Foreign Investment in Infrastructure, Limited Public Funds, and Renegotiation

We examine the interplay between limited public funds and renegotiation when a foreign firm invests in social infrastructure. It is found that the critical factor is how the finance constraint alters the threat point for the government in renegotiation. Through its effect on this threat point, a mild restriction on finance results in higher domestic welfare and total surplus, but a tighter restriction deters entry, even with the finance available being sufficient to cover the investor's total costs. Domestic welfare and the total surplus are non-monotonic in the availability of finance, with implications, for example, for project aid policy.