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Multilateral rules on FDI

S. Venu

THE surge of foreign direct investment (FDI) in the late 1980s and early 1990s, and the associated expansion of MNC activities has transformed the world from what it was 15 years ago. MNCs account for a large share of business activities worldwide and fi gure significantly in the growth of the newly-industrialising East Asian economies (including China), the revitalisation of industry in North America, and the integration of Europe. In addition, they conduct a substantial portion of world trade in non-ag ricultural goods and services. The erstwhile communist nations of East Europe and the former Soviet Union look to FDI as a means to upgrade their economic performance; these are nations to which FDI was all but closed as recently as the late 1980s. The s ources, destinations and the industrial composition of FDI have become much more diverse than was in the 1970s and earlier, when foreign investment was looked upon with suspicion.

India is now trying to make up for its earlier inertia in attracting FDI. This has resulted in much debate over whether the rules and institutions of the world's multilateral trading system should be augmented to cover more explicitly FDI and the interna tional activities of MNCs. While there is no complete consensus on what the substance of the new rules would be, there is a general feeling among specialists that at least three issues should be addressed.

First, the clarification on extent to which national governments should be allowed to engage in discriminatory treatment towards foreign-controlled enterprises (including initial entry of these via FDI); and, if possible, the establishment of internation al standards. Purists argue that the ideal standard is that there would be no such discrimination at all. This is probably unrealistic; governments do, and probably always will, engage in discriminatory behaviour. What is needed is a set of standards to define the unacceptable limits of such behaviour.

Second, and more controversial, is whether there should be limits on the abilities of governments to create and apply measures to foreign investors, diverting investments towards areas considered essential by the host countries.

Third, a more effective mechanism for resolving disputes is needed. The UN centre on Transnational Corporations (UNCTNC) tried in vain to evolve a code acceptable to both MNCs and host countries over many years. Generally, the trend has been towards libe ralisation -- less regulations on MNCs and fewer restrictions on FDI.

At best, the current international policy regime affecting FDI and MNCs is a mishmash of rules that are, in principle, binding upon governments (for example, those of Nafta), voluntary principles (those of APEC), and half-way measures (the TRIMs agreemen t of the WTO). Coverage is not universal in either a geographic or a substantive sense. The obvious question is: Which policy regime is better?

There are at least three alternatives. One would be to do nothing. Proponents of this argue that what really matters is policy at the level of national and sub-national governments and that, during the past decade, in most areas of the world, the directi on of policy change is towards liberalisation. International rules, it is argued, would imply nothing more than a more complex bureaucracy and the costs of additional international civil servants. Extreme advocates of the view argue that, in fact, an opt imal set of policies might be achievable via `policy competition' among nations, where each nation seeks to maximise its own interests with respect to FDI.

This view, however, can be challenged. While the trend worldwide might indeed be towards liberalisation of policies affecting FDI, many restrictions on direct investors remain in place, and often these work to the benefit of local special-interest groups (those firms seeking to protect local monopoly rents) and, hence, `policy competition' might not necessarily be based upon each country maximising overall national interests but rather be dominated in many countries by special-interest groups.

Thus, it is argued that some sort of international rules to spell out the rights and obligations of host and home governments would at least establish an international norm for proper policy. Additionally, if governments are required to specify explicitl y what exceptions to those obligations are in place, international rules could also achieve some measure of transparency, often cited as an important objective in its own right.

It should be noted that the international business community itself seems to favour explicit international rules to `policy competition'. Thus, the remaining alternatives to reforming the international policy regime come down to how to implement an agree ment to establish international rules.

One alternative (say, alternative 2, 1 being to do nothing) would be for a new agreement to be negotiated within the aegis of the WTO. The WTO represents most of the nations of the world with a significant stake in FDI (one major exception is China, but it is likely to be admitted to the WTO sometime soon. Thus, a WTO-based agreement would involve all of the major nations involved in FDI, either as host or home nations.

Further, substantive issues pertaining to FDI are increasingly linked to international trade and, hence, it is desirable that these two sets of issues be dealt with under the `same umbrella'. This might also help in the enforcement of obligations under t he agreement on investment, for example, if violation of obligations could be subject to trade or trade-related sanctions.

The main problem with alternative 2, however, is that the WTO has a very wide membership. It might prove difficult, if not impossible, to achieve consensus on the substance of a WTO agreement on FDI. For instance, though APEC tried to develop a set of no n-binding investment principles, there was no consensus on what should be the substance of these (though the principles were non-binding, nations could not agree on what they were not committing themselves to!), and this difficulty may be magnified sever al-fold at the WTO level.

Thus, it has also been proposed that some sort of agreement on FDI be hammered out among a subset of nations holding something like a common view on the substance of the agreement (say, alternative 3). In fact, such an exercise is being carried out withi n the OECD -- the OECD Multilateral Agreement on Investment (MAI). If successfully completed, it will not even necessarily be binding upon all OECD nations; rather, each nation could decide whether or not to participate in the agreement. Also, non-OECD n ations wishing to commit to the agreement would be free to do so.

Which of the three alternatives is preferable? All three pose problems but, all things considered, the second alternative wins by default. The first alternative is rejected by almost everyone except a small band of laissez-faire enthusiasts who honestly believe that there is a surrogate `policy market' in which governments compete for FDI and, by competing, can arrive at an optimal mix of policies. This concept is rejected even by most multinational firms, though the executives of such firms tend to bel ieve in minimal government. These firms prefer international standards for governmental policies to achieve consistency and predictability and, through a dispute settlement procedure, to have access to some form of recourse in the event that internationa l standards are violated by a government.

The third alternative is likely to produce an agreement to which only the OECD nations (or, more likely, some subset of these nations) commit themselves; it is unlikely that many, or indeed, any, non-OECD nations would be willing to `dock But non-OECD na tions figure importantly as both host and home nations to FDI, and an MAI without the participation of these nations makes little sense. The second alternative has the advantage that such nations necessarily would be included in any arrangement that migh t be achieved under the WTO.

The further advantage is that obligations entered into under a WTO arrangement could be made more enforceable via linkage to trade sanctions. The main difficulty lies in whether nations are, at this time, willing to commit themselves to hard and binding international rules.

The following principles were emphasised as ones to which APEC nations, as host countries to direct investment, might aspire rather than be bound.

1. Transparency: Member countries would make all instruments of policy (including those instruments by which policy is actually implemented) publicly available in a form readily accessible to the public.

2. Non-discrimination among source economies: Countries would extend to investors from any nation treatment in relation to the establishment, expansion, or operation of their (the investors') investments (for example, subsidiaries) that is no less favour able than that accorded to investors from any other nation in like circumstances.

3. National treatment: With exceptions as provided for in domestic laws, regulations, and policies, nations would accord to foreign investors in relation to the establishment, expansion, operation, and protection of their investments treatment no less fa vourable that accorded in like situations to domestic investors.

4. Investment incentives: Nations would not relax health, safety and/or environmental regulations as an incentive to encourage foreign investors.

Performance requirements: Countries would minimise the use of performance requirements (requirements placed by governments on foreign investors to meet certain specified objectives) as a means of achieving policy objectives in circumstances where these w ould distort or limit expansion of trade and investment.

Expropriation and compensation: Nations would not expropriate foreign investments or take measures that have the effect of expropriation.

Repatriation and convertibility of funds: Nations would allow the free and prompt transfer of funds related to FDI, such as repatriation of profits or dividends, royalties, loan payments and liquidations, in freely convertible currencies, subject to the laws of each country.

Settlement of disputes: Countries would accept that disputes arising in connection with foreign investment would be settled promptly through consultations and negotiations between the parties to the dispute (the investor and the host-nation government) o r, failing this, through procedures for arbitration in accordance with members' international commitments or through other arbitration procedures acceptable to both parties.

Entry and sojourn of personnel: Countries would permit the temporary entry and sojourn of key foreign technical and managerial personnel for the purpose of engaging in activities connected with the foreign investment, subject to relevant laws and regulat ions.

10. Avoidance of double taxation: Countries would seek to avoid double taxation of income related to FDI.

11. Investor behaviour: Acceptance of foreign investment is facilitated when foreign investors abide by the host nation's laws, regulations, administrative guidelines, and policies.

12. Removal of barriers to foreign capital: Economies accept that regulatory and institutional barriers to the outflow of investment will be minimised.

(The author is a Chennai-based management professional.)