Foreign Direct Investment and Human Development

The Law and Economics of International Investment Agreements

Olivier De Schutter, Johan Swinnen, Jan Wouters

• Publisher: Routledge
• Year: 2012
• Print ISBN: 9780415535489
• eBook ISBN: 9781135128067
• Topic: Law
• Subtopic: International Business
• Index: Law

This book presents original research that examines the growth of international investment agreements as a means to attract foreign direct investment (FDI) and considers how this affects the ability of capital-importing countries to pursue their development goals. The hope of countries signing such treaties is that foreign capital will accelerate transfers of technologies, create employment, and benefit the local economy through various types of linkages. But do international investment agreements in fact succeed in attracting foreign direct investment? And if so, are the sovereignty costs involved worth paying? In particular, are these costs such that they risk undermining the very purpose of attracting investors, which is to promote human development in the host country? This book uses both economic and legal analysis to answer these questions that have become central to discussions on the impact of economic globalization on human rights and human development. It explains the dangers of developing countries being tempted to 'signal' their willingness to attract investors by providing far-reaching protections to investors' rights that would annul, or at least seriously diminish, the benefits they have a right to expect from the arrival of FDI. It examines a variety of tools that could be used, by capital-exporting countries and by capital-importing countries alike, to ensure that FDI works for development, and that international investment agreements contribute to that end.

This uniquely interdisciplinary study, located at the intersection of development economics, international investment law, and international human rights is written in an accessible language, and should attract the attention of anyone who cares about the role of private investment in supporting the efforts of poor countries to climb up the development ladder.

1 Introduction

Foreign direct investment and human development¹

Olivier De Schutter, Johan Swinnen and Jan Wouters

1.1 Introduction

It is a widely held view that a positive relationship exists between the arrival of foreign direct investment (FDI) and development, and that attracting foreign capital is essential to developing countries in order to finance their growth and to improve their access to technologies. This consensus view is expressed, for instance, by the Partnership for Growth and Development adopted in 1996 at the Ninth United Nations Conference on Trade and Development,² which states that

foreign direct investment can play a key role in the economic growth and development process…FDI is now considered to be an instrument through which economies are being integrated at the level of production into the globalizing world economy by bringing a package of assets, including capital, technology, managerial capacities and skills, and access to foreign markets. It also stimulates technological capacity-building for production, innovation and entrepreneurship within the larger domestic economy through catalysing backward and forward linkages

However, beyond that general language, a number of questions remain. Perhaps the most widely studied of these concerns the relationship between the nature of the foreign investment considered and the impacts on development.³ On the side of the investor, FDI may be undertaken in order to gain access to natural resources or other strategic assets, such as research and development capabilities; in order to reach new consumer markets; or in order to exploit locational comparative advantage.⁴ The investment can take the form of greenfield investment, thus contributing directly to capital formation and enhancing local productive capacity, or simply lead to a transfer of ownership by mergers and acquisitions of local firms by foreign investors. Both the improved access to global markets (due to the trade effects of FDI) and the linkages with the local economy (upstream and downstream from the investment itself) may diverge widely depending on which of these objectives of FDI is primarily pursued by the investor and which form, in turn, the investment strategy takes. Host countries' ability to capture the benefits from increased FDI depends on various factors, such as their general level of technological development, on existing macro-economic conditions, as well as on their absorptive capacity. In Chapter 3 of this volume, Colen et al. note, for instance, that developed economies generally benefit from the presence of foreign companies through the spillover effects of such presence to other companies, or through increased supply of products and increased demand for inputs and employment. At the same time, competing domestic firms may be hurt by increased competition. While FDI can contribute importantly to growth and poverty reduction in developing countries, it is important to acknowledge the complexity of the relationship between FDI and development when attracting foreign investors. Certain types of FDI create jobs for the poorest, yet other types of investment may require a minimum level of technology or education in order to learn from foreign companies, engage in their networks and take up the employment they provide.

1.2 The focus of this volume

In this volume, we pose another set of questions, which relate to the different tools that countries may rely on in order to attract FDI. Particularly throughout the 1990s, one important strategy relied on by countries lacking capital or seeking to improve their access to technology by attracting investors has been to conclude international investment agreements (IIAs).⁵ These agreements may be bilateral or multilateral, and they can cover investment only or, as in the earlier ‘Friendship, Commerce and Navigation’ agreements, be part of broader trade or cooperation agreements. Although they differ in these respects, however, investment agreements present a striking similarity across regions and negotiation fora. Such treaties usually include provisions relating to the scope and definition of foreign investment; admission and establishment; national treatment in the post-establishment phase (a guarantee of non-discrimination against the investor of the other party established in one party); the most favoured nation clause (ensuring that the investor of the other party will benefit from the same treatment as any other foreign investor); fair and equitable treatment, including a protection from expropriation; guarantees of free transfers of funds and repatriation of capitals and profits; and dispute-settlement provisions (State—State and State—investor).

But how successful was such a strategy? Did it serve, indeed, to attract investment, if such was the primary aim of concluding investment agreements?⁶ And even if the strategy did succeed in that respect, how can we assess the ‘sovereignty costs’, or the loss of ‘policy space’,⁷ associated with the conclusion of IIAs? If countries compete for the arrival of foreign investment and if the conclusion of such agreements is one tool they rely on to gain an advantage over potential competitors, does this entail the risk that the concessions they make will go too far, for example by renouncing the possibility of imposing performance requirements on the investor (though this could arguably strengthen the linkages with the host economy), by guaranteeing a freeze in the regulatory framework applicable to the investment, or by authorizing transfer pricing between the local subsidiary and the foreign-based parent, thereby reducing the fiscal revenues that could be gained from the arrival of the foreign investor? By concluding an investment agreement, a country signals its intention to respect the rights of investors and to create a legal and policy framework that will provide the kind of stability they usually expect. But could it be that, while it may be understandable for each country considered individually to seek to conclude IIAs with a view to attracting investors, the result is collectively sub-optimal, as the IIAs lose their ‘signalling’ function once they come to be generalized?⁸

We concentrate specifically on the relationship between the role of IIAs in attracting FDI, and the contribution of FDI to human development. Economic growth, which is usually associated with FDI inflows, has lost its privileged position in debates about development since the mid-1980s, when the traditional focus on the expansion of gross national product or gross domestic product per capita shifted to a greater preoccupation with non purely economic values, encapsulated in the notion of human development understood as the expansion of human freedoms.⁹ One indicator of this shift was the adoption, in 1986, by the United Nations General Assembly, of the Declaration on the Right to Development, which defines development as a ‘comprehensive economic, social, cultural and political process, which aims at the constant improvement of the well-being of the entire population and of all individuals on the basis of their active, free and meaningful participation in development and in the fair distribution of benefits resulting therefrom’, and in which ‘all human rights and fundamental freedoms can be fully realized’.¹⁰ This shift was further confirmed by the introduction of the Human Development Index (HDI) by the United Nations Development Programme (UNDP) in 1990, which for the first time¹¹ provided a clear, and operational alternative to the measures of GNP or GDP per capita.¹² Considering cross-country data availability and pertinence, the UNDP selected three basic dimensions of development to be the main focus of its analysis of development: longevity, as a proxy for health; adult literacy, and later mean years of school enrolment, as proxies for education and learning; and per capita income, or ‘command over resources needed for a decent living’. The HDI, an indicator combining these three components, relied on a multidimensional definition of development, and was seen as capable of bridging the gap between academia and practical policy-making.¹³ The measure of HDI has evolved in many ways since it was first introduced more than twenty years ago.¹⁴ But its main importance lies not in the precise methodology it recommends, but in the changed view of development that it signalled.

In recent years, doubts have been expressed with an increased frequency about the adequacy of a strategy relying on the conclusion of IIAs in order to attract foreign investors, in part because the ability of IIAs to bring about increased investment flows has been questioned, and in part because economic growth, the end of past development efforts, is now considered merely a means towards the broader and richer objective of human development. While the flows of FDI have increased significantly over the years, from 55 billion US dollars of yearly flows of FDI in 1980 to 1,306 billion US dollars in 2006,¹⁵ the impacts of investment agreements committing host countries to guaranteeing certain forms of treatment to the foreign investor have also become more visible. The Outcome Document on the implementation of the Millennium Development Goals (MDGs) that the General Assembly adopted by consensus on 22 September 2010 notes in this regard:

We recognize that the increasing interdependence of national economies in a globalizing world and the emergence of rules-based regimes for international economic relations have meant that the space for national economic policy, that is, the scope for domestic policies, especially in the areas of trade, investment and international development, is now often framed by international disciplines, commitments and global market considerations. It is for each Government to evaluate the trade-off between the benefits of accepting international rules and commitments and the constraints posed by the loss of policy space.¹⁶

The wording chosen by the Outcome Document is cautious, and sounds almost like a warning addressed to States. It is, at least, far removed from the much more optimistic mood of the 1990s. What has happened in the meantime? In part, this change of attitude may be attributable to the fact that the IIAs concluded in large numbers in the late 1980s and in the 1990s have not always fulfilled their promises. Instead, governments may have gradually come to the realization that the agreements were severely imbalanced in favour of investors' rights. Over the past ten years, treaty-based investor—State dispute-settlement cases have multiplied: by the end of 2011, there were 450 known disputes,¹⁷ 220 of which had been concluded. Of this total, approximately 40 per cent were decided in favour of the State and approximately 30 per cent in favour of the investor, the remaining disputes being settled.¹⁸ Altogether, 89 countries have been defendants in such claims, including 55 developing countries: the States facing the largest number of claims are Argentina (51 cases, mostly related to the privatization of the water services), Venezuela (25), Ecuador (23) and Mexico (19). Some of these claims relate to issues that raise important public interest concerns. In 2010 for instance, invoking the Australia—Hong Kong bilateral investment treaty (BIT), tobacco company Philip Morris filed a claim against Australia challenging measures that its government had adopted in order to protect public health and to discharge its obligations under the World Health Organization Framework Convention on Tobacco Control (FCTC).¹⁹ A Swedish investor operating nuclear plants in Germany challenged the decision by that country to phase out its production of energy from nuclear power, following the Fukushima catastrophe in Japan. In addition, some provisions of investment treaties remain subject to widely diverging interpretations by arbitrators, creating the risk of a ‘chilling effect’ on the host State seeking to adopt certain regulations. That is the case, in particular, for the clause referring to the ‘fair and equitable treatment’ that should benefit the investor,²⁰ as well as to the significance of a necessity clause included in an investment treaty.²¹

To a growing number of governments, the lesson from the past fifteen years is that there are real costs to the conclusion of IIAs, that may or may not be fully compensated by the expected gains. Doubts are expressed as to whether countries should bind themselves through IIAs, when they risk losing too much ‘policy space’ – in particular, the ability to adopt certain regulations in the public interest or to impose on the investors a more equitable share of the value created by the investment. Indeed, even where the arrival of FDI is beneficial for economic growth and poverty reduction of the host country in aggregate terms, the debate has devoted increasing attention to the opportunities and threats it may pose to the well-being and human rights of more vulnerable groups of the population. There is general agreement that poor countries require more, rather than less, FDI in order to support their development. But the question that now emerges is under which conditions FDI should be encouraged, towards which ends it should be channelled, and which regulatory framework should be imposed in order to ensure that it effectively contributes to human development. The question in the past was how to increase the attractiveness of one jurisdiction to foreign investors, and the conclusion of IIAs was seen as an obvious means towards that end. The question is now how to align the incentives in order to maximize the positive impacts of FDI while minimizing the potential negative impacts. Both the capital-receiving (host) country and the capital-exporting (home) country may have a role to play in this regard. It is the aim of this book to examine the nature of the challenge they face, and the tools that they can use to achieve this balance.

1.3 An overview

Our contribution to this debate is the outcome of a multi-year r...

Table of contents

• Cover
• Half Title
• Full Title
• Copyright
• Contents
• Illustrations
• Contributors
• 1 Introduction: foreign direct investment and human development
• 2 International investment law: the perpetual search for consensus
• 3 Foreign direct investment as an engine for economic growth and human development: a review of the arguments and empirical evidence
• 4 Determinants of foreign direct investment flows to developing countries: the role of international investment agreements
• 5 What type of foreign direct investment is attracted by bilateral investment treaties?
• 6 The host state: improving the monitoring of international investment agreements at the national level
• 7 Risk managers or risk promoters? The impacts of export credit and investment insurance agencies on human development and human rights
• 8 Improving the framework of negotiations on international investment agreements
• 9 The role of development banks: the European Investment Bank's substantive and procedural accountability principles with regard to human rights, social and environmental concerns
• Appendix A
• Appendix B
• Index