The Economics of Investor Protection: ISDS versus National Treatment

Investor-state dispute settlements (ISDS) are supposed to protect foreign investors against domestic policies causing “unjustified” harm. This paper scrutinizes the effects of ISDS and national treatment provisions in a two-period model where foreign investment is subject to a hold-up problem. It shows that ISDS may increase welfare, but comes with additional regulatory distortions in the first period. A national treatment provision avoids these regulatory distortions, but implies entry distortions because it makes the hold-up problem also apply to domestic firms. If the domestic regulatory framework applies to many domestic firms, a national treatment provision welfare-dominates ISDS.