RIETI Report November 11, 2022

The role of international investment agreements in attracting Japanese foreign direct investment

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Welcome to RIETI Report.
This bi-weekly newsletter will keep you updated with the recent columns, event information and research results by RIETI fellows and other leading economists in Japan and around the world.

In this edition, we present topics related to the role of international investment agreements (IIAs) in attracting Japanese foreign direct investment. Internationally, the rate of increase in the number of IIAs has been declining. Yet, this is not the case for Japan. Baek and Urata analyzed that impact of IIAs on FDI by Japanese firms and found that enacting an IIA with Japan significantly increases the chance of being selected as an FDI destination.

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Editors of RIETI Report (Facebook: @en.RIETI / Twitter: @RIETIenglish / URL: https://www.rieti.go.jp/en/)

This month's featured article

The role of international investment agreements in attracting Japanese foreign direct investment

Youngmin BAEKAssistant Professor, Faculty of Economics at Fukuyama University

URATA ShujiroFaculty Fellow, RIETI

The number of international investment agreements signed by Japan has increased since the 1990s, in contrast to world trends. This column analyses the impact of these agreements on foreign direct investment by Japanese firms. Using data on 12,455 Japanese cases of FDI in 94 countries over the period 1990-2019, it shows that enacting an international investment agreement with Japan significantly increases the likelihood of being selected as an FDI destination. Host countries are encouraged to sign such agreements, as FDI flows can contribute greatly to economic development and growth.

In the mid-1990s, the rate of increase in the number of international investment agreements (IIAs), which are aimed at promoting foreign direct investment (FDI), began to decline, and the interest has continued to decline in the 2010s around the world (Figure 1). One reason is simply the decrease in the remaining number of countries with which IIAs are possible with every IIA signed. Another reason is the growing concern by FDI host governments about the reduction in their policy space resulting from IIAs, as IIAs tie the host government’s hands in formulating and implementing policies. IIAs make it difficult for the host government to restrict FDI with the objective of developing industries of their interest. Yet another reason is mixed research results on the effectiveness of IIAs in terms of attracting FDI, which would contribute to economic growth of the host country. Contrary to the global trend, the number of IIAs signed by Japan continued to increase in recent decades (Figure 2). In light of contrasting developments between the world and Japan regarding IIAs, in Urata and Baek (2022) we examined the impacts of IIAs on FDI in the case of Japan.

Rigorous empirical studies of the impact of IIAs on FDI, including bilateral investment treaties (BITs) and free trade agreements (FTAs) with an investment chapter, began to be undertaken in the 2000s. Their main results can be summarised as follows. First, the impacts of BITs on FDI are mixed, in that some studies found positive impacts (Aisbett et al. 2018, Frenkel and Walter 2019), while some studies did not find significantly positive impacts (Hallward-Driemeier 2003, Tobin and Rose-Ackerman 2005). Second, high quality BITs, that is BITs with low flexibility given to the host government in terms of influencing the behaviour of foreign investors, are shown to promote FDI (Dixon and Haslam 2016). Third, mixed results are obtained regarding the relationship between BITs and the institutional quality of the host government. Some studies found complementary relationships, meaning that BITs are effective in attracting FDI in the countries with high institutional quality (Hallward-Driemeier 2003, Tobin and Rose-Ackerman 2005), while some found substitutability relationships (Busse et al. 2010, Neumayer and Spess 2005). In our study, we considered both the quality of IIAs and the institutional quality of host governments. We broadened the scope of institutional quality of the host government by taking account of the past record of involvement in disputes.

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