When multinational companies invest billions of dollars in emerging economies, they expect their investments to be protected. Governments in these countries, eager to attract foreign capital for economic growth, often promise stable regulations and fair treatment. Yet despite these assurances, we're witnessing a surge in legal disputes between foreign investors and host governments worldwide.
In my new paper, “Institutional quality and investment disputes in emerging and frontier economies” (International Business Review, 2025), I examine 40 emerging and frontier economies over 13 years. This comprehensive study reveals a surprising paradox: while stronger institutions generally reduce investment disputes, the relationship is more complex than policymakers and investors might expect.
Since the late 1980s, international investment agreements designed to protect foreign investors have proliferated rapidly. These treaties grant extensive rights to foreign companies while placing significant obligations on host nations. Paradoxically, as these protections have expanded, so have the disputes.
Between 2008 and 2020 alone, the 40 emerging economies studied faced over 1,000 investor-state disputes. Most common complaints include contractual violations, expropriation, regulatory changes, and unfair taxation—exactly the issues these investment treaties were meant to prevent.
When Good Governance Works
While the world has experienced a rise in investment disputes, this research confirms that countries with better regulatory quality, stronger rule of law, efficient legal systems, and lower expropriation risks do experience fewer disputes. The effects are substantial—a one-unit improvement in regulatory quality, for instance, is associated with significantly fewer legal challenges from foreign investors.
This makes intuitive sense. When countries maintain consistent, transparent regulations and reliable legal frameworks, foreign companies are more likely to resolve conflicts through domestic channels rather than pursuing costly international arbitration. Predictable rules reduce uncertainty, while efficient courts can address grievances before they escalate into major disputes.
The Property Rights Paradox
However, the study uncovered a counterintuitive finding that challenges conventional wisdom: stronger property rights protection can actually be associated with more frequent disputes, at least initially.
This paradox reflects a common challenge in developing countries—the gap between formal laws and their practical implementation. When governments establish robust property rights on paper but lack the enforcement mechanisms to uphold them consistently, they may inadvertently create clearer grounds for legal challenges when violations occur.
Think of it this way: if property rights are poorly defined, investors may have difficulty proving violations. But when rights are well-defined yet poorly enforced, investors have both clear standards to point to and legitimate grounds for complaint when those standards aren't met.
The Double-Edged Sword of Investment Treaties
Perhaps most revealing is the study's finding about international investment agreements themselves. Countries with more of these protective treaties experience significantly more disputes—about 5% more for each additional agreement.
This finding exposes the fundamental tension at the heart of modern investment policy. These agreements serve a dual purpose: they signal credible commitment to protecting foreign investment, helping attract capital, but they simultaneously provide legal avenues for investors to challenge government actions. More treaties mean more legal options for aggrieved investors.
Keys to Reducing Disputes and Attracting Capital
These insights have important implications for both governments and investors. For emerging economies seeking foreign investment, the message is nuanced. Strong institutions remain crucial for creating stable investment climates, but institutional development must be comprehensive. Formal rules must be matched with effective enforcement capabilities.
The research suggests that regulatory quality and rule of law offer the strongest protection against disputes. Countries might achieve the greatest reduction in legal challenges by focusing first on these institutional foundations, while ensuring that property rights reforms include robust implementation mechanisms.
For multinational companies, the findings underscore the importance of thorough due diligence that goes beyond formal institutional rankings. Companies should assess not just what laws exist on paper, but how consistently they're enforced in practice. The efficiency of domestic legal systems and protection against expropriation remain vital factors in risk assessment.
The Bigger Picture
This research reveals that institutional development in emerging economies is not simply about building stronger formal structures—it's about creating systems that work effectively in practice. The relationship between good governance and investment disputes is more complex than a simple "more institutions equals fewer problems" formula.
As emerging economies continue to compete for foreign capital in an increasingly complex global environment, understanding these dynamics becomes crucial. The goal isn't just to attract investment, but to create sustainable frameworks that benefit both foreign investors and domestic development.
The path forward requires recognizing that institutional development can initially create new challenges even as it solves old ones. Success lies in building comprehensive systems that align formal protections with practical implementation, creating truly stable and predictable investment environments.
In our interconnected global economy, these lessons extend far beyond emerging markets. They remind us that the quality of institutions matters not just for their formal strength, but for how effectively they function in practice—a lesson relevant for any country seeking to balance foreign investment attraction with sovereign regulatory autonomy.
Autor
Strategy and Leadership
Director of PhDs