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preferential—and thus less rewarding—to the rich state. We test these hypotheses using
annual data on pairs of developing and developed countries between 1960 and 2004, and
find strong support of our argument.
Two implications follow. First, to the extent that the presence of a BIT tells us
something about the likelihood that a pair of countries signs a North-South trade agree-
ment, they can hardly be dismissed as cheap talk. But second, having many BITs does
not make it more likely that a poorer country will get one of these PTAs. Our results in-
dicate that the tipping point is five, which is roughly two fewer than the average develop-
ing country in our sample has ratified. This finding cautions against the argument that
poor states should negotiate a multitude of BITs to signal that they are “open for busi-
ness,” since their welfare gains are likely to be greater where investment and trade liber-
alization coincide (Egger, Larch and Pfaffermayr 2007).
3
This paper proceeds as follows. Section II elaborates our argument. Section III
discusses our research design. Section IV presents our results. Section V concludes by
discussing some of the more salient implications that follow.
II. Argument
By ruling out expropriation (save with compensation) and offering recourse to
international dispute settlement, BITs are thought to lower the risk that foreign investors
face in a developing country, leading to the expectation that they increase FDI. Govern-
ments seem more than convinced: according to UNCTAD (2006), the number of BITs
rose from 385 in 1990 to 2,392 in 1999, and, by 2005, fully 177 countries had signed on
to at least one investment treaty. Just as telling, providers of political risk insurance, like
the governments of France and Germany, will not underwrite an investment unless a BIT
is in place. For its part, the Multilateral Investment Guarantee Agency (MIGA) encour-
ages countries to adopt BITs to ensure that all investments are sufficiently safeguarded
(UNCTAD 1998).
Why this faith in BITs? The idea is that developing countries “tie their hands”
through investment treaties (Vandevelde 1998), signaling their willingness to swear off
(uncompensated) expropriation by giving foreign investors the right to pursue legal
remedies before a third-party, rather than from the developing country’s domestic court
system. BITs also ensure that a rich state’s investors are treated as favorably as others in
the host country, meaning that they get most-favored nation (MFN) or national treatment,
whichever is better. For those firms looking to outsource to tap cheaper labor, move into
new markets, or capitalize on abundant natural resources, investment treaties thus
4
promise to protect their assets and place them on a “level playing field” with their
competitors.
Although BITs certainly limit the ability of developing countries to expropriate,
they are far from onerous for developed ones. Indeed, curbs on expropriation are
typically in place in wealthy states, and the efficacy of their domestic courts in handling
such cases is not usually called into question. For these reasons, we expect that rich
governments are likely to supply BITs when called on by firms to guard against the risk
of expropriation in host countries.
Yet, firms that outsource have an additional concern: namely, the costs of sending
inputs to, and importing from, foreign affiliates. This turns attention to PTAs; firms want
more liberal trade between, and preferred access to, the country with which they enjoy
the protection of a BIT, and their home market. But trade agreements are more onerous
for rich states to sign, in that they involve deeper and reciprocal obligations, and can
mobilize wider anti-trade groups to weigh in on politics. This means that governments
have to take a closer look at the expected benefits from signing a trade agreement. At the
same time, BITs may help prepare the groundwork for negotiating the more robust
obligations of PTAs. Indeed, since investment treaty and trade agreement negotiations
cover most of the same issues, governments that sign BITs have already incurred many of
the political and economic costs associated with concluding a PTA, including
strengthening the domestic institutions needed to participate. Along these lines, for
example, the US explains that, because of Africa’s “generally low levels of economic,
administrative, and regulatory development,” it is using BITs “to transition from U.S.-
Africa trade and investment relationships based on one-way trade preferences to deeper,
5
more reciprocal partnerships, such as that established by an FTA” (USTR 2007). In this
view, a BIT between a developing and developed country improves the odds of
subsequently signing a PTA.
Of course, one possibility is that FDI, itself, might induce the developed country
to reduce tariffs on the developing country’s trade for precisely this reason, raising the
possibility that BITs could substitute for PTAs. Blanchard (2005) calls this the FDI
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