Between Commitment and Flexibility: The Fragile Stability of the International Investment Protection Regime

Abstract

This article analyzes international investment protection law by using tools of economic contract theory. Contract theory has been applied to international trade law, but investment law has not yet been analyzed under this methodology. Bilateral Investment Treaties or International Investment Agreements may be interpreted as a mechanism for overcoming commitment problems between investor and host state in order to generate mutual benefits. States thereby trade credibility for sovereignty as international investment law restricts the regulatory conduct of states to an unusual extent, subject to control through compulsory international adjudication. A well-known problem in contract theory is how to deal with uncertainty. Parties cannot easily design contracts that maximize jointly beneficial investments and at the same time respond appropriately to changing conditions ex post. Changing conditions are a prevalent characteristic in investment law covering long term investments. Contract theory finds that too strict and inflexible contracts may impair the joint surplus of the contracting parties. Thus, a trade-off arises between ex ante strong commitment devices on the one hand and flexibility ex post in order to uphold the efficiency of the contract on the other hand. The article analyzes commitment and flexibility mechanism in international investment protection law and proposes to use similar mechanisms to the WTO law in order to design more optimal contracts (that is investment treaties).