Does International Commercial Arbitration Promote Foreign Direct Investment?

Abstract

This paper explores the role that international commercial arbitration plays in facilitating foreign direct investment (FDI). International commercial arbitration is a system of private commercial law that enables firms to more effectively enforce contracts by allowing them to avoid inefficiencies that arise from domestic courts. As a result, access to international arbitration should foster FDI. To explain the effect of international arbitration on FDI, this paper develops a model to explain the use and effect of resolving international disputes through arbitration. The predictions of the model are tested empirically in a gravity framework. The results of this analysis suggest that access to arbitration leads to an increase in FDI flows. This increase largely occurs through a change in the volume of investment, with a much smaller effect on the number of investment projects. The effect of arbitration is greater for countries with weaker institutions and for larger projects.