Reach, Range, Reason
Global Development Network series
Edited by José María Fanelli and Lyn Squire
Chapter 5: The Effect of Free-Trade Agreements on Foreign Direct Investment and Property Rights Protection
Lorenza Martínez Trigueros and Roberto Romero Hidalgo Amartya Sen defines ‘range’ as the methods policymakers use to achieve specific goals, and he emphasizes that range involves a variety of institutions. Following his admonition to consider the interactions between reform initiatives and institutions, this chapter focuses on the effects which a tradereform initiative (a trade agreement) can have on institutions (property rights). More specifically, we analyze the negative impact of weak property rights protection on foreign direct investment (FDI) as well as the role of multilateral trade agreements as an alternative to overcome this effect.1 Such agreements affect commercial flows and have the potential to improve property rights protection in these countries. Specifically, multilateral trade agreements have greater impact on FDI going to countries which lack adequate property rights protection. When these agreements include a chapter about conflict resolution through an arbitrage panel, they help mitigate some of the defects of weak domestic institutions by allowing some conflicts to be solved in panels formed by international members. Foreign investors can appeal to this more transparent authority whenever their property rights are violated. This option offers a level of security for investors when legal institutions in a country are corrupt or incompetent. Put another way, these treaties allow countries lacking a clear definition or strong protection of property rights to free ride on the protection offered by more efficient international institutions. This mechanism might even have positive externalities, if it imposes greater discipline on domestic authorities, by diminishing the probability of...
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