The Impact of Investment Agreements on FDI: Do International Investment Agreements (IIAs) Attract FDI?

1. The Impact of Investment Agreements on FDI: Do International Investment Agreements (IIAs) Attract FDI? Debapriya BhattacharyaExecutive DirectorCentre for Policy Dialogue (CPD) October 01, 2007

2. Presentation Layout • Introduction • Major Features of IIA • Recent Trends in IIAs • Impact of IIAs on FDI • Challenges Ahead

3. 1. Introduction FDI and Development: Recipient Perspective • Improved economic growth of the recipient. • Modernization of the national economy. • Expanding the stock of capital in the host economy. • Stimulation of technological capacity-building for production, innovation, and entrepreneurship. • May give rise to a stream of exports of inputs, intermediate goods, machinery and services • Even in the manufacturing sector, the net effect of FDI on trade may well be positive and beneficial to the economies of host and home countries.

4. 1. Introduction • However, lack of Flows absorptive capacity of the host economy are likely to bring about negative side effects e.g. appreciation of the exchange rate. • Ethical and socially responsible FDI can be encouraged through IIAs guidelines and regulations.

5. 1. Introduction Rationale for Liberal Foreign Investment Policies Provides Access to: Foreign pools of privately held savings controlled by companies, banks, pension and mutual funds, and individuals. Markets, raw materials, intermediate goods. Technology, management and technical skills. Generates employment, foreign exchange and tax revenue Spin-offs and multiplier effect

6. 1. Introduction • Protecting national security and defense, e.g. arms and munitions. • Pursuing economic development strategies, e.g. regional development • Protecting local inventors, industries, employment. • Capturing economic rents, e.g. to address transfer pricing. • Safeguarding balance of payments.

7. 2. Major Features of IIAs Basic components International Investment Agreements • Non-discrimination. • Minimum standards of treatment. • Expropriation. • Performance requirements.

8. 2. Major Features of IIAs Objective of the IIAs • To create the necessary domestic and international conditions to facilitate direct investment flows. • Development of a regulatory framework for promoting and protecting investments. • BITs to some extent function as substitute for institutional quality.

9. 2. Major Features of IIAs Forms of IIA • Bilateral Investment Treaties (BITs). • Double Taxation Treaties (DTTs). • Free Trade Agreements (FTAs).

10. 2. Major Features of IIAs A. Bilateral Investment Treaty • Goals of BITs • There are two competing hypotheses about the relationship between a country’s BITs and FDI. • First, a BIT signed with a particular home country sends a signal to investors in that country that prospective investments in the host country will be well protected. • Second, BITs might send a signal to all investors, whether or not their own home country has signed a BIT with a particular host country.

11. 2. Major Features of IIAs B. Double Taxation Treaty: Treaty to avoid tax burden for a single firm (TNC) in two countries at the same time- home-origin of the firm and abroad-where it invests. Goals of DTTs • According to Blonigen and Davies (2004), tax treaties perform four primary functions • Standardize tax definitions of treaty partners. • Reduce transfer pricing and other forms of tax avoidance. • Prevent treaty shopping.(Treaty shopping is described as the routing of income through particular states in order to take advantage of treaty benefit that were designed to be given only to residents of the contracting states). • Affect the actual taxation of multinational corporations

12. 2. Major Features of IIAs • Affect the actual taxation of multinational corporations. • Theoretically, tax treaties can both promote or reduce investment. • On the one hand, tax treaties can promote investment by reducing uncertainty about the tax environment abroad. • A tax treaty, which reduces the ability to transfer price or somehow prevents other types of tax evasion also reduces the incentive to invest (if investment activity is purely for tax minimization reasons). C. The third category includes free trade agreements with investment provisions.

13. 2. Major Features of IIAs Main characteristics of the IIA system • IIA system is universal, i.e. almost all countries in the world are party to at least one IIA. • The IIA network is highly atomized, i.e. it consists of thousands of individual agreements that lack any kind of system-wide coordination. • IIA universe is multilayered, i.e. it consists of investment treaties at various levels. • IIA universe is multifaceted, i.e. it covers not only investment issues, but also related matters such as trade, services, movement of personnel and others.

14. 3. Recent Trends in IIAs • In 2006, 73 new BITs were concluded, bringing the total number of BITs to 2,568. • In 2006, 83 new DTTs were concluded, bringing the total number of DTTs to 2,651 by the end of 2006. • In 2006, 18 new agreements with investment provisions were concluded, bringing the total number to 241 at the end of 2006.

15. 3. Recent Trends in IIAs Even LDCs are in the Game !!! • There were 77 BITs among developed countries and LDCs untill 1990. • At the end of 2006 this number of BITs reached to 173. • Only within 5 years (2001-2005) this number has incresed by 56.

16. 3. Recent Trends in IIAs Trends in National FDI Policies • First bilateral investment agreements (BITs) in 1959 (Germany with Pakistan and Egypt), • Exponential growth in the 1990s: now almost 2600 agreements around the world, though slow to expand after first BITs. • Initially between developed and developing countries, now growing number, more than 40 percent of total are between developing countries. • Investment provisions increasingly included in regional trade agreements, e.g. NAFTA. • Countries continue to adapt new measures to upgrade or enhance ability to attract and benefit from FDI

17. 3. Recent Trends in IIAs Trends in National FDI Policies • In 2005, a total of 205 measures were adopted by 93 economies • Distribution of policy changes by area: Africa-53; Asia and Oceania-48: Developed countries- 44; South East Europe and CIS-39; Latin America and the Caribbean-21 • 80% of regulatory changes tended to make conditions more favorable for foreign companies to enter and operate • New promotional efforts: 51 measures.

18. 3. Recent Trends in IIAs Present Scenario • Growth rate of BITs around the world (5-year annual average) • The largest share of the BITs in the world were signed during the period between 1991-95 and has followed declining trend between 2001-2005. • Share of BITs per country by Region, as at 2002 • Highest number of BITs (45), have been signed by developed countries. (Developing-12, Africa-10 and Asia and pacific-18) • Share of BITs by country group concluded by the end of 2005, • The highest number of BITs where signed between developed and developing countries followed by BITs signed between developing countries.

19. 3. Recent Trends in IIAs Present Scenario • The role of developing countries in international investment rulemaking continues to enhance. • Today developing countries are parties to 77% of all BITs, 61% of all DTTs, and 81% of all other IIAs. • Some developing countries, such as China and Egypt, are amongst the ‘top” signatories of BITs worldwide.

20. 4. Professed Impact of IIAs on FDI • Ethical and socially responsible FDI can be encouraged through IIAs guidelines and regulations(UNCTAD-1999). • Multiple coverage under more than one IIA improves the investment climate in the host countries. • Creates a synergetic effect and fills possible gaps in the overall treatment of foreign investment. • The greater number and diversity of IIAs in terms of their scope, structure and content reflects the flexibility that countries would like to have in choosing the partners to enter into an agreement. • This also helps to tailor individual agreements to their specific situations, development objectives and public concerns. • More elaborate rules may enhance legal clarity on the rights and obligation.

21. 3. Professed Impact of IIAs on FDI (Contd) Effects on Development through Trade: • FDI may have positive indirect effects on trade and further investment flows. • May give rise to a stream of exports of inputs, intermediate goods, machinery, and services. • In the manufacturing sector, the net effect may well be positive and beneficial to the economies of host and home countries (IIAs: Key Issues and IISD).

22. 4. Professed Impact of IIAs on FDI Trade and Investment: Substitute or Complementary? Traditionally, Trade and Investment were seen as alternative means to exploiting foreign markets. • The views have been changed in the recent years. They are complements, rather being substitutes. • The issue is increasingly getting more attention because: • Global and decentralized market • Countries are competing for investment by offering policy incentives: may lead to distortion in the allocation of investment resources • Services have become a more important part of total trade: Investment is required where services are provided.

23. 4. Professed Impact of IIAs on FDI The Theoretical Debate: Do IIAs Increase Investment? Positive Impacts Ratification of BITs has a significant impact on FDI stocks in developing and OECD countries (Egger et al 2004). Strong positive relationship was found between US investment in response to US BITs in 31 countries. (However this does not include a policy effect variable, missing the impact of institutional changes) (Salacuse et al 2005). BITs are significant attractors of FDI from all countries(not just from signatories), indicating a signaling effect (Neumayer et al 2005).

24. 4. Professed Impact of IIAs on FDI The Theoretical Debate: Do IIAs Increase Investment? Positive Impacts • UNCTAD study shows from a panel data set analysis covering FDI in the periods before and after the signing of some 200 BITs has minimal positive relationship. • BITs which emphasize on non-discriminating treatment of FDI are found to have a significant impact on aggregate FDI (Banga, 2003). • National, bilateral and international investment agreements can encourage ethical and socially responsible investment.

25. 4. Professed Impact of IIAs on FDI The Theoretical Debate: Do IIAs Increase Investment? Negative Impacts • Studies found negative relationship between BITs and FDI in situations of high risk while positive relation could be established only in the situation of high risk. • A number of empirical studies that found positive effect of BITs on FDI flows, considers the number of BITs coming into force rather than their power to stimulate FDI. • Limited evidence has found that FDI increases with total no. of BITs signed (Gallagher et al).

26. 4. Professed Impact of IIAs on FDI The Theoretical Debate: Do IIAs Increase Investment? Negative Impacts • UNCTAD’s study shows no discernable link at all between BITs and investment flows. The analysis however does not take into account of other factors influencing BITs. • The cross sectional analysis of 133 countries found no significant relationship between BITs and flows of FDI. • Traditional market related determinants are still dominant factors in affecting FDI (Numnenkamp p. 2002). • FDI was positively influenced by openness and market size, and negatively by instability (inflation is used as proxy) (Hallward-Driemeier 2003).

27. 4. Professed Impact of IIAs on FDI The Theoretical Debate: Do IIAs Increase Investment? Negative Impacts • BITs act as more of a complement than a substitute for domestic institution. • There is a negative relationship between BITs and FDI( as a share of world FDI). • BITs do not substitute for strong domestic institutions (Tobin et al 2005). • Diminishing returns to additional BITs. • US BITs which have stronger protections are more significant than OECD BITs (Salacuse et al 2005). • A world with BITs might reduce the interest of MNCs in property rights reform and enforcement in developing countries (Tobin et al 2005).

28. 4. Professed Impact of IIAs on FDI The Theoretical Debate: Do IIAs Increase Investment? Negative Impacts • BITs do in fact erode the quality of the rule of law in host developing countries, which in effect harm domestic investors (Ginsburg, T. 2005). • Despite the efforts to make economies to force trade and attracting FDI, mostly Arab countries experienced poor record of FDI (Omet, G and Saif, I 2005). • Although the effectiveness of the legally binding international treaties to protect the foreign investors under international law is unquestionable, their role in actually attracting FDIs remains inconclusive (El-Kady, H.). • There is some limited evidence that FDI can be attracted by IIAs.

29. 4. Professed Impact of IIAs on FDI The Theoretical Debate: Do IIAs Increase Investment? Negative Impacts • Affordable access to pharmaceuticals might be made more difficult by IIAs that do not carve out compulsory licencing and parallel importing from their expropriation provisions. • Most IIAs have provisions on expropriation that may conflict with the legitimate exercise of environmental regulatory authority (IISD ).

30. 4. Professed Impact of IIAs on FDI The Theoretical Debate: Do IIAs Increase Investment?Negative Impacts National Treatment: • There is a trade-off between offering national treatment as a means of increasing FDI inflows, and circumscribing national treatment as a means of promoting local enterprise development. • There is a risk that economically strong foreign firms may impede or distort the development of domestic enterprise in a host country. Intellectual Property (IP): • The impact of having IP included in the definition of investment potentially could be subject to the general guarantees afforded to investors under the BITs (Bilateral Investment Treaties). • The extent of protection under a BIT for an investor’s IP will be affected by how the term ‘Intellectual Property ‘is defined, if all, in the treaties.

31. 4. Professed Impact of IIAs on FDI Relationship between IIAs and FDI • There is no systematic relationship between growth rate of IIAs and FDI, whereas the rate of growth of BITs falling over the period, the FDI growth rate is showing an increasing trend for the world. • FDI flows (as share of world FDI) have shown stagnated trend despite the rising number of BITs. • FDI inflow in developing countries shows an increasing trend while the number of BITs signed between developing countries occupied about 26% of the total between 2000 and 2005. • However, it is difficult to determine whether these FDI came in as a result of the IIAs or due to other factors. • The sectors where these FDI are being injected are also a concern.

32. 4. Professed Impact of IIAs on FDI Do IIAs lead to economic development? • IIAs may have impacts on economic growth, but the linkages are uncertain and probably relied on host country level of development, trade openness and other factors. • FDI that does come may indeed foster economic growth, but this probably depends heavily on the presence of other prerequisite factors such as trade openness, macroeconomic stability, an economy of sufficient size and development, and others • There is nothing in the IIAs that compels, or even encourage investors to align their activities with the development goals of the host countries.

33. 15. Challenges Ahead • Potential financial risk for developing countries in maintaining an inconsistent and often non-transparent IIA network. • Increasing complexity of the IIA network and the difficulties to manage it. • Lack of policy coherence in the IIA universe: • Incoherence between a country’s IIA network and its domestic economic and development policies. • Incoherence among a country’s IIAs.

34. Thank You for Your Attention