Regulating Foreign Investment: A Study of the Properties of Bilateral Investment Regimes

Abstract

In this paper, we argue that the signing of Bilateral Investment Treaties (BITs) can be explained by its dierential impact on welfare and the distributive consequences of regulating and enforcing investment standards at the international level. We develop a model that formalizes the logic prevalent in the extant literature on the political economy of BITs. Following that literature we assume that governments compete for a (xed) supply of domestic and foreign investment; we also assume that investors care about the expected return from their investment; and that investing abroad involves higher costs and risks than at home. Investors’ decisions are thus the outcome of a mean-variance optimization problem that explicitly accounts for this home country bias. The interaction between governments is modeled as a network formation process where nodes (countries) choose which arcs to add (treaties to sign). We explicitly model the main provisions of BITs as an enforcement technology that has the potential to reduce costs and risk of investing in the signatory parties; we also model BITs potential to increase the return to investors, as discussed in the literature. In deciding which treaties to sign, governments internalize the potential eects of inward investment on the return to domestic factors of pro