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Revisiting “Rational Design”:

Preferences, Power, and the Design of Bilateral Investment Treaties

Todd Allee Department of Political Science

University of Illinois [email protected]

Clint Peinhardt School of Economic, Political and Policy Sciences

The University of Texas at Dallas [email protected]

Paper prepared for presentation at the Workshop on the Politics of Preferential Trade Agreements:

Princeton University, Niehaus Center for Globalization and Governance

April 29, 2010

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Introduction

During the past three decades states have signed literally thousands of bilateral and regional

economic agreements with the explicit goal of stimulating greater cross-border trade and investment.

These agreements, which include preferential trade agreements (PTAs) and bilateral investment treaties

(BITs), among others, have received substantial attention from scholars across political science and

economics. Attracting the most attention are the central questions of why governments sign PTAs and

BITs, and what effect these treaties have on trade and investment, respectively. In providing answers to

these questions, existing empirical literatures quite logically treat these agreements as an either-or

proposition - states either have a BIT or a PTA or they do not. Yet there is increasing recognition that

these agreements are not homogenous but instead vary in important ways.

Indeed, trade and investment treaties are carefully negotiated by the signatories, and the resulting

PTAs and BITs range from dozens to hundreds of pages in length. They may include exclude particular

provisions, and language within a given provision often varies. Thus a BIT signed by the United States,

for example, may enshrine different substantive and procedural guarantees than one signed by, say, China

or Egypt and their treaty partners. Legal scholars, being particularly interested in the nuances of the

treaties, have explored differences in the language and provisions across selected treaties. Building on

this foundation, comparatively-minded political economy scholars are pushing the research frontier in a

more generalizable direction by collecting the texts of these economic agreements, coding important

treaty components, and producing quantitative and qualitative measures of treaty variation. On the

empirical front, increasingly rich data sources are beginning to emerge that capture variation within both

PTAs and BITs.

As data become richer and more refined, a new challenge now confronts scholars: how to explain

this important variation across the treaties? One could argue that so far data collection efforts are

outpacing attempts at theoretical development. Cumulative knowledge from the earlier wave of studies

can tell us why two governments would sign a BIT, for instance, but there is little guidance for

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understanding why they would include some components in their investment treaty yet exclude others?

In other words, it remains unclear why governments design their BITs in the way they do.

Fortunately, the literature on the “rational design” of international institutions (Koremenos,

Lipson, and Snidal 2001; Koremenos 2005; 2007) provides a logical springboard from which to theorize

about variation across economic agreements such as BITs. Upon careful inspection, several of the

“design features” of international institutions for which rational design puts forward propositions are

indeed present in BITs and vary across the treaties. Therefore, the relevant propositions can be applied

fairly straightforwardly to the variation we observe in BITs. In turn, this newfound variation in BITs

provides an excellent domain in which to test quantitatively the conjectures put forward by the rational

design project – and to do so in a manner that addresses many of the criticisms made about the rational

design project’s empirical shortcomings.

In this paper we explore the design of the most important aspects of BITs – procedures for

dispute settlement – and do so using the “rational design” literature as a guide for theorizing. After

identifying important variation across BITs and compiling an original dataset that captures this variation,

we articulate several hypotheses that draw directly from rational design conjectures. At the same time,

we also address criticisms that the rational design framework fails to account for the power and

preferences of the actors who design the agreements.

Quantitative tests of the design of 1,500 unique bilateral investment treaties reveal relatively

modest support for the rational-design inspired conjectures, yet much is gained by applying the rational

design logic to BITs. First, drawing upon the rational design notion of “design features” helps us to

identify the most important aspects of the treaties and to structure our theorizing and data collection more

tightly around the concepts of centralization and flexibility. Second, several rational design conjectures

do possess considerable explanatory power, thereby helping us to understand that governments include

centralized enforcement procedures in treaties when there are strong incentives to cheat and when one

side lacks information about the other BIT signatories. Somewhat ironically, a third contribution emerges

from our efforts to address earlier criticisms of the rational design framework. The bargaining power and

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preferences of states who sign BITs – which critics of rational design claim are missing from the project’s

framework – turn out to be the strongest and most consistent predictors of BIT design. Treaty language in

BITs ultimately reflects the preferences of the governments who sign them, the interests of important

domestic actors, and the bargaining power of the larger side. All in all, the endeavor to understand BITs

as the result of purposeful design advances scholarship on the rational design of international institutions,

and most importantly, provides a compelling and largely power- and preference-based explanation for

why investment treaties vary in the manner they do.

The Importance and Diversity of BITs

Bilateral investment treaties represent a unique effort to regulate foreign direct investment (FDI)

between pairs of states and their nationals. As such, they attempt to ameliorate the traditional antagonism

between investors and host states that is reflected in developments such as the Hull Rule and the Calvo

Doctrine (see Guzman 1998). For centuries governments have quarreled over issues such as when a

country that hosts foreign investment can legitimately seize (expropriate) that investment, what

constitutes a legitimate versus illegitimate taking, and what compensation is due to the foreign investor

(whether individual or firm) upon expropriation? These and other issues are directly addressed in the

more than 2,500 BITs that pairs of states have signed during the past half-century. In general, all BITs

grant a series of substantive as well as procedural rights to foreign investors (see Muchlinski 2009), with

the explicitly-stated purpose of increasing foreign investment between the signatories.

Given the historical antagonism over foreign investment, it is not surprising that treaty clauses

governing the settlement of investment disputes are widely seen as the most important aspect of BITs. In

fact, treaty provisions regarding investor-state dispute settlement have attracted considerable attention

from legal scholars (e.g., Dolzer and Stevens 1985; Franck 2007a, 2007b; Ginsburg 2005; Sornarajah

2000; Vandevelde 1992; Yackee 2008). Susan Franck (2007b), for one, claims the inclusion of investor-

state dispute settlement clauses represents a “sea change” in the legalization of foreign investment. For

the first time, foreign investors can use international law to directly challenge the legality of host state

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actions through a neutral arbitration panel, and can receive compensation when their complaint is found to

have merit (Paulsson 1995). Because of these investor-state dispute settlement clauses in BITs, Brigitte

Stern, a frequent arbitrator in investment cases, writes that “we are walking with giant steps towards a

general system of compulsory arbitration against States for all matters relating to international

investments, at the initiative of the private actors of international economic relations” (quoted in Williams

2003, 252). The emergence of BITs – with their revolutionary procedures for dispute settlement – is thus

a historical development in international economic relations.

Not surprisingly, scholars have begun to investigate important questions such as why countries

sign BITs (e.g., Elkins, Guzman, and Simmons 2006; Guzman 1998) and what impact BITs have on FDI

(e.g., Egger and Merlo 2007; Hallward-Driemeier 2003; Haftel forthcoming; Kerner 2008; Neumayer and

Spess 2005; Rose-Ackerman and Tobin 2005; Salacuse and Sullivan 2005). Understandably, studies in

this initial wave of research do not distinguish among the treaties and simply record whether or not a pair

of states has a BIT. Yet many of these same authors question this simplifying assumption of BIT

homogeneity, and readily acknowledge that BITs are likely to vary on important dimensions. Neumayer

and Spess (2005, 1571), for example, note that “not all BITs are identical in their provisions” and that

“BITs are also unlikely to be identical in their effect on incoming FDI flows.” Hallward-Dreimeier

(2003, 3), in one of the first studies of BITs, also notes that “(t)oo much attention has been placed on

whether or not a BIT exists rather than on the strength of property rights actually being enshrined in these

agreements.” The pervasive argument is that BITs should increase FDI among signatories because they

represent a “credible commitment” by the parties to respect the terms of foreign investment. This

credibility, however, depends heavily on the ability of aggrieved foreign investors to successfully enforce

the terms of the BIT, which is why the investor-state dispute settlement provisions are so central.

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Interestingly, a careful examination of the text of BITs reveals that the aforementioned dispute

settlement provisions differ considerably across treaties, in ways that are not always recognized.1

Important treaty variation exists in three areas. First, in some BITs states provide advanced consent to

international arbitration of future disputes whereas in others they do not. The jurisdiction of most

international dispute resolution bodies depends critically on whether states have submitted to their

authority (Guzman 2002), which in practice means that they need a state’s written authorization before

they will even hear a dispute. Although many BITs require this consent be given once a dispute arises,

some treaties actually include both state parties’ advance consent for arbitration to proceed whenever a

dispute arises. This often works to the advantage of aggrieved investors because it speeds up the dispute

resolution process and removes delay-prone arguments over jurisdiction while at the same time reducing

the accused state’s options. Second, BITs can specify one or more among several venues for settling

investment disputes. In addition to domestic courts in the host state, more than a dozen international

arbitration venues are sometimes specified as dispute settlement options. These venues may range from

ad hoc arbitration using UNCITRAL rules to more regimented arbitration through standing bodies such as

the International Centre for the Settlement of Investment Disputes (ICSID), the Permanent Court of

Arbitration, or one of several regional arbitration centers. All else equal, the more venues that are

specified, the more options that parties to a BIT have for addressing their disputes. Third, some of the

aforementioned arbitration venues are stronger and more institutionalized than others. ICSID, for

instance, is a permanent institution that has state delegates, a permanent staff, and the ability to enforce

the awards it renders. Other venues are far less institutionalized, and instead rely heavily on the states to

formulate rules and to enforce awards.

Moreover, these three ways in which BITs vary correspond directly to two of the “design”

features for which the rational design literature provides a set of explanations. Those BITs that require

consent to arbitration on a case by case basis, and that list several venues as dispute settlement options,

1 Recent scholarship in legal journals increasingly acknowledges that these clauses vary across BITs (Franck 2007a, 2007b, Swenson 2005, Yackee 2008), yet other, large-n scholarship on BITs from political science and economics does not distinguish among treaties.

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provide greater flexibility to parties. The rational design literature, in turn, has put forward several

conjectures to explain why states would want to design “flexible” international treaties. Similarly,

arbitration institutions like the aforementioned ICSID are heavily centralized: considerable dispute

settlement authority is located in a central, permanent actor that can determine how states resolve their

disputes. Likewise, a substantial number of rational design conjectures attempt to explain such

institutional centralization. Because of this promising conceptual match, it is sensible to turn to the

rational design literature as a basis for theorizing about BIT design.

The Rational Design Project and Its Critics

In an ambitious 2001 International Organization issue on “The Rational Design of International

Institutions,” the editors of the volume, along with several contributors, set out “to offer a systematic

account of the wide range of design features that characterize international institutions” (Koremenos,

Lipson, and Snidal 2001a: 762). This “rational design” issue is tightly anchored around a comprehensive

analytical framework in which the authors propose five dependent variables, or dimensions of variation in

international institutions, among which are the dimensions of centralization and flexibility. To these five

institutional design features they map six independent variables, or “cooperation problems” thought to

influence the manner in which international institutions are designed, resulting in a total of sixteen cause-

and-effect conjectures intended to explain the rational design of international institutions. This general

theoretical framework is then applied to eight case studies of international institutions.2 On the whole, the

case studies are generally supportive of the framework, and Koremenos, Lipson, and Snidal (2001b:

1056) point out that “nearly 70 percent of the findings are strongly positive.”3 Several conjectures

regarding variation in institutional centralization and institutional flexibility are the most supported, but

the findings in support of rational design are far from universal or definitive. Of the sixteen conjectures,

2 Each case study explores only a subset of the rational design propositions. Kydd’s chapter on NATO expansion examines only one proposition, while at the other extreme the articles by Richards (on the International Air Transport Authority) and Morrow (on prisoner of war treaties) examine nine propositions each. 3 See Table 1 of the concluding chapter of the Rational Design issue (Koremenos, Lipson, and Snidal 2001b: 1055) for a summary of the case study findings.

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one is not tested in any of the case studies, three are not supported, and four are supported by only one

case study.

Since its inception, the rational design framework has encountered skeptics, with considerable

criticism focused on problems of case selection, quantification of concepts, and the lack of large-n

empirical testing. Both Wendt (2001) and Duffield (2003) are skeptical of the initial case study evidence,

noting that a majority of the studies focus on topics where one might expect the conjectures to apply—a

criticism largely accepted by Koremenos and Snidal (2003: 439). Duffield (2003: 424) notes another

problem with the choice of case studies, namely that “few of the cases fit neatly with the project’s stated

focus on the rational design of explicit, negotiated arrangements.” He then asserts that future tests

“…should be tightly restricted to cases that are indisputably at the heart of the project’s ambit, namely the

design of explicit, negotiated agreements” (ibid., 428).

Not surprisingly, Duffield (2003) calls explicitly for quantitative tests of the rational design

conjectures as a way to address concerns with empirical evaluation. He challenges the consistency of

measurement in the case studies and argues that quantifying the abstract concepts is the best way to move

the project forward. Koremenos and Snidal (2003: 437) in fact acknowledge that “Duffield’s most

valuable critique regards the empirical shortcomings of the Rational Design project” and echo his call for

large-n empirical tests of the theory. Recent work by Koremenos (2005, 2007) advances this goal, but

represents a less systematic test of the rational design conjectures than our endeavor.4

Just as the rational design literature provides a promising platform on which to theorize about

BIT variation, the rich variation we identify in the 1,500 investment treaties we have coded provides an

excellent empirical domain in which these ideas and criticisms can be put to the test. One somewhat

obvious benefit is that BITs are formal treaties, and as such fit Duffield’s criterion for conducting

empirical tests using explicit, negotiated agreements. Second, focusing on BITs holds constant many

4 Neither of the more recent Koremenos pieces (2005, 2007) tests the originally-stated rational design conjectures directly. Those concepts which reappear from the 2001 volume are generally treated at a higher level of conceptual aggregation than is found in the original volume. Although the important new ideas (renegotiation costs, risk aversion, delegation) advanced in these two articles certainly build on and are consistent with the original rational design project, the well-known conjectures from the 2001 volume are not tested explicitly.

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potentially conflating factors that otherwise would complicate empirical evaluation. All of the treaties are

negotiated by a pair of states, which removes the need to control for the number of signatories or other

conflating dynamics. Furthermore, the treaties all attempt to regulate and protect FDI and enforce

standards of investor protection, and are similar on nearly all dimensions other than centralization and

flexibility of institutional design. Third, the substantive problems that plague foreign direct investment –

such as credibility of commitment, unexpected shocks, and incentives to violate the agreement – conform

closely to several of the “cooperation problems” identified in the rational design literature. Fourth, the

states that have signed BITs are diverse. More than 175 countries have signed BITs over a period

spanning many decades. As a result, our sample includes both cross-sectional variation in terms of the

domestic political institutions and economic conditions of the countries in the sample, and temporal

variation regarding the use of arbitration, patterns of expropriation, and changes in FDI flows.

Using “Rational Design” to Theorize about BIT Variation

Because the rational design approach appears to be applicable to investment treaty design, it

serves as the basis for theoretical development. Along the way, important criticisms of the approach, as

well as the alternate arguments put forward by critics, also serve as a further platform for theorizing.

According to the overall logic of rational design, states will deliberately include or exclude certain dispute

settlement provisions within a particular BIT, and thus variation across treaties should be purposeful as

opposed to random. Different pairs of governments will intentionally tailor their BITs to address the

particular problems they face.

To understand the possible treaty-design solutions to these problems, we first draw upon the

rational design literature to identify the investment-related cooperation problems that are relevant to BIT

signatories. Next we match these cooperation problems to four rational design propositions that are

relevant to BITs and FDI – three from the original 2001 volume (Koremenos, Lipson and Snidal 2001a)

and one from more recent scholarship on rational design (Koremenos 2007). These four propositions are

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discussed in the investment treaty context, and they result in four BIT-design hypotheses that are drawn

from the rational design conjectures.

The four rational design propositions that serve as the theoretical foundation are: 5

1) FLEXIBILITY increases with UNCERTAINTY ABOUT THE STATE OF THE WORLD (F1).

2) CENTRALIZATION increases with UNCERTAINTY ABOUT THE STATE OF THE

WORLD (C2). 3) CENTRALIZATION increases with ENFORCEMENT PROBLEMS (C4).

4) CENTRALIZATION increases with COMMITMENT PROBLEMS (CT). These four conjectures are identified as the most relevant for BIT design after carefully

considering all of the conjectures related to centralization and flexibility, the two dimensions on which the

BITs in our dataset vary.6 The first three conjectures (F1, C2, C4), which are taken straight from the 2001

International Organization volume and reappear in Koremenos 2007, are among the conjectures that

received the greatest support in the original case studies.7 The fourth conjecture (which we label “CT”) is

an important new rational design proposition that highlights commitment problems – a cooperation

problem that is endemic to investment cooperation as well as many other international issues. Although

the original IO volume did not focus on commitment problems directly, the recent identification of

commitment problems by Koremenos (2007) reflects an attempt to expand the rational design framework.

In this regard, our coupling of a new rational design conjecture with three original ones in our empirical

5 We state the conjectures in this manner for both simplicity and consistency. The first three conjectures are phrased in the way they are stated in the original “Rational Design” volume (see Koremenos, Lipson, and Snidal (2001a: 788-789, 793). For the fourth conjecture, we re-organize the proposition to be consistent with the three other conjectures. Koremenos (2007: 194) adds “states facing” before “commitment problems” and then replaces “centralization” with the more precise language of “delegate(d) dispute settlement provisions.” Although we agree with Koremenos’s focus on delegation of dispute settlement, we retain the language of “centralization” given our singular goal of testing the rational design conjectures in a generalizable manner. 6 Four additional conjectures about centralization and flexibility (out of seven total) that appear in the original International Organization volume are easily omitted. Three of the four omitted conjectures (one on centralization and two on flexibility) are irrelevant to BITs because they relate to design influences that are held constant in our design (e.g., the number of actors). A final conjecture from the original edited volume, which relates uncertainty about behavior to centralization, is deemed inapplicable because such uncertainty is not widespread in BITs due to the presence of multinational firms who monitor the behavior of foreign governments toward FDI. 7 Proposition F1, in fact, was the most supported conjecture among the original case studies (Koremenos, Lipson, and Snidal 2001b: 1055).

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tests enhances both the comprehensiveness and validity of our effort to explain BIT design using the

rational design framework.

Flexibility Increases with Uncertainty about the State of the World

One of the first cooperation problems awaiting states who attempt to establish common

investment rules is uncertainty about the state of the world. Koremenos, Lipson, and Snidal conceptualize

this type of uncertainty as: “…states’ knowledge about the consequence of their own actions, the actions

of other states, or the actions of international institutions” (2001a: 778). This uncertainty about the

implications of an international agreement such as a BIT will vary over time as states gather more

information about the consequences of the agreement. Uncertainty about the state of the world, however,

does not automatically decline over the lifetime of a treaty or regime, since the presence of unexpected

developments or “shocks” can alter the landscape within an issue area (Koremenos 2001, 2005, Mattli

2001, Oatley 2001). Such shocks in the world of FDI – such as dramatic fluctuations in investment

patterns, currency crises, or rapid increases (decreases) in the number of investment treaties or disputes –

could generate more or less certainty about how BITs work, who they benefit most, or how they will be

enforced.

Greater uncertainty should lead BIT signatories to incorporate greater flexibility in their treaties,

ceteris paribus. Since other important features of the treaties are relatively fixed, governments should

seek this flexibility in specifying procedures for dispute settlement.8 The manner in which future disputes

are settled can be highly consequential, since different processes and venues can generate different

outcomes for the parties (Brower 2005). When uncertainty about the state of the world is high,

governments will prefer to have several possible options for dispute settlement and to allow for the choice

8 Treaty renegotiation has been used as an indicator of flexibility (Koremenos 2001, 2005; but see Copelovitch 2008). Yet most BITs are in force for a minimum period of 10 years, which renders this type of flexibility less relevant.

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of venue to be made on a case-by-case basis.9 In contrast, when the parties possess greater knowledge

about the implications of their investment agreement, they will be more comfortable including a more

limited range of dispute settlement options in the treaty and granting advanced consent for international

arbitration.10

HF1: BITs will contain more flexible procedures for dispute settlement when uncertainty about the current state of global investment is high.

Centralization Increases with Uncertainty about the State of the World

The second rational design conjecture predicts that this same uncertainty about the state of the

world also should lead to greater centralization of investment treaties. The problem once again is that

governments who sign BITs may do so in an environment where there is relatively little information

about the myriad consequences of the agreement they are about to sign. In such situations of incomplete

contracting, governments may desire to have one or more centralized international institutions provide

additional information about the state of the world and to clarify ambiguities in the treaties they have

signed (Abbott and Snidal 2000, Garrett and Weingast 1993). Because of the bilateral nature of BITs,

governments facing uncertainty may see considerable benefit in centralizing the crucial function of

dispute settlement as a way to enhance the efficacy of the agreement. Centralization also serves a

valuable pooling function (Abbott and Snidal 1998) by providing information to the signatories, as well

as to other BITs signatories (in the case of transparent centralized bodies such as ICSID). In sum,

delegating dispute settlement authority to centralized international institutions (Abbott, et. al. 2000,

Koremenos 2007) can help governments to obtain “more certainty about how the agreement operates and

a better understanding of its costs and benefits” (Koremenos, Lipson, and Snidal 2001a: 794).

HC2: BITs will contain more centralized procedures for dispute settlement when uncertainty about the current state of global investment is high.

9 A mid-1990s UNCTAD (1998) study concluded that governments were seeking flexibility in dispute settlement due to concerns with the enforceability of ICSID awards and the success of UNCITRAL rules in U.S.-Iran tribunals. 10 A more recent UNCTAD (2007b) study, in fact, concluded that governments were including narrower investor-state dispute settlement options in treaties due to information gained through recent ICSID rulings.

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Centralization Increases with Enforcement Problems

A second cooperation problem that BIT signatories face, one which is common to many types of

treaties, is the concern with whether the treaty will be enforced. Within the rational design literature

enforcement problems are equated with “incentives to cheat” on an agreement.11 Governments sign BITs

knowing that the treaties promise long-term gains, yet certain leaders might have short-term incentives to

seize a foreign asset or to change the terms of investment. This is particularly true for leaders who face

strong economic or political incentives to engage in expropriation or who fear little direct or indirect

retribution for cheating. To address this type of enforcement problem, the rational design logic posits that

one should observe greater centralization – in this case centralization of enforcement – to counter these

incentives. Third-party dispute resolution through established international institutions is a way to deter

cheating by opportunistic governments and to encourage compliance with international agreements (e.g.,

Mitchell and Hensel 2007, Simmons 2000).12 Centralizing dispute settlement in the hands of an

established and institutionalized third-party raises the cost of defection.13 It moves investment dispute

settlement outside of the potentially biased and slow-moving institutions of the defecting state and instead

shifts it to a neutral venue with established rules and timelines (Franck 2007b, 2007c). Knowing this,

potential cheaters might be deterred from defection by the prospect of being challenged before a

centralized enforcement body.

HC4: BITs will contain more centralized procedures for dispute settlement when the temptation to cheat on the agreement is high.

11 In the original Rational Design volume, Koremenos, Lipson and Snidal define enforcement problems as “the strength of individual’s actors’ incentive to cheat on a given agreement or set of rules” (2001a: 776). 12 The European Court of Justice (e.g., Alter 1998, Burley and Mattli 1993) and the World Trade Organization’s (WTO) dispute settlement mechanism (e.g., Rosendorff 2005) have played a central role in enforcing agreements signed by members of the European Union and WTO, respectively. 13 Abbott and Snidal predict that “hard” legal commitments (such as legalized dispute settlement through an international organization) should be common in investment agreements, where the incentives for opportunism may be great (2000: 429).

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Commitment Problems Lead to Centralization

Bargaining over the terms of FDI is characterized by an endemic commitment problem – the

time-inconsistency problem associated with the obsolescing bargain (Vernon 1971). Before any initial

investment is made, multinational firms possess considerable bargaining leverage vis-à-vis host states, yet

after the initial investment bargaining power shifts to the host government due to the costs sunk by the

firm. This dynamic creates a commitment problem for states that seek to attract foreign investment, since

the anticipated ex post shift in bargaining power makes potential investors leery of investing in states who

cannot credibly commit to uphold the original bargain. For “host” states who seek to attract FDI, then, it

is essential to demonstrate ex ante the credibility of one’s commitment to respect the terms under which

inward investment is made.

To some degree all BITs attempt to address this commitment problem (e.g., Elkins, Guzman and

Simmons 2006, Guzman 1998, Swenson 2005), but the intensity of the commitment problem varies

across treaties. It is particularly acute for those governments who have a poor record of past behavior,

questionable domestic institutions, or about whom little is known. Centralization provides a way for

these governments to ameliorate the most severe commitment problems (Abbott and Snidal 1998). When

a BIT contains language that allows future host-government actions to be addressed directly by investors

through an institutionalized arbitration body, investors become more confident that any ex post

“takings”14 could be dealt with effectively. This ability to turn to centralized dispute settlement increases

investors’ ex ante confidence in the terms of the initial investment. The centralization of dispute

settlement in the hands of bodies like ICSID and the ICC also serves the interests of credibility-seeking

host governments, who can credibly signal that their hands and those of their successors are effectively

tied (e.g., Abbott et. al. 2000, Ginsburg 2005, Koremenos 2007, Yackee 2008). In contrast to

enforcement problems, where governments actually experience rational, ex post temptations to defect on

an agreement, with commitment problems the problem is largely perceptual. Governments who fully

14 “Taking” is the legal term that incorporates both outright expropriations as well as less blatant violations of investment treaty commitments (Dolzer and Stevens 1995, 98-102; Reisman and Sloane 2004).

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intend to respect inward investment must still find a way to demonstrate this genuine commitment to

governments with whom they sign BITs as well as multinational firms within those partner countries.

HC4: BITs will contain more centralized procedures for dispute settlement when the need for credible commitment is greatest.

Criticisms of Rational Design: Bringing in Power and Preferences

Separate from any of the conjectures discussed above, a major criticism of the rational design

project – which we address directly – is its failure to employ control variables and to account for

alternative explanations such as interstate power relations and state interests. Wendt (2001: 1035)

suggests that powerful states embed their practices into the design of regimes, and Duffield (2003: 417-

418) claims that important power-based and capability-based explanatory variables are absent from the

Rational Design framework. Duffield also criticizes the project for failing to account for the interests of

the actors; that is, the preferences states have over the design of international institutions (2003: 417).

Lake (2009) echoes this concern, claiming that in institutional design approaches “interests are often

treated in an arbitrary or inductive manner and produce, at best, propositions that are hard to falsify”

(240). He then suggests that “rather than building ever more sophisticated models of institutions per se,

scholars of security, human rights, and other important substantive topics might be better served by

developing theories of and focusing attention on the interests of actors” (240). The final three hypotheses,

then, directly address these concerns by emphasizing domestic preferences, government preferences, and

the signatories’ relative bargaining power.

The first of two preference-based variables captures the potential importance of domestic political

interests in investment treaty design. The most relevant domestic actors in this case are multinational

corporations, who have a strong preference for BITs that include the most effective procedures for

challenging foreign government takings. This means they desire more centralized and less flexible BITs.

They want their governments to include greater centralization, since more institutionalized arbitration

procedures are more likely to return swifter, fairer, and more easily-enforced rulings against foreign

violators. Similarly, multinational corporations also prefer to have less flexible BITs, ceteris paribus. In

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practice, greater flexibility in dispute settlement, in the form of more arbitration options or the need to

provide consent, delays any efforts at dispute settlement. This works against multinational investors and

to the advantage of foreign governments, who can use the flexibility to delay arbitration while debates

about jurisdiction and rules play out. Governments who negotiate BITs should be attentive to the

preferences of these important domestic economic actors.

HdomprefC: BITs will contain more centralized procedures for dispute settlement when a significant number of large multinational corporations are located in the signatory countries. HdomprefF: BITs will contain less flexible procedures for dispute settlement when a significant number of large multinational corporations are located in the signatory countries. A second preference-based argument emphasizes the preferences of the signatory governments

themselves. Governments of a right-wing, or more free-market, orientation, have the strongest desire to

design BITs that create the most favorable conditions for continued financial openness and the greatest

investment flows. Once again, this is more likely to occur when dispute settlement procedures are

centralized and inflexible. In such situations, treaty violations are most likely to be effectively

challenged, thus providing swift remedies for illegal takings and deterring others.

HgovtprefC: BITs between right-wing governments are more likely to contain centralized procedures for dispute settlement. HgovtprefF: BITs between right-wing governments should contain less flexible procedures for dispute settlement. Finally, the relative power of the two BIT signatories is included as a predictor of BIT design in

order to incorporate interstate power relations as an explanation for BIT design. One prediction is that

powerful states should prefer, and thus be more likely to obtain, centralized dispute settlement in their

BITs. This seemingly contradicts the traditional realist view (Mearsheimer 1994/1995) and other

accounts of powerful-state attitudes toward legal dispute settlement (Smith 2000). But in the asymmetric

FDI context, centralized dispute settlement serves the interests of powerful states and their investors

because of its greater efficacy in punishing treaty violations. Consequently, it is strongly preferred to ad

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hoc arbitration or the use of domestic courts in the host state (e.g., Franck 2007b, Schreuer 2005).15

States with a significant bargaining advantage over the other signatory also prefer to have less flexible

BITs, ceteris paribus. Greater flexibility in dispute settlement, in the form of consent requirements and a

wider array of arbitration venue choices, delays any efforts at dispute settlement. This works against the

interests of powerful states and their investors, since it stalls any attempts to address treaty violations

committed by the weaker state due to debates over jurisdiction and procedure.

HpowerC: BITs will contain more centralized procedures for dispute settlement when one of the signatories is considerably more powerful than the other. HpowerF: BITs will contain less flexible procedures for dispute settlement when one of the signatories is considerably more powerful than the other.

Measurement of Concepts

Proper measurement of independent and dependent variables is paramount given the criticism

rational design has attracted for its failure to properly operationalize concepts and to incorporate them in

large-n tests. Duffield (2003), for instance, claims that the original Rational Design volume offers little

guidance for translating abstract concepts like “uncertainty” or “centralization” into precisely measured

indicators. To properly measure concepts like those identified in the hypotheses articulated earlier, we

draw heavily upon our substantive knowledge of BITs as well as related empirical literatures on

legalization, investment treaties, foreign direct investment, and international political economy more

broadly. In most cases we identify and provide justification for a primary operational measure, yet also

employ alternate indicators to check for the robustness of findings.

Among the independent variable concepts, the nature of the enforcement and commitment

problems inherent to FDI compels us to focus heavily on the domestic political conditions within each

BIT signatory, which adds to our data collection burden. These domestic as well as state-level variables

present another challenge: how to combine the parallel country-level measures for the two BIT

15 Similar dynamics were evident in Uruguay Round negotiations to establish the dispute settlement mechanism of the WTO. The United States and other powerful states preferred a strong, legalized mechanism because it advanced their interests (Croome 1998).

17

signatories into a single measure? Enforcement or commitment problems may stem from conditions

relevant to either or both states, yet rational design is not clear on how to translate such situations into

empirical tests. Our primary approach is to follow Koremenos (2005) and employ the “weak-link”

approach common to quantitative studies of international conflict, in which the most problematic (highest

or lowest, as dictated by theory) of the two states’ values is selected (e.g., O’Neal and Russett 1997).

Uncertainty about the State of the World

Uncertainty about the state of the world as it relates to BITs and FDI is reflected in two

indicators: one that captures the amount of information states have about BITs and the implications of

BITs, and a second that reflects “shocks” to the prevailing status quo. Because both of these measures fit

the rational design logic but are not correlated, each is included separately and then jointly in regressions

for centralization and flexibility, respectively.

According to the first logic, over time increasing or decreasing amounts of new information,

revealed by waves of treaty-making and actions by governments who have signed BITs, should affect the

degree of certainty governments possess at the time of BIT signing. As the primary way to capture this

uncertainty logic, we include in the regressions a count of the worldwide total number of BITs signed in

the past five years (Number of Recent BITs).16 This indicator provides important information about

recent trends and the resulting level of “certainty” within the FDI regime. A tally of the number of

investment disputes submitted for international arbitration in the past five years (Number of Recent

Investment Disputes) captures a similar logic, and thus is included as a sensitivity check.

The second measure reflects the strand of the rational design literature that equates uncertainty

about the state of the world with “shocks” (Koremenos 2005, 2007). The idea here is that unexpected

events that impact FDI will lead to greater uncertainty among BIT signatories about the current state of

the world in FDI – and thus greater centralization and flexibility in BITs. A tally of global balance of

16 Data on the number of BITs is taken from UNCTAD Investment Instruments Online archive, the primary entity that systematically collects and publishes the text of BITs, and supplemented with data from ICSID and the authors’ additional research.

18

payments crises during the past three years captures shocks directly relevant to BITs and FDI that will

reduce certainty among BIT signatories. This Recent FDI-Related Shocks (3 years) variable is compiled

from data in Kaminsky and Reinhart (1999) and Kaminsky (2006), and lags of one and five years also are

employed as sensitivity checks. Also employed as a sensitivity check is a measure of Variance in Recent

Global FDI Flows, which captures the statistical variance in worldwide FDI flows over the past three or

five years. The logic here is that inconsistent patterns of recent FDI reflect the total collection of recent

global shocks that make BIT signatories less certain.

Enforcement Problems Drawing upon the earlier discussion of enforcement problems as “incentives to cheat,” as many

as three distinct variables capture the severity of the enforcement problem for any given BIT. Each

variable is inserted separately, and then with the others, in a series of regressions intended to predict BIT

centralization as a function of the enforcement problem the states face.

The first variable captures each BIT signatory’s “demand” to cheat on the agreement. Political

leaders will have a greater need to engage in some type of expropriation – and thus will be more tempted

to cheat – when they face poor domestic economic conditions. Given short time horizons, leaders who

face immediate economic problems may decide that it is rational to forego the longer-term benefits

associated with increased FDI and instead to violate investor protections as a way to address short-term

economic problems.17 GDP Growth Rate, measured as the amount of GDP growth (decline) in the

country within the past year, captures the degree to which economic conditions in a state are poor and

thus where short-term incentives to cheat present a greater enforcement problem.18 Low growth rates

increase incentives to deviate from BITs and exacerbate the enforcement problem. Several other

indicators reflect the same logic and are employed as sensitivity checks: under high current rates of

unemployment (Unemployment Rate) and inflation (Inflation Rate), leaders become more willing to seize

17 We measure the economic conditions in the signatories at the time of BIT signing, since conditions at that time represent the two sides’ best guess as to future economic conditions and potential near-term enforcement problems. 18 All indicators in this group are taken from the World Bank’s World Development Indicators.

19

foreign assets and thus present a larger enforcement problem. Alternate indicators for recent trends in

each of three aforementioned rates also are considered as a way to capture the trajectory of these

economic patterns over the recent past.19

A second indicator captures the idea that enforcement problems will be more severe when the

benefits of cheating are greater. Namely, the temptation to cheat will be heightened when global Raw

Materials Prices are higher. In such situations, the value of what might be seized increases, ceteris

paribus, and this in turn intensifies the enforcement problem. We compile data on annual prices (in

constant dollars) of an index of minerals, ores, and metals, taken from the UNCTAD’s Commodity Prices

Database (CPD).

A third enforcement problem variable reflects the sensitivity of the two sides to any costs that

might arise from cheating on the agreement. Signatories with close economic or political ties should have

fewer incentives to defect due to the greater costs of such a move. Most notably, the enforcement

problem will be lessened if the two sides are heavily trade dependent upon one another, since such ties

could be jeopardized in the event of a breakdown in trading relations due to one side cheating on the

terms of the BIT. An indicator of the size of the Bilateral Trade Relationship, taken from the Correlates

of War’s Bilateral Trade data set (v. 2.0), is employed as the primary measure. As a robustness check a

measure of Alliance Ties between the signatories also is employed to reflect reduced incentives to cheat.20

Commitment Problems

Commitment problems within a BIT will be more severe when at least one of the signatories: 1)

lacks credibility-inducing domestic institutions, 2) has no experience hosting investment (since its

commitments cannot be inferred), and 3) has a poor reputation for honoring its past commitments. Once

19 These variables are created by taking the current rate of each economic indicator (growth, unemployment, and inflation) and subtracting from it the average of the respective rates during the past three years. 20 Data on alliance ties come from the Alliance Treaty Obligations and Provisions (ATOP) Data Set (Leeds et. al. 2002). Our indicator captures whether the home and host states possess any type of alliance tie.

20

again, three respective operational indicators are included in a series of centralization regressions, first

one-at-a-time and then all together.

The first variable showcases the importance of domestic political institutions as commitment

devices. The overarching idea is that certain domestic institutions – those which constrain adventurous

behavior or emphasize the rule of law – can enhance the credibility of a state’s commitment to respect the

terms of the BIT and protect FDI. An important factor is whether political executives are relatively free

to pursue any course of action they choose, such as engaging in some form of expropriation, or whether

their power is limited by other domestic political institutions. The presence of legislative or other actors

who constrain political executives (Henisz 2002) can increase the credibility of a state’s commitment to

respect FDI by reducing fears that an executive will change course and engage in some type of

expropriation. As a result, the political constraints (Political Constraints on Executive) variable from

Henisz (2006) is included as a primary measure. Also substituted for purposes of robustness is the

closely-related Checks on Executive variable from the Database of Political Institutions (Keefer and

Stasavage 2003). Similarly, domestic legal institutions also can reduce the commitment problems

inherent to a BIT. Powerful legal institutions within states that receive FDI can restrain adventurous

leaders from engaging in unexpected expropriations. Therefore, additional measures of Respect for Law

and Order and Lack of Corruption, both taken from the International Country Risk Group (PRS 2007),

also are considered.

A second variable captures the fact that commitment problems will be more severe when little is

known about how the current government will treat inward investment. The lack of information could

reflect a range of political changes, any of which might make foreign actors hesitant to cooperate with

governments who have no proven track record. The Tenure of the Ruling Party, taken from the

Database of Political Institutions (Beck et. al. 2001), captures the length of time the current political party

has been in power, and serves as the primary measure. Among alternate indicators considered is the

Tenure of Executive (the number of consecutive years the current executive has been in power) and

21

Regime Tenure (the number of years the country has been democratic, autocratic, etc.), both of which also

come from Beck et.al. 2001.

A third indicator of commitment problems reflects a situation in which information is known

about a signatory, but that information reflects negatively and creates a larger commitment problem. In

the context of FDI, the commitment problem is exacerbated when one of the BIT signatories has

expropriated assets in the past or violated the terms of similar investment treaties. This type of negative

past reputation for respecting FDI and upholding the terms of BIT should lead to centralized dispute

settlement provisions in the current BIT. Each state’s Recent History of Expropriation, measured over

the past five years, serves as the operational indicator of this logic. Data on expropriations come from

Kobrin (1987) and Minor (1994, and personal correspondence).

Power and Preferences

Creating measures for the alternate arguments about domestic preferences, government

preferences, and relative bargaining power also is an important task that requires some diligence and

creativity. Multinational corporations are the primary domestic interests relevant to BITs, and they

should prefer greater centralization and less flexibility in BITs, as discussed earlier. To assess this

argument about potential influence of these actors on the composition of the BIT, we include in all

regressions an original indicator that captures the percentage of the world’s largest multinational

corporations that are headquartered in the two treaty signatories.21 Similarly, we also include a measure

of whether right-wing governments are in power in the BIT signatories. Such governments are likely to

prefer centralized yet inflexible BITs as a means to advance the cause of greater FDI. Data on whether

right-wing governments are in power in BIT signatories is taken from the World Bank’s Database of

21 Data for this measure are taken from Forbes magazine’s annual list of the world’s largest MNCs. To standardize the Forbes lists across years (1980-2002), we count all MNCs that have revenues above a constant threshold (approximately $5 billion in 1980 US dollars). We then identify the percentage of those MNCs in each year that are from each country in our data set. For 2003 we use the Forbes Global 100 and for 2004-2006 we use the Forbes Global 200 list. For years before 1980, we use the values from 1980, although the inclusion or exclusion of the pre-1980 cases does not affect our substantive conclusions.

22

Political Institutions (Beck et.al. 2001). The final indicator is a count of the number of right-wing

governments between the two signatories (0, 1, or 2).22 Finally, a measure is created for the power-based

argument that emphasizes the relative bargaining power of the two BIT signatories. Our primary

indicator captures the relative economic power of the two states, and is created by taking the GDP of the

lower-GDP state and subtracting it from the GDP of the wealthier state.

Dependent Variables: BIT Centralization and BIT Flexibility

The measurement of the two BIT design features – centralization and flexibility – is somewhat

more straightforward. Considerable guidance is provided by a rich legal literature on investment treaty

arbitration, on which we rely heavily. Data collection represents the greatest challenge. We acquired the

text of nearly 1,500 investment treaties and carefully code each according to the following rules for

determining centralization and flexibility of dispute settlement provisions.

The idea of BIT “centralization” reflects the degree to which the investment treaty includes

procedures for dispute settlement that rely upon established, third-party institutions to enforce the terms

of the BIT. This notion of centralization—centralization of enforcement—is one of the most common

ways to conceptualize centralization within an international institution (Koremenos, Lipson, and Snidal

2001a). Centralization in this context also is consistent with the narrower concept of “delegation” of

dispute settlement authority in the legalization literature (Abbott, et.al. 2000, Goldstein, et.al. 2000).

Our primary measure of BIT centralization captures the degree to which investor-state dispute

settlement provisions in the treaty are institutionalized in the hands of a third party. We code a variable

for the Centralization of International Arbitration as equal to: 0 if no international arbitration is specified

in the BIT, 1 if only ad hoc arbitration is specified,23 and 2 if any institutional arbitration option is listed.24

22 We take the original three-category L-C-R variable and recode it with a value of one for “R” governments, and a value of zero otherwise. 23 International arbitration procedures classified as “ad hoc” include the use of: UNCITRAL rules, modified UNCITRAL rules, or treaty-specific rules for dispute resolution. 24 Among the international arbitration options that are classified as “institutional” are: ICSID, International Court of Arbitration of the International Chamber of Commerce, Arbitration Institute of the Stockholm Chamber of

23

This coding reflects distinctions made by legal scholars who study choices in investment arbitration

(Franck 2007a, 2007b, Slate 1996, Sornarajah 2000) and is consistent with previous scholarship within

the rational design literature on arbitration choices (Mattli 2001).

A first important distinction reflected in this coding scheme is whether investors can pursue

grievances through international arbitration instead of being forced to seek redress through national courts

in the host state. Historically, potentially-biased domestic courts in host states have been inadequate to

solve the commitment and enforcement problem inherent to FDI (Franck 2007c, Guzman 1998). Because

international arbitration not only guarantees neutrality, but provides centralized benefits such as a set of

established rules and awards that have mechanisms for enforcement, it is strongly preferred by

multinational investors and their governments to domestic courts (Franck 2007b, Schreuer 2005). A

second important distinction, which gets at the heart of centralization, is between ad hoc and institutional

arbitration (Mattli 2001). Ad hoc arbitration is a notable step up from purely domestic remedies, yet

under ad hoc arbitration the parties still must navigate most aspects of the case, such as choice of law,

rules for selecting arbitrators, objection, compensation, and award procurement (Slate 1996). In contrast,

those who opt for more centralized arbitration benefit from established rules, quality control, basic

administrative support, hearing rooms, management of the proceedings, selection of arbitrators, facilities,

award enforcement, and legal support (ibid., 52-60; also Franck 2007a, 39).

The second institutional design feature, BIT “flexibility,” reflects the degree to which an

investment treaty provides the signatories with a range of choices for settling investment-related disputes.

Flexibility for resolving disputes is a central issue within BITs, since different pathways for dispute

settlement may return different outcomes or entail different time horizons for dispute resolution. As

noted earlier, there are two ways to conceptualize BIT flexibility. Mattli echoes this notion, claiming that

“(f)lexibility characterizes not only arbitral procedures but also the actual institutions of arbitration…”

(2001: 926).

Commerce, Cairo Regional Centre for Commercial Arbitration, Arab Investment Court, and the Permanent Court of Arbitration (Hague).

24

The first variable that captures BIT flexibility is the number of arbitration venues from which

signatories may choose in pursing dispute settlement. Several observers of investment arbitration, in fact,

discuss forum choice and forum shopping as a means to achieve flexibility (Franck 2005, 2007c,

UNCTAD 1998). Governments provide greater future flexibility when they specify a range of possible

venues for the arbitration of investor-state disputes instead of limiting themselves to a single or limited

number of venues. This specification of multiple options allows government to retain greater control of

the process in an environment of future uncertainty. This first indicator of Flexibility (Total Number of

Arbitration Options) sums the number of international arbitration institutions – both ad hoc and

institutional – specified in the BIT.25

The second measure of BIT flexibility captures whether the signatories consent ex ante to

international arbitration of disputes. The least flexible treaties contain language in which both state

parties agree in advance to any international arbitration that results from an investment dispute.

Preconsent reduces flexibility by speeding up and systematizing the arbitration process (Yackee 2008)

and removing one of the three typical objections to jurisdiction – both parties’ written consent.26 In the

absence of a preconsent clause, however, the actors have greater control over issues relate to timing, the

need to exhaust local remedies, and other procedural issues. Once again, choice over such matters is

likely to be appealing to BIT signatories who are unsure about future development related to investment

treaties and investment arbitration. Therefore, we code treaties in which the parties must consent to

investment arbitration on a case-by-case basis as equal to 1 for our Flexibility (Consent Required for

International Arbitration) variable and equal to 0 when they instead give their advanced consent to

investment arbitration.

25 See footnotes 24 & 25 for a complete list of all relevant international arbitration bodies (ad hoc and institutional) used in the count. 26 The other two are ratione personae and ratione materiae (Obadia 2001).

25

Empirical Findings

Attention now turns to empirical tests of the hypotheses described above, most of which are

inspired by the rational design framework, but some of which are inspired by its critics. Five sets of

analyses are conducted on a collection of 1,473 bilateral investment treaties concluded between 1965 and

2006, for which we have coded each treaty according to its degree of centralization and flexibility. The

first three sets of analyses (Tables 1-3) predict BIT centralization, and each one emphasizes a single

rational design cooperation problem that applies to BIT centralization (commitment problems,

enforcement problems, and uncertainty about the state of the world). The remaining two sets of analyses

(Tables 4-5) evaluate uncertainty about the state of the world as a predictor of flexibility, using both

aspects of BIT flexibility discussed earlier (number of arbitration options, advanced consent to

arbitration). All estimations are conducted using poisson, binary probit, or ordered probit estimators with

robust standard errors, depending on the nature of the centralization and flexibility dependent variables.

Additionally, the power and preferences variables are included in every model we estimate. In every case

we also control for changes across time by inserting a series of time-period dummy variables into the

regression, although for purposes of brevity we do not report the estimated coefficients of the time-trend

variables.27

In situations where multiple logics for a rational design concept exists, the primary indicator for

each logic is inserted first one its own, and then later (in the final column) with the primary indicator for

the other logics. Since rational design is not explicit on the issue of how to operationalize concepts in

statistical tests, treating each indicator as both nested and non-nested allows for the most comprehensive

evaluation. Also, in cases where a given logic could be measured in multiple ways, alternate indicators

are substitute one at a time in a series of sensitivity check regressions. The results of these checks are

listed in gray, to denote their secondary status, underneath the primary indicator in the table (which is in

black).

27 We include dummy variables for five-year periods (with 1995-1999 as the baseline) instead of yearly dummies, since some of our measures are constant across all countries in a given year. Our results are very robust to changes in the type of temporal controls (yearly dummies, a “year” variable, etc.) as well as baseline time period.

26

Taken as a whole, the estimated findings produce several general conclusions. First, the design of

BITs is certainly not random. Dtates do design BITs in systematic and purposeful ways, as is consistent

with the general thrust of the rational design program. Each table reveals the presence of multiple, strong

predictors of BIT design. Second, the rational design logic explains some aspects of BIT variation, but

not others. Receiving the most support are arguments about enforcement problems leading to

centralization and the impact of widespread uncertainty caused by shocks on BIT flexibility. Admittedly,

however, the overall support for the rational design conjectures is somewhat modest, particularly in

comparison to the support for alternate explanations. Finally, the preferences of states who sign BITs,

and the power relations between them, provide a strong, pervasive explanation for BIT design on both the

dimension of flexibility and that of centralization, in particular. In short, BITs are likely to contain

greater centralization when such a feature is desired by domestic and government interests in a powerful

state, and are much less likely to contain flexibility in either form when those same interests oppose the

inclusion of such options in BITs.

[Table 1 here]

The findings in Table 1 (along with those in Tables 2 and 3) provide a more in-depth illustration

of the workings of power and preferences as explanations for BIT centralization. All three variables

exhibit the predicted relationship with BIT centralization, all are statistically significant, and two of the

three are significant at the 99% level of confidence. In sum, BITs are more likely to have highly

centralized procedures for dispute settlement when multiple large MNCs are based in the signatories,

right-wing governments negotiate the agreement, and when one of the two states is considerably larger

than the other. This powerful result confirms the importance of preferences, or the “interests” of the

actors, as an important determinant of BIT design. Economic actors who anticipate investing heavily in

the partner states will strong prefer centralization, as will pro-market leaders on both sides – resulting in

treaties that reflect the preferences of these actors. Power also appears to be a central explanation of BIT

centralization. When one of the two states sits in a dominant economic position vis-à-vis the other, that

more powerful states is more likely to view itself as the source of investment into the other. As such, it

27

should strongly prefer to include centralized dispute settlement, and due to its greater bargaining leverage,

the treaty will reflect this preference.

Notwithstanding the strong support for power and preference-based explanations for BIT

centralization, the findings across Tables 1-3 reveal some support for the rational-design inspired

hypotheses. First, the inability of governments to commit to uphold the terms of FDI, based on a lack of

information about the government, does increase the likelihood that a BIT involving that country will be

more centralized. Table 1 reveals that when a ruling party in a signatory state has only been in power a

short time, any BIT involving that country is more likely to entail centralized procedures for dispute

settlement (and vice-versa). This finding holds when the Tenure of the Ruling Party is included as the

only “commitment problem” variable (see Table 1, model 1) as well as when it is included with indicators

that reflect the other commitment problem logics (see Table 1, model 4). Second, multiple results in

Table 2 suggest that enforcement problem, defined in two slightly different ways, can result in greater

BIT centralization. When a BIT signatory has witnessed slow economic growth or high unemployment

during the past three years, its BITs will include more centralized enforcement due to the increased

incentives to cheat in the short term. Likewise, some limited evidence suggest that pairs of states that are

less sensitive to the costs of cheating on a BIT, based on an otherwise small trading relationship, are

somewhat more likely to negotiate centralized BITs. This finding does not hold across expanded

estimations, however, (see Table 2, models 3 and 4) and does not apply to the logic of alliance ties, the

alternate indicator for sensitivity to costs.

[Table 2 here]

Perhaps the most supportive evidence for a rational design-inspired conjecture is found in Table

3, where two types of uncertainty about the current state of global FDI lead to greater centralization in

BITs. First, the presence of more recent investment disputes, which signifies heightened uncertainty

about rules for investment and appropriate behavior toward FDI, are associated with greater BIT

centralization (see model 1). Second, greater variance in recent global FDI flows, which suggests

increased unease about future patterns of investment and future FDI development, also leads to greater

28

BIT centralization. These findings lend support to the idea that uncertainty caused by FDI-relevant

“shocks” should affect BIT design.

[Table 3 here]

Although we find support across Tables 1-3 for various rational-design based arguments, one

should not draw any sweeping conclusions about the validity of the rationality-based framework to

predict BIT centralization. Only about one-quarter of the estimated relationships across the three tables

support the relevant hypotheses. Moreover, variables which reflect the power and preferences of the

actors are stronger and more consistent predictors of centralization in BITs, as detailed earlier.

Moving to the determinants of flexibility in BITs, it once again is apparent that the power and

preferences of the negotiating states play a major role in BIT design. For the first element of BIT

flexibility, advanced consent to arbitration, all three power- and preference-based variables play a role in

reducing flexibility, as predicted. The coefficients for all three variables in Table 4 are negative and

statistically significant at conventional levels. Once again, the interests of large multinationals and right-

wing governments are reflected in agreements that tend to include, as opposed to remove, advanced

consent clauses. Similarly, less flexibility in BITs (i.e., advanced consent to international arbitration) is

more likely when one of the two signatories is much more economically powerful than the other.

Findings are less supportive, yet still notable, when the second aspect of flexibility, the number of

arbitration venue options, is examined. Table 5 reveals that in BITs where the preferences of MNCs are

relevant, fewer options for dispute settlement are included in the BIT. This lends further support to the

argument that investors would prefer to narrow the options for dispute settlement, since greater flexibility

simply leads to battles over jurisdiction and delayed dispute resolution.

[Table 4 here]

[Table 5 here]

Although none of the rational-design inspired arguments predicts BIT flexibility in the form of

case-by-case consent to arbitration (Table 4), multiple pieces of supportive evidence are revealed in Table

5. Put simply, the presence of various FDI-related shocks, which generate greater uncertainty about the

29

future state of global FDI, are positively associated with greater BIT flexibility in terms of more options

for dispute settlement. States specify more venue options for dispute settlement when there has been a

recent global currency crisis, whether in the past year or past three years (see Table 5). Similarly, states

also design greater venue flexibility into their BITs in the face of another type of global shock: high

volatility in global FDI flows during the past half-decade. In sum, the uncertainty-based arguments that

link shocks as a source of FDI-related uncertainty to greater BIT flexibility receive substantial support.

Discussion and Conclusions

Like the editors of the original Rational Design volume, we are motivated by a simple

observation—that investor-state dispute settlement provisions within BITs vary in important and

systematic ways.28 Our goal has been to advance conceptual thinking on how to best explain the

variations within BITs and PTAs that are increasingly apparent. The literature on the “rational design” of

international institutions emerges as a promising theoretical framework for explaining this design

variation. However, a number of striking conclusions emerge after using the framework as a basis for

theorizing about BIT variation and conducting a series of rigorous empirical tests.

Most notable is the importance of power and preferences in explaining investment treaty design.

Across all of the models we estimate, the preferences of governments and their important domestic

interests are significant predictors of BIT design. The relative power of the negotiating governments also

emerges as a consistent predictor. Ironically, these concepts enter into our theorizing because multiple

critics of the rational design approach stress their importance. What is clear is that anyone working in the

“institutional” or “rational” design tradition must think carefully about the preferences and power of the

actors who design institutions.

The mixed findings for rational-design inspired arguments also are informative. Several of the

more intuitive arguments, such as those about domestic institutions as commitment devices and the

28 On the first page of the introduction to the Rational Design volume Koremenos, Lipson, and Snidal write: “We begin with a simple observation: major institutions are organized in radically different ways” (2001a: 761).

30

benefits of cheating on BIT, receive no support. It seems that many of the “rational” conjectures about

treaty design either require more refined argumentation or should be dropped in favor of more supported

arguments. Nevertheless, hypotheses about the design implications of “shocks” receive much more

consistent support, as do some arguments regarding the information treaty signatories possess about one

another. These arguments, then, merit future exploration and development.

This paper represents a unique effort to apply rational design theorizing to an important set of

economic treaties that vary in meaningful ways. As such, it offers several insights for future work on

investment treaties, other economic agreements, and institutional design more broadly. One important

contribution is our identification of dozens of measures for abstract concepts (“cooperation problems”)

common to the study of international relations. Although some of our measures are more original than

others, and the strategic context will differ across issue areas, we have done much of the conceptual heavy

lifting to produce an extensive list of indicators that can serve as a starting point for other researchers who

want to measure “uncertainty” or problems with “credible commitment,” even outside the investment

issue area. Several of our indicators use the statistical concept of variance as a way to measure

uncertainty – something that is rare in studies of political economy. We also believe that our method of

measuring trends, such as those in economic conditions, is another promising way to capture actors’

expectations of future behavior. Finally, our findings suggest an elevated importance for domestic

politics as a predictor of treaty design. The small amount of previous quantitative scholarship on rational

design has largely ignored domestic politics, but we emphasize internal factors as being the source of

many of the problems states face when negotiating treaties, and in international cooperation more

generally. Of course, domestic politics also can be the source of state interests, which our findings

demonstrate to be important. Whether the causal pathway from domestic politics to treaty design

represents a “rational” response to an international problem, or merely the channeling of domestic

interests into an international treaty, is a question left to future analysts.

31

Table 1: Ordered Probit Model of BIT Centralization as a function of Commitment Problems, Preferences, and Power

Model 1 Model 2 Model 3 Model 4 Commitment Problems Domestic Institutions as Commitment Devices Political Constraints on Executive (-) 1.24 + 1.27 + (.284) (.300)

Checks on Executive (-) a .102 + (.040)

Respect for Law and Order (-) a .020 (.043)

Lack of Corruption (-) a .022 (.042)

(Lack of) Information about Signatory Tenure of Ruling Party (-) -.012 *** -.008 ** (.004) (.004)

Tenure of Current Executive (-) a -.011 (.012)

Negative Past Reputation Expropriations in past 5 years (+) .081 .092 (.109) (.115)

Preferences and Power of Signatories Presence of Large MNCs (+) 1.93 *** 1.37 ** 1.59 ** 1.70 ** (.855) (.824) (.831) (.848)

Right-wing Governments (+) .124 * .207 *** .229 *** .108 * (.081) (.079) (.077) (.083)

Relative Economic Power (+) .473 *** .531 *** .553 *** .473 *** (.153) (.161) (.156) (.157)

================================================================================== aTerms in gray are substitutes for terms in black above *p<.10, **p<.05, ***p<.01 (one-tailed tests) Time controls included but not reported Robust standard errors in parenthesis

Number of Observations 1315 1274 1315 1274

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Table 2: Ordered Probit Model of BIT Centralization as a function of Enforcement Problems, Preferences, and Power

Model 1 Model 2 Model 3 Model 4 Enforcement Problems Temptation to Cheat GDP Growth Rate (-) -.006 .002 (.008) (.010)

Unemployment Rate (+) a .010 (.012)

Inflation Rate (+) a .007 (.013)

3-year trend in GDP Growth Rate (-) a -.023 *** (.009)

3-year trend in Unemployment Rate (+) a .043 * (.027)

3-year trend in Inflation Rate (+) a -.003 (.004)

Benefits of Cheating Raw Materials Prices (+) -.002 -.002 (.003) (.004)

Sensitivity to Costs of Cheating Size of Bilateral Trade Relationship (-) -.069 * .062 (.053) (.055)

Alliance Ties (-) a .203 (.108)

Preferences and Power of Signatories Presence of Large MNCs (+) 1.60 ** 1.51 ** 1.71 ** 1.67 ** (.830) (.836) (.880) (.889)

Right-wing Governments (+) .230 *** .226 *** .238 *** .237 *** (.077) (.077) (.100) (.099)

Relative Economic Power (+) .542 *** .564 *** .513 *** .515 *** (.157) (.157) (.191) (.191)


Number of Observations 1313 1315 815 814

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Table 3: Ordered Probit Model of BIT Centralization as a function of Uncertainty about the State of the World, Preferences, and Power

Model 1 Model 2 Model 3

Uncertainty about the State of the World Amount of Information about Current State of FDI Number of Recent BITs Globally (-) .002 + .002 + (.0004) (.0005)

Number of Recent Invest. Disputes Globally (+) a .014 ** (.008)

FDI-Related“Shocks” Global Currency Crises, past 3 years (+) .010 -.007 (.017) (.017)

Global Currency Crises, past 5 years (+) a -.0001 (.021)

Global Currency Crises, past year (+) a .023 (.021)

Variance in Recent Global FDI Flows (+) a .824 *** (.369)

Preferences and Power of Signatories Presence of Large MNCs (+) 1.58 ** 2.03 *** 2.09 *** (.847) (.878) (.893)

Right-wing Governments (+) .235 *** .255 *** .269 *** (.080) (.079) (.083)

Relative Economic Power (+) .617 *** .465 *** .516 *** (.159) (.160) (.163)


Number of Observations 1315 1243 1243

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Table 4: Logit Model of BIT Flexibility as a function of Uncertainty about the State of the World, Preferences, and Power

DV = Flexibility (Lack of Advanced Consent to Arbitration)


Uncertainty about the State of the World Amount of Information about Current State of FDI Number of Recent BITs Globally (-) -.0004 0.0003 (.001) (.001)

Number of Recent Invest. Disputes Globally (+) a .006 (.007)

FDI-Related“Shocks” Global Currency Crises, past 3 years (+) .007 .011 (.023) (.024)

Global Currency Crises, past 5 years (+) a -.015 (.029)

Global Currency Crises, past year (+) a .012 (.027)

Variance in Recent Global FDI Flows (+) a .076 (.247)

Preferences and Power of Signatories Presence of Large MNCs (-) -1.49 * -1.51 * -1.53 * (1.04) (1.07) (1.07)

Right-wing Governments (-) -.315 *** -.330 *** -.332 *** (.089) (.091) (.091)

Relative Economic Power (-) -.887 *** -.880 *** -.883 *** (.223) (.231) (.231)



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Table 5: Count Model of BIT Flexibility as a function of Uncertainty about the State of the World, Preferences, and Power

DV = Flexibility (Total Number of Arbitration Options)


Uncertainty about the State of the World Amount of Information about Current State of FDI Number of Recent BITs Globally (-) .0003 + .0003 + (.0001) (.0001)

Number of Recent Invest. Disputes Globally (+) a .001 (.001)

FDI-Related“Shocks” Global Currency Crises, past 3 years (+) .010 ** .005 (.005) (.006)

Global Currency Crises, past 5 years (+) a .005 (.008)

Global Currency Crises, past year (+) a .022 *** (.007)

Variance in Recent Global FDI Flows (+) a .130 *** (.049)

Preferences and Power of Signatories Presence of Large MNCs (-) -.378 ** -.420 ** -.404 ** (.216) (.219) (.218)

Right-wing Governments (-) .030 .030 .032 (.020) (.020) (.020)

Relative Economic Power (-) .059 .055 .058 (.048) (.049) (.048)



36

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