Does Expropriation Risk Affect Innovation?

We analyze how expropriation risk reduces incentives for innovation and reallocates resources from the innovative sector, building on Romer’s(1990) model. Our framework predicts the R&D expenditure, the share of human capital in R&D, the number of patents, technical progress, and economic growth are all lower due to lower expected profits and patent devaluation in the presence of expropriation risks. Empirical analyses, based on a LASSO Instrumental Variable approach and a novel comprehensive dataset spanning nearly two decades, confirm our theoretical predictions. We find robust evidence that expropriation risk, such as corruption, negatively impacts innovation by reducing R&D expenditure, human capital in R&D, number of patents, scientific publications, and the Economic Complexity Index, which is our proxy for technical progress. These findings highlight the detrimental effects of expropriation risk on innovation and economic development at the country level.