The Exceptions that Prove the Rule? Revisiting the effectiveness of Capital Controls Under International Investment Agreements

This paper examines how international investment agreements constrain the use and effectiveness of capital controls in emerging and developing economies. Leveraging a novel database on the specific content of investment treaties, I identify those that include "macro-stability exceptions", which allow countries to derogate from their legal obliga-tions in times of crisis. Although theoretical models highlight the effectiveness of capital controls in moderating capital flows, empirical evidence remains inconclusive. I argue that this is partly due to the potential conflict between capital controls and countries' treaty commitments, and to the limited attention given to endogeneity bias in existing stud-ies. To address this identification challenge, I construct two indicators of policy space restriction and flexibility, reflecting the content of countries' investment agreements in force, which I use as instruments for capital controls on outflows. Instrumental Variable (IV) estimates reveal that capital controls have a statistically significant causal effect on sudden stops. However, the direction of the effect differs across investment types. More-over, countries with more restrictive treaty commitments are less likely to deploy capital controls, whereas those with greater policy space due to macro-stability exceptions use controls more extensively.