FDI and Capital Account Liberalisation

Policymakers in developing countries have increasingly pinned their hopes on both bilateral investment treaties (BITs) and unilateral capital account liberalisation in order to improve their chances in the worldwide competition for foreign direct investment (FDI). However, the effectiveness of these instruments in inducing higher FDI inflows is still open to debate. It is in several ways that we attempt to clarify the inconclusive empirical findings of earlier studies. We cover a much larger sample of host and source countries by drawing on a previously unpublished dataset on bilateral FDI flows. Employing a gravity-type model and various model specifications, including an instrumental variable approach, we find that BITs do promote FDI flows to developing countries. In addition, BITs are likely to act as a substitute for unilateral capital account liberalization