Escape Tunnels for Foreign Capital: Domestic Capital Controls and BITs

• In Event: Is Global Capitalism Good for Democracy?

Abstract

A country’s regulations governing international capital flows and its obligations under signed bilateral investment treaties (BITs) presumably jointly influence its subsequent FDI inflows. Oddly, no scholarly study has yet focused on the joint effects of capital controls and BITs on inward FDI flows. We propose that domestic capital account regulatory policies mediate the effects of BITs on inward FDI: that is, BITs have no statistically significant effect on inward FDI flows absent interaction with capital account policies. We propose that BITs are most correlated with higher FDI inflows when the host country has more open capital inflow regulations but relatively restricted capital outflows. BITs will be negatively correlated with FDI inflows when both capital inflows and outflows are restricted, and uncorrelated when both are unrestricted. We argue that BITs make the initial investment more attractive in host countries with restrictions on capital outflows but inflow openness since BITs enhance foreign investors’ ability to exit their investments by providing investor-state arbitration clauses, and repatriation and other guarantees for investor capital return or resale. Economies with fully liberal inward and outward capital movements already have full market openness and are unlikely to see additional inflows from signing BITs. In financially closed economies, BITs provide investors with exit options. We estimate models using monadic, dyadic, and firm level data on FDI inflows, and find broad support for the core hypotheses. We also offer evidence that only in the case of BIT signatory country-pairs does FDI increase, suggesting no consistent ‘signaling’ effect. The effects are most precisely estimated for autocratic regimes, suggesting that bilateral BITs are a partial off-set to the ‘democratic advantage’ enjoyed by democracies in attracting FDI.

Authors

• Haillie Na-Kyung Lee, Seoul National University

• Dennis P. Quinn, Georgetown University