Rights of establishment are a key component of the US model of international investment agreements. The US also happens to be the only major trade and investment partner which does not have an international investment agreement with China. The International Investment Agreements Program contains a wealth of information on the agreements and policies on this issue for all countries. Individual agreements can be found at their Investment Instruments Online Database.

A reasonable question for policy-makers and analysts to ask is ‘Should countries make binding legal commitments not to engage in this sort of discrimination at the establishment or acquisition phase of investment?’ In contrast to post-establishment investor protections, there is no literature which suggests any theoretical justification for protecting investors in the pre-establishment phase.

The theoretical justification for protections in the post-establishment phase is basically related to the ‘hold-up’ problem. Countries have an incentive to offer good conditions to attract investors, but once they have sunk cost, the host country (if it is myopic or doesn’t care about future investment flows) has an incentive to expropriate the investment. There is no such problem in the pre-investment or establishment phase.

The closest analogy to protecting rights of establishment for investors is ‘binding’ in trade liberalization. Indeed the closeness of this analogy is almost surely why the logic of protecting rights to invest has been so rarely cross-examined.

It is worth considering the theoretical reason for binding trade liberalization agreements. There are two lines of thinking among economists. One line, attributable to Bagwell and Staiger (The Economics of the World Trading System, MIT Press, 2002) is that inefficiency in the absence of binding agreements arises when countries erect tariffs and trade barriers in an attempt to improve their terms-of-trade. Since their trading partners can be expected to do the same, the terms of trade end up much where they would have been to start with, and the economy suffers due to the distortions of the tariffs.

Hence trade agreements can help countries to co-operate to avoid such terms-of-trade altering attempts and thereby mutually improve their welfare.

The other line of thinking is a political economy story. Governments erect trade barriers which harm overall welfare because they are cajoled into doing so by lobby groups. Farmers blockading the streets of Paris are a classic example, but almost every industry in every country seeks to protect itself. According to this theory, governments sign trade agreements in order to protect themselves from these pressures of political economy. The benefits perceived from the trade agreement by export sectors lend the government the political support it needs to be able to lower trade protection for import-competing industries.

It is this political-economy argument for trade agreements which has the most salience for the question of protecting rights of establishment in foreign investment agreements.

The question is: are the Chinese, Australian and American governments rejecting each others’ investors at the expense of their greater national welfare because of pressure from domestic lobby groups? Or are they simply maximizing a national welfare function which includes a preference for domestic ownership in certain industries?

If it is the latter, then economic theory provides no rationale for value in legal protection of rights of establishment for foreign investors.