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Heterogeneous effects of bilateral investment treaties

Review of World Economics volume 153, pages 631–656 (2017)Cite this article

Abstract

Bilateral investment treaties (BITs) are an increasingly used policy instrument to encourage FDI inflows, particularly inflows into developing countries. In this paper we estimate a gravity model of FDI flows from a sample of OECD countries to a broader sample of developing economies, examining the impact of BITs on these flows. BITs are signed between highly heterogeneous country-pairs, with important differences found in terms of the institutional and economic distance between BIT signatories. These differences may help explain the mixed results on the effects of BITs on FDI flows in the existing literature, with our exploration of non-linearities in this relationship suggesting that the effects of BITs are increasing in the difference in GDP and GDP per capita between source and host. BITs appear to have no impact upon FDI flows for country-pairs that are too dissimilar in terms of the strength of their political institutions.

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Notes

  1. 1.

    http://investmentpolicyhub.unctad.org/IIA, accessed on 12th July 2016.

  2. 2.

    Through this mechanism foreign investors can avoid national legal systems, opting instead for international arbitration, where they can choose one of the three panellists, and where consensus is required for one of the other two (Elkins et al. 2004). Recently there has been a strong increase in the number of arbitration cases (Bellak 2013) and the presence of international arbitrage clauses has caused concern amongst citizens in the EU regarding the proposed TTIP agreement.

  3. 3.

    Aisbett et al. (2009) show that BITs, by entitling foreign firms to compensation from expropriation, may encourage investment by high fixed cost foreign firms that would otherwise not enter a market, and that this entry may crowd out some relatively efficient domestic firms that would otherwise be in the market (p. 380). They further show that compensation may encourage over-investment and excessive entry in risky sectors.

  4. 4.

    Including zero and negative FDI flows precludes a routine application of the log transformation to the FDI data. Two approaches have been employed. The first adds 1 to the zeroes before taking the log (thereby ‘preserving the zero’) and takes the log of the absolute value of a negative flow which is then included with a negative sign (e.g. Kerner 2009). The second approach applies an inverse hyperbolic sine transformation directly to the data as explained below (e.g. Aisbett et al. 2017 and Berger et al. 2010). Both approaches produce very similar results.

  5. 5.

    The results of Myburgh and Paniagua (2016) suggest that foreign investors are less sensitive to host institutions if the host has ratified the Convention on Recognition and Enforcement of Foreign Arbitral Awards.

  6. 6.

    We use distance, common language, common border and the PTA variable as exogenous variables. Results when including host-time fixed effects are available upon request from the authors.

  7. 7.

    In the literature on the gravity equation attempts have recently been made to deal with a form of endogeneity that arises due to the presence of zero trade flows. Helpman et al. (2008) for example propose a modified Heckman selection type model, while Santos and Tenreyro (2006) suggest using a Pseudo Poisson Maximum Likelihood model. In our case neither of these approaches is feasible due to the presence of negative FDI flows. Our full sample of data consists of 9218 observations with positive FDI flows, 2975 observations with negative FDI flows, and 41,496 observations with zero flows.

  8. 8.

    This transformation is also used by Aisbett et al. (2017) and Berger et al. (2010).

  9. 9.

    In reality, there will be a slightly different number of observations in each regime because of ties.

  10. 10.

    The full sets of reporter and recipient countries included in the analysis are listed in the Appendix. While the OECD reports FDI data on up 248 host countries/territories/regions we are only able to include 101 in our sample. Firstly, we drop OECD countries as hosts, thus allowing us to concentrate on the impact of BITs on North–South FDI. Secondly, we are not able to include aggregated regions (e.g. Africa excluding North African countries). Thirdly, we are forced to drop a number of countries due to limited data availability for other variables. Fourthly, we exclude a number of countries that have relatively high per capita GDP (i.e. higher than that in the source countries) and that are financial offshore centres.

  11. 11.

    In practice, this number is lower because of data availability. In the years up to 1991 the number is also lower due to some transition countries not yet being independent.

  12. 12.

    Unfortunately, this database doesn’t give us a comparable indicator of the ‘depth’ of any agreement. We are thus only able to account for the presence of a BIT and not its depth.

  13. 13.

    Data can be downloaded from http://www-management.wharton.upenn.edu/henisz/ (accessed 16th October 2014).

  14. 14.

    In additional, unreported specifications we further control for other host specific variables such as openness (total trade/GDP) and inflation (Aisbett et al. 2017), as well as a dummy variable controlling for the existence of investment disputes against the host country (and its interaction with the BIT dummy variable) (Aisbett et al. 2017). The inclusion of these variables has a minimal impact on the BIT variable and are thus not reported in the paper. They are available upon request, however.

  15. 15.

    This outcome is consistent with Paniagua (2013), who concludes that a BIT deters bilateral disinvestments from Spain.

  16. 16.

    Note that, in our North–South sample there are no cases where the per capita GDP of a host is higher than that of a source, so that GDPPCDIF is always positive. But, while this is also true in the majority of cases for the GDP and the political constraints variables, there are instances where the value of the variable in the host is higher than that in the source. To test if it matters whether source or host has the higher value for these variables, we repeat the analysis using the simple difference in GDP and political constraints of source and host, (using the negative of the log of the absolute value in cases where the GDP difference is negative). The results (available on request) are very similar to those reported in the main text and are thus not included for reasons of brevity. This suggests that it is the cases where the source’s value is greater than the host’s value that are important for the outcome.

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Acknowledgements

The authors would like to thank two anonymous referees for comments on an earlier draft of this paper. All remaining errors are our own.

Author information

Affiliations

  1. Bond Business School, Bond University, Robina, QLD, 4229, Australia

    Rod Falvey

  2. UNU-MERIT, Boschstraat 24, Maastricht, The Netherlands

    Neil Foster-McGregor

Authors
  1. Rod Falvey
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  2. Neil Foster-McGregor
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Corresponding author

Correspondence to Neil Foster-McGregor.

Appendix

Appendix

Country sample

The North (source countries) are: Australia, Austria, Belgium, Canada, Switzerland, Germany, Denmark, Spain, Finland, France, the United Kingdom, Greece, Ireland, Italy, Japan, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Sweden and the United States of America.

The South (host countries) are: Algeria, Argentina, Armenia, Azerbaijan, Bangladesh, Belize, Benin, Bhutan, Bolivia, Bosnia and Herzegovina, Botswana, Brazil, Bulgaria, Burkina Faso, Burundi, Cambodia, Cameroon, Central African Republic, Chad, Chile, China, Colombia, Costa Rica, Cote d’Ivoire, Croatia, Cuba, Djibouti, Dominican Republic, Ecuador, Egypt, El Salvador, Equatorial Guinea, Eritrea, Estonia, Ethiopia, Gabon, Gambia, Guatemala, Haiti, Honduras, India, Indonesia, Iran, Jordan, Kazakhstan, Kenya, Kyrgyzstan, Laos, Latvia, Lebanon, Lesotho, Liberia, Macedonia, Madagascar, Malawi, Malaysia, Mali, Malta, Mauritania, Mauritius, Mexico, Moldova, Mongolia, Montenegro, Morocco, Mozambique, Namibia, Nepal, Nicaragua, Pakistan, Paraguay, Peru, Philippines, Poland, Republic of Korea, Republic of the Congo, Rwanda, Senegal, Serbia, Sierra Leone, Slovakia, South Africa, Sri Lanka, Sudan, Swaziland, Syria, Tajikistan, Tanzania, Thailand, Togo, Trinidad and Tobago, Tunisia, Turkey, Turkmenistan, Uganda, Ukraine, Uruguay, Uzbekistan, Venezuela, Vietnam, Zambia (Table 5).

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Falvey, R., Foster-McGregor, N. Heterogeneous effects of bilateral investment treaties. Rev World Econ 153, 631–656 (2017). https://doi.org/10.1007/s10290-017-0287-z

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Keywords

  • Foreign direct investment
  • Bilateral investment treaties
  • Heterogeneous effects

JEL Classification

  • C21
  • F21