DR.

RAM MANOHAR LOHIYA NATIONAL

LAW UNIVERSITY

PUBLIC INTERNATIONAL LAW

Do BITs Promote Foreign Direct Investment ?

Submitted to :- Submitted by :-
Dr. Manwendra Tiwari Chaitanya
Assistant Professor 170101047

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TABLE OF CONTENT

INTRODUCTION 3

BILATERAL INVESTMENT TREATIES, CREDIBLE COMMITMENT &

RULE OF INTERNATIONAL LAW 4

BITS AND FDI DLOW 7

CONCLUSION 9

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INTRODUCTION
A BIT is an agreement between two countries that sets up “rules of the road” for foreign investment
in each other’s countries.When countries enter into a BIT, both countries agree to provide
protections for the other country’s foreign investments that they would not otherwise have. A BIT
provides major benefits for investors in another country, including national treatment, fair and
equitable treatment, protection from expropriation and performance requirements for investments,
and containing dispute settlement provision allowing investors to unilaterally initiate binding
against state hosting their investment. Treaties have great potential to ‘credibly commit’ developing
countries to pro investment policy by using formal International law to ‘tie the hands’ of policy
maker. In exchange for accepting legal limits on their policy autonomy, the developing countries
can see a corresponding increase in foreign direct investment (FDI). BITs tend to adopt a common,
legal formalist view of how the treaties “work” that places primary theoretical emphasis on access
to International Arbitration. IAs seek to promote FDI by contributing to the creation of stable and
favourable legal environment for investment. The assumption is that clear and enforceable rules
protecting foreign investors reduce political risks and thereby increase the attractiveness of host
countries (Salacuse and Sullivan, 2005: 95; Vandevelde 2005: 171). Furthermore, by granting
foreign investors access to international arbitration, host country governments make a strong
commitment to honour their obligations, which should further enhance investor confidence. IAs
might solve in particular the problem of “obsolescing bargaining”. Since the nationalizations of the
second half of the past century, the risk of “obsolescing bargaining” has been widely recognized as
a major potential deterrent to new investment in developing countries, especially in natural
resources and infrastructure. Foreign investors may fear that once the investment is sunk, a host
country might act opportunistically and unduly interfere with the profitability of investment (Wells
and Ahmed, 2007: 66). A BIT ensures that foreign governments will treat investors the same as
domestic companies; this right is known as “national treatment.” BITs also guarantee that investors
are given the same types of preferences that other foreign investors are given in a market, also
called “most-favored nation” treatment.The promise of equal treatment applies to investments made
prior to the time the BIT enters into force and to new investments in the market. That means that
BITs bar foreign governments from using investment restrictions, like ownership caps, to prevent
foreign companies from investing in their markets.

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BILATERAL INVESTMENT TREATIES, CREDIBLE
COMMITMENT & RULE OF INTERNATIONAL LAW
The FDI surge during the past few decades has been accompanied by a similar growth of
international investment agreements. Pride of place among these agreements belongs to BITs—
treaties that seek to protect and promote foreign investment. To put the evolution of BITs into a
historic context, Kenneth Vandevelde traces the history of such agreements. He distinguishes three
eras of BIT development (Colonial Era, Post-Colonial Era, Global Era), and describes how
investment agreements have been shaped by the political, economic and legal contexts of each
period. He also discusses broadly the evolution of the content of BITs as well as the legal
enforceability of their substantive provisions, and articulates several current developments that may
herald a fourth era in their development.
By the end of 2006, 2,573 BITs had been signed,12 most of them since 1990. In fact, from 1959
(when the first BIT was concluded between Germany and Pakistan) until the end of 1989, only 386
BITs had been signed; more than 2,000 BITs were entered into in the following 15 years. By the end
of 2006, 177 countries had entered into one or more bilateral investment treaties. (UNCTAD has the
best database of BITs, available on its website at http://www.unctad.org/iia.) While BITs were
originally signed overwhelmingly between developed and developing countries, developing
countries now routinely sign investment treaties with other developing countries (and economies in
transition). Indeed, 680 BITs had been signed between developing countries by the end of 2006.
BITs only become legally binding instruments when they enter into force. Although the signing of a
BIT may have some legal consequences for host countries under international law, this act does not
“establish legally binding obligations of the latter vis-à-vis the foreign investors.”15 Some BITs
stipulate that the agreement enters into force upon the signature of both parties. Most BITs,
however, require each party to complete the domestic requirements necessary for the BITs’ entry
into force, for instance the ratification by a national parliament and the notification of ratification to
the treaty partner.
BITs are agreements between two sovereign states. From the point of view of the capital- importing
country, their basic purpose is to help to attract FDI. From the point of view of the capital-exporting
country, the basic purpose of BITs is to protect investors from political risks and instability and,
more generally, safeguard the investments made by its nationals in the territory of the other state.17
This is why, originally, they were concluded primarily between developed and developing
countries, as the former were virtually the only sources of FDI, and the latter were seen as often
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having risky and volatile business environments. Some of the more recent BITs, especially those
with the United States and Canada, go further than protecting investors’ rights and require the
liberalization of certain aspects of the FDI regime of a host country, for example by including
provisions of national and most-favored-nation treatment at the establishment phase of an
investment18 or by prohibiting host country governments from imposing certain performance
requirements on foreign investments.
modern BITs, afford investors an adjudicatory mechanism to enforce substantive rights.21
Typically, investors can choose between arbitral panels at the World Bank’s International Centre for
Settlement of Investment Disputes (ICSID), arbitration at another designated forum22 or ad hoc
arbitration proceedings (especially UNCITRAL). This dispute settlement provision provides
investors a remedy for unlawful or uncompensated actions by host states that affect their
investments, usually without having to exhaust local remedies first before resorting to international
arbitration. The designation of a third-party arbitration process frees investors from reliance on the
political and judicial processes of host countries (which they often consider—rightly or wrongly—
as being insufficient), and gives them direct access to protection under international law. If the
proceeding is conducted under the ICSID Convention, the arbitration process is beneficial for the
respondent state because it eliminates the possibility of diplomatic protection by the investor’s
home country. While the ICSID Convention (Article 36.1) provides that both host country
governments of contracting states and investors of contracting states can initiate investment-dispute
settlement proceedings, BITs limit such initiation to investors.23
There were only a handful of internationally arbitrated investor-state disputes in the 1980s and early
1990s; however, by the end of 2007, 290 known international treaty-based arbitration cases had
been initiated, involving at least seventy-three countries—fifteen developed countries, forty- four
developing countries, and fourteen economies in transition.24 Over three-quarters of these cases
had arisen since the beginning of 2002, and close to two-thirds of them were filed with ICSID (or
the ICSID Additional Facility).
In the empirical literature, evidence on the effects of BITs on FDI is mixed and the role
international dispute settlement provisions play in attracting FDI has hardly been analyzed. The
question of whether BITs, and especially international dispute settlement provisions, are actually
able to achieve their purpose and attract FDI. International dispute settlement constitutes the most
distinguished feature of BITs. The literature argues that international dispute settlement clauses are
a crucial component of BITs as they provide a way to sanction deviating behavior, determine the
credibility of legal promises, and allow investors to enforce their rights independent of the local
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level of the rule of law. Thus, it can be presumed that BITs that grant extensive access to
independent international arbitration have a different effect on FDI than BITs with weaker
international dispute settlement provisions
BITs as a commitment device can help overcome the described time-inconsistency problem.
Especially, ISDS allows countries to credibly commit themselves not to change the terms of an
investment after it is established. The possibility for investors to gain compensation through ISDS
in case host countries pursue discriminatory or discretionary behavior decreases the incentives of
governments to treat FDI unfavorably. Following this reasoning, one might expect that the effect of
BITs on FDI is stronger if international dispute settlement provisions in BITs are stricter. Allee and
Peinhardt (2010) claim that international dispute settlement clauses provide the pivotal legal
characteristic of any BIT, as they determine the costs host countries face when violating a BIT.
Stricter international dispute settlement provisions give investors a higher chance to get
compensation when faced with a breach of a BIT. The consequences that can result from a breach of
the treaty, enforced by the international dispute settlement mechanism, ensure that host countries
will not expropriate or discriminate foreign investment. This cost can either be financial or can be
caused by a loss of reputation, when other investors realize that a host country is taking its promises
not seriously.
Credible commitment theory of BITs ignore the “three distinct characteristics of law” identified by
scholars operating in the law and society tradition: legal ignorance, legal pluralism, and legal
ambiguity.
Legal Ignorance : Decision makers in business often have little accurate knowledge of the content
of governing legal rules. There is unsurprisingly also very little evidence that foreign investors have
much knowledge pf the existence or content of particular BITs, or much appreciation for theoretical
ways in which the International legal system might secure their investments. A small survey of
business executives conducted in 1976 found only 16% of respondents were familiar with ICSID
system generally, and that only 4% felt that ICSID provided adequate safeguard. It means that BIT
and BIT-based arbitration remain an “overlooked tool” in the legal arsenal of multi national
corporations. Even where certain individuals within those corporation might follow BIT
development, this specialised legal knowledge may fail to flow to the non lawyer managers and
executive who actually make business decision.
Legal Pluralism : Credible commitment theories of BITs tend to ignore alternative informal and
formal institution that might successfully resolve problems of obsolescing bargain, rendering BITs,
as a credible commitment devices, largely redundant . Foreign investors have long had the ability to
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create their own indiviualized “BITs” in the form of legally binding investment contract. These
contract based arbitration agreement often reference the very same arbitral facilities named in BITs
and they, as well as resulting arbitral awards, are just as enforceable against host state as are BIT
based arbitrations and awards.
Legal Ambiguity : The substantive promises contained in BITs consist almost entirely of high
ambiguous standards of uncertain meaning and application. This ambiguity is arguably so great that
the treaties “may best be conceptualised not as on objective eternal constraint but rather as a source
of uncertainty. Substantive ambiguity means that arbitral tribunals have trouble interpreting or
applying the treaties consistently, a problem that has lead some observers to claim that BIT system
is suffering from a “legitimacy crisis”. Substantive ambiguity also means that treaties are unlikely
to be of much concrete use to investors in investment- planning process, as it is difficult, if not
impossible, for investor to determine prior how a tribunal will interpret or apply a given promise in
given fact situation.

BITS AND FDI DLOW

Analyzing the impact of BITs with OECD countries on aggregate FDI inflows to 100 developing
countries, Salacuse and Sullivan found that, when developing countries concluded BITs with OECD
countries, FDI inflows were likely to increase. Furthermore, they determined that a U.S. BIT was
likely to have more of an impact than other OECD BITs in promoting overall FDI, and that a U.S.
BIT was likely to promote U.S. FDI as well. Similarly, Eric Neumayer and Laura Spess , looking at
119 developing countries between 1970 and 2001, found that developing countries that signed more
BITs with developed countries that were major source countries of FDI received a higher share of
FDI flowing to developing countries.
Most authors agree that the strength of the impact of BITs on FDI inflows depends on several
political, regulatory and economic factors, both within the host country and globally. For instance,
Neumayer and Spess found that countries with faster-growing economies and larger populations
receive more FDI. Moreover, they suggested that BITs may in fact function as substitutes for poor
host country institutional quality. Precisely because political risk and volatility are constraints on
FDI inflows, Neumayer and Spess suggested that countries “with particularly poor domestic
institutional quality possibly stand the most to gain from BITs,” and that the positive effect of BITs
on FDI decreases as governments become more stable. In fact, it is possible that merely signing a
BIT, before implementation actually occurs, has a positive signaling effect, as Peter Egger and

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Michael Pfaffermayr’s analysis of outward FDI stock from OECD countries suggested, though they
did find that BITs that have entered into force have a stronger positive effect on outward FDI stock
than those that have merely been signed. Buthe and Milner developed a theoretical argument that
explains an increase in overall inward FDI flows as a function of the success of BITs as a political
commitment by developing countries to economically liberal policies, which foreign direct
investors generally seek, at least in developing countries. Investors consider these commitments to
be more credible because BITs signal such commitments and governments’ compliance with them
and, in addition, make breaking such commitments more costly.
A 1998 UNCTAD study, one of the first to evaluate the impact of BITs on FDI flows, concluded
that, on balance, BITs did not play a primary role in increasing FDI, and that a larger number of
BITs ratified by a host country would not necessarily lead to higher FDI inflows. In another early
study, Mary Hallward-Driemeier analyzed the bilateral flow of FDI from 20 OECD countries to 31
developing countries from 1980 to 2000 and noted that BITs had an insignificant effect on FDI
flows. However, she also found that, rather than encouraging more FDI flows in riskier
environments, BITs only have a positive effect on FDI flows in countries with an already stable
business environment and reasonably strong domestic institutions. If a country signs a BIT while
undertaking domestic regulatory reforms that facilitate FDI, it would be the institutional reforms
and liberalization that may affect investors’ locational decisions rather than simply the BIT itself.
Hallward-Dreimer’s results suggested that the size of a host country’s market is a more conclusive
determinant of FDI flows than the conclusion of a BIT.
In an experiment of TSCS analysis of the effects of BITs on FDI. Differentiating BITs by effective
dispute settlement provision alters our understanding of the start of what I would call the “modern”
BIT era, which is characterised by widespread acceptance of BIT based arbitration. Separating out
strong from weak BITs provides a potentially more meaningful test of underlying thesis of the
study: that the treaties formal legal credible commitment potential substantially impacts foreign
decision. From the findings Baseline Additive Model a conclusion can be drawn that, we see no
consistent evidence that investors view BITs as valuable credible commitment devices.
The competitive theory of BITs suggests that Strong BITs should be most effective at attracting
foreign investment when there are few such treaties in force among competitor countries. Tn this
view strong BITs is most likely to have positive and statistically significantly effects when Regional
Strong Bits is low in number. We would thus expect to see, at low values of Regional Strong BITs,
positive marginal effects estimate along with confidence intervals that are consistently above zero
line.
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CONCLUSION
The increased importance of foreign direct investment over the past few decades was accompanied
by a rise in the popularity of BITs. While the number of new BITs continuously increased in the
1990s and 2000s, their number has recently stagnated. Responding to an intense political debate,
some countries even started to withdraw from such treaties. This development goes hand in hand
with a vivid discussion on the effectiveness of BITs in attracting FDI. Especially the advantages of
ISDS are heavily disputed. Remarkably high compensation claims in some arbitration cases have
also increased the awareness of host countries of the risk of high cost associated with ISDS. In
addition, countries have become increasingly aware of the downsides associated with the restriction
of policy autonomy when signing a BIT. Further- more, the empirical evidence on the BIT effects
on FDI activity has so far been weak and there has so far been hardly any evidence on a relationship
between the strength of international dispute settlement provisions in BITs and FDI activity. We
address this issue by directly analyzing the effect of a BIT’s international dispute settlement
provision strength on FDI. Against this background we use data from the UNCTAD’s International
Investment Agreement Mapping Project (UNCTAD, 2017) and develop an index measuring the
international dispute settlement provisions strength of 1,676 BITs. We apply this new index to the
question whether BITs positively affect FDI activity. More specifically, we use a panel data model
for bilateral and total FDI inflows and inward FDI stocks to empirically examine the effect of
international dispute settlement provisions in BITs on FDI.

The principal finding from the empirical analyses shown here is that government commitment to
treaties needs to be made credible before it can have any effect. Simply ratifying a treaty no matter
what it promises seems to have little effect. To show this I have extended the coding developed by
Yackee (2007a) over a broader set of countries and time periods. Further in extending this coding
across a broader set of treaties, I am also able to track how the ISDS provisions change after BIT
renegotiations. Most importantly, this research provides an illustration of how BITs can matter
when it comes to not only shaping the reputation of states participating in this regime but also the
level of FDI flows they can expect to attract. This is in contrast to much of the extant empirical
work on this issue that has typically focused on just the relationship between BITs and FDI.
The broader implication of this is that at most international institutions provide a signal of what a
signatory government is willing to accept, and that signal remains only as powerful as the
governments commitment to it. If a government desires to break a commitment, even as one as
strong as a BIT, they are only limited in their attempts to do so by their ingenuity. In the case of
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BITs, countries have taken steps as diverse as renegotiating treaties to strip away ISDS provisions to
simply ignoring the rulings of arbitration tribunals. In assessing the effect of BITs and whether or
not they fall into a credible commitment or signaling paradigm, the literature has so far paid less
attention to the fact that the treaties themselves should not be considered static. These treaties have
evolved in interesting ways as countries have realized their costs, and through assessing their
evolution we are able to better understand their effect.
Our main findings indicate that stronger international dispute settlement provisions in BITs are
indeed associated with more FDI activity. In a bilateral setting, we estimate that on average a one-
point increase in the new index is associated with a 3.9 per cent increase in FDI inflows from the
partner country. We also show that this relationship between international dispute settlement
provisions and BITs holds, when we use FDI stock as a dependent variable instead of FDI inflows.
Moreover, if we restrict the sample of host countries to developing countries the effects of BITs on
FDI activity increase slightly. We estimate that for developing host countries on average an increase
of the BIT index of one point leads to a 4.3 per cent increase of FDI inflow from the partner
country. On the basis of our analysis we conclude that international dispute settlement provisions
indeed play a crucial role in the FDI-enhancing effect of BITs. The stricter the rules on international
dispute settlement provisions are, and thus the better the possibilities for investors to represent their
rights, the higher is the effectiveness of BITs in attracting FDI. However, there seems to also be
some evidence that already the sheer existence of BITs attract foreign investors. We estimate that a
BIT on average increases inward FDI inflows from the respective partner country by 52 per cent.

From a policy point of view our results support the argument that international dispute settlement
provisions are a key component of BITs and should play an important role in the design of BITs.
Stricter international dispute settlement provisions in BITs are better suited to fulfill their purpose in
attracting FDI. Hence, governments looking for a way to foster the inflow of FDI should be aware
of the importance of international dispute settlement provisions. Notwithstanding the individual
preferences of countries regarding the degree by which they are willing to “tie their hands” through
BITs and international dispute settlement provisions, policy makers should be aware of the fact that
the incentive for foreign investors to invest abroad is strongly connected with international dispute
settlement provisions.

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