The impact of policy uncertainty on foreign direct investment: Micro-evidence from Japan's international investment agreements

Abstract

This study proposes an empirical strategy to identify the impact of policy uncertainty (PU) at the host economy-sector-reservation level on foreign direct investment (FDI) by exploiting sectoral differences in PU before and after the entry into force of international investment agreements (IIAs). These sectoral differences arise because IIAs mitigate PU in host economies, but sectors included in negative lists of IIAs continue to face different degrees of PU owing to exemptions from certain obligations, such as national treatment and the most favored nation in IIAs. Using this empirical strategy, we evaluate how the activities of Japanese multinational enterprises and their foreign affiliates are affected by Japan's 22 IIAs, including bilateral investment treaties and economic partnership agreements with investment provisions, during 1995–2016 at the microdata level. We find that PU regarding a combination of national treatment and most favored nation has a negative impact on FDI. In particular, PU discourages the establishment of new foreign affiliates. However, PU does not necessarily induce affiliates to exit the market.