Is foreign private national debt challenging governance in emerging markets?

Abstract

We study why foreign private national debt is higher in some countries than others by examining its effect on the governance environment in emerging markets. We also questioned whether countries which have ratified bilateral investment treaties have higher debt as a source of external financing than others. Examining the debt capacity of 46 countries from 1993 to 2004, we found that declines in their private debt to international reserve ratios correlate positively with increases in the number of foreign investors-government disputes mediated before international tribunals. As these markets experience financial crises, we calculated a 74% probability that disputes over the property rights of foreign investors are likely to continue. This study uses institutional change theory (North, 1990) where it overlaps with agency and game theory to examine a moral hazard which arises when the government plays the role of a double principal to a contract signed by a foreign investor-agent and governed by its electorate-agent. Gaming behaviour ensues because the government responds to the agent where it can achieve the maximum benefit. The results suggest that governments should strengthen their institutions governing the rule of law prior to contracting with foreign investors.