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?
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?
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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
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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