Determinants of Intra-EU Foreign Direct Investment: The Impact of Bilateral Investment Treaties

Determinants of Intra-EU Foreign Direct Investment:

The Impact of Bilateral Investment Treaties

Sivert Vassdokken Sigstad

Thesis submitted for the degree of Master in Political Science Department of Political Science

Faculty of Social Sciences University of Oslo

Spring 2021 Words: 29.043

Determinants of Intra-EU Foreign Direct Investment:

The Impact of Bilateral Investment Treaties

Sivert Vassdokken Sigstad

June 14, 2021

Abstract

In 2020, the EU Member States agreed to remove intra-EU bilateral investment treaties.

This decision has fuelled a legal and academic policy debate. In this thesis I ask the question: Do intra-EU bilateral investment treaties raise cross border foreign direct in- vestment between EU Member States? While host country determinants of foreign direct investment (FDI) has been researched extensively, there is no consensus on the impact of bilateral investment treaties (BITs) on investment ows. I make two contributions to the eld of research.

First, from an empirical point of view, I contribute to the ongoing study of the deter- minants of foreign direct investment, and in particular, the eect of bilateral investment treaties on investment ows. Previous research has often focused on the impact of BITs on investment ows in developing countries. By using a sample consisting of EU Member States, I supply the eld with two understudied subjects. I zoom in on a group of rela- tively homogenous states, and since member states are also developed countries, it allows me to study these countries in a NorthNorth context. In sum, this allows me to study the impact of BITs on FDI a relatively homogenous sample including developed countries within the EU.

Second, I contribute to the ongoing debate about EU's internal investment policies.

The EU's decision to remove intra-EU BITs is seemingly conducted from a normative perspective due to these treaties conicting with EU law. This thesis examines whether core economic benets have been neglected.

Results indicate a robust, negative, and signicant impact of BITs on FDI, suggesting the EU has rightfully decided to terminate their intra-EU agreements.¹

1Data available at https://bit.ly/34VIQeM

Acknowledgements

This thesis would not have been possible without the help and backing of a great number of people. First, thank you to my supervisor Tarald Berge for always being attentive and motivating. His passion and capacity to guide, comment and teach has been invaluable for me during this project. Thanks also to Felix Haass and Philipp Lutscher for your R-seminars.

To all my friends at PC-stue 236 thank you for being the best co-students one could ever hope to have. I appreciate every single one of you. How you still bear to listen to my silliness and tedious monologues is beyond me. Thanks also to other fellow students throughout my time as a student for memorable years. Special thanks to Soe for proofreading drafts, but most of all, for being encouraging, understanding and motivating throughout. My family also deserve praise for supporting and encouraging me throughout my studies. To my sister, Mari, you are my greatest inspiration. All faults hereafter are my own.

Contents

1 Introduction 1

1.1 Background . . . 1

1.2 Research question . . . 4

1.3 Outline of the thesis . . . 5

1.4 Review of ndings . . . 6

2 Literature, Concepts and Theory 7 2.1 Foreign direct investment and the multinational corporation . . . 7

2.1.1 The relevance of FDI . . . 8

2.2 The investment treaty regime: a brief history . . . 9

2.2.1 Bilateral Investment Treaties . . . 11

2.2.2 Intra-EU BITs . . . 12

2.2.3 InvestorState Dispute Settlement . . . 15

2.3 European integration and investment policy . . . 16

2.3.1 The EU's proposal on intra-EU investment protection . . . 18

2.3.2 Achmea, the ECT, and the project for a Multilateral Investment Court . . . 19

2.4 Theory . . . 20

2.4.1 The OLI-framework . . . 21

2.4.2 Transaction cost economics . . . 23

2.4.3 Credible commitment, signalling, and exposure theory . . . 25

2.5 Literature review . . . 29

2.5.1 The impact of BITs on FDI . . . 29

2.6 Hypothesis . . . 33

2.7 Summary . . . 35

3 Research design: Methodology, sample and data 37

3.1 Quantitative approach . . . 37

3.2 Homogenous sampling . . . 38

3.2.1 Sample bias . . . 39

3.2.2 Sample specic coding and cautions . . . 40

3.3 Dependent variable: FDI Stocks . . . 43

3.3.1 FDI data and potential source to bias . . . 44

3.4 Independent variable 1: BIT . . . 45

3.4.1 Independent variable 2: substantive obligation provision index . . . 46

3.5 Control variables . . . 47

3.6 Statistical model: OLS with xed eects . . . 49

3.6.1 Multicollinearity and serial correlation . . . 51

3.6.2 Endogenity issues . . . 52

3.7 Summary . . . 52

4 Empirical results 54 4.1 The logic of the empirical analysis . . . 54

4.2 Hypothesis 1a and 1b . . . 55

4.3 Hypothesis 2: Post-2004 EU members as hosts . . . 58

4.4 Hypothesis 3: Treaty protection . . . 60

4.5 Robustness tests . . . 60

4.6 Baseline discussion on BITs and treaty provisions impact on FDI . . . 64

4.7 Policy implications for the investment climate within the EU . . . 68

5 Concluding remarks 71 5.1 Summary of ndings and evaluation of expectations . . . 71

5.2 Evaluation of goals and further research . . . 72

A 74 A.1 The argument for trusting results . . . 74

A.2 Descriptive statistics . . . 74

B 77 B.1 Robustness tests . . . 77

List of Tables

4.1 Baseline BIT-models . . . 57

4.2 Post-2004 members as hosts . . . 59

4.3 Treaty provisions . . . 61

A.1 Descriptive Statistics . . . 75

B.1 Parsimonious build . . . 78

B.2 Robustness Sensitivty analysis . . . 79

B.3 Robustness Alternative log transformations . . . 79

B.4 Robustness Omitting phantom investments . . . 80

B.5 Robustness Alternative regressions . . . 81

B.6 Robustness Lagged BIT variable . . . 82

List of Figures

2.1 Intra-EU BIT development . . . 14

2.2 BITs terminated annually . . . 15

2.3 Annual ISDS cases between member states . . . 16

A.1 Boxplot FDI and BITs . . . 75

A.2 Distribution dependent variable FDI . . . 76

A.3 Correlation plot . . . 76

B.1 Robustness Jackknife resampling . . . 77

Chapter 1 Introduction

1.1 Background

The last three decades have seen a surge in foreign direct investment (FDI) around the world. Governments who embrace economic liberalisation are engaged in a global bat- tle for investment, and they try to lure foreign investors to invest in their jurisdiction.

Many states struggle to convince foreign investors that they have legal regimes and policy systems stable enough to protect basic property rights. What is it that assures foreign investors that states maintain benecial and stable terms after they have settled?

There are quite a few supranational instruments that have been developed to allay foreign investors concerns regarding their protection and legal rights in the event of inter- ference by host governments. Taken together, these instruments are often referred to as the investment treaty regime (Bonnitcha, Poulsen, and Waibel 2017). The regime consists of international investment treaties (IIAs) created to protect foreign investors from mis- conduct by the host state.¹ Most commonly, IIAs take the form of bilateral investment treaties, also referred to as BITs. These treaties have reciprocal eect between two states to assure investor rights are maintained. How do these treaties protect investors, and why are they so special?

IIAs give foreign investors extensive protection against a range of state impositions and is backed up by a powerful dispute settlement mechanism: investment treaty arbitration.

This is often referred to as investorstate dispute settlement (ISDS). ISDS allow investors to le claims of misconduct by states under BITs directly before international arbitration

1The terms rm, investor, and multinational corporation (MNC) refer to all parts of a business organization. It consists of multiple internal actors (e.g. management, legal counsel, operations, share- holders). I regard these organizations as unitary actors but recognize that varying internal attitudes and considerations exist across and within units regarding the investment treaty regime.

tribunals, leapfrogging domestic courts. Such disputes concern signicant assets of foreign investors, and even policy measures imposed by the country hosting the investment.

They are special because the tribunal only considers the specic treaty, not investors' or states' rights enshrined in other legal codes such as domestic or EU law. BITs' ability to raise FDI is much debated, especially since they have proven a huge cost for states who lose arbitrations (Bonnitcha, Poulsen, and Waibel 2017, p. 158-166). The mean compensation reward for successful investors in ISDS is US$ 508 million a staggering amount (Wellhausen 2016, p. 133). Moreover, states' defence costs in ISDS are very high, more than ve times higher than the average costs of defending cases before the World Trade Organization's (WTO) dispute settlement mechanisms (Pelc 2017, p. 566).

For these reasons, they have in the last decade become a huge controversy particularly within the EU. There are a few specic events that accelerated this politicization. In 2007, Hamburg City Council allowed the Swedish state-owned energy company, Vattenfall, to place a coal-red power plant on the banks of the Elbe river running from the North Sea through Hamburg. However, due to opposition among civil society groups and local politicians, the urban planning agency of Hamburg decided to impose signicant restric- tions on the plant's water usage in return for nal approval. The measures were costly, but according to local authorities all operating companies along the river were subject to them. Regulations were also consistent with European and German law (Bonnitcha, Poulsen, and Waibel 2017, v-vii).

In March 2009, Vattenfall challenged the decision based on the 1991 Energy Charter Treaty (ECT).² The treaty gave Vattenfall protection against a wide range of state impo- sitions and was backed up by ISDS. As such, Vattenfall could take Germany directly to international arbitration without going through German or EU courts rst. In their case, Vattenfall claimed measures that amounted to indirect expropriation and unfair treat- ment, asking for $1.5billion in compensation. The arbitration enraged non-governmental organization (NGOs) and German politicians. Being sued despite following German and EU laws caused great distress. In 2011, the parties settled. Hamburg lowered environmen- tal requirements on the power plant in exchange for Vattenfall dropping the arbitration proceedings.

In 2012, Vattenfall led a second ISDS claim against Germany. This time asking for $5.1bn in compensation. The subject of dispute was Germany's decision to phase

2The Energy Charter Treaty is a wide IIA that only regards energy investments. It entered into legal force in April 1998. Currently, there are 57 contracting parties to the ECT where 26 of these are EU Member States (all but Italy) (Aceris Law LLC 2020).

out nuclear power after the 2011 Fukushima Daiichi nuclear disaster in Japan, where an earthquake and tsunami caused the most severe nuclear accident since the Chernobyl disaster in 1986. The case is still pending, while other things have happened since. In 2017, the European Court of Justice (ECJ) found the original decision to authorize construction of the power plant breached with EU law because it was not supported by a sucient comprehensive environmental impact assessment.

In part due to the Vattenfall cases, The EU has later shown dissatisfaction with intra- EU BITs. On October 24, 2019, the EU Member States and the European Commission therefore reached an agreement to terminate all bilateral investment treaties between member states. The termination agreement was signed May 5, 2020, and entered into force on August 29, 2020. The termination agreement implements a March 2018 Court of Justice of the European Union (CJEU) judgement deeming all BITs between member states incompatible with EU law due to its ISDS mechanism (European Commission 2020a).

The CJEU was prompted by an ISDS case between the Dutch company Achmea, and Slovakia, where Achmea claimed that various legislative measures introduced by Slovakia constituted a reversal of the previous liberalisation of the Slovak health insurance market.

Achmea stated that this violated their rights under the NetherlandsSlovakia BIT from 1992 (Ankersmit 2018).³ The ECJ's judgement addressed features of the arbitration clause in the BIT incompatible with the EU's judicial system and the autonomy of EU law.

This raises important political, economic, and legal questions. The EU's decision has seemingly been based solely on a normative assessment of intra-EU BITs' (in)compatibility with the EU legal order. I ask whether the EU has neglected to consider core economic benets of intra-EU BITs? BITs are intended to incentivise FDI, but do these treaties actually raise levels of intra-EU cross border investment? The agreement to terminate intra-EU BITs even seems to admit that national and EU law is not equivalent to rights and protections of investors under BITs are other, more sucient replacements needed?

The EU has initiated negotiations for a Multilateral Investment Court (MIC), but as pre- vious multilateral initiatives for investment has proven, this process is far from conclud- ing.⁴ This prompts the question of whether the EU has previously expedited this policy area, or perhaps decided that judicial conditions are more important than economic or development-related areas. After the Treaty of Lisbon, the EU acquired exclusive com- petency over member states' external investment policies. Have they de facto neglected

3Further expanded on in subsection 2.3.2.

4Previous initiatives on a multilateral investment court is discussed in section 2.2

internal investments, and is there now a looming investment protection enforcement prob- lem within the EU?

To summarise, the EU has time and time again emphasised the risks of keeping BITs within the EU. The Commission's concerns revolve around judicial interference, ISDS cases, politicization, and protest from the civil society. I ask whether EU policymakers have neglected potential positive factors of BITs, mainly being raised FDI and a stable investment environment.

To answer this question, I conduct an empirical study of the link between intra-EU BITs and FDI ows. A core premise in nding out whether the EU's decision is valid is studying whether BITs actually raise intra-EU FDI. Are BITs critical instruments to promote economic and political development, or simply a subsidy to already powerful MNCs?

1.2 Research question

The puzzle of this thesis is twofold. First, as illustrated, the EU is moving into a new phase of integration with the policy process on the removal of BITs, making investors solely reliant on EU and domestic law to resolve investment disputes. This has been conducted seemingly without any empirical evidence implying BITs have been redundant, as no studies on the eect of Intra-EU BITs exist. It seems as if the EU has made the decision based on a normative premise of wanting a decisive, non-conicting legal order.

Next to tidying up the legal order, there seems to be a presumption from the European Commission (EC) that BITs between member states are unnecessary and that EU law and member states' laws provide sucient protection for intra-EU investors (European Commission 2018b)

Second, few international associations of states can compare to the framework of the EU. The EU political environment consists of a high degree of integration with close to non-existing barriers of economic interaction. More importantly, the degree of legal coverage the EU provides is unparalleled in other economic co-operations. The quality of domestic institutions within EU Members States is also exceptional in a global context, EU states are concentrated with high geographical proximity, and are relatively homogenous politically and economically.

This makes it a unique, near quasi-experimental group to study the eect of BITs on FDI within. Other studies of BITs impact on FDI have been often conducted on broader, more heterogeneous samples, with observations ranging from the poorest to the richest

countries in the world. This all makes sense seeing how BITs have traditionally been signed between wealthy states hosting large MNCs, and poorer states desperate to attract the thought economic benets that come with FDI (Salacuse 2010; Poulsen 2015). One have often looked upon BITs as a subsidiary for states with weak protection of property to gain attractiveness for foreign investors (Elkins, Guzman, and Simmons 2006; Guzman 1997).

These disproportionated relations have been referred to as NorthSouth treaties, but is the BITFDI dynamic similar when we look at BITs between EU Member States?⁵

The question is then how BITs impact NorthNorth relations, where both treaty par- ties have relatively sound legal systems and high levels of property rights protection?

They are intended to incentivise FDI, but do BITs actually work in creating more FDI when both states seemingly already have sound legal systems?

This outlines the main focus of study for this thesis. With these factors taken into consideration, my research question reads:

Research question: Do intraEU bilateral investment treaties raise cross- border foreign direct investment between EU Member States?

1.3 Outline of the thesis

Chapter 1 presents a background for the topic of interest and a puzzle leading to the research question. Chapter 2 presents the concepts and theories related to the subject.

This includes denitions, international investments law and policies relevant to the sample.

The remainder of the chapter lays out my analytical framework, theories, mechanisms, and the literature on which my assumptions are based on. Chapter 3 includes the research design used to assess my expectations. It emphasises potential biases to the sample, operationalization of variables, and arguments for what method is appropriate to use.

Topics related to reliability and validity are also discussed. Chapter 4 presents an analysis of my hypotheses. It presents results with sequential robustness tests and a discussion interconnected with the theoretical framework. Conclusively a policy recommendation is given. Chapter 5 concludes the study and suggests topics for further research. Appendix A furnishes arguments for validity and provides descriptive statistics. Appendix B includes additional gures and tables, in particular related to robustness tests.

5North refers to developed countries of the Global North, typically OECD-countries, and the Global South, typically developing countries (Bonnitcha, Poulsen, and Waibel 2017).

1.4 Review of ndings

The empirical analysis presented in this thesis does not show support for the hypotheses formulated in section 2.6. It thus supports the EU's act to terminate intra-EU BITs.

Baseline models surprisingly indicate that intra-EU BITs have a negative, statistically signicant impact on cross border FDI within the EU. These results are robust to a number of dierent specications and tests. I also nd that BITs have no signicant eect when only member states acceded after 2004 are set as host countries. Finally, I nd that treaties more dense in substantive protection provisions have a negative, statistically signicant impact on FDI. Overall this indicates that intra-EU BITs are inecient in driving investment within the union. If anything, the treaties have contributed to less investment among treaty parties.

The policy advice for the EU and its member states resolves around implementation of more favourable domestic institutions built to ensure investor protection. The EU seems right in proceeding with their Multilateral Investment Court, as this seems both de-politicizing and a more viable solution for member states.

Chapter 2

Literature, Concepts and Theory

2.1 Foreign direct investment and the multinational cor- poration

The core question all commercial actors are faced with is whether to make or buy their products: A choice between keeping production activity in-house, or contracting it out to someone else. Stripped down, the question is essentially internalization versus exter- nalization (UNCTAD 2011, p. 124). The choice between these two options are based on relative costs and benets, associated risks, and the feasibility of each. Simply put: The option with the highest utility for the investor.

FDI is a special case of internalization, involving the purchase or setting up of physi- cal facilities in a foreign country (Berge 2012). Baldwin and Wyplosz (2012) denes FDI as instances where a company from one nation directly controls an investment in an- other, say a factory, rather than merely owning some shares in the foreign establishment.

(Baldwin and Wyplosz 2012, p. 335). What statistically denes as directly controlling an investment is when an investor holds 10% or more shares (OECD 2020, p. 7-8).¹ This threshold distinguishes direct investments from ordinary portfolio investments. Through FDI, investors hold real control; either by board seat, decision-making; or other types of inuences that help steer the direction of the rm. In short, FDI necessitates some form of substantial ownership from the investor.

There are other forms of international economic interaction that needs to be distin- guished from FDI. Foreign portfolio investment (FPI), or indirect investment, diers from

1Some compilers argue the threshold being 10% of voting power doesn't amount to signicant inuence.

On the other, some argue investors may own less than 10%, but still have an eective voice. In empirical studies, 10% has been the template threshold, but upwards of 20% is not uncommon.

FDI in that it is often conducted over a short time period, and often with a speculative motive. FPI is when an investor buys shares in, or debt of, a foreign company without any form of control over the company (European Commission 2020b).²

What makes an enterprise or corporation multinational is the fact that they in some form conduct foreign direct investment. They own an establishment abroad, but this can be a wide variety of things. Amongst other, retail outlets, factories, plants, oil rigs etc.³ Multinational corporations (MNCs) typically conduct two types of FDI: (I) Greeneld investment, which is when a corporation sets up a plan for a production facility, gets a licence, sets up a service provider, and starts producing or oering their service. (II) Mergers and acquisitions, which is when a MNC buys parts of, or the entire rm (Phung 2019). My analysis does however not distinguish between dierent types of FDI as it runs with aggregated data.⁴

2.1.1 The relevance of FDI

Why should one care about FDI? The main reason is that FDI might inuence a host country's development. Studies show that MNCs pay higher wages than domestic rms (Aitken, Harrison, and Lipsey 1996). Others suggest that the presence of MNCs also raise domestic wages (Lipsey and Sjöholm 2004). Foreign investment is also thought to bring spill-over eects in terms of technology, employment, know-how, raised tax revenues, and even domestic rms' productivity (e.g. Li and Luo 2018; Javorcik 2004; Baldwin 2016).

MNCs might also bring new industries into their host's economy, either through greeneld investments or creating connections with the global market.

This makes MNCs conducting FDI key vehicles of economic growth. The activities of MNCs have historically been one of the main catalysts for growth in developing countries.

However, investments alone cannot stimulate an economy. Inquiries into the FDI and eco- nomic growth relation are less deterministic than the relation between strong institutions and growth (Lipsey and Sjöholm 2004).⁵ What seems to be a consensus is that FDI is associated with signicant growth potential, particularly in developing countries.

2FPI involves e.g. purchasing stocks, bonds, and cash equivalents in foreign markets.

3Multinational corporations (MNCs), multinational enterprises (MNEs), and transnational corpora- tions (TNCs) all direct toward the same concept and body. They have a global prole, control and manage establishment, and are located in two or more countries.

4One typically divides FDI into three types: Horizontal-, vertical-, and conglomerate FDI. Dunning (see e.g. 1977; 1981; 1988; 1993) also divides FDI into four additional types: market seeking, resource seeking, eciency seeking and strategic asset seeking.

5There is a fairly strong consensus on the importance of institutions for economic growth (Rodrik 2000, p. 4)

Dierent types of FDI bring dierent types of benets. FDI through natural resource extraction, like petroleum, has often been thought to have a smaller eect on economic growth than manufacturing and service industries (Cohen 2007, p. 78-9). Service in- dustries have previously not been assumed to have the same positive eect on the host's economy as manufacturing in terms of bringing spill-over eects. This view has changed with FDI in service industries now being perceived as a source of organizational expertise, know-how, information processing systems etc. (UNCTAD 2004, p. 124).

In short, one of the key reasons why we should care about FDI is that there is great development potential in foreign investment ows. How are investments then regulated?

The following part expands on the history of what has been labelled the investment treaty regime, with a particular focus on the key institutions in the regime. I later expound on how the investment treaty regime aects both host states and MNCs.

2.2 The investment treaty regime: a brief history

Historically, international economic relations have been governed multilaterally. Trade has been governed through the General Agreement on Taris and Trade (GATT), and later the WTO. The International Monetary Fund (IMF) has supervised monetary rela- tions. It is therefore peculiar that no multilateral organization to govern international investment ows has been established. This is not due to lack of attempts, as discussions at WTO-, OECD-, and UN conferences have all attempted to establish a multilateral court unsuccessfully (Berge and Hveem 2018, p. 311). This section gives an historical account of investment governance and international investment law, explaining why mul- tilateralism has failed. Thereafter, I elaborate on the current bilateral regime, which has been the subject of much critique as of late.

Dating centuries ago, back to the early days of international trade and shipping, states have exhibited interest in protecting their nations property rights abroad. Some were institutionalized, like Spain and Great Britain's Treaty of Peace and Friendship from 1667 (Chester Brown 2013a, p. 3). In other relations, states backed their commercial interests through gunboat diplomacy, colonial conquest, and rule (Lipson 1985). Berge and Hveem (2018) notes three specic events which were all catalysts for states' accelerated interest in international codes for investor protection: The Vienna Congress of 1815 (and the end of the Napoleonic Wars), the industrial revolution, and the emergence of liberal economic ideas challenging mercantilism.

These events all illustrate what Baldwin (2016) calls the Old Globalization (ca. 1820-

1990).⁶ Inventions like railroads, steamships, steel hulls, the telegraph, and eventually diesel drastically increased the eciency of transportation and communication.⁷ In total, this made it easier for investors to administer properties in a foreign country and drove down overall transaction costs. For investors interested in overseas production, transport- ing merchandise back to the host country became viable. In other words, production was no longer slave to local consumption (Baldwin 2016).

General incorporation laws were also passed in Western Europe and the US, allowing investors to pool capital in dierent rms. Previously, special legislative approval was required for foreign investments, which meant investors had to collaborate with domestic businesses when investing abroad. Such joint ventures included much more risk than direct ownership (Berge and Hveem 2018, p. 312).

The set of rules in place to govern foreign investment in this period was customary international law (CIL). CIL contained provisions on protecting investors but was limited in scope and application. FDI protection was unsurprisingly not a concern for most industrialized countries, as their investments were usually directed to their respective colonies. In the colonies, investments were already protected by military forces or legal systems (Hopkins 1980).

Discussions on a common set of rules for foreign investment were sparked by conicts between the US and Latin American states, centring around how state responsibility should be interpreted under the CIL. Latin American states expressed a wish for host states to give equal treatment to foreign and domestic investors, while retaining exclusive jurisdiction over disputes in domestic courts. The US on the other hand, found domestic jurisdiction so weak in some instances it wanted foreign investment disputes to be treated by an external set of rules (Berge and Hveem 2018, p. 312).⁸ Disagreements like this led to states pursuing a treaty-based system for investor protection.

On numerous occasions, there have been attempts at establishing multilateral treaties for protecting foreign investment.⁹ All of these have been unsuccessful. Of the more

6The timespan 1820-1990 is also referred to as the Great Divergence. The period illustrates a shift from when ancient civilizations like China, Egypt, and Indiawhich had dominated the economy for four millenniawere displaced in less than two centuries by today's rich nation (G7 economies) (Baldwin 2016, p. 57-59).

71819 saw the rst steamship cross the Atlantic. It combined wind and steam power; as fuelling problems prevented isolated reliance on steam powerjust as the lack of charging stations hinders the spread of electric cars today (Baldwin 2016, p. 51).

8Referred to as the Hull Rule, named after SoC Cordell Hull, who after an array of Mexican expro- priations put forth the formulation on a full compensation standard (Berge and Hveem 2018, p. 325).

9An overview over proposed multilateral instruments on protection of foreign investment can be found in (Berge and Hveem 2018, p. 314)

notable ones, the Multilateral Agreement on Investment (MAI) initiated by the OECD between 1996 and 1998 is useful to illustrate why this and so many other attempts have failed. The idea was to establish a code within the OECD that non-OECD countries could opt into. However, the public attention was immense as MAI was put under signicant media spotlight from the moment negotiations commenced in 1996. The political cost for some states joining negotiations therefore increased. A larger issue was the seemingly unbearable dierences between EU- and non-EU countries on basic investment issues, such as the national treatment clause.¹⁰ The negotiation process also gained critique for not including the Southern part of the world.

Another, more general issue, was the civil society's opposition heightened to MAI, and the immense media spotlight it received. While the reasons for why MAI failed reects the complexity of investment regulation, issues related to states' right to regulate were arguably the underlying issue that caused the agreement to fail (Berge and Hveem 2018, p. 317).

After the MAI, a brief discussion around the topic resurfaced at the WTO rounds in Doha 2001, but the discussion relinquished as fast as it came. Bilateralism has since become the standard order of operation, making the regime governing interactions between foreign investors and host states decentralized (Berge 2020).¹¹ By the end of December 2020, the total number of IIAs was 3312.¹²

2.2.1 Bilateral Investment Treaties

BITs refer to an international investment agreement (IIA) between two states. BITs contain reciprocal provisions for the promotion and protection of private investments made by the treaty parties. The agreements establish terms and conditions the host country government needs to abide by (Dunning and Lundan 2008).¹³

The rst BIT was signed in 1959 by Germany and Pakistan (Chester Brown 2013b, p. 3). Since then, numerous BITs have been signed. BITs generally provide protection against aspects damaging to the economic interest of an investor, such as illegal nation-

10National treatment provisions can be dened as a principle whereby a host country extends treatment to foreign investors that is as favourable as the treatment national investors receive (National Treatment 1999)

11How BIT formation started can be found in (Bonnitcha, Poulsen, and Waibel 2017, chapter 7)

12https://investmentpolicy.unctad.org/international-investment-agreements

13International investment agreements (IIAs) are used as an umbrella term for all investment agree- ments between countries containing provisions on investment no matter the amount of countries included.

My use of the term IIA always assumes the inclusion of ISDS, thus excluding Double Taxation Treaties (DTTs) and mere investment promoting agreements.

alisation and expropriation of foreign assets without (appropriate) compensation. BITs dier in content, but some provisions are often common, such as: National treatment, most-favoured-nation treatment (MFN), fair and equitable treatment (FET), and com- pensation in the event of expropriation (UNCTAD 2000b).¹⁴ BITs have arguably become one of the most important international legal mechanism for the encouragement and gov- ernance of FDI how did they come to be?

Traditionally, BITs were signed between a developed country and a developing coun- try, or between two developing countries. Today we also nd BITs between developed countries more common. The idea behind an institutional instrument like BITs was that governments in general, and developing countries in particular, had a dicult time cre- ating a credible commitment to investors. BITs contained the enforcement of promises made by the host state to investors outside the border of the home country in international arbitration (Dunning and Lundan 2008, p. 723).

2.2.2 Intra-EU BITs

Regarding Intra-EU BITs, there is a natural development following the increase in BITs globally. Interestingly enough, the EU accession waves play a large matter in interpreting these. I nd that most intra-BITs were signed between the original EU Member States, and member states that acceded into the EU later.¹⁵ The Central and Eastern European countries had also concluded investment protection treaties amongst themselves. From their date of accession, the agreements turned into treaties among member states, and thus they became intra-EU (European Commission 2018b).

The fact that Eastern European latecomers to the EU had BITs in place with the original EU Member States at the time of their accession is puzzling. The non-EU mem- bers (at the time) had generally been against strong investor protection in multilateral negotiations such as the MAI-initiative discussed above. BITs contain more extensive investment protection than the MAI would, thus it is surprising that the Eastern Euro- pean countries agreed to sign BITs initially. Perhaps even more surprising, as the next paragraphs explain, the number of agreements even signals BITs were much desired by late joiners of the EU.

As of 2020, before the termination agreement on Intra-EU BITs was ratied, slightly

14An overview and description of dierent investment protection provisions can be found in Bonnitcha, Poulsen, and Waibel (2017, chapter 4)

15Modern EU accession waves comprised of respectively 2004 (Cyprus, Czech Republic, Estonia, Hun- gary, Lithuania, Latvia, Malta, Poland, Slovenia, Slovakia), 2007 (Bulgaria, Romania), and 2013 (Croa-

less than 200 intra-EU investment treaties formally existed (European Commission 2018b).

BIT termination is not entirely new, as countries such as Ireland and Italy have success- fully exited certain IIAs prior to the Commission-led denouncement of all EU BITs. Italy for example, withdrew from the ECT on January 1st, 2016.¹⁶

Figure 2.1a illustrates the cumulative development of intra-EU BITs. There is an expo- nential increase around the 1990s, before the development stalls and eventually decreases.

The increase around the 1990s is even more evident in Figure 2.1b.

From Figure 2.2, one can see a reduction in the number of BITs due to parties ter- minating them. In fact, no pair of countries have ratied a BIT after both became EU members. So, although none of the intra-EU BITs were intra-EU when they were signed, they became so when one or both parties to the original BIT joined the EU. Formally, one can therefore say that no intra-EU BIT existed before the 2004 accession wave. This is also illustrated by all gures illustrating an immediate stop to signing and ratication of agreements after parties became EU Members. This is illustrated by the cumulative and ratication gures attening out or stopping.

Most treaties were signed in the 1990s (UNCTAD 2000a; Olivet 2013). This was a general tendency for all BITs. BITs were typically signed at conferences hosted by the UN. Here, representatives of countries negotiated agreements between themselves.¹⁷

The Central and Eastern European countries' motive for signing BITs is interesting.

Did states who joined the EU late sign BITs because they wanted to raise FDI, or were they perhaps thought of as an economic liberalization signal to the rest of the world? This is particularly relevant for Eastern European countries that became independent with the collapse of the Soviet Union. Recent evidence indicates that many of these states struggled to see the risk of ISDS claims that came with BITs (Poulsen 2015).

To summarise, tendencies show that intra-EU BITs were created due to agreement creation between parties where one or more were not EU Members, and that no BITs were created after both parties were member states. Interestingly, and more examined in the following section: Despite stoppage to bilateral treaty signing after parties became members of the EU, the real wave of dispute arbitrations exploded only after both parties became EU members.¹⁸

16Foreign energy-related investments made to Italy before withdrawal are however protected until 2036 by a sunset provision (Aceris Law LLC 2020).

17Examples are The United Nations Conference on Trade and Development in Geneva 1999 and the Third UN Conference on the Least Developed Countries in Brussels 2001 (UNCTAD 2001, 1999)

18After the EU's decision to terminate intra-EU BITs, the number of BITs has fallen drastically. As of 14.04.2021, 24 intra-BITs have been terminated in 2021 alone (2021 not included in gures due to continuous decline).

Figure 2.1: Intra-EU BIT development

(a) Cumulative development of Intra-EU BIts

(b) BITs ratied each year

Figure 2.2: BITs terminated annually

2.2.3 InvestorState Dispute Settlement

The incompatibility between BITs and EU law is the catalyst for the EU taking a stance on intra-EU BITs. The CJEU decided that the ISDS feature in BITs is the main determinant of this, but what is ISDS and how does it work?

The main protection of a BIT is that it allows investors to sue states directly by submitting a claim for breach of the BIT to an international arbitration panel rather than to a local court. Traditionally, states have been the only subjects in international law.

With BITs, states have decided to give investors direct legal standing through broad, ex-ante, consents to arbitrations through ISDS. The system of arbitration included in BITs is based on commercial arbitration. It gives private party-appointed arbitrators, instead of tenured judges, power to decide questions on treaty breach (St John 2018).

ISDS tribunals cannot force states to change or remove regulatory acts interfering with investors right they can however award monetary damages as compensation for loss of property (Berge 2021, p. 8).

The most important institution for ISDS is the Convention on the Settlement of In- vestment Disputes between States and Nationals (The ICSID Convention, 1966). The ICSID Convention established procedural rules for investorstate arbitration in the case of investment disputes. Today it is the most used tool for solving investment disputes under BITs and other IIAs (Berge and Hveem 2018, p. 317).

ISDS cases between EU investors and member states have arisen frequently in the last few years. Figure 2.3 illustrates how many ISDS cases have been initiated between member states. There is a spike in ISDS cases after 2004.¹⁹ This is surprising as it signals that BITs were less frequently invoked when investors did not have the extra layer of EU law to protect them. Perhaps more investment occurred after they became EU Members?

Using UNCTAD's search tool,²⁰I nd 108 intra-EU ISDS cases. This surely illustrates that investors nd ISDS useful even within the EU. Are they not satised with the already existent enforcement the EU provides? The following section explains what measures are available within the EU, as well as investors stated thoughts on them.

Figure 2.3: Annual ISDS cases between member states

2.3 European integration and investment policy

Prior to the Lisbon Treaty of 2009, investment policy was not part of the EU's respon- sibility. After ratication of the treaty, the EU however acquired exclusive competence over member states external investment policies. This enabled the EU to conclude com- prehensive trade and investment agreements on behalf of their member states, which was intended to create a more stable investment climate for EU-investors outside the EU (Woolcock and Kleinheisterkamp 2010, p. 6). Internal investment policy has until re-

19Note that ISDS's before 2004 are not between two member states at the time.

20See https://investmentpolicy.unctad.org/investment-dispute-settlement/advanced-search

cent been left with member states themselves. This section presents how EU's internal investment policy is structured, and what protection the EU provides to internal investors.

Seeing as there were already states within the EU without BITs for investors protection it begs the question: How exactly does the EU protect intra-EU investors, and are there already procedures in place that would substitute for BITs within the EU?

EU cross-border investors benet from the Single Market's fundamental freedoms.

Free movement of capital under the Treaty of Maastricht made restrictions on capital movement and payment across borders prohibited. The Commission highlights that in- vestors are free to establish a business, to invest in companies and to provide services across borders. Investors can also rely on the fundamental rights in the Charter of Fundamental Rights of the EU. This includes right to property, access to justice, and non-discrimination (European Commission 2018a, emphasis added). In addition, general principles of EU law are enjoyed across borders.²¹

Since all member states are also part of the Council of Europe, they have consequently ratied the European Convention on Human Rights (ECHR). Investors can take particular note of Article 1 of Protocol No. 1 regarding the protection of property. Cases led under Article 1 of the ECHR provisions consist of corporations suing states for economic loss where they hold domestic authorities responsible, and for which they have yet to receive compensation.²²

If an investor believes EU rights have been violated by national authorities in an EU country, several options are available. Enforcement of EU rights are guaranteed by national courts, and through preliminary rulings or infringement proceedings, by the ECJ.²³ It is also guaranteed by the EU Commission. The Commission can review na- tional measures to ensure compliance with EU safeguards protecting investors (European Commission 2021). As nations within the EU have also made obligations to the ECHR, foreign investors are also covered by the provisions within the ECHR.

If a private individual or corporation has sustained harm in violation of EU law or other conventions, there are normally two ways to bring forward your case. Either in domestic courts or supranational courts. Before the case goes supranational, the investor must rst

21Investors are protected through a large body of sector-specic legislation covering areas such as nancial services, transport, energy, telecommunications, public procurement, professional qualications, intellectual property and company law.

22See (Council of Europe European Court of Human Rights 2018, p. 120) for examples of corporation V. state cases regarding this provision.

23SOLVIT centres exist within each member state to assist foreign investors who feel authorities have infringed their rights under EU law.

exhaust the domestic court system in the country of investment (Brauch 2017).²⁴

The regional integration within the EU stemming from the European Single Market Act has made previous unexplored markets more popular destinations for investment.

Minor consumer markets like Ireland have become popular exporting platforms for foreign rms who want to reach the EU market. Ireland and countries like it are extensively emphasised in both subsection 3.2.2 and the general analysis, as phantom investments becomes an important factor to consider.

However, the fact that there are provisions in place to protect intra-EU investors does not necessarily justify the removal of intra-EU BITs. What is the EU's stated reason for wanting to abandon all BITs within the union?

The Commissions' view is that EU law suciently protects investors in the absence of bilateral treaties. Amongst others, the issues with intra-EU IIAs, like the ECT and BITs, is that it constitutes a parallel legal system overlapping with Single Market rules.

BITs also conict with the non-discrimination principles of the Single Market Act for EU investors. By conferring rights solely on a bilateral basis, other countries' investors are left in disfavour. Dispute settlement mechanisms of BITs also entrust interpretation of EU law to non-permanent and private arbitral tribunals. They are thus unable to ensure correct and uniform application of EU law, in absence of judicial dialogue with the CJEU.

In a press release from 2018, the European Commission states their position and guidance on BITs and cross-border EU investments:

Today's publication aims to set out the protection enjoyed by investors under existing EU law [...] At the same time, eective and adequate protection does not entail unlimited protection for investors' because other legitimate interests must be considered by public authorities (emphasis added, European Commission 2018b).

2.3.1 The EU's proposal on intra-EU investment protection

In 2020, the EU requested feedback on ways to optimise the investment climate within the EU. Their intention is further to clarify rules that protect and facilitate investment between EU Member States, introduce new measures to ll the gaps, and improve en- forcement in disputes between investors and national governments. The 2021 Commission Work Program envisages the legislative proposal to be adopted in the second quarter of 2021 (Ragonnaud 2021).

24The vast majority of IIAs neither require nor waives the exhaustion of administrative or judicial remedies in the host state before initiation of international proceedings against it (Brauch 2017, p. 7).

MNCs operating abroad within the EU have responded to the EU's wish to optimize its investment climate:

Austrian Erste Group Bank (¿271.983 billion in assets Q3 2020) in response to this states: We are pleased to see the European Commission acknowledges that EU law may not solve all problems investors may face in their activities and that there is an urgent need to improve the investment climate and investment protection. (Erste Group Bank AG 2020)

Better Finance - The European Federation of Investors and Financial Services Users, also commented on the current regulatory framework: Better Finance members consider that the current regulatory framework for cross-border investments is not elaborated or tailored to incentivise, nor to be considered neutral towards intra-EU investments. (Better Finance 2021)

The active use of BITs illustrated in subsection 2.2.3 signals that investment provisions in BITs might protect more than existing legal alternatives proposed and pushed by the EU. In combination with the displease illustrated from investors, this has caused the EU to realise a need for reform. The following section discusses their newly initiated project for a multilateral investment court, and their approach to BITs and the plurilateral ECT respectively.

2.3.2 Achmea, the ECT, and the project for a Multilateral In- vestment Court

One might question why the EU has elected to remove intra-state BITs but keep the ECT. The EU has received critique from Environmental NGOs for the ECT (Keating 2019), and mounting pressure by the European civil society has led to discussions around a modernisation of the ECT (Brauch 2021). Three rounds of modernisation talks were held in 2020, with more discussions to come in 2021. The ECT also constitutes the same violation to EU investment law and policy as BITs do. The ECT thus brings a high risk of ISDS to member states. In fact, the ECT represents the most frequently sued-under treaty out of any, with an astounding 89 ISDS cases led against EU countries out of 252 including BITs and other IIAs (UNCTAD 2021b, acessed 3. May 2021). As the following section explains, rich states being sued is a new phenomenon.

Traditionally, relatively few claims are led against respondent states with high per- capita income (Bonnitcha, Poulsen, and Waibel 2017, p. 26). However, this has gradually changed. Spain for example, have faced 52 arbitrations as of April 2021, 47 of these

through the ECT, and the Czech Republic has faced 40 claims at the time of writing (middle per capita income). These European countries rank amongst the countries with most incoming ISDS cases, along with Argentina, Mexico, Venezuela who respectively have 62, 35, and 53.²⁵ The high number of ISDS cases in general, and the many cases brought under the ECT in particular, begs the question why the EU would want to reform, thus keeping the ECT, but abolish intra-EU BITs?

The idea with keeping the ECT is perhaps that it constitutes a start to multilateralism.

The Council of the European Union has authorised the European Commission to represent the EU and its member states at the intergovernmental talks at the United Nations Commission on International Trade Law (UNCITRAL). The EU's intent is to reform the existing ISDS system through replacing it with a Multilateral Investment Court (MIC) (Colin Brown 2018; Roberts 2018).

The Achmea verdict has likely been a prime catalyst for the EU's decision to reform, both in removing BITs, but also the wish to create the MIC. As discussed in the intro- duction, the case revolves around the Dutch company Achmea, who raised trial over a partial reversal of the Slovak Republic's imposed restrictions on prots generated from private health insurance activities (Ankersmit 2018). The EU, seemingly displeased that the claim was brought before an investment tribunal under a BIT, as opposed to Slovakian courts who also interpret EU law, found the arbitration clause incompatible with EU law.

This concludes the conceptual exploration of this thesis. The following section expands on theories related to investors' decision-making. The section also expands on theories of investorstate relations, with a particular emphasis on the theoretical mechanism of BITs.

2.4 Theory

Several reasons lead MNCs to conduct FDI, and even more premises decide where to locate the investment. The following section lays forth a framework to grasp rationales behind investors decision making and the investorstate relation in general. To do this, I rely upon Dunning (1977; 1982; 1988; 1993; 2008) recognized eclectic paradigm. I further build upon the paradigm, relating it more specically to BITs. After exploring the paradigm, I present more specic theory related to the BITFDI conundrum, thereunder transaction cost economics, and the idea of BITs as credible commitments to investors.

25https://investmentpolicy.unctad.org/investment-dispute-settlement/advanced-search

2.4.1 The OLI-framework

MNCs motives for investing abroad are for instance a lower cost of labour, access to a new market, or higher technological competence. The complexity of considerations to make when deciding whether to move production abroad is overwhelming. Logistics of transportation; language- and culture- barriers; exclusion from local business networks, and the general political risks of overseas investment. Grievances related to expropriation, transfer and convertibility restriction, breach of contracts, and adverse regulatory changes are realistic government interferences rms are often faced with (World Bank Group 2019, p. 1-2).²⁶

Dunning (see e.g. 1991, 1998) eclectic paradigm, more often referred to as the OLI- framework (OwnershipLocationInternalization), serves as a useful starting point to a conceptual framework that illustrates and classies essential relationships between vari- ables explaining why rms decide to conduct FDI.²⁷The OLI framework bases itself upon rational actor presumptions.²⁸ The framework explains the: (1) why's of FDI, distinct to rm properties; (2) where of FDI, specic to host countries of foreign investment; (3) how's of FDI, dening the method of entering the host country. Simply put, it explains what factors impact the decision-making of investors considering to invest abroad.

O stands for ownership-specic advantages, which targets specic traits that gives the rm market power. Ownership advantages refer specically to properties that make the rm perform better than host-country-companies. This is due to natural endowments such as superior market access, ecient labour, or capital intensity. Even more impor- tantly is unique access to production inputs, or valuable properties of a company, such as technology, superior production capacity, or well-established market access through al- ready established sales networks and branding. Typically, this is referred to as intangible assets (Dunning and Lundan 2008, p. 96).²⁹

The I-component stand for internalization and explain benets of a rm keeping production internally, by exploiting e.g. technology or know-how, as opposed to licensing production to another rm. When deciding upon internal production as opposed to outsourcing production, numerous factors need to be taken into consideration. These

26World Bank Group surveys indicate the rate of investors diverting from conducting FDI in developing countries due to government irregularities is approximately 25 per cent (World Bank Group 2019).

27Full name is The Eclectic (OLI) Paradigm of Internal Production. I use OLI-framework as a less profuse term.

28See e.g. (Scott 1999).

29Intangible assets (culminating into ownership advantages) can be technology and information, man- agerial, marketing and entrepreneurial skills, organisational systems, incentive structures, and favoured access to intermediate or nal goods markets (Dunning and Lundan 2008, p. 96).

generally depend upon the type of investment that is conducted and what type of rm is investing. Horizontal (market seeking) FDI typically wants to protect proprietary assets such as intellectual property, while vertical (eciency-seeking) FDI might want to keep the production chain internal to ensure the quality of the intermediate or nal product.

It is common for giant MNCs to licence production in steps of the process.

L stands for locational advantages of the host country and emphasises why rms choose a specic foreign country to invest in rather than its home country, or any other country for that matter. Locational advantages are more emphasised in this paper, as institutional factors such as BITs fall under this branch. Locational advantages provide a framework for assessing the host country's determinants of FDI. It bases itself of a simple question: What makes some countries more attractive for investment than others? The OLI-framework suggests three factors: (i) the policy framework for FDI, (ii) economic determinants, and (iii) business facilitation.

Initially, locational advantages were formulated with Ricardian-type endowments in mind, i.e. related to the specic economic attractiveness of a host country. Examples of such endowments are market size, market growth, natural resources, labour force, consumer purchasing power etc. Today, locational advantages are wider. On a general level, it can be: Government strategy, political, ideological and cultural dierences, legal and regulatory systems, transaction and communication costs, economic systems, and infrastructure (Dunning and Lundan 2008, pp. 1012). Bonnitcha, Poulsen, and Waibel (2017, p. 40-1) note some other, more specic locational advantages, such as: proximity to foreign markets, domestic investment policy of host country (including investment subsidies and taxation), regional integration, and specic assets such as availability of natural resources and technology.

Domestic investment policies of host countries are important. Decisions of developing countries to remove barriers to inward foreign investment theoretically prompts more in- vestment due to previously unexplored markets for MNCs. Market-seeking service MNCs, such as telecom and energy, often benet most from barrier removal (Bonnitcha, Poulsen, and Waibel 2017, p. 41). The removal of barriers is however not itself a locational advan- tage. Even if barriers to FDI are removed, there must be additional locational advantages for FDI to occur. However, assuming that other underlying locational advantages are present, the removal of barriers to invest is a locational factor that makes FDI more likely (Bonnitcha, Poulsen, and Waibel 2017, p. 59).

Common importance for all investors, is the assurance that their investment will not go lost. This highlights the importance of political and judicial property rights institutions

in host states. Any form of IIA is thus considered part of the locational advantage for a country. Through the policy framework for FDI, it serves as a single element of the overall host country viability for foreign investment. The following section illustrates BITs and other locational, institutional advantages as a measure to reduce transaction costs.

2.4.2 Transaction cost economics

How then can BITs constitute an L-factor, and make a country more attractive to foreign investors? One way to understand this conundrum is through transaction costs economics (Coase 1937). This section lays out the compound traits of the transaction cost economics evolved more recently (e.g. North (1990, 1992) and Williamson (1989)). Transaction costs are later used to improve our understanding and the rationality regarding mechanisms of BITs. These mechanisms are presented as theories of credible commitment, signalling, and exposure.

MNCs are bound to transact with external sources to create value. Value realization occurs when they engage in transactions with suppliers and demander's, where goods are swapped in return for other goods or other valuables. This is not always simple as it necessitates the other part to cooperate and hold up their end of the bargain. Should the other party choose not to do this, values can be lost to the investor, and the overall utility of any given investment drops. For this reason, MNCs go to a great length in ensuring that their commercial counterpart follows up on agreements.

Transaction costs are the sum of total cost of making a transaction, including the cost of planning, deciding, changing plans, resolving disputes, and after-sales (Williamson 1989). Investors make investment-related decisions by measuring transaction costs and production costs. This is why it's so closely related to Dunning's L-advantages: Com- panies elect to invest where the transaction costs are low. Technically, transaction costs encompass the cost of control in an economy. They arise when individuals attempt to acquire new ownership rights, or defend their assets against transgression, theft, and other forms of opportunistic behaviour in economic exchange (Eggertsson 2005, p. 27).

Governments are well-aware of the importance of keeping transaction costs low for investors, and they therefore establish institutions to protect and enforce property rights.³⁰ These are constructed to ensure everyone holds up to their agreements. That is why states with a strong judicial system are associated with lower transaction costs (North 1987).

Picture a theoretical market where there are no institutions in place to supervise or

30Institutions include e.g. judiciary and regulatory frames which make sure the set of rules are followed.

regulate the playing rules. One would end up in a situation where actors are in dire demand of selling or buying something, but there is no option to secure the other part will hold up their part of the agreement. The game theory optimal solution will therefore be to not engage in transactions altogether.

In the absence of formal institutions, MNCs would have to protect property rights and enforce contracts themselves. Self-enforcement would drastically increase the costs and eciency as rms would incur levies spent on policing ownership and agreements. If there were formal institutions in place, the costs of these activities would be transferred to the national level, reducing transaction costs for private actors (North 1990, p. 62).

The cost of transaction is thus key to the performance of economies. Often, one think of transport costs as the obstacle for prot, while North (1987) argues this is wrong. As early as the Roman Empire of the two centuries A.D., trade was possible over a vast area.

After the Empire's fall, trade and the well-being of societies declined. It was not due to rising transport costs, but the cost of transacting had risen with the disappearance of a unied political system with eective enforced rules and laws over a large area (North 1987, p. 420).

Enforcement and utility of investment agreements

IIAs are part of the institutional mechanisms in place to reduce transaction costs for MNCs. North (1990, p. 62) states: Institutions in the aggregate dene and determine the size of the discount, and the transaction costs that the buyer and seller incur reect the institutional framework. As such, I interpret the nature of IIAs discount the transaction costs for investors, making them more inclined to invest.

BITs are constructed to reduce transaction costs. As part of North (1990)'s four factors comprising transaction costs: measurement, enforcement, ideological attitudes and perception, and the size of the market. In this construct, BITs fall under enforcement.

Enforcement can be dened as a third party insurer who supervises that neither party of, say a foreign investment, reneges on their part of the deal. In this case, the ISDS in BITs is the measure of enforcement. It prevents states from going back on their agreement with foreign investors. This is why, as previously mentioned, investment agreements are intended as a placeholder for weak institutions. The reason it acts as a direct placeholder to weak institutions, is because companies can claim this compensation without using the host country's domestic court.

In a more theoretical phrasing, one can say that investments agreements raise the

because ISDS reduce commercial uncertainty for investors, and uncertainty in turn lowers overall utility. Using domestic courts may be expensive and time-consuming, and should the judiciary system prove weak, equal terms for state and investor are not guaranteed.

ISDS is thought to be more predictable since international tribunals are less likely to be biased in favour of the host state, than the host state's domestic judiciary.

With BITs as an enforcement against uncertainty How are they theoretically thought to aect foreign investors? The theoretical mechanisms of BITs are sequentially expanded on.

2.4.3 Credible commitment, signalling, and exposure theory

Finding the true causal mechanisms behind how investment treaties drive FDI is essential for future advising to policymakers. As expanded on in subsection 2.4.1, OLI revolve around what factors foreign investors are aected by when venturing abroad. I explain that local institutions such as BITs are regarded as a locational advantage. The following theories are a more in-depth exploration of how BITs aect investors.

In quantitative studies on BITs impact on FDI, the question is often whether to isolate the impact of a BIT on FDI between partner countries. Alternatively, one can assess the impact of entering into a treaty on total inows of FDI to a country, including inows from countries not protected by a treaty. Choosing the appropriate approach depends on theories of which foreign investors are inuenced by BITs (Bonnitcha, Poulsen, and Waibel 2017, p. 157). This is separated into what we call the credible commitment theory (e.g Elkins, Guzman, and Simmons 2006), and the signalling theory (e.g. Tobin and Rose-Ackerman 2011). These provide two dierent, although potentially complementary, approaches to understanding the causal mechanism linking BITs with FDI.

In addition, I provide a third theory, namely the exposure theory (Allee and Pein- hardt 2011). This theory emphasises what happens in investorstate relations where the ISDS mechanism is triggered. Does the outcome of the lawsuit matter for the continued investment relation?³¹

31These theories intend to present dierent theoretical eects of BITs on FDI. They are however dicult to empirically distinguish quantitatively. The analysis of this paper therefore makes no attempt at doing so, but rather discusses how each eect can inuence results.

Credible commitment

The theory of credible commitment can be traced all the way back to Machiavelli (1532)'s The Prince.³² Stemming from economic game theory (e.g North 1993), credible com- mitment regards BITs as a direct catalyst for investors who are covered by the treaty's investment decision-making. The reason being that investment agreements solve hold-up problems or provide investors with exclusive benets or legal rights not available to other competitors. The idea is that rms are incentivised to invest in countries despite a high political risk due to the lowered transaction cost one achieves through having BITs as a safety net. The central premise of commitment theory is that only those covered by a treaty benet from the protection provided by it.

Elkins, Guzman, and Simmons (2006) were some of the rst to combine the empirical reality of BITs to credible commitment. They argue governments main motive is to make a credible commitment to treat foreign investors fairly. BITs allow governments to make a credible commitment because they raise the ex post costs of non-compliance as opposed to the costs without a treaty in place (Elkins, Guzman, and Simmons 2006, p. 823).³³

The credible commitment of putting yourself in danger of being sued under ISDS is a drastic measurement to incentivise FDI inows. Virtually any legal change or rule that aect foreign investors is potentially prone to be reviewed by a foreign tribunal as mistreatment to foreign investors (Elkins, Guzman, and Simmons 2006, p. 826). By creating an agreement, they thus gain a competitive edge in attracting capital if there were previously any doubts about a country's commitment to enforcing contracts and their treatment of foreign investors.

According to Elkins, Guzman, and Simmons (2006), BITs can redirect international capital ows from one country to another. A BIT gives the host country a reputational advantage over comparable rivals in the competition for inward investment. The possi- bility of investment diversion is arguably the single most important reason to implement BITs. It is the perceived ability of BITs to give one country an advantage over similar countries in the competition that is hypothesized to drive BIT-signing (Elkins, Guzman, and Simmons 2006, p. 826).

As previously discussed, foreign investors view BITs as a device that raises expected return on investments due to lower transaction and utility costs. Does observing a host

32His magic bullet has by economists taken the form of credible commitment, a means whereby a ruler's own incentives are brought into conformity with his staying inline (Higgs 2005).

33Arguably, costs are raised due to ISDS. The newfound involvement of the investors host country and the precise contractual obligations of BITs removes plausible deniability. This is because clear violations imply a much greater reputational cost.