Why Should I Believe You? The Costs and Consequences of Bilateral Investment Treaties

Bilateral Investment Treaties (BITs) are the primary legal mechanism protecting foreign direct investment (FDI) around the world. BITs are thought to encourage FDI by establishing a broad set of investor's rights and by allowing investors to sue a host state in an international tribunal if these rights are violated. Perhaps surprisingly, the empirical literature connecting BITs to FDI flows has produced conflicting results. Some papers have found that BITs attract FDI, while others have found no relationship or even that BITs repel FDI. I suggest in this paper that these results stem from statistical models that do not fully capture the causal mechanisms that link BITs to FDI. Extant literature has often suggested that BITs may encourage investment from both protected and unprotected investors, yet the literature has not allowed for a full evaluation of this claim. This paper explores the theoretical underpinnings and empirical implications of an institution that works in these direct and indirect ways, and offers a statistical test that is capable of distinguishing between the two. The results indicate that: (1) BITs attract significant amounts of investment; (2) BITs attract this investment from protected and unprotected investors; and (3) these results are obscured by endogeneity unless corrected for in the statistical model.