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  • African Review of Economics and Finance, Vol. 2, No. 1, Dec 2010

    Journal compilation ©2010 African Centre for Economics and Finance.

      Wasseem Mina

     Publisher: Print Services, Rhodes University, P.O.Box 94, Grahamstown, South Africa

    Pub:

  • Abstract

    This paper empirically examines the short and long term FDI impact of Gulf Cooperation Countries (GCC) countries contracting of bilateral investment treaties and distinguishes it by the income level of the contracting partner. Using panel data for the period 1984-2002 and adopting a GMM estimation methodology, the paper finds that domestic property rights protection institutions, as opposed to investment treaties, matter more for OECD investors. It also finds that while ratified BITs with upper middle income countries have a surprisingly negative, though relatively weak, impact, ratified BITs with high income non- OECD countries have a strong positive short and long term impact.

  • Methodology

    This paper empirically examines the short and long term FDI impact of Gulf Cooperation Countries (GCC) countries contracting of bilateral investment treaties and distinguishes it by the income level of the contracting partner. Using panel data for the period 1984-2002 and adopting a GMM estimation methodology, the paper finds that domestic property rights protection institutions, as opposed to investment treaties, matter more for OECD investors. It also finds that while ratified BITs with upper middle income countries have a surprisingly negative, though relatively weak, impact, ratified BITs with high income non- OECD countries have a strong positive short and long term impact.

    Results and Discussions

    Bilateral investment treaties (BITs) are legal instruments under international law between two contracting countries, the aim of which is to establish clear, simple, and enforceable rules for the reciprocal protection of foreign investment from expropriation in each contracting country. A BIT identifies the circumstances under which government expropriation of foreign investment can take place and the associated compensation standards, and establishes an investment dispute settlement mechanism. BITs therefore externally commit contracting countries to honouring the property rights of the partner country’s investors and reduce host country political risks. As a result, BITs increase foreign investors’ confidence and promote foreign investment (Hallward-Driemeier, 2003; Neumayer and Spess, 2005; UNCTAD, 1998).

    The GCC countries have contracted, i.e. signed or ratified, an increasing number of bilateral investment treaties since 1990 to promote FDI. The rationale behind this increase is controversial, however. On the one hand, the GCC countries may have contracted BITs out of recognition of the positive influence of commitment to property rights protection for foreign investment. The GCC countries greatly desire such positive influence in light of their plans for economic diversification, and the lagging performance of their domestic institutions. In pursuing economic diversification, the GCC countries need to attract foreign investors into non-oil industries. These foreign investors are new to the GCC countries and are not the traditional foreign oil companies with which the GCC countries have historically established trusted business relationships. Contracting BITs would therefore reduce the risk of government expropriation risk for new investors.

    On the other hand, BITs may not be beneficial in promoting foreign investment in the GCC countries for two important reasons. The first reason is that FDI in GCC countries has historically been associated with oil exploration and extraction, despite the absence of BITs. Contracting BITs may therefore be unnecessary for the GCC countries, with a likely inelastic response of FDI to BIT contracting.

    The second reason is associated with the institutional copying hypothesis, which Ginsburg (2005) raises. He argues that institutional copying is one possible explanation for why states contract BITs, given the minimal effect on investment flows found in the early empirical literature. Because of their “desire to seem modern,” states get involved in institutional copying. In light of the strong competition among the GCC countries to promote their global image as modern, competitive economies, and the sharp increase in the number of BITs contracted by GCC countries since 1990, it is possible that GCC countries may have been involved in institutional copying. This view may be further supported by the fact that in the 1990s the GCC countries signed 43 BITs with lower middle income and low income countries, despite their limited investment potential, as opposed to 37 BITs with high income and upper middle income countries with more investment potential.

    Given the controversy surrounding the FDI benefits of BITs, the purpose of this paper is to examine empirically the impact of BITs on FDI in GCC countries, in both the short and long terms. This distinction is important, as the response of investors to BIT contracting may be sluggish in the short term. Foreign investors in the non-oil sector may take a long time to observe the actual commitment of ©2010 The Author (s) Journal compilation ©2010 African Centre for Economics and Finance 3 the GCC governments to the protection of property rights. In addition, foreign investment in oil exploration and extraction takes place over a long period of time. In examining BITs impact, the paper distinguishes BITs by the income level of the contracting partner in order to account for GCC countries different BITs contracting motives.

    Using panel data for the period 1984–2002, the paper adopts a generalized method of moments (GMM) estimation methodology to deal with endogeneity resulting from reverse causal relationship between FDI and BITs. Although from a host country perspective, contracting BITs may encourage FDI, FDI may encourage home countries to contract BITs in order to protect investments. Endogeneity also results from the omission of time-invariant unobservable country effects, such as the degree of strength of foreign relations between the GCC and OECD countries such as France, Germany, and Italy. The paper finds that while ratified BITs, reflecting actual commitment to property rights protection, with high income non-OECD countries have a strong positive short and long term impact on FDI, ratified BITs with upper middle income countries have a surprisingly negative, though relatively weak, impact. The paper also finds that investors from OECD countries seem to weigh the strength of domestic institutional function of property rights protection in their foreign investment decisions as opposed to the intended strengthening through BITs.

    This paper contributes to the international law and FDI literature(s), in which the impact of BITs was examined, in one main respect. It examines for the first time in the literature the short and long term FDI impact of BITs contracted by GCC countries. Characteristic of the GCC countries are the oil resources which lure resource-seeking FDI, the desire to diversify their economies and attract non-oil FDI, and the lagging performance of property rights protection compared to other GCC domestic institutions. These characteristics enrich and flavour the context in which the impact of BITs is examined.

    The paper proceeds as follows. Section 2 discusses the FDI and BITs experience of the GCC countries. Section 3 briefly presents the findings of the empirical literature on the FDI impact of BITs. Section 4 discusses the empirical model and its underlying theoretical framework, conceptual issues, and data. Section 5 discusses empirical issues and the estimation methodology. Section 6 discusses the empirical results; section 7 explores the robustness of the results, while section 8 presents the conclusion.

    References

    Arellano, M. & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence with an application for employment equations, Review of Economic Studies 58, 277-97.

    Bowerman, B. L., O'Connell, R. T., & Koehler, A. B. (2005), Forecasting, time series, and regression. California: Thomson Brooks/Cole.

    Dunning, J. (1981). International Production and the Multinational Enterprise. © 2010 The Author (s) Journal compilation © 2010 African Centre for Economics and Finance 29 London: Allen & Unwin.

    Egger, P., & Merlo, V. (2007). The impact of bilateral investment treaties on FDI dynamics, World Economy 30, 1536-1549.

    Egger, P., & Pfaffermayr, M. (2004). The impact of bilateral investment treaties on foreign direct investment, Journal of Comparative Economics 32, 788- 804.

    Energy Information Administration (2007). International Energy Data and Analysis. http://www.eia.doe.gov/emeu/international/contents.html (accessed January 30, 2007)

    Ginsburg, T. (2005). International substitutes for domestic institutions: Bilateral investment treaties and governance, International Review of Law and Economics 25: 107-203.

    Hallward-Driemeier, M. (2003). Do bilateral investment treaties attract FDI? Only a bit and they could bite, World Bank Policy Research Working Paper 3121.

    Mina, W. (2009). External commitment mechanisms, institutions, and FDI in GCC countries, Journal of International Financial Markets, Institutions, & Money 19: 371-386.

    Mina, W. (2007). The location determinants of FDI in the GCC countries, Journal of Multinational Financial Management 17, 336-348.

    Neumayer, E. & Spess, L. (2005). Do bilateral investment treaties increase foreign direct investment to developing countries? World Development 33, 1567-85.

    Tobin, J., & Rose-Ackerman, S. (2006). When BITs have similar bite: The political economic environment for bilateral investment treaties. www.law. yale.edu/documents/pdf/When_BITs_Have_Some_Bite.doc.

    UNCTAD (1998). Bilateral Investment Treaties in the Mid-1990s. Geneva: United Nations.

    World Bank (2005). Global Development Finance. Washington, DC: The World Bank.

    World Bank (2008). The Road Not Traveled: Education Reform in the Middle East and Africa. Washington, DC: The World Bank.

  • Editor-in-Chief: Prof. Paul Alagidede
    Wits Business School, University of the Witwatersrand, 2 St David's Place, P.O. Box 98, Wits 2050, Johannesburg, South Africa.
    Email: paul.alagidede@wits.ac.za or alagidede@gmail.com

    Editor: Dr. Franklin Obeng-Odoom
    School of Built Environment, University of Technology Sydney, P.O. Box 123 Broadway NSW 2007, Australia.
    Email: Franklin.Obeng-Odoom@uts.edu.au or odoomj6@yahoo.co.uk


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