Protecting foreign investment: implications of a WTO regime and policy options 9781350222014, 9781842771822, 9781842771839

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Tables, figures and boxes

Tables

2.1 Global FDI inflows, by broad host groups, 1991–2000 2.2 Relative importance of FDI and exports as means of market servicing 2.3 Major source countries of technologies in the world, 2000 5.1 Notifications submitted under Article 5.1 of the TRIMs Agreement, by February 2001 5.2 Restrictive business practices by TNCs in developing countries, their possible outcome and TRIMs designed to deal with them 5.3 Incidence of export restrictions imposed by MNEs on their Indian affiliates, 1986–94 5.4 Types of export restrictions imposed by MNEs on their Indian affiliates 5.5 An illustrative list of investment incentives given by industrialized country governments 7.1 Summary of commitments under the GATS made by countries under Mode-4 of supply

8 9 10 88 97 98 98 100 133

Figures

2.1 FDI inflows to industrialized and developing countries in the 1990s 11 2.2 Share of developing countries in global FDI inflows in the 1990s 11 2.3 Share of least developed countries in global FDI inflows in the 1990s 12 Boxes

4.1 Negotiating positions on TRIMs 5.1 Rules of origin imposed by NAFTA and the EU to increase local content: select case studies 6.1 Performance requirements in the draft MAI

72 94 115

Abbreviations

BIPA BIT BOP EC ECOSOC FDI FIAS GATS GATT ICSID ILO LCRs M&As MAI MEA MFI MFN MIGA MIT MNC MNE MVA NAFTA OECD OEM PMFI RBP R&D RIA SME TFP TNC

Bilateral Investment Promotion and Protection Agreement Bilateral Investment Treaty balance of payments European Community Economic and Social Council (of the UN) foreign direct investment Foreign Investment Advisory Service General Agreement on Trade in Services General Agreement on Tariffs and Trade International Convention on the Settlement of Investment Disputes; later the Centre for Settlement of Investment Disputes International Labour Organization local content regulations mergers and acquisitions Multilateral Agreement on Investment Multilateral Environment Agreement multilateral framework on investment most-favoured nation Multilateral Investment Guarantee Agency Multilateral Investment Treaty multinational corporation multinational enterprise manufacturing value-added North American Free Trade Agreement Organisation for Economic Co-operation and Development original equipment manufacturer Possible Multilateral Framework on Investment restrictive business practice research and development regional integration arrangement small and medium enterprises total factor productivity transnational corporation (preferred term in UN parlance

for describing an MNE or MNC; MNE, MNC and TNC have been used interchangeably) TRIMs Trade-Related Investment Measures TRIPs Trade-Related Intellectual Property Rights UNCITRAL UN Centre for International Trade Law UNCTAD UN Conference on Trade and Development UNCTC UN Commission on Transnational Corporations URUruguay Round (of the GATT) VER voluntary export restraint WGTI Working Group on Trade and Investment (of the WTO)

xxi | xi

Preface

The investment issue has emerged as the most contentious in the WTO negotiations. At the Doha Conference of the WTO ministerial meeting in November 2001, the finalization of the draft Declaration was held up because of differences between the developed and developing countries on investment issues, among others. This book explores the extent to which the adoption of a global investment regime in the WTO, if politically feasible, would be welfare enhancing, and in particular whether it would help developing countries to attract investment that fosters their economic and technological development. Developed countries are likely to seek international rules that protect their investors and maximize their freedom to shape their international operations. Developing countries are logically interested in channelling foreign investment in a way that addresses their needs, especially to improve their technological capacity and further their industrialization process. Discussions on investment, even if conducted under the umbrella of the organization dealing with world trade, inevitably involve broader issues and difficult choices. This book examines prior international initiatives on international investment, transfer of technology and regulation of multinational enterprises, and particularly the current WTO rules on trade-related investment measures. It is designed to provide an overview of available evidence on the impact of foreign investment, as well as options with regard to the form and content of a possible multilateral framework on investment. While it may be particularly useful to policy-makers and negotiators in evolving their positions in international fora, we also hope it will stimulate further debates and studies on issues of crucial importance for the international community. We would like to thank our respective institutions for providing support for this enterprise. Kumar has benefited from many discussions on the investment issue with Ambassador K. M. Chandrasekhar, India’s permanent representative at the WTO, Mr S. N. Menon, additional secretary (trade policy), and Dr V. Seshadri, joint secretary (Trade Policy Division) in India’s Ministry of Commerce. He has also benefited from the feedback of participants at his presentations on the subject at FICCI, RIS, a seminar of the SAARC Network of Researchers held in New Delhi in July 2002 and the experts’ meeting of the Like-Minded Group at the WTO headquarters on 24 May

2002. Correa owes a substantial intellectual debt to UNCTAD staff who have worked extensively on this subject. We would like to thank our respective institutions for providing the support to this enterprise. Carlos Correa and Nagesh Kumar

xiii | xiii xii

Chapter one

Introduction

The context and objectives

Foreign direct investment (FDI) emerged as one of the most important aspects of cross-border economic activity over the 1990s. Compared to the total exports of goods and services of the order of US$7.4 trillion in 2001, the sales of affiliates of multinational enterprises (MNEs) totalled $18.5 trillion in 2002, while in 1990 sales of foreign affiliates were only marginally higher than those of global exports. The expansion of FDI inflows generated the belief that the expanded inflows would help in filling up the resource, technology and foreign exchange gaps that constrain the process of development of poorer countries. Governments of developed and developing countries alike competed among themselves to attract more FDI inflows through policy liberalizations and incentives. However, FDI has been concentrated in developed countries and in a few developing countries. In addition, there has been increasing awareness of a wide variation in the quality of FDI. While some investments may bring to host countries valuable developmental gains and other favourable externalities (such as employment generation, diffusion of technology and expansion of exports), others may actually crowd out domestic investments and may be immiserizing. Hence governments have employed various policy measures such as screening mechanisms, performance requirements, incentives for diffusion of knowledge, and so on, to make the operations of foreign investors conform to the development policy goals of the host countries. Recognizing the limitations of national policies and laws in regulating the operations of MNEs, the international community also launched several initiatives aimed at the regulation of different activities and practices of these enterprises. These include the United Nations Code of Conduct on Transnational Corporations, the UNCTAD International Code of Conduct on Transfer of Technology, the Multilaterally Agreed Set of Principles for Control of Restrictive Business Practices, the ILO’s Declaration on Multinational Enterprises and Social Policy and the OECD’s Code on Multinational Enterprises, among others. Given that the bulk of the FDI flows originate in developed countries and developing countries are mostly at the receiving end, there has been a North–South divide on the investment issue. Developed countries have

striven to secure favourable conditions for investment by their enterprises worldwide, by seeking the liberalization of investment regimes through bilateral and multilateral negotiations. They have resisted the attempts of developing countries to evolve binding codes of conduct of MNEs within the UNCTC and UNCTAD framework. Furthermore, they have strategically used the multilateral trade negotiations to create a more favourable framework for FDI worldwide even though investment is more a development issue than a trade issue. Thus, despite the resistance of developing countries, the Final Act of the Uruguay Round of the GATT included an Agreement on Trade-Related Investment Measures (TRIMs). The Agreement requires member countries to phase out performance requirements relating to trade, such as local content requirements and foreign exchange neutrality. The General Agreement on Trade in Services (GATS) provided a framework for liberalization of trade in services including through cross-border commercial presence, which is akin to FDI. The TRIMs Agreement also provided for a review within five years of the operation of the Agreement and to ‘consider whether the Agreement should be complemented with provisions on investment policy and competition policy’. The industrialized countries have made a number of attempts to widen the scope of the multilateral regime on investment beyond what is covered in the Agreements on TRIMs and GATS (viz. commercial presence as a mode of delivery of services). These attempts include an initiative to negotiate a Multilateral Agreement on Investment (MAI) launched in 1995 under the aegis of the OECD, an attempt that failed. Since the First Ministerial Conference of the WTO at Singapore in 1996, the industrialized countries have pushed to bring a more comprehensive agreement on investment than TRIMs on to the WTO agenda. The Singapore Ministerial Conference decided to establish a WTO Working Group on Trade and Investment (WGTI). The Fourth Ministerial Conference of the WTO, held in November 2001 in Doha, resolved to launch negotiations on trade and investment after the Fifth Ministerial Conference, subject to an explicit consensus at that conference. As a result, investment has emerged as one of the most contentious issues in the WTO negotiations. Developing countries fear that a multilateral framework on investment negotiated within the single undertaking of WTO will curtail their ability to regulate the operations of foreign enterprises in tune with their development policy objectives, and hence that it will not serve their interests. They would also like to understand the implications of such a framework for their development more fully  | 

before deciding to undertake negotiations in such a critical area. The developed countries, on the other hand, are persisting in their demand for a multilateral framework, which they see as important for securing ‘transparent, stable and predictable conditions for cross-border investments’. In this context, the Fifth Ministerial Conference of the WTO, scheduled to be held in September 2003 in Cancun, Mexico, is going to be of critical importance. The developing countries will have to debate the various pros and cons of a possible multilateral framework so as to evolve their position for a ministerial conference. They will also have to examine their position on different elements of a multilateral framework, should a negotiating mandate be granted by the Cancun Conference. Against this backdrop, this book discusses various issues concerning the involvement of the WTO in the area of investment, overviews the literature on the developmental implications of a possible multilateral framework and discusses various options open to developing countries in this area. It also provides reflections on different elements of a possible multilateral framework on investment, should the negotiating mandate be given by the ministerial conference. The chapter layout

The subject matter of the book is divided into four parts. Part I deals with FDI and its impact on development, Chapter 2 examines host country policies and Chapter 3 the international framework dealing with FDI. Part II deals with the WTO’s TRIMs Agreement. Chapter 4 introduces the TRIMs Agreement, the negotiating history, its scope and coverage and its main provisions. Chapter 5 discusses the implications of the TRIMs Agreement for developing countries. It also presents a way forward for developing countries for the review of the Agreement in the light of the evidence on its impact. Part III deals with a possible multilateral framework on investment. Chapter 6 discusses the OECD’s attempt to evolve a Multilateral Agreement on Investment (MAI). Chapter 7 examines the case for a multilateral framework on investment in the WTO from a development perspective. It finds that developing countries are not likely to benefit significantly from such a framework, and that building a consensus would also be difficult, in view of the OECD’s experience with MAI negotiations. Finally, Chapter 8 in Part IV discusses various options for developing countries. It discusses four alternative positions that developing countries could adopt depending upon the circumstances of the negotiating process.  | 

Chapter two

Foreign direct investment, host government policy and development

§ Foreign direct investment (FDI) inflows have increasingly engaged the attention of national policy-makers as well as the international negotiators over the past decade. The rapid growth of the magnitudes of FDI over the past decade has generated optimism among the developing countries about not only solving their resource scarcities with greater inflows but also getting along with them other critical resources for development such as entrepreneurship, technology, organizational capability and, sometimes, even market access. Therefore, most developing countries have liberalized their policy regimes governing FDI and have attracted them with incentives and other preferences. However, FDI inflows have been highly concentrated in the high- and middle-income countries. Furthermore, there is a great variation in their quality. Hence their developmental impact has varied across countries quite widely. This chapter summarizes some broad trends and patterns in FDI flows and reviews the literature on their developmental impact, to serve as a background to the analysis of other chapters of the book. The structure of the chapter is as follows: the first section summarizes the trends and patterns in FDI inflows and highlights the North–South dimension. The second section presents a selective review of literature on the developmental impact of FDI. The fourth section overviews the various aspects of policy that the governments of developed and developing countries have employed to improve the developmental impact of FDI inflows. The final section outlines some implications for policy. Trends and patterns in FDI inflows and the North–South divide

FDI flows expanded at an unprecedented rate during the 1990s to become the most visible and prominent manifestation of the increasing global integration of economic activity. Compared to the average annual growth of trade in goods and services of about 6–7 per cent over the 1990s, FDI inflows grew at an average annual rate of 20 per cent over 1991–95 and at 32 per cent during 1996–2000 despite the economic crisis in some important regions of the world. As a result, the magnitude of

23.66 1.46 0.84

24.15 1.83 1.15

Source: UNCTAD data.

173.76 119.69 49.62 28.56

158.94 114.79 41.70 26.23

World Industrialized countries Developing countries Share of developing countries (%) Share of developing countries (excl. China) (%) Least developed countries Share of LDCs (%)

1992

1991

Host region

23.89 1.74 0.80

218.09 138.76 73.04 33.49

1993

32.01 1.17 0.46

255.99 145.13 104.92 40.99

1994

1995

25.69 2.00 0.60

331.84 205.69 111.88 33.72

Table 2.1 Global FDI inflows, by broad host groups, 1991–2000 (US$ billion)

31.08 2.39 0.63

377.52 219.79 145.03 38.42

1996

31.38 2.52 0.53

473.05 275.23 178.79 37.79

1997

21.33 3.71 0.55

680.08 480.64 179.48 26.39

1998

20.27 4.53 0.52

865.49 636.45 207.62 23.99

1999

16.21 4.41 0.35

1,270.76 1,005.18 240.17 23.89

2000

global FDI inflows increased from US$159 billion in 1991 to $1.27 trillion in 2000 (Table 1.1). To a large extent, the recent growth of FDI flows has been fuelled by cross-border mergers and acquisitions (M&As) in North America and Europe as a part of an ongoing wave of industrial restructuring and consolidation. However, FDI has become an increasingly important channel of market servicing as a part of the trend of globalization. Table 2.2 shows that sales of foreign affiliates of corporations were roughly of the same order ($2 trillion) as world exports in 1982. By 2000, the affiliate sales had grown to more than double the world exports at $15.7 trillion compared to world exports of $7 trillion. Table 2.2 Relative importance of FDI and exports as means of market

servicing (billion US$)

Sales of foreign affiliates Exports of goods and non-factor services

1982

1990

2000

2,465 2,124

5,467 4,381

15,680 7,036

Source: UNCTAD, World Investment Reports.

The bulk of FDI flows originate in developed countries and developing countries are on the receiving end most of the time. Table 2.3 shows that the top ten industrially and technologically most advanced countries account for as much as 74 per cent of FDI outflows. Therefore, the North–South divide is quite prominent in the case of investment. The North–South divide becomes apparent from the positions adopted by developed countries at the international negotiations concerning investment. Keeping in mind the increasing importance of FDI as a channel of servicing the markets, a favourable international framework for FDI is seen by developed countries as furthering their commercial interests and national competitiveness. Therefore, developed country governments identify themselves with the investors and have tended to protect their interests at these negotiations, as is observed in Chapter 3. It will be seen that developed countries have resisted initiatives of the UN system evolving binding Codes of Conduct on corporations in the 1980s and have, on the other hand, been seeking to evolve an international regime guaranteeing an unfettered movement for their corporations through multilateral trade negotiations.  | 

40.8 17.3 8.0 5.4 4.3 2.3 2.2 1.4 1.4 0.9 84.0 100.0

* belongs to 1997. Source: updated from Kumar (1998b).

212.8 90.1 42 28.1 22.6 12.1 11.4 7.5 7.1 4.8 438.5 522

R&D expenditure* $ billion PPP $ % of total

USA Japan Germany France UK Italy Canada Netherlands Sweden Switzerland Subtotal 10 World

Country

1,337 429.4 173.8 68.2 67.4 29 48.4 22 22.9 31 2,229.1 2,364.9

57 18 7 3 3 1 2 1 1 1 94 100

US Patents taken, 1977–2000 ,000 % of total

Table 2.3 Major source countries of technologies in the world, 2000

33.8 6.9 11.9 2.2 5.8 1.6 1.3 6.2 0.4 2.8 72.9 80.1

42.2 8.6 14.9 2.7 7.2 2.0 1.6 7.7 0.5 3.5 91.0 100.0

Technology fees received* $ billion % of total 139.3 32.9 48.6 172.5 249.8 12.1 44.0 73.1 39.5 39.6 851.3 1149.9

12.1 2.9 4.2 15.0 21.7 1.1 3.8 6.4 3.4 3.4 74.0 100.0

FDI outflows $ billion % of total

FDI inflows (US$ billion)

1,400 1,200 1,000

Global FDI inflows

800 600 Developed countries

400 200 0 1991

Developing countries

1992

1993

1994

1995

1996

1997

1998

1999

2000

Figure 2.1 FDI inflows to industralized and developing countries

in the 1990s (source: based on Table 2.1)

FDI Inflows to developing countries

FDI inflows are expected to be less volatile and non-debt-creating. They are also expected to be accompanied by a number of other assets that are valuable for development, such as technology, organizational skills, and sometimes even market access, among others. Hence, most countries – developed as well as developing – compete among themselves in attracting FDI inflows with increasingly liberal policy regimes and incentive packages. However, the expansion of the magnitude of FDI over the 1990s has benefited only a handful of developing countries, as is clear from the following summary of emerging trends and patterns. 50 Share of developing countries

Share (%)

40 30 20

Share of developing countries excl. China

10 0 1991

1992

1993

1994

1995

1996

1997

1998

1999

Figure 2.2 Share of developing countries in global FDI inflows

in the 1990s (source: based on Table 2.1)

 |  

2000

1.4

% share in FDI inflows

1.2 1.0 0.8 0.6 0.4 0.2 0.0 1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Figure 2.3 Share of least developed countries in global FDI

inflows in the 1990s (source: based on Table 2.1)

FDI inflows received by developing countries expanded from under US$42 billion in 1991 to $240 billion in 2000. The growth of FDI inflows in developing countries seem to have been slower than that of global inflows, especially in the late 1990s (see Figure 2.1). The share of developing countries in FDI inflows rose sharply during the early 1990s from 26 per cent in 1991 to over 40 per cent in 1994. Since then it has steadily declined to below 24 per cent in 2000 (see Figure 2.2). The sharp rise in the share of developing countries in the early 1990s was largely owing to the emergence of China as the most important host of FDI in the developing world. 1. Growing marginalization of poorer countries

The shares of different regions also tend to mask the inter-country variations in the relative importance as hosts of FDI. FDI inflows are highly concentrated in a handful of high- and middle-income countries. Low-income and least developed countries remain marginalized in the distribution of FDI inflows. The share of 45 least developed countries as a group in global FDI inflows is negligible at half a per cent and it shows a declining trend over the 1991–2000 period (see Figure 2.3). Just ten most important hosts of FDI among developing countries account for over 80 per cent of all inflows received by developing countries in 2000. The concentration in the top ten recipients increased from 66 per cent in the mid-1980s to over 80 per cent in the late 1990s.

 |     

2. Prospects for expansion of FDI inflows to low-income and least

developed countries The expanding magnitudes of FDI inflows tend to create optimism among poorer countries regarding the potential of these inflows for expediting the process of their development. However, the 1990s saw an even greater concentration of these flows among a handful of high- and middle-income countries. A recent study of the determinants of inter-country variation in the FDI penetration in the host countries, made in the framework of an extended model of the location of foreign production in a three-dimensional setting, found that factors such as country size, level of income or development, and extent of urbanization affect a country’s ability to attract globalized production from MNEs (Kumar 2000). The elasticities of these factors’ effect on FDI inflows are greater than one, suggesting that size and income levels impact on FDI inflows more than proportionately. The availability of better infrastructure adds to the attractiveness of a country to MNEs. A competitive advantage of developing countries based on availability of low-cost labour is inadequate to prompt MNEs to locate there. The study also finds the role of geographical and cultural proximity between home and the host countries to be important in encouraging intensive investment links. Hence relatively smaller, poorer and agrarian countries have their limitations in tapping the resources of MNEs for their industrialization. Therefore, policy liberalization alone is not adequate for attracting MNEs to invest in poorer countries (Kumar 2002). Developmental impact of FDI on the host economies: a selective review of the literature

FDI usually flows as a bundle of resources including, besides capital, production technology, organizational and managerial skills, marketing know-how, and even market access through the marketing networks of multinational enterprises (MNEs) that undertake FDI. These skills tend to spill over to domestic enterprises in the host country. Therefore, FDI can be expected to contribute to growth more than proportionately compared to domestic investments in the host country. There is now a body of literature that has analysed the effect of FDI on growth in inter-country framework and another analysing knowledge spillovers to domestic enterprises from MNEs (see e.g. De Melo 1997; Kumar and Siddharthan 1997; and Saggi 2000 for recent reviews of the literature). However, the mixed findings reached by these studies on the role of FDI inflows in host country growth and on knowledge spillovers from  |  

MNEs suggest that these relationships are not unequivocal. The primary consideration for expecting a more favourable effect of FDI on growth is the externalities of MNE entry for domestic firms. Externalities such as knowledge spillovers may not take place in some cases because of poor linkages with the domestic enterprises or poor absorptive capacity, for instance. FDI projects vary in terms of generation of linkages for domestic enterprises. There is also a possibility of MNE entry affecting domestic enterprises adversely given the market power of their proprietary assets such as superior technology, appeal of brand names and aggressive marketing techniques. Therefore, FDI may crowd out domestic investment and may thus be immiserizing (Fry 1992; Agosin and Mayer 2000). The crowding out effect may be sharper when the technology gap to be bridged between foreign and domestic firms is very wide. Furthermore, because FDI may be attracted to a country by high growth rates, among other factors, the observed relationships between FDI and growth rate may suffer from causality problems. FDI, growth and domestic investment: empirical evidence

Although a number of studies have analysed the relationship between FDI inflows and economic growth, the issue is far from settled in view of the mixed findings reached. These studies have typically adopted the standard growth accounting framework for analysing the effect of FDI inflows on growth of national income along with other factors of production. A number of early studies have generally reported an insignificant effect of FDI on growth in developing host countries. For instance, Singh (1988) found the FDI penetration variable to have little or no consequence for economic or industrial growth in a sample of 73 developing countries, and Hein (1992) reported an insignificant effect of FDI inflows on medium-term economic growth of per capita income for a sample of 41 developing countries. Fry (1992) examined the role of FDI in promoting growth in the framework of a macro-model for a pooled time series cross-section of 16 developing countries for the 1966–88 period. The countries included in the sample are Argentina, Brazil, Chile, Egypt, India, Mexico, Nigeria, Pakistan, Sri Lanka, Turkey, Venezuela and five Pacific basin countries – Indonesia, Korea, Malaysia, the Philippines and Thailand. For his sample as a whole he did not find that FDI exerted a significantly different effect from domestically financed investment on the rate of economic growth, as the coefficient of FDI after controlling for gross investment rate was not significantly different from zero in statistical terms. FDI had  |     

a significant negative effect on domestic investment, suggesting that it crowds out domestic investment. Hence FDI appears to have been immiserizing. However, this effect varies across countries and in the Pacific basin countries FDI seems to have crowded in domestic investment. Blomström et al. (1994) found that FDI inflows had a significant positive effect on the average growth rate of per capita income for a sample of 78 developing and 23 developed countries. However, when the sample of developing countries was split between two groups based on level of per capita income, the effect of FDI on the growth of lower-income developing countries was not statistically significant, although still positive. They argue that least developed countries learn very little from MNEs because domestic enterprises are too far behind in their technological levels to be either imitators or suppliers to MNEs. Borensztein et al. (1995), for a sample of 69 developing countries for the period 1970–89, find that the effect of FDI on host country growth is dependent on the stock of human capital. They infer from it that the flow of advanced technology brought along by FDI can increase the growth rate only by interacting with country’s absorptive capability. They also find FDI to be stimulating total fixed investment more than proportionately. In other words, FDI crowds in domestic investment. However, the results are not robust across specifications. Balasubramanyam et al. (1996) find the effect of FDI on average growth rate for the period 1970–85 for the cross-section of 46 countries as well as the sub-sample of countries that are deemed to pursue an export-oriented strategy to be positive and significant, but not significant and some times negative for the sub-set of countries pursuing inward-oriented strategy. Pradhan (2001) finds a significant positive effect of lagged FDI inflows on growth rates only for Latin American countries in a panel data estimation covering the 1975–95 period for 71 developing countries. The effect of FDI was not significantly different from zero for the overall sample and for other regions. De Mello (1999) has conducted time series as well as panel data estimation for a sample covering 15 developed and 17 developing countries for the period 1970–90 of the relationships between FDI, capital accumulation, output and productivity growth. The time series estimations suggest that the effect of FDI on growth or on capital accumulation and total factor productivity (TFP) varies greatly across countries. The panel data estimation suggests a positive impact of FDI on output growth for developed and developing country sub-samples. However, the effect of FDI on capital accumulation and TFP growth varies across developed (technological leaders) and developing countries (technological followers).  |  

FDI has a positive effect on TFP growth in developed countries but a negative effect in developing countries, but the pattern is reversed in case of effect on capital accumulation. De Mello infers from these findings that the extent to which FDI is growth-enhancing depends on the degree of complementarity between FDI and domestic investment. The degree of substitutability between foreign and domestic capital stocks appears to be greater in technologically advanced countries than in developing countries. Developing countries may have difficulty in using and diffusing new technologies of MNEs. The findings of Xu (2000) for US FDI in 40 countries for the period 1966–94 also corroborate the finding of De Mello that technology transfer from FDI contributes to productivity growth in developed countries but not in developing countries, which he attributes to lack of adequate human capital. Agosin and Mayer (2000) analyse the effect of lagged values of FDI inflows on investment rates in host countries to examine whether FDI crowds in or crowds out domestic investment over the 1970–95 period. They find that FDI crowds in domestic investment in Asian countries and crowds out in Latin American countries, while in Africa the relationship is neutral (or one-to-one between FDI and total investment). Therefore, they conclude that the effects of FDI are by no means always favourable, and simplistic policies are unlikely to be optimal. These regional patterns tend to corroborate the findings of Fry (1992), who also reported East Asian countries to have a complementarity between FDI and total investment. Kumar and Pradhan (2002), in a recent quantitative study analysing relationships between FDI, growth and domestic investment for a sample of 107 developing countries for the 1980–99 period, postulated a dynamic nature of the effect of FDI on host country growth with an initial generally adverse competitive effect and a subsequent usually more favourable effect through backward linkages with the net effect, depending on the quality of FDI. Panel data estimations in a production function framework suggest a positive effect of FDI on growth. However, tests of causality find that in a majority of cases the direction of causation is not pronounced, and in a substantial number of cases the direction of causation actually runs from growth to FDI. Further estimations corroborate the proposition that FDI affects domestic investments in a dynamic manner with a negative initial effect and the subsequent positive effects for the panel data as well as for most of the countries individually. Although FDI appears to crowd out domestic investments in net terms, in general, some countries have experienced a favourable  |     

effect of FDI on domestic investments in net terms, suggesting a role for host country policies. Therefore, they inferred that policy flexibility is important for developing countries for benefiting from FDI. Knowledge spillovers and productivity improvements

The other stream of studies has related the productivity levels across industries or firms within a country to the extent of foreign presence in an attempt to evaluate the presence of knowledge spillovers, following Caves (1974). These studies have also had mixed findings. Blomström (1989, ch. 4) has found a strong positive association between the labour productivity of local enterprises and the foreign share in employment in 1970 in Mexican manufacturing industries. However, foreign entry was not found to be related to changes in the technological frontier or to changes in labour productivity of the least efficient plants. A simple relationship between productivity levels and foreign ownership as examined by these studies has the limitation of the potential overestimation of the positive impact of foreign presence if the FDI was concentrated in more productive industries. Blomström and Wolff (1989), in a further work on 20 two-digit Mexican industries for the period 1965–84, found increasing convergence of the productivity levels of locally owned firms and those of foreign-owned firms, suggesting the presence of knowledge spillovers. Haddad and Harrison (1993), in the case of Morocco’s manufacturing sector using a firm level panel data set for 1985–89, found no significant relationship between higher productivity growth in domestic firms and greater foreign presence in a sector. Aitken and Harrison (1999), in a similar exercise for Venezuela, found that foreign ownership affected the productivity of domestically owned plants adversely and that negative effects of FDI were large and robust. Similar results were reported for Indonesia, where negative effect on productivity of domestic plants was slightly weaker. Therefore, the authors inferred that the benefits of FDI are limited to direct effects on productivity improvements with improved technology by enterprises receiving foreign participation, and that the spillovers to other local enterprises are negligible and do not justify the incentives granted by host governments to foreign investors. Kokko (1994), by examining Mexican data, found no evidence of spillovers in industries where the foreign affiliates had a much higher productivity and larger market shares than local firms. In other industries, there appeared to be a positive relationship between foreign presence and local productivity. This result suggests that spillovers from foreign  |  

enterprises are dependent upon the local capability in the industry. If the local firms are too weak they will not be able to absorb spillovers and might vanish in the face of competition from foreign firms. Similar findings were obtained by Kokko et al. (1996) in Uruguay and by Kathuria (1998) in India. 1. Inter-industry spillovers and vertical inter-firm linkages

The vertical inter-firm linkages created by foreign enterprises could be an important externality for the host economy and could also be sources of diffusion of knowledge from them. Katz (1969), for instance, noted that the inflow of FDI into the Argentine manufacturing sector in the 1950s had a significant impact on the technologies used by local firms. The technical progress took place not only in the MNEs’ own industries, but also in other sectors, because the foreign affiliates forced domestic firms to modernize by imposing on them minimum standards of quality, delivery schedules, prices, and so on in their supplies of parts and raw materials. The volume of vertical backward linkages generated is determined by two decisions concerning the sourcing of raw materials and intermediate products of the firm: ‘import or procure locally’ and ‘make or buy’. A number of studies have compared the dependence of foreign and local firms on imported raw materials in order to get an idea of the extent of linkages generated in the domestic economy, as the local content in production is an indicator of the strength of local linkages. Foreign affiliates can be expected to import a higher proportion of their raw materials and other inputs than local firms, because of their familiarity with foreign suppliers and the alleged inadequacies of local producers, and sometimes to provide a market for the products of their associates elsewhere. Foreign firms have been found to depend more on imports than their local counterparts in studies by Subrahmanian and Pillai (1979) for India. Cohen (1975) in the case of South Korea, Taiwan and Singapore, and Reidel (1975) in the case of Taiwan, Jo (1980) for South Korea, and Newfarmer and Marsh (1981) for the Brazilian electrical industry have found foreign firms importing a greater proportion of their inputs than their local counterparts. Lall and Streeten (1977) in a study of six countries including India, however, did not find any significant difference between the import dependence of foreign and local firms. Kumar (1994b, ch. 4) also did not find a statistically significant difference between the import dependence of foreign and local firms across 43 branches of Indian manufacturing.  |     

The make or buy decision actually relates to the degree of vertical integration. The latter is inversely related to subcontracting parts of the production run to unassociated vendors. In countries such as India, which have evolved a strict trade and exchange control regime that restricts the freedom of firms to import, subcontracting may be an important aspect of a firm’s decision-making concerning the sourcing of intermediates and raw materials. A number of market failures may tempt a firm to internalize the manufacture of intermediate inputs, so as to ensure the certainty of delivery schedules and quality standards. A certain monopoly rent may also be associated with vertical integration. On the other hand, firms can internalize a part of the scale economies in the manufacture of intermediates and can escape problems of industrial relations by subcontracting their production to other firms. Cohen (1975) found that local firms had a greater degree of vertical integration among the export-oriented enterprises in Taiwan, South Korea and Singapore. Newfarmer and Marsh (1981), and Willmore (1986) found a reverse pattern in the case of Brazil. Lall (1980) did not find any significant difference between the extent of subcontracting of a foreign subsidiary and a local company in India both producing trucks. Kumar (1994b, ch. 4) found foreign-controlled firms to have a greater extent of vertical integration than their local counterparts in 43 Indian manufacturing industries even after controlling for firm size, profitability and financial variables in the framework of multivariate analysis. On the basis of analysis of patterns of FDI by US and Japanese MNEs in developing countries, Kumar (1998b: 212) has noted a slow progress with respect to generation of backward linkages by either US or Japanese MNEs in developing host countries. In this context it may also be useful to keep in mind the strategy of multinational companies, especially those from Japan, which tend to transplant their traditional Keiretsu links existing in the home country to their host countries. This generally takes the form of vendors of the Japanese parent company in Japan following the overseas production strategy of the parent (see e.g. Manifold 1997 for evidence). This tends to limit the diffusion of knowledge brought in by the MNE in the host country through vertical inter-firm linkages. The extent of these practices for MNEs from other home countries is not clear. 2. Training and employee mobility

Some studies have documented the spillovers from FDI to local economies in the form of on-the-job training provided by MNE affiliates to their  |  

personnel and through the mobility of trained personnel. Gerschenberg (1987) examined detailed career data for 72 top and middle-level managers in 41 manufacturing firms and concluded that MNE affiliates offer more training to their managers than local private firms, although the mobility seemed to be lower for managers employed by MNEs than for those in private local firms. Chen (1983) also reported significantly higher training expenditures on the part of MNE affiliates in Hong Kong than for local firms in three of the four industries sampled. Tan and Batra (1995) found that although foreign firms were more likely to train their workers, once other factors were controlled the effect remained significant only for Taiwan and Malaysia. Therefore, the limited evidence that is available suggests that while MNE affiliates may invest more in human resource development, the diffusion of these resources within the host economies may be insignificant. 3. Indirect effects on export performance

It has been pointed out in the literature that firms that penetrate export markets reduce the costs of entry into export markets of other potential exporters through spillovers of information on export potential and potential markets, by demonstration effect. Therefore, substantial spillovers of information may flow from entry of export-oriented foreign affiliates into the country. Aitken et al. (1994) examine the hypothesis that MNEs act as export catalysts for panel data on 2,113 Mexican manufacturing plants for the period 1986–90. The logit estimations show that controlling for factor costs, output prices and other variables that affect the export decision, MNEs were roughly twice as likely as domestic plants to export. They also found that locating near a MNE exporter significantly raises the probability of exporting for an individual firm. This effect is not observed from a higher concentration of export activity in general. However, it remains the solitary evidence on market access spillovers from FDI so far. Effect of FDI on host country market structures or the level of competition

The studies analysing the impact of MNEs or FDI on host country market structures, conduct and performance have confined themselves to an examination of relationships between FDI and the level of concentration, advertisement and R&D intensities or performance in terms of profitability. Lall (1978) provides an early survey of the literature. See Caves (1996) and Kumar and Siddharthan (1997) for a more up-to-date survey.  |     

Market structure can be affected by the relative scale of operation of enterprises. A number of studies have provided evidence on the larger scale of operations of foreign enterprises than that of their local counterparts – for instance, Newfarmer and Mueller (1975) for Mexico and Brazil; Lall and Streeten (1977) for India, Colombia and Malaysia. Radhu (1973) in Pakistan and Willmore (1976) in Guatemala have observed a significant correlation between the degree of the presence of MNEs and seller concentration. Evans (1977) and Willmore (1989) for Brazil, Lall (1979) for Malaysia and Blomström (1986) for Mexico found a positive influence of foreign ownership on industry concentration even after controlling for entry barriers. Market structures or the level of concentration could also be affected by the relative conduct of MNEs, such as their behaviour in terms of advertising and R&D behaviour. Caves et al. (1980) and Gupta (1983) found the foreign share in industry sales to have a significant positive influence in explaining the proportion of advertising expenditure in Canadian manufacturing industries. Willmore (1986) found that foreign enterprises spent a higher proportion of sales on advertising than their local counterparts in Brazil even after controlling for firm size and industry. Fairchild and Sosin (1986) in Latin American countries and Kumar (1987) reported that the local firms had a greater inclination to do in-house R&D than their foreign-controlled counterparts. Lall (1985, ch. 7) found a positive relationship between foreign ownership and R&D in the Indian engineering industry but a negative one in the chemical industry. Braga and Willmore (1991) found a positive effect of foreign ownership on the probability of firms having a systematic programme of new product development in the Brazilian industry. Kumar (1991) attempted to provide a framework explaining behavioural differences between foreign and local enterprises in a country. He contends that in order to maximize the revenue productivity of their dowry of intangible assets such as internationally recognized brand names, captive access to technology and reservoirs of technical, managerial and organizational skills, MNE affiliates are more likely to pursue non-price modes of rivalry than their local counterparts. Nonprice modes of rivalry involve product differentiation accompanied by extensive advertising and marketing campaigns to highlight the unique features of the product and thus obtain monopolistic advantage in the market. The empirical findings of Kumar (1991), relating to a comparison of the behaviour of two groups of firms in 49 Indian industries in the framework of both univariate as well as multivariate discriminant  |  

analysis, showed that the MNE affiliates operate at relatively larger scales because of the economies of scale involved in advertising and marketing, are more vertically integrated because of greater proprietary element in product specifications. Because of their monopolistic hold over the markets through brand and trade name goodwill they are able to charge higher prices, and they concentrate on the upper ends of the markets with relatively inelastic demand curves. Hence they are found to enjoy higher profit margins even after controlling for extraneous factors. With regard to advertising and R&D, they also benefit from the global expenditures of their associates. The tendency of MNE affiliates to opt for non-price modes of rivalry has important implications for the market structure and competitive situation in the host developing countries. MNE affiliates’ preference to operate on a larger scale, and to depend more heavily on marketing, advertising and R&D activity to differentiate their products, raises barriers to the entry of new firms. Hence they tend to perpetuate the concentration of market structures and the level of competition is affected adversely. These ‘contrived barriers’ to entry perhaps explain the continued domination by MNE affiliates of several brand-sensitive consumer goods industries despite the instruments of the government’s policy, which sought to curb monopolies as observed in India (Kumar 1994b, ch. 2). Furthermore, the recent global trend for the restructuring of the global industry through mergers and acquisitions (M&As) between large multinational enterprises (MNEs) results in a consolidation of their market position. Besides the consolidation of the market power of affected companies, M&As between large MNEs could have more direct adverse effects on the market structures in their host countries. For instance, the global pharmaceutical industry is consolidating, with the mergers of Ciba-Geigy and Sandoz to form Novartis, of Glaxo, Wellcome and Smith Kline and Beecham, of Pharmacia and Upjohn among others; the automobile industry with the takeover by BMW of Rover, the merger of Daimler-Benz and Chrysler, takeovers of Mazda and Volvo cars by Ford; and with the takeover of Brooke Bond by Unilever, which already owned Lipton, two of the largest packaged tea companies in the world came under common control. The recently strengthened and harmonized international regime of intellectual property protection under the TRIPs Agreement also fortifies the monopolistic hold of MNEs on technologies. While the EU and the USA are equipped with effective anti-trust regulations to deal with the possible abuse of monopoly power  |     

of patent-holders and anti-competitive effects of international mergers, most developing countries lack anti-trust legislation designed to deal with such situations. The exiting literature, therefore, suggests that the host country may not benefit from knowledge spillovers when the technology gap between foreign and domestic firms is too wide, as is generally the case in poorer countries. The literature also found the effect of FDI on growth to be dependent on the presence of skills that facilitate the absorption of new knowledge. In view of the relatively low levels of skill accumulation, poorer countries are not able to experience more favourable effects of FDI. Some studies have observed an insignificant or adverse effect of FDI on low-income countries and a more favourable effect on middleincome countries. Therefore, not only is FDI concentrated in relatively richer countries, these countries are also able to experience its more favourable effects than poor countries. FDI also often generates fewer linkages and tends to crowd out domestic investments in net terms in more countries than it crowds in. The fact that some countries have experienced a favourable effect of FDI on domestic investments in net terms suggests a role for host country policies. Therefore, policy flexibility is important for developing countries for benefiting from FDI. Given the tendency of MNEs to operate at larger scales and pursue non-price modes of rivalry, FDI could also have an adverse impact on competition in domestic industries and may perpetuate concentration. Furthermore, the on-going global industrial restructuring in the industry leading to consolidation of market power of large MNEs is also leading to further concentration in the host countries where the corporations involved in these deals have operations. Role of government policy and performance requirements: experiences and evidence

It is clear that the effects of FDI on domestic investments and growth depend very much on the nature or quality of FDI. Certain types of FDI tend to have more favourable developmental externalities than others. In that context attention needs to be paid by host countries to the quality of FDI inflows besides attracting greater magnitudes of FDI. Recent work has shown that host country policies have an important bearing on the quality of FDI inflows received (see Kumar 2002, among others). Governments have employed various measures to improve the overall quality of FDI inflows. These include selective policies to target more desirable FDI inflows. East Asian countries such as South Korea have, in  |  

the past, pushed FDI into high technology and export-oriented sectors with various policy instruments. Trade policy

Different host governments have also used protectionist policies such as tariffs and non-tariff barriers to encourage the tariff-jumping type of FDI inflows (see Caves 1996 for a review of the evidence). Empirical studies have corroborated the effectiveness of host country protectionism in attracting FDI (Lall and Siddharthan 1982; Kumar 1994b). In more recent times, industrialized countries in the EU, for instance, have used neo-protectionist or grey area measures such as voluntary export restraints (VERs), quotas, screwdriver regulations and anti-dumping measures to encourage foreign-based MNEs, especially from Japan, to increase the domestic content in their sales (see e.g. Belderbos 1997; Moran 1998). The EU and NAFTA have also adopted stringent rules of origin to increase the domestic content of foreign enterprises’ sales in the trade bloc, taking advantage of RTA exceptions available under Section XXIV of the GATT. The rules of origin determine the extent of domestic content a product must have to qualify as an internal product in a preferential trading agreement. Thus they have the same effect as local content regulations (see Box 5.1 for illustrations). Selective FDI policies

Most governments at some stage of their development have employed selective policies to channel FDI inflows in desirable directions. These have included positive list (listing sectors where FDI is welcomed) or negative list (listing sectors where FDI is restricted) approaches to FDI entry policy. Some governments restrict foreign entry to certain areas to protect domestic small and medium enterprises (SMEs). Furthermore, screening mechanisms or approval systems have also been employed to select more desirable FDIs. Some governments engage in negotiations with potential entrants to determine the terms and conditions of entry. Because MNE entry through acquisition of domestic enterprises is likely to generate less favourable externalities for domestic investment than greenfield investments, some governments discourage acquisitions by foreign enterprises (see Agosin and Mayer 2000 for examples). Performance requirements

Many governments – in developed as well as developing countries alike – have imposed performance regulations on FDI at the time of entry to  |     

pattern their operations in consonance with the country’s development objectives (see Guisinger et al. 1985; UNCTC 1991, UNCTAD 2001a). These performance requirements include, among others, the following: • • • • • • • • • • • •

local content requirement; trade balancing requirements; foreign exchange neutrality requirements; export controls; export performance requirements; requirement to establish a joint venture with domestic participation; requirement for minimum level of domestic equity participation; employment performance requirements; requirement to transfer technology, production processes or other proprietary knowledge; research and development requirements; requirement to act as the exclusive supplier of goods and services provided; and requirement to locate headquarters for a specific region or the world market.

The evidence that is now available suggests that the performance requirements have generally been effective in improving the quality of FDI inflows, although they may have cost some inflows by making the conditions of investment somewhat restrictive. For instance, a number of theoretical and empirical studies have found the local content regulations, which have been the most widely practised performance requirement, to be welfare-improving (see for instance Balasubramanyam 1991; Richardson 1993; Lahiri and Ono 1998; Yu and Chao 1998; see also Chapter 5 for more details). Similarly, export performance requirements have been employed by different countries to exploit the advantages of MNEs, such as their captive global marketing networks for expanding their manufactured exports, and hence offset the adverse balance of payment effect of their operations. Export obligations may also prompt the MNE to set up world-scale plants and employ best-practice technologies and generate other favourable externalities. Many countries, such as Mexico, Brazil and Thailand, among others, have successfully employed export obligations for ‘triggering a burst of export-focused investments’ in different industries (see Moran 1998: 53–68). A detailed empirical analysis of US and Japanese FDI in a sample of 74 countries in seven broad branches of manufacturing over the 1982–94 period found the local content regulations to be favouring the extent of localization of MNE affiliates’  |  

production in the host countries. Export commitments have been found to be effective in prompting MNEs to export a greater proportion of output to third countries (see Kumar 1998a, 2000a, 2002). Therefore, the study concluded that local content regulations and export obligations could be an important means of deepening the commitment of MNEs entering an economy and for generating local value added, exports and hence on employment and the related spillovers of knowledge, although they may cost some inflows by making conditions of entry somewhat restrictive. Investment incentives

Many governments, especially in industrialized countries, offer considerable investment incentives or tax concessions to attract desirable types of FDI inflows or to create jobs. The examples include US$484 million given to Ford in Portugal in 1991 for creating 1900 jobs, and $300 million to Mercedez-Benz in Alabama in 1996 for creating 1,500 jobs. The capacity of developing countries in extending such incentives is obviously limited. However, some governments do offer tax concessions or other assistance, such as subsidized infrastructure to export-oriented investments. Some governments, such as Singapore and Malaysia, among others, have employed incentives such as pioneer industry programmes to attract FDI in industries that do not exist in the country and hence have the potential to generate more favourable externalities for domestic investment (see UNCTAD 1999b, 2001b, for examples). Another sphere where governmental intervention may be required to maximize gains from globalization is the diffusion of knowledge brought in by foreign enterprises. An important channel of diffusion of knowledge brought in by MNEs in the host economy is vertical inter-firm linkages with domestic enterprises. The host governments could consider employing proactive measures that encourage foreign and local firms to deepen their local content, as a number of countries, such as Singapore, Taiwan, Korea and Ireland, have done successfully (see Battat et al. 1996). The knowledge diffusion could also be accomplished by creating sub-national or sub-regional clusters of interrelated activities that facilitate the spillovers of knowledge through informal and social contacts among the employees in addition to traditional buyer–seller links. UNCTAD (2001b) also highlights the policy measures employed by different governments in promoting linkages.

 |     

Competition policy

There is also a development dimension of the competition policy. The competition policy in a developing country, especially in a liberalized regime for trade and investment, has to provide a level playing field for domestic enterprises vis-à-vis subsidiaries of MNEs which enjoy access to their parent’s brand and trade names besides a number of other intangible assets. To use their advantages most effectively, MNE affiliates tend to adopt non-price modes of rivalry dominated by a heavy reliance on advertising and product differentiation. These strategies raise barriers for the entry of new firms and are referred to as ‘contrived entry barriers’ in the industrial organization literature. In order to promote a healthy competition between local firms and MNE affiliates, the competition policy could take the form of either offsetting the monopoly power of MNE affiliation and foreign brands through fiscal measures or assisting national firms to build their own brands and technological capability. Concluding remarks

This chapter has shown that FDI represents an area of greatest North–South divergence. FDI emerged over the 1990s as the most important vehicle of overseas expansion. Hence developed countries tend to see a freer regime for investment furthering their commercial and strategic interests. The trends in FDI suggest that FDI inflows have been highly concentrated in high- and middle-income countries. The poorer countries are marginalized in the distribution of FDI inflows despite the liberalization of policy. The studies on determinants of FDI suggest that liberalization of policy has its limitations in expanding FDI inflows in poorer agrarian economies. A review of the literature on the developmental impact of FDI suggests wide variation across countries in their experiences. While some countries have had favourable developmental effects of FDI through crowding in of domestic investments and spillovers of knowledge, in many others, FDI has crowded out domestic investments and led to little spillovers of knowledge, and may have proved immiserizing. Given the wide variation in the quality of FDI inflows, governments have attempted to improve their quality with a variety of policies such as selective entry policies, performance regulations imposed at the time of entry, trade policy to foster greater domestic content and supplementary policies to promote vertical linkages. These findings have implications for the on-going attempt of some developed countries to write GATT-type investment rules through multi |  

Chapter three

Multilateral Agreements on Investments: a historical background

§ Foreign direct investment (FDI) is the most important channel of harnessing the resources of transnational corporations (TNCs) for industrialization of developing countries. However, the impact of FDI on the host countries is uneven depending upon the areas of operations, nature and the extent of technology or new knowledge brought in, extent of domestic value added and the exports and inter-firm linkages generated, among other factors, as observed in Chapter 2. It has been emphasized in Chapter 2 that host country policies play an important role in determining the impact of TNCs on a host country, especially a developing one. International businesses such as the operations of the TNCs transcend national barriers. Hence, national governments’ ability to deal with them is limited. This is because national regulation and control are inadequate to deal effectively with the global strategies of TNCs. Many states, particularly small developing countries, have encountered difficulties in regulating transnational corporate conduct to ensure conformity of TNCs’ activities with domestic laws, regulations and policies, adequate disclosure of information, and consumer protection; and to prevent tax evasion, restrictive business practices, illicit payments and abusive transfer pricing. It is for this reason that a multilateral approach to international intervention has been emphasized by developing countries. Over the 1970s, a number of initiatives were launched to provide a framework for the international regulation of international business. Some of these initiatives, however, could not be completed successfully because of a lack of consensus between developed and developing countries on their legal status. On the other hand, there were initiatives in the 1980s and later that tended to curtail the ability of national governments to regulate the operations of TNCs through multilateral trade negotiations. This chapter provides a description of various initiatives taken by the international community in this regard. Need for international intervention

Transnational corporations have the economic power and resources to act as effective instruments of development. Yet the pervasive role

attributed to these corporations in the world – and the disclosure of certain instances of corporate misconduct – have given rise to serious concern about their impact on economic development and political and social affairs. The attempts to regulate their corporate conduct in developing countries has been accompanied by the desire to establish an international regime of minimum standards for the treatment of TNCs. The objective of these endeavours has been to create an international framework that would minimize the negative effects of the activities of these corporations while maximizing their positive contribution to development. A multilateral approach is also helpful in settling intergovernmental disputes as to the treatment of TNCs within national jurisdictions, particularly where such jurisdictions impose conflicting requirements on various entities of TNCs. Further, multilateral intervention can play an important role in promoting flows of FDI to developing countries by providing investment guarantees and finance to TNCs. The international intervention in the arena of international business has evolved over the past three decades with the growing expansion and complexity of operations of TNCs. Not only have the existing multilateral organizations such as UNCTAD, World Bank and the GATT started their activities concerning international business gradually in consonance with their mandate, but new ones have been created just to deal with international business. The most prominent example of the latter was the United Nations Commission on Transnational Corporations. Types of international intervention

Broadly, the international intervention in the area of investment can be classified into two groups: promotional and regulatory. The former could cover the initiatives taken by the international community to promote FDI flows and globalization of business by creating a favourable climate, such as by providing financing and protecting against non-commercial risks. The latter includes the initiatives to protect the interests of host countries by evolving norms of corporate conduct and control of restrictive business practices. The promotional role has been played by the World Bank affiliates, MIGA and ICSID, which are sponsored by the Bank. The regulatory initiatives include attempts to evolve norms and codes of conduct of TNCs by different United Nation agencies (the UN Commission on TNCs and UNCTAD), the ILO and the OECD. Further, multilateral trade negotiations have concluded certain agreements such as TRIMs and the GATS,  |                    

which have a bearing on the operations of TNCs. In what follows we briefly overview the various international codes and agreements that have evolved over time to govern FDI. Regulatory interventions

As observed earlier, regulatory international interventions were evolved in the 1970s in the form of various codes of conduct for the behaviour of TNCs by different intergovernmental organizations, as follows. Initiatives of the United Nations

A number of initiatives dealing with international investment were taken in the framework of the UN Economic and Social Council as a result of the conflicts that characterized relations between developing countries and TNCs in the 1960s and early 1970s. The sensitivities of developing countries in the immediate post-independence era coincided with an unprecedented expansion of FDIs spearheaded by TNCs based in the developed market economies. The United Nations Commission on Transnational Corporations was created in 1974 as follow-up to the recommendation of the Eminent Persons Group on TNCs appointed by the United Nations. The UN Commission on Transnational Corporations was established as an intergovernmental subsidiary body of one of the major organs of the United Nations, the Economic and Social Council (ECOSOC). It had 48 members. Election of member states to the Commission was based on geographical distribution. Twelve members were from Africa, eleven from Asia, ten from Latin America, ten from the developed countries of Western Europe, North America and Oceania, and five from the socialist countries of Eastern Europe. Members served a three-year term and were eligible for re-election. The main home countries of the TNCs (the USA, the United Kingdom, Germany and Japan) were always members of the Commission. The Commission’s main functions were to discuss and keep under review all issues related to TNCs and to advise ECOSOC in all matters relating to TNCs. Sixteen Expert Advisers were elected by the Commission to assist it in its deliberations. The Advisers, from developed, developing and socialist countries, were drawn from trade unions, business, public interest groups and universities. They acted in a private capacity. The Commission was conceived as a forum under whose auspices measures could be taken to strengthen the host country’s position vis |  

à-vis TNCs. Among the measures envisaged were the formulation and implementation of an effective code of conduct on TNCs, strengthening of the bargaining position of developing countries, and a system of information on TNCs. The later two objectives were entrusted to the UN Centre on Transnational Corporations (UNCTC), set up to provide a secretariat to the Commission. As a part of the restructuring of the United Nations, the UNCTC was later merged with the Transnational Corporations and Management Division of the Department of Social and Economic Development of the United Nations in 1992, before finally becoming a part of the Division on Investment, Enterprise Development and Technology of UNCTAD. 1. UN Code of Conduct on Transnational Corporations

Given the importance of TNCs in the world economy, the need was recognized for standards to govern the relationship between host governments and TNCs establishing the basic general rules for the conduct of TNCs and their treatment by governments. The formulation of a Code of Conduct on Transnational Corporations was the Commission on TNCs’ highest priority since its inception. Negotiations began in 1977 in an intergovernmental working group and continued from 1983 in a series of meetings of a special session of the Commission, open to all states. Therefore, the Code was negotiated with the active participation of countries from all geographic regions. The process received inputs from the Expert Advisers, the business community, trade unions and other organizations. The negotiations succeeded in preparing a draft text in which about 80 per cent of the provisions were agreed to (see Annex I). Compromise formulations existed for all the remaining principal outstanding issues. When adopted, the Code was expected to be the first multilaterally agreed framework governing all aspects of the relations between states and TNCs. The Code had two main objectives. First, it sought to establish standards for the conduct of TNCs from all countries to protect the interests of host countries, strengthen their negotiating capacity and ensure conformity of the operations of TNCs with national development objectives. These standards were to apply in such areas as the general and political aspects of the activities of TNCs, the economic, financial and social aspects of the activities of TNCs and the disclosure of information. Second, it proposed to set standards for the treatment of TNCs by countries to protect the legitimate interests of investors, create a stable,  |                    

predictable and transparent framework for the activities of TNCs and create a climate for foreign direct investment that was beneficial to all parties in the investment relationship. These standards would apply in such areas as national treatment, transparency, nationalization and compensation, dispute settlement procedures, fair and equitable treatment and jurisdiction. Thus, the Code was to define the rights and responsibilities of states and TNCs in a balanced manner. It would have helped to minimize any negative effects and maximize the positive effects associated with the activities of TNCs and thereby contribute to a reduction of friction and conflict between host governments and TNCs, as well as enable the flow of FDI to realize its full potential in the development process. However, because of the rigid attitude adopted by the industrialized countries on certain contentious issues (such as the applicability of international law and national treatment) the negotiations pertaining to the establishment of the Code never succeeded. In fact the intergovernmental group convened by the UN General Assembly in 1992 to finalize the Code recommended alternative methods to encourage global FDIs and strengthen the investor–host country relationships, as it was not possible to adopt the Code of Conduct. UNCTAD’s Codes of Conduct on technology transfer and restrictive business practices (RBPs)

The United Nations Conference on Trade and Development (UNCTAD) was set up by the United Nations General Assembly in 1964 as one of its permanent organs, mandated to promote international trade, particularly that of developing countries with a view to accelerating their economic development. UNCTAD is composed of 191 member states. One of the areas of work of UNCTAD since 1970 has been on international technology relations in view of the important bearing it has on trade and development.1 UNCTAD’s studies showed that the gap between industrialized and developing countries in the area of technology had been vast, and had widened with the technological advances of the twentieth century. It also showed that the technological superiority of the developed nations had been protected jealously by the industrial property system, and that transfer of technology to developing countries had been prone to restrictive practices and high royalty payments. UNCTAD attempted to propagate a wider understanding of technology and its transfer with in-depth studies, particularly focusing on building up national technological capacity, reducing external dependence, and  |  

strengthening the bargaining position with transnational corporations. UNCTAD helped developing countries with the adoption of national policies, plans, strategies, laws and regulations concerning technology consistent with their development plans. To restructure international technological relations UNCTAD spearheaded the initiative towards the establishment of an International Code of Conduct on Transfer of Technology. 1. International Code of Conduct on Transfer of Technology

After substantial preparatory work, the UN General Assembly decided (Resolution 32/88 of December 1977) to convene a United Nations Conference on an International Code of Conduct on the Transfer of Technology, and to negotiate the Code under the auspices of UNCTAD. The draft Code aimed to strengthen the position of developing countries’ parties in international transactions, of transfer of technology, by providing general and equitable standards as a basis for the relationship between parties. It sought to facilitate and increase the international flow of technologies. It specified the restrictive business practices (RBPs) from which parties to a technology transfer transaction should refrain, and set forth a set of responsibilities and obligations of parties to transfer of technology transactions. It recognized the right of each state to employ all appropriate means to facilitate and regulate transfer of technology within the principles of sovereignty, political independence and sovereign equality of all states. The Code negotiations proved to be cumbersome. Despite the convening of six sessions of the UN Conference between 1979 and 1985, the negotiations failed, mainly because of the rigid attitude adopted by the developed countries on some key issues. Their attitude not only prolonged the negotiations but aimed at softening the standards to be applied. For one thing, they opposed the legally binding character of the Code, which would become a set of ‘universally acceptable recommendations’. For another, it did not apply to the transactions between a resident but foreign (owned and) controlled entity and a local one; the TNCs could, therefore, easily side-track the Code. Besides, the definition of what constituted restrictive business practices was narrowed down. The industrialized countries maintained that the restrictions for the purpose of rationalization of functions among affiliated firms should not be considered contrary to the Code. Because the bulk of technology transactions are of an intra-firm nature, the scope of the Code as far as RBPs were concerned was substantially reduced.  |                    

The negotiations on the Code of Conduct finally collapsed, with the negotiating parties failing to agree on key issues, such as the concept of restrictive business practices, applicable law and jurisdiction. 2. Set of Multilaterally Agreed Equitable Principles and Rules for

Control of RBPs The concern about the market power exercised by developed countries’ enterprises in domestic and international markets and their resort to RBPs to strengthen that power led developing countries to press for international action in this area. Although the Havana Charter had a chapter dealing with RBPs, it was not included in the GATT. The efforts of ECOSOC in the early 1950s to adopt an international code on the matter had been thwarted by the industrial countries. Despite the opposition of developed countries, UNCTAD initiated work in the area of RBPs in 1968 under Resolution 25 (II) adopted by roll-call vote. The work was steadily pursued and developed over subsequent years, through studies and expert and intergovernmental discussions culminating in the unanimous adoption of the Set of Multilaterally Agreed Equitable Principles and Rules for the Control of RBPs in 1980. This specifies voluntary recommended norms both for enterprises, including TNCs, and for states (see Annex II). It is not a legally binding instrument. Although it can be hailed as the first decisive step in international efforts to control RBPs, it is yet to be effective. The Intergovernmental Group of Experts on RBPs established by the Trade and Development Board of the UNCTAD to monitor the application implementation of the Set has repeatedly expressed its concern about the persistent resort to the use of RBPs in international trade transactions. Developing countries unsuccessfully attempted to transform the principles and rules into binding provisions, but faced the constant opposition of industrialized countries. ILO Tripartite Declaration

The Tripartite Declaration of Principles on Multinational Enterprises and Social Policy was approved by the Governing Body of the International Labour Organization on 16 November 1977 and has been subsequently amended from time to time (last time in 2000).2 The Declaration is voluntary in character. It concentrates on employment, training, working conditions and industrial relations and is addressed to TNCs, employers’ and workers’ organizations and governments.  |  

OECD Guidelines for MNEs

The OECD Guidelines on International Investment and Multinational Enterprises adopted in 1976 lay out a rather comprehensive set of voluntary norms of behaviour for TNCs. A number of these guidelines deal in part with issues that are causes of concern to the governments, including their fiscal authorities, and to the international labour movement. In a sense, the OECD Guidelines cover the behaviour both of governments and TNCs; they are comprehensive from the point of view of coverage of substantive issues, but limited geographically to developed countries. Although the OECD Committee on International Investment and Multinational Enterprises is not empowered to reach conclusions on the conduct of individual enterprises, its interpretation of principles embodied in the Guidelines may have influenced decisions of TNCs in certain cases. The OECD Guidelines were revised in 1991 and 2000. The Guidelines as amended in 2000 cover the norms for good corporate behaviour in respect of disclosure of information, employment and industrial relations, environment, combating bribery, consumer interests, science and technology, competition and tax policy. On the part of the adhering host governments, it provides for a treatment of foreign-controlled enterprises not less favourable than that accorded to domestic enterprises. However, the Declaration ‘does not deal with the right of adhering governments to regulate the entry of foreign investment or the conditions of establishment of foreign enterprises’.3 Therefore, the national treatment is restricted to the post-establishment stage. Promotional interventions

As observed earlier, there have been a number of attempts that tend to promote and liberalize the regimes governing the movement of capital by creating favourable conditions and providing an international framework for investment protection. These include initiatives by the World Bank and recent attempts to include investment issues within the framework of the multilateral trade negotiations. World Bank-sponsored agreements on investment

The World Bank sponsored the Convention on the Settlement of Investment Disputes, which provides arbitration facilities for international business. It also sponsored a Convention Establishing the Multilateral Investment Guarantee Agency (MIGA) in 1985.  |                    

1. International Convention on Settlement of Investment Disputes

The World Bank sponsored the adoption of the Convention on Settlement of Investment Disputes between States and Nationals of Other States in 1965. The Convention is a binding treaty that came into force on 14 October 1966, aimed to facilitate the flow of capital from industrialized to developing countries by providing arbitration facilities. The International Centre for Settlement of Investment Disputes (ICSID) was set up under the Convention at the World Bank headquarters in 1966 and is equipped to deal with disputes between states and nationals of other states. A large number of countries including the major capital importers, however, have not signed the Convention on the ground that it gives preference to foreign over domestic investors. They contend that investments within their boundaries, such as domestic investments, should be subject to domestic jurisdiction equally. 2. The Convention Establishing the Multilateral Investment Guarantee Agency (MIGA) The Convention Establishing the Multilateral Investment Guarantee Agency as a binding treaty was adopted in 1985. As a follow-up to the adoption of the Convention, the Multilateral Investment Guarantee Agency (MIGA) was established in 1988 at the World Bank. It seeks to promote economic development by encouraging the flow of private FDI to developing countries. MIGA aims to achieve this objective by insuring such investment against loss due to political risks such as expropriation, blocked currency transfers, breach of contract, and war, revolution and insurrection. By June 2002, as many as 157 countries had joined MIGA.4 MIGA insures new investments, including the expansion of existing investments, privatization and financial restructuring. Projects must be registered with MIGA before the investments are made or irrevocably committed. MIGA can insure up to 90 per cent of the investment amount, subject to a limit of $50 million of coverage per project. Eligible investments include equity, loans made or guaranteed by equity holders, and certain other forms of direct investment. MIGA’s standard policy covers investments for 15 years; in exceptional cases, coverage may be extended up to 20 years. MIGA also cooperates with national investment insurance agencies and private insurers to co-insure or reinsure eligible investments. MIGA also provides promotion and advisory services to its developing member countries to support their efforts to attract foreign direct investment. These services include the organization of investment pro-

 |  

motion conferences, executive development programmes, foreign investment policy roundtables, research and specialized advisory assistance to governments. MIGA’s advisory assistance includes significant work on the legal framework for FDI in member states. MIGA has worked with a number of countries as they have liberalized the laws applying to foreign investments. Several developing countries have enacted new statutes that provide for international arbitration to settle investments disputes, and many have entered into bilateral treaties for protection and promotion of foreign investments. MIGA has also concluded legal protection agreements with six member countries that will make it easier for MIGA to issue investment guarantees. The advisory functions consist of improving investment policies, programmes and institutions to facilitate direct investment. This function is entrusted to the FIAS (Foreign Investment Advisory Service) set up jointly with the IFC. The consultative functions, covering investment promotion and applied research, are undertaken by MIGA’s Policy and Advisory Services. Multilateral trade negotiations and investment

The General Agreement on Tariffs and Trade (GATT) came into existence in 1948 following the Havana Conference with the principal objective of ‘substantial reduction of tariffs and other barriers to trade’. The GATT had over a hundred contracting parties (countries) that took part in trade negotiations (called Rounds). The basic principle of the GATT is of non-discrimination. Countries that belong to the GATT accept the so-called most-favoured nation (MFN) clause. This means that a country shall unconditionally extend the better treatment accorded to any single nation to all the contracting parties of the GATT. The MFN clause, in principle, rules out any preferential treatment among nations as far as trade policy is concerned. However, the GATT has made exceptions to that principle. The formation of custom unions and free trade areas are thus permitted among groups of countries. As a result, today a large part of world trade is carried out within custom unions or free trade areas such as EFTA, the Single European Market and NAFTA. The Eighth Round of multilateral trade negotiations was launched in the GATT Framework at a ministerial meeting in September 1986 in Punta del Este, Uruguay. The prominent feature of the Uruguay Round (UR), as it came to be called, was the attempt of developed countries to extend GATT-type rules and principles applicable to trade in goods to services, international flows of capital and technology. Services, invest |                    

ment and technology had never been a focus in the GATT negotiations. In this respect the UR represented a point of departure. The objective was to evolve a multilateral system with built-in provisions for the elimination of regulatory measures that host country governments might adopt. These have been sought to be covered through the General Agreement on Trade in Services (GATS), the Agreement on Trade-Related Investment Measures (TRIMs), and the Agreement on Trade-Related Intellectual Property Rights (TRIPs). These attempts of developed countries to extend the domain of the GATT to services, investments and technology were resisted by developing countries, though without any success because of the domination of GATT decision-making by major trading countries. 1. Agreement on Trade-Related Investment Measures (TRIMs)

The developed countries, led by the USA, moved to include the Agreement on TRIMs in the Uruguay Round of GATT negotiations, with the objective of phasing such measures out. Host governments have used a variety of performance requirements such as local content requirements, phased manufacturing programmes and export obligations to orient the operations of transnational enterprises in conformity with their public policy. These performance requirements are called ‘TRIMs’ as they affect the international trade (exports and imports) resulting from the operations of an enterprise. Both developing and developed host countries have used TRIMs as policy tools. Thus the European Community (EC) countries have imposed rules of origin, screwdriver regulations and voluntary export restraints (VERs), among other measures, on Japanese exporters of automobiles and electronics to force them to produce locally for the EC markets. TRIMs became a major source of North–South contention in the Uruguay Round negotiations. The industrialized countries argued that TRIMs cause distortions in patterns of trade and investment because business decisions on the part of TNCs come to be made on the basis of considerations other than market forces. The developing countries argued that TRIMs could be useful policy tools to promote development objectives and strengthen trade balances. As seen later in Chapters 4 and 5, the TRIMs Agreement in the Uruguay Round thus seriously curtails the ability of host developing countries to regulate the operations of TNCs in accordance to their policy. The Agreement on TRIMs provides for phasing out of two types of TRIMs and also provides an illustrative list of them. These are:  |  

• TRIMs that are inconsistent with the national treatment principle, such as local content requirements and import balancing imposed on foreign corporations. • TRIMs that are inconsistent with elimination of quantitative restrictions, such as limitation of imports to certain proportion of output or exports, foreign exchange limits and export limitation. The TRIMs Agreement allowed for a phased implementation of its provisions and for a review by the Council for Trade in Goods within five years from the date of entry into force of the WTO Agreement, which could consider whether the Agreement should be complemented with provisions on investment policy and competition policy, as discussed later in Chapters 4 and 5. 2. The General Agreement on Trade in Services (GATS)

Services, like investment and intellectual property, were brought within the ambit of multilateral trade negotiations for the first time in the UR. The General Agreement on Trade in Services (GATS) negotiated during the UR provides a framework for the liberalization of trade in services. The GATS approaches liberalization progressively. Hence Section XIX of the Agreement mandates Successive Rounds beginning in 2000, which are already under way. The Doha Declaration provides for continuation of these negotiations. GATS incorporates MFN and national treatment on the lines of the GATT. However, exception from and flexibility of these rules are permitted, recognizing the basic principle that ‘liberalization should take place with due respect for the level of development of individual members’.5 The GATS defines four modes of trade in services: • • • •

Mode 1: cross-border supply; Mode 2: consumption abroad; Mode 3: supply through commercial presence abroad; and Mode 4: supply through movement of natural persons.

Of these, Mode 3 – supply through commercial presence abroad – can be treated as foreign direct investment in services. Members may make commitments guranteeing the right to supply services under any or all of these modes. For each service on which a commitment is made, the schedule must indicate, under each of the four modes, any limitations on market access or national treatment that are intended to be maintained. For instance, market access commitments could be subject to ‘economic needs test’, or the number of foreign natural persons could be limited  |                    

to a certain proportion of the workforce. Limitations from national treatment could relate to a special subsidy or tax treatment granted to domestic suppliers, differential capital requirements and special operational limits applying only to operations of foreign suppliers. Therefore the national treatment under the GATS is subject to conditions and qualifications set therein. 3. The OECD’s MAI

The attempts by developed countries to evolve a more comprehensive multilateral framework on investment beyond what is covered under TRIMs and GATS, include an aborted initiative to establish a Multilateral Agreement on Investment (MAI) under the aegis of the OECD initiated in 1995. The MAI was to be a legally binding treaty open to even non-OECD member states to ensure higher standards of protection and legal security for foreign investors. In any case the OECD expected the proposed MAI Treaty to become a sort of benchmark for investors to rate the treatment accorded to foreign investors. The OECD negotiations on the MAI could not be successfully concluded, however, because of differences among the OECD countries, and were abandoned in 1998. The OECD’s draft MAI was based on the principles of national treatment and most-favoured nation (MFN) to foreign investors applicable to both pre- and post-investment phases (see OECD 1997; European Commission 1995). The implication of these provisions was that the host countries would not be able to accord a more favourable treatment to local enterprises over foreign enterprises, although according a more favourable treatment to the latter was not excluded. Since the provisions were to apply to both pre- as well as post-investment phases, the screening mechanisms established by host countries to select FDI projects would not be possible and all types of performance requirements on MNEs will have to be phased out, as seen later in Chapter 6. 4. Multilateral Framework on Investment at the WTO: Singapore to

Doha The MAI negotiations failed because of the failure of OECD members to reach a consensus on the issue. The OECD members were seeking the recognition of standards in other countries that they were not willing to give themselves. This is clear from the fact that the lists of exceptions submitted by different countries to the negotiations numbered over 700. Given the fact that WTO membership is infinitely more heterogeneous than OECD membership, covering as diverse a group as rich developed  |  

countries, least developed countries, low-income countries and so on, it is rather audacious to expect to bring about a consensus in this forum on an issue as contentious as investment regimes. However, even before the experiences of MAI negotiations in OECD were available, an attempt was made to push the investment issue on to the WTO’s agenda. The EU and Canada proposed to create a Possible Multilateral Framework on Investment (PMFI) under the auspices of the WTO at its first ministerial meeting in Singapore in 1996. The OECD’s MAI was to provide a model for PMFI, if not one to be adopted bodily. However, developing countries resisted a negotiating mandate on the issue. Hence a compromise was found to establish a Working Group on Trade and Investment (WGTI) in the WTO to study the issue without a negotiating mandate. 6 The study process at the WGTI has continued since 1996. Before it could conclude its work and recommend the desirability, if any, of a multilateral framework on investment within WTO’s ambit, the EU with the support of other industrialized countries pushed the investment issue for negotiations at the Fourth Ministerial Conference of WTO held in Doha in November 2001. Despite the resistance of the developing countries, which wanted first to complete the study process at the WGTI before agreeing to a negotiating mandate, the Doha Declaration provided for the launch of negotiations on trade and investment after the Fifth Ministerial Conference ‘on the basis of a decision taken, by explicit consensus, at that Session on the modalities of negotiations’.7 Concluding remarks

This chapter has overviewed international intervention in the area of investments. The need for and relevance of international intervention for regulating cross-border economic activity has been highlighted. The intervention has been both promotional as well as regulatory. The regulatory intervention includes initiatives taken by the UN Commission on TNCs, UNCTAD, the ILO and the OECD to evolve norms and codes of conduct of TNCs during the 1970s. Most of these initiatives, though well intentioned, were crippled or rendered ineffective by the resistance and stiff attitude adopted by industrialized countries at the negotiations. The World Bank affiliates have been promoting FDI flows by providing investment guarantees and arbitration facilities. Since the late 1980s industrialized countries have attempted to curb the ability of national governments to regulate the operations of TNCs through multilateral trade negotiations. The Agreement on TRIMs came into being as a result of such initiatives. There have been further attempts by developed  |                    

countries to evolve a far more rigorous and favourable regime for TNCs in the 1990s. These include WTO Agreements on TRIPs, the GATS and the WGTI and the Doha Declaration’s intent to launch negotiations on a multilateral framework on trade and investment, which are likely to have far-reaching consequences for the process of development of developing countries, as will be seen in the following chapters. Notes

1 See for instance UNCTAD (1974) Major Issues Arising from the Transfer of Technology, Geneva, UN. 2. See the full text of the Declaration at www.ilo.org. 3. Declaration of International Investment and Multinational Enterprises, DAFFE/IME (2000: 20). Paris: OECD, available at www.oecd.org. 4. See http://www.miga.org, for more details. 5. See WTO (2001), Market Access: Unfinished Business – Post-Uruguay Round Inventory of Issues, Special Study 6, Geneva: WTO, p. 99. 6. See Singapore Ministerial Declaration, WT/MIN(96)/DEC, 18 December 1996. 7. See Doha Ministerial Declaration adopted on 14 November 2001; WT/ MIN(01)/DEC/1.

 |  

Appendix one

Draft United Nations Code of Conduct on Transnational Corporations as of summer 1986

Preamble and objectives a/ Definitions and scope of application

1. (a) [The term ‘transnational corporations’ as used in this Code means an enterprise, comprising entities in two or more countries, regardless of the legal form and fields of activity of these entities, which operates under a system of decision-making, permitting coherent policies and a common strategy through one or more decision-making centres, in which the entities are so linked, by ownership or otherwise, that one or more of them may be able to exercise a significant influence over the activities of others, and, in particular, to share knowledge, resources and responsibilities with the others.] [The term ‘transnational corporation’ as used in this Code means an enterprise whether of public, private or mixed ownership, comprising entities in two or more countries, regardless of the legal form and fields of activity of these entities, which operates under a system of decision-making, permitting coherent policies and a common strategy through one or more decision-making centres, in which the entities are so linked, by ownership or otherwise, that one or more of them [may be able to] exercise a significant influence over the activities of others, and, in particular, to share knowledge, resources and responsibilities with the others.] (b) The term ‘entities’ in the Code refers to both parent entities – that is, entities which are the main source of influence over others – and other entities, unless otherwise specified in the Code. (c) The term ‘transnational corporation’ in the Code refers to the enterprise as a whole or its various entities. (d) The term ‘home country’ means the country in which the parent entity is located. The term ‘host country’ means a country in which an entity other than the parent entity is located. (e) The term ‘country in which a transnational corporation operates’ refers to a home or host country in which an entity of a transnational corporation conducts operations. 2. [The Code is universally applicable in, and to this end is open to adoption by, all States.]

[The Code is universally applicable in [home and host countries of transnational corporations] [as defined in paragraph 1 (a)], and to this end is open to adoption by, all States [regardless of their political and economic systems and their level of development].] [The Code is open to adoption by all States and is applicable in all States where an entity of a transnational corporation conducts operations.] The Code is universally applicable to all States regardless of their political and economic systems and their level of development.] [This Code applies to all enterprises as defined in paragraph 1 (a) above.] [To be placed in paragraph 1 (a).] [4. The provisions of the Code addressed to transnational corporations reflect good practice for all enterprises. They are not intended to introduce differences of conduct between transnational corporations and domestic enterprises. Wherever the provisions are relevant to both, transnational corporations and domestic enterprises should be subject to the same expectations in regard to their conduct.] [To be deleted]1 [5. Any reference in this Code to States, countries or Governments also includes regional groupings of States, to the extent that the provisions of this Code relate to matters within these groupings’ own competence, with respect to such competence.] (To be deleted) Activities of Transnational Corporations A. General and political

Respect for national sovereignty and observance of domestic laws, regulations and administrative practices 6. Transnational corporations should/shall respect the national sovereignty of the countries in which they operate and the right of each State to exercise its [full permanent sovereignty] [in accordance with international law] [in accordance with agreements reached by the countries concerned on a bilateral and multilateral basis] over its natural resources [wealth and economic activities] within its territory. 7. [Transnational corporations] [Entities of transnational corporations] [shall/should observe] [are subject to] the laws, regulations [jurisdiction] and [administrative practices] [explicitly declared administrative practices] of the countries in which they operate. [Entities of transnational corporations are subject to the jurisdiction of the countries in which they operate to the extent required by the national law of these countries.]  |  

8. Transnational corporations should/shall respect the right of each State to regulate and monitor accordingly the activities of their entities operating within its territory. Adherence to economic goals and development objectives, policies and priorities 9. Transnational corporations shall/should carry on their activities in conformity with the development policies, objectives and priorities set out by the Governments of the countries in which they operate and work seriously towards making a positive contribution to the achievement of such goals at the national and, as appropriate, the regional level, within the framework of regional integration programmes. Transnational corporations shall/should co-operate with the Governments of the countries in which they operate with a view to contributing to the development process and shall/should be responsive to requests for consultation in this respect, thereby establishing mutually beneficial relations with these countries. 10. Transnational corporations shall/should carry out their operations in conformity with relevant intergovernmental co-operative arrangements concluded by countries in which they operate. Review and renegotiation of contracts

11. Contracts between Governments and transnational corporations should be negotiated and implemented in good faith. In such contracts, especially long-term ones, review or renegotiation clauses should normally be included. In the absence of such clauses and where there has been a fundamental change of the circumstances on which the contract or agreement was based, transnational corporations, acting in good faith, shall/should co-operate with Governments for the review or renegotiation of such contract or agreement. Review or renegotiation of such contracts or agreements shall/should be subject to [the laws of the host country] [relevant national laws and international legal principles]. Adherence to socio-cultural objectives and values

12. Transnational corporations should/shall respect the social and cultural objectives, values and traditions of the countries in which they operate. While economic and technological development is normally accompanied by social change, transnational corporations should/shall 

avoid practices, products or services which cause detrimental effects on cultural patterns and socio-cultural objectives as determined by Governments. For this purpose, transnational corporations should/shall respond positively to requests for consultations from Governments concerned. Respect for human rights and fundamental freedoms

13. Transnational corporations should/shall respect human rights and fundamental freedoms in the countries in which they operate. In their social and industrial relations, transnational corporations should/shall not discriminate on the basis of race, colour, sex, religion, language, social, national and ethnic origin or political or other opinion. Transnational corporations should/shall conform to government policies designed to extend equality of opportunity and treatment. Non-collaboration by transnational corporations with racist minority regimes in southern Africa 14. In accordance with the efforts of the international community towards the elimination of apartheid in South Africa and its continued illegal occupation of Namibia, [(a) Transnational corporations shall progressively reduce their business activities and make no further investment in South Africa and immediately cease all business activities in Namibia; (b) Transnational corporations shall refrain from collaborating directly or indirectly with that regime especially with regard to its racist practices in South Africa and illegal occupation of Namibia to ensure the successful implementation of United Nations resolutions in relation to these two countries.] [Transnational corporations operating in southern Africa; (a) Should respect the national laws and regulations adopted in pursuance of Security Council decisions concerning southern Africa; (b) Should within the framework of their business activities engage inappropriate activities with a view to contributing to the elimination of racial discrimination practices under the system of apartheid.] Non-interference in internal political affairs

15. Transnational corporations should/shall not interfere [illegally] in the internal [political] affairs of the countries in which they operate [by resorting to] [They should refrain from any] [subversive and other [illicit]] activities [aimed at] undermining the political and social systems in these countries.  |  

16. Transnational corporations should/shall not engage in activities of a political nature which are not permitted by the laws and established policies and administrative practices of the countries in which they operate. Non-interference in intergovernmental relations

17. Transnational corporations should/shall not interfere in [any affairs concerning] intergovernmental relations [, which are the sole concern of Governments]. 18. Transnational corporations shall/should not request Governments acting on their behalf to take the measures referred to in the second sentence of paragraph 65. 19. With respect to the exhaustion of local remedies, transnational corporations should/shall not request Governments to act on their behalf in any manner inconsistent with paragraph 65. Abstention from corrupt practices

20. [Transnational corporations shall refrain, in their transactions, from the offering, promising or giving or any payment, gift or other advantage to or for the benefit of a public official as consideration for performing or refraining from the performance of his duties in connection with those transactions. Transnational corporations shall maintain accurate records of payments made by them, in connection with their transactions, to any public official or intermediary. They shall make available these records to the competent authorities of the countries in which they operate, upon request, for investigations and proceedings concerning those payments.] [For the purposes of this Code, the principles set out in the International Agreement on Illicit Payments adopted by the United Nations should apply in the area of abstention from corrupt practices.]2 B. Economic, financial and social Ownership and control

21. Transnational corporations should/shall make every effort so to allocate their decision-making powers among their entities as to enable them to contribute to the economic and social development of the countries in which they operate. 22. To the extent permitted by national laws, policies and regulations of the country in which it operates, each entity of a transnational corporation should/shall co-operate with the other entities, in accordance 

with the actual distribution of responsibilities among them and consistent with paragraph 21, so as to enable each entity to meet effectively the requirements established by the laws, policies and regulations of the country in which it operates. 23. Transnational corporations shall/should co-operate with Governments and nationals of the countries in which they operate in the implementation of national objectives for local equity participation and for the effective exercise of control by local partners as determined by equity, contractual terms in non-equity arrangements or the laws of such countries. 24. Transnational corporations should/shall carry out their personnel policies in accordance with the national policies of each of the countries in which they operate which give priority to the employment and promotion of its [adequately qualified] nationals at all levels of management and direction of the affairs of each entity so as to enhance the effective participation of its nationals in the decision-making process. 25. Transnational corporations should/shall contribute to the managerial and technical training of nationals of the countries in which they operate and facilitate their employment at all levels of management of the entities and enterprises as a whole. Balance of payments and financing b/

26. Transnational corporations should/shall carry on their operations in conformity with laws and regulations and with full regard to the policy objectives set out by the countries in which they operate, particularly developing countries, relating to balance of payments, financial transactions and other issues dealt with in the subsequent paragraphs of this section. 27. Transnational corporations should/shall respond positively to requests for consultation on their activities from the Governments of the countries in which they operate, with a view to contributing to the alleviation of pressing problems of balance of payments and finance of such countries. 28. [As required by government regulations and in furtherance of government policies] [Consistent with the purpose, nature and extent of their operations] transnational corporations should/shall contribute to the promotion of exports and the diversification of exports [and imports] in the countries in which they operate and to an increased utilization of goods, services and other resources which are available in these countries.  |  

29. Transnational corporations should/shall be responsive to requests by Governments of the countries in which they operate, particularly developing countries, concerning the phasing over a limited period of time of the repatriation of capital in case of disinvestment or remittances of accumulated profits, when the size and timing of such transfers would cause serious balance-of-payments difficulties for such countries. 30. Transnational corporations should/shall not, contrary to generally accepted financial practices prevailing in the countries in which they operate, engage in short-term financial operations or transfers or defer or advance foreign exchange payments, including intra-corporate payments, in a manner which would increase currency instability and thereby cause serious balance-of-payments difficulties for the countries concerned. 31. Transnational corporations should/shall not impose restrictions on their entities, beyond generally accepted commercial practices prevailing in the countries in which they operate, regarding the transfer of goods, services and funds which would cause serious balance-of-payments difficulties for the countries in which they operate. 32. When having recourse to the money and capital markets of the countries in which they operate, transnational corporations should/shall not, beyond generally accepted financial practices prevailing in such countries, engage in activities which would have a significant adverse impact on the working of local markets, particularly by restricting the availability of funds to other enterprises. When issuing shares with the objective of increasing local equity participation in an entity operating in such a country, or engaging in long-term borrowing in the local market, transnational corporations shall/should consult with the Government of the country concerned upon its request on the effects of such transactions on the local money and capital markets. Transfer pricing

33. In respect of their intra-corporate transactions, transnational corporations should/shall not use pricing policies that are not based on relevant market prices, or, in the absence of such prices, the arm’s length principle, which have the effect of modifying the tax base on which their entities are assessed or of evading exchange control measures [or customs valuation regulations] [or which [contrary to national laws and regulations] adversely affect economic and social conditions] of the countries in which they operate. 34. Transnational corporations should/shall not, contrary to the laws and regulations of the countries in which they operate, use their cor

porate structure and modes of operation, such as the use of intra-corporate pricing which is not based on the arm’s length principle, or other means, to modify the tax base on which their entities are assessed. Competition and restrictive business practices

35. For the purpose of this Code, the relevant provisions of the Set of Multilaterally Agreed Equitable Principles and Rules for the Control of Restrictive Business Practices adopted by the General Assembly in its resolution 35/63 of 5 December 1980 shall/should also apply in the field of restrictive business practices.c/ Transfer of technology

36. [Transnational corporations shall conform to the transfer of technology laws and regulations of the countries in which they operate. They shall co-operate with the competent authorities of those countries in assessing the impact of international transfers of technology in their economies and consult with them regarding the various technological options which might help those countries, particularly developing countries, to attain their economic and social development. Transnational corporations in their transfer of technology transactions, including intra-corporate transactions, shall avoid practices which adversely affect the international flow of technology, or otherwise hinder the economic and technological development of countries, particularly developing countries. Transnational corporations shall contribute to the strengthening of the scientific and technological capacities of developing countries, in accordance with the science and technology policies and priorities of those countries. Transnational corporations shall undertake substantial research and development activities in developing countries and make full use of local resources and personnel in this process.] [For the purposes of this Code the relevant provisions of the International Code of Conduct on the Transfer of Technology adopted by the General Assembly in its resolution___________ of _________shall/ should apply in the field of transfer of technology.]3 Consumer protection

37. Transnational corporations shall/should carry out their operations, in particular production and marketing, in accordance with national laws, regulations, administrative practices and policies concerning consumer protection of the countries in which they operate. Transnational  |  

corporations shall/should also perform their activities with due regard to relevant international standards, so that they do not cause injury to the health or endanger the safety of consumers or bring about variations in the quality of products in each market which would have detrimental effects on consumers. 38. Transnational corporations shall/should, in respect of the products and services which they produce or market or propose to produce or market in any country, supply to the competent authorities of that country on request or on a regular basis, as specified by these authorities, all relevant information concerning: Characteristics of these products or services which may be injurious to the health and safety of consumers including experimental uses and related aspects; Prohibitions, restrictions, warnings and other public regulatory measures imposed in other countries on grounds of health and safety protection on these products or services. 39. Transnational corporations shall/should disclose to the public in the countries in which they operate all appropriate information on the contents and, to the extent known, on possible hazardous effects of the products they produce or market in the countries concerned by means of proper labelling, informative and accurate advertising or other appropriate methods. Packaging of their products should be safe and the contents of the product should not be misrepresented. 40. Transnational corporations shall/should be responsive to requests from Governments of the countries in which they operate and be prepared to co-operate with international organizations in their efforts to develop and promote national and international standards for the protection of the health and safety of consumers and to meet the basic needs of consumers. Environmental protection

41. Transnational corporations shall/should carry out their activities in accordance with national laws, regulations, administrative practices and policies relating to the preservation of the environment of the countries in which they operate and with due regard to relevant international standards. Transnational corporations shall/should, in performing their activities, take steps to protect the environment and where damaged to [restore it to the extent appropriate and feasible] [rehabilitate it] and should make efforts to develop and apply adequate technologies for this purpose. 

42. Transnational corporations shall/should, in respect of the products, processes and services they have introduced or propose to introduce in any country, supply to the competent authorities of that country on request or on a regular basis, as specified by these authorities, all relevant information concerning: Characteristics of these products, processes and other activities including experimental uses and related aspects which may harm the environment and the measures and costs necessary to avoid or at least to mitigate their harmful effects; Prohibitions, restrictions, warnings and other public regulatory measures imposed in other countries on grounds of protection of the environment on these products, processes and services. 43. Transnational corporations shall/should be responsive to requests from Governments of the countries in which they operate and be prepared where appropriate to co-operate with international organizations in their efforts to develop and promote national and international standards for the protection of the environment. C. Disclosure of information

44. Transnational corporations should disclose to the public in the countries in which they operate, by appropriate means of communication, clear, full and comprehensible information on the structure, policies, activities and operations of the transnational corporation as a whole. The information should include financial as well as non-financial items and should be made available on a regular annual basis, normally within six months and in any case not later than 12 months from the end of the financial year of the corporation. In addition, during the financial year, transnational corporations should wherever appropriate make available a semi-annual summary of financial information. The financial information to be disclosed annually should be provided where appropriate on a consolidated basis, together with suitable explanatory notes and should include, inter alia, the following: (a) A balance sheet; (b) An income statement, including operating results and sales; (c) A statement of allocation of net profits or net income; (d) A statement of the sources and uses of funds; (e) Significant new long-term capital investment; (f ) Research and development expenditure. The non-financial information referred to in the first subparagraph should include, inter alia:  |  

(a) The structure of the transnational corporation, showing the name and location of the parent company, its main entities, its percentage ownership, direct and indirect, in these entities, including shareholdings between them; (b) The main activity of its entities; (c) Employment information including average number of employees; (d) Accounting policies used in compiling and consolidating the information published; (e) Policies applied in respect of transfer pricing. The information provided for the transnational corporation as a whole should as far as practicable be broken down: By geographical area or country, as appropriate, with regard to the activities of its main entities, sales, operating results, significant new investments and number of employees; By major line of business as regards sales and significant new investment. The method of breakdown as well as details of information provided should/shall be determined by the nature, scale and interrelationships of the transnational corporation’s operations, with due regard to their significance for the areas or countries concerned. The extent, detail and frequency of the information provided should take into account the nature and size of the transnational corporation as a whole, the requirements of confidentiality and effects on the transnational corporation’s competitive position as well as the cost involved in producing the information. The information herein required should, as necessary, be in addition to information required by national laws, regulations and administrative practices of the countries in which transnational corporations operate. 45. Transnational corporations should/shall supply to the competent authorities in each of the countries in which they operate, upon request or on a regular basis as specified by those authorities, and in accordance with national legislation, all information required for legislative and administrative purposes relevant to the activities and policies of their entities in the country concerned. Transnational corporations should/shall, to the extent permitted by the provisions of the relevant national laws, regulations, administrative practices and policies of the countries concerned, supply to competent authorities in the countries in which they operate information held in other countries needed to enable them to obtain a true and fair view of 

the operations of the transnational corporation concerned as a whole in so far as the information requested relates to the activities of the entities in the countries seeking such information. The provisions of paragraph 51 concerning confidentiality shall apply to information supplied under the provisions of this paragraph. 46. With due regard to the relevant provisions of the ILO Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy and in accordance with national laws, regulations and practices in the field of labour relations, transnational corporations should/shall provide to trade unions or other representatives of employees in their entities in each of the countries in which they operate, by appropriate means of communication, the necessary information on the activities dealt with in this code to enable them to obtain a true and fair view of the performance of the local entity and, where appropriate, the corporation as a whole. Such information should/shall include, where provided for by national law and practices, inter alia, prospects or plans for future development having major economic and social effects on the employees concerned. Procedures for consultation on matters of mutual concern should/ shall be worked out by mutual agreement between entities of transnational corporations and trade unions or other representatives of employees in accordance with national law and practice. Information made available pursuant to the provisions of this paragraph should be subject to appropriate safeguards for confidentiality so that no damage is caused to the parties concerned. Treatment of Transnational Corporations A. General treatment of transnational corporations by the countries in which they operate

47. States have the right to regulate the entry and establishment of transnational corporations including determining the role that such corporations may play in economic and social development and prohibiting or limiting the extent of their presence in specific sectors. 48. Transnational corporations should receive [fair and] equitable [and non-discriminatory] treatment [under] [in accordance with] the laws, regulations and administrative practices of the countries in which they operate [as well as intergovernmental obligations to which the Governments of these countries have freely subscribed] [consistent with their international obligations] [consistent with international law]. 49. Consistent with [national constitutional systems and] national  |  

needs to [protect essential/national economic interests,] maintain public order and to protect national security, [and with due regard to provisions of agreements among countries, particularly developing countries,] entities of transnational corporations should be given by the countries in which they operate [the treatment] [treatment no less favourable than that] [appropriate treatment]4 accorded to domestic enterprises under their laws, regulations and administrative practices [when the circumstances in which they operate are similar/identical] [in like situations] . [Transnational corporations should not claim preferential treatment or the incentives and concessions granted to domestic enterprises of the countries in which they operate.] [Such treatment should not necessarily include extension to entities of transnational corporations of incentives and concessions granted to domestic enterprises in order to promote self-reliant development or protect essential economic interests.] 5 [50. Endeavouring to assure the clarity and stability of national policies, laws, regulations and administrative practices is of acknowledged importance. Laws, regulations and other measures affecting transnational corporations should be publicly and readily available. Changes in them should be made with proper regard to the legitimate rights and interests of all concerned parties, including transnational corporations.] [To be deleted] 51. Information furnished by transnational corporations to the authorities in each of the countries in which they operate containing [legitimate business secrets] [confidential business information] should be accorded reasonable safeguards normally applicable in the area in which the information is provided, particularly to protect its confidentiality. [52. In order to achieve the purposes of paragraph 25 relating to managerial and technical training and employment of nationals of the countries in which transnational corporations operate, the transfer of those nationals between the entities of a transnational corporation should, where consistent with the laws and regulations of the countries concerned, be facilitated.] [To be deleted] 53. [Transnational corporations should be able to transfer freely and without restriction all payments relating to their investments such as income from invested capital and the repatriation of this capital when this investment is terminated, and licensing and technical assistance fees and other royalties, without prejudice to the relevant provisions of the ‘Balance of payments and financing’ section of this Code and, in particular, its paragraph 29.] 

[To be deleted] B. Nationalization and compensation

54. [In the exercise of its right to nationalize or expropriate totally or partially the assets of transnational corporations operating in its territory, the State adopting those measures should pay adequate compensation taking into account its own laws and regulations and all the circumstances which the State may deem relevant. When the question of compensation gives rise to controversy or should there be a dispute as to whether a nationalization or expropriation has taken place, it shall be settled under the domestic law of the nationalizing or expropriating State and by its tribunals.] [In the exercise of their sovereignty, States have the right to nationalize or expropriate foreign-owned property in their territory. Any such taking of property whether direct or indirect, consistent with international law, must be non-discriminatory, for a public purpose, in accordance with due process of law, and not be in violation of specific undertakings to the contrary by contract or other agreement) and be accompanied by the payment of prompt, adequate and effective compensation. Such compensation should correspond to the full value of the property interests taken, on the basis of their fair market value, including going concern value, or where appropriate other internationally accepted methods of valuation, determined apart from any effects on value caused by the expropriatory measure or measures, or the expectation of them. Such compensation payments should be freely convertible and transferable, and should not be subject to any restrictive measures applicable to transfers of payments, income or capital.] [In the exercise of its sovereignty, a State has the right to nationalize or expropriate totally or partially the assets of transnational corporations in its territory, and appropriate compensation should be paid by the State adopting such measures, in accordance with its own laws and regulations and all the circumstances which the State deems relevant. Relevant international obligations freely undertaken by the States concerned apply.] [A State has the right to nationalize or expropriate the assets of transnational corporations in its territory against compensation, in accordance with its own laws and regulations and its international obligations.] C. Jurisdiction

[55.] [Entities of transnational corporations are subject to the jurisdiction of the countries in which they operate.]  |  

[An entity of a transnational corporation operating in a given country is subject to the jurisdiction of such a country] [in respect of its operations in that country.] [To be deleted] 56. [Disputes between a State and an entity of a transnational corporation operating in its territory are subject to the jurisdiction of the courts and other competent authorities of that State unless amicably settled between the parties.] [Disputes between a State and an entity of a transnational corporation which are not amicably settled between the parties or resolved in accordance with previously agreed dispute settlement procedures, should be submitted to competent courts or other authorities, or to other agreed means of settlement, such as arbitration.] [Disputes between States and entities of transnational corporations, which are not amicably settled between the parties, shall/should be submitted to competent national courts or authorities in conformity with the principle of paragraph 7. Where the parties so agree, such disputes may be referred to other mutually acceptable dispute settlement procedures.] [57. In contracts in which at least one party is an entity of a transnational corporation the parties should be free to choose the applicable law and the form for settlement of disputes, including arbitration, it being understood that such a choice may be limited in its effects by the law of the countries concerned.] [To be deleted] 58. [States should [use moderation and restraint in order to] [seek to] avoid [undue] encroachment on a jurisdiction more [properly appertaining to, or more] appropriately exercisable, by another State.] Where the exercise of jurisdiction over transnational corporations and their entities by more than one State may lead to conflicts of jurisdiction, States concerned should endeavour to adopt mutually acceptable [principles and procedures, bilaterally or multilaterally, for the avoidance or settlement of such conflicts,] [arrangements] on the basis of respect for [their mutual interests] [the principle of sovereign equality and mutual interests.] [To be placed in the section on intergovernmental co-operation.] Intergovernmental Co-operation

59. [It is acknowledged] [States agree] that intergovernmental cooperation is essential in accomplishing the objectives of the Code. 

60. (States agree that] intergovernmental co-operation should be established or strengthened at the international level and, where appropriate, at the bilateral, regional and interregional levels [with a view to promoting the contribution of transnational corporations to their developmental goals, particularly those of developing countries, while controlling and eliminating their negative effects].6 61. States [agree to] [should] exchange information on the measures they have taken to give effect to the Code and on their experience with the Code. 62. States [agree to] [should] consult on a bilateral or multilateral basis, as appropriate, on matters relating to the Code and its application [in particular on conflicting requirements imposed on transnational corporations by the countries in which they operate and issues of conflicting national jurisdictions] [in particular in relation to conflicting requirements imposed by parent companies on their entities operating in different countries] and with respect to the development of international agreements and arrangements on-issues related to the Code. 63. States [agree to] [should] take into consideration the objectives of the Code as reflected in its provisions when negotiating bilateral or multilateral agreements concerning transnational corporations. 64. States [agree not to use] [should not use] transnational corporations as instruments to intervene in the internal or external affairs of other States [and agree to take appropriate action within their jurisdiction to prevent transnational corporations from engaging in activities referred to in paragraph 15 to 17 of this Code]. 65. Government action on behalf of a transnational corporation operating in another country should/shall be subject to the principle of exhaustion of local remedies provided in such a country and, when agreed among the Governments concerned, to procedures for dealing with international legal claims. Such action should not in any event amount to the use of any type of coercive measures not consistent with the Charter of the United Nations and the Declaration on Principles of International Law concerning Friendly Relations and Co-operation among States in accordance with the Charter of the United Nations. Implementation of the Code of Conduct A. Action at the national level

66. In order to ensure and promote the implementation of the Code at the national level, States shall/should, inter alia:  |  

(a) Publicize and disseminate the Code; (b) Follow the implementation of the Code within their territories; (c) Report to the United Nations Commission on Transnational Corporations on the action taken at the national level to promote the Code and on the experience gained from its implementation; (d) Take actions to reflect their support for the Code and take into account the objectives of the Code as reflected in its provisions when introducing, implementing and reviewing laws, regulations and administrative practices on matters dealt with in the Code. B. International institutional machinery

67. The United Nations Commission on Transnational Corporations shall assume the functions of the international institutional machinery for the implementation of the Code. In this capacity, the Commission shall be open to the participation of all States having accepted the Code. [It may establish the subsidiary bodies and specific procedures it deems necessary for the effective discharge of its functions.] The United Nations Centre on Transnational Corporations shall act as the secretariat to the Commission. 68. The Commission shall act as the focal international body within the United Nations system for all matters related to the Code. It shall establish and maintain close contacts with other United Nations organizations and specialized agencies dealing with matters related to the Code and its implementation with a view to coordinating work related to the Code. When matters covered by international agreements or arrangements, specifically referred to in the Code, which have been worked out in other United Nations forums, arise, the Commission shall forward such matters to the competent bodies concerned with such agreements or arrangements. 69. The Commission shall have the following functions: (a) To discuss at its annual sessions matters related to the Code. If agreed by the Governments engaged in consultations on specific issues related to the Code, the Commission shall facilitate such intergovernmental consultations to the extent possible. [Representatives of trade unions, business, consumer and other relevant groups may express their views on matters related to the Code through the non-governmental organizations represented in the Commission.] (b) Periodically to assess the implementation of the Code, such assessments being based on reports submitted by Governments and, as appropriate, on documentation from United Nations organizations and 

specialized agencies performing work relevant to the Code and nongovernmental organizations represented in the Commission. The first assessment shall take place not earlier than two years and not later than three years after the adoption of the Code. The second assessment shall take place two years after the first one. The Commission shall determine whether a periodicity of two years is to be maintained or modified for subsequent assessments. The format of assessments shall be determined by the Commission. [(c) To provide [, upon the request of a Government,] clarification of the provisions of the Code in the light of actual situations in which the applicability and implications of the Code have been the subject of intergovernmental consultations. In clarifying the provisions of the Code, the Commission shall not draw conclusions concerning the conduct of the parties involved in the situation which led to the request for clarification. The clarification is to be restricted to issues illustrated by such a situation. The detailed procedures regarding clarification are to be determined by the Commission.] [To be deleted] (d) To report annually to the General Assembly [through the Economic Social Council] on its activities regarding the implementation of the Code. (e) To facilitate intergovernmental arrangements or agreements on aspects relating to transnational corporations upon request of the Governments concerned. 70. The United Nations Centre on Transnational Corporations shall provide assistance relating to the implementation of the Code, inter alia, by collecting analysing and disseminating information and conducting research and surveys, as required and specified by the Commission. C. Review procedure

71. The Commission shall make recommendations to the General Assembly [through the Economic and Social Council] for the purpose of reviewing the Code. The first review shall take place not later than six years after the adoption of the Code. The General Assembly shall establish, as appropriate, the modalities for reviewing the Code. 7

 |  

Appendix: Non-collaboration by transnational corporations with racist minority regimes in southern Africa a/

14. In accordance with the efforts of the international community towards the elimination of apartheid in South Africa and its illegal occupation of Namibia, (a) Transnational corporations shall/should refrain from operations and activities supporting and sustaining the racist minority regime of South Africa in maintaining the system of apartheid and the illegal occupation of Namibia; (b) Transnational corporations shall/should engage in appropriate activities within their competence with a view to eliminating racial discrimination and all other aspects of the system of apartheid; (c) Transnational corporations shall/should comply strictly with obligations resulting from Security Council decisions and shall/should fully respect those resulting from all relevant United Nations resolutions; (d) With regard to investment in Namibia, transnational corporations shall/should comply strictly with obligations resulting from Security Council resolution 283 (1970) and other relevant Security Council decisions and shall/should fully respect those resulting from all relevant United Nations resolutions. Notes

The text of paragraph 14 was agreed ad referendum in the working group on paragraph 14, but no final decision thereon was taken by the Commission. 1. On the grounds, inter alia, that the text within the first pair of brackets goes beyond the mandate of the Intergovernmental Working Group on a Code of Conduct. 2. To be included in one of the substantive introductory parts of the Code. 3. To be included in one of the substantive introductory parts of the Code. 4. In this alternative, the sentence will end here. 5. Some delegations preferred not to have a second sentence. 6. It is agreed that the last bracketed text will be deleted provided that the concept embodied therein is referred to in the section on objectives. 7. Further discussion of this provision will take place after related issues, such as the mode of adoption and the legal nature of the code, have been settled. a/ No drafting was done on the Preamble and objectives of the Code. However, the following text was drafted during the discussion on other parts 

of the Code and the decision was taken to place it in one of the substantive introductory parts of the Code: ‘For the purposes of this Code, the principles set out in the Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy, adopted by the Governing Body of the International Labour office, should apply in the field of employment, training, conditions of work and life and industrial relations.’ (No decision has yet been taken on the exact location of this paragraph.) b/ Some delegations accepted paragraphs 26, 30, 31 and 32 on balance of payments and financing on an ad referendum basis. c/ The placement of this paragraph has not yet been decided.

 |  

Appendix two

Multilaterally agreed equitable principles and rules for the control of restrictive business practices

Part IV – Section D: Principles and rules for enterprises, including transnational corporations

• Enterprises should conform to the restrictive business practices laws, and the provisions concerning restrictive business practices in other laws, of the countries in which they operate, and, in the event of proceedings under these laws, should be subject to the competence of the courts and relevant administrative bodies therein. • Enterprises should consult and co-operate with competent authorities of countries directly affected in controlling restrictive business practices adversely affecting the interests of those countries. In this regard, enterprises should also provide information, in particular details of restrictive arrangements, required for this purpose, including that which may be located in foreign countries, to the extent that in the latter event such production or disclosure is not prevented by applicable law or established public policy. Whenever the provision of information is on a voluntary basis, its provisions should be in accordance with safeguards normally applicable in this field. • Enterprises, except when dealing with each other in the context of an economic entity wherein they are under common control, including though ownership, or otherwise not able to act independently of each other, engaged on the market in rival or potentially rival activities, should refrain from practices such as the following when, through formal, informal, written or unwritten agreements or arrangements, they limit access to markets or otherwise unduly restrain competition, having or being likely to have adverse effects on international trade, particularly that of developing countries, and on the economic development of these countries: i. Agreements fixing prices, including as to exports and imports; ii. Collusive tendering; iii. Market or customer allocation arrangements; iv. Allocation by quota as to sales and production; v. Collective action to enforce arrangements, e.g. by concerted refusals to deal; vi. Concerted refusal of supplies to potential importers;

vii. Collective denial of access to an arrangement, or association, which is crucial to competition. • Enterprises should refrain from the following acts or behaviour in a relevant market when, through an abuse or acquisition and abuse of a dominant position of market power, they limit access to markets or otherwise unduly restrain competition, having or being likely to have adverse effects on international trade, particularly that of developing countries, and on the economic development of these countries: a. Predatory behaviour towards competitors, such as using below-cost pricing to eliminate competitors. b. Discriminatory (i.e. unjustifiably differentiated) pricing or terms or conditions in the supply or purchase of goods and services, including by means of the use of pricing policies in transactions between affiliated enterprises which overcharge or undercharge for goods or services purchased or supplied as compared with prices for similar or comparable transactions outside the affiliated enterprises; c. Mergers, takeovers, joint ventures or other acquisitions of control, whether of a horizontal, vertical or a conglomerate nature; d. Fixing the prices at which goods exported can be resold in importing countries; e. Restrictions on the importation of goods which have been legitimately marked abroad with a trademark identical with or similar to the trademark protected as to identical or similar goods in the importing country where the trademarks in question are of the same origin, i.e. belong to the same owner or are used by enterprises between which there is economic, organizational, managerial or legal interdependence and where the purpose of such restrictions is to maintain artificially high prices; f. When not for ensuring the achievement of legitimate business purposes, such as quality, safety, adequate distribution or service: Partial or complete refusals to deal on the enterprise’s customary commercial terms; i. Partial or complete refusals to deal on the enterprise’s customary commercial terms; ii. Making the supply of particular goods or services dependent upon the acceptance of restrictions on the distribution or manufacture of competing or other goods; iii. Imposing restrictions concerning where, or to whom, or in what form or quantities, goods supplied or other goods may be resold or exported;  |  

iv. Making the supply of particular goods or services dependent upon the purchase of other goods or services from the supplier or his designee. Source: http://www.unctad.org/en/subsites/cpolicy/docs/CPSet/cpsetp4d. htm

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Chapter four

The Agreement on Trade-Related Investment Measures

§ This chapter discusses the background surrounding the negotiations on investment Trade-Related Investment Measures in the Uruguay Round of Multilateral Trade Negotiations and the resultant Agreement on TradeRelated Investment Measures (TRIMs). The analysis provides an insight into political and commercial forces in developed and developing countries that acted in shaping the consensus reached in the Uruguay Round. It then discusses the main provisions of the TRIMs Agreement. Negotiating TRIMs in the Uruguay Round1

Trade-Related Investment Measures are performance requirements that have been employed extensively by host countries – both developing as well as developed – in order to regulate the operations of foreign investors, generally multinational corporations (MNCs), in tune with their development policy objectives. These include certain goals related to industrialization, employment creation, export promotion and other objectives of the host country. In some cases, TRIMs are just conditions imposed, in the form of performance requirements, on the operation of a foreign investor, but in others they are linked to the access to advantages offered by the host country’s government, such as tax incentives or subsidies. After the conclusion of the Tokyo Round of Multilateral Trade Negotiations in 1979, some developed countries, particularly the USA, attempted to bring under the purview of the General Agreement on Tariffs and Trade (GATT) the consideration of a limited number of performance requirements introduced by host countries with regard to foreign investors, particularly in relation to the use of local content and to export performance. Such countries argued that those requirements had effects clearly related to trade and should be addressed by the contracting parties of the GATT. However, several other contracting parties of the GATT, especially developing countries, maintained that the issue of foreign direct investment was beyond the competence of the GATT. No agreement on this issue was reached at the 1982 GATT ministerial meeting. A dispute brought by the USA against Canada on the administration of the Foreign Investment Review Act (FIRA) in 1982 gave an opportunity

to consider the extent to which investment measures were covered by the GATT, particularly Articles III:4 (national treatment on internal taxation), III:5 (national treatment on internal quantitative regulation), XI (general elimination of quantitative restrictions) and XVI:1 (subsidies). The FIRA case related to requirements imposed on foreign investors to purchase goods of Canadian origin in preference to imported goods, to manufacture goods in Canada that would otherwise have to be imported, and to export specified quantities of production. Despite the position of many countries, which held that investments were outside the scope of the GATT, the General Council decided to allow the panel to proceed. The panel found certain inconsistencies of Canada’s practice with Article III:4 and Article XVI:1 of the GATT. The USA then unilaterally adopted legislation in 1984 linking investment with trade. The United States Trade Act, as amended in 1984, authorized the government to retaliate against countries where the United States Trade Representative (USTR) determined that action by the USA was appropriate to respond to any export performance requirements of any foreign country or instrumentality that adversely affected the economic interests of the USA. In such a case, the USTR was empowered to seek to obtain the reduction and elimination of such export performance requirements and could impose duties or other import restrictions on the products or services of such entities for such time as is determined appropriate, including the exclusion from entry into the USA of products subject to such requirements (sections 301 and 307). During the preparatory process for the Uruguay Round, the USA proposed2 that the negotiations should: 1. seek to increase discipline over government investment measures that divert trade and investment flows at the expense of other contracting parties; 2. explore a broad range of investment issues in the negotiations, including national/most-favoured nation (MFN) treatment for new and established direct investment and the right to establish an investment; and 3. examine various types of Trade-Related Investment Measures such as local content requirements, export performance requirements, incentives and product mandating, which should be controlled and reduced in the light of specific articles of the GATT as well as its overall objectives. Despite the reluctance of developing countries, the investment issue was finally introduced as part of the negotiating package in the Punta del  |   

Este Ministerial Declaration (1986), which launched the Uruguay Round. GATT contracting parties agreed that as a part of the new Round, Following an examination of the operation of GATT Articles related to the trade restrictive and distorting effects of investment measures, negotiations should elaborate, as appropriate, further provisions that may be necessary to avoid such adverse effects on trade.3

The negotiations evidenced a variety of positions (see Box 4.1). A key negotiating point was the extent to which TRIMs were already covered by the GATT, or whether it was necessary to develop new disciplines. For many countries, any agreement to be reached in this area should only clarify existing rules, rather than creating a new set of disciplines. Other countries called for new rules. There were even attempts to go beyond the negotiated framework provided by the Punta del Este Ministerial Declaration, so as to develop broader rules, including on the right of establishment and national treatment. Thus the USA and Japan were in favour of an international investment regime that would establish rights for foreign investors and reduce constraints on transnational corporations. They believed that TRIMs could and did have adverse trade effects, and that this was a sufficient reason to make the case for applying general principles and disciplines to control them. Another significant point of contention was whether some or all actionable TRIMs should be prohibited per se or should be dealt with case by case, on the basis of demonstration of direct and significant restrictive and adverse effects on trade. According to some developed countries, the effects of TRIMs could not be separated from the measures themselves and hence they argued for their elimination altogether rather than for their reduction or control. This was, for instance, the position of the USA. The 1988 United States Omnibus Trade and Competitiveness Act, which provided the United States executive power with negotiating authority for the Uruguay Round, stipulated specific negotiating objectives for the USA in the area of FDI. Such objectives included the development of internationally agreed rules, including dispute settlement procedures, which will reduce or eliminate the trade-distortive effects of certain Trade-Related Investment Measures (Sections 1101 (b)(11), 102 Stat.1107 (codified at 19 U.S.C. sect. 2901 (1988). The position of other developed countries was more flexible. The European Community and the Nordic countries4 held that the direct and indirect trade effects of investment measures should be evaluated  |  

Box 4.1 Negotiating positions on TRIMs USA GATT already covered Trade-Related Investment Measures,

but these should be addressed more explicitly through the elaboration of additional disciplines. Certain TRIMs should be categorically prohibited, a test should be established to evaluate the adverse trade effects of other TRIMs, a framework should be developed to phase out prohibited TRIMs, a notification procedure should be developed, and an oversight committee should be established to review the work of the Agreement on TRIMs. Effective disciplines against TRIMs should be established prior to negotiating any arrangements for a transitional period during which developing countries would eliminate the prohibited TRIMs. TRIMs linked to incentives should be covered. Japan There is a need to include both national and local govern-

ment measures. In order to facilitate examination of the effects of TRIMs, they may be classified into those that are clearly inconsistent with the GATT (type A) such as local content, export performance, trade balancing, domestic sales, technology transfer, manufacturing, product mandating requirements, which should be prohibited, and those that are consistent with the GATT but are relevant to its provisions (type B) for which further general disciplines should be elaborated. Japan did not include investment incentives. Nordic countries Two types of TRIMs, i.e. local content and export

separately. TRIMs with direct effects were those with a significant restrictive impact on trade and a direct link to existing GATT rules. Indirect trade effects, in their opinion, were caused by TRIMs related to licensing, local equity and technology transfer requirements, remittances and exchange restrictions, and investment incentives. TRIMs with indirect effects should be subject to consultation and dispute settlement procedures. They also drew a clear distinction between the general issue of FDI and the more specific issues of Trade-Related Investment Measures, and opposed the inclusion in the negotiations of the right of establishment and transfer of resources. Developing countries from all regions (e.g. Brazil, Colombia, India, Bangladesh, Egypt, Pakistan, Malaysia, United Republic of Tanzania)  |   

performance requirements, should be phased out in accordance with a notification process, then undergo a binding period based on the results of the notifications, and finally an adjustment period in the light of the situation of developing and least developed countries. European Community Eight TRIMs meet the criterion of being

directed at the exports and imports of a company with the immediate objective of influencing its trading patterns: local content, manufacturing, export performance, product mandating, trade balancing, exchange restrictions, domestic sales, and manufacturing limitations concerning components of the final product. Developing countries (i) there could be no a priori presumption

that investment measures were inherently trade restrictive or distorting; (ii) if it were demonstrated that, in certain circumstances and on a case-by-case basis, some investment measures did indeed have a direct and significant adverse effect on trade, a clear causal link would need to be established between the measure and the alleged effect; (iii) if such a link was established, the nature and impact on the interests of the affected party would have to be assessed; (iv) once the above-mentioned steps had been undertaken, appropriate ways and means would have to be found to deal with the demonstrated adverse effects; and (v) the foregoing meant that it was the effects and not the measures themselves that needed to be addressed.5

called for strict adherence to the mandate and for limiting the negotiating exercise to the effects of investment measures or regulations that had a direct and significant negative effect on trade. While highlighting their need for foreign direct investment, they maintained that certain investment measures or performance requirements were necessary to channel foreign investment according to their national development policy objectives. Developing countries argued that they used TRIMs to offset the anti-competitive practices of the transnational corporations (TNCs), and that these should be addressed, particularly the restrictive business practices (RBPs), which in themselves would have trade-distorting effects. Developing countries also stressed the necessity of differential and  |  

more favourable treatment. In this context they cited the FIRA Panel’s recognition that in disputes involving less-developed (i.e. developing) GATT contracting parties, full account should be taken of the special provisions of the General Agreement on Tariffs and Trade relating to these countries (such as Article XVIII:C – governmental assistance to economic development). Malaysia linked TRIMs to the provisions of GATT Part IV (trade and development), in particular Articles XXXVI:3, XXXVI:5, XXXVI:9 and XXXVII:3(c). Some developed countries believed that, following the establishment of disciplines on TRIMs containing obligations for all participants, considerations relating to development could be addressed (see Box 4.1). India’s comprehensive proposal on TRIMs included, inter alia, a part on specific investment measures and their trade effects, in which it was stated that there were two performance requirements that could have trade effects: export performance requirements and local content/manufacturing. These measures, however, did not have adverse trade effects in all circumstances; their developmental dimensions far outweighed their trade effects in the case of developing countries; and they were used to counter restrictive business practices of TNCs. After May 1990 the chairman of the TRIMs Negotiating Group issued several drafts6 designed to integrate the different approaches mentioned above.7 The chairman’s drafts encountered considerable opposition on all sides, particularly on the following questions: (i) on coverage, whether the agreement would cover measures imposed only when the investment was made, or also measures applied to established firms, and whether TRIMs that were enforceable through a government offering or the withdrawal of advantages and particularly subsidies should be covered or only TRIMs that were legally enforceable; (ii) on prohibition, the divergences of view related to whether TRIMs should be avoided on a case-by-case basis through trade remedies only, or in certain cases by prohibition as well (e.g. those already prohibited by Articles III and XI); (iii) whether the developing countries should be given additional flexibility, e.g. through an extended transitional arrangement; and (iv) whether restrictive business practices should be addressed. As a result of these divergent views, the Brussels text of the Final Act did not contain any text on TRIMs. The Draft Final Act submitted by the director-general of the GATT in December 1991 tackled the above-mentioned issues by proposing compromise texts. The TRIMs Agreement adopted at Marrakesh is identical to that contained in the 1991 Draft Final Act.  |   

Provisions of the TRIMs Agreement Preamble

The Preamble of the TRIMs Agreement expresses the desire of promoting ‘the expansion and progressive liberalization of world trade and to facilitate investment across international frontiers so as to increase the economic growth of all trading partners, particularly developing country Members’. It is also indicated that such a process should be made ‘while ensuring free competition’. This linkage between the disciplines on investment with those related to competition is not further developed in the operative provisions of the TRIMs Agreement, but is subject to possible further review (see Article 9). The Preamble notes the ‘particular trade, development and financial needs of developing country members, particularly those least-developedcountries’, an aspect that is taken into account in terms of transitional periods for such countries, rather than of differential or preferential treatment thereof. Finally, it is recognized that ‘certain investment measures can cause trade-restrictive and distorting effects’, but without any qualification on whether investments measures produce such effects per se or depending upon the circumstances of each case. Coverage

The coverage of the TRIMs Agreement is circumscribed by Article 1, which stipulates that it applies to investment measures related to trade in goods only. Investment measures affecting trade in services are not covered by this Agreement. The provisions of the General Agreement on Trade in Services (GATS) should be considered in this regard (see Chapter 3). It should be noted that despite the fact that discussions on TRIMs have been dominated by issues relating to foreign direct investments, neither Article 1 nor other provisions of the TRIMs Agreement restrict its application to foreign investments. Hence, the Agreement may be applied to any TRIM, independently from the nationality of the investor. Relationship with GATT 1994

The TRIMs Agreement prohibits only those measures that are covered by GATT Articles III or XI, ‘without prejudice to other rights and obligations under GATT 1994’ (Article 2.1). Article III of the GATT deals with ‘National treatment on internal taxation and regulation’ and Article XI regulates the ‘General elimination of quantitative restrictions’.  |  

An important point for interpretation is whether the TRIMs Agreement just clarifies those existing GATT articles, or whether it goes beyond them and constitutes an autonomous basis for action against certain TRIMs. This point has been addressed in the Indonesia-Autos dispute, where the panel made clear that the TRIMs Agreement is not just a corollary of GATT Articles III and XI.8 Article 2 indicates, however, that the TRIMs Agreement has a rather limited scope of application and, as sought by developing countries, it does not extend to other aspects of investment policies introduced by some developed countries during the negotiations, such as the ‘right of establishment’ or ‘national treatment’ for the pre- or post-establishment of foreign investors. Therefore, under the TRIMs Agreement member countries maintain their sovereign rights to regulate FDI, except with regard to the trade-related performance requirements covered by the Agreement. This is in contrast to the GATS, which includes rules on foreign ‘commercial presence’ as one of the modes of supply of services (Article XXVIII). Illustrative list

The TRIMs Agreement does not contain a definition of TRIMs. In an Annex to the Agreement an illustrative list of such TRIMs that are inconsistent with the obligation of national treatment (as provided for in paragraph 4 of Article III of GATT 1994) and with the obligation of general elimination of quantitative restrictions (as provided for in paragraph 1 of Article XI of GATT 1994), is included. According to the Annex of the TRIMs Agreement, TRIMs that are inconsistent with paragraph 4 of Article III of GATT 1994 include those which are mandatory or enforceable under domestic law or under administrative rulings, or compliance with which is necessary to obtain an advantage, as follows: 1. the purchase or use by an enterprise of products of domestic origin or from any domestic source (i.e. local content requirement); or 2. that an enterprise’s purchases or use of imported products be limited to an amount related to the volume or value of local products that it exports (i.e. trade balancing requirement). In addition, TRIMs that are inconsistent with the obligation of GATT Article XI:1 are those that restrict: 1. the importation of products to an amount related to the quantity or value of local products exported (i.e. trade balancing);  |   

2. the importation of products by restricting an enterprise’s access to foreign exchange to the amount of foreign exchange inflows attributable to the enterprise (i.e. exchange restrictions); or 3. the exportation of products specified in terms of volume or value of local production (i.e. domestic sales requirement). The approach followed in drafting the TRIMs Agreement leaves considerable room for interpreting which other TRIMs – not included in the Illustrative List – constitute a ‘Trade-Related Investment Measure’. There are, however, some TRIMs that clearly remain outside the scope of the Agreement, such as performance requirements relating to participation of local equity, undertaking of research and development, technology transfer, and employment of local personnel, among others. In addition, the Agreement does not define whether the listed TRIMs are prohibited per se, or subject to the determination of inconsistency with the referred GATT 1994 obligations.9 It should be noted that TRIMs covered by the Agreement include not only those that establish a restriction or obligation, but also those that make a certain advantage conditional upon certain performance requirements. This means that the concession of incentives subject to TRIMs may also be deemed to be in violation of the Agreement. Exceptions

All exceptions under GATT 1994 apply, as appropriate, to the provisions of the TRIMs Agreement (Article 3). Such exceptions may include, for instance, those necessary to protect public morality, human, animal or plant life or health, the conservation of exhaustible natural resources (Article XX, a), b) and g) of the GATT) and national security (Article XXI of the GATT). Developing countries are also free to deviate temporarily from the provisions prohibiting certain TRIMs (Article 2) to the extent that Article XVIII of the GATT, the Understanding on Balance-of-Payments Provisions of the GATT and the Declaration on Trade Measures Taken for Balance-of-Payments Purposes adopted on 28 November 1979 permit a member to deviate from Articles III and XI (Article 4). Notification

According to Article 5 of the TRIMs Agreement (‘Notification and Transitional Arrangements’), members were obliged, within 90 days of the date of entry into force of the WTO Agreement (1 January 1995), to notify the Council for Trade in Goods of all TRIMs of general or  |  

specific application they were applying that were not in conformity with the provisions of the Agreement (Article 5.1). The TRIMs so notified were bound to be eliminated within five years of that date by developing country members. The least developed countries obtained a seven-year transitional period for eliminating the prohibited TRIMs (Article 5.2). 10 These transitional periods could be extended if they demonstrated particular difficulties in implementing the provisions of the Agreement, taking into account the individual development, financial and trade needs of the members in question (Article 5.3). TRIMs introduced less than 180 days before the entry into force of the WTO did not benefit from the transitional arrangements. In addition, the TRIMs Agreement introduced a ‘freezing clause’ according to which members shall not modify the terms of any notified TRIM so as to increase the degree of inconsistency with Article 2 (Article 5.4). The TRIMs Agreement, however, permitted members to apply TRIMs to new investments during the transition period in order ‘not to disadvantage established enterprises which are subject to a TRIM notified’, provided that: 1. the products of the new investment are like products to those of the established enterprises; 2. the TRIM is necessary to avoid distorting the conditions of competition between the new investment and the established enterprises; 3. the terms of the TRIM is equivalent in their competitive effect to those applicable to the established enterprises, and is terminated at the same time; and 4. the TRIM in question is notified to the Council for Trade in Goods (Article 5.5). This exception addressed a major concern of investors existing at the time of entry into force of the WTO Agreement, particularly in the automotive sector, which feared being put at a disadvantage vis-à-vis new investors. Transparency

Article 6 reaffirms members’ commitments to their general obligation on transparency and notification under Article X of GATT 1994, the understanding on ‘Notification’ contained in the Understanding Regarding Notification, Consultation, Dispute Settlement and Surveillance of November 28, 1979, and in the Ministerial Decision on Notification Procedures of April 15, 1994 (Article 6.1).  |   

Each member is obliged to notify the WTO Secretariat of the publications in which TRIMs may be found, including those applied by regional and local governments and authorities within their territories (Article 6.2). Members also assume obligations to sympathetically consider requests for information and to afford opportunity for consultations. Members, however, are not bound to disclose information which would impede law enforcement or ‘otherwise be contrary to the public interest or would prejudice the legitimate commercial interests of particular enterprises, public or private’ (Article 6.3). Committee on TRIMs

The Agreement establishes a Committee on Trade-Related Investment Measures to afford members the opportunity to consult on any matters relating to the operation and implementation of the Agreement and to monitor the latter (Article 7). Dispute settlement

The consultations and settlement of disputes shall be conducted according to the Dispute Settlement Undestanding (Article 8). This means that no member can apply unilateral measures against another member on the basis of application of certain TRIMs. Review

Although the developing countries managed to limit the scope of the TRIMs Agreement during the Uruguay Round, Article 9 provides for the review of the operation of the Agreement no later than five years after the date of entry into force of the WTO Agreement, and for consideration as to whether the Agreement should be complemented with provisions on investment policy and competition policy. Concluding remarks

This chapter has shown how developed countries extended the scope of multilateral trade negotiations to cover investments by bringing the TRIMs Agreement into the Uruguay Round despite the opposition of developing countries. The TRIMs Agreement is a limited one restricted to phasing out certain performance requirements that are imposed by host countries to regulate the operations of foreign investors in tune with their development policy objectives. However, it included a provision for a possible review to extend its scope and coverage later. The  |  

deadline for the review was 2000. However, no submissions were made by the members for the review of the Agreement except for a recent joint submission by Brazil and India (in October 2002) seeking flexibility for implementing development provisions by amendment of TRIMs Agreement. This is because developed countries have focused since the 1996 Singapore Ministerial Meeting on evolving a more comprehensive multilateral framework on investment in its own right rather than looking for the TRIMs review. A Working Group on trade and investment was established within WTO by the First WTO Ministerial Conference in Singapore in 1996 (see Chapter 3). Subsequently developed countries sought to expand the scope of WTO on investment beyond TRIMs and the GATS by proposing future negotiations on a multilateral framework on trade and investment. The Doha Ministerial Declaration conditioned the launch of such negotiations, in any case after the Fifth Ministerial Conference, on the existence of ‘explicit consensus’ for that purpose. These developments explain the neglect of the process of review of the TRIMs Agreement. Notes

1. This section is substantially based on an analysis of the negotiating process prepared by Ms M. Mashayekhi (UNCTAD Secretariat). 2. GATT document PREP.COM(86)/W/35, 11 June 1986. 3. UNCTAD 1989, Annex I, p. 376. Emphasis added. 4. See submissions by the EC, documents MTN.GNG/NG12/W/8, W/ 10 and W/22, and the submissions by the Nordic countries, documents MTN. GNG/NG12/W/6 and W/23. 5. See submissions by Malaysia (MTN.GNG/NG12/W/13), Singapore (MTN.GNG/NG12/W/17), India (MTN.GNG/NG12/W/18), Mexico (MTN. GNG/NG12/W/19), and Bangladesh (MTN.GNG/NG12/W/21). Mexico proposed that the effects of two TRIMs (export requirements and local equity requirements) be empirically tested. See the joint submission by developing countries (Argentina, Brazil, Cameroon, China, Colombia, Cuba, Egypt, India, Tanzania, United Rep. of, and Yugoslavia) (MTN.GNG/NG12/W/25), and draft Declaration on TRIMs submitted by Bangladesh, Brazil, Colombia, Cuba, Egypt, India, Kenya, Nigeria, Pakistan, Peru, Tanzania, United Rep. of, and Zimbabwe (MTN.GNG/NG/W/26). 6. The chairman’s first to fifth drafts were dated 18 May 1990, 29 June 1990, 19 July 1990 (MTN.GNG/NG12/W/27), 24 October 1990 and 20 November 1990. The latter, known as the Hong Kong draft, was prepared by Hong Kong on behalf of the chairman of the Trade Negotiations Committee (TNC) in consultation with several delegations. 7. The drafts originally included a submission written by the chairman  |   

which became the ‘A’ text, document MTN.GNG/NG12/W/24 from the United States was known as the ‘B’ text; and document MTN.GNG/NG12/ W/26 from developing countries became the ‘C’ text. Subsequently, the texts were merged. 8. Panel report on Indonesia – Certain Measures Affecting the Automobile Industry, WT/DS54, 55, 59 64/R, adopted on 23.7.98. 9. In the Indonesia-Autos Dispute the per se concept was held by the United States and the European Commission, while Japan argued the need for demonstrating the effects of the questioned measures. The panel did not rule on this issue. Other TRIMS-related cases considered under the Dispute Settlement Understanding included TRIMS in the automotive sector applied in Brazil (WT/DS51, WT/DS52, WT/DS65), India (WT/DS146 and WT/DS175), Philippines (WT/DS195) and Canada (WT/DS139/AB/R and WT/DS142/AB/R). 10. In the case of developed countries, the transitional period was two years counted from the same date.

 |  

Chapter five

Implications of the TRIMs Agreement for developing countries and the way forward

§ The implementation of the TRIMs Agreement is likely to have important implications for developing countries by taking away some of the flexibility to regulate foreign investors in pursuing their developmental policy objectives. The Agreement also brings into being a number of asymmetries. For instance, a number of policies practised by developed countries that are akin to local content requirements are allowed to continue while their use by developing countries is proscribed. Also the imposition of trade-related restrictions by foreign investors on their affiliates is not regulated. These are issues that could be taken up in the mandated Review of the Agreement. This chapter discusses some of the issues concerning implementation, implications and asymmetries of the TRIMs Agreement. The second section analyses issues relating to the implementation and interpretation of the Agreement’s provisions, its relationship with other WTO agreements, the application of the transitional periods and the activities of the Committee on TRIMs. The third section raises issues concerning the developmental implications of the TRIMs Agreement. The fourth section highlights some asymmetries in the TRIMs Agreement. The final section offers some suggestions for the review of the Agreement. Interpretation and implementation of the TRIMs Agreement Coverage of TRIMs

The TRIMs Agreement, as discussed in Chapter 4, provides neither a definition of what a TRIM is nor an objective test for identifying when such measures may be deemed inconsistent with the Agreement. Moreover, it does not specify whether the TRIMs indicated in the Illustrative List are to be deemed prohibited per se or subject to an effects test, that is, to determination of their trade-distorting effects in an individual case. Therefore, it is the responsibility of each WTO member to evaluate which TRIMs that it may apply are banned under the Agreement. If another member considers that a violation exists, it may initiate, after consultations, the procedures under the Dispute Settlement Understanding. Similarly, the Agreement does not prevent a member from establish-

ing export performance requirements, which remain permissible. Many developing countries apply export requirements, for instance, in relation to investments in free trade or exclusive economic zones. However, subsidies for exports, if granted, may be covered by the disciplines of the Agreement on Subsidies and Countervailing Measures. Several other performance requirements can be maintained, such as those relating to: • • • • • •

technology transfer; research and development; local participation in equity; employment of local personnel; localization in a given area; and training of personnel.

In contrast, import-substitution measures taken by many developing countries may be prohibited if they violate GATT Articles III or XI. The exact frontier of the prohibition beyond the scope of the Illustrative List is, however, uncertain and is to be determined in particular cases. Mandatory and advantage-related TRIMs

It is clear that the TRIMs Agreement does not prevent the granting of investment incentives (as accorded in many developed and developing countries to attract FDI). The Agreement only prohibits that a member condition the access to certain advantages upon compliance with any listed TRIMs.1 The TRIMs Agreement specifies measures that are ‘mandatory or enforceable under domestic law or administrative rulings’, but it also refers to measures ‘compliance with which is necessary to obtain an advantage’. Thus, under the TRIMs Agreement, WTO members are prohibited from establishing certain TRIMs if linked to an advantage, but the Agreement does not prohibit the granting of any advantage per se. An ‘advantage’ is not defined in the TRIMs Agreement and therefore its scope could be wide, including, inter alia, subsidies. As discussed below, the latter may be subject to the disciplines of the Agreement on Subsidies and Countervailing Measures. The 1990 Panel on EC-Regulation on Imports of Parts and Components considered the scope of application of GATT Article III in respect of advantages granted by governments. The Panel ruled that the comprehensive coverage of all laws, regulations or requirements affecting the internal sale, etc., of imported products suggests that not  |  

only requirements that an enterprise is legally bound to carry out, such as those examined by the FIRA Panel, but also those that an enterprise voluntarily accepts in order to obtain an advantage from the government, constitute requirements within the meaning of that provision. The Panel noted that the EC made the grant of an advantage, namely the suspension of proceedings under the anti-circumvention provision, dependent on undertakings to limit the use of parts or materials of Japanese origin without imposing similar limitations on the use of like products of EC or other origin, hence dependent on undertakings to accord treatment to imported products less favourable than that accorded to like products of national origin in respect of their internal use. Foreign and domestic investment

The Agreement does not distinguish between ‘foreign’ and ‘domestic’ investments. Hence, it may be applied to performance requirements applied to any kind of investment, including that wholly owned by nationals. The Panel in the Indonesia-Autos case2 stated that: the use of the broad term ‘investment measures’ indicates that the TRIMs Agreement is not limited to measures taken specifically in regard to foreign investment ... nothing in the TRIMs Agreement suggests that the nationality of the ownership of enterprises subject to a particular measure is an element in deciding whether that measure is covered by the enterprise. Relationship with GATT 1994

The nature of the relationship between the TRIMs Agreement and GATT 1994 is one of the basic questions to be addressed in the implementation of the Agreement. Is it a mere interpretation of Articles III and XI of the GATT, or has it a separate and autonomous scope of application? The relationship between the TRIMs Agreement and the GATT has been addressed by two panel decisions. In the Banana III case, the Panel considered that: the TRIMs Agreement essentially interprets and clarifies the provision of Article III (and also of Article XI) where trade-related investment measures are concerned. Thus the TRIMs Agreement does not add to or substract from those GATT obligations, although it clarifies that Article III: 4 may cover investment-related matters.3  |                  

The relationship between the TRIMs Agreement and the GATT was also examined in the already mentioned Indonesia-Autos case. The Panel was asked to decide on the consistency of Indonesia’s National Car Programme with certain articles of GATT 1994, the Agreement on Subsidies and Countervailing Measures, the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs), and, specifically, with Article 2 of the TRIMs Agreement. The main issue under consideration was the admissibility of local content requirements, which were linked to incentives from the government. Indonesia did not enjoy the transitional period under Article 5 of the TRIMs Agreement, and had not invoked the exceptions of Articles 3 and 4. The Panel stated that the TRIMs Agreement is not merely a corollary to GATT 1994, but a ‘fully fledged agreement in the WTO system’. The Panel thus dismissed Indonesia’s argument that the Agreement merely interpreted Article III of the GATT. According to its reasoning, though Article III.4 of GATT and Article 2.1 covered the same subject matter, the latter referred to the actual provisions of Article III, and not to the application of said Article. It concluded that: Since the TRIMs Agreement and Article III remain two legally distinct and independent sets of provisions of the WTO Agreement, we find that even if either of the two sets of provisions were not applicable the other one would remain applicable.

The Panel considered that local content requirements are clearly traderelated, since they favour the use of domestic over imported products. It also found that a measure that was described by the language of Item 1(a) of the Illustrative List was inconsistent with Article III.4 and, therefore, in violation of Article 2.1. However, the Panel found that in the context of the case under examination, it was not necessary to rule whether a measure that fell within the description of the Illustrative List contained in the Annex to the TRIMs Agreement constituted a per se violation of the Agreement. Relationship with the Agreement on Subsidies and Countervailing Measures

As indicated, certain TRIMs linked to an advantage (e.g. subsidy) are subject to the TRIMs Agreement. It is also of interest, therefore, to elucidate the relationship between that Agreement and the Agreement on Subsidies and Countervailing Measures, as it also applies to tradepromoting investment measures or incentives. Moreover, the Agreement  |  

on Subsidies and Countervailing Measures specifically refers to subsidies tied to export performance and domestic sourcing requirements in Article 3, paragraph 3.1: Except as provided in the Agreement on Agriculture, the following subsidies, within the meaning of Article 1 above, shall be prohibited: (a) subsidies contingent, in law or in fact, whether solely or as one of several other conditions, upon export performance, including those illustrated in Annex 1; (b) subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods.

Measures or programmes usually referred to as investment incentives could be legally defined as subsidies subject to the disciplines of the Subsidies Agreement (SCM). The SCM also provides for non-actionable subsidies: research and pro-competitive development activities, regional aids, and the adaptation of existing plants to new environmental measures. The relationship between the TRIMs Agreement and the Agreement on Subsidies and Countervailing Measures was examined in the Indonesia-Autos case. The Panel considered that both the latter Agreement and the TRIMs Agreement covered advantage-related performance requirements. It argued, however, that they were concerned with different types of obligations and cover different subject matter; while under the Agreement on Subsidies and Countervailing Measures it was the grant of a subsidy contingent on the use of domestic goods that was banned, under the TRIMs Agreement it was a local content requirement, and not a subsidy, that was prohibited. The Panel considered that the said Agreements could have an: ‘overlapping coverage in that they may both apply to a single legislative act, but they have different foci, and they impose different types of obligations’. In another case submitted to a Panel, in which the application of the TRIMs Agreement was at stake, Japan has claimed that government incentives given to car manufacturers in Canada were inconsistent with said Agreement.4 Relationship with the GATS

The TRIMs Agreement covers only trade in goods. Hence performance requirements may be established with respect to trade in services, such as local acquisition of services, subject only to any obligation applicable under the GATS. The TRIMs Agreement does not contain any obligation on the establishment of foreign investment in a WTO member. In the GATS context,  |                  

however, trade is defined to also include sales by foreign firms that have established a commercial presence in a country. The GATS ‘represents an effort to address what are largely investment issues through an agreement modelled after the GATT’.5 Under the GATS, WTO members may assume specific commitments in their Schedules relating to the ‘commercial presence’ of services suppliers, that is, of any type of business or professional establishment including through subsidiaries or a branch or representative office. Application of the transitional period

As indicated in Chapter 4, WTO members were permitted to notify, within 90 days of the date of entry into force of the WTO Agreement (1 January 1995), the Council for Trade in Goods all TRIMs that they were applying that were inconsistent with the TRIMs Agreement (Article 5.1). This procedure allowed the maintainance of the notified TRIMs for a period of five years from that date for developing countries, and of seven years for least developed countries (Article 5.2).6 In March 1995 the Committee on TRIMs approved a uniform model for the notifications under Article 5.1. Only a few developing countries notified TRIMs under the said Article, namely: Argentina, Barbados, Chile, Cyprus, Colombia, Costa Rica, Cuba, Ecuador, Egypt, Philippines, India, Indonesia, Malaysia, Mexico, Nigeria, Pakistan, Peru, Poland, Dominican Republic, Rumania, South Africa, Thailand, Uruguay and Venezuela. As shown in Table 5.1, some notifications were made after the expiration of the 90-days terms. Other countries notified that they did not apply TRIMs incompatible with the Agreement, though they were not required to do so.7 Article 5.3 stipulates that, on request, the Council for Trade in Goods may extend the transition period for the elimination of TRIMs that were notified, when a developing country – including an LDC – ‘demonstrates particular difficulties in implementing the provisions of this Agreement’, taking into account ‘the individual development, financial and trade needs’ of the member in question. There is no maximum time limit for such extension. The criteria for allowing an extension of the transition term are considerably broad, particularly as they explicitly include ‘development needs’. In order to make this criterion operative, a set of more specific elements may be suggested, such as the need of a particular TRIM in terms of technological upgrading, employment generation or improvement of the competitive capacity of a sector or branch. It may be also  |  

30 October 1995 26 April 1995

20 March 1996 29 September 1995 31 March 1995; 22 December 1995; 18 March 1996; 11 April 1996 23 May 1995; 28 October 1996

Costa Ricad Cubae

Cyprusf Dominican Republic

Ecuador Egypt India

Malaysia

Indonesia

21 March 1995;

30 March 1995; 21 March 1997 31 March 1995 24 June 1998 14 December 1995 31 March 1995; 4 June 1995; 31 July 1995; 30 September 1996 30 March 1995 18 July 1995

Argentina

Barbados Boliviab Chilec Colombia

Date of communicationa

Member

Paragraph 2 (c) Paragraph 1 (a)

Consumer goods Automotive industries, utility boilers, soyabean and fresh milk products

Automotive industries General

Paragraph 1 (a) and 2 (a) Paragraph 1 (a)

Agro-industry General Fuel, raw and other materials, tools, equipment, spare parts accessories, consumer goods; transport and marine insurance Cheese and groundnut products General

Paragraph 1 (a) Paragraph 1 (a) Paragraph 1 (a), 1 (b) and 2 (a) Paragraph 1 (a) Not specified

Paragraph 1 (a) and 2 (a) Paragraph 1 (a) Paragraph 2 (c) Paragraph 1 (a) and 1 (b)

Category of the illustrative list

Automotive industries Pork processing enterprises Hydrocarbons sector Automotive industries

Sector

Table 5.1 Notifications submitted under Article 5.1 of the TRIMs Agreement, by February 2001

30 March 1995

17 June 1997 31 March 1995; 30 March 1995 31 March 1995

Thailand

Uganda Uruguay

Paragraph 1 (a) Not specified Paragraph 1 (a) Paragraph 1 (a)

Automotive industries Automotive industries

Paragraph 1 (a)

Paragraph 1 (a) Not specified Not specified Paragraph 1 (a) Paragraph 1 (a) Paragraph 1 (a) and 2 (b) Paragraph 1 (a) Paragraph 1 (a)

Automotive industries and industrial sector Automotive industries General Engineering, electrical goods and automotive industries Milk powders, anhydrous fat and other milk products Automotive industries and coconut-based chemicals Cash registers General Automotive industries, telecommunication equipment, tea and coffee Automotive industries, manufacture of milk and dairy products, aluminium sheets, TV picture tubes, transformers, air-conditioners and paper products General

Source: UNCTAD (2001) Host Country Operational Measures, New York and Geneva: UNCTAD/ITE/IIT/26, pp. 21–3.

Notes: a. Most of the TRIMs notified are probably no longer in place as only ten members (Argentina, Chile, Colombia, Egypt, Malaysia, Mexico, the Philippines, Pakistan, Romania and Thailand) have sought extension of the transition period. b. Bolivia subsequently submitted a notification indicating that it does not apply any TRIMs that are not in conformity with the Agreement. c. Initially, Chile notified its measure under the Automotive Statute as a prohibited subsidy under the WTO Agreement on Subsidies and Countervailing Measures. However, after further analysis, this measure was also notified as a TRIM. d. Costa Rica subsequently submitted a notification indicating that it intends to eliminate measures notified under Article 5.1 in advance of the expiry of the transition period. e. Cuba subsequently informed the Committee that the measures notified by Cuba under Article 5.1 are no longer in force. f. This notification superseded Cyprus’s previous one of 29 June 1995; Cyprus subsequently submitted a notification indicating that it has eliminated measures notified under Article 5.1. g. Nigeria subsequently submitted a notification indicating that the Nigerian Enterprises Promotion Act of 1989 has been repealed and replaced with the Nigerian Investment Promotion Commission Decree 1995. h. Poland has subsequently submitted a notification indicating that it has eliminated measures notified under Article 5.1.

Venezuela

14 March 1996 31 March 1995 17 July 1996 30 March 1995 3 March 1995 31 March 1995 28 September 1995 31 March 1995 19 April 1995

Mexico Nigeriag Pakistan Peru Philippines Polandh Romania South Africa

agreed that TRIMs that are necessary for balance of payments reasons, that do not have a substantial distortive effect on trade, and/or that are linked to an incentive, may be maintained. Under the provision of Article 5.3, nine developing countries – Malaysia, Pakistan, Philippines, Mexico, Chile, Colombia, Argentina, Romania and Thailand – have applied for an extension of transition period in respect of certain TRIMs that had been notified by them. Examination of their requests is undertaken by the Council for Trade in Goods of WTO. Some developing countries, such as India and Brazil, had proposed during the Seattle Ministerial Conference that an extension of the transition period for developing countries should be provided on a multilateral basis and not on an individual basis; and that another opportunity should be provided to developing countries to notify unnotified TRIMs and maintain them for an extended transition period. The Seattle Ministerial Conference was inconclusive and no decision could be taken on these proposals. However, the General Council Meeting of 8 May 2000 took the following decisions: Members agree to direct the Council for Trade in Goods to give positive consideration to individual requests presented in accordance with Article 5.3 by developing countries for extension of transition periods for implementation of the TRIMs Agreement. Members have noted the concerns of these Members who have not notified TRIMs or have not yet requested an extension. Consultations on the means to address these cases should also be pursued as a matter of priority, under the aegis of the General Council, by the Chairman of the Council for Trade in Goods. Activities of the Committee on TRIMs

The TRIMs Committee entered into operation 1995. It examined notifications made. Some delegations requested clarifications or additional factual information. While some delegations requested information on plans for phasing out and eliminating the notified TRIMs, other delegations considered that such a matter was beyond the transparency obligation under Article 6.3 of the Agreement and that the Committee had no competence to monitor the implementation of Article 5.2.8 The measures that prompted requests for clarification were mainly related to the automobile sector, agriculture and general provisions on local content in investment laws. The main issues that have arisen during the initial years of implementa |                  

tion of the TRIMs Agreement relate to timing of notifications in relation to the provisions of Article 5.1. Some developing countries have taken longer to identify and notify their TRIMs, and developed countries have not been flexible with respect to the time limit set in that Article. The relationship between the TRIMs Agreement and other WTO Agreements, particularly the Agreement on Subsidies and Countervailing Measures and the Agreement on Agriculture, has also been discussed. Article 6.2 of the TRIMs Agreement also required WTO members to notify the WTO Secretariat concerning the publications in which TRIMs may be found, including those applied by regional and local governments and authorities. The Committee agreed that such notifications should be submitted by February 1997, but the majority of members did not comply with that deadline. The work by the Committee, in sum, has not provided clear guidance on which measures are prohibited. Different opinions have been held. However, a joint study was prepared by the Secretariats of WTO and UNCTAD on TRIMs and other performance requirements for the Committee on TRIMs in October 2001.9 The study surveys the scope and definition of performance requirements and provisions in international agreements. It then reviews evidence on the use of performance requirements by different countries, summarizes the policy objectives for employing them and reviews the evidence on their impact. An assessment of the TRIMs Agreement

Developing countries seek FDI inflows as developmental resources. FDI inflows are expected to assist their host countries by supplementing the domestic resources of capital, technology, skills and market access. However, as has been shown in Chapter 2, there is a great variation in the developmental impact of different FDI projects on the host countries depending upon the extent of new knowledge brought in, employment, value added and exports generated, and contribution made to the local technological capability-building. In other words the quality of FDI inflows varies a great deal (see Kumar 2002 for a detailed treatment). The empirical evidence now available suggests that in some countries FDI crowded out domestic investments and proved to be immiserizing, while in others it complemented or crowded in domestic investments and had more favourable developmental effects. Host country governments have employed a variety of policy measures to influence the quality of FDI in tune with their developmental objectives. These include screening mechanisms and performance regulations. The TRIMs Agreement  |  

phases out some of the most important performance regulations that have been used, such as local content regulations and foreign exchange neutrality obligations. In what follows we critically evaluate the TRIMs Agreement in the light of evidence of its possible effects on development and other asymmetries. Development impact of TRIMs

Local content regulations (LCRs) have been the most widely practised performance requirement employed by host governments. By limiting the extent of imports to the extent of exports, foreign exchange neutrality regulations also have an effect similar to that of local content regulations. The host country objectives in employing these regulations are to develop local input supplying capabilities with a view to promoting employment and conserving foreign exchange. It has been argued that under conditions of perfect competition, LCRs reduce host country welfare in case the price of local inputs are higher than the world prices. Therefore, an increased use of domestic inputs imposes a tax on the foreign producers necessitating the need for protection. However, the assumption of perfect competition hardly prevails in real-life situations. For instance, local components required by an MNC may be of specifications and designs that are proprietary or patented. Hence they would not be available in the host country unless the MNC licenses their manufacture to some local vendor and passes on the designs and drawings. There may be other considerations for not licensing local production of components – for example, to utilize production capacities created elsewhere in the world more fully. Local content regulations play a useful role in prompting the MNC to consider licensing the local manufacture of such components, which it may not do otherwise because of such considerations. LCRs may therefore force MNCs to identify nascent local capabilities and provide them with the know-how and technology. A number of theoretical and empirical studies have shown LCRs to have welfare improving and having favourable developmental effects for host countries. For instance, Balasubramanyam (1991) argues that the dynamic benefits resulting from LCRs, such as the development of local supplier capabilities, far outweigh the short-run welfare losses that they may impose. Richardson (1993) shows using a general equilibrium model that an effective LCR will induce foreign firms to increase their own domestic production of the component input and will induce capital flows, thus furthering the process of industrialization of the host country. Lahiri and Ono (1998) develop a partial equilibrium  |                  

model of an oligopolistic industry and show that LCRs imposed on foreign firms raise employment in host countries. Yu and Chao (1998) have shown that LCRs may be put to good use to improve allocative efficiency and enhance host country welfare. Among the empirical studies, a recent detailed empirical analysis of US and Japanese FDI in a sample of 74 countries in seven branches of manufacturing over the 1982–94 period found LCRs to be favouring the extent of localization of MNE affiliates’ production in the host countries (see Kumar 2000, 2002). Therefore, the study argued that LCRs could be an important means of deepening the commitment of MNEs entering an economy and for generating local value added, and hence employment and the related spillovers of knowledge. In view of these favourable effects, LCRs have been employed by most of the developed countries and developing countries at one time or other (see Sercovich 1998; Low and Subramanian 1995; WTO/UNCTAD 2001 for illustrations). In particular governments have employed LCRs in the auto industry to promote backward integration and localization of production of value added. Until recently, many of the developed countries imposed LCRs in the auto industry. For instance, Italy imposed 75 per cent local content rule on Mitsubishi Pajero, the UK 75 per cent on Toyota Camry and the UK 90 per cent on Nissan Primera (Sercovich 1998). Australia imposed 85 per cent local content rule on motor vehicles until 1989 (Pursell 1999). While these developed countries have exploited the potential of LCRs and other similar regulations for their industrialization and development, the same flexibility is being taken away from developing countries by the TRIMs Agreement, thus creating an asymmetry. The transition period allowed to developing countries – three years more than that given to developed countries – is hardly adequate to cover the development gap that exists between developed and developing countries. Use of policies similar to LCR in the industrialized countries

In the past the European Union countries have extensively used the screwdriver regulations, which are in effect local content regulations to deepen the local commitment of Japanese corporations in consumer goods industries. Even currently the industrialized countries, especially the EU and NAFTA member countries, taking advantage of RTA exceptions that are available under Section XXIV of the GATT, are effectively using the rules of origin to increase domestic value addition. Rules of origin determine the extent of domestic content a product must have  |  

to qualify as an internal product in a preferential trading agreement. Hence they have the same effect as the local content requirements. By now considerable evidence is available on the use of rules of origin by EU and NAFTA countries to increase the extent of localization of production by MNEs supplying to them (see Box 5.1).

Box 5.1 Rules of origin imposed by NAFTA and the EU to increase local content: select case studies NAFTA rules of origin

The objective of the US effort in NAFTA through rules of origin has been to prevent ‘screwdriver’ assembly operations from being set up within the region that could utilize low-cost inputs from outside. NAFTA rules of origin require that a substantial portion of inputs originate within the region for automobiles, electronic products (printers, copiers, television tubes), textiles, telecommunications, machine tools, forklift trucks, fabricated metals, household appliances, furniture and tobacco products. For example: Telecommunications: NAFTA rules require that nine of every ten printed circuit board assemblies, the essential component of office switching equipment, be packaged within the NAFTA countries. In response, AT&T shifted some production from Asia to Mexico, and Fujitsu and Ericsson brought new investments to Mexico as well. Colour televisions: NAFTA requires that television tubes be produced within the region to qualify for preferential status. Prior to NAFTA, there was no North American manufacturer of television tubes; in the first two years after NAFTA’s passage, five factories took shape within the NAFTA region, with investments from Hitachi, Mitsubishi, Zenith, Sony and Samsung. Computers: US negotiators proposed a rule that would have required two of the three key components (the motherboard, flat panel display and hard disk drive) to be North American in origin. With forceful opposition from IBM and other companies that wanted to maintain their more flexible international sourcing patterns, the negotiators settled on a final rule requiring at least the motherboard to be North American. Office equipment: NAFTA tightened origin rules for printers, photocopiers and fax machines, requiring more components to be  |                  

manufactured locally. For printers and photocopiers, all major subassemblies have to be produced in North America (equivalent to an 80 per cent domestic content requirement). Apparently this rule was instrumental in motivating Canon to construct a plant costing more than $100 million in Virginia, rather than somewhere in Asia where the production costs would be lower. Automobiles: The domestic content rule was raised from 50 per cent in the United States–Canada Free Trade Agreement to 62.5 per cent in NAFTA. It required Japanese and European firms to replace imports from their home countries. EU rules of origin

The European Union has adopted high domestic content rules of origin in automobiles and other industries such as photocopiers, as well, and has also entertained proposals for even tighter requirements for printed circuit boards and telecom switching equipment. The European Union also established product-specific rules that require printed circuit board assembly within Europe. It has negotiated association agreements in Central and Eastern Europe that require 60 per cent domestic content for products to qualify for entry into the European Union. Select examples are as follows: Semiconductors: In 1989, the European Union abruptly changed the rule of origin to require wafer fabrication for semiconductors be done within Europe to avoid a 14 per cent semiconductor tariff. Whereas US companies performed most of their diffusion operations in the USA prior to the decision, seven of the largest ten US producers built fabrication facilities in Europe following the rule change. Citing the need to comply within the new rule of origin, for example, Intel invested $400 million in Ireland for wafer fabrication and semiconductor assembly. Even though wafer fabrication was not cost-competitive in Europe, compared to Asia or the United States, 22 new fabrication facilities were set up in Europe within two years of the change in the rule of origin. Automobiles: The United Kingdom and France proposed an 80 per cent local content rule for the Nissan Bluebird to qualify as an EC product. In the end, they backed down in the face of Italian and German opposition and decided to rely on quantitative restrictions to protect against Japanese imports. The 60 per cent domestic content  |  

in the automotive sector has forced the General Motors engine plant in Hungary to use high-cost German steel as an input, preventing the utilization of locally available cheaper steel. Textiles and apparel: The near 100 per cent domestic content requirement in textiles and apparel has forced the German partner in the Brinkmann–Prochnik joint venture in Poland to load a truck with cotton fabrics, thread, buttons and even labels in Germany; transport it to Lodz for stitching into trench coats; and reimport it for sale in the European Union, rather than allow the Polish partner to source from cheaper supplies locally. Source: Kumar 2001 based on Moran 1998; Belderboss 1997; and other sources.

TRIMs and control of RBPs

Besides helping in industrial development and managing the balance of payments objectives, it has been argued that TRIMs have been employed by host countries to deal with the restrictive trade business policies pursued by MNCs (Puri and Brusick 1989, Balasubramanyam 1989). For instance, MNCs may engage themselves in importing more to provide markets to related companies or may indulge in manipulation of transfer prices of imports from related sources to transfer profits. LCRs or foreign exchange neutrality could moderate the effect of such RBPs (see Table 5.2). The TRIMs Agreement takes away the ability of host countries to impose such measures, but does not address the ability of MNCs to indulge in RBPs. This is another asymmetry introduced by the TRIMs Agreement. One-sided approach to trade-restrictive policies

The TRIMs Agreement requires the phasing out of restrictions on exports or imports imposed by the host governments. However, it does not require the phasing out of the export restrictions that are imposed by the MNCs on their affiliates. MNCs often impose restrictions on exports of their subsidiaries, affiliates and licensees or on the sourcing of their purchases. The surveys of foreign affiliates operating in India conducted by the Reserve Bank of India have repeatedly observed a high incidence of restrictive clauses imposed by MNCs on their local affiliates through technology transfer agreements. The latest survey for  |                  

 |  

Source: Puri and Brusick 1989

Predatory pricing Transfer pricing

Collusive tendering B. Vertical RBPs Refusal to deal Exclusive dealing Differential pricing Resale price maintenance Tied selling

A. Horizontal RBPs Market allocation Refusal to deal (boycott) Price fixing

RBPs

Local content requirement Export requirement Local content requirement; domestic sales requirement Export requirement; local equity requirement Domestic sales requirement; licensing and technology transfer requirement Manufacturing requirement Remittance and exchange restrictions; manufacturing requirement; domestic sales requirement.

Import refusal or prohibition Export prohibition Excessive pricing for imports Excessive pricing for exports and imports Excessive conditions for imports

Predatory pricing for imports Predatory pricing for imports or excessive pricing which results in remittance evasion

Trade-balancing requirements; export requirement Manufacturing requirement Local content requirement; local equity requirement; joint venture with government participation Local content requirement; domestic sales requirement

Associated TRIMs

Export prohibition; specific market allocation Refusal to supply Excessive pricing for imports; low pricing for exports Excessive pricing for imports

Possible outcome

Table 5.2 Restrictive business practices by TNCs in developing countries, their possible outcome and TRIMs designed to deal with them

132 572 404 1,108

Affiliates covered

60 351 404 815

Affiliates having technology transfer agreements 109 637 753 1,499

No. of agreements

43 268 291 602

Agreements with export restrictions 39.45 42.07 38.65 40.16

Proportion of agreements with export restrictions, %

25 (58.14) 13 (30.23) 0 (0.00) 0 (0.00) 5 (11.63) 0 (0.00) 43 (100)

Majority-owned

183 (68.28) 66 (24.63) 9 (3.36) 1 (0.37) 0 (0.00) 9 (3.36) 268 (100)

Minority-owned

167 (57.39) 82 (28.18) 14 (4.81) 3 (1.03) 3 (1.03) 22 (7.56) 291 (100)

Technology licensees

375 (62.29) 161 (26.74) 23 (3.82) 4 (0.66) 8 (1.33) 31 (5.15) 602 (100)

Total

Source: extracted on the basis of RBI (1999) Foreign Collaboration in Indian Industry: Sixth Survey Report, Mumbai: Reserve Bank of India

1. Ban on exports: total or to specified countries 2. Permission of collaborator for exports is needed 3. Exports only through collaborator/his agents/distributors 4. Prohibition on the use of trademarks for exports 5. Restriction on export prices 6. Any other export restriction Total

Types of export restrictions

Table 5.4 Types of export restrictions imposed by MNEs on their Indian affiliates

Source: extracted on the basis of RBI (1999) Foreign Collaboration in Indian Industry: Sixth Survey Report, Mumbai: Reserve Bank of India

Majority-owned Minority-owned Technology licensees All

Type of affiliate

Table 5.3 Incidence of export restrictions imposed by MNEs on their Indian affiliates, 1986–94

the 1986–94 period finds as many as 40 per cent of technology transfer agreements containing export restrictions (see Table 5.3). As is clear from Table 5.4, the bulk of these restrictions (62 per cent) imposed by MNEs on their Indian affiliates prohibit their export to all the countries or specified countries. Another 27 per cent require the affiliate to obtain their parent’s permission for exports. Obviously these restrictions are as trade-distorting as those imposed by the host governments and should come under the purview of the TRIMs Agreement. No phasing out of investment-distorting investment incentives

Yet another asymmetry in the TRIMs Agreement is its failure to discipline the investment incentives given by host governments to attract FDI inflows. The empirical evidence has shown that these incentives tend to distort the investment patterns much in the same way as export subsidies do patterns of trade (see Kumar 2000 for evidence). Industrialized countries have largely indulged in the incentive wars to attract foreign investments to particular locations and have been offering substantial subsidies to MNEs to attract investments (see Table 5.5 for some illustrations). Because developing countries lack the capacity to provide matching subsidies, investment incentives do tend to distort the normal pattern of location of investments in favour of industrialized countries. Theoretical and empirical studies have shown that LCRs and other performance requirements could have favourable developmental consequences and improve host country welfare by promoting backward linkages of FDI. Most developed countries have extensively employed LCRs until recently. By taking away the freedom to employ such an important policy from developing countries in their process of development, the TRIMs Agreement is creating an asymmetry from a development perspective. The Agreement suffers from a number of other asymmetries as well. For instance, it does not cover measures such as screwdriver regulations and rules of origin, which are still widely employed by developed countries to achieve the objectives similar to that of LCR, viz. deepening the local industrial structures. The TRIMs Agreement does not address restrictive business practices such as the tendency of MNCs to import more and to manipulate transfer prices. Furthermore, there are trade restrictions imposed by MNCs on their subsidiaries that are not dealt with by the Agreement and that are probably more distorting for trade patterns compared to LCRs or trade-balancing requirements. Finally, the Agreement also does not deal in a significant manner with investment  |  

Table 5.5 An illustrative list of investment incentives given by industrialized

country governments Site

Kentucky, USA S. Carolina, USA Alabama, USA New Mexico, USA Setubal, Portugal Germany United Kingdom United Kingdom United Kingdom

MNE and year

Subsidy Jobs Subsidy per ($ million) created job ($)

Toyota, 1985 BMW, 1992 Mercedes Benz, 1996 Intel, 1993 Ford, 1991 Dow, 1996 Samsung, 1994 Siemens, 1995 Lucky Goldstar, 1996

150 150 300 289 484 6,800 89 77 320

3,000 1,900 1,500 2,400 1,900 2,000 3,000 1,500 6,100

50,000 79,000 200,000 120,000 254,000 3,400,000 30,000 51,000 48,000

Sources: Moran (1998); UNCTAD (1996); and sources cited therein

incentives that are known to be distorting investment patterns. In the light of the above the Agreement comes out as one that threatens to perpetuate the inequalities between developed and developing countries in the coming years, unless an effort is made to address its asymmetries in the mandated review of the Agreement. In what follows, some issues for the review of the Agreement are discussed. Reviewing the TRIMs Agreement

This section examines the different negotiating options that developing countries and LDCs may face in relation to investment issues in the light of the mandatory review provision of the TRIMs Agreement. It addresses aspects relating to a possible review of the TRIMs Agreement, examines issues that should be considered if a comprehensive instrument on investment was to be negotiated, and contains conclusions. As mentioned previously, in accordance with Article 9 of the TRIMs Agreement, the Council for Trade in Goods had to review the Agreement’s operation in year 2000 and propose appropriate amendments to the WTO Ministerial Conference. In the course of the review, the WTO General Council was to consider whether provisions on investment and competition should be added to the Agreement. Only 25 countries (including 22 developing countries and one LDC) notified TRIMs in order to benefit from the transitional period. A few countries have indicated that they may require an extension of the transitional period, given the difficulties that they have faced to phase out the  |                  

notified TRIMs. The consideration of such requests may have given an opportunity to examine the effects of the Agreement in particular cases. In fact, there seems to have been very little data collection and research on the impact of the TRIMs Agreement since its adoption, so as to provide a solid basis for future action. The positions already submitted in the preparatory process for the WTO Ministerial Conferences illustrate the diverging objectives that different countries may have in a possible review of the Agreement. Thus the government of India has indicated that the TRIMs Agreement should be reviewed with the objective of not impeding industrialization of developing countries. It points out that ‘developing countries should have the freedom to use regulatory measures to channel investments in such manner that it leads to increase in exports’ and emphasizes the critical importance of local content requirements for industrialization and conservation of foreign exchange.10 In contrast, for the USA the Agreement should be fully complied with as it stands by January 1 2000, and the list of TRIMs should be broadened so as to include ‘export performance requirements, technology transfer requirements, and product mandating requirements’.11 A similar, or even greater, divergence of views may be expected with regard to the possible development of a new set of comprehensive multilateral rules on investment. The mandate of the Working Group established by the Ministerial Conference in Singapore (1996) to deal with the relationship between trade and investment policy has not decided conclusively to start negotiations on the subject.12 Yet the Doha Ministerial Conference adopted an ambiguous resolution to launch negotiations after the Fifth Conference subject to an ‘explicit consensus being there at that Conference on the modalities of negotiations’. One possible and almost obvious strategic option for developing countries in future negotiations is to try to keep the TRIMs Agreement without any substantial amendment. Any process of revision may improve the Agreement’s text in the perspective of developing countries and LDCs but, depending on their preparation and bargaining power, it may also lead to more stringent conditions (such as an expanded illustrative list of prohibited TRIMs). If the route of revision of the Agreement were adopted by WTO members, developing countries and LDCs should aim at fully introducing the ‘development dimension’ in the Agreement, through the amendment of several of its provisions. One possible approach may be based on the revision of the general provisions of the Agreement, in order to clarify,  |  

for instance, the concept of prohibited TRIMs. A second approach may address the list of prohibited TRIMs. Any combination of these approaches is, of course, possible. It should be noted that unlike other WTO agreements, and except for the transitional period, the TRIMs Agreement does not provide for special and differential treatment for developing countries and LDCs. Definition and effects

As examined in Chapter 4, the TRIMs Agreement does not contain a definition of TRIMs but has an ‘illustrative list’ of prohibited measures. In addition, the Agreement does not define whether the listed TRIMs are to be considered illegal per se or according to their effects in a particular case. No indication exists so far about a possible interest to review the Agreement in respect of these issues. The applicability of the Agreement may become more predictable (and less dependent on interpretation under the Dispute Settlement Understanding mechanism) if clarification were provided thereon. In the perspective of developing countries and LDCs, for instance, it may be useful to subject the prohibition of a particular TRIM to an analysis of its actual trade-distorting effects. Performance requirements are important policy tools of developing countries to enhance the benefits from FDI and to integrate it with the domestic economy. A per se prohibition of TRIMs represents a too rigid approach, in view of the many circumstances that may justify the application of a particular measure. As in other areas of trade and competition law, the admissibility of a TRIM should be evaluated case by case, taking into account its overall effects. A related question is whether the distortion of trade should be the only criterion to be taken into account to judge the legality of TRIMs. In some cases, the negative distortive effects may be offset by positive effects on local value added, employment, technological learning and balance of payments in a developing country or LDC. These situations may provide the grounds for exceptions beyond those currently admitted under Article 3 of the Agreement. Pruning the illustrative list

A review of the TRIMs Agreement may also entail changes in the illustrative list. An issue of particular importance for many developing countries and LDCs, including members, relates to requirements that may enhance the contribution of FDI to local industrialization. Some studies  |                  

suggest that the countries that have benefited the most from FDI were those (such as South Korea and China) that established frameworks that selectively attracted ‘quality’ FDI, that is, FDI that did not displace local investments but complemented them and supported capacity-building in their economies, including by the application of local content requirements (Kumar 1996: 7; South Centre 1997: 38; UNCTAD 1997: 9). One possible approach would be to exclude local content requirements from the illustrative list. Alternatively, exceptions could be defined for the application of different TRIMs. Such exceptions may be accorded on different grounds, for instance, in cases where: • a particular TRIM, including local content requirement, is linked to advantages granted to the investor; • investors’ practices are not substantially distorted by the imposed requirements; and • elimination of a TRIM may have a significant negative impact on local production and employment, particularly in small and medium enterprises (SMEs). The TRIMs Agreement may also allow for sectoral reservations, in order to provide developing countries with the option of determining which sectors may be permanently or temporarily excluded. National reservations, as mentioned in Chapter 6, were envisaged in the draft Multilateral Agreement on Investment (MAI) of the OECD countries. No doubt the case of the car industry may be one of the most significant while considering a possible sectoral exemption. Strengthening the development dimension

Because TRIMs are primarily imposed by developing countries as policy tools for deepening their industrial structure as a part of the strategy to industrialize in the same manner as EU and NAFTA members use rules of origin, they should seek exceptions from the provisions of TRIMs based on low levels of industrialization and development in the review. Article 5(3) of the Agreement could be amended to provide this exception linked to a per capita manufacturing value-added (MVA) threshold. All the countries with MVA per capita below that threshold level should qualify for exemption from the provisions of TRIMs. The Agreement would, in this way, have taken care of the development dimension as well as the graduation because once a country reaches the threshold level, it will have to phase out TRIMs. The two-year extension to the transition period for implementation as proposed in the Draft of  |  

the Seattle Meeting was not appropriate, as different developing countries are at different levels of development and their requirements are different. One size does not fit all! Phasing out the trade-distorting restrictive conditions imposed by corporations

Evidently MNCs impose certain restrictions on exports and imports of their affiliates and these distort their trade patterns. Given the tradedistorting effect of these restrictions, developing countries should seek to discipline the restrictive conditions that MNCs impose on their foreign affiliates in the review of the Agreement. Resisting the expansion of the scope of the Agreement

Some industrialized countries may seek to expand the list of types of performance requirements that are inconsistent with the provisions of the TRIMs Agreement or to broaden the scope of the Agreement with a more comprehensive instrument on investment, taking advantage of Section 9 of the Agreement. Such attempts need to be resisted. As with local content requirements, other performance requirements are also used as a part of development policies by countries at the lower levels of development. It is important to retain the freedom to apply them as and when needed. The empirical evidence shows that export performance requirements have served a useful purpose in setting up export-oriented manufacturing bases in a number of Latin American and East Asian countries (see Moran 1998; Kumar 1998a, 2001). Similarly, a more comprehensive investment regime will hurt developing countries’ interests by taking away the freedom to regulate the quality of FDI without giving anything in return, as will be seen later. Discipline the investment incentives

The review of the TRIMs Agreement may consider an instrument to phase out the investment incentives. This could be done in conjunction with the review of the Agreement on Subsidies and Countervailing Measures (SCM). Because of the prisoner’s dilemma inherent in the investment incentives competition, an international discipline to limit the investment-distorting incentives would maximize the collective welfare of the participating countries. Notes

1. Likewise, the draft OECD MAI, which is examined in Chapter 6, does not contain provisions to limit the establishment of investment incentives.  |                  

Chapter six

Attempts to evolve a Multilateral Treaty on Investment: the OECD’s MAI

§ The built-in provision for a review of the TRIMs Agreement provides for a consideration of whether the Agreement should be complemented with provisions on investment policy and competition policy. The developed world, however, without waiting for the upcoming review of the TRIMs Agreement, had initiated moves to push for a Multilateral Agreement on Investment (MAI) under the aegis of the OECD in 1995. As observed earlier, the industrialized countries are seeking to bring investment on the WTO agenda beyond the TRIMs Agreement on the model of the OECD’s failed MAI. Given the considerable progress made in the elaboration of the draft MAI, it provides a good illustration of the objectives that developed countries may seek in possible future negotiations on trade and investment. This chapter briefly considers some of the outstanding aspects of the draft MAI. Main elements of the draft MAI

The regimes on foreign investments have become more open and welcoming to foreign investors worldwide in the last ten years. Over 2000 Bilateral Investment Treaties (BITs) are in force and some plurilateral and multilateral instruments deal with certain aspects of investment treatment and protection (e.g. GATS, MIGA). However, so far there is no international agreement comprehensively dealing with such investments. The TRIMs Agreement as discussed in the previous chapters covers only a limited aspect of investment-related issues. The negotiations launched by the OECD ministers1 in 1995 to establish an MAI aimed at ensuring high standards of protection and legal security for foreign investors. The European Commission (EC) also made a proposal,2 in 1995, to negotiate an MAI in the framework of the WTO. A Working Group on the Relationship between Trade and Investment was established in the WTO at its first ministerial conference (December 1996). This action indicated the willingness of the WTO member states to explore the issue without prejudging, however, whether negotiations on the matter will be initiated in the future. The Working Group has been continuing its work.3

A multilateral framework on investments, as negotiated under the auspices of the OECD, would have meant the creation of a new, legally binding, framework for all types of investments, including a dispute settlement mechanism. Such a framework would not have amounted to the establishment of an absolute standard on investment policy, nor necessarily eliminate all differences in national investment regimes. However, if approved, it would have significantly restrained the room for manoeuvre of contracting parties to adopt, at the national level, policies with regard to the admission of FDI and to establish and modify conditions for the operation of foreign investors. According to the framework discussed within the OECD, for instance, parties would be under an obligation not to introduce new restrictions on foreign investments in the future (the ‘standstill’ clause), even if required by new circumstances and developmental needs.4 While developed countries, the main sources and destinations of FDI, seem to support the elaboration and adoption of an MAI, many developing countries fear the implications of a possible framework on the capacity of host countries to conduct their processes of development and, particularly, on their ability to foster the development of domestic industries5 and to determine conditions for benefiting from FDI. Such countries have admitted a role for the WTO in the discussion of trade and investment issues, but have not agreed to negotiate new disciplines on the matter. There is no a priori reason to think that a predictable and stable framework for foreign investments can not be maintained with the present array of national laws, bilateral agreements and other international instruments. If the negotiation of such a framework were agreed, however, a key question would be the extent to which it may adequately address developmental concerns of developing countries. The negotiations in the OECD collapsed in December 1998, as a result of strong differences among some of the OECD members. However, some developed countries, particularly the USA and Japan, have indicated in the Working Group on the Relationship between Trade and Investment their intention to broaden the scope of the TRIMs Agreement, so as to develop a multilateral investment code dealing with all kinds of investments. Given that the draft6 negotiated within the OECD has been so far the most advanced proposal on a multilateral framework on investment, it can be taken as a basis for considering the issues that may arise if developing countries were brought to a negotiation on the matter.7  |  ’ 

Scope

A key issue in the development of any international framework on investment is the definition of the types of investments to be covered. ‘Investment’, as defined in many BITs, the Energy Charter Treaty, NAFTA and the draft MAI, is an all-encompassing concept including all assets of an enterprise, such as movable and immovable property, equity in companies, claims to money and contractual rights, intellectual property rights, concessions, licences and similar rights. This concept (much broader than the notion of FDI), includes portfolio investments (UNCTAD 1996: 174), as well as rights arising from trade transactions and bank operations, although such transactions and operations would not be covered as such. Investments, whether foreign or domestic, are subject to the TRIMs Agreement, but only as far as certain performance requirements may distort trade (as discussed in Chapter 4). On the other hand, the GATS applies only to FDI required to establish a ‘commercial presence’ for the supply of services. None of these agreements encompasses such a broad range of assets as proposed in the draft MAI. It should be noted, in addition, that the draft MAI covers all sectors of the economy, including agriculture, natural resources, manufacturing and services. Unlike NAFTA, no negative list (that is, areas specifically excluded from the scope of the agreement) was incorporated in that draft, without prejudice to the national reservations that, on a temporary basis, could be made by contracting parties. The adoption of a broad definition of ‘investment’ and an allencompassing sectoral coverage, as proposed, would have important implications at the national level. For instance, it would entail limitations on the control of financial flows and reduce the ability to manage financial crisis. It would also add another layer of protection to intellectual property rights, beyond the standards agreed upon in the TRIPs Agreement. To the extent that mining and oil concessions were included, the capacity to design long-term policies on the conservation and use of natural resources could be affected as well. In sum, if negotiations on investment were initiated, a critical issue would be the coverage of a future instrument. A broad coverage, if admitted, will inevitably call for exceptions and reservations, in order to keep some room for manoeuvre at the national level. Pre- and post-establishment national treatment

The national treatment and the MFN standards, originally recognized as essential elements of trade agreements, have become common ele |  

ments of BITs and other international instruments relating to foreign investment. Both standards oblige a country to provide not a certain level or type of treatment, but only the same, or a not less favourable treatment than that accorded to nationals or to the ‘most-favoured’ nation, respectively. Subject to this limitation, foreign investors may hence be subject to regulations and policies generally applicable to the type of activity they undertake. Under most existing BITs and international instruments on foreign investments, the national treatment principle applies only after an investment has been made in consonance with the existing regulations and policies, i.e in the post-establishment phase. The host country therefore keeps the right to admit an investment or not (Ganesan 1997). Only once admitted can it benefit from that principle. BITs allow a host country flexibility to pursue its policies and laws and promote investments by providing protection to foreign investments.8 In the draft MAI, however, national treatment and MFN apply to both the pre- and post-establishment phases. This means that states would not be able, in principle, to impose conditions for the entry of an investment in a manner less favourable than that applied to nationals or to nationals of the most-favoured nation. Entry restrictions on foreign investments have been widely applied by developing as well as developed countries, on the basis of screening and prior authorization of FDI. Such restrictions are in most cases, by their nature, discriminatory vis-à-vis foreign investors and have been based on a wide range of grounds, including the willingness to promote the development of local companies, particular regions or areas of the economy, the acquisition of technology, the creation of employment or the generation of exports. In some cases, a broad notion of ‘national security’ has justified such restrictions in areas of critical interest to a country. Typical pre-establishment measures with respect to FDI applied in many countries 9 include: 1. restrictions on the type of assets that may be acquired by foreigners (e.g. real estate); 2. conditions on the structure of ownership (e.g. minimum participation of local investors); and 3. specific requirements relating to the future operation of the foreign firms (e.g. employment of local personnel, utilization of local raw materials and supplies, environment protection, exports of a certain proportion of production, etc.).  |  ’ 

In sum, the application of the national treatment and MFN standards to the pre-establishment phase would limit a state’s right to admit or not a foreign investment on the basis of its own national policies and objectives. In particular, the extension of the national treatment standard to the pre-establishment phase would create a ‘right of market access’ that would override the state’s right to decide how to admit and channel investment flows. Coverage

Even if ‘investment’ were broadly defined in terms of the categories of assets included, it may be possible to decide to which sectors or activities a possible multilateral framework would apply. Developed and developing countries have normally applied restrictions on foreign investment in certain sectors (such as natural resources, public utilities and cultural industries). In the draft MAI negotiations, it was proposed that the application of the multilateral framework should encompass all sectors and activities, unless specifically excluded. This approach (based on the concept of a ‘negative list’) is in contrast to the one adopted by the GATS, which applies only to those sectors and activities that a WTO member puts ‘on offer’ in its schedule (‘positive list’ approach). This positive list approach of the GATS provides flexibility for developing countries to make market access and national treatment commitments on commercial presence on those sectors where they wish to liberalize and attract investment. Conditions for the firms benefiting from the access commitment can also be specified. The draft MAI, in contrast, adopted a ‘negative list’ approach in which, as a general principle, only the sectors that were explicitly excluded from its disciplines under ‘national reservations’ would be exempted from national treatment and other obligations. States would be obliged, in order to become parties to the MAI, to disclose all nonconforming measures at the time the MAI was signed or at the time they joined. An additional objective of the draft MAI was gradually to eliminate the exceptions or reservations made by contracting parties, so as to end up with a code uniformly applicable across sectors. Obligations and reservations in the draft MAI are subject to ‘standstill’ and ‘roll-back’ provisions that, taken together, would produce a ‘ratchet effect’ (Sikkel 1997: 23). On the one hand, any new liberalizing measure adopted by a contracting party would be ‘locked in’ so that it could not be reduced or nullified over time. On the other hand, contracting parties are obliged  |  

to eliminate over time any non-conforming investment measures. This means that in the draft MAI reservations are deemed as essentially temporary; the objective is to establish an all-encompassing framework without sectoral limitations. However, the draft MAI allows contracting parties to apply ‘general exceptions’ so as to take measures to protect their essential security interests and the fulfilment of their obligations under the United Nations Charter concerning the maintenance of international peace and security. Discussions also took place with regard to a general exception for public order, for cultural industries and for regional economic integration organizations. The generalized application of national treatment to all sectors and activities has proven to be unsuccessful in NAFTA: neither the USA nor Canada was prepared to roll back any sectoral exception to national treatment (Graham 1996: 44). This issue was also one of the main factors behind the collapse of the draft MAI negotiation, given the large number of sectors and activities that the OECD countries wished to exclude from the general rules. To sum up, any initiative to cover investment in any sector or activity would undermine the state’s right to orient investment in accordance with its needs and policies. Such an initiative is likely to face significant opposition. While developing countries may not accept it (South Centre 1997: 38), developed countries may also find difficulties in imposing it in their own jurisdictions. Performance requirements

The impact of the TRIMs Agreement in developing countries has not yet been systematically assessed. The work by the Committee on TRIMs has been limited to the analysis of particular, potentially infringing cases. Little academic research has been conducted on the issue. As a result, there is no new empirical evidence or theoretical work that would support a revision of the Agreement’s provisions, particularly the broadening of TRIMs that are to be prohibited. The draft MAI specifies the performance requirements that contracting parties should not apply, either as a condition for entry or for the operation of a foreign investment. In the draft, performance requirements are not allowed with regard to the ‘establishment, acquisition, expansion, management, operation or conduct’ of an investment, that is, neither as a pre- or a post-establishment condition. The draft MAI went far beyond the TRIMs Agreement in this area.  |  ’ 

Box 6.1 Performance requirements in the draft MAI

The following performance requirements shall be prohibited: (a) export a given percentage of goods or services; (b) achieve a given level of domestic content; (c) purchase, use or accord a preference to locally made goods and services to buy goods and services from local persons; (d) relate the volume or value of imports to the volume or value of exports or to the amount of foreign exchange inflows associated with such investment; (e) restrict investors’ sales in its territory by relating these to its exports or foreign exchange earnings; (f ) transfer technology, a production process or other proprietary knowledge to local persons or enterprises, unless this is enforced by a court or competition authority to remedy violation of competition laws, or this concerns the transfer of intellectual property and is undertaken in a manner consistent with the TRIPs Agreement; (g) locate its headquarters for a region or world market in the contracting party’s territory; (h) supply its goods or services to a region or the world market exclusively from the contracting party’s territory; (i) achieve a level or value of R&D in its territory, (j) hire a given level of local personnel/nationals; (k) establish a joint venture with domestic participation; and (l) achieve a minimum level of local equity participation, other than nominal qualifying shares for directors of corporations.

It sought to curb a wide range of performance requirements (see Box 6.1), while a number of others would be illegal if not linked to investment incentives. Unlike the TRIMs Agreement, performance requirements that have no direct effect on trade are listed in the draft MAI. Some of them may be of special importance to members and other developing countries, such as employment of a given level of nationals, establishment of joint ventures with nationals, and minimum level of local equity participation. The requirements indicated in Box 6.1 (a) and (f ) through (l) may be admitted if an advantage were provided. This would include commitments  |  

to locate production, provide particular goods or services, train or employ workers, construct particular facilities, or carry out R&D. It should be noted that developed countries have used investment incentives with much the same effect as developing countries used TRIMs, as observed in Chapter 5 (Brewer and Young 1997: 184). The incentives may enhance the attractiveness of a particular location for foreign investors and deviate investment flows from other destinations, including developing countries. However, such incentives are not prohibited by the draft MAI, but are subject only to the three basic GATT principles: national treatment, MFN and transparency. In addition, despite the fact that such incentives are often granted through fiscal measures, all tax aspects would be left outside the MAI, except where linked to expropriation. A ‘TRIMs-plus’ agreement prohibiting an expanded list of performance requirements, as proposed in the draft MAI, would reduce the options available to members and other developing countries to determine the conditions for the entry and operation of foreign investments in line with their developmental needs. Such an agreement, in contrast, may not affect the granting of investment incentives that in many instances may replace the use of TRIMs. Investment protection

One of the main components of an agreement on investment, as illustrated by the draft MAI and other instruments on the matter, relates to investment protection. These include: • • • • •

disciplines on expropriation; obligations regarding compensation; protection from strife; free transfer of payments related to an investment (considered further below); and subrogation.

Disciplines on expropriation constitute one of the typical and important provisions found in BITs and other international instruments on investment. In some of those instruments, the application of such disciplines is conditional upon the meeting of certain conditions. 10 In other cases, rules on expropriation and other forms of taking of property are non-contingent and not subject to any condition. NAFTA and the Energy Charter Treaty, in particular, include strict criteria on the legality  |  ’ 

of expropriations and elaborate provisions on the compensation to be paid. The prevailing standard on expropriation requires ‘prompt, adequate and effective compensation’ in case of expropriation on any protected investment,11 and the right of the investor to substantiate its case before a judicial court or other independent authority in the host country. In OECD negotiations, for instance, there has been agreement on the following elements (Karl 1997: 14): • ‘prompt’ means without delay; • ‘adequate’ means that the compensation must be equivalent to the fair market value immediately before the expropriation took place, without any deduction due to the fact that the pending expropriation became publicly known in advance; • ‘effective’ means that compensation shall be fully realizable and freely transferable; and • ‘due process of law’ includes the right of an investor to have its case reviewed by a judicial authority or any other independent body in the host country. The expropriation clauses are generally linked to a subrogation clause, whereunder a host country is bound to recognize the assignment of the rights and claims of an investor to its home country, when the latter has made a payment under a guarantee, indemnity or contract of insurance in respect of an investment. In this case, the home country may exercise by virtue of subrogation the rights and claims of the foreign investor. Under protection from strife clauses, as provided in BITs and other instruments, a host country would be obliged, in principle, to confer on foreign investors national treatment and MFN. In the draft MAI, it is proposed to replace this contingent standard with an absolute obligation. The host country would be obliged to pay compensation for losses arising from war, any other armed conflict, state of emergency or similar cases, if the losses were due to requisition or destruction by the host country’s forces or authorities. Moreover, if a contracting party decides to pay, even when not obliged, it would be subject to the national treatment and MFN principles. Movement of personnel

The draft MAI subjects the entry, stay and work of ‘key personnel’ (including executives, managers and specialists) and of the investors  |  

themselves to national immigration and labour regulations. However, it does not permit denial of entry, stay or authorization to work for reasons related to labour markets or other economic needs tests or numerical restrictions, as often found in national laws, regulations and procedures. Ownership requirements

The draft MAI does not permit contracting parties to oblige foreign investors to establish a joint venture or to achieve a minimum level of local equity participation. Non-discrimination with regard to ownership and control also applies, in the draft MAI, with respect to concessions (except when they confer a monopoly) relating to rights to search for, cultivate, extract or exploit natural resources. Under the OECD model, the general rule would be the freedom for foreign investors to invest without restrictions on ownership or control. According to the negotiated text, such rules may not apply in some cases, such as in the case of a state monopoly or when ownership requirements are a condition to receive an advantage. The draft MAI would not disallow the application of competition law to block or put conditions on takeovers of local companies, as currently done by many OECD countries. Further, the draft MAI provided that it was a government’s decision to privatize a state enterprise, but once the decision was taken the national treatment principle and the MFN clause would apply12 to both initial and subsequent sales associated with all kinds of privatization, irrespective of the method employed (whether public offering, direct sale or other method). Transfer of funds

OECD countries have pursued the recognition of a ‘freedom to transfer’ funds to foreign investors. This is a typical element of investment treaties. An unrestricted ‘freedom to transfer’ may, however, have adverse effects on the balance of payments and sensitive stock markets, particularly in times of financial turmoil. According to the draft MAI, only under exceptional circumstances affecting the balance of payments would a contracting party be able to introduce exchange restrictions and capital controls for a temporary period, subject to a number of conditions, including the MFN treatment, a review by the Parties Group and approval by the International Monetary Fund.  |  ’ 

A contracting party may also apply measures that do not conform to the national treatment, MFN and other provisions of the treaty in the financial services, if necessary to protect investors, depositors, and so on or to ensure the ‘integrity and stability’ of the financial system. State monopolies and purchases

The draft MAI, as proposed, does not affect the right of a state to establish or maintain state monopolies, but the latter would be obliged to provide non-discriminatory treatment to foreign firms with regard to the sale of goods and services made by a monopoly, as well as with respect to its purchase of goods and services from third parties. The non-discrimination obligation with regard to the purchase of goods and services by the monopoly also extends to government procurement, if the purchase is made with a view to commercial resale or for use in the production of goods and services for commercial sale. Dispute settlement

If an agreement on investment was negotiated, another important issue would be the extent to which it would contain rules and mechanisms on dispute settlement, and whether these would apply to state-tostate and/or investor-to-state relationships. The draft MAI includes the proposal for establishing a specific dispute settlement mechanism that would deal with both state-to-state and investor-to-state disputes. In the case of state-to-state arbitration, following the WTO system of dispute settlement, the first step would be consultations attempting an amicable solution to the dispute. If this was not reached, an arbitration panel (consisting of three or five members) would be appointed, based on a proposal by the secretary-general of the ICSID (International Centre for Settlement of Investment Disputes). The treaty would establish the basic rules and procedures for the arbitration, although the parties to a dispute would be always allowed to apply agreed modifications to the rules. The substantive law to be applied would be the provisions of the MAI, while other international rules might be applied for the interpretation and application of the treaty. Domestic laws would be taken into account only if relevant to and consistent with the MAI. The awards issued by a panel would be final and binding upon the parties to the dispute. In addition the draft MAI develops an investor-to-state arbitration system, which would operate as follows (Baldi 1997: 39):  |  

1. The investor would be free to choose whether: to submit the dispute for resolution to any competent court or administrative tribunal of the contracting party to the dispute; • to solve the dispute in accordance with any dispute settlement procedure agreed upon before the dispute arose; or • to follow the procedures provided for by the MAI itself; 2. MAI contracting parties, through the adoption of the treaty, would give unconditional consent to submission of a covered dispute to arbitration under: • the rules of arbitration of the ICSID or under the rules of the ICSID Additional Facility; • the UNCITRAL (United Nations Centre for International Trade Law) rules; or • the Court of Arbitration of the International Chamber of Commerce. Prior consent by the contracting parties, as indicated in ii) above, would mean, in practice, that it would be exclusively up to the investor to decide whether or not to refer the dispute to arbitration (Baldi 1997: 40). Unconditional prior consent, without any possible exception, may raise problems of a constitutional nature in some countries (DAFFE/ MAI/NM(97)2: 130).13 A number of important issues remained to be defined in OECD negotiations on this matter, including the consequences if a contracting party failed to comply with a final award, such as the suspension of voting rights in the Parties Group (the body that would monitor and interpret the treaty in order to facilitate its operation) and the withdrawal of concessions under the MAI (with the exception of rules relating to the general treatment and expropriation of investments). Other countermeasures, including trade retaliations, were also discussed. A particularly delicate problem is whether a dispute settlement mechanism could be applied with regard to the pre-establishment phase. How would it be possible for a potential – and not an actual – investor to initiate procedures against a contracting party where it is not yet established ? Firms’ obligations

As described, the draft MAI implies a number of important restrictions regarding the design and implementation of policies on FDI and other forms of investment. From the perspective of members and other developing countries and LDCs, a major missing issue in the OECD exercise is the lack of obligations to be applied on investors. A proposal was  |  ’ 

made to include as an annex to the MAI the ‘Guidelines for Multinational Enterprises’ approved by the OECD, but just as a ‘voluntary code of conduct’, without any binding effect. Therefore, the MAI has approached the issue from a narrow investor/home country perspective. Possible obligations of a multilateral framework on investment may relate to restrictive business practices of firms, enhancing foreign exchange income, the transfer of technology and protection of the environment. The draft MAI does not include specific obligations for investors in any of these areas. With regard to the environment, a provision was discussed instead aimed at imposing the obligation on contracting parties not to lower environmental standards/measures as an encouragement to investment. However, performance requirements to achieve a certain percentage of domestic content, and to purchase or use goods produced or services provided in a contracting party’s territory, could be acceptable under the draft MAI14 if necessary to protect human, animal or plant life or health, or for the conservation of living or non-living exhaustible natural resources. A Resolution passed by the European Parliament on 10 March 1998 has highlighted the asymmetric treatment of firms’ and states’ obligations in the draft MAI. It called ‘on the Parliaments and Governments of the EU Member States not to accept the MAI as it stands’. The Resolution pointed out the following several concerns of developing countries and LDCs regarding the draft MAI: 1. The draft MAI ‘reflects an imbalance between the rights and obligations of investors, guaranteeing the latter full rights and protection, while the signatory states are taking on burdensome obligations, which might leave their populations unprotected’; and 2. ‘the MAI must not only provide benefits to the industry of the countries of origin, but should also contribute to responsible development of the country of establishment by promoting technology, sustainable economic growth, employment, healthy social relations and the protection of the environment’. The extent to which a multilateral framework should impose obligations on investors is an important issue for consideration. Of course, investors do not possess a legal status equivalent to states and cannot be directly subject to international obligations. However, nothing would prevent that certain obligations on investors be established through the action of the states in their respective jurisdictions.  |  

Development concerns

The development dimension has been absent in the OECD negotiations, although the draft MAI was elaborated under the assumption that it would be open for signature by any non-OECD country, including developing countries and LDCs. Such dimension should be an essential component in any future negotiation on investment, as already reflected in the discussions of the Working Group as well as the Doha Declaration. The above-mentioned Resolution by the European Parliament of 10 March 1998 specifically addressed the situation of developing countries. It called upon the European Commission to: 1. carry out, within a reasonable period, ‘an independent and thorough impact assessment in the social, environmental and development fields’, and investigate to what extent the draft MAI is in conflict with relevant international agreements, such as the Rio Declaration, Agenda 21, the UN guidelines on consumer protection (1985), the UNCTAD Set of Multilaterally Agreed Principles for the Control of Restrictive Business Practices (1981), etc. 2. refrain from exerting any pressure on developing countries in order to induce them to accede to the MAI because of a major shortcoming of the Agreement: these countries may not exert any influence on the content of the Agreement; 3. examine the question of investment protection in a multilateral context in which all developing countries are involved, so that UNCTAD, as well as the WTO, would be an appropriate forum for these negotiations; the WTO’s consideration of this question must take full account of the results of the UN conferences, particularly with regard to the environmental and social dimensions; 4. respect the principle of partnership in order to take into account the interests of developing countries and their national policies, as well as the interests of investors; 5. ensure that foreign investors do not enjoy more favourable treatment than national investors, although the European Parliament supports MFN, transparency and national treatment as the basic foundations of the MAI; 6. make a derogation for balance of payments (BOP) disequilibria with a provision to deter parties from abusively invoking BOP problems; and 7. ensure that in formulating prohibitions of specific performance requirements, these do not conflict with the right of states to im |  ’ 

plement existing industrial policies and to develop any new ones as required in the future, in the field of social and environmental legislation, culture and intellectual property. The Resolution also indicated that reference should be made to compliance with international human rights conventions and environmental and social standards not only in the preamble of the MAI. It stated that the MAI should contain unequivocal provisions to prevent a lowering of existing environmental and social standards, and make possible the introduction of new ones. Furthermore, the Resolution advocated that the OECD Guidelines for multinational undertakings should constitute a compulsory component of the MAI, and called on the member states to encourage international enterprises to draw up their own codes of conduct comprising provisions in the field of environmental protection, human rights and social matters. On investment, the Resolution called for a more precise definition in the area of patents for plants, animal and human genes and insisted that the provisions on intellectual property, copyright and neighbouring rights should be excluded from the MAI. While welcoming the comprehensive definition of the term ‘investor’, it acknowledged that the broad definition of ‘investment’ might create difficulties in the future, and therefore called on the European Commission to monitor further work on definitions, and notify parliament of any changes. In the opinion of the European Parliament, the proposed disputes settlement procedure, which will enable private companies to take action against the government of a contracting party, is questionable. It requested the European Commission to consider whether existing national and international disputes settlement procedures were inadequate. It also called for a ‘balanced system of legal protection which enables both the investor to enforce the rights he derives from the agreement and the contracting state to ensure compliance with binding provisions of its environmental and social legislation’. Although this Resolution reflects the point of view of representatives of OECD countries, it illustrates quite well the imbalances of the draft MAI and the lack of consensus on this initiative, even within the group of developed countries. Concluding remarks

The negotiations conducted within the OECD to establish a Multilateral Agreement on Investment illustrate the possible objectives of  |  

developed countries in a multilateral investment agreement. The failure of the exercise – despite the fact that the negotiations were confined to OECD countries15 – also shows how complex and difficult the establishment of such an agreement may be, particularly with the participation of countries with significant differences in economic development. The negotiations on the MAI addressed a broad range of investments, not limited to FDI, including in fact any ‘asset’ owned or controlled by a foreign investor in any sector of the economy (unless specifically excluded), including agriculture, natural resources, manufacturing and services. A basic element in the draft MAI was also that (unlike most existing BITs) it included standards of national treatment and MFN not only with regard to the operation of investments (post-establishment phase) but also to the their entry (pre-establishment phase). Under this approach, contracting parties would thus waive their right to determine the patterns to and limitations to FDI. Under the draft MAI, contracting parties accept not to impose a large number of performance requirements unless they are linked to incentives. In this sense, the draft MAI clearly is a ‘TRIMs-plus’ initiative. Provisions for the protection of investments against expropriation and from strife, and aiming at the establishment of a specific system of dispute settlement, both state-to-state and investor-to-state, are also part of the draft MAI. The draft MAI sets forth the obligations of the states that would adhere to it, but it is silent about the obligations that investors should comply with. Basically, states’ obligations consist of limitations on their power to establish conditions on ownership and control (including with respect to privatized enterprises and concessions on natural resources), the immigration of key personnel, the management and transfer abroad of investment-related funds, among others. Finally, negotiations in the OECD have not considered the development dimension of investment, a critical issue in any possible discussion on this matter. Notes

1. As indicated in Chapter 2, OECD countries account for nearly 85 per cent of global outflows of FDI and nearly 75 per cent of global inflows. 2. EC Commission, ‘A level playing field for direct investment world-wide’, COM(95)42. See also Brittan 1995: 1–10. 3. See the series of documents WT/WGTI/W for the reports of the Work |  ’ 

ing Group on the Relationship between Trade and Investment to the General Council and various communications submitted to the Working Group at the http://docsonline.wto.org. 4. The OECD MAI (as well as the EC MIA) would also include a ‘roll-back’ commitment to gradually eliminate measures that run counter to the new rules. This means that, even if certain measures were exempted, they would be accepted only on a temporary basis. 5. See Kumar 1996; South Centre 1997; Khor 1996 and the NGO Joint Statement on the Foreign Investments Issue in WTO, Penang, November 1995. 6. The analysis made in this chapter is based on the OECD document: ‘Multilateral Agreement on Investment. Consolidated text and commentary’, DAFFE/MAI/NM(97)2, Paris. 7. This analysis explicitly recognizes, and is limited by, the provisional and unconcluded nature of the draft text. There is no intention to suggest that the OECD draft MAI should be a basis for possible negotiations on the matter involving non-OECD countries. 8. See UNCTAD 2002, TD/B/COM.2/EM.11/2 May 2002. 9. See UNCTAD 1996: 176. 10. For instance, the Overseas Private Investment Corporation (OPIC) requires that an FDI project meet some criteria as far as impact on host and home countries is concerned (e.g. positive developmental effects and absence of negative environmental effects). 11. It should be noted that, given the proposed scope of the draft OECD MAI, a rescheduling of the foreign debt needed by a contracting party to handle a financial turmoil or for other reasons, may become a sort of taking of property or expropriation (Shekulin 1997: 13). 12. A discussed exception was the so-called ‘special share arrangements’ whereunder a certain group of persons are granted exclusive rights as regards the initial privatization. 13. A possible qualification to the prior consent rule may be the right of a state to withhold consent in cases where the investor has previously submitted the dispute either to a national court or to international arbitration under another agreement (Baldi 1997: 41). 14. In accordance with a provision that had not been agreed upon at the time when negotiations were discontinued. 15. A few developing countries participated as observers.

 |  

Chapter seven

A multilateral framework on investment in the WTO: is there a case for it?

§ As observed earlier, developed countries have continuously striven to evolve a more comprehensive GATT-type multilateral framework on investment beyond what is covered under TRIMs and the GATS. One such attempt was the initiative to establish the MAI under the aegis of the OECD launched in 1995, as discussed in Chapter 6. The OECD negotiations on the MAI, however, could not be successfully concluded and were abandoned in 1998. The MAI negotiations failed because of the failure of OECD members to reach a consensus on the issue. However, even before the experiences of MAI negotiations in the OECD were available, an attempt was made to push the investment issue on the WTO’s agenda at the First Ministerial Conference of the WTO in Singapore, where the EU and Canada proposed the creation of a Possible Multilateral Framework on Investment (PMFI) under the auspices of WTO. However, given the resistance of developing countries, a negotiating mandate could not be obtained on the subject, but a Working Group on Trade and Investment (WGTI) was set up in the WTO to study the issue without a negotiating mandate.1 Before the WGTI’s study process could conclude its work and recommend the desirability, if any, of an MFI within the WTO’s ambit, the EU with the support of other industrialized countries pushed the investment issue for negotiations at the Fourth Ministerial Conference of WTO held in Doha in November 2001. Despite the resistance of developing countries, which wanted to first complete the study process at the WGTI before agreeing to a negotiating mandate, the Doha Declaration provided for launch of negotiations on the trade and investment after the Fifth Ministerial Conference ‘on the basis of a decision taken, by explicit consensus, at that Session on the modalities of negotiations’.2 There is some ambiguity in the Doha mandate as to whether the explicit consensus will be needed to decide whether or not to launch the negotiations or explicit consensus is required only for deciding the modalities of negotiations. In response to a query from India, while leading the developing country resistance on the issue, the Conference Chair clarified that explicit consensus would be needed for the launch of the negotiations. However, the developed countries

appear determined to push to launch the negotiations on these subjects at the Fifth Ministerial Meeting of the WTO scheduled in September 2003 in Cancun. A basic question before entering into any negotiation on an MFI is to determine to what extent there is a need for a new multilateral instrument on investment, and what its costs and benefits for developing country members may be. Against that backdrop, in this chapter we make an assessment of an MFI from a developing country perspective. Is there a case for MFI? What implications would an MFI have for developing countries? This analysis is followed in the next chapter by a discussion of the possible elements of a framework as listed in paragraph 22 of the Doha Declaration. Conceptual relevance of a GATT-type framework

The recent attempts to extend trade regime-type rules such as national treatment to investment is clearly misconceived conceptually as well as in practice. There is a conceptual basis for trade liberalization on the principle of comparative advantage where countries with different comparative advantage benefit from trading mutually. One country has one strength, the other has another, and both benefit by swapping or trading their goods. Therefore, all countries participate in international trade and each country’s exports and imports are close to each other in terms of value. The key difference between the trade of developing and industrialized countries is in terms of the sectoral composition of goods exported (and imported), with developing countries specializing in labour- and raw material-intensive goods while industrialized countries specialize in knowledge- and capital-intensive goods. Unlike trade, FDI flows emerge because of differences in the levels of development and bundles of created assets. Indeed, the theory of international firms explains the evolution of a national firm into an international corporation in terms of monopolistic ownership of intangible assets that have revenue productivity abroad and that more than offsets the disadvantages of operating in an alien environment. These advantages include proprietary technology, globally recognized brand names, access to cheaper sources of capital and accumulated experience of organizing complex tasks, among others.3 From the start, therefore, MNE entrants enjoy an edge over local enterprises, if any exist at all, because of their monopolistic ownership advantages.4 The margin of the edge enjoyed by them is inversely related to the extent of development of local industrial capabilities and hence the level of development. It is  |  

particularly wide in low-income countries. It is no accident that 90 per cent of global stock of FDI outflows are owned by the industrialized countries. Developing countries nearly always play the host and are very seldom home countries of FDI flows. Therefore, in contrast to the argument of the proponents of MFI, the playing field is already tilted in favour of MNCs. MNCs when they enter a country are already much ahead of the domestic enterprises in the potential host country, especially in developing countries because of their monopolistic ownership of unique assets. Offering national treatment to foreign enterprises and domestic enterprises would amount to discriminating against the latter. In most developing countries, the little local entrepreneurship that exists runs the risk of vanishing altogether if forced to compete with the mighty global corporations under ‘national treatment’. Furthermore, MNE affiliates and local enterprises face very different opportunities and react to them differently. The access to information on world markets and opportunities present in different places, coupled with the MNCs’ objective of global profit maximization, may result in rationalization of production internationally on the basis of costs. MNC affiliates may therefore have a relatively higher dependence on international trade than their local counterparts. Foreign affiliates’ perception of risks may also be different because of their better access to information. The centralization of strategic decision-making responding to global opportunities in MNCs may lead to a different reinvestment and financing behaviour, propensity to undertake R&D, raw material sourcing, export behaviour and profit repatriation behaviour, among other characteristics, of foreign affiliates compared to local enterprises. A number of empirical studies have found the decisions to enter, diversify and undertake R&D of MNC affiliates determined less by local conditions than in the case of their local counterparts in Canada and India, among other countries (Gorecki 1976, 1980; Howe and McFetridge 1976; Kumar 1987, 1994b). Local enterprises in developing countries have to locate their further investments in production facilities and R&D in their home countries, barring a few exceptions. The affiliates of MNCs have wider options and opportunities. Furthermore, the objective of global profit maximization may lead to conflict of interest between the MNC subsidiary and the host country. MNCs may manipulate transfer prices to transfer profits from a higher tax regime to a lower tax regime. In view of the growing evidence on the practice of transfer pricing manipulation by MNCs to reduce their tax liability by shifting them in tax havens and other  |                    

money-laundering activities, the OECD has started an initiative against the tax havens. As discussed in Chapter 2, given their superior asset bundles, the entry of MNCs may crowd out domestic firms from the product markets or factor markets. Evidence is also available on the adverse effect of foreign ownership on productivity of domestic enterprises in developing countries.5 Given these differences in corporate strategy and decision-making, special advantages of MNCs, host governments in developing countries may wish to protect domestic ‘infant enterprises’ or small and medium enterprises from foreign competition either through selective policies towards FDI or through some measures favouring domestic enterprises. Discriminatory support measures favouring the domestic enterprises in strategic industries are quite common even in the developed world. A well-known example is SEMATECH, a consortium of computer chip manufacturers that has excluded foreign participation and has received substantial subsidies from the US government.6 The trade–investment link is not unambiguous

The inclusion of investment on the WTO agenda has also been justified on the grounds of trade relatedness of investment. However, the trade–investment link, other than what is covered under the TRIMs Agreement, is by no means straightforward. The bulk of FDI flows continue to be of the market-seeking (or tariff-jumping) type. These inflows actually replace trade. Therefore, after taking care of possible trade-distorting investment policies under the TRIMs Agreement, there is very little justification for including a full-fledged investment agreement in the multilateral ‘trade’ negotiations. FDI, like domestic investment, is a development and industrialization issue rather than a trade issue. Bringing it on to the WTO agenda would unnecessarily divert the attention of the WTO from its main purpose: trade liberalization. The WTO also does not have competence to deal with the investment and development issue. This is clear from the fact that the Working Group on Trade and Investment set up as per the Singapore Meeting in 1996 has not been able to complete its work so far. FDI policy and the level of development

The FDI policy needs to be evolved continuously as per the development of the country. A one-size-fits-all approach to FDI policy that is sought to be evolved through MFI in the WTO is not optimal for the following reasons.  |  

Countries at different levels of development receive different types of FDI inflows

It has been argued in the literature that countries at different levels of development receive different types of FDI (e.g. Porter 1990; Ozawa 1992). For instance, a country at the beginning of the factor-driven stage will attract resource-seeking or labour-seeking inward FDI. The transition from the labour-driven to the investment-driven stage attracts inward investments in capital and intermediate goods industries and outward investments to lower-wage countries in labour-intensive manufacturing. Similarly, the transition from the investment-driven to the innovationdriven stage brings about inward investments in technology-intensive industries and outward investments in intermediate goods industries (Ozawa 1992). Naturally the need for policy framework dealing with FDI would depend upon the level of development. The proposed harmonization of investment policy through a WTO regime will not serve the best interests of countries at different levels of development. That an across-the-board approach is not appropriate is clear from the fact that the negotiating parties to the Draft MAI of the OECD had sought 700 exceptions to the Agreement despite the fact that it was negotiated by countries generally at similar levels of development, being all members of the OECD. The developmental impact of FDI depends on host country policies

The studies examining the developmental impact of FDI from different countries have come up with mixed findings. Some countries have been able to benefit more from FDI inflows than others, as observed earlier in Chapter 2 (see Kumar 2002 for a recent review of evidence). The host governments have used a variety of policies and performance requirements to channel FDI inflows in tune with objectives of their development policy. It is evident that countries that pursued selective policies with respect to FDI – for instance, South Korea, Taiwan and China, among other Southeast Asian nations – for instance, in channelling FDI into export-oriented and high technology activities – have had a greater success in achieving their developmental objectives with FDI inflow than those that pursued more open policies, such as those in Latin America.7 UNCTAD (1999b) after reviewing the literature on FDI and development observes that ‘the impact of FDI on development goes well beyond its linkage with trade … and … can be negative … The effect of FDI on development depends on the initial conditions prevailing in the host countries, on investment strategies of companies and on the  |                    

host government policies. Governments, therefore, cannot be passive.’ A multilateral regime will take away the ability of the host governments to direct FDI in accordance with their development policy objectives, and the overall ‘quality’ of any FDI inflows received may suffer. As Bhagwati (1998) argues, the FDI policy such as performance requirements is an area where ‘host countries should be free to make their own choices, based on their own (even if often harmful) assumption about externalities and spillover effects on their national economies’. MFI and the magnitude of FDI inflows

Proponents of a GATT-type MFI argue that such a framework would help developing countries to increase their attractiveness to foreign investors. However, as numerous empirical studies have shown, FDI inflows are largely driven by the gravity factors such as market size, income levels, the extent of urbanization, geographical and cultural proximity with the major source countries of FDI, and the quality of infrastructure. The policy factors play a relatively minor role at the margin (that is, holding gravity factors constant) (see, for instance, Contractor 1990; Wheeler and Mody 1992; Kumar 2000, among others). After harmonization of policy regimes across the world as proposed, the concentration of FDI in the industrialized countries may increase further. The irrelevance of government policy regime as a determinant of FDI inflows is clear from the fact that many African countries that have liberalized their FDI policy as a part of structural adjustment programmes administered by the IMF and the World Bank during the 1980s have failed to receive any significant FDI inflows. A number of countries with a much more restrictive policy framework are able to attract such inflows – for instance, China attracts over $40 billion worth of FDI inflows every year. Despite the fact that the USA and China do not even have a bilateral investment treaty, the USA is the most important source of FDI in China. As observed in Chapter 2, the share of the 45 least developed countries in the global distribution of FDI inflows actually declined from 0.8 per cent in the early 1990s to 0.34 per cent in 2000 (see also UNCTAD 2001b). A distinction can be made between ‘investment opportunities’ and ‘investment climate’. The latter is generally insufficient to attract investors if the opportunities are not perceived by them as sufficiently predictable and profitable. Conversely, investment opportunities may be by themselves insufficient to attract investors if a hostile ‘investment climate’ is to be faced. An MFI may at best be a ‘confidence-building’ device, but may still not be a key factor in determining decisions on FDI as com |  

pared to other more significant country-specific circumstances. However, as observed later, alternative frameworks of confidence building exist at bilateral and multilateral level. Therefore, as stated in an UNCTAD study: in all probability, an FDI, which would otherwise not have taken place in a host country, would still not take place even if the country signs up to an MFI; nor would an FDI which would otherwise have taken place, be lost to a host country because it is not a signatory to an MFI. An MFI would not by itself make up for those conditions that at present deter investment in developing and least developed countries. National legislation and transparent procedures which facilitate and provide security for foreign investment, and the development of basic infrastructure for the installation and operation of production units are issues to be resolved through a reorientation of domestic policy measures. These conditions can be provided within the framework of a stable macroeconomic policy regime, and by a stable political leadership that is committed to development, and not by an MFI. (UNCTAD 1998) Asymmetric approach of multilateral framework Asymmetry between investment and labour mobility

Capital and labour are two mobile factors of production. The proposed framework on investment proposes to liberalize capital movements without providing for the labour mobility, and hence would create asymmetry. The economic arguments for the free movement of labour are no weaker than those for the free movement of capital (Hoekman and Saggi 2001). As Panagariya (2000) argues, ‘symmetry dictates that alongside investment agreement, there also be an agreement on the movement of natural persons. Since the current ethos is unlikely to permit the inclusion of such proposals into the negotiating agenda, there is no reason for inclusion of investment into the agenda either.’ The regional blocs such as the EU that provide for free capital movement between the member states also assure free labour mobility across the member states. As Malaysia’s Prime Minister Dr Mahathir observed at the opening of the ILO Conference in Geneva on 11 June 2002: If capital is to be allowed to cross borders freely then workers too should be allowed to do the same. If this cannot be accepted, then free capital flows cannot be accepted either. If free flows of workers have to be regulated in a world without borders, a globalized world, then capital flows must also be regulated.  |                    

Table 7.1 Summary of commitments under the GATS made by countries

under Mode-4 of supply (percentage of commitments on service activities) Country group

Movement of natural persons No limits Limits Unbound

Market access Total Developed Developing Transition

2 0 5 0

92 100 81 99

6 0 14 1

National treatment Total Developed Developing Transition

30 17 45 51

61 83 34 48

9 1 21 1

Source: WTO 1999

The reluctance of developed countries to liberalize labour mobility is clear from the lack of commitments made by them in respect of Mode-4 in the GATS, which covers the movement of natural persons. Table 7.1 summarizes the commitments made by different groups of countries in respect of Mode-4 of supply under market access and national treatment. It is clear that 100 per cent of all market access commitments made by developed countries in respect of movement of natural persons have limitations such as economic needs tests or being subject to a specified proportion of the workforce. Similarly, 83 per cent of commitments in respect of national treatment made by developed countries are also subject to limitations such as tax treatment or other discriminating treatments that are sometimes non-transparent. This situation prevails notwithstanding Article IV.1(c) of the GATS, ‘the liberalization of market access in sectors and modes of supply of export interest to developing countries’ (see RIS 2002 for more details). Asymmetry between the rights and responsibilities of foreign investors

As observed in Chapter 6, the MAI draft that is proposed to be used as a model for MFI has essentially been written from a narrow investor’s point of view, and is asymmetric as it provides for responsibilities of host governments and rights of corporations but not the other way round. It does not have any provisions concerning the protection of host country  |  

interests. A lot of work done in the 1970s demonstrated the tremendous economic power wielded by MNCs in the global economy, and concerns over the possible misuse of this power in private hands led the international community to launch several initiatives at the international level to curb it. These include the international codes of conduct and rules for controlling restrictive business practices. Some of these initiatives, however, could not be concluded successfully due to differences between the negotiating parties (especially between the industrialized and developing countries on the binding nature of the instruments).8 If at all, the economic power of MNCs has certainly increased greatly since the early 1970s, when these concerns were first raised in view of increasing global economic integration. A recent spate of corporate restructuring has given rise to mega-corporations with dominant market positions in their respective market segments and a gigantic scale of operation. The international initiatives intended to curb possible restrictive business practices, misuse of their economic power and obviation of corporate responsibility for their actions are not of a binding nature (in fact the UN Code of Conduct on TNCs and the UNCTAD’s Code on International Transfer of Technology were negotiated in protracted negotiations but were not adopted by the UN General Assembly). MNCs follow different standards with respect to environment, treatment of labour, respect of consumer protection and rights in different countries. It is well known that they relocate polluting industries and export products that are banned in their home countries to developing countries that may have lax environmental or product standards. The glaring lack of a binding international regulation of activities of international corporations has often been noted. The 1984 Bhopal tragedy, where the concerned MNC sought to shirk the liability arising from actions of its majority-owned subsidiary, is a case in point. The practice of manipulation of transfer prices for shifting funds across countries to evade taxes is also well known. Therefore, an agreement not providing any matching provisions on international regulation of business or obligations of MNCs and rights of host governments is not going to appeal to developing country governments that are on the receiving end of FDI in net terms. Furthermore, while there are attempts to curb the ability of the host governments to impose performance obligations, that of corporations to impose restrictive clauses on their subsidiaries – which are often trade-distorting, as seen in Chapter 5 and 6 – is not regulated. According to Bergsten and Graham (1992) an ‘ideal accord would grant specific rights to, and simultaneously place certain obligations on, three sets of actors: (a) governments of nations that are host to FDI (including  |                    

subnational governmental entities), (b) governments of nations that are home to international corporations, and (c) international corporations themselves’. Existing bilateral and multilateral frameworks for investment protection and dispute settlement

A general impression created by the protagonists is that an adequate framework for protection of investment and dispute settlement does not exist. This impression is completely flawed. There exists an elaborate framework for investment protection and dispute settlement at the bilateral as well as multilateral levels. There is an extensive network of bilateral investment promotion and promotion treaties (BIPAs or BITs) between different pairs of countries. By the end of 2001, 2,096 such treaties had been signed by 174 countries. The bulk of these treaties were signed during the 1990s following the rapid growth of FDI flows. Thirtyone per cent of these treaties were concluded between developed and developing countries and 45 per cent between developing countries. 9 Typically these BITs provide protection and national treatment for investments that have been established in tune with the existing national regulations and policies. Hence they provide host countries with the flexibility to pursue their development policy while at the same time giving a sense of security to foreign investors. They promote investments by giving protection to them and have served the purpose very well, as is clear from the rapid growth of their numbers over the 1990s from 385 in 1989 to 2,096 by 2001. It also suggests that BITs are much easier to conclude compared to a multilateral framework. The OECD’s MAI could not be concluded even though all the negotiating parties were developed countries. Furthermore, there do exist multilateral instruments for the protection and guarantee of international investments. These include the Multilateral Investment Guarantee Agency (MIGA), under the World Bank which came into being in 1988. The International Convention on the Settlement of Investment Disputes (ICSID), also under the aegis of the World Bank, has provided a framework for dispute settlement since the mid-1960s (see Chapter 3), besides the UN Committee on International Trade Law (UNCITRAL) and the International Chamber of Commerce (ICC). Is there a grand bargain for developing countries?

Some proponents of putting the investment issue on the WTO agenda have argued that developing countries may give in on invest |  

ment in return for huge gains in other areas. Moran (1998), for instance, argues that a discipline on investment incentives given by industrialized countries could be a grand bargain for developing countries in return for agreeing to a multilateral investment regime. However, disciplining of investment incentives should happen for its own sake, and given the prisoners’ dilemma inherent in it, every country will benefit from it. It is certainly no grand bargain given what developing countries will be giving in return – that is, the policy flexibility to screen and regulate FDI inflows. As Hoekman and Saggi (2001) argue in a paper prepared for the World Bank, ‘devising a grand bargain (by developing countries) will be difficult. Account must be taken of potential downside – issue linkage can be a two-edged sword.’ Concluding remarks: is there a case for an MFI?

The foregoing discussion shows that there is hardly any justification for a GATT-type multilateral framework on investment either conceptually or in practical terms. The conventional rationale for trade liberalization cannot be extended to investment liberalization. The playing field is already tilted in favour of foreign investors that are large MNCs who enjoy tremendous resources and market power due to their brand names and their worldwide appeal. With the global integration of media and other channels of information flows, the edge that MNCs enjoy over national companies has increased. The investment–trade link is not unambiguous and does not provide justification for the MFI to be included in the WTO framework. FDI policy needs to be continuously adjusted in line with the levels of development as the nature of investments received by countries at different levels of development differs greatly, making a one-size-fitsall policy inappropriate. Furthermore, it has been demonstrated by the literature that the development impact of FDI inflows depends upon the host country policies. Selective policies and performance requirements help the host countries to improve the quality of FDI received. Hence any attempt to curb the policy of autonomy to pursue selective policies and impose performance requirements in the framework of an MFI is likely to have adverse developmental consequences. It is difficult to understand the reasons for pushing the MFI in the WTO on the part of developed countres. The FDI regimes have become increasingly liberal over the past decade on their own and will continue to move in that direction in the coming years, given the competition among countries for FDI inflows. The multilateral trade negotiations leading to the establishment of the WTO have already included an agreement  |                    

on eliminating the Trade-Related Investment Measures (TRIMs), which limits the ability of host governments to regulate FDI inflows. An international framework for settling investment disputes – the International Convention on the Settlement of Investment Disputes (ICSID) – already exists under the auspices of the World Bank. The Multilateral Investment Guarantee Agency (MIGA) has also been launched to protect and insure overseas investments against political risks such as expropriation, blocked currency transfers, breach of contract, war, revolution and insurrection. There are more than two thousand BITs providing protection to FDIs. There have not been any glaring cases of disputes that could not be settled through the existing framework. The argument given in favour of the MFI is that it will obviate the need for concluding numerous bilateral investment treaties. Bilateral treaties are concluded between countries to deal with specific issues of concern between a pair of countries, and are much easier to conclude. A multilateral framework may not be able to provide a general solution of all the issues of bilateral concern. If there is any need at all for international intervention it is for enforcing certain norms of responsible corporate behaviour, given the unprecedented power that MNCs now enjoy. FDI, like domestic investment, concerns development more than trade. Hence the WTO is not an appropriate forum in which to deal with investments. While the proposed framework cannot guarantee bigger inflows of FDI, it threatens to take away the ability of host countries to influence their quality, which, as has been observed earlier, can vary greatly. Finally, the experience of negotiating the OECD’s MAI suggests that it would not be easy to achieve a consensus on the nature and provisions of MFI. Given the fact that WTO membership is infinitely more heterogeneous than the OECD membership, covering as diverse a group as rich developed countries, least developed countries, low-income countries, and so on, it is rather audacious to expect to bring about a consensus in this forum on an issue as contentious as an investment regime.

Notes

1. See Singapore Ministerial Declaration WT/MIN(96)/DEC dated 18 December 1996. 2. See Doha Ministerial Declaration adopted on 14 November 2001; WT/ MIN(01)/DEC/1. 3. See Dunning 1993 and Caves 1996 for expositions of theoretical approaches to FDI. 4. See Kumar 2001.  |  

Chapter eight

From Doha to Cancun and beyond: options for developing countries

§ Chapter 7 has reviewed the merit of various arguments that are made in favour of a GATT-type multilateral framework on investment (MFI). It is clear that an MFI is justified on neither conceptual nor policy grounds. The reduced flexibility to regulate FDI inflows in tune with their development policy objectives resulting from agreeing to a multilateral framework could lead to considerable loss of welfare in developing countries. While the proposed MFI would reduce the policy space available to developing countries, it does not offer them anything in return for this. Neither they can expect more inflows of FDI nor any reciprocity in other sectors such as labour mobility. In view of this developing countries resisted a negotiating mandate on investment at the Doha Ministerial Conference held in November 2001. However, developed countries, especially the European Union, strongly pushed for a negotiating mandate. The final Doha Declaration provides for the launch of negotiations after the Fifth Ministerial subject to an explicit consensus being there ‘on the modalities’ of negotiations, as follows. Relationship between trade and investment 20. Recognizing the case for a multilateral framework to secure transparent, stable and predictable conditions for long-term cross-border investment, particularly foreign direct investment, that will contribute to the expansion of trade, and the need for enhanced technical assistance and capacity-building in this area as referred to in paragraph 21, we agree that negotiations will take place after the Fifth Session of the Ministerial Conference on the basis of a decision to be taken, by explicit consensus, at that session on modalities of negotiations.1

Although the language of the Declaration talks of the need for a consensus on the modalities of negotiations, the Chairman’s understanding and clarification that enabled the adoption of the Declaration at the Doha Ministerial suggests that the negotiating mandate would itself be subject to an explicit consensus: I would like to note that some delegations have requested clarifica-

tion concerning paragraphs 20 … of the draft declaration. Let me say that with respect to the reference to an ‘explicit consensus’ being needed, in these paragraphs, for a decision to be taken at the Fifth Session of the Ministerial Conference, my understanding is that, at that session, a decision would indeed need to be taken by explicit consensus, before negotiations on trade and investment … could proceed. In my view, this would also give each member the right to take a position on modalities that would prevent negotiations from proceeding after the Fifth Session of the Ministerial Conference until that member is prepared to join in an explicit consensus. (H.E. Youssef Hussain Kamal, Qatari Finance, Economy and Trade Minister, Chairman of Doha Ministerial Conference at the closing plenary session, 14 November 2001)2

Going by the Chairman’s understanding, the negotiating mandate on investment is yet to be obtained at the Fifth Ministerial scheduled to be held in Cancun in September 2003. In light of that this chapter reviews the various options that developing countries can consider at this ministerial. Options for developing countries

In the light of the Doha mandate, there are four possible options for developing countries, as follows. Option I: resist a negotiating mandate in the WTO

Keeping in mind the Chairman’s clarification, it may still be possible to resist a negotiating mandate on investment. For this to happen the coalition of developing countries would be of critical importance. Developing countries will have to argue their case effectively. They could also draw attention to the practical problems involved in arriving at a consensus on the subject in the light of the OECD’s MAI experience, when a relatively homogeneous group of 29 OECD member states failed to arrive at a consensus even after negotiations lasting over three years. Another attempt to evolve a multilateral framework on investment – the UN Code of Conduct on TNCs – similarly could not be concluded successfully despite protracted negotiations lasting from 1977 to 1992. In a forum such as the WTO, whose membership covers the entire spectrum of high-income, middle-income, low-income and least developed countries, possibilities of arriving at a consensus would appear to be abysmally low. The potential cost in terms of world development and welfare could be substantial while the promise of gains is negligible at most, as discussed in Chapter 7. Instead developing countries could seek a review of the reasons for failure  |    

of the OECD’s MAI and the lessons learned from that experience as a part of the ongoing study process launched at the Singapore Ministerial in the form of the WGTI. This option would be by far the most desirable from a developing country point of view. But it would also be most challenging to achieve, given the serious pursuit by developed countries of an MFI. Yet it is feasible depending upon the ability of developing countries to form a coalition on the issue. Option II: a Multilateral Investment Treaty negotiated outside the single undertaking

In case developed countries persist with their demand for an MFI, a compromise solution could be a multilateral treaty on investment negotiated outside the WTO. The objective of proponents of an MFI is ‘to secure transparent, stable and predictable conditions’ for cross-border investments, particularly FDI, that can be well served by a freely standing independent multilateral treaty on investment negotiated within the United Nations framework like many other international treaties, such as a the Law of the Sea which have served their purpose well. An independent Multilateral Investment Treaty (MIT) could be modelled in large part on the Bilateral Investment Promotion and Protection Treaties (BIPAs) that provide protection to investments approved under the existing policies. It could also cover some provisions on the obligations of investors, among other provisions that are considered necessary. It could link itself with the existing institutional infrastructure on investment protection and settlement of investment disputes in the framework of ICSID, UNCITRAL, ICC and MIGA. Developing countries could argue that the WTO does not have the necessary expertise to deal with investment, which is more a subject dealt with by finance ministries or industry ministries and not by trade diplomats. UNCTAD could probably be a more appropriate forum, having inherited the United Nations Commission on TNCs. UNCTAD is also well placed to put development dimension at the core of an MIT. Option III: re-examining the United Nations Code of Conduct on Transnational Corporations

In case there is an agreement to negotiate a treaty on investment outside the WTO, one alternative could be to resurrect the draft UN Code of Conduct on TNCs, which could be adopted with some amendments. The draft UN Code was negotiated in the protracted negotiations over the 1977–92 period. The draft Code represents a balanced approach to a  |  

multilateral framework providing the rights and obligations of investors and the host governments (see Chapter 3 for more details). The draft Code could not be adopted because of the differences between developed and developing countries on its legal status and was abandoned in 1992. In view of the fact that considerable negotiating effort has been spent in refining different elements, its balanced treatment of host country, home country and investor interests, and its ability to provide a stable, predictable and transparent framework for FDI, it would serve the objective of both developed and developing countries very ably. It was negotiated within the negotiating platform of the UN Commission on TNCs, which is currently serviced by UNCTAD. UNCTAD has the capability to provide the Secretariat of the Code and service its implementation given its work on investment. Option IV: last resort – negotiating a development-friendly multilateral framework in the WTO

In case a negotiating mandate on investment is unavoidable then developing countries have to ensure that the framework covers adequate development provisions so that their process of development is not disrupted, and that sufficient flexibility to pursue their developmental policy objectives is retained. This will be a big challenge and has to be responded to by proactive homework by the developing country negotiators in evolving a development-friendly draft of the MFI. In such a draft each and every element will have to be defined in such a manner that the concerns of developing countries are kept in mind. Some reflections in this regard are discussed in the following section. Incorporating a ‘development dimension’ in a possible MFI

In case it is decided to negotiate a multilateral framework on investment within or outside the Single Undertaking, developing countries would have to reflect on different elements of such a framework from their perspective including scope and definition, transparency, non-discrimination (national treatment and MFN) and development provisions. A basic consideration in the analysis that follows is the incorporation throughout a possible MFI of a ‘developmental dimension’. Under this concept, the effects on development of various obligations should be systematically assessed, in order to ensure that the overall impact of a possible agreement on development is positive, and that obligations with a likely negative effect are excluded or minimized. A possible framework should therefore be based on the concept of investment as a tool for  |    

development, and not simply as a profit-seeking mechanism, to be made in the mutual benefit of investors and host countries. The Doha Declaration places heavy emphasis on the development provisions, as follows: 22. In the period until the Fifth Session, further work in the Working Group on the Relationship Between Trade and Investment will focus on the clarification of: scope and definition; transparency; nondiscrimination; modalities for pre-establishment commitments based on a GATS-type, positive list approach; development provisions; exceptions and balance-of-payments safeguards; consultation and the settlement of disputes between members. Any framework should reflect in a balanced manner the interests of home and host countries, and take due account of the development policies and objectives of host governments as well as their right to regulate in the public interest. The special development, trade and financial needs of developing and least-developed countries should be taken into account as an integral part of any framework, which should enable members to undertake obligations and commitments commensurate with their individual needs and circumstances. Due regard should be paid to other relevant WTO provisions. Account should be taken, as appropriate, of existing bilateral and regional arrangements on investment.3

Therefore, the challenge before developing countries is to define different elements of an MFI in such a manner that their developmental concerns are taken care of. Given the different impact that an MFI may have on developed and developing countries, an MFI may allow for differential treatment with regard to developing countries (and LDCs), as generally permitted under the GATT/WTO agreements. A crucial point for the negotiation of an MFI is how to achieve a balance between rights and obligations. In other words, an MFI should not only contain a set of restrictions on members’ policies, but it should also spell out clearly the obligations of investors. Host states and investors may be seen as parties to a ‘contract’ to the mutual benefit of both parties. Under this contractual approach, the enjoyment of benefits under an MFI could be made conditional upon the compliance by investors with their specific obligations. In particular, developing countries should retain flexibility to pursue selective policy in tune with their development policy objectives and impose performance requirements on foreign investors. Scope and definition

It is important to clarify the implications of the different criteria adopted for scope and definition from the perspective of host and home  |  

countries. The adoption of broad scope and definition has obvious problems. For instance, a broad assets-based definition and all-encompassing sectoral coverage would limit the governments’ ability to regulate financial flows and manage the financial crises. Given the frequency of crises in various parts of the world, international financial institutions such as the World Bank are advising caution on the part of the governments with respect to capital account liberalization.4 Protection of intellectual property assets is covered under the TRIPs Agreement. Similarly, extending the coverage to include mining and oil concessions would affect the capacity of the host governments to design long-term policies on the conservation and use of natural resources. Past experience suggests that a broad and general scope of investment agreements is not able to keep in mind the specific conditions and interests of different countries. Hence there is a need for establishing exceptions. The experience of the OECD’s Multilateral Agreement on Investment (MAI) is illustrative in this context as it had to be annexed with several hundreds of exceptions despite the fact that the contracting parties were all highly developed OECD member countries. Although bilateral investment treaties adopt broad assets-based definitions, their scope is limited to investments undertaken in accordance with the national laws and policies and their purpose is essentially protection. Similarly, the investment treaties within the regional integration arrangements (RIAs) such as the EU and NAFTA are also generally broad in their coverage. However, the treatment accorded under these treaties is given on a discriminatory basis to the member states in the RIA only, and these RIAs generally cover mobility of all the goods and factors of production such as labour along with that of capital. In the present context, it is important to keep in mind the mandate of the Doha Declaration, which in Para. 20 suggests that the focus is on ‘long-term cross-border investment, particularly foreign direct investment, that will contribute to the expansion of trade’. Thus the mandate has clearly limited the scope of the possible MFI to ‘long-term cross-border investments, particularly foreign direct investments’. It is important to focus on FDI because it is essentially long-term in nature. In the WGTI meetings, Japan, among other countries, argued for the need to restrict the scope of the MFI to FDI.5 Furthermore, the Doha Declaration focuses on ‘foreign direct investment, that will contribute to the expansion of trade’. Clearly the focus is on investments that contribute to the expansion of trade and eventually to development, rather than on all cross-border investments.  |    

There are certain types of foreign direct investments that contribute to expansion of trade more than other investments. While the bulk of FDI flows continue to seek the domestic markets in the host countries and generally replace trade, export-platform investments undertaken by multinational enterprises as a part of the restructuring of production according to international differences in factor costs have contributed significantly to expansion of world trade over the past three decades. The export-oriented foreign direct investments have evidently helped the East and Southeast Asian countries rapidly build their manufacturing export capabilities. Therefore, these investments can contribute to the expansion of trade besides expediting the development of the host countries. The literature suggests that export-oriented FDI is a special type of FDI and is determined by different factors (see Kumar 1994a, 1998a). Therefore, in view of the language of Para. 22 of the Doha Declaration, it is worthwhile to argue a case for limiting the scope of possible MFI to export-oriented FDI and not all the cross-border investments. FDI is distinguished from foreign portfolio investments on the basis of whether ownership is accompanied by management control. Therefore there is a need to define a threshold of equity ownership that ensures the management control and hence could be used to distinguish FDI from all other types of foreign investments. Different levels of equity ownership are used in different countries for defining the controlling stake. For instance, the IMF considers 10 per cent equity ownership to be adequate for exercising control, some countries use 25 per cent ownership as sufficient (as followed by the Reserve Bank of India), while 33 per cent applies in some countries. However, all these criteria are ‘arbitrary’ in nature. Indeed, the proportion of ownership necessary for exercising effective control over an enterprise would depend upon how the rest of the shareholding is dispersed. Majority ownership is the only objectively defined threshold because only the majority shareholder is able to take all the important decisions. Hence majority ownership could be employed to define FDI. The GATS, CARICOM, and the statute of a ‘European company’ have adopted the majority ownership rule for defining a controlling stake.6 1. Entry mode

FDI’s developmental impact on the host country also depends upon whether it takes the form of a greenfield investment or acquisition of an existing enterprise. UNCTAD’s studies suggest that ‘the potential of an adverse effect is greater in the case of M&As than in the case of  |  

greenfield investment’.7 It may be argued that greenfield investment has the greater potential to contribute to the expansion of trade by concentrating on the manufacturing and export capabilities rather than on the acquisition of existing enterprises. Therefore, developing countries may wish to exclude acquisitions of existing enterprises from the scope of the possible MFI. Transparency

In an effort to attract FDI, developing countries are themselves moving towards making their investment policy regimes more transparent. It is not clear whether binding rules on transparency are necessary. APEC’s approach to Non-binding Investment Principles may be adequate. Keeping in mind the generally life-long relationship that they entail, governments are more cautious in dealing with investments, especially FDI, than in dealing with trade. The WTO Secretariat has observed that transparency provisions in existing bilateral and regional investment treaties – where they exist – are generally less detailed and prescriptive than similar requirements in the WTO.8 While transparency with respect to FDI policy framework might be unexceptional, some of the procedures for the processing and evaluation of proposals might not be made transparent in the public interest. The exceptions for confidential information in the public interest need to be provided. In dealing with foreign investors, governments of developing and least developed countries often experience an information asymmetry, with little availability of information about the background and track record of the investors in other countries with respect to corporate social responsibility, their involvement in bribery and corruption and restrictive business practices. The recent cases of Enron, Anderson and Xerox are examples. In this context, the MFI should provide for transparency on the background and track record of corporations and other investors. Investors and home governments must accept obligations to share information on their involvement in questionable dealings. The MFI could also provide for the creation of a centralized on-line database recording cases of fraud, bribery and corruption, transfer pricing manipulations and questionable dealings and other cases of violation of national laws from different host countries in respect of foreign investors. Such a database will be particularly useful for governments, especially in smaller and poorer countries with limited resources, to verify the credentials of foreign investors.  |    

National treatment

The proponents of MFI are seeking GATT-type national treatment for investment in post- as well pre-establishment stages. 1. National treatment in post-establishment phase

As argued in Chapter 7, MNC affiliates enjoy several monopolistic advantages such as globally known brand names, proprietary superior technology, captive access to resources and talent, and they have different opportunities and pursue different objective functions compared to national enterprises. The margin of the edge enjoyed by them may be particularly wide in poorer developing countries. The literature has shown that FDI has more favourable externalities or knowledge spillovers for local enterprises in high- or middle-income countries because of the relatively smaller gap between the technology employed by MNCs and local enterprises. In low-income countries, because of the wide technology gap not only may knowledge spillovers fail to take place, but the foreign entry may sometimes crowd out domestic enterprises and hence reduce host country welfare (see Chapter 2 for a review of the evidence). Therefore, governments in developing countries often need to adopt policies supporting and nurturing local enterprises, especially the small and medium enterprises (SMEs) in developing countries. Given the scarcity of public funds that may be committed through tax exemptions or subsidies to promote development-related activities (such as R&D, employment, local value added), governments in developing countries may need to limit the granting of incentives to national firms or to a certain category thereof, for instance, SMEs. In fact, in some cases even developed countries currently discriminate in favour of their local companies, in respect of the access to R&D funds or to other benefits aimed at enhancing their firms’ competitiveness, especially in strategic industries. 9 The recognition of national treatment as a general principle in an MFI would prevent any future change in legislation aimed at providing some advantages to nationals not available to foreign investors. The Doha Declaration indicates that any framework should ‘take due account of the development policies and objectives of host governments as well as their right to regulate in the public interest’ (emphasis added).10 To protect the flexibility for developing countries, granting of national treatment in the post-establishment phase may be structured on the basis of a GATS-type positive list approach, which is more developmentfriendly11 and subjected to limitations as considered necessary. The GATS |  

type approach leaves to the members the possibility of determining in which sectors the national treatment standard will be applicable. National treatment, therefore, is not unconditionally and automatically applicable (as in other WTO agreements), but it is subject to the prior decision of the respective member which prepares its own ‘positive list’ of sectors where it is ready to give concessions. 2. National treatment in pre-establishment phase or market access

Currently WTO member states can apply measures aiming at screening FDI inflows, either in particular sectors or across the board, in order to admit those projects that are consistent with their development needs. Since the objectives sought by host countries (such as the building up of domestic industrial and technological capabilities, the development of SMEs, the protection of the environment, and the development of particular regions) may vary significantly, the criteria to assess investment proposals are also likely to differ among countries. In view of great variation in the quality or developmental impact of different FDI proposals on the host country’s economy and in the light of a possible adverse impact on domestic enterprises and host country welfare, as reviewed in Chapter 2, host governments may wish to protect domestic ‘infant enterprises’ or SMEs from foreign competition through selective policies towards FDI. Host governments may also impose, subject to the TRIMs Agreement as examined in Chapter 4, performance requirements on foreign entrants to regulate their operations in tune with their development policy objectives. The policy flexibility of governments of developing countries to pursue a selective policy towards FDI and impose performance requirements is crucial and needs to be retained in any multilateral framework. The Doha Declaration does provide for such flexibility and suggests due regard of development policy and preserves their right to ‘take due account of the development policies and objectives of host governments as well as their right to regulate in the public interest’.12 The application of the national treatment principle for pre-establishment would limit host countries’ freedom to exclude or restrict foreign investment in specified sectors or activities, stipulate domestic ownership requirements, and adopt other permissible performance measures at the entry of FDI. The pre-establishment national treatment has not been provided under the bilateral investment treaties except for a few treaties signed by the USA. Investment agreements as a part of RIA agreements such as NAFTA provide for pre-establishment national treatment. But  |    

these are limited to partners on a reciprocal basis and also include full labour mobility alongside capital mobility. The MFI, on the other hand, is limited to capital mobility and does not include labour mobility. Therefore, developing countries should resist the national treatment obligation for the pre-establishment stage to retain the policy flexibility. However, if that principle is to be unavoidable, its application could still be restricted to certain sectors or activities, based on a ‘positive list’ approach as in the GATS. The GATS obliges members to admit the ‘commercial presence’ of a foreign service supplier under national treatment standards. However, developing countries have accepted the commercial presence or the movement of capital under the conditions of specificity of purpose, limited duration and discreteness of transaction. This implies that the GATS does not recognize an unconditional ‘right of establishment’. Furthermore, as discussed earlier, the definition of ‘commercial presence’ in the GATS is linked to the establishment of an enterprise. Most-favoured nation (MFN)

The extension of the MFN treatment to investment may be seen as a logical requirement in a multilateral system. It may, however, affect the special treatment conferred by many developing countries to ‘ethnic overseas investors’, despite the fact that they may be permanent residents in or citizens of other countries. Therefore, exceptions for a differential treatment for ethnic overseas investors may be retained in a possible MFI. Ownership and control

The application of the national treatment in the post-establishment phase may affect a wide range of national policies, such as those regarding the ownership and control of assets by foreign investors, in general or in particular sectors, including minimum equity participation of national investors. In order to promote the development of local enterprises or further other national interests, many countries discriminate between foreign and national investors. In some cases, they require the establishment of joint ventures to operate in certain sectors or activities (such as oil extraction, telecommunications, publishing). An MFI based on the national treatment principle would prevent contracting parties from applying such conditions or limitations. This should not, however, affect the right of a state to designate or maintain a state monopoly. Ownership and control requirements may be related to an  |  

advantage (for instance, by limiting the access to some incentives to joint ventures or to firms with a minimum level of local equity participation).13 Moreover, sector-specific or general exceptions may be carved out. Access by foreign investors to the local market through FDI may also be subject to competition or other laws. Most OECD countries, for instance, can block takeovers of domestic firms by foreign companies, based on broad, often ill-defined, ‘national security’ grounds that encompass reasons related to the preservation or acquisition of competitive advantages vis-à-vis foreign rivals.14 Governments in some developed countries have also obtained legal rights to block the transfer of control to foreign interests to protect national interests using the socalled Golden Share.15 Development provisions

Developing countries seek FDI as a resource for their industrialization and development. FDI is supposed to bring to its host country a number of valuable resources for development such as capital, technology, managerial and marketing skills, and sometimes market access in the case of export-oriented FDI. The knowledge and technologies brought in may diffuse through the host economy and hence be more productive. However, not all the cases of FDI bring such resources. The experiences of host countries have been mixed, as observed earlier. Hence host governments – developed as well as developing – have generally employed policies that bring the operations of MNCs in consonance with the host country developmental goals. Left to themselves, FDI projects may not bring any significant new technology, generate very little value added or employment and develop virtually no linkages with domestic enterprises in the host country, as seen in Chapter 2. Hence developing countries should have flexibility to pursue policies that help them in exploiting the resources of MNCs for their development more effectively. These include policies such as performance requirements. Performance requirements may be employed to increase the depth of the involvement of MNCs’ operations with the host economy and enhance their vertical linkages, and so on, or to moderate the adverse effect of FDI on the BOP of host countries. 1. Performance requirements for fostering industrialization and local

linkages Empirical studies have shown that affiliates of US MNCs in developing countries in manufacturing buy the bulk of their inputs from their  |    

parents and other affiliated companies, leaving a relatively small proportion of their inputs bought from unaffiliated suppliers within the host country or in third countries, and that proportion has not grown over time.16 Furthermore, the evidence suggests that Japanese MNCs tend to transplant the vendor–OEM links or production networks prevailing in the home country to the host countries in that the traditional component suppliers of Japanese equipment manufacturers follow their OEMs’ overseas investments.17 UNCTAD’s Trade and Development Report 2002 has also highlighted the poor record of generation of value added and linkages by MNCs (see pp. 75 and 83). This pattern tends to limit the generation of vertical interfirm linkages between MNCs and domestic enterprises that help in the diffusion of knowledge brought in by MNCs. To promote the domestic linkages of MNCs, host governments have employed the policies such as local content regulations to prompt MNCs to pay attention to localization of production in the host country. Local content regulations were used by a large number of developed countries until as late as the 1990s (as observed in Chapter 5).18 Many developed countries have also employed other policies such as screwdriver regulations, which are in effect like local content regulations to deepen the local commitment of foreign investors. A detailed empirical analysis of US and Japanese FDI in a sample of 74 countries in seven broad branches of manufacturing over the 1982–94 period found the local content regulations to be favouring the extent of localization of MNE affiliates’ production in the host countries. Therefore, the study concluded that local content regulations could be an important means of deepening the commitment of MNEs entering an economy and for generating local value added, and hence having an effect on employment and the related spillovers of knowledge (see Kumar 2000a: 442–76). Therefore, development provisions will have to cover the policy flexibility for developing countries to impose local content requirements on foreign investors. Since, as discussed in Chapter 4 and 5, the TRIMs Agreement limits the right to apply such requirements, the Agreement would have to be amended to ensure that flexibility. Similarly, joint venture requirements also facilitate the absorption of the knowledge brought into the host country by foreign investors. The performance requirements on employment generation, transfer of technology, training and R&D activity all contribute to the achievement of the development policy goals of developing countries and are outside the TRIMs disciplines. Flexibility to impose such performance require |  

ments should continue to be available, and developing countries should oppose any moves to curtail that flexibility. 2. Performance requirements to deal with adverse balance of payments (BOP) impact of FDI and to build export capability FDI generally has a negative effect on the balance of payments (BOP) of host countries. UNCTAD’s World Investment Report 1999 is emphatic in concluding that ‘the net present value in terms of direct foreign exchange effects of any profitable FDI project ought to be negative, if all profits are repatriated’ (p. 166, emphasis added). The negative effect of FDI creates special hardships for developing countries, which generally have a weak balance of payments situation. Some countries have attempted to deal with this situation by imposing foreign exchange neutrality or dividend balancing or export performance requirements on foreign investments. Developing countries should retain the policy flexibility to impose such performance requirements. Similarly, host countries need to retain exceptions to defer the transfer of remittances/proceeds of divestments in the case of economic crisis such as those faced by the East Asian countries during the 1997–99 period. Besides moderating the adverse BOP effect, export performance requirements also generate other favourable externalities for the host economies. There is well-documented evidence on how Mexico, Brazil and Thailand have used performance requirements successfully for ‘triggering a burst of export-focused investments in the auto industry’ (Moran 1998: 53–62). Furthermore, it has been argued that export performance requirements have prompted MNEs to establish world-scale plants incorporating best-practice technology and have generated significant knowledge spillovers for local firms. Another study using the database covering US and Japanese FDI in a sample of 74 countries in seven broad branches of manufacturing over the 1982–94 period found export performance requirements to be effective in increasing the export orientation of MNE affiliates to third countries (see Kumar 1998a: 450–83). Therefore, it is important to retain flexibility to impose export performance requirements by developing countries as a part of the development dimension. 3. An objectively defined criterion for development

The special and differential provisions for developing countries should be based on the level of development rather than additional transition years. For instance, these provisions and policy flexibility could be linked  |    

to developing countries reaching a threshold of per capita manufacturing value added (MVA per capita). In this way the concept of graduation is built in as countries crossing the development threshold will cease to enjoy the special and differential treatment. As in the case of the Agreement on Subsidies and Countervailing Measures (SCM), a threshold level could be defined of MVA per capita, keeping in mind the world average of the MVA per capita at US$1,000 (MVA accounting for roughly 20 per cent of the GDP and an average per capita income for the world of US$5,000 for 2000). Once a country crosses the threshold of US$1,000 of MVA per capita, it may be required to accept higher commitments compared to those still under the threshold level. 4. Labour mobility

MFI is a framework for liberalization of capital flows and will benefit developed countries. Developing countries could seek a reciprocity in the form of a multilateral framework for liberalization of labour flows. This would make it a balanced framework. Investors’ obligations

The proponents of the MFI have been seeking rights of foreign investors, which the host country governments should commit to provide. However, nothing is being said about the obligations of the investors or the home countries. Any multilateral framework on investment has to be a balanced one defining the rights and responsibilities of all the actors involved. The Doha Declaration indicates need for a balanced framework covering host and home country interests. FDI is generally undertaken by TNCs. Given the massive economic power and resources that they command and their operations transcending the globe, host governments are limited in regulating their conduct. In view of their goal of global profit maximization, there could be a conflict of interests between their objectives and the development policy objectives of the host countries, and they could indulge in restrictive business practices (RBPs), manipulation of transfer prices and other anticompetitive or corrupt practices. A number of cases of corporate misconduct have been reported from different parts of the world involving some of the largest TNCs. The national regulations have their obvious limitations in regulating the operations of TNCs, although countries such as the USA have adopted regulations covering operations conducted outside their national boundaries, such as the Foreign Corrupt Practices Act, or their anti-trust regulations.19  |  

Recognizing the limitations of host governments in regulating the activities of TNCs, the international community has made several attempts to establish international norms of conduct for TNCs. These include the OECD’s Guidelines of 1976, the ILO’s Tripartite Declaration, UNCTAD’s Multilaterally Agreed Set of Principles on Restrictive Business Practices and UNCTAD’s Draft Code of Conduct on International Transfer of Technology, among others (see Chapter 3). The most ambitious and comprehensive of such attempts has been to establish a United Nations Code of Conduct on TNCs (hereafter TNCs Code), a draft of which was developed over lengthy negotiations during 1977–92. The draft TNCs Code as drafted in 1992 provided for a number of obligations to be complied with by foreign investors. During the period since the late 1990s, there has been a massive trend towards consolidation and restructuring in the corporate world with mergers and acquisitions (M&As). These M&As have further increased the concentration in larger corporations and, hence, their market and political power. Some of these obligations and others that could be considered for incorporation appropriately in a possible MFI include the following. In terms of general principles, the foreign investors would: • respect the national sovereignty of host government and the right of each state to regulate, monitor and determine the role such corporations may play in economic and social development and limiting the extent of their involvement in specific sectors; agree to not interfere in internal affairs of host country and inter-governmental relations; adhere to economic goals and development objectives, policies and priorities, and work seriously towards making a positive contribution to the achievement of broad developmental objectives; adhere to socio-cultural objectives and values, and avoid practices, products or services that may have detrimental effects; and abstain from corrupt practices; • contribute to the strengthening of the scientific and technological capacities of developing countries; • contribute to technical and managerial training of nationals of host states and give priority to employment of local personnel at all levels; • refrain from imposing restrictive clauses in technology transfer contracts with their affiliates and licensees that prevent absorption and assimilation of technology transferred;20  |    

• refrain from imposing conditions on their overseas affiliates that restrict the sourcing of equipment, spares, raw material and services to affiliates’ sources; • contribute to the promotion and diversification of exports and to increased utilization of goods, services and other resources available locally; • refrain from imposing restrictions on overseas affiliates regarding their exports; either limiting their quantum or the destination; • cooperate with the host governments in periods of BOP crisis by delaying remittances of profits and by phasing out divestment proceeds; • desist from engaging in short-term financial operations or intracorporate transfers in a manner that would increase currency instability and BOP difficulties; • prohibit imposition of restrictions on affiliates regarding the sourcing of their purchases and on their exports; • apply fair pricing policies in intra-corporate trade and curb transfer pricing manipulations; • pay due regard to international standards of consumer protection 21 • adopt fair employment practices, provide a safe and healthy working environment, pay remuneration to workers that provides them an adequate standard of living and to recognize their right to join organizations of their own choice without previous authorization, eliminate discrimination unrelated to an individual’s ability to perform his/her job, and protect children from economic exploitation;22 • take steps to protect the environment and rehabilitate when there is damage; and • disclose financial as well as non-financial information on the structure, policies and activities of the TNC as a whole, as well as that of the local affiliate.23 Transfer of technology

For developing countries and LDCs, the access to foreign technology is a critical issue that has not been adequately addressed so far in the WTO agreements. There are limitations of the national regulations in effecting technology transfer from MNCs, as is clear from the evidence that is available.24 As mentioned, an attempt was made in the 1980s to establish an International Code of Conduct on Transfer of Technology under the auspices of UNCTAD, but these negotiations have failed. If an MFI is to be negotiated, an important target for developing  |  

countries may be to include provisions relating to transfer of technology, so as to ensure that foreign investment effectively contributes to the technological development of the host country. Issues to be considered in this framework may include: • requirements of transfer of technology as a condition for entry or operation of a foreign investment; • obligations to train and employ local personnel; • performance requirements related to a given level or value of research and development; • restraints on the TNCs from imposing restrictions on their overseas affiliates that adversely affect the process of absorption of technology and diversify sources of capital equipment and services; • measures to attract FDI in R&D activities; and • granting of subsidies and tax benefits in developed countries to promote the transfer of technology (including associated equipment) to developing countries and LDCs.25 Competition policy and RBPs

Concern about the market power of TNCs and possible abuse of it has attracted the attention of the international community. MNCs have been found to have engaged in a number of anti-competitive arrangements with other firms. These include horizontal international marketing and price-fixing cartels, vertical international distribution systems established by MNCs for the sale of their products, and the use of joint ventures with other firms.26 The national competition policy may have limitations in dealing with the abuse of market power by MNC affiliates that have operations transcending national boundaries. As indicated in Chapter 3, these concerns led to adoption of the Set of Multilaterally Agreed Equitable Principles and Rules for Control of Restrictive Business Practices (RBPs) under the auspices of UNCTAD in 1980. The Set provides for collaboration between governments and an international mechanism to facilitate control of RBPs. Enterprises are obliged to refrain from RBPs defined to include price fixing, collusive tendering, market or customer allocation arrangements, allocation of sales or production quota, concerted refusal to deal with or supply to potential importers, and collective denial to access to an arrangement. The enterprises are also required to refrain from abuse of market power in the form of predatory behaviour, discriminatory pricing or terms, joint ventures, M&As, and refusal to deal, among other provisions. It also facilitates appropriate action taken at a multi |    

lateral level. However, the Set is not a binding instrument. An effective regulation of RBPs and other anti-competitive practices through binding provisions should form an integral part of the MFI if it is negotiated. Home country obligations

In a balanced framework, the home governments should accept some obligations. The home governments’ policies do have influence over the behaviour of TNCs originating in their territories. Some home governments, such as that of the USA, have asserted their power to restrict exports of goods by the overseas subsidiaries of US enterprises. Home governments must accept an obligation not to impose such trade- or investment-related restrictions on the overseas affiliates of corporations based in their territories. They should also undertake to provide information regarding the involvement of TNCs in any illegal dealings and other information on their background that may be useful for the host government at the time of approval. The home governments should also cooperate with the host governments in control of RBPs and transfer-pricing manipulation, and in the recovery of the liabilities of TNCs resulting from their misconduct in host countries. Incentives

As observed in Chapter 5, a number of investment incentives are granted by developed and some developing countries as a part of their industrial, technological and other policies. It has been demonstrated that these incentives distort investment patterns in favour of developed countries, as developing countries are at a disadvantage to provide matching incentives. Because of the prisoners’ dilemma inherent in the investment incentives competition, an international discipline to limit the investment-distorting incentives would maximize the collective welfare of the participating countries. Such a discipline should form a part of any possible MFI. However, exceptions allowing developing countries and LDCs to use such incentives to promote such policy objectives as industrial development and regional development of backward regions have to be built into such a discipline. Environmental issues

Under the broad concept of ‘investment’ the national treatment principle would apply to concessions and other authorizations or permits for the exploitation of natural resources. This may undermine the application of certain national policies, such as those relating to the conservation  |  

and management of living resources (including those in the sea), and the property rights over and exploitation of hydrocarbons.27 An MFI should not restrict the state’s right to adopt legitimate environmental measures, even if they disadvantage foreign investors, such as requiring foreign investors to carry additional liability insurance, to maintain a minimum level of assets within the host country, or to post a bond or deposit to guarantee regulatory compliance (WWF International 1997: 5). An MFI should also ensure that its provisions do not impair the capacity of contracting parties to implement their obligations under Multilateral Environment Agreements (MEA), and enhance the accountability of foreign investors for environmental damage. Environment-related performance requirements should also be clearly permissible, such as obligations to achieve a certain percentage of domestic content, or to purchase or use goods locally produced or services provided in a contracting party’s territory, if necessary to protect human, animal or plant life or health, or for the conservation of living or nonliving exhaustible natural resources. Finally, an important issue in a possible MFI may be the obligation on the part of contracting parties not to lower environmental standards/ measures as an encouragement to FDI. Investor protection

Standards relating to investor protection, such as general treatment, compensation in cases of expropriation, protection from strife, free transfer of payments, and subrogation are generally contained in BITs and regional agreements on investment. Those standards are by and large accepted and established in bilateral and regional treaties. The implications of a possible inclusion of those standards in an MFI will largely depend on the scope of the adopted definition (particularly important with regard to the free transfer of payments) and on the extent to which protection would be an absolute standard, or subject to a ‘contractual approach’ as suggested above, that is, to compliance by the concerned investor of the host country’s laws and regulations. The right to initiate a dispute should be limited to member states as currently provided under applicable rules for dispute settlement. Investor-to-state disputes would not acceptable in an MFI negotiated in the WTO framework. Furthermore, there is a need to adopt a cautious and restrictive definition of expropriation in the light of evidence on litigations brought by affiliates of US corporations against the Canadian government under  |    

Chapter 11 of NAFTA seeking compensation for the government regulations and actions affecting the business prospects of companies as amounting to regulatory takings. For instance, the United Parcel Service (UPS) has sued the Canadian government under this chapter of NAFTA for $230 million over what it alleges is unfair cross-subsidization by Canada Post of its Xpresspost and Priority Courier operations.28 Regulatory actions of host governments for pursuing their development policy goals, environmental and social objectives in the broad public interest should be specifically excluded from the scope of expropriation or regulatory takings. Government procurement

Government procurement has been extensively used, in developed and developing countries, to promote the development of local industries by means of preferential treatment in terms of prices or other conditions of supply. From a developmental perspective, a possible MFI should be flexible enough to permit the use of public purchasing power as an instrument to promote the development of local firms.29 BOP safeguards

Safeguards should be built into the possible MFI for periods of BOP difficulties faced by developing countries. BIPAs have sometimes incorporated provisions of temporary suspension of remittances of profits and dividends and repatriation of disinvestments proceeds by companies in the periods of BOP difficulties faced by host countries. Such provisions could be built into the MFI as well. Concluding remarks

This chapter has reviewed the options open to developing countries on investment at the Cancun Ministerial Conference of the WTO, which is to decide whether or not to launch negotiations on a multilateral framework on the subject. Given the high opportunity cost of the policy flexibility for the process of development and no reciprocity or gains even in the form of higher inflows of FDI, the most prudent option for developing countries would be to resist a negotiating mandate on investment at Cancun. In view of the clarificatory statement by the Chairman of the Doha Ministerial, which led to the adoption of the Declaration, it may still be possible. However, this would require effective coordination among developing countries and their ability to put up a strong coalition against the negotiating mandate.  |  

A compromise solution could be to negotiate a multilateral treaty on investment on the lines of bilateral treaties outside the WTO. A better one would be to re-examine the UN Code of Conduct on TNCs, a draft of which exists and could be adopted as a binding UN instrument. The draft UN Code provides a multilateral framework balancing the host country, investor and home country interests and could serve the purpose of the protagonists of the MFI very well. In case a negotiating mandate at the Fifth Meeting is adopted, then efforts should be made to ensure that developing countries’ concerns are built into each element of the proposed framework. We have outlined different elements of a possible MFI capturing the development dimension to aid preparations of developing countries in negotiations. This is to be secured by limiting the scope of the MFI to trade-oriented FDI, providing for flexibility to pursue selective policy and impose performance requirements by developing countries, incorporating investors’ obligations and home country obligations, providing for transfer of technology, control of RBPs and competition policy among other provisions. Notes

1. http://www.wto.org/english/tratop_e/dda_e/dohaexplainede.htm# investment. Emphasis added. 2. http://www.wto.org/english/thewto_e/minist_e/min01_e/min01_ chair_speaking_e.htm#clarification. Emphasis added. 3. http://www.wto.org/english/tratop_e/dda_e/dohaexplained_e.htm #investment. Emphasis added. 4. See for instance, World Bank 1999: 146. 5. See paper submitted by Japan at WGTI, WT/WGTI/W/111, April 2002. 6. See UNCTAD/ITE/IIT/11 (vol. II) 1999, Scope and Definition, pp. 41–3. 7. UNCTAD, 1999, 2000: 171. 8. WTO, Working Group on Trade and Investment, Transparency, WT/ WGTI/W/109, 2002, a Note by the Secretariat. 9. For instance, the cases of SEMATECH in the USA as observed in Chapter 7. 10. Para. 22 of the Doha Declaration. 11. The pro-development approach of the GATS is reflected in many provisions of the Agreement. For instance, the second preambular paragraph of the GATS states: ‘Wishing to establish a multilateral framework of principles and rules for trade in services with a view to the expansion of such trade under conditions of transparency and progressive liberalization and as a means of promoting the economic growth of all trading partners and the  |    

development of developing countries.’ The fifth preambular paragraph states: ‘Desiring to facilitate the increasing participation of developing countries in trade in services and the expansion of their service exports including, inter alia, through the strengthening of their domestic services capacity and its efficiency and competitiveness.’ Article IV on Increasing Participation of Developing Countries, and Article XIX(2) on Negotiation of Specific Commitments, provide flexibility for the developing countries in liberalizing trade in services and in attaching conditions to market access aimed at achieving objectives referred to in Article IV. In addition, developed countries should facilitate participation of developing countries in trade in services through negotiated specific commitments, relating to strengthening of their domestic services capacity by access to technology, distribution channels and information networks, markets in sectors and modes of supply of export interest to them, and market information. Another example is given by Article XIII on Restrictions to Safeguard Balance of Payments. It recognizes that particular pressures on the balance of payments of a member in the process of economic development may necessitate the use of restrictions to ensure, inter alia, the maintenance of a level of financial reserves adequate for the implementation of such programmes. Moreover, in determining the incidence of such restrictions, members may give priority to the supply of services which are more essential to their economic or development programmes. 12. Doha Declaration, Para. 22. 13. The draft MAI accepted this possibility. 14. For example, under the so-called Exon-Florio authority, the US government can block takeovers by foreigners as it did in the fields of aerospace and capital goods for the production of advanced integrated circuits (Graham 1996: 40). 15. The French government has obtained these rights under the 1993 Privatization Law. Similar provision of Golden Share exists in the UK as well. See Muchlinski 1999: 181–4. Under this device, the government obtains a special share in the company and the Articles of Association of the company concerned specify that certain matters are deemed to be a variation of the rights of the special share and can be effective only with the consent in writing of the special shareholder. In certain strategically significant cases the Golden Share has been used specifically to restrict foreign ownership, e.g. British Aerospace, British Airways and Rolls-Royce. 16. See Lipsey 1998: 107. 17. See Manifold 1997. 18. See Sercovich 1998; Kumar 2001 and WTO/UNCTAD Joint Study (October 2001) G/C/W/307 for evidence. 19. See Muchlinski 1999: Chapter 6 for an analysis of the limitations of national regulation on TNCs given their operations transcending national boundaries.  |  

20. See Kumar 1985 for evidence on restrictive clauses included in technology transfer contracts signed by TNCs. 21. The Working Group on Transnational Corporations of the UN SubCommission on Human Rights is deliberating on Responsibilities of Transnational Corporations to Human Rights. A significant part of the obligation of TNCs being discussed relates to consumer protection. TNCs are required to ensure the safety and quality of the goods and services they provide and not to produce, market or advertise potentially harmful products. The enforcement mechanisms and appropriate sanctions in case of non-observance of obligations by TNCs is also being debated. See http://www.unhchr.ch/html/ menu2/2/sc.htmas for more details. Also Times of India, 4 August 2002. 22. Such obligations are being debated by the TNCs Working Group of the UN Sub-Commission on Human Rights. 23. The European Commission already has Directives on the reporting and disclosure requirements requiring consolidated accounts. See Muchlinski 1999: Chapter 10. 24. See Muchlinski 1999: 447 for the Nigerian experience with transfer technology regulation, which has been largely ignored by foreign and local investors when entering into technology licensing contracts. 25. The establishment of this type of incentives may require appropriate adjustments to the Agreement on Subsidies and Countervailing Measures. It should also be noted that under Article 66.2 of the TRIPs Agreement, developed countries are bound to provide incentives domestically to promote the transfer of technology to LDCs. 26. See Muchlinski 1999: 387. 27. It should be noted that the parties to NAFTA exempted their fisheries and other environmentally related sectors from national treatment obligations. 28. See National Post, 24 July 2002, posted at http://www.tradeobservatory. org/news/index.cfm?ID=3695. 29. In contrast, the draft MAI did not affect the right of a state to establish or maintain state (or private) monopolies, but prevented discrimination against foreign investors with regard to the sale of goods and services made by a monopoly, as well as with respect to its purchase of goods and services from third parties, except to the extent that the purchase were not made with a view to commercial resale or for use in the production of goods and services for commercial sale.

 | 

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