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Signing a Bilateral Investment Treaty - A tradeoff between investment protection and regulation

Chen Li

Annual Conference 2016 (Augsburg): Demographic Change from Verein für Socialpolitik / German Economic Association

Abstract: We develop a theoretical model of bilateral investment treaties (BITs) to analyze their effects on firm profits and government welfare with heterogeneous firms. We explicitly model the trade-off between attracting foreign direct investment (FDI) and protecting the government's scope to regulate. We show that BITs can improve overall efficiency by internalizing externalities, but with firms gaining at the government's expense. The efficiency improvement does not hold for less profitable industries. We also show that attracting new FDI through a BIT may decrease welfare, while the protection of existing FDI unambiguously raises it. We propose redesigning BITs by including a tax on firm profits, in order to redistribute gains from a BIT such that both firms and the government see a Pareto improvement. In an empirical exercise, we estimate the expected annual cost for Germany resulting from an EU-US BIT to be $27mn, and the compensating profit tax to be 0.5%.

JEL-codes: F21 F23 F53 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-int
Date: 2016
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