Contracting with Whom? The Differential Effects of Investment Treaties on FDI

Under what conditions can governments use international commitments such as Bilateral Investment Treaties (BITs) to attract foreign direct investment (FDI)? Although numerous studies have attempted to answer this question, none considers how investment treaties may have heterogeneous affects across industry. I argue BIT effect is strongest when the obsolescing bargaining problem between firms and governments is most protracted, namely, when FDI relies on strong contracts between firms and states. Using a time series cross-sectional data set of 114 developing countries from 1985 to 2011, I find BITs are associated with increases in infrastructure investment, an industry particularly reliant on the sanctity of government contracts, but not with total FDI inflows. Moreover, BITs with strong arbitration provisions display the strongest statistical effect on infrastructure investment, while BITs that do not provide investors with such protections are not associated with increased investment. My results have implications for both scholarship on the relationship between governments and multinational firms as well as for the study of international institutions more broadly. To properly ascertain the effects of international treaties and institutions, scholars should consider not just whether institutions constrain or inform—or matter at all—but also the extent to which the targets of institutions have heterogeneous responses to them.     

When BITs have some bite: The political-economic environment for bilateral investment treaties

Political risk frequently impedes the flow of capital into developing countries. In response, governments often adopt innovative institutions that aim to attract greater flows of international investment and trade by changing the institutional environment and limiting the risk to outside investors. One primary example of this is the Bilateral Investment Treaty (BIT), aimed specifically at increasing the flow of foreign direct investment (FDI) to developing countries. Yet the literature in political science and economics is inconclusive about whether or not BITs do indeed stimulate FDI, and it provides conflicting theoretical reasoning for the claimed connection. This article argues that BITs do attract FDI to developing countries, but the story is a complicated one. Two important factors must be taken into account. First, BITs cannot entirely substitute for an otherwise weak investment environment. Countries must have the necessary domestic institutions in place that interact with BITs to make these international commitments credible and valuable to investors. Second, as the coverage of BITs increases, overall FDI flows to developing countries increase. However, although remaining positive, the marginal effect of a country’s BITs on its own FDI may fall because of heightened competition for FDI from other BIT countries. Using data from 97 countries for 1984–2007, we provide empirical evidence consistent with both of these theoretical claims.     

Variation in Bilateral Investment Treaty Provisions and Foreign Direct Investment Flows to China, 1997–2011

This article examines the differentisal effects of specific provisions included in China’s bilateral investment treaties (BITs) in inducing foreign direct investment (FDI). Empirical analysis yields some evidence suggesting that while the signing of a BIT does not necessarily boost FDI, the entry into force of a BIT does exert a strong effect on investment flows. More importantly, we find substantial evidence that BITs with stronger investment protection provisions such as absolute and relative standards of treatment and dispute settlement procedures are more likely to induce greater FDI flows. These results suggest that the variation in the institutional design of bilateral investment treaties strongly influences FDI flows by shaping foreign investors’ expectations of their asset security and the overall stability of the host country investment environment.     

Learning and the Precision of International Investment Agreements

The international regime for the promotion and protection of foreign investment consists of a multitude of close to 3,000 bilateral investment treaties (BITs) and related international investment agreements (IIAs). Yet, despite a growing body of research on IIAs, scholars in political economy have paid little attention to the legal language in the treaties themselves. In this research note, we draw on the conceptual apparatus of the legalization literature and focus on legal precision in BITs. We use a new data set created through quantitative text analysis to develop an index measuring legal precision. We then investigate the causes of the pronounced increase in precision in BITs and the considerable variation across treaties. We argue that capital-exporting countries are the primary drivers of change, and that they are motivated because they learn the implications of existing legal language from two sources: First, from the growing number of arbitration proceedings, and second, when they themselves are targeted by such claims. We provide statistical tests of our hypotheses and find ample support.     

Political institutions and FDI inflows in autocratic countries*

ABSTRACT

Why do some autocratic countries attract more foreign direct investment (FDI) than others? Surprisingly, few studies have explored the considerable variation in FDI inflows to non-democratic countries. In this article, I argue that non-democratic countries with seemingly democratic political institutions, such as elected legislatures, attract more FDI inflow than others. This is because these institutions can (1) reduce the transaction costs of investment activities due to the relative transparency of the policy-making process, and (2) act as veto players, making the existing market-friendly policy changes difficult, and thus, promising a more stable investment environment. My empirical results support the main expectation that autocratic countries with legislatures attract more FDI than other autocratic countries, and the institutions’ effects are conditionally modified by the quality of market protecting institutions.     

Delegating Differences: Bilateral Investment Treaties and Bargaining Over Dispute Resolution Provisions

Bilateral investment treaties (BITs) have become the dominant source of rules on foreign direct investment (FDI), yet these treaties vary significantly in at least one important respect: whether they allow investment disputes to be settled through the International Centre for the Settlement of Investment Disputes (ICSID). Through the compilation and careful coding of the text of nearly 1,500 treaties, we identify systematic variation in "legal delegation" to ICSID across BITs and explain this important variation by drawing upon a bargaining framework. Home governments prefer and typically obtain ICSID clauses in their BITs, particularly when internal forces push strongly for such provisions and when they have significantly greater bargaining power than the other signatory. Yet some home governments are less likely to insist upon ICSID clauses if they have historical or military ties with the other government. On the other hand, although host governments are often hostile toward ICSID clauses, particularly when sovereignty costs are high, they are more likely to consent to such clauses when they are heavily constrained by their dependence on the global economy. Our findings have significant implications for those interested in FDI, legalization, international institutions, and interstate bargaining.     

Why Should I Believe You? The Costs and Consequences of Bilateral Investment Treaties

Bilateral Investment Treaties (BITs) are the primary legal mechanism protecting foreign direct investment (FDI) around the world. BITs are thought to encourage FDI by establishing a broad set of investor's rights and by allowing investors to sue a host state in an international tribunal if these rights are violated. Perhaps surprisingly, the empirical literature connecting BITs to FDI flows has produced conflicting results. Some papers have found that BITs attract FDI, while others have found no relationship or even that BITs repel FDI. I suggest in this paper that these results stem from statistical models that do not fully capture the causal mechanisms that link BITs to FDI. Extant literature has often suggested that BITs may encourage investment from both protected and unprotected investors, yet the literature has not allowed for a full evaluation of this claim. This paper explores the theoretical underpinnings and empirical implications of an institution that works in these direct and indirect ways, and offers a statistical test that is capable of distinguishing between the two. The results indicate that: (1) BITs attract significant amounts of investment; (2) BITs attract this investment from protected and unprotected investors; and (3) these results are obscured by endogeneity unless corrected for in the statistical model.     

Campaigning for Capital: Fair Elections and Foreign Investment in Comparative Perspective

This article makes several contributions to the literature on political risk and the determinants of capital inflows. First, I clarify the relationship between capital flows and democracy’s constituent parts in a way that takes arguments beyond aggregate democracy indicators and static political institutional structures. Specifically, I argue that fair elections signal government respect for democracy and the rule of law in a highly visible manner investors can access. I show how investors therefore use the fairness of elections as a way to assess political risk and to inform their investment strategies. However, the type of investment and the kinds of evidence of electoral misbehavior condition elections’ influence on capital flows. I also disaggregate capital flows into foreign direct investment (FDI) and portfolio investment. I argue that the logic of investing is different in the short term (portfolio) versus the long term (FDI). When it comes to political risk, I provide evidence that portfolio investment is much more sensitive to risk factors than FDI because of the relative ease with which portfolio investors can extricate themselves from an increasingly risky market and seek safer returns elsewhere compared to direct investors.     

The Catalytic Effect of IMF Lending: Evidence from Sectoral FDI Data

Our study contributes to the search for the elusive catalytic effect of International Monetary Fund (IMF) lending on inflows of foreign direct investment (FDI). Recent scholarship has found that the catalytic effect is conditional on political regime and program stringency. We contribute to this literature by developing and testing a theory which describes how the catalytic effect also varies by economic sector. This is a departure from existing studies, which have tended to focus on aggregate FDI flows after crises. Our findings corroborate previous research, which finds that in general IMF lending has a substantial and negative effect on FDI. However, we find that the negative effect is concentrated in sectors that are highly dependent on external capital and have low sunk costs in the host country. Our findings are robust to several alternative explanations common in IMF literature, namely the importance of IMF program design and the ability of governments to make credible commitments to reform. Substantively, our findings suggest that investors are more likely to use IMF lending as an escape hatch in countries where FDI is dependent on external capital and has low sunk costs.     

Credibility,preferences, and bilateral investment treaties

When is a commitment mechanism employed as a solution to a time-inconsistency problem? This article provides a nuanced answer to this question by studying bilateral investment treaties (BITs). We develop a game theoretic model of BIT signing in which the government of a capital-importing country and an investor from a capital-exporting country strategically interact. The model predicts that, on the one hand, when host states highly value foreign direct investment (FDI), the likelihood of BITs increases as their judicial institutions lack credibility. On the other hand, when their preferences for FDI are only modest, the likelihood of BITs increases as their judicial institutions become more credible. We employ Cox proportional hazard models to test our hypotheses, and the results largely support our theory. Our findings have broad implications for the large literature on credible commitment, which has paid insufficient attention to the interplay between preferences and credibility.     

The Political Determinants of Foreign Direct Investment: A Firm-Level Analysis

Many large-N cross-national studies claim to show that political institutions and phenomena determine where foreign direct investment (FDI) flows. In this article, I argue that these studies tend to overemphasize statistical significance and often neglect to assess the explanatory or predictive power of their theories. To illustrate the problem, I estimate variations of a statistical model published in an influential article on “Political Risk, Institutions, and FDI.” I find that none of the political variables that the authors consider accounts for much of the variation in aggregate FDI inflows. To ensure that this underwhelming result is not driven by misspecification or measurement error, I leverage a large firm-level data set on the investment location decisions of thousands of multinational firms. Using nonparametric machine-learning techniques and out-of-sample tests, I show that gravity variables can help us develop very accurate expectations about firm behavior but that none of the 31 “political determinants” of FDI that I consider can do much to improve our expectations. These findings have important implications because they suggest that governments retain some room to move in the face of economic globalization.     

Bringing the Company Back In: A Firm-Level Analysis of Foreign Direct Investment

The industry standard for studying multinational corporations (MNCs) has been to evaluate patterns in aggregate country-level measures of foreign direct investment (FDI). Though certainly related, these data are at best a proxy for the actual commercial and productive activities of multinationals that most political scientists purport to be interested in. Simply put, this is a very indirect way of testing theories about the sociopolitical and economic factors that motivate MNCs’ choice of host countries. This article introduces a new firm-level data set designed to get around this problem by permitting more direct analysis of multinationals’ foreign operations. It then revisits the relationship between regime type and direct investment, finding evidence that MNCs are more likely to establish new subsidiaries in democracies than in nondemocracies. However, further analysis reveals that the strength of this relationship varies by context. Specifically, MNCs rely on regime type as an indicator of political risk when they lack an existing relationship with the host state. In addition, those operating in extractive industries are generally less responsive to political institutions than those operating in manufacturing or services. These results suggest that firm- and sector-specific factors deserve greater consideration than they have been given in the existing literature.     

The influence of interest: Real US interest rates and bilateral investment treaties

Bilateral Investment Treaties (BITs) present developing countries with a trade-off. BITs plausibly increase access to international capital in the form of foreign direct investment (FDI), but at the cost of substantially curtailing a government’s policy autonomy. Nearly 3000 BITs have been entered into, suggesting that many countries have found this trade-off acceptable. But governments’ enthusiasm for signing and ratifying BITs has varied considerably across countries and across time. Why are BITs more popular in some places and times than others? We argue that capital scarcity is an important driver of BIT signings: The trade-off inherent in BITs becomes more attractive to governments as the need to secure access to international capital increases. More specifically, we argue that the coincidence of high US interest rates and net external financial liabilities heightens governments’ incentives to secure access to foreign capital, and therefore results in BIT signings. Empirical evidence is consistent with our theory.     

Democracies only: When do IMF agreements serve as a seal of approval?

Conditional lending by the IMF is predicated, in part, on the belief that IMF programs are associated with increased capital inflows to participating countries. This belief is generally consistent with theoretical arguments in the academic literature (e.g., Bird and Rowlands 1997; Bordo et al. 2004) but the empirical literature often finds otherwise (e.g., Jensen 2004). This paper argues that the effect of IMF agreements on a country’s access to foreign direct investment (FDI) depends on its domestic institutions. Access to FDI depends on a country’s ability to credibly commit to implementation, and this ability varies systematically across regime type. The theory is empirically tested using a treatment effects model with a Markov transition in the treatment equation in a dataset covering 142 countries from 1976 to 2006. We find that in democracies IMF program participation has a strong positive effect on FDI inflows and in autocracies participation has a weak negative effect.     

Political Investment Cycles in Democracies and Autocracies

Extant research has shown considerable interest in whether host countries’ political uncertainty impedes foreign direct investment (FDI). Building upon the scholarly consensus on the adverse impact of political uncertainty on FDI, this article demonstrates that the extent to which investment climates are unpredictable varies cyclically, on the basis of election timing in democracies and leadership turnover in autocracies. The empirical results show that in presidential democracies, FDI tends to slowly increase after an executive election and then decline as the next executive election nears. However, I find that an electoral investment cycle is not found in parliamentary democracies where election timing is irregular, less predictable, and endogenous to domestic economic conditions. I also find that a similar political investment cycle exists in autocracies not through electoral cycle but through leadership tenure cycle. The level of FDI inflows tends to be relatively low early in autocrats’ tenure when political uncertainty is high and rise as autocratic leadership tenure increases over time but eventually wane again as autocratic leadership is destabilized in the late period of power transition. The findings indicate the existence of heterogeneous political investment cycles, depending on regime type.     

Domestic Institutions,Capacity Limitations,and Compliance Costs: Host Country Determinants of Investment Treaty Arbitrations, 1987–2007

The number of investment treaty arbitrations has exploded in recent years. However, the distribution of known arbitral claims varies among states. Some states have had multiple claims brought against them, while others appear not to have experienced any. This article represents the first study to seek causal explanations for this variation. My principal hypothesis is that a country's institutional capacity for protecting investor rights should be negatively correlated with the number of treaty-based arbitral claims brought against it. A panel analysis suggests that, after controlling for other determinants, countries with greater institutional capacity experience fewer disputes than those with lower capacity. This finding reveals an important truth about investment treaties: while they may be designed to help developing countries compensate for domestic-level institutional deficiencies in order to attract more foreign investment, it is precisely those countries with the weakest institutions for which the costs of treaty compliance are likely to be the highest.     

Economic Policy,Political Constraints,and Foreign Direct Investment in Developing Countries

As foreign direct investment (FDI) has become increasingly important in the world economy, a large body of literature has emerged regarding the determinants of FDI flows. Some scholars argue that democracy attracts FDI through the mechanism of political constraints, which reduce the risk of negative policy changes. However, the value of policy stability should be conditional on the attractiveness of contemporary FDI-relevant policies. I therefore propose a theoretically more comprehensive argument: political constraints are attractive to investors when the host country policy environment is FDI-friendly, because these political constraints reduce the probability of negative policy changes in the future. When the policy environment is hostile to FDI, on the other hand, political constraints will have little positive effect, and, to the extent they indicate that FDI-relevant policies are unlikely to improve, may even deter FDI. This argument helps explain why the positive relationship between democracy and FDI seems to emerge after a global shift toward FDI-friendly polices. I find robust empirical support for the argument in tests covering more than 100 developing countries from 1970 to 2014, indicating significant effects using a variety of policy and political constraint measures.     

The Effects of Political Risk on Different Entry Modes of Foreign Direct Investment

Although numerous studies document the effect of political institutions on foreign direct investment (FDI), few works in the political economy literature have investigated the link between political institutions and the mode of entry chosen by investors, be it mergers and acquisitions, joint ventures, or greenfield investments. Using panel data for 111 developing countries covering 1980–2006, we find that countries with political institutions that uphold good governance tend to attract higher levels of mergers and acquisitions, as opposed to joint ventures and greenfield investments, because such institutions help to mitigate the special risks faced by merger and acquisition investors. Our findings provide a nuance for understanding the different effects of political institutions based on the particular mode of entry.     

Coercive Assets? Foreign Direct Investment and the Use of Economic Sanctions

How does foreign direct investment (FDI) affect the use of economic coercion? This article argues that while FDI matters, the effect depends on the entry mode of the FDI. The economic interdependence created by FDI does not have a monotonic effect on economic statecraft because the relative costs incurred by economic disruption differ depending on the forms of foreign investment. In particular, the FDI that creates wholly-owned subsidiaries (for example, cross-border mergers and aquisitions) imposes greater costs to the sender's firms than cross-border joint ventures with local partners, while FDI through joint ventures incurs greater costs for the host than the home country and its firms. By utilizing US sanction episodes from the Threat and Imposition of Economic Sanctions (TIES) dataset, the empirical analysis supports the argument. The results show that economic sanctions are less likely to occur as the share of FDI through cross-border mergers and acquisitions increases.     

Conditional on Conditionality: IMF Program Design and Foreign Direct Investment

The article explores how International Monetary Fund (IMF) program design influences foreign direct investment inflows. The author argues that stricter IMF conditionality signals a program-participating government's commitment to economic reforms, as it incurs larger ex ante political cost and risks greater ex post political cost. Thus, the catalytic effect of an IMF program is conditional on conditionality: programs with stricter conditions catalyze more foreign direct investment than those with less stringent conditions. Empirical analysis of the IMF conditionality dataset supports the argument and shows that after accounting for IMF program participation, the more structural conditions included in an IMF program, the more foreign direct investment flows into the country.