《国际政治经济学》文献资料（Institutions and International Political Economy）Contingent Credibility The Impact of Investment Treaty Violations on Foreign Direct Investment

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Contingent Credibility:The Impact of Investment Treaty Violations on Foreign Direct Investment Todd Allee and Clint Peinhardt Abstract During the past few decades governments have signed nearly 2,700 bilateral investment treaties (BITs)with one another in an attempt to attract greater levels of foreign direct investment(FDI).By signing BITs,which contain strong enforcement provisions,investment-seeking governments are thought to more cred- ibly commit to protecting whatever FDI they receive,which in turn should lead to increased confidence among investors and ultimately greater FDI inflows.Our unique argument is that the ability of BITs to increase FDI is contingent on the subsequent good behavior of the governments who sign them.BITs should increase FDI only if governments actually follow through on their BIT commitments;that is,if they com- ply with the treaties.BITs allow investors to pursue alleged treaty violations through arbitration venues like the International Centre for the Settlement of Investment Dis- putes (ICSID),a heavily utilized and widely observed arbitral institution that is part of the World Bank.Being taken before ICSID,then,conveys negative information about a host country's behavior to the broader investment community,which could result in a sizeable loss of future FDI into that country.We test these contingent effects of BITs using cross-sectional,time-series analyses on all non-OECD coun- tries during a period spanning 1984-2007.We find that BITs do increase FDI into countries that sign them,but only if those countries are not subsequently challenged before ICSID.On the other hand,governments suffer notable losses of FDI when they are taken before ICSID and suffer even greater losses when they lose an ICSID dispute. For developing countries,signing bilateral investment treaties (BITs)has become an attractive way to try to stimulate greater inward foreign direct investment(FDI). By granting numerous substantive rights to investors and allowing for inter- national arbitration of any disputes that arise,signatory governments signal their For helpful comments on this article we thank Tana Johnson,Kris Miler,Irfan Nooruddin,Stephanie Rickard,seminar participants at Ohio State University and Texas A&M University,as well as panel participants at the 2008 American Political Science Association conference,the 2d Annual Conference on the Political Economy of International Organizations,and the 2009 Midwest Political Science Asso- ciation conference. International Organization 65,Summer 2011,pp.401-32 2011 by The IO Foundation. do:10.1017/S0020818311000099

Contingent Credibility: The Impact of Investment Treaty Violations on Foreign Direct Investment Todd Allee and Clint Peinhardt Abstract During the past few decades governments have signed nearly 2,700 bilateral investment treaties ~BITs! with one another in an attempt to attract greater levels of foreign direct investment ~FDI!+ By signing BITs, which contain strong enforcement provisions, investment-seeking governments are thought to more credibly commit to protecting whatever FDI they receive, which in turn should lead to increased confidence among investors and ultimately greater FDI inflows+ Our unique argument is that the ability of BITs to increase FDI is contingent on the subsequent good behavior of the governments who sign them+ BITs should increase FDI only if governments actually follow through on their BIT commitments; that is, if they comply with the treaties+ BITs allow investors to pursue alleged treaty violations through arbitration venues like the International Centre for the Settlement of Investment Disputes ~ICSID!, a heavily utilized and widely observed arbitral institution that is part of the World Bank+ Being taken before ICSID, then, conveys negative information about a host country’s behavior to the broader investment community, which could result in a sizeable loss of future FDI into that country+ We test these contingent effects of BITs using cross-sectional, time-series analyses on all non-OECD countries during a period spanning 1984–2007+ We find that BITs do increase FDI into countries that sign them, but only if those countries are not subsequently challenged before ICSID+ On the other hand, governments suffer notable losses of FDI when they are taken before ICSID and suffer even greater losses when they lose an ICSID dispute+ For developing countries, signing bilateral investment treaties ~BITs! has become an attractive way to try to stimulate greater inward foreign direct investment ~FDI!+ By granting numerous substantive rights to investors and allowing for international arbitration of any disputes that arise, signatory governments signal their For helpful comments on this article we thank Tana Johnson, Kris Miler, Irfan Nooruddin, Stephanie Rickard, seminar participants at Ohio State University and Texas A&M University, as well as panel participants at the 2008 American Political Science Association conference, the 2d Annual Conference on the Political Economy of International Organizations, and the 2009 Midwest Political Science Association conference+ International Organization 65, Summer 2011, pp+ 401–32 © 2011 by The IO Foundation+ doi:10+10170S0020818311000099

402 International Organization receptiveness to outside investment and commit to protect whatever investment they receive.In turn,foreign investors should be more willing to invest in coun- tries who have signed BITs because of these additional protections.This is the standard account advanced in existing scholarship on the effects of BITs on FDI. Yet the investment-treaty story does not end once an agreement is signed.Instead, investors will look to see whether the promises made in the treaties are being upheld and will reevaluate their investment decisions as new information is revealed.Gov- ernments that sign BITs,then,could receive more or less investment in the years after they sign the treaties. To provide a more complete answer to the central question of whether these treaties are effective in generating greater investment,we shift the study of BIT effects in an important new direction by emphasizing compliance,or lack thereof, with the treaties.We inject an important,overlooked caveat to the claim that BITs should be beneficial:governments who sign BITs should receive greater FDI,but only if they are not later revealed to have violated their treaty commitments.Exist- ing studies typically record when a state signs a BIT and then examine whether more FDI flows to that state from that point onward.In effect,ongoing future compliance with the treaties is assumed.Yet this assumption is rendered problem- atic by the emergence of a significant number of investor-state disputes in which an investor explicitly claims that a BIT signatory is not complying with its treaty obligations.Therefore,compliance with the treaties,as revealed by the presence or absence of subsequent treaty-related disputes,should be a critical determinant of BITs'ability to stimulate greater investment. Our central claim is that the net investment effect of BITs is contingent upon the future behavior of the governments who sign them.Investment treaties should stimulate greater investment flows into signatories provided that no new informa- tion arises that contradicts the investor-friendliness signified by the treaty.How- ever,given the substantial uncertainty that surrounds investment decisions,any new information that reveals a weak host-state commitment to respect FDI could damage that state's reputation in the eyes of investors.Once an investment dispute emerges,investors will rethink their assessments of political risk in the "defen- dant"country and be less likely to invest in a country with a now questionable track record. The key cog in this theoretical account is the international arbitration institu- tion,which reveals information to investors about whether governments are uphold- ing the terms of the treaties.These legal institutions,which are largely neglected in FDI studies within political science and economics,generate new information that is salient to investors as long as the cases taken before them are observable and legal judgments are not rendered confidentially.Most disputes arising from BITs are taken before the International Centre for the Settlement of Investment Disputes (ICSID),a prominent and heavily utilized arbitral institution affiliated with the World Bank.The ICSID arbitration process transmits information to global investors and thus has the potential to reduce future investment in two ways.First, the mere appearance of a government before an arbitration venue like ICSID sends

receptiveness to outside investment and commit to protect whatever investment they receive+ In turn, foreign investors should be more willing to invest in countries who have signed BITs because of these additional protections+ This is the standard account advanced in existing scholarship on the effects of BITs on FDI+ Yet the investment-treaty story does not end once an agreement is signed+ Instead, investors will look to see whether the promises made in the treaties are being upheld and will reevaluate their investment decisions as new information is revealed+ Governments that sign BITs, then, could receive more or less investment in the years after they sign the treaties+ To provide a more complete answer to the central question of whether these treaties are effective in generating greater investment, we shift the study of BIT effects in an important new direction by emphasizing compliance, or lack thereof, with the treaties+ We inject an important, overlooked caveat to the claim that BITs should be beneficial: governments who sign BITs should receive greater FDI, but only if they are not later revealed to have violated their treaty commitments+ Existing studies typically record when a state signs a BIT and then examine whether more FDI flows to that state from that point onward+ In effect, ongoing future compliance with the treaties is assumed+ Yet this assumption is rendered problematic by the emergence of a significant number of investor-state disputes in which an investor explicitly claims that a BIT signatory is not complying with its treaty obligations+ Therefore, compliance with the treaties, as revealed by the presence or absence of subsequent treaty-related disputes, should be a critical determinant of BITs’ ability to stimulate greater investment+ Our central claim is that the net investment effect of BITs is contingent upon the future behavior of the governments who sign them+ Investment treaties should stimulate greater investment flows into signatories provided that no new information arises that contradicts the investor-friendliness signified by the treaty+ However, given the substantial uncertainty that surrounds investment decisions, any new information that reveals a weak host-state commitment to respect FDI could damage that state’s reputation in the eyes of investors+ Once an investment dispute emerges, investors will rethink their assessments of political risk in the “defendant” country and be less likely to invest in a country with a now questionable track record+ The key cog in this theoretical account is the international arbitration institution, which reveals information to investors about whether governments are upholding the terms of the treaties+ These legal institutions, which are largely neglected in FDI studies within political science and economics, generate new information that is salient to investors as long as the cases taken before them are observable and legal judgments are not rendered confidentially+ Most disputes arising from BITs are taken before the International Centre for the Settlement of Investment Disputes ~ICSID!, a prominent and heavily utilized arbitral institution affiliated with the World Bank+ The ICSID arbitration process transmits information to global investors and thus has the potential to reduce future investment in two ways+ First, the mere appearance of a government before an arbitration venue like ICSID sends 402 International Organization

The Impact of Investment Treaty Violations on Foreign Direct Investment 403 a negative but noisy signal to investors that could make them hesitant to direct future investment into that country.Second,losing an arbitral panel ruling should be particularly damaging,since it provides more precise information to investors about what a government has done and the definitive illegality of its actions. Our empirical tests reveal robust support for these hypothesized relationships between investment dispute activity and future FDI inflows.We find that signing BITs is associated with greater future investment,ceteris paribus,but BIT-signatory governments whose policies are challenged before an international arbitration body consistently receive less FDI afterwards.If the government ultimately loses the dispute,it suffers an even greater loss in inward FDI,which can more than offset any gains received from signing even multiple BITs.Overall,the empirical evi- dence reveals that BITs,through their provisions for dispute resolution,help those governments who steer clear of treaty violations but harm those who fail to com- ply with the terms of the treaties. Theoretical Development BITs arose a half-century ago to govern and stimulate investment between con- tracting parties and now serve as the primary international vehicle by which FDI is regulated.According to recent estimates from the United Nations Conference on Trade and Development(UNCTAD),179 countries are parties to at least one BIT,and these countries have signed a total of 2,676 BITs with one another.'Coun- tries as diverse as Germany,Italy,China,and Egypt have signed more than 100 BITs with various partners,which attests to the widespread global coverage of the treaties.2 Irrespective of the identity of the signatories,a defining feature of BITs is that they historically have been signed between a capital-rich"home"country, which is the likely source of any investment,and a developing"host"country that seeks to attract greater investment from investors in the home country.3 BITs represent the latest and most widespread attempt by governments to address the pervasive time inconsistency problem that plagues much foreign investment.4 Before any investment is made,investors from the home country have consider- able bargaining leverage over potential host governments who seek to attract the investment.But once the investment is made and costs are sunk,bargaining lever- age shifts to the host government,who then may face political and/or economic 1.See UNCTAD 2008a,2-3,and 2009,1. 2.UNCTAD2009.3. 3.South-South BITs represent a relatively small percentage (26 percent)of all BITs,and this per- centage is declining.UNCTAD(2009,5)reports that only thirteen out of fifty-nine (22 percent)of BITs signed in 2008 were between developing countries. 4.Vernon 1971 describes the fundamental "obsolescing bargain"problem,in which the host state cannot credibly promise to refrain from trying to extract a greater share of the return from an invest- ment once it is sunk

a negative but noisy signal to investors that could make them hesitant to direct future investment into that country+ Second, losing an arbitral panel ruling should be particularly damaging, since it provides more precise information to investors about what a government has done and the definitive illegality of its actions+ Our empirical tests reveal robust support for these hypothesized relationships between investment dispute activity and future FDI inflows+ We find that signing BITs is associated with greater future investment, ceteris paribus, but BIT-signatory governments whose policies are challenged before an international arbitration body consistently receive less FDI afterwards+ If the government ultimately loses the dispute, it suffers an even greater loss in inward FDI, which can more than offset any gains received from signing even multiple BITs+ Overall, the empirical evidence reveals that BITs, through their provisions for dispute resolution, help those governments who steer clear of treaty violations but harm those who fail to comply with the terms of the treaties+ Theoretical Development BITs arose a half-century ago to govern and stimulate investment between contracting parties and now serve as the primary international vehicle by which FDI is regulated+ According to recent estimates from the United Nations Conference on Trade and Development ~UNCTAD!, 179 countries are parties to at least one BIT, and these countries have signed a total of 2,676 BITs with one another+ 1 Countries as diverse as Germany, Italy, China, and Egypt have signed more than 100 BITs with various partners, which attests to the widespread global coverage of the treaties+ 2 Irrespective of the identity of the signatories, a defining feature of BITs is that they historically have been signed between a capital-rich “home” country, which is the likely source of any investment, and a developing “host” country that seeks to attract greater investment from investors in the home country+ 3 BITs represent the latest and most widespread attempt by governments to address the pervasive time inconsistency problem that plagues much foreign investment+ 4 Before any investment is made, investors from the home country have considerable bargaining leverage over potential host governments who seek to attract the investment+ But once the investment is made and costs are sunk, bargaining leverage shifts to the host government, who then may face political and0or economic 1+ See UNCTAD 2008a, 2–3, and 2009, 1+ 2+ UNCTAD 2009, 3+ 3+ South-South BITs represent a relatively small percentage ~26 percent! of all BITs, and this percentage is declining+ UNCTAD ~2009, 5! reports that only thirteen out of fifty-nine ~22 percent! of BITs signed in 2008 were between developing countries+ 4+ Vernon 1971 describes the fundamental “obsolescing bargain” problem, in which the host state cannot credibly promise to refrain from trying to extract a greater share of the return from an investment once it is sunk+ The Impact of Investment Treaty Violations on Foreign Direct Investment 403

404 International Organization incentives to renege on the contract.It is therefore difficult for investors to deter- mine ex ante a host government's true,long-term commitment to foreign partici- pation in the domestic market. Existing Research on the FDI Effects of BITs BITs reassure fearful investors in two ways.5 First,signing BITs is a way for host governments to signal their true intention to refrain from interfering with foreign investment.According to this "signaling"logic,negotiating a BIT is a way for an investment-seeking government to convey its seriousness about protecting inward investment.Governments that sign multiple treaties may be able to send a more effective signal,and this accumulation of numerous treaties demonstrates a stronger general commitment to protect investment and to promote a healthy investment climate for all foreign investors.To be effective,however,the signals must be "costly,"or informative enough to differentiate committed liberalizers from gov- ernments with other intentions.The major worry for investors is that an initial signal to protect investment may turn out to be"cheap talk,"if a government later changes course and behaves in ways that are hostile toward investment. A second line of argument is that BITs increase the credibility of host states' promises to abide by the terms of a contract,which then should stimulate greater inward FDI.BITs provide significant protections to foreign investors because they include provisions on national treatment,most-favored nation status,the ability to repatriate profits,and appropriate compensation in the event of a taking.Most importantly,these promises are made credible due to investor-state dispute settle- ment clauses that allow aggrieved investors to challenge via international arbitra- tion any policies of host governments that violate these BIT commitments.3 A government that violates its treaty commitments and is challenged by investors through international arbitration would suffer direct financial costs of contesting the litigation,reputational costs associated with being a defendant,and the pay- ment of a potentially sizable arbitration award.Therefore,a BIT signatory is likely to uphold the treaty's terms because of the prospect of these self-inflicted costs, which in turn should reassure investors,who then are more likely to invest in the country.Many scholars utilize some type of credibility-based logic to argue that BITs should lead greater FDI to flow into signatories.Several studies provide 5.For an excellent review and discussion of the arguments that have been applied to BITs,see Buthe and Milner 2009. 6.Neumayer and Spess 2005.Also see Egger and Pfaffermayr 2004;Haftel 2010;and Salacuse and Sullivan 2005. 7.For recent discussions of the contents of bilateral investment treaties,see Dolzer and Schreuer 2008;and Muchlinski 2009. 8.Allee and Peinhardt 2010. 9.See Bubb and Rose-Ackerman 2007;Buithe and Milner 2009;Egger and Pfaffermayr 2004;Haf- tel 2010:Hallward-Driemeier 2003;Kerner 2009;and Salacuse and Sullivan 2005.For a contrasting view,see Yackee 2009

incentives to renege on the contract+ It is therefore difficult for investors to determine ex ante a host government’s true, long-term commitment to foreign participation in the domestic market+ Existing Research on the FDI Effects of BITs BITs reassure fearful investors in two ways+ 5 First, signing BITs is a way for host governments to signal their true intention to refrain from interfering with foreign investment+ According to this “signaling” logic, negotiating a BIT is a way for an investment-seeking government to convey its seriousness about protecting inward investment+ 6 Governments that sign multiple treaties may be able to send a more effective signal, and this accumulation of numerous treaties demonstrates a stronger general commitment to protect investment and to promote a healthy investment climate for all foreign investors+ To be effective, however, the signals must be “costly,” or informative enough to differentiate committed liberalizers from governments with other intentions+ The major worry for investors is that an initial signal to protect investment may turn out to be “cheap talk,” if a government later changes course and behaves in ways that are hostile toward investment+ A second line of argument is that BITs increase the credibility of host states’ promises to abide by the terms of a contract, which then should stimulate greater inward FDI+ BITs provide significant protections to foreign investors because they include provisions on national treatment, most-favored nation status, the ability to repatriate profits, and appropriate compensation in the event of a taking+ 7 Most importantly, these promises are made credible due to investor-state dispute settlement clauses that allow aggrieved investors to challenge via international arbitration any policies of host governments that violate these BIT commitments+ 8 A government that violates its treaty commitments and is challenged by investors through international arbitration would suffer direct financial costs of contesting the litigation, reputational costs associated with being a defendant, and the payment of a potentially sizable arbitration award+ Therefore, a BIT signatory is likely to uphold the treaty’s terms because of the prospect of these self-inflicted costs, which in turn should reassure investors, who then are more likely to invest in the country+ Many scholars utilize some type of credibility-based logic to argue that BITs should lead greater FDI to flow into signatories+ 9 Several studies provide 5+ For an excellent review and discussion of the arguments that have been applied to BITs, see Büthe and Milner 2009+ 6+ Neumayer and Spess 2005+ Also see Egger and Pfaffermayr 2004; Haftel 2010; and Salacuse and Sullivan 2005+ 7+ For recent discussions of the contents of bilateral investment treaties, see Dolzer and Schreuer 2008; and Muchlinski 2009+ 8+ Allee and Peinhardt 2010+ 9+ See Bubb and Rose-Ackerman 2007; Büthe and Milner 2009; Egger and Pfaffermayr 2004; Haftel 2010; Hallward-Driemeier 2003; Kerner 2009; and Salacuse and Sullivan 2005+ For a contrasting view, see Yackee 2009+ 404 International Organization

The Impact of Investment Treaty Violations on Foreign Direct Investment 405 in-depth,credibility-based theoretical accounts,either through the development of formal models or lengthy discussions that draw on numerous scholarly traditions. A sizeable number of the aforementioned studies provide evidence that BITs are associated with greater levels of FDI.2 Perhaps the most robust finding is that the number of BITs a country signs is positively correlated with inward FDI.3 The validity of this finding is enhanced by that fact that these studies examine a wide range of countries over a long time-series and utilize more reliable country- level FDI data.Several others also find that BITs stimulate greater FDI more nar- rowly among the pair of treaty signatories.4Because these latter studies rely on dyadic FDI data,which is more incomplete,this more specific positive finding is less robust and somewhat more contested.5 Therefore,although mounting evi- dence shows that BITs in the aggregate are associated with greater inward FDI, particularly at the country level,more research is needed to illuminate precisely how,and under what conditions,BITs should produce the desired investment benefits. A limitation of existing empirical approaches is the inability to parse out the precise mechanisms by which BITs increase FDI.Although many studies advance nuanced theoretical arguments,they typically utilize a common,undifferentiated empirical strategy.Regardless of the logic posited,the default measurement approach is to tally each country's number of BITs(for those that use a country- level research design)or to assign to all pairs of countries a zero or one for a BIT dummy variable(for those that employ a dyadic design).The validity of the resulting empirical findings is not in question,yet it is difficult to ascertain the causal mechanism at work or to pinpoint the conditions under which BITs will increase FDI.Indeed,studies that employ nearly identical research designs and generate similar results sometimes attribute their positive findings to very differ- ent logics.6 Neumayer and Spess,in fact,acknowledge this empirical limitation: "How important is the signaling effect,which benefits investors from all coun- tries,compared to the commitment effect,which only relates to investors from BIT partner countries,is difficult to say."7 10.See,for example,Aisbett 2009;and Bubb and Rose-Ackerman 2007. 11.See,for example,Buthe and Milner 2009. 12.See Buthe and Milner 2009;Egger and Pfaffermayr 2004;Haftel 2010;Neumayer and Spess 2005;and Salacuse and Sullivan 2005. 13.See Buithe and Milner 2009:and Neumayer and Spess 2005 14.See Egger and Pfaffermayr 2004;Haftel 2010;Kerner 2009;and Salacuse and Sullivan 2005. 15.Hallward-Driemeier 2003:Tobin and Rose-Ackerman 2005;and UNCTAD 1998 fail to find a consistent relationship between BITs and FDI,and Peinhardt and Allee forthcoming uncover little evi- dence that U.S.preferential economic agreements increase U.S.FDI to partner countries.Also see Aisbett 2009;and Yackee 2009 for arguments about possible reverse causality,model misspecification, and measurement error. 16.Neumayer and Spess 2005;and Buthe and Milner 2009 both employ country-level research designs,measure BITs similarly,and uncover positive relationships between BITs and FDI.Yet the former attributes this to signaling whereas the latter espouses a more credibility-based logic. 17.Neumayer and Spess 2005,1571

in-depth, credibility-based theoretical accounts, either through the development of formal models10 or lengthy discussions that draw on numerous scholarly traditions+ 11 A sizeable number of the aforementioned studies provide evidence that BITs are associated with greater levels of FDI+ 12 Perhaps the most robust finding is that the number of BITs a country signs is positively correlated with inward FDI+ 13 The validity of this finding is enhanced by that fact that these studies examine a wide range of countries over a long time-series and utilize more reliable countrylevel FDI data+ Several others also find that BITs stimulate greater FDI more narrowly among the pair of treaty signatories+ 14 Because these latter studies rely on dyadic FDI data, which is more incomplete, this more specific positive finding is less robust and somewhat more contested+ 15 Therefore, although mounting evidence shows that BITs in the aggregate are associated with greater inward FDI, particularly at the country level, more research is needed to illuminate precisely how, and under what conditions, BITs should produce the desired investment benefits+ A limitation of existing empirical approaches is the inability to parse out the precise mechanisms by which BITs increase FDI+ Although many studies advance nuanced theoretical arguments, they typically utilize a common, undifferentiated empirical strategy+ Regardless of the logic posited, the default measurement approach is to tally each country’s number of BITs ~for those that use a countrylevel research design! or to assign to all pairs of countries a zero or one for a BIT dummy variable ~for those that employ a dyadic design!+ The validity of the resulting empirical findings is not in question, yet it is difficult to ascertain the causal mechanism at work or to pinpoint the conditions under which BITs will increase FDI+ Indeed, studies that employ nearly identical research designs and generate similar results sometimes attribute their positive findings to very different logics+ 16 Neumayer and Spess, in fact, acknowledge this empirical limitation: “How important is the signaling effect, which benefits investors from all countries, compared to the commitment effect, which only relates to investors from BIT partner countries, is difficult to say+”17 10+ See, for example, Aisbett 2009; and Bubb and Rose-Ackerman 2007+ 11+ See, for example, Büthe and Milner 2009+ 12+ See Büthe and Milner 2009; Egger and Pfaffermayr 2004; Haftel 2010; Neumayer and Spess 2005; and Salacuse and Sullivan 2005+ 13+ See Büthe and Milner 2009; and Neumayer and Spess 2005+ 14+ See Egger and Pfaffermayr 2004; Haftel 2010; Kerner 2009; and Salacuse and Sullivan 2005+ 15+ Hallward-Driemeier 2003; Tobin and Rose-Ackerman 2005; and UNCTAD 1998 fail to find a consistent relationship between BITs and FDI, and Peinhardt and Allee forthcoming uncover little evidence that U+S+ preferential economic agreements increase U+S+ FDI to partner countries+ Also see Aisbett 2009; and Yackee 2009 for arguments about possible reverse causality, model misspecification, and measurement error+ 16+ Neumayer and Spess 2005; and Büthe and Milner 2009 both employ country-level research designs, measure BITs similarly, and uncover positive relationships between BITs and FDI+ Yet the former attributes this to signaling whereas the latter espouses a more credibility-based logic+ 17+ Neumayer and Spess 2005, 1571+ The Impact of Investment Treaty Violations on Foreign Direct Investment 405

406 International Organization Various studies have begun to employ empirical approaches that test theoretical mechanisms more directly.For instance,Tobin and Rose-Ackerman interact a BIT variable with various indicators for the political risk or level of development of treaty signatories to determine whether BITs have a greater effect on FDI in coun- tries where political risk is high or development is low.8 Egger and Pfaffermayr, as well as Haftel,distinguish in their measurement strategy between signed and ratified BITs-with the logic that the former can only serve as signals whereas the latter represent more credible commitments.Our approach similarly advances and tests precise arguments regarding the impact of BITs by focusing not just on treaties,but also on the information environment created by the use of inter- national arbitration to solve investment disputes.This approach stands in contrast to other studies of investment treaty impacts and reintegrates the BIT literature with the larger focus on compliance in international law and organization. The Importance of BIT Compliance Our foundational claim is that BITs should only be credible-and generate greater FDI-for those signatories for whom no evidence emerges of behavior that con- tradicts the letter of the law.Therefore,we introduce compliance as an important, yet omitted,concept within the study of BITs.Simply put,whether the desired gains encoded in investment and other treaties are realized depends on whether governments live up to the commitments stipulated in the agreements.20 Existing studies of the FDI effects of BITs fail to include compliance as an explanatory variable,despite the fact that treaty compliance is a major theme in international relations scholarship on the environment,21 trade agreements,22 and current account liberalization.23 In fact,the dominant approach toward evaluating the BIT-FDI relationship not only neglects compliance but implicitly assumes that governments automatically comply with all of their concluded BITs.In effect,once a treaty enters into force,it is recorded and entered into empirical tests without any follow up to see whether the signatories actually adhere to their BIT-related commitments.But the reality is that not all governments comply with the BITs they have signed.The hundreds of investment disputes that have been arbitrated under BIT guidelines suggest that any assumption of widespread compliance is untenable.Therefore,the issue of compliance with BITs needs to be incorporated directly into our theories and empirical tests. 18.Tobin and Rose-Ackerman 2005. 19.See Egger and Pfaffermayr 2004;and Haftel 2010. 20.International law scholars often downplay such worries about compliance,and reference the widespread norm that treaties should be followed (pacta sunt servanda).See Chayes and Chayes 1993; and Koh 1997.For the contrasting perspective from international relations scholars,see Downs,Rocke, and Barsoom 1996. 21.Brown Weiss and Jacobson 2000. 22.Downs and Rocke 1995. 23.Simmons 2000

Various studies have begun to employ empirical approaches that test theoretical mechanisms more directly+ For instance, Tobin and Rose-Ackerman interact a BIT variable with various indicators for the political risk or level of development of treaty signatories to determine whether BITs have a greater effect on FDI in countries where political risk is high or development is low+ 18 Egger and Pfaffermayr, as well as Haftel, distinguish in their measurement strategy between signed and ratified BITs—with the logic that the former can only serve as signals whereas the latter represent more credible commitments+ 19 Our approach similarly advances and tests precise arguments regarding the impact of BITs by focusing not just on treaties, but also on the information environment created by the use of international arbitration to solve investment disputes+ This approach stands in contrast to other studies of investment treaty impacts and reintegrates the BIT literature with the larger focus on compliance in international law and organization+ The Importance of BIT Compliance Our foundational claim is that BITs should only be credible—and generate greater FDI—for those signatories for whom no evidence emerges of behavior that contradicts the letter of the law+ Therefore, we introduce compliance as an important, yet omitted, concept within the study of BITs+ Simply put, whether the desired gains encoded in investment and other treaties are realized depends on whether governments live up to the commitments stipulated in the agreements+ 20 Existing studies of the FDI effects of BITs fail to include compliance as an explanatory variable, despite the fact that treaty compliance is a major theme in international relations scholarship on the environment, 21 trade agreements, 22 and current account liberalization+ 23 In fact, the dominant approach toward evaluating the BIT-FDI relationship not only neglects compliance but implicitly assumes that governments automatically comply with all of their concluded BITs+ In effect, once a treaty enters into force, it is recorded and entered into empirical tests without any follow up to see whether the signatories actually adhere to their BIT-related commitments+ But the reality is that not all governments comply with the BITs they have signed+ The hundreds of investment disputes that have been arbitrated under BIT guidelines suggest that any assumption of widespread compliance is untenable+ Therefore, the issue of compliance with BITs needs to be incorporated directly into our theories and empirical tests+ 18+ Tobin and Rose-Ackerman 2005+ 19+ See Egger and Pfaffermayr 2004; and Haftel 2010+ 20+ International law scholars often downplay such worries about compliance, and reference the widespread norm that treaties should be followed ~ pacta sunt servanda!+ See Chayes and Chayes 1993; and Koh 1997+ For the contrasting perspective from international relations scholars, see Downs, Rocke, and Barsoom 1996+ 21+ Brown Weiss and Jacobson 2000+ 22+ Downs and Rocke 1995+ 23+ Simmons 2000+ 406 International Organization

The Impact of Investment Treaty Violations on Foreign Direct Investment 407 In fact,compliance is essential to the credibility-based logic by which BITs should increase FDI,which makes the omission of compliance from existing stud- ies even more striking.We emphasize the important distinction between what Buthe and Milner usefully characterize as“ex ante'”and“expo.sr”information.24 Recall that BITs are believed to enhance host government credibility because any future treaty violations committed by the host can be enforced by investors and will require compensation by host states.Thus,knowing that their poor behavior would be punished,host governments should behave in accordance with the treaty's pro- scriptions.This ex ante account of BIT credibility,however,hinges on the assump- tion that treaty signatories will not renege in the future from the pledges enshrined in the BIT.But some governments certainly do take future,ex post,actions that harm investors and contravene their treaty obligations.Therefore,although the trea- ties promise enhanced credibility,this credibility is contingent on future behavior. Despite the importance of what happens after a treaty is signed,nearly all stud- ies of BITs focus only on the ex ante half of the story and predict that BITs should have an unconditionally positive effect on FDI into the indefinite future.Yet much of the information that is revealed ex post,long after a BIT enters into force,will be received negatively by investors.Governments may renege on some aspect of the treaty,take actions that flout their treaty obligations,or refuse to pay compen- sation to investors.These types of ex post actions provide valuable,updated infor- mation to the investment community that counteracts any positive information that the country's signing of a BIT might have conveyed ex ante.Yet even those who stress the importance of ex post information,such as Buthe and Milner,do not include in their empirical tests any measures of ex post actions that should nega- tively affect future FDI flows,such as treaty violations or investment disputes. Investors want to know whether a government has signed a BIT,but they also care about that government's behavior after any treaty is signed.BITs should pro- duce FDI benefits for governments as long as they do not do anything to disrupt the initial credibility they receive from concluding a treaty.But when a govern- ment clearly contravenes its BIT obligations,the credibility-based investment boost once provided by the treaty no longer applies.In fact,existing investors may with- draw from the country and prospective investors may look elsewhere,thus result- ing in less investment than would have occurred otherwise.This potential for BITs to actually be harmful to signatories-and result in less FDI-is novel in the lit- erature and is an important original contribution.The key is that compliance deter- mines the nature of the treaties'effects:BITs should positively affect FDI in the absence of any negative information but can negatively affect FDI if noncompli- ance is observed. How,then,do investors learn whether governments are or are not complying with the treaties?Compliance with treaty obligations can be difficult to monitor,25 24.Buthe and Milner 2009,184-86. 25.Dai2005

In fact, compliance is essential to the credibility-based logic by which BITs should increase FDI, which makes the omission of compliance from existing studies even more striking+ We emphasize the important distinction between what Büthe and Milner usefully characterize as “ex ante” and “ex post” information+ 24 Recall that BITs are believed to enhance host government credibility because any future treaty violations committed by the host can be enforced by investors and will require compensation by host states+ Thus, knowing that their poor behavior would be punished, host governments should behave in accordance with the treaty’s proscriptions+ This ex ante account of BIT credibility, however, hinges on the assumption that treaty signatories will not renege in the future from the pledges enshrined in the BIT+ But some governments certainly do take future, ex post, actions that harm investors and contravene their treaty obligations+ Therefore, although the treaties promise enhanced credibility, this credibility is contingent on future behavior+ Despite the importance of what happens after a treaty is signed, nearly all studies of BITs focus only on the ex ante half of the story and predict that BITs should have an unconditionally positive effect on FDI into the indefinite future+ Yet much of the information that is revealed ex post, long after a BIT enters into force, will be received negatively by investors+ Governments may renege on some aspect of the treaty, take actions that flout their treaty obligations, or refuse to pay compensation to investors+ These types of ex post actions provide valuable, updated information to the investment community that counteracts any positive information that the country’s signing of a BIT might have conveyed ex ante+ Yet even those who stress the importance of ex post information, such as Büthe and Milner, do not include in their empirical tests any measures of ex post actions that should negatively affect future FDI flows, such as treaty violations or investment disputes+ Investors want to know whether a government has signed a BIT, but they also care about that government’s behavior after any treaty is signed+ BITs should produce FDI benefits for governments as long as they do not do anything to disrupt the initial credibility they receive from concluding a treaty+ But when a government clearly contravenes its BIT obligations, the credibility-based investment boost once provided by the treaty no longer applies+ In fact, existing investors may withdraw from the country and prospective investors may look elsewhere, thus resulting in less investment than would have occurred otherwise+ This potential for BITs to actually be harmful to signatories—and result in less FDI—is novel in the literature and is an important original contribution+ The key is that compliance determines the nature of the treaties’ effects: BITs should positively affect FDI in the absence of any negative information but can negatively affect FDI if noncompliance is observed+ How, then, do investors learn whether governments are or are not complying with the treaties? Compliance with treaty obligations can be difficult to monitor, 25 24+ Büthe and Milner 2009, 184–86+ 25+ Dai 2005+ The Impact of Investment Treaty Violations on Foreign Direct Investment 407

408 International Organization and in the BIT context this problem is acute given the vastness of the global invest- ment landscape.Thankfully,the unique enforcement provisions in BITs provide an important way for compliance to be observed.As noted earlier,BITs contain investor-state dispute settlement clauses,which legal scholars have lauded as the most important element of the treaties.26 These clauses constitute a major shift in investment relations because they give investors direct recourse to enforce the trea- ties themselves.Multinational firms who have grievances no longer must convince their own government to pursue their claims but instead may seek redress against the host government directly through international arbitration.This reduces the potential for delay and guarantees that any perceived violation by a BIT-signatory host government can be pursued by firms in a neutral,third-party setting.For our purposes,this also means that treaty violations are singled out by those firms who are directly harmed by noncompliance and who have the strongest incentives to pur- sue such violations.Therefore,to identify possible treaty violations,one can look to the international arbitration venues where these claims are handled. ICSID Disputes as a Source of Information on BIT Compliance BITs typically specify multiple venues through which investors may pursue their grievances,yet among the arbitration options ICSID clearly stands alone as the single most important arbitral venue.27 It is used far more than all other options combined,its strong institutional structure enhances its effectiveness,and most importantly,its proceedings and awards are widely observable.Investors have turned to ICSID to contest foreign governments'violations of BITs more than eight times as frequently as they have turned to all other institutionalized arbitration bodies.28 Moreover,ICSID's prominence is enhanced due to its establishment by an inter- national convention as well as its direct ties to the World Bank.Its functioning is aided by a secretary-general with unique abilities to disregard frivolous cases and to appoint arbitrators as well as a secretariat that disseminates information on ICSID cases and proceedings.Another major source of ICSID's power is that its awards carry the same effect as the judgment of a national court;rulings are legally bind- ing on the parties and the domestic courts of an ICSID member state can be used to enforce the award.29 26.For further discussions of the importance of these clauses,see Dolzer and Stevens 1995;Franck 2007;and Walde 2005. 27.Allee and Peinhardt 2010.Among other institutional arbitration options are the International Chamber of Commerce in Paris,the Stockholm Arbitration Institute,the Arab Investment Court,and the Cairo Regional Centre for International Commercial Arbitration. 28.UNCTAD(2008b,1-2)reports that as of 2007,ICSID had been used 182 times in investor- state dispute settlement while other institutional arbitration options had been used only 21 times.These same UNCTAD data also indicated that 80 treaty-based disputes were addressed using ad hoc arbitra- tion (as compared to instirutionalized arbitration),generally under UNCITRAL rules. 29.See Dolzer and Schreuer 2008,287-90 for an overview of the enforcement process;and Bald- win,Kantor,and Nolan 2006 for specific cases

and in the BIT context this problem is acute given the vastness of the global investment landscape+ Thankfully, the unique enforcement provisions in BITs provide an important way for compliance to be observed+ As noted earlier, BITs contain investor-state dispute settlement clauses, which legal scholars have lauded as the most important element of the treaties+ 26 These clauses constitute a major shift in investment relations because they give investors direct recourse to enforce the treaties themselves+ Multinational firms who have grievances no longer must convince their own government to pursue their claims but instead may seek redress against the host government directly through international arbitration+ This reduces the potential for delay and guarantees that any perceived violation by a BIT-signatory host government can be pursued by firms in a neutral, third-party setting+ For our purposes, this also means that treaty violations are singled out by those firms who are directly harmed by noncompliance and who have the strongest incentives to pursue such violations+ Therefore, to identify possible treaty violations, one can look to the international arbitration venues where these claims are handled+ ICSID Disputes as a Source of Information on BIT Compliance BITs typically specify multiple venues through which investors may pursue their grievances, yet among the arbitration options ICSID clearly stands alone as the single most important arbitral venue+ 27 It is used far more than all other options combined, its strong institutional structure enhances its effectiveness, and most importantly, its proceedings and awards are widely observable+ Investors have turned to ICSID to contest foreign governments’ violations of BITs more than eight times as frequently as they have turned to all other institutionalized arbitration bodies+ 28 Moreover, ICSID’s prominence is enhanced due to its establishment by an international convention as well as its direct ties to the World Bank+ Its functioning is aided by a secretary-general with unique abilities to disregard frivolous cases and to appoint arbitrators as well as a secretariat that disseminates information on ICSID cases and proceedings+ Another major source of ICSID’s power is that its awards carry the same effect as the judgment of a national court; rulings are legally binding on the parties and the domestic courts of an ICSID member state can be used to enforce the award+ 29 26+ For further discussions of the importance of these clauses, see Dolzer and Stevens 1995; Franck 2007; and Wälde 2005+ 27+ Allee and Peinhardt 2010+ Among other institutional arbitration options are the International Chamber of Commerce in Paris, the Stockholm Arbitration Institute, the Arab Investment Court, and the Cairo Regional Centre for International Commercial Arbitration+ 28+ UNCTAD ~2008b, 1–2! reports that as of 2007, ICSID had been used 182 times in investorstate dispute settlement while other institutional arbitration options had been used only 21 times+ These same UNCTAD data also indicated that 80 treaty-based disputes were addressed using ad hoc arbitration ~as compared to institutionalized arbitration!, generally under UNCITRAL rules+ 29+ See Dolzer and Schreuer 2008, 287–90 for an overview of the enforcement process; and Baldwin, Kantor, and Nolan 2006 for specific cases+ 408 International Organization

The Impact of Investment Treaty Violations on Foreign Direct Investment 409 For our purposes,the most important feature of ICSID disputes is their observ- ability.In contrast to other arbital venues,ICSID consistently publicizes informa- tion,through its Web site and various publications,about the nature,timing,and outcomes of its proceedings and awards.Therefore,when investors pursue claims against host governments before ICSID,important details about the arbitration pro- cess are observed by other investors or potential investors.Others will know when a dispute has been registered and can follow any subsequent debates over jurisdic- tion of the dispute and will be able to identify when a three-person arbitral panel has been formed.Once the panel hears arguments from both parties on the merits of the dispute,observable outcomes include a settlement agreement between the two sides or a tribunal ruling in favor of the claimant(the investor)or the respon- dent (the host state).From beginning to end this process takes on average slightly less than three years,with the period from the constitution of a panel to the issu- ance of an award spanning the last two-thirds of that period.30 During this entire process,interested audiences can follow the timing and evolution of all of the aforementioned major events. ICSID has provided a vast amount of information about compliance with BITs due to the rising number of disputes it has arbitrated during the past few decades.31 ICSID was established in 1966 and sporadically heard investment treaty disputes in the 1970s.From the early 1980s until the mid-1990s,it received several such disputes annually (see Figure 1).At that point the number of disputes increased markedly,reflecting the increasing number of BITs in existence (and a larger vol- ume of worldwide FDI),which generated greater opportunities for ICSID to be used.32 Beginning in 1997,it received approximately a dozen or more investment disputes each year for the next six years.Since 2003,an even greater number of investment disputes (an average of twenty-seven per year)have been brought by investors before ICSID. The disputes brought before ICSID have involved dozens of countries and clar- ified compliance with several important treaty provisions.33 Table 1 lists all of the countries that have been respondents in ICSID disputes through 2007.Dis- putes involving these countries have centered on several of the most important substantive provisions of BITs:right of establishment,national treatment,fair and 30.Across all of the fully resolved ICSID disputes in our data set(those settled by a panel ruling or a postpanel settlement),the average time from registration of a dispute to a final panel ruling is 1,044 days.The average time from tribunal constitution to a tribunal ruling is 755 days. 31.See Bishop,Crawford,and Reisman 2005;Sornarajah 2000;and UNCTAD 2005 and 2008b. 32.The increasing number of ICSID cases tracks closely with the number of BITs (as shown in Figure 1)as well as with rising worldwide FDI during the past three decades.Therefore,we view the increase in ICSID disputes as a logical reflection of the greater opportunity for investment disputes resulting from greater numbers of investment treaties and expanding global investment.The fact that global FDI systematically increases over time presents an especially challenging context for our argu- ment that some states should actually witness decreases in FDI(due to investment disputes),which cuts against this secular trend toward increased FDI worldwide. 33.See UNCTAD 2008b,2-3,for an overview of disputes brought before ICSID

For our purposes, the most important feature of ICSID disputes is their observability+ In contrast to other arbital venues, ICSID consistently publicizes information, through its Web site and various publications, about the nature, timing, and outcomes of its proceedings and awards+ Therefore, when investors pursue claims against host governments before ICSID, important details about the arbitration process are observed by other investors or potential investors+ Others will know when a dispute has been registered and can follow any subsequent debates over jurisdiction of the dispute and will be able to identify when a three-person arbitral panel has been formed+ Once the panel hears arguments from both parties on the merits of the dispute, observable outcomes include a settlement agreement between the two sides or a tribunal ruling in favor of the claimant ~the investor! or the respondent ~the host state!+ From beginning to end this process takes on average slightly less than three years, with the period from the constitution of a panel to the issuance of an award spanning the last two-thirds of that period+ 30 During this entire process, interested audiences can follow the timing and evolution of all of the aforementioned major events+ ICSID has provided a vast amount of information about compliance with BITs due to the rising number of disputes it has arbitrated during the past few decades+ 31 ICSID was established in 1966 and sporadically heard investment treaty disputes in the 1970s+ From the early 1980s until the mid-1990s, it received several such disputes annually ~see Figure 1!+ At that point the number of disputes increased markedly, reflecting the increasing number of BITs in existence ~and a larger volume of worldwide FDI!, which generated greater opportunities for ICSID to be used+ 32 Beginning in 1997, it received approximately a dozen or more investment disputes each year for the next six years+ Since 2003, an even greater number of investment disputes ~an average of twenty-seven per year! have been brought by investors before ICSID+ The disputes brought before ICSID have involved dozens of countries and clarified compliance with several important treaty provisions+ 33 Table 1 lists all of the countries that have been respondents in ICSID disputes through 2007+ Disputes involving these countries have centered on several of the most important substantive provisions of BITs: right of establishment, national treatment, fair and 30+ Across all of the fully resolved ICSID disputes in our data set ~those settled by a panel ruling or a postpanel settlement!, the average time from registration of a dispute to a final panel ruling is 1,044 days+ The average time from tribunal constitution to a tribunal ruling is 755 days+ 31+ See Bishop, Crawford, and Reisman 2005; Sornarajah 2000; and UNCTAD 2005 and 2008b+ 32+ The increasing number of ICSID cases tracks closely with the number of BITs ~as shown in Figure 1! as well as with rising worldwide FDI during the past three decades+ Therefore, we view the increase in ICSID disputes as a logical reflection of the greater opportunity for investment disputes resulting from greater numbers of investment treaties and expanding global investment+ The fact that global FDI systematically increases over time presents an especially challenging context for our argument that some states should actually witness decreases in FDI ~due to investment disputes!, which cuts against this secular trend toward increased FDI worldwide+ 33+ See UNCTAD 2008b, 2–3, for an overview of disputes brought before ICSID+ The Impact of Investment Treaty Violations on Foreign Direct Investment 409

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