Department of Economics, University of Kansas

Department of Economics, University of Illinois at Urbana- Champaign

March 1999

This paper examines the role of multilateral organizations in directing private capital flows when enforcement is inadequate. We analyze the investment decision of a country that faces a repayment incentive constraint. It is well known that "under investment" occurs when this constraint binds. As a consequence of the market failure (i.e., inadequate contractual enforcement), there is scope for policy intervention designed to promote private investment. We consider two policies that are frequently used by multilateral organizations: technical assistance and loan subsidies. We show that these policies improve private investment flows and welfare, and hence provide a rationale for the operation of organizations such as the World Bank in conjunction with private markets.

Key words: Enforcement, Foreign Investment and Multilateral Organizations.

JEL Classification: F34.

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