B&E | The Awareness of International Economic Agreements

B&E | The Awareness of International Economic Agreements

By World Bank

Do international treaties influence investment decisions into developing countries? Can governments boost the attractiveness of their country to foreign investors by signing on to international trade and investment agreements?

Image Attribute:  An image of a great amount of shipping containers at the Hong Kong Container Terminal./ Creative Commons

Image Attribute:  An image of a great amount of shipping containers at the Hong Kong Container Terminal./ Creative Commons

The survey and subsequent analysis by Kenyon and Margalit (2012) shed light on these questions.16 Respondents were first asked whether they had knowledge of the international trade and investment agreements signed by the country in which their largest investment is located. The majority of respondents (74 percent) were unaware of any regional or bilateral trade agreements to which the host country is a signatory. Of the 229 investors that answered this question, only 60 respondents (26 percent) had knowledge of participation in international trade agreements by their largest host country. Interestingly, this awareness varied across countries. Almost 60 percent of South African investors and 56 percent of Brazilian respondents claimed to be aware of the trade agreements signed by their largest host country. By contrast, only 30 percent of Indian and less than 6 percent of Korean respondents claimed to know whether their main investment destination had a trade agreement.

More than half (51 percent) of those with knowledge of trade agreements signed by the host country said the latter actually had influence on their companies’ business operations. When asked about the specific benefits derived from these agreements, 30 percent mentioned the expansion of the size of the export market and 23 percent said they contributed to a reduction in the costs of trade. Access to raw materials (16 percent) and improved access to finance (13 percent) were also identified as important potential benefits of trade agreements by the host country. Notably, no respondents selected the option of the trade agreement including a chapter on investment and investor protection as the main benefit. Almost 70 percent of respondents said there were no potential disadvantages from membership in trade agreements.

A smaller proportion (43 percent) of investors were aware of the host country’s record in terms of BITs. Ninety percent of those who claimed to be aware of the BITs signed by their host country were from Korea. To the follow-up question of whether these treaties influenced their companies’ business operations, only 16 respondents (30 percent) gave an affirmative answer, citing, among other potential benefits, greater safety and clarity in the investment process.

These results suggest that while the host country’s participation in international trade and investment treaties is not the most prominent factor influencing the choice of an investment location by TNCs from emerging markets, it is taken into account by a sizable share of foreign investors. To shed further light on the ways in which membership in international economic agreements may influence the attractiveness of a host country in the eyes of foreign investors, the survey included an experimental question, in which executives were asked to assess and rate four hypothetical investment scenarios from the perspective of their own firm (Kenyon and Margalit 2012). By randomly assigning respondents to receive different information about the investment conditions, such as whether or not the potential host country participated in international trade and investment treaties, it is possible to evaluate the causal impact of these agreements on potential investors’ perceptions and assessments of the investment climate.

More specifically, firm executives were presented with four vignettes containing the description of “Country X,” which included a set of details about the hypothetical investment destination (such as population size, rate of growth and degree of political stability) that were held constant across all respondents. However, all respondents were randomly assigned to receive one of four different treatments, which varied in respect to the economic policy actions the government of the country has taken. While all four treatments included a government that is openly supportive of free market economic policies, in only two of the scenarios the country was a member of international trade and investment treaties. In addition, two of the treatments referred to specific pro-market policies that the government had introduced.

In sum, executives were presented with four potential investment scenarios differing as follows:

1. The country signed on to international treaties
2. The country implemented pro-market reforms
3. The country signed on to international treaties and implemented pro-market reforms
4. The country has done neither

Respondents were then asked to rate the business climate with a five-point scale: very bad (1), bad (2), indifferent (3), good (4), and very good (5).

Kenyon and Margalit (2012) examine the causal effect of the government’s decision to join international trade and investment agreements on the attractiveness of the country to potential foreign investors using a test of means of these ratings of the investment climate. Their results show that, indeed, the combination of signing onto international treaties and implementing pro-market reforms leads to the most favorable assessment of the investment climate (3.95) (see figure 3.15). Moreover, membership in international agreements is associated with a higher rating (3.71) than only implementing liberal economic policies (3.28).

In sum, the findings suggest that membership in international economic agreements does indeed increase the perceived attractiveness of a developing country in the eyes of potential investors. The comparison of means test, however, provides no information as to the specific mechanisms through which trade and investment agreements boost the attractiveness of host countries. Thus, Kenyon and Margalit (2012) test empirically for the presence of possible mechanism that may account for this effect, including the role of international treaties as signaling mechanisms, their use as commitment devices constraining predatory behavior by host governments, and their market-enhancing and cost-reducing effects.

Chart Attribute: Perceived Attractiveness of Investment Climate
Chart Attribute: Perceived Attractiveness of Investment Climate

Their analysis finds strong support for the market-enhancing effects of international agreements. In other words, firms appear to prefer investing in countries that are members to trade and investment agreements because these treaties allow firms to benefit from lower barriers of access to other countries’ markets and to export back to the home country. Indeed, firms that described their main motivation for investment abroad as either “to export back to the home country” or “to benefit from a trade agreement” rated scenarios in which countries signed onto international agreements more positively than other firms. This large and positive association between trade motives and rating of investment climates holds when controlling for sector of operation, home country and size of the firm.

In contrast, this study found little empirical evidence in support of the other three possible mechanisms. The authors demonstrate that those firms that are most concerned with the quality of the legal framework and the transparency of business regulations in the host country do not assign a greater premium to those countries that participate in international economic agreements than other firms that have different concerns. Their analysis also fails to find any evidence suggesting that firms with less mobile investments, which one would expect to be more concerned about political risk, assign a higher rating to host countries that are members of an international economic institution. Thus, international treaties seem to have a limited impact in reducing developing countries’ time-inconsistency and credible commitment problems.

Similarly, Kenyon and Margalit (2012) find no evidence that participating in international agreements contributes to increase investor confidence by signaling that the country has a market-friendly orientation. Indeed, respondents gave the hypothetical country that signed international economic agreements a more favorable rating than they assigned to the two hypothetical scenarios in which the government of the country made pro-market statements and implemented liberal reforms. This suggests that signing onto a treaty has an independent effect that goes beyond signaling a market-friendly orientation and policies. Finally, the study found little empirical support for the cost-efficiency mechanism. Contrary to what one would expect to observe if this mechanism was at play, firms whose motives for investing abroad is efficiency of production do not rate a country that participates in an international treaty more favorably than firms who are less concerned about enhancing production efficiency.

Source: New Voices in Investment (2015) by The World Bank 

This work is made available by the Original Publisher – The World Bank, under the Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO)  http://creativecommons.org/licenses/by/3.0/igo
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