Do Bilateral Investment Treaties Promote Foreign Direct Investment ...

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Dec 4, 2011 - Abstract: The future of the international investment regime is rapidly evolving and many different kinds of investment treaties are now being ...
Transnational Corporations Review Volume 3, Number 4 December 2011 www.tnc-online.net [email protected]

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Do Bilateral Investment Treaties Promote Foreign Direct Investment? Preliminary Reflections on a New Methodology Julien Chaisse and Christian Bellak*

Abstract: The future of the international investment regime is rapidly evolving and many different kinds of investment treaties are now being negotiated. In particular, the EU, which is emerging as a new actor on the scene of international Foreign Direct Investment (FDI) policy will need to know what kind of FDI-related provisions it should favour. We argue that much can be learned from the substance of existing Bilateral Investment Treaties (BITs) as differences in legal provisions of BITs are crucial regarding the application of BITs in praxi. Therefore, this paper presents a new methodology to measure the effect of the essential legal provisions of BITs. Starting from a review of 40 empirical studies, the (heterogeneous) empirical results of the effects of BITs on FDI are summarized. In the conceptual part of this paper, the most important legal substantive criteria as well as the key technical features of BITs are identified together with their variants. These are the components of new BITSEL index. Keywords: Bilateral treaties, Foreign Direct Investment, law, policy, econometrics

1. Introduction International investment agreements (IIAs), instruments of cooperation for the promotion, protection and liberalization of foreign investment, have all increased over recent years. The legal framework of investment agreements has also evolved substantially since the growing package of jurisprudence raises new questions about interpretation and implementation for governments and investors both in developed and developing countries. The current framework consists of a wide variety of national and international rules and principles that differ in form, strength and coverage. An important advantage of BITs and preferential trade agreements (PTAs) is that they can be tailored to the specific circumstances of the parties concerned, such as their development issues. However, with the number of BITs and PTAs continuing to expand, different standards and disciplines are beginning to be exerted over foreign investments. At the same time, the landscape of international investment regulation is evolving rapidly with the emergence of new important actors. One can notably observe constitutional changes concerning the transfer to the supranational level of                                                              *

Julien Chaisse, Faculty of Law, 5/F, Lee Shau Kee Building, The Chinese University of Hong Kong, Sha Tin, NT, Hong Kong SAR, E-mail: [email protected] Christian Bellak, Department of Economics, WU, Augasse 2-6, A-1090 Vienna, E-mail: [email protected]



Do Bilateral Investment Treaties Promote Foreign Direct Investment?

an external competence in the field of investment resulting from the Treaty on the Functioning of the European Union (TFEU). The European Union (EU) external action is about to experience a new important development because the 2009 Treaty of Lisbon establishes for the first time a competence over foreign investment by including it in the scope of the Common Commercial Policy. This new power is promising. Bringing trade and investment and partly competition matters into the same hands contributes to ensuring the development of a strong, coherent and efficient external economic policy for the EU what will affect the whole architecture of international investment law.i From an economic policy point of view, BITs have two rationales: firstly, the “inward” rationale of BITs is to attract inward Foreign Direct Investment (FDI); and, secondly, the “outward” rationale of BITs is to protect own investors abroad. Hence, the assumed effects of BITs on FDI are twofold: (1) a positive effect on inward FDI is likely, because a host country provides an institutional element, which may not be available in other host countries and thus reduce the costs of investing in otherwise comparable locations; and (2) a positive effect on outward FDI is hypothesized, because FDI to riskier countries will increase, ceteris paribus, if the institutional environment is improved and investors are protected and thus some risks are reduced. Because BITs are an instrument which affects inward and outward FDI through its differentiation of country pairs from those without a BIT, the size of the effect will diminish (decreasing returns), the more BITs are concluded. From a country viewpoint, the question arises whether these assumed effects of BITs occur at all and how large any effects are. This is an empirical question. Needless to mention, the abovedescribed effects of BITs on FDI can only be appropriately assessed in empirical studies, if BITs and FDI are adequately measured. As will be shown in more detail below, prior studies (with few exceptions like Busse, 2010) have only used information on the number of BITs of a country (newly concluded or cumulative). BITs consist of many provisions, so that the implicit assumption that they are all equal cannot be justified. Yet, differences in these legal provisions are crucial when it comes to the application of BITs in practice, e.g., in investment disputes or at a foreign market entry of a firm. The aim of this article is therefore to present a new methodology to measure BITs by evaluating their essential elements/components/features. This is important, because the need to empirically assess the impact of BITs on FDI may also be justified as an exercise of ex post policy evaluation. This paper is structured as follows. The common elements of BITs are discussed in section 2. Section 3 presents existing studies and provides a brief summary of our reading of their results. Section 4 provides a summary and a few insights on the “BITSEL index”.

2. What are the empirical results? The results of about 40 empirical studies have been analyzed to get an idea about the typical or average effect of BITs on FDI. Let us start with a basic problem, which unfortunately has not been properly addressed in every study. As, for example, Aisbett (2009) correctly states, “the primary 4 

Julien Chaisse and Christian Bellak

problem for researchers wishing to assess the impacts of policies to promote FDI is that policy adoption is endogenously determined" (Aisbett, 2009, p. 396). This applies particularly to BITs, since governments will be more inclined to conclude a BIT with each other if bilateral FDI are larger, or because large companies will lobby for the conclusion of a BIT prior to their investment. Empirical studies estimating the impact of BITs on FDI usually derive some type of elasticity, i.e., they show how much the dependent variable (FDI) changes upon a change in the independent variable (BIT), ceteris paribus. An elasticity is usually calculated from the percentage change of the dependent variable compared to the percentage change of the independent variable. Yet, a percentage change of a BIT is not meaningful information, because a BIT can change only by 100%: either it exists, or it does not exist (or, if cumulative BITs are used, the number may only increase or decrease by 1). Therefore, we use a semi-elasticity in order to assess the effect. Unlike an elasticity, a semi-elasticity tells us the percentage change of the dependent variable upon a change of the independent variable by one unit. In our case it is of interest, when a BIT comes into existence – either when ratified or when implemented. The main hypothesis tested in these studies is whether BITs affect (inward or outward) FDI positively, as this is the only plausible effect of a BIT on FDI from an economic point of view. Coefficients with negative signs as well as positive coefficients, which are not statistically significant, are implausible. To this end, we calculate the mean value of 795 semi-elasticities and sub-groups (see table 1 below), which are derived from coefficients taken from 34 empirical studies. According to our argument, we have used only 511 semi-elasticities, since 284 semi-elasticities carried negative signs. Table 1. Mean semi-elasticity of BIT on FDI, classified by different measures of FDI and BIT BIT stock FDI flow

BIT flow

FDI stock

FDI flow

FDI stock

All positive Number of semi-elasticities

171

4

256

80

Mean

5.16

20.89

16.08

18.31

Standard deviation

7.28

18.68

13.52

11.97

Positive and significant only Number of semi-elasticities

140

4

183

61

Mean

4.47

20.89

17.69

18.43

Standard deviation

4.15

18.68

14.07

11.29



Do Bilateral Investment Treaties Promote Foreign Direct Investment? Notes: • • • • • • •

BIT stock is a stock measure of the total number of BITs concluded by a country. BIT flow is a flow measure of BIT, i.e. a single BIT, concluded between a pair of countries. Semi-elasticities between 0 and 50 only. If all semi-elasticities (N=795) are used, the mean value amounts to 3.61e+07 with a standard deviation of 6.52e+08. Interpretation of the semi-elasticity: For example, the value of 5.159649 in col. 2, line 5 means that FDI flows increase by 5.16 percent, if the stock of BITs rises by 1 BIT. The list of references of all studies is available upon request. Table produced 30.8.2011.

Table 1 shows that with the exception of the combination of BIT stock and FDI flowii , which include about 40 percent of all elasticities and which yields a very low effect around 4 percent, the effect is very similar across the measurement of FDI and BITs. Note that several studies find different effects of signing and ratifying a BIT on FDI, which we do not discuss here in greater detail. Overall, our results suggest that the size of the effect of BITs on FDI is substantial, as an additional BIT increases FDI by approximately 19 percent, if the statistically significant elasticities are taken only (see table 1). These results should be seen in the light of the fact that many other factors determine FDI. For example, Büthe and Milner (2008) use beta coefficients iii to show the importance of BITs relative to other location factors which determine FDI flows: An increase of BITs by one standard deviation results in 11.1 per cent of a standard deviation of FDI, while an increase in the market size by one standard deviation results in 4.4 per cent of a standard deviation of FDI and an increase in the GATT/WTO membership by one standard deviation results in 10.4 per cent of a standard deviation of FDI. (Büthe and Milner, 2008, p. 750) The results discussed so far are based only on the information on whether a BIT exists or not. As has been outlined in the Introduction, in order to “finetune” the economic impact assessment of BITs, it is necessary to focus on the substance of the most important legal provisions of BITs, and to these we turn now.

3. Why is legal drafting essential to FDI flows assessment? Investment agreements enshrine a series of obligations on the parties aimed at ensuring a stable and favourable business environment for foreign investors. These obligations pertain to the treatment that foreign investors and their investments are to be afforded in the host country by the domestic authorities, as well as ensuring that foreign investors have the ability to perform certain key operations related to their investment. The “treatment” granted to investors encompasses all sorts of laws, regulations and practices from public entities that apply to or affect the foreign investors or their investmentsiv. The core provisions found in an investment agreement typically include a mostfavoured nation treatment obligation, the granting of national treatment, an obligation to provide fair and equitable treatment (FET) as well as protection and security to foreign investors, and an obligation to allow international transfers of funds.



Julien Chaisse and Christian Bellak

However, while the substance of these principles remains the same throughout the great number of investment agreements, the precise scope and reach of each obligation depends on the precise wording featured in each case. Because BITs are very diverse in their provisions and the way the existing provisions are drafted giving birth to a broad kaleidoscope of legal obligations and hence regulatory effects, we have developed an index which allows a better analysis of the likely effect of a BIT on the FDI flows between two countries.

4. An overview of the BITSEL index In this paper, we provide preliminary insights on the “BITSEL index” which is based on the 11 most important elements found in most of the existing BITs as presented in table 2. Each of them is reviewed below following a standard methodology: What is the criterion? How can it be legally defined? What are the examples in existing treaties? Table 2. Matrix of BITs legal drafting variations What is the criterion? Definition of investment

How can it be legally defined? Subject-matter of the investment agreement

Admission versus establishment

Allows the host country to apply any admission and screening mechanism for foreign investment that it may have in place and therefore to determine the conditions on which foreign investment will be allowed to enter the country

National Treatment

Requires that countries not discriminate against foreign investors in favour of domestic investors

Most favored nation

Requires that a government does not discriminate between foreign investors from different countries

Expropriation and indirect expropriation

Seizure of actual physical taking of property, effective loss of management, use or control, or a significant depreciation of the value of the assets of a foreign investor

Fair and Equitable Treatment

Relates to the concept of investors’ legitimate expectations which heavily depends on Arbitrators analysis. Repeatedly raised questions before arbitrators, such as: (1) To what extent may an investor legitimately rely on the stability of the legal and factual conditions under which he made his investment? and (2) What sort of changes in the host state must the investor anticipated

Transfer of investment-related funds out of the host state

Guarantee to allow outward transfers ensures foreign investors their ability to repatriate the amounts derived from their investment

Non-economic standards

Any protection offered to non-eco standards (be they environmental, labour, etc)

Investor-State dispute mechanism

Disputes between a state party and an investor national of the other state are settled by international arbitration rather than by the domestic courts of the host state (as would be the case otherwise)



Do Bilateral Investment Treaties Promote Foreign Direct Investment?

Umbrella clause

Umbrella clause extends the scope of the application of a BIT, it offers more protection to the investor

Temporal scope of application

Either the treaty protection is extended to investments made before the entry into force of the agreement, or the coverage is restricted to the future

Source: Authors’ elaboration

Even if comprehensive, this index does not pretend to be a perfect picture and transcription into data of the sophistication of certain provisions. Some elements are missing, such as the subtle differences in the wording of certain clauses, when their characteristics are defined only in a binary way. The “BITSEL index” is however an attempt to reduce the gap between economics and legal studies by combining the two disciplines in order to provide a new and more sophisticated assessment of the regulatory effect on FDI.

5. The research hypotheses The first hypothesis refers to all clauses. It states that once a clause is included in a BIT, it is more favourable to FDI than a BIT without the clause. For example, if investment is clearly defined and broad, the uncertainty of an investor concerning future investments in the host country is clearly reduced; inclusion of NT is more favourable than the lack of it etc. The second hypothesis refers to the binary nature of several clauses, like admission versus establishment, direct and indirect expropriation etc. The second hypothesis states that the more broadly the clause is defined, the more favourable it is for FDI. For example, if expropriation also includes indirect expropriation, this enables the investor to better understand his or her investment risk; admission clause is less appealing than establishment clause etc. The third hypothesis refers to the non-economic standards, labour and environmental standards in particular. The more that these standards are included in the BIT, the less favourable is the effect of all other clauses on FDI. For example, if the developed home country would require certain environmental standards to be followed by the investor in the host economy as a precondition for the application of the BIT, this would increase the costs of the investment and thus reduce the value of other clauses, even if broadly defined.

6. Concluding remarks Already 700 BITs have been included in a database, which builds on the criteria explained above and which provides a detailed reading of recent legal advances in investment rule-making. This allows a finer appreciation of how rules have evolved in response to various stimuli, as well as allowing a better sense of the extent to which such agreements have been drivers of investors’ strategies. This type of information will enable us and other researchersv to analyse questions, such as:



Julien Chaisse and Christian Bellak

• • • • • • •

How do the different elements and their broader or narrower formulation impact on FDI? Which countries favour certain kinds of provisions? Do patterns of provisions differ between N-S and S-S BITs? Is a shift between narrow and broad provisions discernible over time? How do combinations of different elements impact on FDI? How can negotiators decide to adjust the provisions to their specific needs? Could negotiators adopt a different template for each new negotiations (or renegotiations)?

Answering these questions will provide valuable information for decision-makers, both in the field of consulting countries, when concluding new BITs or revising existing BITs, as well as for the design of national policies or the advancement of the EU investment policy. More knowledge on how the different elements of BITs impact on FDI would enable countries, particularly developing countries, to develop negotiating strategies which will eventually yield results that better serve their social and economic goals while protecting their development needs. Finally, whereas the more subtle differences between BITs (the gradual nature of some clauses) cannot be fully grasped by our approach, we believe it is a step in the right direction to improve the future performance of BITs and provisions included in other international treaties with respect to FDI, an issue which is heavily debated in the empirical literature.    

References Aisbett, Emma Kate (2009). “Bilateral Investment Treaties and Foreign Direct Investment: Correlation versus Causation” in: Karl P. Sauvant; Lisa E. Sachs, “The Effect of Treaties on Foreign Direct Investment” (Oxford: Oxford University Press) 395–435. Büthe, Tim; Milner, Helen v. (2008) “The Politics of Foreign Direct Investment into Developing Countries: Increasing FDI through International Trade Agreements?” American Journal of Political Science, Vol. 52, No. 4, October 2008, 741–762 Busse, Matthias; Königer, Jens; Nunnenkamp, Peter (2010) “FDI promotion through bilateral investment treaties: More than a bit?” Review of World Economics, Vol. 146, Issue 1, 147–177.

Acknowledgements This article is part of the research entitled “Revisiting the role of legal parameters in economic empirical research” led by Christian Bellak and Julien Chaisse since May 2010 and supported by the Chamber of Labour (Arbeitskammer), Vienna (Austria). Eleonora Kalivoda provided excellent research assistance for the empirical part.



Do Billateral Invesstment Treatties Promote e Foreign Dirrect Investm ment? About the e Authors Christia an Bellak in th he Department of Econom mics; Dr. Bella ak works primarily on interna ational factorr flows, such h as Foreign Direct Investm ment and Migration. He teaches “econo omic policy” and a “law and eco onomics of FDI”. He also has research h interests in the area of economic policy and a industrial policy. C holdss a PhD in in nternational economic law and has Julien Chaisse develop ped practical and theoreticcal expertise in Internation nal trade law, Eu uropean econ nomic law, an nd the interna ational law of o foreign direct inve estment.

Contact Information aisse, Assista ant Professorr (Research), Faculty of La aw at 5/F, Lee e Shau Kee Building. B The Chinese Julien Cha Universityy of Hong Ko ong, Sha Tin n, NT, Hong Kong SAR, E-mail: [email protected], Website: W www.law.ccuhk.edu.hk/p people/chaissse-julien.php. Christian Bellak, Asssociate Proffessor, Deparrtment of Eco onomics, WU U, Augasse 2-6. 2 1090 Vie enna, Austria, E-mail: bellak@w wu.ac.at, Webs site: www.wu.ac.at/usr/vw4 4/bellak/

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Increasing coordination n of external ecconomic relations within thee EU may soonn expand the BITs’ B scope annd lead to o countriess. This would arguably connstitute an the emergeence of EU IIAs and broad-encompassingg PTAs with other important step s towards more m coherencee; this is becausse, firstly, EU countries are amongst a the moost active negootiators of BITS and the number off such agreemeents may thus be diminishedd internationallly, and, seconndly, a European model a important siggnalling effectt which will noot be overlookeed internationallly. may arguabbly also have an 2

For the tiime being, it remains r uncleaar, why this efffect is much loower. An econnometric meta--analysis by Bellak B and Kalivoda (2011) confirm ms that the meaasurement of FDI F as a flow has h a substantial negative im mpact on the siize of the t confirms the t descriptivee evidence. effect and thus 3

A beta coefficient c is in nterpreted in the t following way: How larrge is the channge in FDI (inn terms of perrcent of a standard deeviation of FDII) resulting from a one standaard deviation change c in a regrressor. 4

All publiic entities are bound by thee international obligations, including the federal f and suub-federal goveernments, where applicable, local authorities, reggulatory bodiees, and entitiess that exercisee delegated puublic powers. Measures adopted byy private actors can also – although a ratherr exceptionallyy – fall under the t scope of innternational aggreements when such private measu ures can ultimattely be attributted to a governmental entity. 5

The databbase will be made m public oncce completed.

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