Explaining The Popularity of Bilateral Investment Treaties:Why LDCs Sign Treaties That Hurt Them

Andrew T. Guzmán *
26 August, 1997

Abstract

	Bilateral Investment Treaties (BITs) have become the dominant mechanism for the international regulation of foreign direct investment.  The tremendous popularity of these treaties is puzzling because they provide investment protections that exceed those offered by the former rule of customary international law, the Hull Rule, to which developing countries have long objected on sovereignty grounds.  Furthermore, as the paper demonstrates, BITs may be welfare reducing for developing countries.  By forcing LDCs to compete for inward foreign investment, and by providing a mechanism through which developing countries are able to make binding commitments to investors, BITs may reduce the benefit developing countries obtain from foreign investment.
	Because the treaties are bilateral in nature, however, they offer an LDC an advantage over other countries in the competition to attract investment.  For this reason, individual countries are willing to sign such agreements, despite the fact that LDCs as a group are harmed.
	After developing the above analysis, the paper discusses the implications of its results on the role of BITs in the formation of customary international law, concluding that the treaties should not be taken as evidence of the existence of customary law.

Explaining The Popularity of Bilateral Investment Treaties:
Why LDCs Sign Treaties That Hurt Them
Andrew T. Guzmán 

I. Introduction	
II. Background	
III. The Hull Rule	
IV. The Paradoxical Behavior of Developing States	
A. The Sovereignty Approach	
B. The Bilateral Treaty Approach	
1. Description & History of BITs	
2. The Contents of a BIT	
V. The Dynamic Inconsistency Problem	
A. The Basic Problem	
B. Dynamic Inconsistency Applied to Foreign Investment	
VI. Explaining the Paradoxical Behavior of LDCs	
A. Have Developing Countries Changed Their Position?	
B. Other possibilities	
C. A Strategic Analysis of LDC Behavior	
1. Efficiency considerations	
2. Distributional Considerations	
3. Understanding the Results of the Analysis	
D. Understanding the Results of the Analysis	
VII. Implications for Welfare Maximization and International Law	
A. The Welfare Implications of BITs	
B. The Impact of BITs on Customary International Law	
VIII. Conclusion	

I.  	Introduction
	In recent years, foreign direct investment (“FDI”) has grown at an unprecedented rate.  Between 1986 and 1990, total world FDI flows increased from US$88 billion dollars to US$234 billion, representing an average rate of increase of twenty-six percent in nominal terms and eighteen percent in real terms.  From 1980 to 1993, the stock of foreign investment increased at an average annual rate of eleven percent in real terms, reaching a total of $2.1 trillion in 1993.  A significant proportion of FDI flows is directed at developing countries.  FDI flows to these countries grew from $13 billion in 1987 to $22.5 billion in 1989 to $90.3 billion in 1995.
	This paper considers how the treatment of foreign investment is regulated at the international level.  Specifically, it considers bilateral investment treaties (“BITs”) and why they have become the preferred way to govern the relationship between host governments and investors.  Because BITs impose obligations that are similar – and, indeed, that exceed – the obligations imposed by the traditional rule of customary law (the “Hull Rule), and because the legal position advocated by developing states has always been for fewer such legal requirements, the simultaneous opposition to the Hull Rule and embracing of BITs is a paradox.  The paper offers a novel explanation of why developing states fought aggressively against the former rule of “prompt, adequate, and effective” compensation for expropriation and in favor of a more lenient standard, and why they contemporaneously flocked to sign BITs that offer investors much greater protection than the old rules of customary law.  It is demonstrated that although an individual country has a strong incentive to negotiate with potential investors -- thereby making itself a more attractive location than other potential hosts --  developing countries as a group are likely to benefit from forcing investors to commit to a country through their investment before the final terms are established -- thereby giving the host a much greater ability to gain value from the investment.  Put another way, developing countries as a group may have sufficient market power in the “sale” of their resources as host countries that if they act collectively they stand to gain more than if they compete against one another and bid down they receive.  The analysis in this paper offers a better explanation for the behavior of developing countries than what is currently in the literature and allows an assessment of the desirability of BITs.
	In addition, the paper discusses the welfare implications of BITs, as compared to the “appropriate compensation” standard that developing countries have advocated at the United Nations -- concluding that while they almost certainly increase global efficiency, they may be welfare reducing for developing states.  Developing countries continue to sign these treaties, however, because although the treaties are welfare reducing for LDCs as a group, an individual developing country is better off agreeing to BITs.  Finally, the paper discusses the impact of BITs on customary international law -- pointing out that if BITs represent a successful drive to undermine the efforts of developing countries to increase their gains from foreign investment, then the treaties should not be considered to support a customary law that includes the Hull Rule.  Instead, they should be recognized as a mechanism through which capital importing countries are forced to compete for investment dollars -- thereby offering the greatest return to the foreign investor.  BITs effectively elevate the relationship between a private foreign investor and a host state to the level of international law -- including a mandatory dispute settlement procedure.  Although international law does not formally recognize private firms as international actors, it does, through BITs, allow states to bind themselves to agreements with such firms.
	A serious analysis of the origin of BITs and their implications on both investment levels as the distribution of the gains from investment is timely.  BITs have become the dominant vehicle through which investment is regulated under international law.  As of the summer of 1996, there were 1010 BITs in existence around the globe, more than half of which have been signed or brought into force since the start of 1990.  The number of countries who have signed at least one BIT has reached 149 (including some countries which have ceased to exist, such as the USSR), leaving very few countries without any such treaties.  Surprisingly little attention has been given to these treaties which have established a web of regulations for the protection of foreign investment that reaches virtually every corner of the globe.  This paper seeks to contribute to a deeper and more coherent understanding of BITs, their role in the regulation of foreign investment, and their impact of the welfare of nations.
	The paper proceeds as follows.  Section II offers some background material.  Section III describes the Hull Rule and its role in the regulation of foreign investment.  Section IV outlines the position of developing states both with respect to the Hull Rule and BITs.  Section V presents and applies a theoretical framework that will be used to analyze foreign investment regulation.  Section VI examines the behavior of developing countries and offers an explanation of their behavior with respect to the Hull Rule and BITs.  Section VII considers some of the implications of the analysis in the paper and Section VIII concludes.
II.  	Background
	In the last forty years, the international community has witnessed a fundamental change in the regulation of foreign investment.  Not long ago, the rights of foreign investors vis a vis the state in which they invested (the “host”) were protected by two forces.  First, foreign investors had the protection of customary international law.  Public international law, though lacking an effective enforcement mechanism, offered investors at least some assurance that their investment would not be seized by host governments.  Although the existence of expropriations demonstrates that this protection was not perfect, there is no serious doubt that international law offered investors some security.  In the context of investments, like in many other contexts, it is recognized that nations consider themselves bound by international law and will often modify their behavior in order to avoid being seen to be as violators of that law.  Beyond the general sense of moral or legal obligation, violations of international law often carry a tangible price.  States recognize that a failure to abide by the dictates of international law can have adverse consequences on their relations with foreign states and, in serious cases, may lead to the imposition of sanctions against them.  The second source of protection for investors was the international political, and sometimes military, power of their “home” state.  To the extent that host nations feared reprisals of some form from the home state of investors, the investment was not at serious risk.
	The customary international law that has traditionally applied to takings by the host state is referred to as the “Hull Rule,” in reference to Secretary of State Cordell Hull who authored the most famous articulation of the rule in 1932.  The key words, penned by Hull, that have come to represent the traditional “full compensation” position is that the expropriation of property owned by foreigners requires “prompt, adequate and effective” compensation.
	The world is very different today. The customary international law that once governed foreign investment was successfully called into question by developing states who advocated an alternative international norm and who ultimately left the international community without any legal standard having the status of customary law.  The Hull rule was challenged by developing countries who claimed, on sovereignty grounds, the right to determine how they would treat investors and the standard of compensation that should apply if that treatment was sufficiently harmful.  Although many countries continue to advocate the Hull Rule, a sufficient number of developing states oppose it to ensure that it can no longer be considered a rule of customary law.
	The bilateral investment treaty has risen to fill the void created by the demise of the old customary rules.  These treaties are typically signed between developed and developing nations, and are binding international treaties governing the treatment of foreign investment.  Curiously, despite the fact that developing countries as a group have objected vociferously to the Hull Rule for many years (and continue to do so), these same developing countries have signed hundreds of BITs that incorporate obligations equivalent to the Hull Rule.  Indeed, looking at the entire text of most BITs, it is clear that they offer investors much greater protection, at the expense of the host countries, than the Hull Rule ever did.  For example, and most importantly, BITs include terms that protect the foreign investor against a “contractual breach” by the host.  In other words, when a BIT is in place between the host and the home state, an agreement made between the investor and the host is binding on both.  A breach of the agreement by the host is a violation of the BIT and, therefore, a violation of international law.  The BIT also provides the aggrieved investor with binding dispute resolution mechanisms; thereby creating an enforcement mechanism that is much more effective, and thus better able to ensure compliance by the host than what existed under the Hull Rule.  Because BITs allow investors and hosts to establish binding contracts whose terms are subject to arbitration in a neutral forum, potential investors can negotiate for much greater protection than they ever enjoyed under the Hull Rule.
	Before proceeding, a note of caution is in order.  The bulk of the literature on BITs and foreign investment protection has focused on expropriation, devoting much  less attention to other types of disputes between investors and hosts.  It is important to recognize, however, that the analysis here encompasses all disputes between investors and hosts.  Indeed, disputes that do not involve a direct taking are the more interesting ones today because takings are quite rare.  The importance of the contracting provisions and the dispute resolution mechanisms present in BITs is magnified by the rarity of expropriation.  The most common source of tension between an investor and a host state is not expropriation but rather conflicts that fall short of a taking.  Customary international law -- even under the Hull rule -- provides virtually no protection for the investor against these less extreme actions by the host.  BITs, on the other hand, allow potential investors to negotiate for whatever protections and safeguards they feel are needed.  In other words, over the bulk of investor-host conflicts, BITs provide the investor with protections that are far superior to those of customary law.
III.  	The Hull Rule
	Before BITs were conceived of, foreign investment was protected by customary international law.  Because BITs arose, in part, due to of the demise of the old customary law, a discussion of the role of BITs must begin with a review of the regime that preceded these treaties.
	Early in this century, there was a broad consensus among the world’s principal nations regarding the appropriate level of protection for foreign investment.  These countries believed that investors were entitled to have their property protected by international law and that the taking of an alien’s property by a host nation required compensation that was “prompt and adequate.”  This view should not surprise us.  The nations forming this rule were, by and large, wealthy, European countries, whose nationals were engaged in investment abroad but which faced relatively little inward foreign direct investment.  Nevertheless, customary international law does not consider the intentions behind countries’ behavior, merely the practice and sense of legal obligation.  Regardless of the motivation of these countries, therefore, it is fair to say that the prompt and adequate standard was customary international law at the time.
	One version of this standard is presented in The Chorzow Factory Case, decided by the Permanent Count of International Justice (P.C.I.J.).  The case has its roots in the Treaty of Versailles, signed in 1919.  The treaty contained a requirement that certain territories be transferred from German to Polish control and that the status of certain other lands be determined by plebiscite.  The Geneva Convention -- adopted to implement the Treaty of Versailles -- and the plebiscites that followed ceded the region of Chorzow, located in Upper Silesia, to Poland.  Under the Geneva Convention, countries that took over German territory had the right to seize land owned by the government of Germany and credit the value of that land to Germany’s reparation obligations.  Any disputes that arose under the Convention were to be referred to the P.C.I.J.
	Shortly after Poland took over Chorzow, a Polish court decreed that land belonging to the German company, Oberschlesische Stickstoffwerrke A.G., be turned over to Poland.  Litigation ensued on the question of whether the land was “property” of Germany or if it was privately owned by Oberschlesische Stickstoffwerrke A.G.  The dispute eventually reached the P.C.I.J..  The Permanent Court concluded that the land was privately owned, and that Poland had seized private property.  The Court stated that “there can be no doubt that the expropriation . . . is a derogation from the rules generally applied in regard to the treatment of foreigners and the principle of respect for vested rights.”  The Court also spoke to the question of appropriate compensation, stating that “reparation must, as far as possible, wipe out all the consequences of the illegal act and reestablish the situation which would, in all probability, have existed if that act had not been committed.”  Thus, the Permanent Court enunciated the then existing international law -- expropriations were not permitted and if they occurred, full compensation must be paid.
	The requirement of full compensation for expropriation was most clearly articulated in the 1930s when it was challenged by the government of Mexico.  Mexico confiscated various properties between 1915 and 1940.  The United States, whose nationals suffered from these acts of expropriation, sought compensation for its affected citizens.  In response to the takings by Mexico, the American Secretary of State, Cordell Hull, put forth what has become the leading formulation of the full compensation standard:
The Government of the United States merely adverts to a self-evident fact when it notes that the applicable precedents and recognized authorities on international law support its declaration that, under every rule of law and equity, no government is entitled to expropriate private property, for whatever purpose, without provision for prompt, adequate, and effective payment therefor.
The requirement of “prompt, adequate, and effective” compensation has become known as the “Hull Rule,” in reference to this statement by Secretary of State Hull.
	The protection of foreign investment is typically considered a matter of international law, but domestic law makers have from time to time sought to influence the treatment of investors abroad through domestic legislation.  In the early 1960s, for example, the United States Congress passed what would become known as the “First Hickenlooper Amendment.”  This law requires that the President terminate aid to any country that has seized American-controlled property, has repudiated or nullified contracts with Americans, or has “imposed or enforced discriminatory taxes or other exactions, or restrictive maintenance or operational conditions,” and that has failed to “discharge its obligation under international law . . . including speedy compensation for such property in convertible foreign exchange, equivalent to the full value thereof . . . .”  The statute represents an attempt on the part of the United States to provide an enforcement mechanism, through domestic law, that could carry out the American interpretation of international law.  Since its adoption, however, the First Hickenlooper Amendment has been applied only twice, once against Ceylon in 1963 and once against Ethiopia in 1979.
	A few years later, Congress passed the “Second Hickenlooper Amendment,” which was a reaction to the United States Supreme Court decision in Banco National de Cuba v. Sabbatino.  In the early 1960s, the United States reduced the import quota for Cuban sugar.  In response, Cuba nationalized various companies in which American citizens held interests, including C.A.V..  A commodities broker named Farr, Whitlock that had contracted to purchase Cuban sugar from C.A.V. found that its seller had been nationalized.  Farr, Whitlock entered into a new agreement to purchase the sugar from the Cuban government, agreeing to make payment to Banco National de Cuba.  Instead of making payment to Banco National, however, Farr, Whitlock made payment to C.A.V..  Banco National then sued for recovery of the proceeds.  The Supreme Court, after reviewing the case, held that:
[T]he Judicial branch will not examine the validity of a taking of property within its own territory by a foreign sovereign government . . . in the absence of a treaty or other unambiguous agreement regarding controlling legal principles, even if the complaint alleges that the taking violates customary international law.
The Permanent Court relied on the act of state doctrine in ruling that it would not examine the legality, under international law, of the actions of Cuba’s government in expropriating property.
	This Supreme Court ruling provoked a strong reaction from the business community and from the legislative branch.  Congress very quickly passed the Second Hickenlooper Amendment which effectively overruled the holding in Sabbatino.
[N]o court in the United States shall decline on the ground of federal act of state doctrine to make a determination on the merits giving effect to the principles of international law in a case in which a claim of title or other right to property is asserted be any party . . . based upon . . . a confiscation or other taking.
	Although the Hull Rule could, at one time, lay claim to the status of customary international law, it can no longer be said to represent a binding international legal norm.  This change in status is the result of disagreement between developed and developing countries as to the validity of the Hull Rule.  The set of countries that are, and that have been, net importers of investment capital in this century includes a majority of the developing countries (LDCs) of the world.  This is true both at the individual country level -- most developing countries import capital -- and at the collective level -- LDCs, taken as a group, are very clearly net importers of investment.  On the other hand, most of the outward foreign investment is made from developed countries.
IV.  	The Paradoxical Behavior of Developing States
	The conflicting views of developed and developing nations on the question of compensation for expropriation is evidence of the predictable fact that one’s view regarding the appropriate standard of compensation is determined by whether one is a net importer or exporter of investment capital.  It is the direction of the flow of investment capital and wealth and power disparities between developed and developing countries that gives them different perspectives on questions of investment regulation.
	Consider the behavior of developed states on the topic of expropriation and dispute settlement.  The publicly stated view and the behavior of these countries have remained quite consistent over the years.  These countries have, over all relevant periods, insisted that expropriation of property owned by foreigners should be permitted only if it is for a public purpose and only if accompanied by prompt, adequate, and effective compensation.  In other words, they have advocated international rules to protect the investment made by their nationals.
	LDCs, in contrast to developed states, have exhibited behavior that is, at first glance, contradictory.  In public statements, LDCs as a group have condemned the Hull Rule as an infringement on the sovereignty of the expropriating nation and have called for a less exacting expropriation standard.  In fact, as is discussed below, LDCs have objected so strenuously to the Hull Rule that they have succeeded in calling into question its validity as customary international law.  In their private behavior, however, many LDCs, have agreed to treaties that not only implement the Hull Rule, but that go much further in providing protections for foreign investors.
A.  	The Sovereignty Approach
	Consensus surrounding the Hull Rule was possible during the first half of this century at least in part because many countries that currently oppose the rule were colonies rather than sovereign states.  While under the control of colonial powers, the views of these states were, of course, controlled by their colonial masters, who supported a regime of full compensation.  Furthermore, colonies were not recognized as independent states, implying that even if they had an independent view of how international law should protect investors, that view would have no impact on the establishment of international customary law.  As decolonization took place, LDCs were able to voice their own views and those views became relevant to the determination of international law.  As the number of independent former colonies grew, their opinions carried greater weight in the international arena, and as they questioned international norms that had previously been considered unobjectionable, the status of those norms changed.
	An early demonstration of the view that would eventually find its way to the floor of the United Nations General Assembly is provided by the government of Mexico during discussions with the Untied States regarding Mexican expropriations of property in the first half of this century.  In a note dated August 3, 1938, the Mexican Minister of Foreign Affairs stated:
My Government maintains . . . that there is in international law no rule universally accepted in theory nor carried out in practice, which makes obligatory the payment of immediate compensation nor even of deferred compensation, for expropriations of a general and impersonal character . . . .
	It was not until after the Second World War, however, that expropriation and conflict over expropriation became common.  Nationalizations and expropriations in the form of direct takings became much more common as newly communist countries in Eastern Europe and, later, the People’s Republic of China, seized property, and as former colonies became newly independent states and sought to flex their newfound sovereignty.  Such expropriations continued into the 1970s.  The home countries of the investors who suffered losses due to expropriations reacted by attempting to discourage and punish such behavior.  Whether for this or other reasons, the period of simple takings turned out to be relatively short lived.  By the early 1980s, acts of direct and explicit taking of property had become very rare.  In fact, from 1984 to 1992, one observer counts only 3 expropriations.
	Throughout this period, the majority of the developing world supported a less stringent compensation requirement for expropriations than the Hull Rule’s “prompt, adequate, and effective” standard.  The inevitable disputes that arose following expropriations proved difficult to resolve.  Without an existing procedure to deal with such disputes, and without a mechanism to resolve the conflicting views of LDCs and developed countries, the international community appeared to be at an impasse.  The lines of disagreement were clear; capital importers supported a less stringent rule and capital exporters supported the Hull Rule.  There seemed to be no room for negotiation.  In the battle for international legitimacy, both sides of the debate claimed that customary international law was on their side.  The developed world pointed to the history of the Hull Rule and to the support it had received both in practice and in writings by commentators.  In response, LDCs pointed out that practice had not always accorded with the Hull Rule and that, in any event, the rule simply lacked the broad international support that customary international law requires.  Although the developed world denied the point, it seemed that the debate itself was undermining the claim that the rule retained its status as customary international law.  Although one can always ask how much practice is necessary and how many countries must feel legally bound in order for a norm to become customary law, as the number of countries against the Hull Rule increased, the claim that it was customary law would prove unpersuasive.
	While the debate over the status of customary international law was ongoing, LDCs used the strength of their numbers to undermine the developed states’ position.  From the early 1960s through the mid 1970s, the General Assembly of the United Nations -- dominated by LDCs -- passed a series of resolutions intended to emphasize the sovereignty of nations with respect to foreign investment.  First, in 1962, the Resolution on Permanent Sovereignty over Natural Resources (Resolution 1803) was passed.  This resolution provided that in cases of expropriation, “appropriate compensation, in accordance with the rules in force in the State taking such measures in the exercise of its sovereignty” must be paid.  Resolution 1803 used the term “appropriate” compensation, which has since come to mean a standard that is lower than the traditional Hull Rule of “prompt, adequate and effective” compensation.  In the 1960s, however, advocates of the Hull Rule were not prepared to concede that the Hull Rule had lost its status as customary law.  The United States, for example, chose to interpret “appropriate” to mean “prompt, adequate and effective.”  Though perhaps not the fairest reading of the resolution, such an interpretation allowed the United States to persist in its claim that the Hull Rule remained international law.
	In 1973, the General Assembly adopted another Resolution on Permanent Sovereignty over Natural Resources (“Resolution 3171”), which removed any doubt that may have existed about whether or not the Hull Rule was included in the term “appropriate.”  The resolution stated, among other things, that:
the application of the principle of nationalization carried out by States, as an expression of their sovereignty in order to safeguard their natural resources, implies that each State is entitled to determine the amount of possible compensation and the mode of payment, and that any dispute which might arise should be settled in accordance with the national legislation of each State carrying out such measures . . . .
	Resolution 3171 made absolutely clear that the General Assembly, dominated by developing countries, supported a rule under which expropriation was permitted with less than full compensation.  At this point, it would have been difficult to make a persuasive argument that the Hull Rule retained its status as customary international law.  With 109 countries voting in favor of a resolution contradicting the Hull Rule, it is simply not plausible to claim that it remained a general practice and that it was considered legally binding.
	In May of 1974, the General Assembly went a step further, declaring a New International Economic Order in Resolution 3201.  This resolution stated that every state enjoys:
[f]ull permanent sovereignty over its natural resources and all economic activities. . . . [E]ach State is entitled to exercise effective control over them and their exploitation with means suitable to its own situation, including the right to nationalization or transfer of ownership to its nationals . . . .  No State may be subjected to economic, political or any other type of coercion to prevent the free and full exercise of this inalienable right.
	Note that Resolution 3201 considers unacceptable any form of sanction on a country that has expropriated the assets of an investor.  This resolution, therefore, seeks to undermine one of the few mechanisms that might enforce a rule against expropriation, whether it be the Hull Rule or the standard of “appropriate” compensation favored by many LDCs.  In addition, this resolution, like the earlier United Nations General Assembly resolutions, does not even recognize the existence of an international obligation of repayment.  Although the resolutions are not inconsistent with such an obligation, they do not explicitly recognize one, except in suggesting that the resolution of the dispute should be consistent with domestic legislation.
	Finally, in December of 1974, the General Assembly adopted Resolution 3281, the Charter of Economic Rights and Duties.  The Charter states that each state has the right:
(a) To regulate and exercise authority over foreign investment within its national jurisdiction in accordance with its laws and regulations and in conformity with its national objectives and priorities. . . .
(b) To nationalize, expropriate or transfer ownership of foreign property, in which case appropriate compensation should be paid by the State adopting such measures, taking into account its relevant laws and regulations and all circumstances that the State considers pertinent.  In any cases where the question of compensation gives rise to a controversy, it shall be settled under the domestic law of the nationalizing State and by its tribunals, unless it is freely and mutually agreed by all States concerned that other peaceful means be sought on the basis of the sovereign equality of States and in accordance with the principle of free choice of means.
The Charter served to further emphasize the sovereignty of LDCs with respect to their treatment of foreign investors, including over the dispute resolution process.  Essentially, the Charter puts the host country government in full control and places the investor at the mercy of that government.  
	Taken together, the above resolutions offer powerful evidence that developing countries, when acting as a group, prefer a regime under which they are able to expropriate property when they feel it is justified and to pay what they determine to be appropriate compensation.  These repeated efforts to establish the “appropriate compensation” standard represent a frontal assault on the traditional norm of full compensation.  The developing states undertook an active campaign to change international customary law.  This point is important because it demonstrates a vigorous opposition to the Hull Rule.  The resolutions also demonstrate a preference among developing states for a dispute resolution system that relies on local courts rather than international fora.  They seek control over the entire relationship between investor and host; essentially rendering it a matter of domestic law rather than international law.
	All of the actions described in this section and taken by developing states rely on the notion of state sovereignty in order to support their view that international law provides only minimal protections against expropriation.  The actions discussed succeeded, by demonstrating a lack international consensus, in undermining the Hull Rule’s status as customary international law.  Once it became clear that the Hull Rule was no longer customary law, which certainly occurred in the wake of Resolution 3171, and may have occurred much sooner, there was no other source of international law to govern international investment.  There was nothing to prevent individual states from determining what constitutes appropriate compensation.
B.  	The Bilateral Treaty Approach
	The behavior of developing countries, as manifested through the United Nations Resolutions and calls for rejection of the Hull Rule, stands in stark contrast to their behavior as manifested through the signature of bilateral investment treaties.  In this section, we will briefly review the history of these treaties and consider their most important terms.  In a very short period of time, BITs have become an important part of the foreign investment landscape.  By 1991, well over 400 BITs had been signed with more than ninety developing states and “virtually every developed state” being party to at least one such treaty.  By mid 1996, over one thousand such treaties had been signed, and almost every country on the globe has signed at least one such treaty.  Regardless of the impact that these treaties have on customary international law, they represent an important part of the international investment landscape in their own right.
1.  	Description & History of BITs
	The United States BIT program has existed for almost twenty years, and it has been fifteen years since the first American BIT treaty was signed with Egypt.  Bilateral Investment Treaties, however, have been part of the international landscape for a considerably longer period; as have American treaties that include investment protections.  This section will review the origins of the BIT, both in the United States and elsewhere.
	The United States began to sign treaties of “Friendship, Commerce and Navigation” (FCNs), the precursor to the BIT, soon after the birth of the country.  FCNs were a common part of United States policy toward outward foreign investment until after the Second World War.  As the name of these treaties suggests, and contrary to the BIT, Treaties of Friendship, Commerce and Navigation were not exclusively, or even primarily, vehicles to protect investments abroad.  Nevertheless, the treaties included some protections for American investors in foreign countries, including a prohibition on expropriation without compensation.  The primary purpose of these agreements, however, was the promotion of international trade.  With the rise of the General Agreement of Tariffs and Trade (“GATT”) after World War II, the international law of trade came to be governed by this multilateral agreement, reducing the need for FCNs.  Because many of the objectives of the FCNs were met by the GATT, the treaties were supplanted by it and, by the mid 1960s, the American FCN program had wound down.
	At about the same time, other countries were discovering and implementing a new instrument for the protection of foreign investment -- the BIT.  By the time the American FCN program had completely shut down, several European countries were busy negotiating and signing bilateral investment treaties with developing countries.  Unlike the FCNs, these treaties focused exclusively on the protection of investment -- a topic not covered by GATT.  The first such treaty was between West Germany and Pakistan, and was signed in 1959.  Switzerland was also an early participant in  BITs and other European countries began to establish BITs in the late 60s.  Eventually, Japan and the United States would join the growing number of developed states with BIT programs aimed at developing states.
	The United States, a latecomer to the BIT, established its BIT program in 1977.  The program was put in place with a number of specific objectives regarding the protection of foreign investment overseas.  These goals were (1) to bolster the claim that the Hull Rule remained customary international law by establishing a network of treaties that included this principle; (2) to protect current and future foreign investment from host government behavior; and (3) to provide a mechanism for resolving investment disputes that did not rely on either local courts or direct involvement by the United States Government.
	As was true of most BITs, the developed partner to these agreements -- the United States -- initiated the process.  Indeed, the United States made considerable preparations prior to the start of negotiations with potential BIT partners.  With the objectives of the BIT program in mind, the United States prepared a prototype BIT which was to form the foundation for negotiations with potential BIT partners.  The original model text was completed in 1981 and has since been modified several times.  Although the U.S. treaty is, in principle, open to negotiation, the final BIT is usually very similar to the model treaty, demonstrating the strong negotiating position of the United States.  While some negotiation is possible on some issues, the United States is committed to the basic structure of the model treaty and will only accept relatively small changes.  In fact, looking beyond BITs signed by the United States to those of other developed  countries reveals that BITs around the world are bear a strong resemblance to one another.  Typical provisions include terms governing compensation for expropriation, the repatriation of profits, dispute settlement procedures (usually through some neutral forum), national treatment requirements, and “most favored nation” requirements.  In order to provide greater context, we will briefly review the main elements of the U.S. model treaty.
2.  	The Contents of a BIT
	The model United States Bilateral Investment Treaty consists of a preamble and sixteen articles.  Article I defines certain key terms.  Of greatest interest for present purposes is the definition of “investment,” which is defined to include:
every kind of investment owned or controlled directly or indirectly by that national or company, and includes investment consisting or taking the form of: 
(i) a company;
(ii) shares, stock, and other forms of equity participation, and bonds, debentures, and other forms of debt interests, in a company;
(iii) contractual rights, such as under turnkey, construction or management contracts, production or revenue-sharing contracts, concessions, or other similar contracts;
(iv) tangible property, including real property; and intangible property, including rights, such as leases, mortgages, liens and pledges;
(v) intellectual property . . . 
(vi) rights conferred pursuant to law, such as licenses and permits.
	Notice the broad reach of this definition.  It covers not only hard investments such as real estate and equipment, but also financial assets (stocks, bonds, etc.) and, critically, contractual rights and rights conferred by law.  This definition is important because, as mentioned above, “hard-core” expropriation that involves the outright seizure of assets has become quite rare.  The definition of investment, however, protects not only against these seizures, it also protects against the “breach” of agreements signed between the host and the investor and the withdrawal of licenses and other such rights.  By defining investment in this way, the United States is essentially making any agreement between the host and the investor part of the “investment.”  The relationship between the host and the investor is made to look very much like the relationship between two private contracting parties within a single country.  It is important to keep this definition in mind as one examines the other terms of the BIT.  As will be discussed below, the protection of contractual rights is one of the most interesting and potentially influential aspects of the BIT.  Indeed, it is the definition of investment that makes virtually any dispute between host and investor -- at least any dispute based on negotiated agreement between the two -- a matter of international law.  Combined with the dispute settlement provisions, the definition of investment effectively removes these disputes from the legal control of the host -- something customary international law never did.
	Article II attempts to provide investors  with a certain minimal level of protections that are intended to cover all investments, regardless of the agreement that the host and the investor reach.  In other words, taken as a whole, Article II serves to establish the minimum standards of treatment required from the host country.  It ensures that investors will not suffer discriminatory treatment relative to either nationals of the host country or other foreign investors, and it emphasizes that the host’s conduct must conform to international law
	Article II(1) of the treaty requires that foreign investment be accorded national treatment or most favored nation treatment, whichever is more favorable to the investment.  Exceptions to this requirement are permitted for certain sectors that are subject to negotiation and inclusion in the Annex to the treaty.
	Article II(3) is intended to ensure that investment from a BIT partner receives the basic protections of international law.  Specifically, Article II(3)(a) provides that the host must provide “fair and equitable treatment and full protection and security and shall in no case accord treatment less favorable than that required by international law.”  Although Article II does not, in principle, change any substantive rights, it at least brings those protections that exist under international law within the reach of the treaty and, therefore, within the reach of the dispute resolution mechanism. Also in subpart three is a prohibition on unreasonable or discriminatory measures that impair the management, conduct, operation, and sale or other disposition of investments.  Article II(4) requires the host country to “provide effective means of asserting and enforcing rights.”
	Article III deals with the expropriation of investments.  Because “investment” is defined so broadly in Article I, however, the section on expropriation applies to any number of actions that a host may take in violation of an agreement with an investor.  Section 1 prohibits expropriation or nationalization “directly or indirectly,” “except for a public purpose; in a non-discriminatory manner; upon payment of prompt adequate and effective compensation; and in accordance with due process of law . . . .”  This clause is, of course, a restatement of the Hull Rule.  Because of the context in which the rule applies, however, this clause imposes obligations on host governments that far exceed the traditional Hull Rule.  Because it applies not only to the expropriation of assets, but also to “breach” of an agreement, a host may be required to make “prompt, adequate, and effective” compensation for actions that, under the customary law version of the Hull Rule, would not have been considered expropriations.  Also, notice that dispute resolution mechanisms discussed below imply that neutral parties can be called upon to establish the amount of compensation that is required.  Given the expansive definition of investment, this section provides tremendous security for investors, both in terms of their hard assets and in the rights they have acquired through contract with the host government.
	Article V governs the transfer of assets to and from the host country.  It requires that the host allow free transfer both into and out of the country as long as they relate to covered investments.  For example, the host is not permitted to restrict the repatriation of profits.
	Article VI prohibits performance requirements such as local content requirements, technology transfer requirements, and so on.  Notice that rather than being an alternative to the national treatment requirement, the prohibition against performance requirements is an additional obligation.  Therefore, even if domestic firms must meet, for example, a local content regulation, Article VI makes it a violation of the BIT to demand the same from a foreign investor.
	Articles IX and X provide a dispute settlement mechanism to govern relations between the host and the investor.  Under these provision, arbitration is available to settle disputes and is binding on both parties.  This mechanism effectively solves the dynamic inconsistency problem discussed in Section IV of this paper because it allows disputes to be settled in binding fashion in a neutral forum.  It thus becomes possible for a country to commit itself by contract in a manner that can be enforced through arbitration.
	The above discussion demonstrates that BITs offer foreign investors much greater protection that the Hull Rule ever did.  They do so primarily by providing a mechanism through which a potential investor and a potential host can establish a contract that is binding under international law.  In addition, the provision of dispute settlement procedures offers investors a disinterested forum in which they can be heard and whose decisions bind the host.  The other provisions of BITs offer substantive protections such as national treatment, most favored nation treatment, free transfer of assets, and a prohibition on performance requirements.  Finally, not to be forgotten is the fact that BITs reproduce the Hull Rule’s requirement of prompt, adequate, and effective compensation for expropriation, including “expropriations” that fall short of a direct taking.
V.  	The Dynamic Inconsistency Problem
A.  	The Basic Problem
	When two parties enter into a contract in a domestic setting, we expect them to negotiate, subject to transaction costs, the most efficient possible agreement.  When a potential investor enters into an agreement with a host nation, however, the two will not generally arrive at the most efficient agreement.  The parties are unable to reach the optimal agreement because of the unusual nature of their relationship and the dual roles played by the host country.  The host country is not merely one of the contracting parties, but is also able, through legislation, to establish and change the legal rules under which the investor must operate.  Domestic legal structures, critical to the bargain struck between two private parties under domestic law, are no longer adequate.  The central problem is that a sovereign state is not able to bind itself to a particular set of legal rules when it negotiates with a prospective investor.  Regardless of the assurances given by the host prior to the investment and, importantly, regardless of the intention of the host at the time, if it later feels that the existing rules are less favorable to its interests than they could be, it can change them.  It can also unilaterally change the terms of whatever agreement may have been negotiated with the investor.  In a private setting there is relatively little risk that the legal rules will be changed in order to favor one party to the transaction because the government has little incentive to change the laws to suit one party to a contract.  In the foreign investment context, however, the host government is a direct participant and has interests and objectives of its own that may conflict with those of the investor.
	Because the host may decide to change the domestic laws to suit their own purposes, the investor cannot rely on those laws to protect his interests.  The only alternative legal structure is international law.  Unlike domestic law, the host cannot change the requirements of international law in order to suit itself.  Unfortunately for both the potential investor and the potential host who wishes to reassure a potential investor, international law does not directly govern the relationship between states and firms.  This is so because international law does not recognize private firms as actors on the international stage, it recognizes only sovereign states.  Because private firms are not recognized by international law, a contract that includes a private party is not recognized under international law.  A potential investor can sign a contract with a host, but there is no remedy under customary international law if that contract is breached.
	That potential hosts and investors cannot sign a binding and enforceable contract under international law explains why the debate over the protections afforded by customary international law was so important.  Until the rise of BITs, there were few constraints, beyond those provided by customary law, on the behavior of host countries toward foreign investors.  If the international community agreed that customary law did not require prompt, adequate, and effective compensation upon the taking of property, there would be no way for investors to achieve these protections.  On the other hand, if  it were accepted that the Hull Rule was international law, there would be no way for developing countries to except their own behavior from the rule -- after all, it is not possible for a country to derogate from customary law.
	Prior to the use of BITs, therefore, neither domestic nor international law offered potential host states the ability to bind themselves to a particular course of conduct vis-a-vis an investor.  The two parties could, of course, sign a contract -- as was often done -- but that contract was recognized only at the domestic level and would, presumably, only be enforceable to the extent that the host country chose to allow it to be enforced.  The investor had no legal protection against the host.
	The lack of a mechanism to allow contracting between firms and states creates a dilemma that is sometimes referred to as a problem of  “dynamic inconsistency.”  Dynamic inconsistency describes situations in which a “future policy decision that forms part of an optimal plan formulated at an initial date is no longer optimal from the viewpoint of a later date, even though no new information has appeared in the meantime.”  In other words, a plan that is optimal at one point in time will not be optimal at some later point.  The problem is akin to wanting to “tie oneself to the mast” but being unable to do so.  A certain strategy may be known to be the preferred one, but once it is undertaken, it will not be possible to stick to the initial plan unless some commitment mechanism has been established.
B.  	Dynamic Inconsistency Applied to Foreign Investment 
	Turning to the particular problem facing foreign direct investment, one must consider how the lack of contracting options affects the incentives of a government in its dealings with a particular foreign investor.  Initially, while negotiations with a firm are taking place, the government of a potential host country, by assumption, wishes to encourage the investor to invest in its country.  The firm, on the other hand, would like to achieve the greatest possible return and will invest in the host country only if that country offers the greatest anticipated profit.  In a domestic law setting, and ignoring transaction costs, we would expect the investor to write a binding contract with the party that offered the most efficient location for its capital.  The agreement would spell out the conditions on which the investment would take place and would provide for some division of the “surplus” (i.e., profit) from the investment between the investor and the host.  This division of surplus need not be stated explicitly, but could take the form of concessions and commitments on the part of each party.  For example, the host may agree to offer certain tax advantages to the investor, it may agree to allow the repatriation of profits and it may waive certain import restrictions that are in place in the country.  The firm, on the other hand, will provide benefits to the country in the form of employment, technology transfers, and so on.  The firm might also agree to a set of conditions on its behavior.  It might reinvest a certain percentage of profits in the business, may agree to certain labor and environmental standards, and may offer to provide some services to the community in which it is located.
	In the absence of a contractual mechanism, however, it is not possible to write such a contract.  This makes the investment problem much more difficult.  Even if an investment is valuable enough to make it worthwhile for the country to commit to some form of concessions to benefit the investor -- favorable tax treatment, for example -- it cannot do so.  The host country can do no more than make non-binding promises to the potential investor.  If the investment takes place, it will be based on these promises and nothing more.
	Once the firm has sunk its capital into the investment, the relationship between the parties undergoes a dramatic transformation.  The host country, in particular, faces an entirely different set of incentives.  It no longer needs to offer benefits sufficient to attract the investment, it only has to treat the investor well enough to keep the investment.  The difference between the two time periods (before and after investment) comes about because both the host and the investor know that once the firm has made its investment, it typically cannot disinvest fully.  In other words, once it has invested, withdrawal would impose a cost on the firm.  The host country can take advantage of this situation, and extract additional value from the firm by, for example, increasing the tax rate beyond the level that was agreed upon when the investment took place.  Had the firm known that the tax rate would be higher than the agreed upon level, it may have chosen to invest elsewhere, or not to have invested at all.  Once the investment is made, however, it may be cheaper for the firm to simply pay the higher tax rather than attempting to disinvest in order to reinvest in a different country.
	To illustrate this point, consider the following simple numerical example.  Suppose that a firm is considering investing in one of two potential host countries.  Assume that the investment will cost $60 million for the initial investment and $10 million after that in order to pay for salaries, upkeep, and so on, regardless of which country is chosen.  In an effort to attract the investment, the potential hosts negotiate with the firm.  Assume further that the firm eventually decides to invest in one of the two countries and that it has succeeded in extracting from that country a promise of a complete exemption from corporate taxes, and preferential access to power and water in the region in which it intends to build its facility.  Suppose that, with these concessions, the investment is expected, to yield revenues of $100 million.  The host has agreed to these terms because even without any tax revenues, and despite the disruption the investment may cause to the power and water supply, the gain  in terms of employment, technology transfer, and so on makes the investment beneficial to the host.  Under these assumptions, the host and the investor would be willing to sign a binding agreement committing themselves to the terms stated above.  Because no such agreement is available, however, the host can change the conditions at any time.  Consider the incentives of the host once the facility is built at a cost of $60 million.  At this point, the firm anticipates a return of $100 million, and will have to spend only $10 million in additional expenses.  Because the host is not bound by its agreement with the firm, however, it can alter the terms of their agreement unilaterally.  For example, it can withdraw the promise of preferential access to water and power and it can impose a tax on the revenues of the firm.  For concreteness, suppose that it imposes a tax of 40% on revenues.  Rather than making $100 million in revenues, therefore, the firm may only make, say, $85 million due to the loss of access to power and water.  Furthermore, 40% of this amount will be claimed by the tax authority -- making the after-tax revenue only $51 million.
	Now, consider the reaction of the firm.  Obviously, had it known that the host would behave in this way it never would have invested.  The total cost of the investment was $70 million and it will earn only $51 million in revenues.  Once the facility is built, however, we assume that the firm cannot recoup its investment by tearing it down, or even by selling it.  It has two choices.  It can continue with its plan to operate the facility and suffer a loss of $19 million, or it can close down the operation altogether and lose the $60 million that has already been invested.  Obviously, the firm will choose to operate the facility in order to minimize its loses.
	The problem is even worse than the above example suggests, however, because the host can impose any level of tax (or other mechanism to take value from the firm) it chooses.  In the above example, the host can levy taxes of up to $75 million.  Any tax of less than this amount will leave the firm with some return on its investment, which will be preferred by the firm to a return of zero.  Most importantly, the host can assess the firm’s situation and select the maximum possible transfer of value that the government can demand without driving the firm out of the country altogether.
	As an aside, note that changing the tax rate is not the only method through which the host can extract value.  Once the investment is sunk, the host has a range of options from which to choose in order to maximize its own benefit from the investment.  It can, obviously, abide by the non-binding promises it made, in which case it will receive the benefits to which it implicitly agreed when it negotiated prior to the investment.  At the other extreme, it could simply expropriate the investment of the firm entirely and attempt to run the enterprise itself.  Under this scenario, the country would receive the benefit of running the business itself, including all the profits it could generate, as well as the benefits that the firm had agreed to provide.
There are two categories of costs facing a country that chooses to expropriate outright.  The first is that the government (or the private parties to whom the government gives or sells the enterprise) may be much less able to run the facility than was the original firm.  After all, when the assets are expropriated, the managers will depart, taking a substantial amount of human capital with them.  It is unlikely that the host government will be able to run the business as well as the investors who built the facility.  This will impact on both the profits that the enterprise will generate (if any) and the level of spillover benefits that will be provided (employment, technology transfer, etc).  A second cost is the international cost that the action will entail.  The firm whose assets have been taken will undoubtedly complain to its home country, and that country may take action.  Indeed, if the expropriation is severe enough, even countries whose nationals have not been affected may sanction the host country.  In addition, the expropriation will be noticed by other firms who, as a result, may be hesitant to invest in the future.
	An intermediate course of action for the host is to attempt to squeeze more value out of the firm, while allowing the firm sufficient revenue to ensure that it does not attempt to disinvest.  This can be done in a wide variety of ways, including changing the tax rate, restricting the repatriation of profits, imposing new labor or local content requirements, and so on.  This approach, which is sometimes called “creeping expropriation,” allows the country to take advantage of the existing management and their skills, thus avoiding the major costs of an outright expropriation, while still extracting value from the enterprise.  Because the assets have not been seized, and because it is difficult to identify where the right of a government to set policy crosses over into unreasonable conduct, it is also much less likely that this sort of action will provoke significant sanctions by the home country of the investor.  It also leaves the enterprise in the hands of the investor who will typically be the best able to run the firm.  It may, therefore, be preferred to outright expropriation.  It is worth noting that the attractiveness of this final option may offer a partial explanation of why outright expropriation is now uncommon, and why dispute settlement between host countries and foreign investors is a topic of some import.
	The “intermediate” option of extracting value without expropriation is the most relevant for the study of current foreign investment.  Outright expropriations are now very rare, but disputes between foreign investors and host countries are common.  Any allegation of wrongdoing made by the investor must turn on the notion that the host has breached some part of the implicit or explicit agreement under which the firm made its initial investment.
	For any irreversible investment, then, the host country will be able to demand a higher payment after the investment takes place than it could have demanded prior to the moment when the capital was invested.  This is so because the investor will invest only if it expects to receive revenues that are greater in present value terms than its total costs.  Prior to the investment, total costs include both those costs that are irretrievable once the investment is made and all other costs.  Once the investment has been made, however, the investor will not include the sunk (irretrievable) costs in its calculation because those funds are lost regardless of the decision.  Once the investment is made, therefore, it is possible to extract at least up to the value of the sunk costs without making it profitable for the firm to withdraw.
	When the firm and the potential host begin negotiations regarding a potential investment, the firm is, of course, aware of the dynamic inconsistency problem.  As a result, it may be very hesitant to invest, and, indeed, may simply choose not to do so.  The potential host country, on the other hand, wants the investment and rather than have the investor decide against investing, would be willing to bind itself in some way to behavior that will encourage the investment.  Because there is no contracting mechanism available, however, the host no longer has any reason to keep its promises once the investment is made.  It can extract value from the firm as discussed above.
	Given the above, one may ask why there is any direct foreign investment, and why the investment that takes place is often treated very well.  The reason is that the above description is based on a single investment decision.  In reality, countries want to maximize their returns over longer horizons.  They may resist the temptation to seize assets today in order to create or maintain a reputation for treating investment well.  In this way, it is more likely that future investment will be attracted.  They may also resist the temptation to extract value from the firm if they fear that sanctions will be imposed by the home country of the investor.   The repeated nature of the investment decision changes the incentives of the host country.  It does not, however, completely remove the dynamic inconsistency problem.  When the host country considers the reputational effect of its actions, it must weigh the gains from breaching its contract with the firm against any lost benefits due to reduced efficiency within the firm, the cost of any sanctions by other countries and the effect of the action on its reputation.  A priori, there is no reason to think that this balancing establishes an efficient set of incentives for the host.  Potential investors are likely to still be wary of foreign investments because they lack the protections offered by domestic law.
	The above discussion considers some of the impact of the dynamic inconsistency problem on the host country.  We now consider its effect from a global perspective.  In global terms, the efficient outcome is achieved if investment takes place where it will earn the greatest total return.  We know that, absent transaction costs, this outcome is achieved when the parties are able to contract with one another and when a breach of contract is accompanied by expectation damages.  There is no reason to think that the situation described above approximates this globally efficient outcome.  The dynamic inconsistency problem will discourage investment that would be desirable because the firm realizes that the host will squeeze additional value from the firm after the investment is made -- causing the firm to avoid certain investments altogether.  Furthermore, in cases in which the host is considering expropriation, it does not face expectation damages.  Instead, it faces the combination of lost future investment, and sanctions from foreign countries.  There is no reason to think that these sanctions are similar to expectation damages -- implying that the decision to breach the contract with the investor will not be made efficiently.
VI.  	Explaining the Paradoxical Behavior of LDCs
	As discussed in Part III, the behavior of developing states presents an apparent inconsistency.  On the one hand, they have repeatedly sought to establish a norm that leaves significant power in the hands of the sovereign state in its relations with investors, makes it impossible for states to enter into binding contracts with foreign investors and, therefore, leaves the dynamic inconsistency problem unresolved.  On the other hand, developing countries have willingly and, indeed, enthusiastically, signed BITs with developed countries.  These bilateral treaties effectively undermine precisely the independence and control that the countries have fought hard to protect.  In this section, we will consider and reject the possibility that developing countries have simply changed their views on the subject or that they use customary international law as a bargaining chip to extract more in the negotiation of BITs.  We will then consider another possibility -- that LDCs face a prisoner’s dilemma in which it is optimal for them, as a group, to reject the Hull Rule, but in which each individual LDC is better off “cheating” and agreeing to prompt, adequate, and effective repayment.  Indeed, it will be argued that each individual LDC is motivated to accept conditions that offer investors much more protection than does the Hull Rule.
A.  	Have Developing Countries Changed Their Position?
	One possible explanation of the behavior of LDCs is that they have come to conclude that they will be better off if they allow themselves to be bound through a contractual mechanism with investors.  These countries may have simply come to conclude that the dynamic inconsistency problem is sufficiently severe that the loss of sovereignty implicit in BITs is worthwhile in order to capture the benefits of foreign investment.
	This theory is unsatisfactory for at least two reasons.  First, the existence of BITs has overlapped considerably with efforts of LDCs to discredit the Hull Rule.  The first BIT was signed in 1959, when West Germany established a treaty with Pakistan.  By the mid-1970s, West Germany had concluded over forty bilateral investment treaties.  The major efforts to undermine the Hull Rule at the multilateral level took place during the 1960s and 1970s.  In other words, during the very period when the General Assembly was voting in support of the sovereignty approach, large numbers of developing countries were prepared to sign bilateral treaties, and many of them had already signed such treaties.  If developing countries had changed their views on the value of commitment mechanisms and binding agreements, we would expect BITs to appear only sometime after the General Assembly voted 109 to 1 in favor of the 1973 Resolution on Permanent Sovereignty over Natural Resources, and after the adoption of the New International Economic Order and the Charter of Economic Rights and Duties.  Nor can it be argued that the countries signing BITs and those fighting against the Hull Rule are different subsets of countries.  Both the movement against the Hull Rule and the BIT movement have included a majority of developing countries.
	Furthermore, had developing countries decided, as a group, that it served their interest to provide greater protections for foreign investors, they could have adopted additional General Assembly Resolutions or signed multilateral agreements to that effect.  They have done neither.
B.  	Other possibilities
	Before presenting what I believe to be the most promising explanation for the paradoxical behavior of developing countries, two other possible explanations are considered.
	Consider first the view of Sornarajah, who argues that developing countries, after successfully tearing down the Hull Rule, adopted BITs in reaction to the confused status of foreign investment and the uncertain protections afforded to it by international law.  “[K]nowing the confused state of the law, [countries] entered into such treaties so that they could clarify the rules that they would apply in case of any disputes which may arise between them.”  Put another way, although a developing “state subscribes to a particular norm of international law, it is prepared to treat the nationals of a state with which it has entered into a bilateral treaty in accordance with the norm which has been agreed to in the treaty.”  Sornarajah views BITs as acceptable because they are the product of negotiations and because they serve to clarify the rules governing international investments.  Implicit is the consent-based argument is the presumption that consensual agreements make it likely that the developing state will do better than it would under the Hull Rule.
	The claim that the treaties are better than the Hull Rule because they are the product of negotiations and based on consent is unsatisfactory.  Even if we leave aside the fact that it is more appropriate to focus on outcomes than on procedures, BITs hardly qualify as paradigmatic examples of negotiations between equally well positioned parties.  Negotiations typically begin with a model treaty, prepared by the developed country, which leaves room for only minor changes on a case-by-case basis.  Furthermore, although the notion of treaty by consent may seem inherently better than rules imposed against the will of developing countries, it appears that BITs actually provide more protection to investment than international law ever has.  In addition, by allowing binding and enforceable contracting between a host government and an investor, BITs give potential investors the ability to use their significant bargaining power prior to investment in order to extract value from the potential host.  Finally, with respect to the claim that BITs bring desirable clarity to investment regulation, it is difficult to understand why LDCs would undermine the Hull Rule -- which provided a clear rule regarding the protection of foreign investment -- only to adopt BITs in order avoid the legal ambiguity generated by the demise of the Hull Rule.
	Rudolf Dozer advances a slightly different explanation.  He claims that developing countries are prepared to accept the Hull Rule in the context of BITs because of the “special benefits that developing countries enjoy under such treaties.”  This view, like Sornarajah’s, is difficult to reconcile with the content of most bilateral treaties.  There is little in such treaties that inures to the benefit of the host countries.
C.  	A Strategic Analysis of LDC Behavior
LDC behavior can best be understood through a strategic analysis of the incentives facing developing countries individually and as a group.  In order to explain the apparent paradox of the struggle against the Hull Rule as customary international law and the simultaneous embracing of BITs that mandate even stricter investment protections, one must realize that developing countries have different interests when they behave as a group than they do when they behave individually.  In other words, the decision of individual countries to sign bilateral agreements is not a sign that these agreements are in the interest of LDCs as a group.  In order to demonstrate why this is so, this section compares the effect of a regime governed by a network of BITs and one governed by the Charter of Economic Rights and Duties.  It first considers the efficiency implications of each regime, and then examines the impact of each regime on the distribution of the gains from investment.
1.  	Efficiency considerations
a)	BITs
	Under most BIT arrangements, contracts between investors and host countries are binding on the later at the international level.  Failure to respect the terms of the agreement is a violation of the bilateral investment treaty and, as such, a violation of international law.  If such a violation occurs, the treaty gives the investor the right to pursue a remedy through arbitration by an international tribunal.  Assuming that the international tribunal grants relief similar to that which would be granted by a court in a domestic dispute (recall the BIT typically requires prompt, adequate and effective compensation for any “expropriation” which, because of the broad definition of investment, includes the breach of the terms of an agreement), the BIT regime will generate an incentive scheme that is reasonably efficient.
	More important than the measurement of damages, however, is the fact that the BIT framework, by providing a binding contractual mechanism, allows the parties to avoid the dynamic inconsistency problem.  Because the investor has access to an impartial dispute settlement mechanism that is capable of ensuring compliance by the host, the investor can be confident that any agreement made by the host will be honored.  In essence, the treaty establishes a framework that resembles a domestic legal system -- contracting is possible and contracts will be upheld and enforced by a court.  As a result, the cost of investing is reduced, and investment in developing countries is more attractive.  As a result, BITs provide an efficient regulatory scheme for foreign direct investment decisions.
Consider the incentives facing an individual developing country.  Assume, for the moment, that the market for the resources of that countries (raw materials, labor, governmental regulations, location, and so on) is characterized by many sellers and many buyers of the resources.  In such a market, the demand for the “goods and services” of a particular LDC will be highly elastic -- meaning that a small reduction in price will lead to a very large increase in demand.  In the investment context, this implies that a country can, by credibly offering more favorable conditions to potential investors, attract a large increase in investment.  In the context of foreign investment, the change in “price” comes about through a reduction in the conditions imposed on the investor.  Fewer such conditions reduce the cost of investing.  From the perspective of the individual country, this change in “price” will lead to a net gain because the increase in investment will more than make up for the slightly lower level of benefits the country receives from each dollar invested.  For an individual country this is a desirable outcome. A single country, therefore, will find it worthwhile to make the conditions on which it allows foreign investment more favorable to the foreign investor.
Without a BIT, however, the country cannot make credible promises to potential investors.  A country’s desire to attract investment, therefore, will cause it to negotiate and sign BITs.  Specifically, an individual country will find it advantageous to adopt a BIT if the treaty allows it to commit itself to honor agreements made with investors.  An individual country will, therefore, be eager to sign BITs.
	Based on analyses similar to the above discussion, many commentators have concluded that a regime which allows developing countries to contract with investors is preferred to the sort of regime advocated by developing countries in their United Nations Resolutions.  The general thrust of the argument is that a contracting regime increases the number of efficient investments, which in turn leads to greater global wealth and, therefore, is the preferred regime.  Furthermore, many commentators argue that a contracting regime is also in the interest of developing states because it allows them to offer incentives that will increase investment and well-being in their countries.  It is also suggested that, under a regime of binding contractual agreements between hosts and investors, a developing country that does not want to be bound by a negotiated agreement can simply choose not to make such a commitment.  The requirement of consent, the argument goes, ensures that LDCs will be better off.
b)	The Charter of Economic Rights and Duties
	Under the rules of the Charter of Economic Rights and Duties, on the other hand, some degree of inefficiency is introduced.  Recall that under the Charter, the security of an investment would be dependent on the goodwill of the host state.  Investment would not enjoy any protections against actions by the host, except the discipline provided by the market for foreign investment.  While these reputational concerns may provide non-trivial protection in many cases, investors would still have cause to be concerned about expropriation and other, less dramatic, actions by the host state.  That is, the investor would face a dynamic inconsistency problem, as discussed in Section V.
	The host, of course, would share the costs of the dynamic inconsistency problem.  A developing country would not be able to commit itself credibly to respect agreements with investors and would, therefore, have a reduced ability to negotiate with prospective investors in order to attract investment.  This will drive up the cost of investment and cause profitable investments that both the host and the investor wish to undertake to be foregone because they are not rendered unprofitable by the dynamic inconsistency problem.  This is an inefficient result.
	As discussed above, therefore, an individual LDC will be in favor of signing a BIT which allows it to make a credible commitment to a potential investor.  Because, for an individual country, investment is sensitive to the cost of investing, the country can expect benefit from an increase in investment that exceed the costs imposed by the fact that the country can now bind itself to conditions that favor investors.
	This paper does not dispute the fact that global wealth will be maximized under a contracting regime.  It does, however, challenge the notion that developing countries will be better off under such a regime.  By allowing firms and investors to contract with one another, we are not only encouraging efficient projects to take place, we are also affecting the distribution of the benefits from those projects.  Although a regime, like the BIT regime, that allows for binding contracts will maximize global wealth and provide the most efficient investment regulation scheme, an efficiency analysis, by itself, is insufficient to conclude that BITs are preferred over a regime with fewer protections for investors.
2.  	Distributional Considerations
a)	The BIT Regime
	The previous section points out that by allowing contracting prior to the investment, we achieve the efficient outcome.  This is so because as countries compete for investment, the country that offers the firm the greatest return on its investment will be able to attract the investment.  Thus the capital will find itself in the country in which it can earn the largest return – which is the efficient outcome.
	Although the BIT regime leads to a larger global gain than the Charter regime, it is likely to offer developing countries, as a group, a lower level of welfare.  For the host county, the competition to attract investment – competition that is possible because BITS allow the host to make binding commitments -- is welfare reducing.  Imagine two or more countries competing to attract a potential investor.  Each country will make concessions to the potential investor, and is able to do so through a BIT.  A country whose offer is insufficient to attract the investment has an incentive to increase the concessions it offers as long as the benefits of the investment for the country exceed the costs of attracting it.  The result, therefore, is a bidding up of the concessions made to the investor.  Ultimately, if the market for the resources of the developing countries is competitive, potential hosts will bid against one another until the benefit enjoyed by the host due to the investment is zero.  Only then will it be impossible for the country that stands to “lose” the investment to offer the firm a more attractive package while still profiting from the investment.  Once the incentives for the firm have been bid up to the point where the country stands to make no net gain from the investment, the firm does not have to share any of the surplus with the host and can, therefore, simply choose the location that offers the highest overall return.
	The distributional impact of this bidding contest is dramatic.  The country that receives the investment will have won the competition to attract the capital, but will gain little from its victory.  The benefits to the country generated by the investment (in the form of employment, technology transfers, tax revenues, and so on) will be offset by the incentives and concessions that were needed to attract the firm (tax breaks, reduced pollution and employment regulations, and so on).  In other words, like in any competitive market, the seller – here the host country – receives no economic profit.  The entire profit is enjoyed by the investor.
	Taking into account the behavior of all countries, then, potential host countries who have signed BITs will bid down the conditions on which they allow investment in an attempt to attract as much investment as possible.  Ultimately, the price paid may be bid down to the point where countries are indifferent between having the investment and not having it.  Due to the competitive nature of the market, the benefits of investment will all go to the investor, leaving no surplus for the host.
	Despite the fact that individual countries want to sign BITs, as demonstrated in section VI.C.1.a, therefore, LDCs as a group will be better off if they are unable to contract with investors and are, therefore, unable to offer, in a binding way, concessions to investors in for investment conditions.  To see why this is so, it is important to recognize two things.  First, every potential host faces the same incentives and will try to make itself a more desirable location for foreign investment, relative to every other country.  Second, developing countries as a group will be competing for a limited pool of investment.  It is true that reducing the cost of investment in all LDCs simultaneously will stimulate some additional investment.  Individual countries, however, are also driven to offer more attractive conditions to investors in order to attract investment away from one another.  Because the shift of investment from one country to the other is not a gain for LDCs as a group, any policy changes designed to compete for existing investment dollars reduces the overall welfare of developing countries -- some benefit is lost because the host country gets less from the investment, and nothing is gained because the policy affects only the distribution of investment. 
b)	The Regime of the Charter of Economic Rights and Duties
	Consider the example of two countries competing for a potential investor, as discussed above.  Assume, however, that there is no way for either country to make a binding commitment to the investor.  That is, there is no BIT in place in either country.  Although the investor cannot obtain any guarantees, he may still decide to invest.  After all, the countries in question have reputational concerns that encourage them to treat investment well, and the investor can also take steps to protect itself.  For example, the investor might enter into a joint partnership with the host so that the host has a strong incentive to let the investor maximize profits; the investor might place a few critical operations abroad so that if the investment is seized the host will stand to gain very little; and the investor might demand a signed agreement which, although not binding under international law, may cause the host international embarrassment if it treats the investment poorly.
	Most importantly, the investor may choose to invest without any binding commitments from the host country because LDCs offer advantages that are unavailable in the investor’s home country (e.g., low labor costs, favorable environmental or labor laws, locational advantages, natural resources, and so on).  The risk that the host will attempt to seize value from the investor can be thought of as a random tax.  The investor knows that he may or may not be subject to this tax.  He will invest despite this risk if the benefits are sufficiently large.
	If the investment takes place despite the absence of a BIT, whichever country receives the investment will then be able to extract some value from the investor.  The amount of value extracted will depend on the reputational concerns of the country and the value that can be extracted from the firm.  As a result, the host will gain much more than it would in a world of BITs.
	The critical difference between the individual country analysis and the group analysis is the sensitivity of investment to the cost of investing.  For a single country, it is reasonable to assume that the foreign investment decisions regarding investment in that country are relatively sensitive to the cost of investing (i.e., the elasticity of demand is sufficiently high).  The absence of a contracting regime will increase the cost of investment to potential investors and, all else equal, will reduce the amount of investment significantly.  The increased cost of investing prompted by the dynamic inconsistency problem leads to a large reduction in the total amount of foreign investment because the potential investor can invest in a different developing country that offers similar advantages and that has a contracting regime through, a BIT.  The investment that would otherwise have been made in the country will simply move to a different developing country that can make a binding agreement.  Because investment levels in a single country will be higher if it is possible to offer the investor more protections, being able to agree to a binding contract would be useful for the individual country.  The potential host would avoid the dynamic inconsistency problem by committing not to extract additional value after the investment takes place.
	For developing countries as a group, however, the sensitivity of investment demand is likely to be much lower.  Consider a particular firm that is considering an investment in a developing country.  If the cost of investment rises in one country, it is likely that the firm could find another country that also meets its needs.  On the other hand, if the cost of investment rises in all developing countries, the firm must either invest despite the increased cost or abandon its intention to invest in a developing country.  Because the advantages offered by one developing country are much more likely to be found in another developing country than in a developed country, the firm is much more likely to invest in a developing country despite such an increase in the cost of investment.  In other words, investment will be much less sensitive to the cost of investing (i.e., the elasticity of investment will be lower) when we consider LDCs as a group rather than individually.
	Because investment decisions, with respect to investment in LDCs as a group, are relatively inelastic -- meaning that a change in price leads to only a small change in the amount invested -- a large amount of foreign investment will take place even in the absence of a binding contractual regime between host governments and firms.  That is, although the ability to contract might attract some additional investment, the difference between the amount invested under a contracting regime as compared to a non-contracting regime would be small.
	Consider the implications of price-insensitive investment for the interests of capital importing states.  If capital importers, as a group, can implement a system under which contracts between investors and host governments are not recognized under international law, it becomes impossible for any single country to overcome the dynamic inconsistency problem.  In other words, one country cannot bid against another country in order to attract foreign investment.  Offering more attractive terms to investors would be futile in such a world because both the potential host and the potential investor know that those offers are not binding and, therefore, not credible.  Regardless of the agreement that might be reached between an investor and the host state, once the investment is in place, the host can abrogate the agreement and impose whatever conditions it chooses, including expropriation, as long as it pays “appropriate” compensation.  The dynamic inconsistency problem will increase the expected cost of investment, and will, therefore, deter some investors.  Given the assumption that investment decisions are not price sensitive, however, there will be only a modest reduction in investment relative to a contracting regime.
	Once an investment is made, the firm and the host state face one another in a new negotiating posture.  The host has the power to unilaterally change the conditions under which the firm operates and the firm’s only defenses are the ability to stop operations and pull out of the country and the reputational concerns of the host.  It would, therefore, be possible for the host to extract considerable surplus from the firm through increased tax rates, restrictions on the repatriation of profits, domestic content regulations, and so on.  LDCs, therefore, are better off.  Although there may be a small reduction in total investment, developing countries will gain much more from each dollar of foreign investment that does take place. 
3.  	Understanding the Results of the Analysis
	We can represent the above discussion as follows.  Under a contracting regime, the firm seeks “bids” from countries that hope to attract its investment.  It then chooses a bid and signs a binding contract with the country that has made that bid.  Only then does it invest, by which time the host is bound to the contract.  In this way, potential host countries must bid against one another and can be expected to bid down the “price” of their resources to the point at which they earn zero profit.
	Under a regime without contracting, however, the order of events is different.  The firm must first commit itself to a particular country by investing.  Only then does the country choose the conditions under which it will allow the firm to operate.  The host faces some constraints.  It must provide the protections to which investment is entitled under international law, it must not impose conditions that are so arduous that the investor will prefer to pull out rather than continuing to operate its business, and it must consider the effect of its actions on its reputation and on future investors.  Despite these constraints on its choice of conditions, the host is in a much better position under the no-contract case than it is under the contract case.
	Even if there is less investment under the no-contract case, capital importing countries may still be better off because they capture a larger fraction of the gains from the investment.  Of course, any individual country would prefer to be able to offer a contract to potential investors because it could then attract much more investment at the expense of other capital importing countries.  Capital importing countries as a group, however, would be worse off if contracting were allowed.
	An alternative way to understand the above discussion is to recognize that the presence or absence of binding contracts changes the competitiveness of the market.  If there are binding contracts, every potential host country must compete for the investment -- leading to the competitive result and zero profit for the “seller.”  A country that does not offer competitive conditions will receive no investment.  Without contracts, however, there is no competition.  The investor’s demand for the resources of LDCs as a whole is likely to be inelastic since LDCs offer a set of resources that are very different from those offered by developed countries, implying that the total amount of investment will be similar to the amount that would exist under a contracting regime.  The host is in the position of a monopolist and can extract monopoly rents.
	The host is able to extract rents because, once the investment is made, the host is in the position of a monopolist.  It can choose to set the “price” for its resources at the level that maximizes its own return.  The basic theory of monopoly pricing teaches that a monopolist will set a price that is above the competitive price in order to extract monopoly rents.  The result, of course, is a reduction in the demand for the resources, a loss to the buyer (here, the investor), and increased profits.  Overall, there is a net loss, referred to as a “deadweight loss.”  In this context, the host will demand more value from the investor than it would in a competitive environment.  Thus, to the extent potential hosts compete against one another for investment, and to the extent this leads to a competitive markets for the resources offered by potential hosts, it should be expected that hosts will seek to extract value from the firm after the investment takes place.  Because the investor has made an irreversible investment, it cannot easily withdraw from the country -- making its demand for those resources very inelastic indeed.
D.  	Understanding the Results of the Analysis
	The above discussion offers considerable insight into the behavior of developing countries with respect to the United Nations Resolutions and BITs.  Within the United Nations, developing countries are able to cooperate and pursue an international legal structure that prevents contracting between firms and states and that provides only minimal protection to investment.  Cooperation in this forum is easy because the General Assembly acts as a single body, and there is nothing to be gained by refusing to cooperate.  The General Assembly, therefore, provided capital importing countries with an excellent forum in which to advocate for the dismantling of the Hull Rule and the “adoption” of a much more lenient rule with respect to expropriation and other conflicts between investors and host countries.
	If such a regime were to be accepted as international law, it would force investors to invest before the terms of the relationship are specified.  Although individual countries would like to “cheat” by signing contracts with investors prior to the investment, those contracts would be void under international law and, therefore, would not offer investors any additional security.  In other words, cheating would not be possible and LDCs would be able to raise the “price” of access to their resources.
	BITs, however, provide a mechanism through which individual countries can easily “cheat” on this “cartel” of capital importers.  By signing a BIT, the potential host country agrees, in a binding treaty under international law, to refrain from expropriation and to respect any contracts that it signs with investors.  Derogation from such a contract then becomes a violation of the treaty which is, in turn, a violation of international law.  In other words, the contract becomes binding because the BIT elevates a breach of the contract to a violation of international law.  Signing such a treaty is, as already mentioned, in the interest of any single capital importing country, which may explain the popularity of the BIT.  On the other hand, the treaties are harmful to capital importers as a group because it leads to a world in which contracts between firms and host states are binding.  
	The history of BITs and, indeed, of opinions on the protection of foreign investment generally, are consistent with the analysis presented in this section.  First, we note that BITs are bilateral rather than multilateral.  If LDCs supported the principles of compensation that are enumerated in BITs, they could promote them through multilateral efforts, including General Assembly Resolutions, multilateral codes of conduct, and multilateral treaties.  The absence of multilateral efforts is consistent with the theory of strategic behavior presented in this paper.
	It is noteworthy that no two developed country’s have signed BITs with one another.  While it may be true that investors are usually less concerned about expropriation by developed states, these investors nevertheless may have legitimate concerns about the  contractual arrangements and the conditions under which they made their investment.  One explanation for the North-South nature of BITs is the bargaining power of the two sides.  Without a BIT, a particular developing country may enjoy a much lower level of investment.  Investment in a developed country, on the other hand, is much less likely to be sensitive to the presence of such treaties.  Developing countries, therefore, are much more eager to reach an agreement on investment with major capital exporting countries and those countries can, in turn, demand very strong protections for their foreign investors.  This explains the presence of clauses that enforce contracts between a private actor and a sovereign state.
	Finally, we must consider whether or not it is reasonable to assume that investment in developing countries would continue even if LDCs were unable to make binding commitments.  Because the lack of a method for creating binding contracts has the effect of raising the costs of investing, we are asking whether it is reasonable to assume that the demand for the resources of LDCs is relatively insensitive to changes in the cost of investing.  In other words, we are asking whether developing countries, if they behave as a group, have monopolistic power.  If they do not have monopolistic power, potential investors faced with the dynamic inconsistency problem will simply choose to invest in developed countries -- where the risks to the investment may be considered less severe.  The assumption can be justified on at least two grounds.  First, although developing countries and developed countries share certain traits, there are enough identifiable traits of developing countries that are different from those of the developed world to support our assumption.  For example, labor in developing countries is often extremely inexpensive relative to developed countries.  Even the threat of an increase in the wage rate in an LDC may not deter an investor because even if there were a substantial increase in the cost of labor, it would remain below that of the developed world.  Similarly, developing countries have natural resources that do not exist in developed countries, or that are not as abundant.  In addition, the legal and regulatory climate of developing countries may be more advantageous for investors.
	The second reason why the assumption of monopolistic power is reasonable is empirical.  Even before the rise of BITs, firms frequently invested in developing countries.  This demonstrates that even in the presence of the dynamic inconsistency problem, firms were prepared to invest.  That is, firms were prepared to invest even though they knew that the host could extract value from them after they had invested.  This is precisely what is meant by market power -- the investor chooses to invest even though she knows the host will extract more than the initially agreed upon amount.
VII.  	Implications for Welfare Maximization and International Law
A.  	The Welfare Implications of BITs
	The analysis carried out in this paper has several implications for how we should view the regulation of foreign investment and the presence of BITs.  First, consider the implications for efficiency.  There is no question that BITs compare favorably, on efficiency grounds, to either the Charter of Economic Rights and Duties, which does very little to constrain LDC behavior toward foreign investment, and the Hull Rule, which regulates only “expropriation,” leaving open the question of what constitutes expropriation and what rights the firm has when less extreme action is taken by the host.
	Like the Hull Rule, BITs typically provide for prompt, adequate, and effective compensation in the event of expropriation.  The reality of modern foreign investment practices, however, is that full expropriation of the hard assets of an investor is extremely rare.  The more important aspects of BITs is how they treat the overall relationship between investor and host.  This includes the broad scope of activity covered by the BITs definition of investment, the requirement of providing the more favorable of national treatment or most favored nation treatment, the transfer of assets in and out of the country, the prohibition of performance requirements, and perhaps most importantly, binding dispute resolution mechanisms.  These conditions allow a host and a potential investor to negotiate over the terms of the investment, and allow the host to bind itself to a contract.  As with any two contracting parties, if the host and the investor are able to create a binding contract, the result will be an efficient allocation of assets.  
	This binding contractual mechanism of BITs is made possible by the dispute settlement procedures.  To the extent that the damages scheme under BITs is interpreted as “expectation damages,” (as opposed to, say, restitution damages) the efficient outcome is achieved.  Moreover, even if the damage measure is not expectation damages, the BIT regime is more efficient than the Charter of Economic Rights and Duties or the Hull rule because it governs a wide range of issues and not merely expropriation.
	The efficiency of BITs, however, is not the whole story.  Under a network of BITs, relative to the regime of the Charter, the market for the resources of developing countries is competitive, implying a minimal return to the host country.  Under the regime of the Charter, the market for foreign investment and LDC resources would be imperfectly competitive, allowing developing countries (the sellers) to capture a larger share of the rents.  This implies that capital importers are likely to be better off under the regime of the Charter than under the BIT regime.  Indeed, from the point of view of the welfare of developing countries, this paper demonstrates that the best of the three regimes is the Charter, followed by the Hull Rule, which only covers expropriation, and finally, the BIT regime, which allows even more competition among developing countries than does the Hull Rule because it includes a more expansive definition of investment.
	Of course, the increased welfare that developing countries would enjoy under the Charter comes at the expense of investors.  Like any monopolistic behavior, the behavior of host countries under a regime without contracting would lead to a deadweight loss.  That is, the benefits to the host would be smaller than the loss to investors.
	This paper does not advocate either the ever more popular regime of BITs, or the fading regime of the Charter of Economic Rights and Duties.  Rather, it seeks to point out that the distributional issue is relevant.  Without a mechanism to redistribute wealth between countries, the distributional consequences of a particular policy should be considered.  The rise of BITs has reduce the market power held by developing countries which, in turn, reduces the benefit they capture from any particular investment.  For this reason, the BIT regime is likely to have the effect of reducing the overall welfare of developing countries and should not be cheered by those who seek the interests of LDCs.
	On the other hand, there can be no serious doubt that, from a global efficiency perspective, a regime that allows for contracting between host governments and investors is more desirable that a regime in which potential hosts cannot effectively commit to any particular behavior or agreement.
B.  	The Impact of BITs on Customary International Law
	There is ongoing debate about the role of BITs in the establishment of customary international law.  Do these treaties codify an agreed upon set of principles that applies to all countries regardless of whether a country has signed such an agreement or do they merely represent lex specialis as between the parties.  Those who believe the treaties represent the codification and entrenchment of customary principles of international law point to the large number of such treaties and the fact that many nations that claimed to reject the traditional Hull rule standard of compensation have signed BITs.  In other words, the argument is essentially that BITs demonstrate that both developed and developing countries consider the traditional compensation standard to be the relevant standard of international law.
	Other commentators remind us that “the repetition of common clauses in bilateral treaties does not create or support an inference that those clauses express customary law . . . .  To sustain such a claim of custom one would have to show that apart from the treaty itself, the rules in the clauses are considered obligatory.”  It is pointed out by these commentators that developing countries receive benefits in exchange for accepting treaties that include a full compensation standard.  This demonstrates, the argument goes, that BITs are contractual agreements that result from negotiation between countries.  A related argument is that BITs have flourished because of “the uncertainty that pervades international investment law since the advent of the developing countries on the international scene.”
	The analysis of this paper implies that the popularity of BITs should not be taken as evidence in support of customary international law.  Indeed, it suggests that BITs have come about because developing countries successfully challenged the Hull standard.  Once the standard of full compensation was undermined, developing states, as a group were better off.  The absence of international law protecting investors and the refusal of international law to recognize and uphold agreements between host countries and investors would have allowed developing states to enjoy monopoly profits in the sale of their resources to investors.  It is, however, in the interest of individual LDCs to gain a competitive advantage vis-a-vis other LDCs by signing BITs.  Developed states have, thus, regained the protections of the Hull Rule and, indeed, much more protection than that rule of customary law provided, through the establishment of BITs.  That is, by negotiating bilaterally, they have established a web of treaties that establishes international law to protect investors.  Increasing numbers of developing states have accepted BITs out of economic necessity.  The bilateral nature of the treaties drives these countries to compete for foreign investment and confers an advantage in that competition to those countries that have signed a BIT.  BITs, therefore, rather than representing the codification of  customary law, are actually a derogation from it -- the existence of BITs should be taken as evidence that there is no customary law guaranteeing prompt, adequate and effective compensation.
VIII.  	Conclusion
	Bilateral investment treaties have become the dominant vehicle through which North-South investment is protected from host country behavior.  Because these treaties allow investors and hosts to establish binding and enforceable contracts, there is little doubt that BITs increase the efficiency and reduce the cost of foreign investment.  In particular, the treaties solve the dynamic inconsistency problem by permitting the host state to bind itself to a particular course of action before the investment takes place.
	This paper has shown, however, that there is more to the story.  First, the enthusiasm of LDCs to sign BITs appears to be inconsistent with the attempts by developing countries to reduce the obligations of host states toward investors.  This paradox is explained, however, when one recognizes that the welfare of individual developing states may be in conflict with the welfare of developing states as a group.  An individual country will almost certainly be better off, all else equal, if it is able to negotiate and agree to a binding and enforceable contract with potential investors.  The ability to do so will make the country a much more attractive location for investment and, accordingly, is likely to lead to a greater inflow of FDI.
	The benefits to such a country, however, will come in large part from a shift in investment toward itself and away from another developing country.  This will be the case if investment flows to developing countries, as a group, are relatively insensitive to changes in the costs of investment.  The investment flows from one LDC to another will not, of course, enhance the welfare of developing countries as a group.
	If, rather than competing against one another to attract investment, however, developing countries could force potential investors to commit to investing in a particular country before the host and the investor settled the terms of the investment, developing countries could extract much more from foreign investors.  This latter situation is what exists if neither the Hull Rule nor BITs govern investment.  If investors have very few protections, the host can wait until an investment is made and, at that point, increase the costs to the investor.  Just as a monopolist increases the price and reduces the quantity of goods sold in order to maximize profits, host countries under the Charter of Economic Rights and Duties can increase the costs to investors and maximizes the gains to the host country.
	This strategic analysis of the behavior of developing countries explains why they support the Charter of Economic Rights and Duties -- a collective action which allows them to maximize their profits as a group -- and, contemporaneously, sign BITs -- an individual action which gives a signatory an advantage relative to other developing countries.  It also allows us to assess the welfare implications of BITs.  There is little doubt that BITs increase the overall efficiency of foreign investment, but they appear to do so at the cost of reducing the gains to developing countries.  Whether this is a desirable trade off is beyond the scope of this paper.
	Finally, the analysis herein suggests a strong argument against viewing BITs as evidence of customary law.  Developing countries sign these treaties in order to gain an advantage in the competition for investment.  They do not appear to do so out of a sense of legal obligation, as is required to establish customary law.