Making treaties matter: The interactive effects of bit strength and domestic political constraints on FDI

Under what conditions can governments use international commitments such as Bilateral Investment Treaties (BITs) to attract foreign direct investment (FDI)? Previous research on the effect of BITs on FDI flows have largely ignored the role of domestic political variables in conditioning the effect of international treaties and institutions. The ability of BITs to attract FDI should depend both upon the extent to which treaties help make contracts more complete through pre-consent to investor-state arbitration and the extent to which domestic political constraints reassure firms that governments will honor their international commitments. Using a time series cross sectional dataset of 118 developing countries from 1970 to 2000, I find statistical support for my hypotheses. Treaty strength and domestic political constraints have an interactive effect on FDI inflows to developing countries. BITs with no pre-consent to arbitration have no effect on FDI inflows regardless of domestic political constraints. BITs that do require pre-consent to arbitration, however, have an increasing and statistically significant positive effect on FDI inflows as domestic political constraints increase. These findings reiterate the importance of the interactive effect of international and domestic institutions. The ability of states to benefit from an open international economic system depends in part upon domestic politics. International treaties and institutions can help governments mitigate informational problems that impede growth, but their ability to do so depends upon the strength of domestic institutions to hold government to their commitments.