The influence of interest: Real US interestrates and bilateral investment treaties

Timm Betz1 & Andrew Kerner2

# Springer Science+Business Media New York 2015

Abstract Bilateral Investment Treaties (BITs) present developing countries with atrade-off. BITs plausibly increase access to international capital in the form of foreigndirect investment (FDI), but at the cost of substantially curtailing a government’s policyautonomy. Nearly 3000 BITs have been entered into, suggesting that many countrieshave found this trade-off acceptable. But governments’ enthusiasm for signing andratifying BITs has varied considerably across countries and across time. Why are BITsmore popular in some places and times than others? We argue that capital scarcity is animportant driver of BIT signings: The trade-off inherent in BITs becomes moreattractive to governments as the need to secure access to international capital increases.More specifically, we argue that the coincidence of high US interest rates and netexternal financial liabilities heightens governments’ incentives to secure access toforeign capital, and therefore results in BIT signings. Empirical evidence is consistentwith our theory.

Keywords Bilateral investment treaties . International capital flows . Foreign directinvestment . International institutions . Foreign exchange . Liberalism . Legalization .

Delegation . Ratification

Bilateral Investment Treaties (BITs) establish a set of legal rights for foreign directinvestors and typically allow protected investors to sue host states in international foraif these rights are violated. BITs represent a trade-off, especially for developing

Rev Int OrganDOI 10.1007/s11558-015-9236-6

Electronic supplementary material The online version of this article (doi:10.1007/s11558-015-9236-6)contains supplementary material, which is available to authorized users.

* Timm Betztimm.betz@tamu.edu

1 Department of Political Science, Texas A&M University, 2010 Allen Building, 4348 TAMU,College Station, TX 77843, USA

2 Department of Political Science, University of Michigan, Ann Arbor, 5700 Haven Hall, 505 SouthState St, Ann Arbor, MI 48109, USA

countries. On the one hand, BITs may help governments overcome perceptions ofpolitical risk that might otherwise deter investors and dampen foreign direct investment(FDI). This is important because FDI is often linked to new jobs, technologicalspillovers, increased export revenue, and a stable inflow of capital. On the other hand,BITs subject host countries to the threat of litigation and the possibility of Bregulatorychill^ (Neumayer 2001; see also Poulsen 2014; Poulsen and Aisbett 2013). Manygovernments have apparently found this to be an acceptable compromise: nearly 3000BITs have been entered into to date, almost all of which involve one, and occasionally,two, developing countries.

Despite a general enthusiasm for BITs since the 1980s, the rate of new BITadoptions has varied substantially across space and time. Some countries have enteredmany BITs, others have entered very few or none. New BIT ratifications spiked in thelate 1990s and have flagged considerably since. This is not simply the result of a lack ofeconomically relevant dyads without BITs; BITs are substantially less popular than theyused to be. Governments in Latin American countries, Indonesia, and India have allrecently sought to phase out their BIT programs or to substantially narrow theprotections that are offered to investors in new BITs (Gaillard 2008; Gomez 2011;Tevendale and Nalsh 2014; UNCTAD 2014).

Why are BITs so much more popular in some places and at some times than inothers? We are not the first to ask this question, and existing arguments stress a varietyof ideational and material motives. BITs are fundamentally a trade-off between a cost –legal restrictions – and a benefit – the possibility of increased FDI. Recent literaturefocuses on shifts in governments’ perceptions (and misperceptions) of the costs ofBITs. Jandhyala et al. (2011) argue that a wave of BIT-related suits in the early 2000sincreased common perceptions of the costs of BITs, which in turn truncated a Bnormcascade^ that had developed during the 1990s. Poulsen (2014) and Poulsen and Aisbett(2013) argue that governments have signed BITs according to a Bbounded rationality^in which governments underestimated BITs’ costs until they were themselves sued for aBIT violation. Other explanations suggest that new BITs emerge as the consequence ofBcompetition for capital^ among developing countries (Elkins et al. 2006), and thatgovernments sign more and more stringent BITs during economic slowdowns(Simmons 2014).

This paper presents a novel theory of the politics of BIT formation. Whereas muchof the extant literature emphasizes variation in governments’ perceptions of the costs ofBITs, or the necessity of signing BITs to successfully compete in the internationaleconomy, our theory emphasizes variation in governments’ perceptions of the value ofthe capital that BITs plausibly help attract. For us, the key feature of BITs is that theFDI they are meant to attract can provide developing countries with reasonably stableaccess to a flow of hard currency while avoiding the costs of borrowing capital oninternational debt markets. Governments should be more willing to accept the trade-offs inherent in BITs when steady access to foreign capital is especially valuable, andbe less willing to do so when that capital is less valuable.

Thus, our theory’s predictions rest on the macroeconomic climate and the extent towhich governments in developing countries are incentivized to prioritize access toforeign capital over other policy goals. We locate these conditions at the systemic andthe national level. At the systemic level, access to international capital becomes moredifficult in the presence of high US interest rates. High US interest rates increase the

T. Betz, A. Kerner

Brisk free^ returns to capital, which increases financing costs for developing countrygovernments and tends to reduce the flow of capital into developing economies (see,e.g., Chen and Khan 1997; Frankel and Roubini 2001). The resulting foreign currencyneeds should induce governments to sacrifice more regulatory autonomy through BITsin order to help secure and improve access to foreign capital in the form of FDI. At thenational level, we argue that this logic of sacrificing regulatory autonomy in exchangefor better prospects of attracting foreign capital should be especially powerful incountries where large foreign currency denominated liabilities exacerbate a country’sforeign currency needs. The reliance on foreign currency denominated debt is endemicin the developing world (see, for example, the literature on BOriginal Sin^, e.g.,Eichengreen et al. 2005), but it is not universal, and it exists to different degrees indifferent countries. The combination of substantial foreign currency debt and high USinterest rates should instigate especially concerted efforts to attract foreign capital,which we argue, should include signing and ratifying more BITs.

We evaluate the plausibility of our theory by estimating a series of regression modelson a sample of developing countries between 1961 and 2011. The results are consistentwith our theoretical expectations. We find that more bilateral investment treaties aresigned and entered into force when US interest rates are high, and that US interest ratesare most strongly associated with BIT formation for governments whose countries areexternal net debtors. These findings are robust to the inclusion of a variety of macro-economic and political control variables.

We also demonstrate several additional findings that bolster our interpretation ofthis evidence. We show, for example, that governments paying higher interest rateson newly issued government debt sign more BITs. We also find evidence that theinterest rate environment affects the time between BIT signature and ratification:While BITs sometimes linger in the ratification stage, we show that governmentsratify already negotiated agreements more quickly when US interest rates are high.Moreover, we show that governments enter into stronger BITs (that delegatedecision making authority over disputes) when US interest rates are high, suggest-ing that governments are willing to give up more autonomy in exchange for thepotential gains from a BIT. Finally, we demonstrate that a scarcity of internationalcapital brought on by the combination of high US interest rates and foreignliabilities also correlates with tariff increases. This parallel finding suggests thatthe pattern of BIT signatures and ratifications is not driven by a more generalembrace of neo-liberal policy-making. Rather, it seems more likely that tariffincreases and BIT negotiations take place under the same circumstances becausethey both plausibly help governments manage their finances at times when hardcurrency is more needed and harder to come by.

These findings add most directly to the extant literature on the formation of BITs andcomplement the portion of that literature that focuses on ideational factors (e.g.,Jandhyala et al. 2011; Poulsen 2014; Poulsen and Aisbett 2013). While our focus ison material factors, our findings do not challenge the importance of ideas to BITformation. Our arguments provide a material rationale for when certain ideas should beascendant. Fluctuations in US interest rates and the coincidence with external liabilitiesexplain which countries are most susceptible to be convinced by BITs’ perceivedbenefits and when. By showing that tariffs move in opposite directions, our findingsbuttress the notion articulated in the literature that BIT formation is driven by norms

The influence of interest: Real US interest rates and bilateral

and beliefs that are specific to BITs, and are not necessarily part of a more general neo-liberal turn in ideas.

This paper has broader implications as well. Our theoretical approach qualifies theconventional wisdom that international capital scarcity drives countries towards illib-eral policies, such as capital account closures, increased tariffs, and exchange ratemanipulations (Eichengreen 2008). The appeal of these policies at times of capitalscarcity is their ostensible ability to ‘trap’ hard currency reserves in the domestic marketby preventing current account deficits or capital flight. This logic has been argued to beespecially compelling in developing countries: Bwhen international credit is unavail-able, it is harder for weaker countries to resist domestic pressures for a more closedeconomy^ (Block 1977, p. 4). Nothing in our argument disputes this relationshipbetween capital scarcity and illiberal policymaking, but we do suggest that thisrelationship is more complicated than typically understood. Prominent and consequen-tial forms of liberal economic policies, such as BITs, are driven by the same capitalscarcity that is more typically understood as a driver of illiberal economic policies. Thefact that BITs can be a liberal response to capital scarcity is particularly notable giventhat BITs can impose lasting constraints on governments even after the macroeconomicconditions that led to their signature and ratification have dissipated.

Finally, the United States’ role in setting financial conditions worldwide highlights alink between financial hegemony and political behavior that cumulatively and, perhapsunintentionally, shapes significant aspects of global economic relations. To the extentthat US governments have sought to build a more legalized economic environment thatprioritizes the rights of businesses relative to those of the government, the interest rateappears to be a particularly potent factor towards achieving this goal. Not only do highUS interest rates result in more BIT signatures, they also result in BITs with morestringent investor protections. High global interest rates shift bargaining power awayfrom the developing country governments whose economic growth relies so heavily oncapital imports. Developed country governments that happen to be in office whenglobal interest rates are high may be systematically more successful in their attempts tobroaden participation in the liberal international economic order. Moreover, BITs implylong-lasting commitments, with the typical BIT continuing to bind governments up tofifteen years even after its termination (Simmons 2014). BITs therefore reinforcetemporary bargaining asymmetries between governments brought on by high interestrates by institutionalizing them in treaty form.

In the next section we briefly discuss the reasons why developing countries needaccess to foreign capital and the role that US interest rates play in determining itsavailability. Section III describes various economic policies that countries have histor-ically pursued to address shortages of foreign capital and how BITs fit into thiscategory. Section IV describes a series of cross-country regressions that provideempirical evidence consistent with our argument. Section V notes our conclusionsand reiterates some of this paper’s main implications.

1 Section II - US interest rates, global capital flows, and debt positions

The return on US bonds typically represents the risk free rate of return against whichthe return on other assets is benchmarked. The higher the rate of return on US bonds,

T. Betz, A. Kerner

the higher the risk-adjusted return that an investor must demand from any alternativeproject. As US interest rates go up, other investments must offer a higher rate of returnto investors in order to attract capital. The subsequent increase in financing costs tendsto reduce the number of projects that are able to finance themselves. Conversely, a dropin the risk free return to capital reduces the financial appeal of investing in US bonds,decreases the returns that other investment projects need to offer their investors in orderto attract financing, and tends therefore to expand the pool of investible projects.

These dynamics play out on a global scale. Low US interest rates typically catalyzecapital flows into higher risk assets including investments in emerging markets, makingit cheaper for emerging market governments and firms to attract the capital they need tooperate. High US interest rates do the opposite. This centrality of US interest rates tothe availability and cost of capital outside of the US is well documented (e.g., DiGiovanni and Shambaugh 2008; Frankel and Roubini 2001; Calvo et al. 1993). AsFrankel and Roubini summarize, Bthe most important identifiable factors behind[global capital flows into emerging markets are] US interest rates and other macroeco-nomic variables external to the emerging market countries^ (2001, p. 6).

The primacy of the global and, especially, US interest rate environment to the costand availability of capital elsewhere has been at the center of many historicallyimportant financial episodes. For example, Eichengreen (2008) notes that when theUS Federal Reserve increased interest rates in order to slow the Wall Street boom at theonset of the Great Depression, US lending abroad fell to virtually zero in the secondhalf of 1928, which exacerbated economic problems in Europe. Likewise, the onset ofthe Latin American debt crises is often linked to the high US interest rates institutedunder Paul Volcker in the early 1980s, which increased the cost of new capital andraised debt service costs beyond what many heavily indebted governments couldshoulder (Diaz-Alejandro 1984). Conversely, the relative lack of financial crises inemerging markets between 2002 and 2008 has been attributed to favorable US interestrate policies and the availability of cheap capital during this time (Eichengreen 2008).This relationship has received particular attention recently, as low US interest ratesfollowing the 2008 financial crash flooded foreign countries with capital seeking higherreturns abroad and occasionally created asset bubbles in the process. 1 Even morerecently, an anticipated rise in US interest rates is forcing emerging markets to facethe possibility of large capital outflows and the attendant rise in the cost of capital. Asone observer put it, the attempts of individual governments to counter such globalfinancial pressures are bound to be Bto no avail. Their power is not sufficient to counterthe American [Federal Reserve].^2

Notably for our purposes, the negative relationship between US interest rates andemerging markets’ access to capital and hard currency is evident in the sample ofemerging market data that we use in this paper. Column 1 in Table 1 presents the resultsfrom very simple OLS regressions that note the empirical relationship between USinterest rates – captured here and elsewhere in our analyses by the real US lending

1 Forbes 3/5/2014. Why The Worst Is Still Ahead For Turkey’s Bubble Economy.http://www.forbes.com/sites/jessecolombo/2014/03/05/why-the-worst-is-still-ahead-for-turkeys-bubble-

economy/2 Die Zeit, January 2014.

The influence of interest: Real US interest rates and bilateral

interest rate reported by the World Development Indicators – and (the log of) foreignreserves in emerging markets between 1970 and 2011.3 The negative coefficient on ourinterest rate variable suggests, intuitively, that when US interest rates go up, emergingmarkets tend to see their stores of foreign reserves depleted. This could be the result ofreduced access to foreign capital, higher capital outflows in the form of interestpayments made to foreign creditors, economic slowdowns abroad leading to reducedexport receipts, or a combination of all three and perhaps other factors. Regardless ofthe causal mechanism, the empirical link between interest rates and foreign reservessuggests that periods of higher US interest rates should correspond with periods inwhich foreign capital seeking governments are more incentivized to take proactivesteps to attract foreign capital. Column 2 in Table 1 further shows that higher USinterest rates are associated with reductions in foreign direct investment inflows.4 Theseregressions are far from establishing a firm causal link, but this relationship is none-theless what we should expect to observe given the underlying relationship betweencapital inflows into the developing world and the global interest rate environment. Thissuggests that at precisely the time that we might expect governments to be especiallyproactive in seeking all manner of capital inflows, they might be especially incentivizedto be proactive in their pursuit of FDI.

3 As in all of the following, we exclude OECD countries from the sample as a means of limiting our analysisto primarily capital importing countries. (Another rationale for excluding high-income countries, with morestable and mature economies, is that they should be less affected by changes in US monetary policies; see alsoDi Giovanni and Shambaugh 2008.) Except for the initial OECDmembers, a country is included in the sampleup to the point when it joined the OECD. The equation of OECD membership with Bcapital exporting^ is, ofcourse, inexact. And while this coding rule benefits from conceptual parsimony, some countries – Turkey formost of the 20th century, for example – are likely mislabeled by it. In practice, this rule does not seem to mattermuch to the reported regressions: We did not find substantially different results when using alternative proxiesfor capital exporting. The regressions in Table 1 include a linear year trend and a control for the gross domesticproduct (GDP) (measured in billions of $US). We obtain similar results when including country fixed effects,or when including a lagged dependent variable. We also obtain similar (and slightly stronger) results if wesubstitute the three-year moving average of the US interest rate as the key independent variable.4 Notably, the negative relationship between interest rates and FDI inflows speaks only to the financial aspectsof FDI, and does not necessarily imply that such a relationship exists with regards to commercial aspects ofFDI (Kerner 2014).

Table 1 US interest rates and financial flows

Log Reserves Log FDI

US interest rate −0.043*** (.006) −0.053*** (0.016)

GDP 0.988*** (.008) 0.889*** (0.023)

Year 0.030*** (.001) 0.068*** (0.004)

Constant −62.4*** (2.41) −138*** (8.57)

Obs. 5263 4476

Years 1961–2011 1970–2011

Linear regression coefficient estimates and robust standard errors in parentheses

* significant at 10 %, ** at 5 %, *** at 1 %

T. Betz, A. Kerner

2 Section III - how countries respond to expensive and limited accessto capital

Increases in US interest rates tend to make access to foreign capital more difficult andmore expensive in emerging markets. This can be a problem for any emerging marketeconomies whose growth is constrained by a lack of domestic savings, but it can becatastrophic for countries that rely on inflows of hard currency from abroad to servicetheir foreign currency denominated debts. In either case, the financial environmentbrought about by high US interest rates is one that for many emerging marketgovernments merits a proactive policy response.

That response has historically taken the form of illiberal policy measures meant toretain hard currency within the domestic economy. Increasing tariffs, for example, canreduce the need to use foreign reserves to finance imports, and can thereby help protectan economy from balance of payments problems that might otherwise accompany highglobal interest rates. The interwar trade closure as well as across-the-board tariffs in theUK in 1964 (Roberts 2013) and in the US in 1971 (Irwin 2013), for example, are bothcommonly understood as reactions to balance of payments problems. Even the GATTand, later, the WTO, acknowledged the role of protectionist trade policies in balance ofpayments crises. GATTArticles XII and XVIII:B allow safeguard protections to shieldthe balance of payments. These safeguards were the most common form of administrativeprotection under the GATT, with over 3400 cases as of 1992 (Finger and Hardy 1995).5

Capital accounts are similarly often closed to preserve access to hard currency, tolimit speculators’ ability to attack the currency, or to provide governments with theshort run monetary autonomy needed to pursue an expansionary policy when globalinterest rates are high (Alesina et al. 1993).6 While not explicitly linked to the interestrate environment, the contemporary Greek case illustrates the risk of substantial capitaloutflows and the use of capital account closures to stem them (Blackstone et al. 2015).Similar episodes include the occasional use of using controls on capital inflows oroutflows during the East Asian financial crisis and the 1982 Latin American debt crisis(Brooks and Kurtz 2007).

Our central argument is that the same concern for maintaining access to hardcurrency that typically leads governments to install illiberal policies also leads themto sign and ratify more BITs. BITs are in many ways an odd bed-fellow to the tariffsand capital account closures that are more commonly associated with governmentreactions to capital scarcity. While tariffs and capital account closures embody thetriumph of state power over the will of non-state economic actors, BITs represent theopposite: a deeply neo-liberal abdication of regulatory discretion made in the hope thatgreater flexibility for multinational corporations (MNCs) will redound positively to the

5 More recently – and exotically – in early 2014 the Argentinean government announced a 50 percent tax onpurchases over US $25 made by Argentinean customers on international websites, and it limited suchtransactions to at most two such purchases a year. These measures were, as observers noted, a deliberateBattempt to shore-up dipping reserves of foreign currency^ (Garcia-Navarro, National Public Radio, 2014) andBto curb capital flight and prevent a possible balance-of-payments crisis^ (Gilbert and Rathbone, FinancialTimes, 2014).6 The ability to maintain interest rates at below world levels also allows governments to finance themselvesdomestically at cheaper rates, which is particularly valuable when foreign debt-loads are significant(Aizenman and Guidotti 1990).

The influence of interest: Real US interest rates and bilateral

signatory countries. But the connection between these policies is more practical thanideological: BITs are plausibly helpful to countries facing capital scarcity through theirputative capacity to attract foreign capital, while illiberal policies can help preventexisting stocks of capital from exiting.

BITs can help build new sources of foreign capital through a number of channels.First, BITs might actually promote FDI. To the extent that they do, FDI can provide astable inflow of foreign capital that is less subject to macroeconomic fluctuations than,for instance, portfolio investment. Second, a lot of FDI in emerging markets involveslocal production that is meant to serve foreign markets. This type of FDI can boost acountry’s exports and thereby increases access to foreign exchange. In the long run,technological spillovers from MNCs to domestic firms can help countries expandcompetitive export sectors beyond their resident foreign firms (e.g., Wei and Liu2006). The resulting capital inflows and export revenue can help ease the balance ofpayments challenges that typically accompany high global interest rates and the longterm effects can help countries deal with future periods when capital is expensive andscarce.7

To be clear, it is less important to our argument that BITs attract FDI as it is thatsome non-trivial portion of government leaders believe that they might. As for the firstquestion – whether or not BITs actually work – the answer from the empirical literatureis not entirely clear. While there is a sizable empirical literature to suggest that BITsattract FDI (e.g., Kerner 2009; Neumayer and Spess 2005), others suggest that theeffect of BITs on FDI is small or conditional (Kerner and Lawrence 2014; Tobin andRose-Ackerman 2011), and yet others suggest that BITs have no clearly discernableeffect on FDI at all (e.g., Yackee 2007, Gallagher and Birch 2006). The absence ofconsistent empirical evidence does not in itself prove BITs’ lack of efficacy. Theendogeneity of entering into BITs remains a problem throughout this literature andvery plausibly results in underestimates of the effects of BITs (e.g., Rosendorff andShin 2012, 2014; Rosendorff and Kongjoo 2014). Perhaps more tellingly, work byYackee (2010) and Poulsen (2014) makes clear that BITs are not equally relevant forevery firm, and for many firms BITs appear to wholly irrelevant. Systematic distinc-tions across firms remain under-theorized, and empirical work tends to focus onmeasures of MNC activities that are too aggregated to identify heterogeneous reactionsto BITs, even if they were theoretically anticipated. Thus, while it is possible thatconsistent evidence of BITs’ efficacy is being held back by data and research designs, itis also entirely possible that BITs simply do not work. At a minimum, BITs do notappear to work well enough for their effects on FDI to be obvious to the casual observer

However, what is important for our purposes is not whether BITs work, or whetherthey have or can be proven to work, but whether non-trivial portions of governmentleaders believe that BITs might work. The possibility that BITs might catalyze moreFDI flows is not the only reason that governments of capital importing countries signand ratify BITs – coercion and diplomacy likely play substantial roles, for example –but we are quite confident that this motivation is common. One indication that

7 It is also possible that creditors and credit rating agencies may favor countries that make durable, treaty-based commitments to the liberal economic order (Biglaiser and DeRouen 2007). BITs may provide anopportunity for countries to send such a signal (Büthe and Milner 2009; Kerner 2009) and may thereby easeaccess to other investment flows as well. While possible, Poulsen (2014) suggests good reason for skepticismin this regard.

T. Betz, A. Kerner

government officials might believe that BITs plausibly work is that other people seemto believe it. The possibility that BITs attracts FDI is plausible enough within theacademic community that evidence of their inefficacy, such as gathered by Yackee(2010) and Poulsen (2014), is notable, as are failures to find empirical evidence forBITs’ effects on FDI (e.g., Gallagher and Birch 2006). Indeed, the fact that academiccommunities in political science, in law, and in economics have examined the evidenceof BITs’ efficacy in so many ways and over so many years speaks to a common (even ifnot universal) set of underlying expectations that BITs should work, at least sometimesand to some degree. It seems to us highly plausible that these expectations would beshared by government officials. Moreover, to the extent that governments look to theempirical literature for cues about BITs’ likely effects, it takes a particularly motivatedreading of that literature to conclude with any certainty that BITs do not work. Thereare more than enough studies to (rightly or wrongly) provide any governmentofficial desperate to catalyze capital inflows with a justification for taking a chanceon BITs.

The most important evidence on this score are testimonies from government officialsthemselves about what they were actually thinking when they signed or negotiatedBITs. Existing survey results, as reported by other scholars, suggest to us that attractingFDI has often been central to governments’ motivations to sign BITs. For example,Poulsen and Aisbett (2013) note that policymakers Btreated BITs as one out of a longlist of diplomatic gestures without any practical implications apart from helping toattract foreign investment^ (p. 282; emphasis added). Poulsen (2014) is even morestraightforward in this regard. Poulsen’s Bbounded rational competition model^ assertsthat beliefs about national economic benefits were in fact crucial to BIT signings,though these beliefs are or were almost certainly overstated. Poulsen’s interview withSouth African officials revealed that those officials believed a BIT with Great Britainwas Ban important value-added enhancement that could add to the peace of mind forforeign investors^ and Bprove to foreign investors… that South Africa was an investorfriendly country^ and that officials believed that Bthe moment a BIT was signed with acountry, capital would start flowing from there^ (Poulsen 2014, p. 8; emphasis added).We can’t testify to how common these beliefs have been, though we doubt they arecompletely exceptional. But the minimal assertion necessary for our theory – that somegovernment officials assign a positive probability to BITs attracting capital – seems tobe conceptually plausible and backed up by existing data. If BITs have been commonlyviewed as a vehicle for developing countries to attempt to attract foreign capital, weexpect to observe BITs being signed and ratified more frequently when that foreigncapital is especially valuable, which is typically the case when US interest rates arehigh.8

8 It is important to point out explicitly that even the most fervent believer in BITs’ efficacy is unlikely tobelieve that the potential increases in capital inflows and export receipts would in themselves provide asolution to (potential or real) balance of payments issues. But to the extent that BITs do attract FDI, expandexports, or function as signals to creditors, they can very plausibly provide marginal help to countries duringtimes of capital scarcity. To the extent that BITs do play such a role they almost certainly do so as a minor partin a larger set of liberal and illiberal policy initiatives meant to maintain access to hard currency. Our argumentis simply that the intrinsic trade-off between the possibility of gaining access to foreign capital in exchange forpolicy autonomy will appear more palatable to governments at times when that capital is especially needed.

The influence of interest: Real US interest rates and bilateral

The second part of our argument is that the US interest rate’s effect on BIT formationshould be felt disproportionately in countries with large external financial liabilities.External liabilities need to be serviced, which can place severe pressure on an economy,especially when access to finance at affordable rates is limited. This is especially truewhen the foreign liabilities are predominantly denominated in foreign currencies. Owncurrency denominated liabilities can be serviced by taxing the domestic economy or, ifneed be, by printing money.9 They do not require steady access to foreign exchange.For a variety of reasons, however (notably including inflation fears and the lack ofdemand for payment streams in minor currencies), the vast majority of low- andmiddle-income countries have been chronically unable to borrow externally in theirdomestic currency. Their external liabilities are much more commonly denominated inthe US dollar, euro, or yen, and servicing these debts requires access to those curren-cies. Poorer countries’ reliance on foreign currency denominated debt – commonlyknown as BOriginal Sin^ (Eichengreen et al. 2005; Hausmann and Panizza 2003) –enhances the importance of maintaining access to foreign capital, through financialinflows such as those that typically accompany FDI, or through export receipts, whichare also closely linked to FDI.10 Losing access to foreign capital due to high US interestrates is particularly damaging for these countries. We therefore expect emerging marketgovernments with large foreign liabilities to be particularly sensitive to the globalinterest rate environment and particularly likely to take policy actions that are consistentwith their interests in retaining and attracting source of foreign capital. Such govern-ments should be most likely to react to such an environment by signing and ratifyingmore BITs.

Our theory therefore suggests two testable hypotheses.

H1: High US interest rates should correlate with more BIT formations.H2: The positive correlation between US interest rates and BIT formation shouldbe especially strong in emerging markets with large net foreign liabilities.

In the next section we turn to the data to test these implications of our theory.

3 Section IV - evidence

The first and simplest prediction that we test is that years with high US interest ratesshould be associated with more bilateral investment treaties entered into globally. Weform our dependent variables for this test by calculating (1) the number of new BITssigned in any given year and (2) the number of new BITs entering into force in anygiven year. Dates for the signing and entry into force of BITs are available fromUNCTAD. Because we are interested in BITs signed and ratified in the reasonable

9 If the lender has taken on the exchange rate risk, devaluation of a country’s domestic currency will decreasethe effective debt load (e.g., Walter 2008; Betz and Kerner 2014).10 While some of the larger emerging markets have lessened the extent of their original sin in recent years, itremains a substantial problem even in the most developed of emerging market economies (e.g., Kynge 2015).This dynamic is reinforced by the fact that emerging markets typically borrow in short-term maturities (Broneret al. 2013).

T. Betz, A. Kerner

anticipation of attracting FDI (rather than protecting FDI exports), our sample is limitedto BITs signed or ratified by non-OECD countries with OECD counterparts.11

We measure US interest rates using the current real US lending interest rate from theWorld Bank’s World Development Indicators. The real (net of inflation) interest rate isthe relevant measure for gauging returns on investments, and therefore the relevantmeasure for the availability of capital to countries other than the United States (Frankeland Roubini 2001, p. 6). We also report results using the 3-year average interest rate,which captures periods of persistently high US interest rates. Our results are robust tothis alternative. We estimate negative binomial regression models, which are well-suited to the count nature of the dependent variable.12 All of our models include a timetrend (year fixed effects are precluded in these models by the perfect collinearity withthe US interest rate). Accounting for data limitations, our main models cover the years1961 through 2011.

Table 2 shows the results from estimating several models. These models vary by thedependent variable (some use BIT signing, others BIT ratification) and by the numberof control variables added to the specification. All of these estimates suggest that highUS interests are positively and statistically significantly associated with an increasedrate of BITs. Column 1 in Table 2 shows the estimates of a simple model relating BITsignatures to US interest rates with no additional control variables. The coefficient ispositive and statistically significant, as anticipated by hypothesis 1. The results ofcolumn 1 suggest that moving from an interest rate of 2.35 % (the 25th percentile inthe sample) to an interest rate of 5.99 % (the 75th percentile in the sample) correspondswith an increase of roughly 25 BIT signings between OECD and non-OECD countriesper year. The sign and statistical significance of this result is robust to the inclusion ofvarious control variables. Column 2 controls for the US growth rate and the USinflation rate. US interest rates should be directly related to macroeconomic conditionsin the US and it is possible that the coefficient estimate in column 1 captures a reactionto those conditions, rather than the interest rate per se. This seems not be the case. Boththe US inflation and growth rate are negatively associated with new BITs, but theirinclusion leaves the coefficient on the US interest rate positive and statistically signif-icant, though slightly smaller in magnitude (the estimates of model 2 suggest thatmoving from the 25th to the 75th percentile in US interest rates corresponds to anadditional 18 BIT signings between OECD and non-OECD countries per year).Column 3 includes additional controls for the average world growth rate. It is possiblethat US interest rate policies reflect and respond to the global world economy, and thatthose growth conditions may be the proximate concern of non-US governments. Again,the results remain largely unchanged, suggesting that the association between USinterest rates and BITs is not driven by booms and busts in the world economy.Column 4 includes the lagged number of BIT signatures as a control variable. Givenwell-known nonlinearities in the progression of BIT signings over time, we include thiscontrol in its linear, squared and cubed form. The addition of these variables also (andmore substantially) reduces the magnitude of the correlation between the US interestrate and BIT formations but it nonetheless leaves a positive and statistically significant

11 Notably, this eliminates south-south BITs from our analysis.12 The negative binomial model is a generalization of the Poisson model that allows for overdispersion in thedata (Cameron and Trivedi 2005).

The influence of interest: Real US interest rates and bilateral

Tab

le2

USinterestrateandBIT

signatures

andentryinto

force

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

BIT

signature

BIT

entryinto

force

USinterestrate

0.224***

(0.059)

0.163***

(0.042)

0.187***

(0.043)

0.063***

(0.024)

0.163**(0.067)

0.100**(0.050)

0.126***

(0.047)

0.043(0.030)

USgrow

th−0

.093*(0.052)

−0.094*(0.049)

−0.004

(0.022)

−0.101*(0.057)

−0.105*(0.055)

0.015(0.037)

USinflation

−0.151**

(0.060)

-0.172***

(0.061)

0.002(0.025)

−0.161**

(0.069)

−0.178**

(0.073)

−0.005

(0.047)

World

grow

th1.955(1.545)

−0.253

(0.653)

2.157(1.623)

−0.578

(0.914)

Previous

BITs

0.087***

(0.013)

0.087***

(0.028)

Previous

BITs2

−0.001***(0.000)

−0.001

(0.001)

Previous

BITs3

0.000**(0.000)

0.000(0.000)

Constant

2.47***(0.263)

3.76***(0.342)

3.56***(0.361)

1.36***(0.224)

2.63***(0.313)

4.00***(0.397)

3.77***(0.389)

1.31***(0.414)

Num

berObs.

5151

5151

5151

5151

Negativebinomialregression,coefficient

estim

ates,standarderrorsin

parentheses

*significantat10

%,*

*at5%,*

**at1%

T. Betz, A. Kerner

relationship between the US interest rate and BIT formation. The estimates of model 4suggest that moving from the 25th to the 75th percentile in US interest rates roughlycorresponds to 7 additional BIT signings between OECD and non-OECD countries peryear, which still corresponds to an increase of about 25 % compared to the sampleaverage.

Columns 5 through 8 report estimates from the same models as in columns 1through 4, except that we replace the dependent variable with the number of BITs thatenter into force in any given year. The results are substantively similar to the previousresults: Higher US interest rates are associated with more BITs entering into force,though the coefficient estimates are consistently smaller than with BIT signatures (theresults of model 5 suggest that moving from the 25th to 75th percentile of US interestrates increases the rate of ratification by roughly 16 extra BITs between OECD andnon-OECD countries per year; model 8 suggests an increase of 4 BIT ratifications ayear). Another difference is that model 8, which includes the lagged number of BITratifications, its square, and its cube, the coefficient on the interest rate variable losesstatistical significance at the 0.1 level. While admittedly an ex post rationalization, thesomewhat weaker results for BIT ratification than for BIT signings may reflect thatratification typically requires the assent of more veto players than BIT signing, some ofwhom are likely to have priorities beyond the national interest in maximizing access toforeign capital. We might for that reason alone expect a slightly weaker statisticalrelationship between the interest rate environment and BIT ratifications. Even in theabsence of a Bpolitical economy^ explanation, legislative wheels often move slowlyand the extra step of ratification may alter the temporal link between the interest rateand BIT ratification. Consistent with this interpretation, in a set of unreported robust-ness checks we find much stronger and consistent evidence of a correlation between theinterest rate environment and BIT ratification when all independent variables are laggedby 1 year.

As a robustness check, we report in Table 3 the results when re-estimating themodels from Table 2, but using the 3-year moving average of the US interest rate ratherthan the current rate. The substitution of the 3-year moving average provides a betterpicture of the interest rate environment that a country has faced over time, albeit at thecost of deemphasizing conditions at the moment of signing. The coding decisionappears to have little practical impact. The estimates of the interest rate’s effect onBIT signing (models 1–4 in Table 3) are similar to those reported in Table 2. Models 5–8 in Table 3 report the results of our estimates of the US interest rate’s effects on BITratification. For the most part these estimates provide evidence of a stronger and morestatistically significant correlation between US interest rates and BIT ratification thando previously reported estimates. The coefficient estimate in the single variable modelis 39 % larger when considering the moving average than when considering thecontemporaneous interest rate, now implying over 22 additional BIT ratifications peryear, and 70 % larger (and now statistically significant at the 0.05 level) in model 8,which is the most fully specified model that we estimate, where the marginal effectincreases to 7 additional BIT ratifications per year. The exception in Table 3 is Model 6,which provides little evidence for a link between interest rates and BIT ratification. Asbefore, unreported robustness checks suggest that the relative weakness of our BITratification models compared to the BIT signing models is mitigated by simply laggingall variables by a year.

The influence of interest: Real US interest rates and bilateral

Tab

le3

3-year

averageUSinterestrateandBIT

signatures

andentryinto

force

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

BIT

signature

BIT

entryinto

force

USinterestrate

(3-YearAvg.)

0.279***

(0.060)

0.156***

(0.054)

0.199***

(0.063)

0.066**(0.031)

0.226***

(0.071)

0.088(0.066)

0.135*

(0.071)

0.073**(0.037)

USgrow

th−0

.061

(0.053)

−0.057

(0.048)

0.005(0.023)

−0.079

(0.060)

−0.074

(0.055)

0.009(0.036)

USinflation

−0.174***(0.055)

−0.193***(0.053)

0.011(0.028)

−0.189**

(0.063)

−0.205***(0.064)

−0.016

(0.044)

World

grow

th2.315(1.717)

−0.124

(0.821)

2.41

(1.74)

0.083(0.772)

Previous

BITs

0.090***

(0.015)

0.070***

(0.026)

Previous

BITs2

−0.001***(0.000)

−0.001

(0.001)

Previous

BITs3

0.000**(0.000)

0.000(0.000)

Constant

2.24***(0.258)

3.69***(0.431)

3.34***(0.481)

1.20***(0.307)

2.38***(0.328)

4.03***(0.532)

3.63***(0.563)

1.39***(0.420)

Num

berObs.

4949

4949

4949

4949

Negativebinomialregression,coefficient

estim

ates,standarderrorsin

parentheses.Allmodelsexcept

columns

4and8includeayear

trend

*significantat10

%,*

*at5%,*

**at1%

T. Betz, A. Kerner

Occasional weakness notwithstanding, the results reported in Tables 2 and 3 areconsistent with US monetary policies being an important driver of new bilateralinvestment treaties.

The estimates noted in Tables 4 and 5 move away from the systemic levelanalyses and towards analyses of the data at the country-year level. Disaggregatingthe data to the country-year allows us to include controls for potential country-level confounders (Table 4) as well as to test hypothesis 2 (Table 5). We focus thefollowing on the determinants of BIT signatures, rather than entry into force. Thisfocus is partially done for the sake of presentational concision, but also because ofour belief, consistent with the results presented in Tables 2 and 3, that the linkbetween the interest rate at time t and governments’ willingness to enter into BITsat time t is more reliably reflected in patterns of BIT signing than in patterns ofBIT ratification.

Table 4 shows the estimates of models that extend the analyses in Table 2 by addingcountry-level control variables. Column 1 in Table 4 shows the result of a simple, singlevariable model relating the US interest rate to the number of BITs a country signs in ayear. This model and all that follow are negative binomial models with robust standarderrors clustered by year and a time trend.13 The positive and statistically significantcoefficient suggests that governments do sign more BITs when US interest rates arehigh. The estimates reported in column 2 in Table 4 expand on the simple model byincluding several macroeconomic controls. These include a measure of the country’sgross domestic product (GDP, measured in billions of US dollars) and the GDP growthrate. Domestic economic conditions are a potential confounder insofar as BITs’ inher-ent trade-off – the potential for more investment in exchange for less policy autonomy –is likely to be more attractive to governments facing a declining domestic economy(Simmons 2014). These economic conditions may be correlated with high US interestrates but could act as the proximate cause of BIT formations.14 We also control forforeign economic dynamics that may be related to the interest rate environment as wellas the rate of new BIT signings. These are the US growth rate, the US inflation rate andthe world GDP growth rate. As shown in column 2, the coefficient on US interest ratesremains positive and statistically significant, which suggests that the US interest rate’seffect on BIT signatures are not entirely (or even mainly) the product of the US interestrates’ effects on foreign and domestic growth rates. A movement in the US interest ratefrom the 25th percentile to the 75th percentile corresponds to an estimated increase ofroughly 0.1 BITs with an OECD partner, per country annually. While this may notappear an especially large effect, it is quite substantial given that the mean number ofBITs with OECD countries signed annually in this sample is 0.22 – the effect isequivalent to almost a 50 % increase in BIT signings. Notably, we find no evidencethat a declining domestic economy results in more BIT signatures.

The model reported in column 3 adds additional controls for a country’s foreigndirect investment inflows as a percentage of GDP and trade (the sum of exports andimports) as a percentage of GDP. The results are robust to these modifications.

13 Nearly identical results when clustering standard errors by country or estimating these models withunclustered standard errors.14 These results are also robust to controlling for the domestic interest rate.

The influence of interest: Real US interest rates and bilateral

Tab

le4

USinterestratesandBIT

signatures,country-leveldata

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

USinterestrate

0.151***

(0.042)

0.135***

(0.047)

0.102**(0.045)

0.108**(0.052)

0.150**(0.065)

0.043***

(0.017)

0.114***

(0.019)

0.110***

(0.021)

Dom

estic

grow

th0.314(0.217)

0.758***

(0.167)

0.498**(0.196)

0.487**(0.192)

0.385*

(0.224)

0.396*

(0.203)

0.517**(0.239)

GDP

0.001**(0.000)

0.000**(0.000)

0.000*

(0.000)

0.000*

(0.000)

0.000***

(0.000)

−0.000

(0.000)

−0.000

(0.000)

USgrow

th0.012(0.045)

0.006(0.044)

0.000(0.061)

0.001(0.062)

−0.009

(0.017)

0.031*

(0.018)

0.050**(0.021)

USinflation

−0.162***(0.046)

−0.222***(0.063)

−0.364***(0.093)

−0.366***(0.093)

0.000(0.982)

−0.170***(0.027)

−0.182***(0.030)

World

grow

th−0

.415

(1.68)

−0.677

(1.76)

0.273(2.154)

0.266(2.159)

−0.863

(0.570)

−0.758

(0.606)

−1.29*

(0.727)

FDI/GDP

−0.870*(0.492)

Trade/GDP

−0.002**

(0.001)

Leftgovernment

0.024(0.096)

0.394(0.302)

xUSinterest

−0.073

(0.060)

Previous

BITs

1.46***(0.136)

Previous

BITs2

−0.381***(0.057)

Previous

BITs3

0.031***

(0.006)

Previous

globalBITs

0.052***

(0.011)

Previous

globalBITs2

−0.001**

(0.015)

Previous

globalBITs3

0.000(0.000)

Constant

−105***(12.4)

−58.4***

(12.7)

−21.1***

(26.6)

20.3***(43.6)

21.7***(43.6)

−3.22***

(0.159)

−53.2***

(7.13)

Num

berObs.

9008

6634

4594

2273

2273

6634

5708

5708

Coefficient

estim

ates,standard

errors

inparentheses.Colum

ns1–6:

Negativebinomialregression

models.Colum

n7:

Fixedeffectsnegativ

ebinomialregression

model.Colum

n8:

Dichotomized

dependentvariable,conditionallogitmodel.A

llmodelsincludeayear

trend

*significantat10

%,*

*at5%,*

**at1%

T. Betz, A. Kerner

Tab

le5

USinterestrates,foreignliabilities,andBIT

signatures

Netassets

Assetratio

New

debt

rate

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

USinterestrate

0.136***

(0.040)

0.107**(0.044)

2.54***(0.768)

2.45***(0.923)

xforeignasset

−0.641**

(0.258)

−0.685**

(0.330)

−0.682**

(0.275)

xassetratio

−4.81***

(1.54)

−4.70**(1.83)

−4.68***

(1.56)

Interestnew

debt

0.138***

(0.021)

0.121***

(0.023)

0.118***

(0.021)

Foreign

assets

1.99**

(0.899)

2.91***(0.970)

3.45***(0.834)

Assetratio

16.2***(5.62)

20.4***(5.75)

23.3***(4.86)

Dom

estic

grow

th0.679***

(0.164)

0.697***

(0.165)

0.677***

(0.161)

0.691***

(0.162)

1.00***(0.200)

1.01***(0.199)

GDP

0.001**(0.000)

0.001***

(0.000)

0.001**(0.000)

0.001***

(0.000)

0.000(0.000)

0.000*

(0.000)

USgrow

th0.010(0.045)

0.010(0.045)

0.027(0.050)

USinflation

−0.222***(0.064)

−0.221***(0.064)

−0.285***(0.087)

World

grow

th−0

.212

(1.73)

−0.217

(1.72)

−1.68(1.91)

FDI/GDP

−0.788

(0.506)

−0.591

(0.479)

−0.762

(0.510)

−0.552

(0.482)

−0.444

(0.701)

−0.057

(0.719)

Trade/GDP

−0.002*(0.001)

−0.002*(0.001)

−0.002*(0.001)

−0.002*(0.001)

−0.002*(0.001)

−0.002**

(0.001)

Constant

−82.2***

(15.3)

−22.9(26.9)

−0.935***(0.080)

−90.2***

(15.5)

−32.9(27.4)

3.59

(3.60)

−98.0***

(18.4)

−22.1(32.7)

−1.35***(.086)

Num

berObs.

5203

4342

4342

5203

4342

4342

4465

3675

3675

Negativebinomialregression,coefficient

estim

ates,standarderrorsin

parentheses.*significantat10

%,*

*at5%,*

**at1%

The influence of interest: Real US interest rates and bilateral

Intuitively, larger FDI inflows appear to dampen the likelihood of a new BIT signature.Perhaps less intuitively, high levels of trade also correlate negatively with the rate ofnew BIT signatures. Column 4 controls for government partisanship using a variable onthe party orientation of the executive with respect to economic policy, obtained fromthe Database of Political Institutions (Beck et al. 2001). Some argue that right-winggovernments are more inclined to conclude new and more stringent BITs in order tosignal that their hands are tied with respect to their commitment to treating foreigninvestors favorably (Ginsburg 2005).15 We find little evidence that government parti-sanship affects BIT signatures in our model. However, this may be because governmentpartisanship has no independent effect, and instead affects how international economicpressure translates into choices over economic policies, such as BITs (Quinn and Inclan1997; Clark 2002). Column 5 therefore interacts the government partisanship variablewith the US interest rate. Our results indicate that, at least in this specific instance, thereis no evidence that government partisanship makes a difference: high US interest ratesare associated with more BITs, regardless of the partisanship of a country’s executive.Column 6 includes as a control the number of BITs signed worldwide the previous yearand the number of BITs signed in the specific country the previous year. Both of thesevariables enter the equation in their linear, squared and cubed forms. The coefficient onthe interest rate reduces, but it remains positive and statistically significant, which is inline with our theoretical expectations.

Columns 7 and 8 report estimates of our model using alternative estimators. Theestimates in column 7 are obtained from a conditional fixed effects negative model; weobtain similar results when including country dummies into a negative binomial modelinstead.16 The coefficient on our interest rate variable remains positive and statisticallysignificant. Column 8 reports results when we dichotomize our dependent variable(coded 0 if no BITs were signed and 1 if any BITs were signed) and estimate aconditional, fixed effects logit model. Again, our results remain positive and statisti-cally significant.

To summarize, the reported evidence of a positive correlation between BIT forma-tion and the US interest rate is robust across a variety of specifications and consistentwith our first hypothesis.

4 US interest rates, foreign liabilities, and BITs

Our second hypothesis is that a country’s sensitivity to changes in US interest ratesdepends on the country’s net financial position. Net debtors have more need than netcreditors to gain access to foreign exchange (or, perhaps more accurately, more to fearfrom a loss of access). Net debtor governments should therefore more proactively usewhatever policy tools are at their disposal to open up new sources of capital and toretain existing stocks of foreign exchange when interest rates are high. We expect thathis dynamic extends to governments’ propensity to sign BITs: the correlation betweeninterest rates and BIT formation should be strengthened as foreign debt increases.

15 See Betz (2014) for a different perspective on partisan hands-tying.16 See Allison and Waterman (2002) for a discussion of fixed effects in negative binomial models.

T. Betz, A. Kerner

We test this hypothesis using data from Lane and Milesi-Ferretti (2007), whichcapture the Bexternal wealth of nations^. These data measure investment positions asnet assets and liabilities in foreign portfolio investments, foreign direct investments,debt obligations, and foreign exchange reserves. The data cover the years from 1970 to2011. Lane and Milesi-Ferretti note that the net foreign assets measure that we use –which measures how well a country’s foreign liabilities are matched by foreign assets –captures a Bfundamental determinant of external sustainability^ (Lane and Milesi-Ferretti 2001, p. 264). Higher net liabilities imply less external sustainability and,consequently, more sensitivity to changes in the availability of international capital.While our concern is primarily with foreign currency liabilities rather than liabilities perse, in the sample of low- and middle-income countries that we use in this paper the twoconcepts are virtually synonymous (Lane and Shambaugh 2010).

We construct two variables from the Lane and Milesi-Ferretti data. First, wecalculate an economy’s net assets as the difference between assets and liabilities, suchthat a value of zero indicates balanced assets and positive values correspond to netcreditors. In our sample, the variable is measured in trillion US dollars and ranges from−0.852 to 0.746, with a mean of −0.002.17 Second, we calculate the proportion of assetsto liabilities. In order to create a variable that is independent of scale (and hence ofcountry size) and that is bounded, we create this proportion as (1+assets)/(2+assets+liabilities). The resulting variable is bounded between zero (for a country with almostno assets relative to liabilities) and one (for a country with almost no liabilities relativeto assets); countries with exactly balanced assets and liabilities receive a score of 0.5. Inour sample, the variable ranges from 0.4 to 0.6. We interact these measures of net assetswith US interest rates. Our hypothesis suggests that the interaction term should benegative, such that the total effect of US interest rates should be larger for countrieswith more net liabilities and reduce as a country moves towards being a net creditor; atleast for net debtors, the total effect of US interest rates should remain positive.

We estimate nine models to gauge the extent of support for our hypothesis. Weinclude a variety of macroeconomic controls (Domestic GDP, Domestic GDPgrowth, US inflation, World GDP growth rates) as well as controls meant to capturethe extent of a country’s economic openness (FDI and Trade as percentages ofGDP). The latter control variables are especially important as they reduce the extentto which any correlations between a country’s financial position and their BITsigning are plausibly jointly determined by an omitted indicator of economicopenness. Other aspects of the models are kept identical to previously reportedmodels, except where indicated.

Table 5 reports the results of our models. Columns 1, 2, and 3 use the Bnet assets^operationalization of foreign liabilities. Column 1 reports the results of a model thatincludes just the US interest rate, net assets, and their interaction as independentvariables, with no further control variables; column 2 reports the results of a modelthat includes the battery of control variables described above. In column 3, we replacethe year trend with year fixed-effects. While the fixed effects are collinear with the US

17 These calculations omit China, which has substantially larger net assets than any other country in thesample. Including or omitting China from the sample does not matter for the substantive conclusions presentedin the following, however.

The influence of interest: Real US interest rates and bilateral

interest rate and other variables that do not vary within years, we report coefficientestimates for our measure of net foreign assets and its interaction with US interest rates.

All three models produce results that are consistent with hypothesis 2. In bothmodels in which a coefficient is estimated, the coefficient on the US interest rate ispositive and statistically significant, which indicates that US interest rates have apositive correlation with BIT formation when a country has balanced assets andliabilities. This is a relatively exceptional case – only 18 % of the sample has a valueof net foreign assets that is at or above zero. The negative and statistically significantinteraction terms in columns 1, 2, and 3 indicate that this positive effect of US interestrates on BIT formation is larger in countries with more net foreign liabilities andsmaller in countries with net foreign assets. This is consistent with hypothesis 2.Turning to the marginal effects of US interest rates at various levels of foreign assets,for countries with large foreign liabilities, the effect of US interest rates on BITsignatures is positive and statistically significant at the 5 % level: net debtors signmore BITs as US interest rates increase. By contrast, for countries with large foreignassets, the effect of US interest rates on BIT signatures turns negative – suggesting thatnet creditors sign fewer BITs as US interest rates increase – though this effect isstatistically insignificant.

Maybe surprisingly, the positive and statistically significant coefficients for the netforeign assets variable across columns 1, 2, and 3 indicate a negative relationshipbetween foreign liabilities and BIT signing when US interest rates are held equal tozero. The zero real interest rate value occurs within our sample, but rarely: 1975 is theonly year in our sample with negative real interest rates. Interest rates are greater thanzero in all other years, and for many years interest rates are high enough for theconditional effect of foreign assets on BIT signings to become positive, such thatcountries with larger foreign liabilities sign more BITs.18

Columns 4, 5, and 6 use the ratio of assets to liabilities as our operationalization ofnet external liabilities. The results of these models are substantively similar to theresults in columns 1, 2, and 3: the interaction term is always negative and statisticallysignificant, which is consistent with hypothesis 2. The coefficient on US interest ratesremains positive and statistically significant, but it captures a quantity – the conditionaleffect when the ratio of assets to liabilities is equal to zero – that in these models is farout of our sample and has no relevant interpretation. As in model 3, replacing our timetrend variable with year fixed effects has no substantial effect on our estimates of theinteraction term.

A clearer way to illustrate the effect of an increase in US interest rates is through aplot of marginal effects across the range of observed values of net foreign assets.Figure 1 displays the marginal effects of a one-percentage point change in US interestrates at various levels of foreign assets, averaging over all observations in the sample.19

The left panel of Fig. 1 plots the marginal effects for net assets (column 2), the rightpanel plots the marginal effects for the ratio variable (column 5). The solid line

18 It should be noted, however, that while our models provide evidence to suggest the existence of a range oflow interest rates for which the effect of an increase in net foreign assets is to increase BIT signings and a rangeof high interest rates for which the effect of an increase in net foreign assets is to decrease BIT signings, ourresults give a substantially less consistent picture of how large those ranges are. The average effect, in anyevent, tends to be not statistically significant at conventional levels.19 For better readability, the left panel of Fig. 1 omits the largest and smallest one percent of net foreign assets.

T. Betz, A. Kerner

indicates the marginal effect, while the dashed lines represent 95 % confidence intervalsfor the marginal effect.

Figure 1 reveals that the estimated relationship between BITs, interest rates, andforeign liabilities is as anticipated by our hypothesis. For countries that are net debtors,higher US interest rates are associated with a statistically significant increase in BITsignatures (except for the observations at the lower extreme of the distribution, wherethe effect loses statistical significance at the 5 % level). Based on the estimatesdescribed by the left side panel, the estimated marginal effect of a 1-percentage pointincrease in the US interest rates when net foreign assets is equal to −0.2 is an increase of0.06 BITs with an OECD country annually. Based on the estimates described by theright side panel, the estimated marginal effect of a 1-percentage point increase in the USinterest rates when the foreign asset ratio is equal to 0.45 is an increase of 0.08 BITswith an OECD country annually. While both effects are fairly small, it is worthnoting for reference that the median number of BITs signed with OECDcountries per year in either sample is 0, and the mean is below 0.3. Forcountries that have balanced foreign assets – zero on the horizontal axis inthe left panel and 0.5 on the horizontal axis in the right panel – US interestrates are still associated with more BIT signatures, but the effect is substantiallysmaller. Net creditors, by contrast, are not significantly affected by higher USinterest rates. The effect is close to zero and statistically insignificant atconventional levels in both models.

-.1

0.1

.2.3

Mar

gina

l Effe

ct o

f US

Inte

rest

Rat

e

-.2 -.1 0 .1 .2 .3

Net Foreign Assets

-.1

0.1

.2.3

.45 .475 .5 .525 .55

Net Foreign Asset Ratio

Fig. 1 Marginal effect of a one-percentage point increase in the US interest rate on new BIT signatures, as afunction of net foreign assets (assets minus liabilities, left panel) and asset ratio (right panel). Balanced assetsat 0 (left panel) and 0.5 (right panel). Observations to the left of this cut-off, indicated by the shaded area, arenet debtors. The marginal effect is indicated by the solid line, the dashed lines represent the 95 % confidenceinterval for the marginal effect. Horizontal axis restricted to omit largest and smallest 1 % of sample values.Based on Table 5, column 2 (left panel) and column 4 (right panel)

The influence of interest: Real US interest rates and bilateral

As an additional test of the conditional hypothesis we consider the relationshipbetween BIT signings and governments’ difficulty in gaining access to internationalcapital as captured by the interest rate that they pay on newly issued government debt.For this purpose, we draw on the World Development Indicators to obtain the averagerate interest rate on new, external debt that is either public or publicly guaranteed.While this variable does not allow us to differentiate between different maturities orcurrency denominations, the interest rate on new government debt has a number ofadvantages over the previous measure. First, it is inherently independent of scale, suchthat country size, for instance, is not a confounder. Second, the interest rate is arealization of a government’s ability to access international capital, and in this senseincorporates information that we may be unable to capture with US interest rates and itsinteraction with net foreign assets. The larger the interest rate on new debt issues, themore expensive it is for issuers to access international finance, and the more we wouldexpect them to proactively court alternative forms of international capital, such asforeign direct investment. These data are measured in percentage points and range from0 to 16, with an average of about 3.8 and a standard deviation of 2.9.20 If our theory iscorrect we should find that higher interest rates on new government debt are associatedwith more BIT signatures. Columns 7, 8, and 9 replace measures of the US interest rateand its interaction with foreign assets with the interest rate on new government debt. Asexpected, the results show that higher interest rates on newly issued government debtare associated with more new BIT signatures, corroborating the previous results on theinteraction between US interest rates and a country’s foreign asset position. The impliedsubstantive effect are comparable to earlier estimates: based on the estimates in model9, a one-percentage point increase in the interest rate on new debt yields in increase in0.03 BITs signed with an OECD country per year; a one standard deviation increase inthe interest on new debt issues yields an increase of 0.08 BITs.

5 Time to ratification and BIT stringency

This section provides two additional pieces of corollary evidence. First, we exploit thatmany BITs linger in the ratification stage for long periods of time after being signed.Ratifying BITs that were already signed but have not been ratified offers a relativelyeasy opportunity for governments to increase their country’s attractiveness to foreigninvestors. Thus, we expect that, for already signed BITs, the time to ratification shoulddecrease as US interest rates increase, and that this effect is particularly pronounced forcountries with large foreign liabilities. Data on the time between signature and ratifi-cation is available from Haftel and Thompson (2013).

We estimate the time to ratification using duration models21 and follow Haftel andThompson’s choice of a Cox proportional hazards model. We include a number of

20 Several low-income countries had, at times, an interest rate of zero on newly issued government debt. Manyof these countries obtained interest-rate free loans from the World Bank’s International DevelopmentAssociation. The following results are robust to omitting these countries from the sample.21 A duration model has a number of advantages in the present context. Most importantly, we can includetime-varying variables, such as US interest rates, in a straightforward manner (whereas with a standard linearregression model, we would have to use period-averages or another arbitrary value within the time period forsuch variables).

T. Betz, A. Kerner

control variables, all from Haftel and Thompson: common language, colonial ties,alliance commitments, ratification hurdles, and the ratio of GDP between theparticipants. Column 1 in Table 6 includes US interest rates and the controlvariables. Column 2 adds the interaction between the US interest rate and netforeign assets. The estimates imply that a one percentage point increase in USinterest rates is associated with an increase in the hazard ratio of about 5 %, whichis consistent with hypothesis 1. However, our estimates in column 2 provide littleevidence that the effect of US interest rates on the time to BIT ratification isconditional on a country’s net foreign assets; the interaction term between USinterest rates and net foreign assets carries the expected sign, but it is notstatistically significant.

Second, in addition to the quantitative effects that we have previously demonstrated– higher US interest rates are associated with more BIT signatures and BIT ratifications– we might also expect to observe a qualitative effect – higher US interests should alsobe associated with more stringent BITs. One aspect of BIT stringency is the extent towhich BITs delegate investment disputes to the International Centre for Settlement ofInvestment Disputes (ICSID) for settlement. Investors in capital-exporting countriestend to have strong preferences for including such provisions into BITs (see, e.g., Alleeand Peinhardt 2010). These provisions, however, go even farther to erode the policyautonomy of host states. The decision to include delegation to ICSID thereforereinforces the trade-off of an increase in FDI in exchange for sovereignty that is

Table 6 Time to ratification and BIT stringency

Ratification delay Stringency

(1) (2) (3) (4)

US interest rate 0.125** (0.023) 0.105 (0.103) 0.049*** (0.001) 0.055*** (0.000)

x foreign assets 0.754 (0.653) −0.091 (0.694)

Foreign assets −3.755 (0.722) 2.97*** (0.010)

Domestic growth 0.510 (0.162) 0.620* (0.061) 0.314* (0.069) 0.298 (0.100)

GDP −0.010 (0.860) −0.021 (0.744) 0.052*** (0.001) 0.079*** (0.000)

US inflation 0.132 (0.104) 0.128 (0.112) 0.017 (0.482) 0.029 (0.237)

US growth −0.085 (0.239) −0.036 (0.649) 0.041** (0.039) 0.028 (0.187)

Colonial ties −0.007 (0.963) −0.111 (0.473) −0.422*** (0.000) −0.407*** (0.000)

Alliance −0.276** (0.027) −0.375*** (0.005) 0.294*** (0.000) 0.289*** (0.000)

Ratification hurdle −0.103** (0.017) −0.102** (0.024)

GDP ratio 0.135*** (0.000) 0.136*** (0.000)

Common language 0.024 (0.810) −0.043 (0.682)

Number Obs. 1237 1142 6144 5819

Columns (1)-(2): Cox proportional hazards model, coefficient estimates and p-values in parentheses. Depen-dent variable: Time to ratification since signature. Columns (3)-(4): Ordered logit model, coefficient estimatesand p-values in parentheses. Dependent variable: BIT stringency, coded as delegation to ICSID

* significant at 10 %, ** at 5 %, *** at 1 %

The influence of interest: Real US interest rates and bilateral

inherent in BITs. If host countries need to attract foreign investment during times ofhigh US interest rates and net foreign liabilities, we should see this reflected in a greaterpropensity of BITs to delegate to ICSID.

Data on the extent of delegation to ICSID is available from Allee and Peinhardt(2010). The dependent variable takes on one of three possible values. It is coded 0 ifICSID is not mentioned, 1 if ICSID is mentioned as an option for internationalarbitration, and 2 if ICSID is the only venue for international arbitration. In our sample,about a quarter of BITs choose ICSID as the only venue for international arbitration,and just above half of all BITs mention ICSID as an option. We follow Allee andPeinhardt and estimate ordered logit models. Column 3 of Table 6 presents theestimates from a model that includes just US interest rates, but not its interaction withforeign assets. Column 4 adds the interaction. The coefficient estimate on US interestrates is positive in column 3, as expected. In substantive terms, a one percentage pointincrease in US interest rates is associated with an increase of about 2.5 percentagepoints in the probability that an agreement relies on ICSID exclusively, which is anincrease of about 10 % in relative terms. As with the time to ratification, however, theresults are less convincing for the interaction with net foreign assets, as the interactionterm lacks statistical significance.

6 Beyond BITs: Liberal ideas and international capital

The data presented thus far suggest that high US interest rates are associated with moreBIT signatures, a shorter time between BIT signature and ratification, and morestringent BITs. We also presented evidence that some of these effects are especiallypronounced for countries with net foreign liabilities. However, it is plausible that theseempirical relationships are in fact due to a link between economic conditions andsupport for economic globalization more generally. For instance, capital scarcity mayoccur coincidentally with an ideological shift away from viewing illiberal policies asbeneficial. This could happen organically: an economy suffering from limited andexpensive access to capital may engender popular beliefs that Bgood^ macroeconomicmanagement equates with proactively courting foreign capital. It could also happenthrough coercion, if acceptance of neo-liberal principles is or is perceived to be a pre-condition of bilateral or multilateral aid. Either way, we would expect to observe notonly an embrace of BITs, but also a refutation of more traditional, illiberalpolicymaking responses to capital scarcity. As noted earlier, tariff policy is amongthe most consequential and most written about policy responses to capital scarcity.Capital scarcity makes it more expensive to finance a current account deficit; across theboard tariff increases can help reduce a financially burdensome current account deficit,or prevent it from expanding. If the observed uptick in BIT formations during times ofcapital scarcity is actually a response to that capital scarcity, as we have argued, weshould expect to see that the same conditions that produce more BITs should alsoproduce higher tariffs. By contrast, if BITs are an indicator of a more general embraceof liberal policies during times of high US interest rates, we should observe that thesame conditions that lead to BITs should also lead to a decline in tariffs.

We evaluate whether periods of high US interest rates are associated with moreliberal policies more generally using the World Bank’s data on the applied tariff rate.

T. Betz, A. Kerner

We use the simple average, which aggregates across product categories with equalweighting. These data cover the years from 1989 to 2011. Table 7 shows the results oftwo models that estimate the relationship between interest rates and tariffs.22 Column 1includes the US interest rate along with standard control variables. The US interest rateis positively and statistically significantly associated with higher tariffs, suggesting thathigh US interest rates contribute to tariff increases. This is not a surprising findinggiven the long history of tariffs being used as a means of combating capital scarcity. Butit is a clearly illiberal response to the same indicators of capital scarcity that, in thecontext of BITs, produced a liberal response. The fact that the same circumstances thatlead to BITs also lead to higher tariffs is an indication that neither is being driven bybroader ideological shifts about the proper balance of business interests and nationalsovereignty.

Column 2 includes net foreign assets and its interaction with the US real interest rate.As in our models of BIT signing and BIT ratification, the coefficient on the interactionis negative and statistically significant, indicating that the correlation between USinterest rates and tariff increases is especially strong in countries with significantforeign liabilities. Figure 2 plots the conditional coefficients based on the estimates incolumn 2, with all control variables held at their mean. These results mirror those foundearlier: high US interest rates correlate with higher tariffs in all but net creditorcountries. These findings suggest fairly strongly that the previously observed coinci-dence of high US interest rates, net foreign liabilities and participation in BITs is notlikely to be attributable to a more general embrace of neo-liberal ideas aboutpolicymaking and quite plausibly are an attempt by governments in developingcountries to do whatever they can to attract, retain, and raise foreign capital.

22 We include in our specification controls for GDP, GDP growth, the US inflation rate, and the US growthrate. The findings are robust to the inclusion of many other controls, including FDI and Trade as percentagesof GDP, GDP per capita and others. These findings are also robust to excluding all controls.

Table 7 US interest rate and tariffs

(1) (2)

US interest rate 0.735*** (0.211) 0.748*** (0.209)

x net foreign assets −3.88** (1.59)

GDP 0.000 (0.000) 0.002*** (0.000)

Domestic growth −3.28 (2.42) −3.85 (2.52)

US inflation −0.587 (0.701) 0.015 (0.798)

US growth 0.358** (0.148) 0.239 (0.160)

Net foreign assets −1.56 (3.60)

Constant 8.36*** (1.51) 7.42*** (1.62)

Number Obs. 1432 1379

Ordinary least squares, coefficient estimates, standard errors in parentheses

* significant at 10 %, ** at 5 %, *** at 1 %

The influence of interest: Real US interest rates and bilateral

7 Conclusion

This paper applies a fairly straightforward argument – countries that need to enhanceand preserve access to foreign capital will tailor policymaking to that end – to shedmore light on when countries participate in BITs and which countries are most likely todo so. Our results strongly and consistently suggest that participation in BITs can betraced to high US interest rates. We also find a fair amount of evidence that this effect isconditional on a country’s net financial liabilities, though this interaction does notappear to be a robust predictor of BIT ratification speed or BIT design.

This paper has implications for the way we think about policy reactions to capitalscarcity. By creating liberal avenues for countries to gain access to hard currency, thelegalization of the international investment environment alters the political implicationsof capital scarcity that were so evidently and tragically tied to economic closure duringthe interwar years. It is certainly not the case that the increased usage of legalized,liberal economic institutions during times of capital scarcity represents a reversal of therelationship between capital scarcity and illiberal policymaking. Governments still turnto illiberal policies. But the possibility to pursue liberal policies, and the frequency withwhich countries take advantage of these liberal channels, muddles this previouslystraightforward relationship.

Our findings also have implications for the literature on the legalization of worldpolitics (Goldstein et al. 2000). Membership in bilateral investment treaties can affectthe future economic trajectory of both capital importing and exporting countries inways that last far longer than the capital scarcity that brought them into existence in thefirst place. To the extent that legalization is preferred by capital holders, legalization islikely to increase during times of capital scarcity and less so during times wheninternational capital is plentiful. Thus, this paper implies a direct connection between

Fig. 2 Marginal effect of a one-percentage point change in the US interest rate on the average applied tariffrate as a function of net foreign assets (assets minus liabilities). Balanced assets at 0 (left panel). Observationsto the left of this cut-off, in the shaded area, are net debtors. The marginal effect is indicated by the solid line,the dashed line represents the 95 % confidence interval. Based on Table 7, column 2

T. Betz, A. Kerner

global economic conditions – which, in turn, are dependent on US economic policies –and the prominence and design of international institutions.

This paper also suggests an interesting line of research into the ability of USadministrations to promote BITs. Such initiatives should be more successful duringtimes of high interest rates and global capital scarcity than when international capital isrelatively available to emerging market economies. This relationship implies a powerfulrole for the US Federal Reserve, which can influence some of the foreign policysuccesses of United States administrations through its monetary policy choices. Thisis notable in a variety of respects, but especially in light of recent research suggestingthat the Federal Reserve crafts monetary policies with a view on election outcomes.Clark and Arel-Bundock (2013) show that policies of the Federal Reserve tend towardshigher interest rates over the course of Democratic administrations and lower interestrates over the course of Republican administrations (see also Vaubel 1997). Thisdynamic bodes well for Democratic globalizers but undermine their Republicancounterparts.

Appendix

Table 8 Countries included in sample

Afghanistan Equatorial Guinea Mali South Korea

Albania Eritrea Malta South Sudan

Algeria Estonia Marshall Islands Sri Lanka

Angola Ethiopia Mauritania Sudan

Antigua and Barbuda Faeroe Islands Mauritius Suriname

Argentina Fiji Mexico Swaziland

Armenia Finland Micronesia Syria

Aruba French Polynesia Moldova Tajikistan

Australia Gabon Monaco Tanzania

Azerbaijan Gambia Mongolia Thailand

Bahamas Georgia Montenegro Togo

Bahrain Ghana Morocco Tonga

Bangladesh Greenland Mozambique Trinidad and Tobago

Barbados Grenada Namibia Tunisia

Belarus Guatemala Nepal Turkmenistan

Belize Guinea New Caledonia Tuvalu

Benin Guinea-Bissau New Zealand Uganda

Bermuda Guyana Nicaragua Ukraine

Bhutan Haiti Niger United Arab Emirates

Bolivia Honduras Nigeria US Virgin Islands

Bosnia & Herzegovina Hong Kong Oman Uruguay

Botswana Hungary Pakistan Uzbekistan

The influence of interest: Real US interest rates and bilateral

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