Global Corporations and National Governments

Global Corporations and National Governments

EDWARD M. GRAHAM

Global Corporations and National Governments

INSTITUTE FOR INTERNATIONAL ECONOMICS Washington, DC May 1996

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Edward M. Graham, Senior Fellow, was Associate Professor in the Fuqua School of Business at Duke University (1988–90), Associate Professor at the University of North Carolina (1983–88); Principal Administrator of the Planning and Evaluation Unit at the OECD (1981–82); International Economist in the Office of International Investment Affairs at the US Treasury (1979–80) and Assistant Professor at the Massachusetts Institute of Technology (1974–78). He is author or coauthor of numerous studies on competition policy, international investment, and technology transfer, including Foreign Direct Investment in the United States (third edition 1995).

Copyright © 1996 by the Institute for International Economics. All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by information storage or retrieval system, without permission from the Institute.

INSTITUTE FOR INTERNATIONAL ECONOMICS 11 Dupont Circle, NW Washington, DC 20036-1207 (202) 328-9000 FAX: (202) 328-5432 http://www.iie.com

Library of Congress Cataloging-inPublication Data

C. Fred Bergsten, Director Christine F. Lowry, Director of Publications Cover Design by Naylor Design, Inc. Typesetting by Sandra F. Watts Printing by Kirby Lithographic Co., Inc.

For reprints/permission to photocopy please contact the APS customer service department at CCC Academic Permissions Service, 27 Congress Street, Salem, MA 01970. Printed in the United States of America 98 97 96 54321

Edward M. Graham, 1944Global corporations and national governments / Edward M. Graham. p. cm. Includes bibliographical references and index. 1. Investments, Foreign. 2. International business enterprises. 3. International economic relations. I. Title. HG4538.B455 1995 338.8'8—dc20 95-6145 CIP ISBN 0-88132-111-7

Marketed and Distributed outside the USA and Canada by Longman Group UK Limited, London The views expressed in this publication are those of the author. This publication is part of the overall program of the Institute, as endorsed by its Board of Directors, but does not necessarily reflect the views of individual members of the Board or the Advisory Committee.

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Contents

Preface

vii

Acknowledgments

x

1 Introduction

1

2 Recent Trends in the Globalization of Business FDI and Trade FDI and R&D National Comparisons Changes in Policies Toward FDI Predicting Which Way FDI Will Flow Globalization in Historical Perspective Regionalism and the Global Firm

9

13 14 15 19 22 24 29

3 Why Does Business Globalize?

33

4 Toward New Rules on International Investment

47

What Is a Global Firm? Impacts of National Policy on Globalization Implications of the Clash between Government and Global Business

An Accord on FDI Ancillary Codes Conclusion

33 41 45

48 61 67 v

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5 Postwar Efforts at Rule Making

Multilateral Efforts to Create FDI Rules Regional Approaches to FDI Bilateral Treaties Changing Positions of Major Home and Host Nations Conclusion

6 Negotiating and Implementing an Investment Accord Finding the Right Forum The World Trade Organization Organization for Economic Cooperation and Development Regional Arrangements Other than the OECD Where Do We Go from Here? Conclusions

Appendices A Foreign Direct Investment and Technological Spillovers in the Developing Nations

69

70 80 87 88 100

101

101 102 104 115 117 118

123 131

B A Game Theoretic Approach to Sanctions References

135

Index

143

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Preface

Foreign direct investment has become a major component of the world economy. Offshore production by multinational companies far exceeds international trade. A large part of world trade in fact takes place within these international firms. Yet foreign direct investment is understood much less perfectly than trade. As recently as the 1970s, intense controversy in fact raged over whether international investment was even a good thing and whether corporations or governments were more dominant. Moreover, there are no global rules or institutional arrangements to govern foreign direct investment as there are for trade through the World Trade Organization, for monetary issues through the International Monetary Fund or for development finance through the World Bank. This book attempts to fill both gaps. At the analytical level, it addresses two sets of growing conflicts: between globalizing firms and inherently national governments, as they pursue their different goals, and between governments themselves as they compete to attract the benefits of foreign direct investment. At the policy level, the book reviews previous international agreements and proposes a new regime to help deal with the newly significant range of problems. The Institute for International Economics is a private nonprofit institution for the study and discussion of international economic policy. Its purpose is to analyze important issues in that area and to develop and communicate practical new approaches for dealing with them. The Institute is completely nonpartisan. The Institute is funded largely by philanthropic foundations. Major institutional grants are now being received from the German Marshall vii

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Fund of the United States, which created the Institute with a generous commitment of funds in 1981, and from the Ford Foundation, the Andrew Mellon Foundation, and the C. V. Starr Foundation. A number of other foundations and private corporations also contribute to the highly diversified financial resources of the Institute. The GE Fund provided support for this study. About 16 percent of the Institute’s resources in our latest fiscal year were provided by contributors outside the United States, including about 7 percent from Japan. The Board of Directors bears overall responsibility for the Institute and gives general guidance and approval to its research program— including identification of topics that are likely to become important to international economic policymakers over the medium run (generally, one to three years), and which thus should be addressed by the Institute. The Director, working closely with the staff and outside Advisory Committee, is responsible for the development of particular projects and makes the final decision to publish an individual study. The Institute hopes that its studies and other activities will contribute to building a stronger foundation for international economic policy around the world. We invite readers of these publications to let us know how they think we can best accomplish this objective. C. FRED BERGSTEN

Director April 1996

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INSTITUTE FOR INTERNATIONAL ECONOMICS 11 Dupont Circle, NW, Washington, DC 20036-1207 (202) 328-9000 Fax: (202) 328-5432 C. Fred Bergsten, Director BOARD OF DIRECTORS *Peter G. Peterson, Chairman *Anthony M. Solomon, Chairman, Executive Committee Leszek Balcerowicz Raymond Barre W. Michael Blumenthal Chen Yuan Jon S. Corzine Miguel de la Madrid George David *Jessica Einhorn George M. C. Fisher Maurice R. Greenberg * Carla A. Hills W. M. Keck II Nigel Lawson Lee Kuan Yew *Frank E. Loy Donald F. McHenry Ruben F. Mettler Minoru Murofushi Kaneo Nakamura Suliman S. Olayan Paul H. O’Neill I. G. Patel Karl Otto Pöhl Edzard Reuter David Rockefeller Stephan Schmidheiny Laura D’Andrea Tyson Paul A. Volcker * Dennis Weatherstone Marina v.N. Whitman Lynn R. Williams Peter K. C. Woo Andrew Young

ADVISORY COMMITTEE Richard N. Cooper, Chairman Robert Baldwin Barry P. Bosworth Susan M. Collins Rimmer de Vries Wendy Dobson Juergen B. Donges Rudiger Dornbusch Gerhard Fels Isaiah Frank Jacob A. Frenkel David D. Hale Dale E. Hathaway Nurul Islam Peter B. Kenen Lawrence B. Krause Anne O. Krueger Paul R. Krugman Roger M. Kubarych Robert Z. Lawrence Jessica T. Mathews Rachel McCulloch Isamu Miyazaki Michael Mussa Richard R. Nelson Sylvia Ostry Tommaso Padoa-Schioppa Jacques J. Polak Dani Rodrik Jeffrey D. Sachs Lawrence H. Summers Alan Wm. Wolff Robert B. Zoellick

Ex officio *C. Fred Bergsten Richard N. Cooper Honorary Directors Alan Greenspan Reginald H. Jones Akio Morita George P. Shultz *Member of the Executive Committee

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Acknowledgments

Given its relatively short length, this book has had an unusually long gestation period. The author has benefited from discussions with numerous people, far too many for them all to be acknowledged here. Nonetheless, special thanks must be given to those people who carefully reviewed the text in its penultimate form: C. Fred Bergsten, John H. Dunning, Sylvia Ostry, Raymond Vernon, Marina v.N. Whitman, and Douglas Worth. Others who have provided substantial input or valuable criticism include William Barreda, Thomas Brewer, Steven Canner, Geoffrey Carliner, Dennis Encarnation, Mark Mason, Carl Green, Stephen Guisinger, J. David Richardson, Pierre Sauvé, and Jeffrey J. Schott. Research assistance on this and related projects has been provided by Naoko Anzai, Ming Wah Lam, Aaron Tam, Mark Warner, and Chi Zhang. The author has also benefited from discussions with a number of people within the Department of Trade and Industry of Canada who cannot be acknowledged because of the sensitivity of their positions. None of those mentioned, of course, should be held responsible for any errors of fact or judgement that appear in this volume; the author alone is responsible for these.

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Introduction

During the past 10 years, a massive surge in foreign direct investment (FDI) has led to the deepest integration of the world economy in history. FDI, as a share of the world’s total fixed capital formation, rose almost 80 percent. FDI now contributes 5 to 6 percent of total capital formation in the United States and Europe and an astounding 20 percent in China.1 But FDI does not contribute only capital to the world economy. Foreign operations of large multinational firms also help to transform the economies in which they operate through technology transfer, and by introducing new and better management techniques, providing market access to other countries, and increasing competition. The recent surge in FDI has forced many governments to reconsider attitudes and policies toward FDI and global corporations. In the developing world in particular, these firms have long been viewed with suspicion. In many countries, such firms stood accused of exploiting the local economy to benefit the economy of the firm’s home nation and creating an unhealthy dependence of the host nation upon foreign capital. But the positive contributions of FDI and global corporations to 1. More correctly, FDI contributes these percentages to gross national saving augmented by net capital flows from abroad. Because by the national income identities I = S + NCF, where I is gross domestic investment, S is gross domestic saving, and NCF is net capital flows from abroad (NCF bears a negative sign if there is a net capital outflow) and because FDI is a component of NCF, FDI contributes the same percentage to I as it does to S + NCF. FDI is best seen in this light as a source of financing of real domestic investment rather than an actual component of it. 1

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economic development in a number of host nations during the past decade (the outstanding examples, almost at opposite ends of the spectrum in terms of total population, are China and Singapore) has shown that they play a significant role in raising growth levels, efficiency, and living standards. This study focuses on the relationships between national governments and global corporations in light of this transformation. The main conclusion is that new rules on international investment by these corporations and their worldwide operations are urgently needed. Chiefly, such rules should reinforce a worldwide trend toward liberalization of policies on FDI, offsetting the more restrictive and interventionist policies of the 1970s and early 1980s. The global benefits of international capital flow and technology transfer as well as those accruing to individual nations are maximized when policies are liberal—that is, when restrictions are minimal. Therefore, one reason for new international rules is to lock in the liberalization that has taken place and continues to occur. But even in the face of this trend toward liberalization, there remain government laws and policies that distort international investment flows and resulting commercial activities. The distortions impose major costs on the world economy in terms of lost output. Thus, another rationale for new rules is to capture the significant potential gains from getting rid of the distortions. A third rationale is to reduce conflicts between governments over FDI and the multinational firm, conflicts that can also reduce the net benefits accruing from FDI. The case for new international rules to govern investment is built on four premises: that globalization is increasing, global firms face national policies, conflicts are inevitable, and the goals of both global firms and governments are legitimate. 1. Growing numbers of corporations are increasingly global in terms of the scope of their operations and the nature of their concerns. The internationalization of business is not a new thing, of course (some history of international business is provided in chapter 2). However, an unprecedented surge in FDI began about 10 years ago and continues into the present. The result is an increase in the global spread of corporate activities that profoundly changes the world economic landscape, with implications that are not yet fully understood. How great is this globalization? The next chapter details salient facts and figures. But, as a way of introduction, let us note that in 1993 FDI flows worldwide represented 4.1 percent of the world’s gross fixed capital formation (GFCF);2 during 1981-85 this percentage was 2.3 percent (UNCTAD, World Investment Report 1995, annex table 5). This percentage varied substantially from nation to nation and from region to region.

2. FDI outflows were $222 billion while GFCF was $5,351 billion. 2

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For example, FDI inflows as a percentage of GFCF in 1993 was 5.1 percent for the United States, 5.8 percent for the European Union, 9.1 percent for East Asia, 20 percent for China, and an incredible 43 percent for Singapore (which, however, is something of a special case—the whole nation being a single city). But for the capital-starved least-developed economies, the figure was only 3.3 percent, and for some such nations it was much lower (for example, 0.2 percent for Kenya). Two things must be remembered about these figures. First, FDI is undertaken mostly by the world’s largest and most technologically dynamic firms. Second, the foreign investment these firms make does not represent their total direct investment; typically they also invest in their home nations (thus the global figure almost surely understates the importance of these firms in global capital formation, a subject dealt with in the following chapter). 2. Despite the 10-year trend toward globalization of business that began during the mid-1980s and continues into the mid-1990s, global corporations operate in a world economy that remains imperfectly integrated and a political system wherein nation-states, pursuing interests that are necessarily national, set regulatory and other policies. These include policies for the defense of national currencies (and thus exchange rates and trade balances), internationally immobile factors of production (notably unskilled labor and to some extent land), and national security. Also, many governments are concerned about the international competitiveness of national industries and how to enhance this competitiveness. National priorities and goals are not necessarily the same as those of the firms themselves. Consequently, one major debate in many nations is to what extent policies should ensure that global firms do meet these national priorities and goals. But here a problem arises. Policies that are effective to maximize the benefits one nation derives unilaterally from the activities of global firms might not be optimal from a global perspective. Rather, such policies can have a “beggar-thy-neighbor” effect, such that benefits are transferred from one nation to another. Likewise, if all nations simultaneously pursue such policies, the consequent misallocation of resources causes a net reduction of world economic efficiency and welfare over that which would obtain if nations were collectively to abstain from such policies.3 Finally, these policies might not be optimal from the perspective of the global firm in its efforts to rationalize its worldwide activities. This is one reason for new international rules: to constrain “beggarthy-neighbor” policies that are collectively self-defeating. Governments have already accepted constraints in their trade policies, as expressed in World Trade Organization (WTO) rules, and the overall desirability of

3. In the formal parlance of economics, the result will be “Pareto-suboptimal.”

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these constraints is well understood. This study will build the case that similar constraints ought to govern FDI policies. 3. Conflicts inevitably arise between governments and between business enterprises and governments; these can lead to inefficiencies and/or misallocations of resources that reduce global and national welfare. The potential for such conflicts is not limited to those between host countries and global firms. Home countries might also pursue policies to ensure that firms based in their territories meet local goals (the failed Burke-Hartke bill of the 1970s in the United States represents such an example; similar policies have been discussed in other countries that are home to FDI, including France and Japan). Such policies raise the same issues of potential inefficiency and/or misallocation of resources as hostcountry policies do. The potential benefit of eliminating these distortions is very high. In 1992, sales of multinational corporations’ foreign affiliates worldwide has been estimated to be about $5.2 trillion dollars (UNCTAD, World Investment Report 1995, table I.13). These sales represent output generated somewhere in the economies in which these firms operate (although not necessarily in the affiliates themselves).4 If the distortions and inefficiencies generated by government policies that would be curbed under international rules were to represent only 1 percent of this total value added, the addition to world output would be $52 billion per annum, a figure that by itself would surely justify some effort to create such rules. But is the 1 percent figure even approximately accurate? No one really knows, although, if anything, the figure is probably higher. The only claim here is that the potential gains to eliminating inefficiencies generated by government policies toward international business activity are immense even on a very conservative estimate. That the estimate is probably conservative can be argued (although not proved) by means of examples: n During the late 1980s, a multinational firm producing a chemically based product used in high-technology applications faced rapidly increasing demand in East Asia and realized that it needed to augment its production capacity. Two choices were available. First, it could increase the capacity of an existing facility in a major East Asian nation. Second, it could create an entirely new facility in some other East Asian country. Economic analysis done by the firm revealed that the first alternative would result in lower costs (i.e., increased efficiency) than the second alternative, irrespective of where the new plant might be 4. There is, however, some double counting in this figure because some of the sales of these affiliates are to other affiliates. Such sales should be removed from the total. Alas, the data do not exist that would permit this adjustment. 4

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located. However, one East Asian nation offered the firm a large subsidy to create a new plant within its national territory. The firm proceeded to negotiate a still larger subsidy, one large enough to compensate it for the higher costs of doing so (and then some) and then went ahead with the second alternative by creating a new plant in that country. In this case, the subsidy represented a transfer from the taxpayers of the country granting the investment incentive to the firm and its shareholders. But, more worrisome, the subsidy represented compensation for increased costs (and hence lower efficiency), the implications of which are that potential world output was reduced. The subsidy was in the range of $100 million. n Numerous governments protect domestic firms from international competition by restricting direct entry of foreign firms into domestic markets. The result typically is monopoly or olipolistic competition in the domestic market, resulting in the well-understood costs of imperfect competition (higher costs to consumers resulting from both monopoly pricing and inefficiencies in production and distribution). Often such protection is most rife in highly regulated markets—for example, those for basic telecommunications and financial services in many nations. The regulation itself often is (or at least originally was) justified as a means to protect consumers from the excesses of monopoly in markets believed to be “natural monopolies”—that is, ones in which only one or a small number of firms can survive. In modern times, the original conditions that in many cases once led to natural monopoly have disappeared but the regulation has not. A consequence is that the regulation more often protects incumbent producers rather than consumers. Opening such markets to international competition would in most such cases increase efficiency as well as reduce prices. n Wherever governments regulate firms, conflict is likely between governments with differing policies. If not resolved in economically appropriate ways, such conflicts can impose costs in the form of lost or inefficient output. For example, suppose two governments, each reacting to the other, were to require that a multinational firm produce a good or service locally as a condition for doing business within their territories. Costs could be higher with the requirement than without it if consolidating production in one plant would be more efficient than operating two plants. n A large manufacturing firm sought to establish an affiliate in a large developing country but had to obtain permission from the government to do so. Permission was granted on condition that the affiliate export a certain percentage of its output. The firm would not have chosen this particular location for export; INTRODUCTION

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the economic analysis of the firm indicated that while local manufacture for the domestic market was economical, export was not. However, the value to the firm of the permission to enter the local market overrode the negative value of being forced to export from this site. Such export performance requirements distort world trade and hence pose a cost to the world economy. In fact, such requirements are now banned under the Trade Related Investment Measures (TRIMs) Agreement implemented under the WTO. However, other types of so-called performance requirements that might have similar distortive effects are still permitted. New rules might enlarge the coverage of the TRIMs agreement, banning such requirements where they impose additional costs on the world economic system. This premise—that conflicts are inevitable—must be viewed in light of the fourth premise. 4. The goals and priorities of both global corporations and national governments are legitimate. This premise differs fundamentally from the view of certain critics of the multinational enterprise during the 1970s, who by and large perceived only the interests of government as legitimate. Much of the relevant academic literature of that time bolstered that view. This literature often stressed the monopoly power of the multinational enterprise and the putative ability of such enterprises to ride roughshod over national interests. More recent literature (reviewed in chapter 3) takes a much more positive stance toward multinational enterprises, emphasizing, for example, that a great deal of rivalry exists among these firms and that this rivalry can lead to more rapid development and diffusion of desirable new technologies than would take place in a world without such enterprises. Also, an ascendant hypothesis is that in order for national firms to be internationally competitive, domestically owned firms must be exposed to competition from foreign-owned firms and allowed to develop and operate their own international networks of affiliates and alliances. These ideas are explored further in chapters 2, 3, and 4. Kindleberger (1969) and Bergsten (1974) long ago argued that enlarging and restructuring international investment rules could reduce costly inefficiencies and misallocations of resources. That the global system needs a major overhaul to deal with the new issues that the globalization of industry raises has been argued as early as the late 1960s and early 1970s as well as more recently (Committee for Economic Development 1990; Ostry 1990; Christy 1991; Investment Canada 1991; Nicolaïdes 1993; Brewer 1996). Unlike most of these works, however, this volume attempts to lay out what new rules are needed. Ideally, such rules should complement international trade rules administered by the WTO. Indeed, the Uruguay Round created some such rules (see chapter 5) but left much unfinished business in this domain. 6

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Expanding the WTO’s role to encompass international investment and investment-related issues would be the ideal way in which to implement the rules this study envisages. However, the ongoing effort by the Organization for Economic Cooperation and Development (OECD) to develop a Multilateral Agreement on Investment (MAI) as well as other international initiatives on investment might be important way stations on the road to an expanded role for the WTO. Chapter 4 in particular outlines what the specific changes and improvements might be, while chapter 5 evaluates the existing international policy framework in light of current requirements. Chapter 6 concludes by examining institutional issues related to an overhaul of international policies on investment.

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Recent Trends in the Globalization of Business

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The rate and extent of globalization of business during the second half of the 1980s, as measured by flows of FDI, was spectacular. Following 1990, with the onset of worldwide recession, the rate of global business expansion slowed considerably throughout much of the world, but early indicators suggest that the expansion rate has picked up substantially since 1992.1 Whereas the surge of direct investment during the 1980s took place largely among the highly industrial nations, much of the activity of the mid-1990s appears to be directed toward the newly industrializing nations, especially the rapidly growing economies of East Asia, and China in particular. It is not the intention of this book to explain the waxing and waning of international business activity since the late 1980s (on this topic, see Graham and Krugman 1993). Rather, the focus here is on the consequences of the expansion. FDI largely consists of the equity and debt held by firms in affiliated corporations located in nations other than the home nation of the investor firm.2 Flows of FDI thus are an indicator of the international spread 1. The early indicators include, most notably, information on US inward and outward FDI, which is released in advance of information for most other countries. Combined US FDI capital inflows and direct investment abroad outflows were $113 billion for 1993 and $98 billion for 1994, up from $60.2 billion for 1992. 2. Unfortunately, countries are not wholly consistent with respect to how they measure domestic firms’ holdings of equity in foreign affiliates. Some nations follow International Monetary Fund guidelines and count retained earnings as part of these holdings whereas other countries do not. This among other things leads to differences in reported FDI flows and stocks among nations. The figures reported in the text are for reported outflows of FDI; because of inconsistencies in measurement, these do not therefore equal reported inflows. 9

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Table 2.1 World GDP, international trade, and measures of the expansion of international business 1981-93 (annual compound growth rates in dollar value)

FDI outflows FDI stocks Sales of multinational corporations Exports of goods and nonfactor services World GDP

1981-85

1986-90

1991-93

0.8 5.4

28.3 19.8

5.6 7.2

1.3

17.4

-2.6

-0.1 2.1

14.3 10.6

3.5 3.3

Source: UNCTAD, World Investment Report, 1995, table I.1.

of corporations. What can be seen in table 2.1 is that FDI and related activity was lethargic during 1981-85, surged dramatically during 198690, and then slowed considerably during 1991-93. Focusing for a moment on the figures for the surge period (1986-90), the figures in table 2.1 contain an inflationary component that must be netted out to give real growth rates. If this component is roughly 5 percent per annum, then world income grew at a real rate of roughly 6 percent per annum over this period, exports at roughly 9 percent, and FDI flows at about 23 percent—a rather astounding figure. Independently, other scholars have looked at the FDI surge of the 1980s. Julius (1991), for example, calculates the annual real growth of outward FDI flows from the G-5 nations (the United States, Japan, Germany, France, and the United Kingdom) to be 27 percent over roughly the same period. This figure, which has been widely cited, seems to be slightly on the high side. Nonetheless, FDI grew at rates little short of spectacular. The exact magnitude of the current stock of world FDI is not known with great precision, but reasonable estimates suggest that it is a very large number. For example, the United Nations estimated the stock of FDI worldwide to have been about $503 billion as of the end of 1980 (UNCTAD, World Investment Report 1995), rising to $1.70 trillion at the end of 1990 and $2.14 trillion at the end of 1993. Julius (1991) arrives at a somewhat lower estimate, calculating the stock of the G-5 nations to be $929 billion at the end of 1989; she further estimates that these nations held somewhat more than 75 percent of total world stocks of FDI, suggesting a total worldwide figure of something like $1.2 trillion. Whatever the exact figure, it must be noted that the FDI figures cited here measure the historic value rather than the market value of the sum of equity of foreign affiliates and net lending of parent firms to those affiliates. (FDI is not, as is sometimes mistakenly claimed, the assets of these affiliated firms.) In drawing a clear picture of the extent of 10

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FDI, it would be ideal, of course, to have current market value estimates. But the current market value of all the world’s FDI is not known. However, it is almost surely significantly higher than the historic value. In order to arrive at a crude estimate of the current market value of FDI stock worldwide, one can extrapolate from US government estimates. Unlike other national governments, the US government prepares estimates of the current market value of FDI as well as its historic cost value. One might think that the “wedge” between the current and historic values of the stock of US outward FDI would be higher than for FDI of most other nations; foreign affiliates of US firm are older on average than foreign affiliates of firms based in other nations, and it is reasonable to expect that the wedge would grow with time.3 In particular, it might be expected that the wedge between the market value of US outward direct investment would be greater than that for FDI in the United States because the latter is, on average, of more recent vintage. This is, in fact, the case. The value of the stock of US inward direct investment (the “inward direct investment position”) at historic cost at the end of 1994 was $504.4 billion while the estimated market value was $771.1 billion. Calculated as the ratio of the market value to the historic value, the wedge for US inward FDI was about 1.53. For US direct investment abroad, the value of the stock (the “outward direct investment position”) at historic cost was $612.1 billion, and the estimated market value was $1,048.4, yielding a wedge of 1.71. Using the average of these two estimated ratios (1.62), the market value of FDI worldwide can be estimated to have been slightly less than $3.5 trillion at the end of 1993, using as the historic base value the UN estimate. But, as just suggested, this figure must be taken only as a very crude approximation and nothing more. The stock of FDI grew more slowly than flows during the surge of the late 1980s, which is what might be expected given that the stock of FDI at the beginning of the period was already quite high whereas flows were somewhat suppressed due to worldwide recession of the early 1980s. Nonetheless, the real (inflation-adjusted) annual compound growth rate of the worldwide stock of FDI was upward of 11 percent over the whole decade. As impressive as the figures on the growth of FDI are, they may actually understate the true extent of the internationalization of business during the past decade. For example, by and large these figures do not fully capture the spread of so-called nontraditional forms of international business. Important among these are “strategic alliances” among firms from different countries. These alliances take the form of joint ventures and other cooperative activities between firms that are other3. This last is true, if for no other reason, because of inflation, which tends to raise the current nominal value of any asset over its nominal value at time of acquisition.

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wise rivals. Strategic alliances appear to be particularly prevalent in the high-technology industries, and more is said about these later. For the moment, let it simply be noted that these and other nontraditional forms of international business (including nonequity participation of one firm in the activities of another) are believed to be of considerable significance but that it is very difficult to measure their magnitude. The spread of international business via FDI has led to the creation of several thousand firms whose operations span national boundaries; such firms are termed variously multinational enterprises (MNEs), multinational corporations (MNCs), transnational corporations (TNCs), and global corporations. Some analysts have attempted to differentiate among these terms, and in the following chapter there is a discussion of the resulting differences in nomenclature. Despite these efforts, no widely accepted taxonomy exists; indeed, to a large degree these terms have been used interchangeably. The United Nations estimates that there were upward of 37,000 such firms in existence in 1992 but admits that there is some double-counting in this estimate (UN Center for Transnational Corporations, World Investment Report 1993). In that year, these firms controlled about 200,000 affiliates in nations other than their home nations and employed worldwide an estimated 73 million people on a full-time basis. The figures on direct investment do not include the value of parent organizations’ equity but only the equity value of parents’ holdings in their overseas affiliates. Unfortunately, there are no data series on global corporations’ consolidated net worth. But to hazard a very crude guess, if we assume that the book value of equity in overseas affiliates represents 35 percent of the consolidated net worth of the average global corporation,4 then the combined net worth (total equity at historic value) of all of these corporations is in the range of $6.5 trillion. But, again, this figure is likely to understate the current market value of these corporations significantly. Using the market-to-historic ratio of 1.62, as estimated above, this market value amounts to $10.5 trillion—again, a very crude guess. For some purposes, it might be desirable to know the value of assets under the control of these corporations. Again, no global data series exist on this value, so once again we must hazard guesses based on US data. One guess can be made on the basis of asset-to-equity ratios. The ratio of assets of majority-owned affiliates of US firms to owners’ equity in 1989 was slightly greater than 3.9.5 If this figure is assumed to be 4. This 35 percent figure is the approximate percentage of the assets held by the world’s 100 largest multinational firms outside their home countries (UNCTAD, World Investment Report 1995, 19). 5. 1989 is chosen because it is the most recent year in which comprehensive “Benchmark Survey” data on US direct investment abroad are available from the US Commerce Department (1992). 12

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equal to the assets-to-owners’ equity ratio for all multinational firms worldwide in 1993, then the global value of the total assets of these firms would have been more than $25 trillion in that year. A less crude guess by the United Nations puts the assets under control of the world’s largest 100 multinational firms at $3.7 trillion in 1993, or a little less than 15 percent of the $25 trillion estimate. The $25 trillion total asset estimate includes financial assets as well as fixed assets and inventories—that is, total assets do not represent a measure of stock of the real capital held by these corporations. For nonbank affiliates of US multinational firms, net fixed assets—the best measure of real capital stock—were almost exactly 25 percent of total assets. If this ratio applies to all multinational firms worldwide, the net fixed assets of these firms would be about $6.25 trillion.

FDI and Trade Foreign direct investment has by some measures become even more important than international trade, although only marginally so. The United Nations estimates that the total value of all exports of goods and nonfactor services was about $4.8 trillion in 1993, whereas the total sales of foreign affiliates of multinational firms was about $5.2 trillion (UNCTAD, World Investment Report 1995, table I.1).6 For US-based firms, the ratio of sales of overseas affiliates to US exports is higher than these figures would suggest. Julius (1991) estimates, for example, that in 1987 the local sales of overseas affiliates of US-based firms worldwide exceeded US exports by a factor of over 2.1 to 1. Similar results are presented by Encarnation (1992).7 This probably reflects the longer average experience of US firms with global business compared with that of firms from most other nations. Additionally and importantly, international trade itself is increasingly dominated by the operations of multinational corporations. In 1991, for

6. It is somewhat tempting to claim on the basis of the sales figure that overseas affiliates and their suppliers account for about 23 percent of world GDP (estimated to have been $23.3 trillion in 1993). Such a claim would ignore, however, that a substantial but unknown portion of the sales of these affiliates consists of intermediate goods and services bought as inputs by other such affiliates and hence would have to be subtracted from the aggregate sales figure to avoid double counting. What can be said is that these affiliates and their suppliers do account for some very substantial percentage of world GDP (e.g., if the double counting were one-third of aggregate sales, this percentage would be about 15 percent.) 7. A comparison of sales of multinational firms to exports raises something of an “apples to oranges” problem. It would be better to compare the value added by multinationals to exports. Alas, such data are simply not available at an international level.

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example, exports to majority-owned overseas affiliates of US firms accounted for about 26.2 percent of total US exports of merchandise, while exports of foreign-owned enterprises in the United States accounted for another 23.3 percent.8 Likewise, in that same year US firms’ imports from their overseas affiliates accounted for upward of 18.5 percent of total US imports of merchandise; foreign-owned enterprises in the United States accounted for another 36.5 percent of these imports. Thus, intrafirm trade by MNCs accounted for almost 50 percent of US exports and well over 50 percent of US imports of merchandise in 1991.9 The United Nations has calculated the share of intrafirm trade of MNCs in total world trade to be about one-third (UNCTAD 1994). The higher percentage for US-based firms, again, probably reflects these firms’ longer experience, on average, with linking overseas affiliates via trade than have firms based in most other nations. A long-standing (and largely unresolved) issue involves the relationship between international trade and direct investment: are they substitutes or complements? If they are substitutes, an increase in the stock of FDI would reduce trade. If FDI and trade are complements, an increase in FDI would increase trade. The issue cannot be resolved theoretically; there are theoretical reasons to support either side. But a fair amount of empirical evidence has also been gathered and analyzed.10 The best evidence would suggest that, in the manufacturing sector, net FDI and both exports and imports are complements and not substitutes. To the extent that this is true, further growth of FDI will thus move in tandem with world trade growth.

FDI and R&D Multinational firms figure heavily in the development of technology worldwide, and, indeed, one of the major reasons countries seek FDI is to 8. These percentages are calculated from figures on exports and imports reported in the following sources: for US-based MNCs, US Commerce Department, Bureau of Economic Analysis (BEA), US Direct Investment Abroad: Operations of US Parent Companies and their Foreign Affiliates, revised 1991 estimates (1994); for foreign-controlled affiliates in the United States, BEA, Foreign Direct Investment in the United States, Operations of US Affiliates of Foreign Companies, revised 1991 estimates; and for US exports and imports of merchandise, BEA, “US International Transactions 1991,” Survey of Current Business, March 1993. These percentages are not adjusted to reflect the slightly different bases of reporting of the data among these three sources. 9. These estimates might understate multinational firms’ share in the total amount of US trade; they do not include, for example, exports or imports generated by sales or purchases of US-based MNCs to or from unaffiliated foreign entities. 10. The relevant literature is reviewed, and some original analytic results presented, in Graham (1996). 14

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encourage technology transfer by multinationals. Alas, no global data are available on the technology-related activities of these firms. Again, some insight can be gained from US data. US multinational firms in 1989 expended $82.2 billion on in-house research and development— that is, R&D performed by themselves—of which $57.6 billion was for their own use, $21.9 billion was for the use of the US federal government, and $2.7 billion was for the use of other parties.11 In addition, in this year these firms also expended $2.3 billion in the United States for R&D for their use that other parties performed. In addition, overseas majority-owned affiliates of these firms performed $7.9 billion in the same year, of which $6.3 billion was for their own use and $1.6 billion was for the use of other parties. These affiliates also spent $0.7 billion on R&D for their use that other parties performed. The total R&D performed by US parent firms ($82.2 billion) represented over 58 percent of all R&D done in the United States and over 80 percent of the R&D done by private firms in the United States. The R&D performed by these firms for their own use ($57.6 billion) represented over 88 percent of all R&D performed by firms for their own use in the United States. Thus, from almost any perspective, global firms dominate industrial research and development in the United States. And while R&D performed by these firms abroad as a percentage of all R&D performed by these same firms (8.8 percent if one considers all R&D performed by these firms, or 9.9 percent if one considers only R&D performed for their own use) is not large, the amount of R&D these firms did outside the United States, in absolute numbers, is very significant.12

National Comparisons The vast bulk of flows of FDI in the 1980s both originated in and went to the nations of the “triad”—that is, the nations of Western Europe, North America, and Japan. Table 2.2 gives some indicative figures. (The reader is cautioned to read the source notes to the table.) Several points stand out. Compound rates of growth of FDI were

11. Again, data are for 1989 because this is the most recent year for which the extensive “benchmark” data are available. 12. This R&D is significant from a qualitative perspective also. Several Nobel prizes, for example, have been awarded to researchers for work performed in non-US laboratories of US-owned firms. But also, several Nobel prizes have been awarded for work performed in US laboratories of non-US-owned firms. Nonetheless, it should be noted that the best evidence suggests that all multinationals, and not just US-based ones, conduct the bulk of their R&D inside their home countries (or, in the case of large multinationals based in certain smaller European nations, within Europe if not within the home country). On this, see Cantwell (1994).

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Table 2.2 Stocks and flows of inward and outward FDI by region, 1985 and 1993a (billions of dollars except where noted) Outward stock Region

1985

1993

North America 292.5 647.0 United States 251.0 559.7 Canada 40.9 86.3 Mexico 0.5 1.0 Western Europe 312.3 1063.9 EU 286.3 962.0 Other 23.4 101.8 South and East Asia Japan 44.0 259.8 Singapore 1.3 6.3 China .13 11.8 Other 4.2 71.7 Rest of World 25.0 80.1 World Total 679.4 2134.6

Rate of growth

Inward stock

Rate of Growth

(percent)

1985

1993

(percent)

9.9 10.0 9.3 8.7 15.3 15.1 18.3

264.1 184.6 64.7 14.8 242.2 223.8 18.3

593.1 445.3 106.0 41.93 883.5 832.1 51.4

10.1 11.0 6.2 13.0 16.2 16.4 12.9

22.2 19.7 56.3 35.4 14.5 14.3

4.7 16.9 13.0 50.8 3.4 57.2 47.9 138.0 152.6 340.0 727.9 2079.5

16.0 17.0 35.2 13.2 10.0 13.1

Source: UNCTAD, World Investment Report, 1995, annex tables 3 and 4. a. Stock figures are for year end. The estimates are derived from national government sources which use somewhat different accounting standards (e.g. Japan and several European nations do not count retained earnings by affiliates of foreign firms as FDI, whereas most other nations do). Hence, reported total inward flows do not equal reported total outward flows.

quite high for almost all categories indicated in table 2.2 but were especially high for inward and outward FDI to and from Japan, Western Europe, Singapore, and China, and outward FDI from (but not into) other East Asian nations. Categories for which FDI flows were low included FDI into and out of Canada and into and out of “the rest of the world.” Bear in mind that the magnitudes of the figures for Japan are somewhat understated relative to other figures, given that the Japanese authorities do not count as direct investment the retained earnings of either foreign affiliates of Japanese-based firms (in the case of outward FDI) or Japanese affiliates of foreign firms in the case of inward FDI (as do most other nations). FDI stocks in Japan grew rapidly mostly because they started from a low initial level in 1985; indeed, even at the end of the period these stocks remained low relative to the size of the economy, at least when Japan is compared with other advanced nations. This is a fact that has been widely noted (e.g., Julius 1990 and 1991; Lawrence 1993; Encarnation 1992; Yoshitomi and Graham 1996). Indeed, Japan stood alone among the advanced industrial nations in not having a significant foreign-owned business presence in the domestic economy. This is largely due to major 16

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official restrictions on inward FDI into Japan that persisted until the early 1980s (Mason 1992; Tamura 1996). The growth of stocks of outward direct investment from Japan is another story because this FDI did not start at particularly low levels. Indeed, Japanese direct investment became the subject of much interest during the late 1980s and early 1990s, inspiring a number of popular books, including at least one fictional bestseller (Crichton 1992). Many of these have taken a critical or even hysterical tone (e.g., Burstein 1988; Choate 1990; Frantz and Collins 1989). Japanese investors have been accused of little less than attempting to conquer the whole world by dominating important markets and systematically annihilating their nonJapanese competitors. But the facts as depicted in table 2.2 fail to bear out this view: despite the rapid growth of Japanese outward FDI, Japan accounted for less than 13 percent of the world’s stocks of FDI at the end of 1993, and since 1991 the Japanese share of the stock of world FDI has been falling. Stocks of Japanese FDI were less than half of those held by US direct investors and less than a third of those held by EU direct investors. Despite the rapid buildup of Japanese FDI during the 1980s, relative to the size of the Japanese economy Japan remains somewhat underrepresented as a home nation to FDI when compared with either the United States or the EU nations. Given that Japanese firms are widely perceived to hold managerial and technological competencies more advanced than those of major nonJapanese rivals, and given that current thinking about the ultimate determinants of FDI emphasizes firm-specific advantages (see chapter 4), perhaps the major surprise about Japanese FDI is that there was not more of it sooner. Thus, the surge of Japanese FDI that took place during the 1980s is probably better viewed as a catch-up phenomenon rather than as the emergence of a new and possibly sinister force in the world economy (for an insightful and rational account of the internationalization of the operations of Japanese firms, see Emmott 1992; see also Graham and Krugman 1995). The most spectacular growth of FDI in Asia occurred in China. Figure 2.1 indicates the inflows of FDI into China from 1988 through 1995. As can be seen, these inflows did not really accelerate until 1992, and from 1992 through 1995 the growth was truly explosive. Whether this growth will continue is, of course, not known. But even if inflows stabilize around 1994 levels, it will be only 10 years or so until China surpasses the United States as the largest host nation to FDI. Much of the growth of European FDI stocks, both inward and outward, that was reported in table 2.2 represented direct investment from one European nation to another. This intra-European FDI presumably was stimulated at least in part by the “Europe 1992” program to “complete” the internal market. Indeed, large European firms were by most RECENT TRENDS IN THE GLOBALIZATION OF BUSINESS

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Figure 2.1 FDI flows to China, 1988-95 billions of dollars 40

30

20

10

0

1988 1989 1990 1991 1992 1993 1994 1995p Source: 1988–94 data from International Monetary Fund, International Financial Statistics; 1995 preliminary data from China's Ministry of Foreign Trade and Economic Cooperation (MOFTEC).

accounts the most important single driving force behind the “1992” program. It has been noted that whereas Western European integration prior to the 1980s was achieved largely by expansion of trade flows among the EC nations (and between the EC nations and those of the European Free Trade Association, or EFTA), the 1980s were unique in that they were characterized by intra-European FDI (e.g., Cantwell 1992; Thomsen and Woolcock 1993). Analysts note that a likely effect of intraEuropean FDI is that interdependence among European nations will become more irreversible than in the past. With respect to the slow growth of FDI into and out of the rest of the world, the affected nations are mostly developing ones. Indeed, the fact that FDI has been slow to enter most developing nations has sharply shifted the nature of these countries’ concerns regarding FDI. During the 1970s, developing world analysts and intellectuals severely criticized FDI and transnational corporations, and numerous developing nations restricted these firms’ entry into their economies and strictly regulated the behavior of firms that did enter. But during the late 1980s developing countries’ concerns over exploitation were largely replaced by concerns over the paucity of FDI they were receiving. And these new concerns were justified: although the gross value of FDI flows to many developing areas was greater during the 1980s than during the 1970s, the share of world FDI going to developing nations during the 1980s shrank considerably from shares typical during the 1970s. FDI flows to developing nations have accelerated during the 1990s, but, as already noted, these have been concentrated in a handful of the more rapidly growing of these nations, such as Mexico, Brazil, China, 18

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and certain (but not all) of the ASEAN nations. Some areas of the developing world have hardly witnessed any new FDI at all, including most of Africa, much of Latin America, most of western Asia and the Middle East, and much of southern Asia.

Changes in Policies Toward FDI Partly in response to declining shares of inward FDI and partly as an element of overall liberalization of economic policies, a number of developing nations significantly liberalized their policies toward this investment and multinational corporations during the late 1980s and 1990s (UN Center for Transnational Corporations, World Investment Report 1991). The changes were most pronounced in the newly industrializing economies (NIEs), where the focus was on lifting restrictions on foreign ownership of domestic activities. In certain countries that made marked policy changes (e.g., Mexico), the liberalization of policy toward FDI was part of a larger movement away from state intervention and toward marketoriented policies. Even some nations traditionally considered somewhat hostile toward MNC participation in their economies (e.g., India) have recently taken steps to open internal markets to such firms. China is worthy of special note in this regard.13 During the first three decades of its existence, the People’s Republic of China was for all practical purposes closed to FDI. A partial opening was achieved in 1979 with the passage of the Law on Joint Ventures Using Chinese and Foreign Investment, and the window that this law cracked was opened wider with the passage of the Law Concerning Enterprises with Sole Foreign Investment in 1986 and the Sino-Foreign Cooperative Joint Venture Law in 1988. These laws established that FDI was welcome in China (but not in all sectors) and furthermore granted foreign investors preferential treatment not accorded to most domestic firms. In particular, foreign-invested enterprises (the translation of the Chinese term for affiliates of MNCs) were granted (1) exemption from or reduction of corporate income taxes for two to three years after profits were first recorded, (2) exemptions from tariffs and value-added taxes on imported capital goods and materials, (3) the right to maintain foreign exchange accounts, (4) subsidized land, water, power, and other services,14 (5) greater freedom in the hiring of personnel than is accorded to domestic enterprises, and (6) some special export rights. In addition, foreign-invested

13. A comprehensive but already somewhat dated history of China’s policies toward FDI is Jio (1994). 14. Foreign-invested enterprises were given access to these resources at the same costs as state-owned enterprises, which are lower than those local private companies pay.

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enterprises that bring advanced technologies to China or export substantial proportions of their output receive further preferential tax treatment. In June 1995, the number of sectors open to FDI in China was significantly enlarged; in particular, foreign firms now have limited access to service industries that previously were off-limits. Much of the preferential treatment received by foreign-invested enterprises in China has been the result of their freedom from stateimposed regulations that apply to domestically owned firms. But over the past few years, regulatory reform in China has reduced foreignowned firms’ relative advantage in this regard. In December 1995, the Chinese government announced that it would end exemptions and reductions of tariff and value-added taxes for foreign-invested enterprises on imported capital goods and materials, but this was accompanied by tariff reductions applicable to all imports. Not all nations have likewise liberalized their policies. Some countries have even adopted somewhat more restrictive policies. Most notable in this regard is the United States, long the principal advocate of open FDI policies and the major instigator of international efforts to liberalize FDI policies among nations. (See chapter 4 for a recounting of US efforts to liberalize FDI.) In particular, in 1988 the United States enacted the Exon-Florio provision of the Omnibus Trade and Competitiveness Act, a provision enabling the president to block foreign takeovers of US firms on national security grounds.15 Neither the Bush nor the Clinton administration has implemented Exon-Florio in a manner that is particularly restrictive toward FDI, but the bill provides a legal foundation on which a future administration could do so (see discussion in Graham and Krugman 1995). During the 103rd Congress (1993-94), a number of bills were introduced that would have altered the traditional US policy of unconditional national treatment of foreign-controlled firms—that is, the principle that these firms, with some exceptions, are to be treated no less favorably than US firms in similar lines of business are treated. None of the bills that sought to introduce varying degrees of “conditional” national treatment actually passed, but they did seem to reflect the mood of much of the Congress. These are examined in more detail in chapter 6. Interestingly, the United States has not experienced a particularly rapid rate of growth of FDI relative to the rest of the world (table 2.2). Indeed, the growth has been significantly less than in many other nations. Much of the furor over FDI in the United States was a reaction to trends in the late 1980s, when in fact FDI grew very rapidly, and to a significant degree, the furor has since died down. 15. The Exon-Florio provision was modified slightly by 1992 legislation; the statute as originally passed is discussed in detail in Graham and Ebert (1991). 20

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The United States has not been unique, however, in its alarm over the rapid growth of FDI. The European Community also pondered more restrictive FDI policies when FDI from Japan during the late 1980s grew rapidly and continued into the first half of 1991 (although these flows started from a very low base and hence even in 1991 were not extremely high in absolute terms).16 One manifestation of this was the inclusion of locally assembled automobiles in Community-wide quotas on Japanese automobiles. By and large, however, European policy toward FDI has not been overtly restrictive so much as it has been regulated. European nations have been eager to attract what they consider to be “good” direct investment—specifically, direct investment in high-technology industries or in high value-added activities. To this end, most European nations have offered substantial incentives to direct investors in the form of direct subsidies, low-interest (or even interest-free) loans, tax relief, and subsidized land and/or infrastructure. More often than not, a condition for receipt of these incentives has been the investor’s agreeing to performance requirements, often in the form of “assurances” negotiated between the recipient firm and the government offering the incentive. For example, most European national governments have been especially eager to lure semiconductor manufacturing to their territory. In doing so, governments have often competed to offer the most attractive incentives. Yet these governments have also suspected that direct investors in this industry will perform only “downstream” operations (e.g., assembly and testing) in Europe, keeping “upstream” activities perceived to generate large external benefits at home. Governments thus have sought assurances from direct investors that a fully integrated fabrication facility will be built, that certain levels of employment will be provided, and that the domestic content of the output be above a certain percentage. Consequently, the semiconductor investment has been scattered throughout the European Union, probably resulting in losses in economic efficiency—for example, because plants have been built at suboptimal scale and economies associated with clustering may have been lost (see Tyson 1992; Tyson and Yoffie 1992). Gaster (1992) offers an account of how European governments have used performance requirements to affect the operations of multinational firms in Europe. But while Gaster claims that these performance requirements have been of benefit to Europe, he provides scant evidence that this in fact has been the case. Whether or not performance requirements on FDI have significantly enhanced local economic performance (at some cost to global economic 16. As with much of the rest of the world, FDI flows into Europe from Japan (and elsewhere) tapered off dramatically in late 1991, and thus the impetus to enact restrictive measures was reduced considerably.

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Table 2.3a Rates of return on Dutch outward direct investment by host nation or region, 1986-90 United States Other North America (Mexico, Canada) European Union Other Europe (EFTA) Japan Southeast Asia

6.3 10.5 7.7 14.4 6.3 17.6

Source: van Nieuwkirk and Sparling 1985, from base data from the Central Bank of the Netherlands

efficiency), some European governments have begun to wonder whether they are getting value from their investment incentives. Even Ireland— an EU state that has honed the tailoring of these incentives into a fine art—has questioned the value of granting lavish incentives (Financial Times, 10 July 1992). Both investment incentives and performance requirements are discussed further in chapter 4.

Predicting Which Way FDI Will Flow Differential Rates of Return Don’t Tell Us Exactly why FDI flows during the 1980s were so concentrated in the triad nations is not wholly clear. Rates of return on FDI in the triad were not higher than elsewhere; rather, available evidence suggests they were lower.17 Dutch data on outward FDI of firms based in the Netherlands clearly show that rates of return on their FDI activities outside the triad are significantly higher than on such activities within the triad (table 2.3a). The US data are partly corroborating. Table 2.3b presents “naive” data on rates of return on US direct investment abroad, calculated simply as the average of income from direct investment over the direct investment position (on a historic cost basis) by nation or region. They suggest that returns are significantly higher both in Africa (other than South Africa) and the Asia Pacific (other than Japan, Australia, and New Zealand) than in the triad, but that rates of return in the triad seem to be higher than in Canada, Mexico, South America, or Australia, New Zealand, and South Africa (the published base data for these last three nations are aggregated together). The US data also show that rates 17. In this data, profits are reported as originating within a region. However, because MNCs have worldwide operations, operations in one region can affect returns realized in other regions. Thus, reported profits within one particular region may not truly reflect the value to the entire firm of their operations in that region. 22

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Table 2.3b Rate of return on US direct investment abroad by host nation or region, 1986-1990 European Union Other Europe (EFTA) Japan Other Asia and Pacific, except Australia and New Zealand Mexico Canada Africa, except South Africa South America Australia, New Zealand, and South Africa

15.1 15.4 13.9 22.3 7.5 9.3 17.8 10.3 11.1

Source: Calculated by the authors from data in U.S. Commerce Department, Bureau of Economic Analysis, “US Direct Investment Abroad: Detail for Historic-cost Position and Balance of Payments Flows, 1990,” Survey of Current Business, August, 1991, table 17. Rate of return is calculated as average income divided by average historic cost direct investment position in the country or region.

of return for the EFTA countries are virtually the same as for the EU nations. Both sets of data do suggest that rates of return on FDI vary substantially from region to region and that FDI does not necessarily flow from regions with low rates of return to ones with high rates, as classical theory of capital movements suggests. Defenders of classical theory would argue that capital should move from areas where marginal rates of return are low to those where it is high, and that the data in tables 2.3a and 2.3b, which indicate average rates of return rather than marginal ones, do not necessarily rule this possibility out. But it is not a huge leap of faith that marginal rates are correlated with average ones, and hence that the data in these tables are suggestive of flows moving contrary to the predictions of classical theory. Certainly the data do not suggest that rates of return on FDI in either the United States or Europe are extraordinarily high relative to those in Japan and thus fail to support the classical theory explanation of why FDI should flow from Japan to these two areas. Likewise, the substantial two-way flows of FDI between the United States and Europe cannot readily be explained on the basis of different rates of return. Indeed, given the dismal returns on FDI in the United States (profits on FDI in the United States as reported by the Bureau of Economic Analysis would suggest that the Dutch experience is not unique; see Graham and Krugman 1995), one might well wonder why this investment came at the rates and magnitudes that it did during the late 1980s. It has been suggested that the low rates of return in the United States could be the result of transfer price manipulation—that prices of RECENT TRENDS IN THE GLOBALIZATION OF BUSINESS

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goods and services imported into the United States by local affiliates of foreign-owned multinational firms were raised to above-market levels so that profits actually earned in the United States could be reported somewhere else in the world. However, research into this issue indicates that such transfer price manipulation, if it occurs, can only account for part of the low profitability of US affiliates of foreign-owned firms (see, e.g., Grubert, Goodspeed, and Swenson 1991). In the next chapter, reasons for FDI other than differential rates of return are discussed. For the moment, let us simply note that, on the surface at least, the classical theory of international capital movement fails to explain these flows.

Globalization in Historical Perspective As spectacular as the globalization of the past 10 or so years has been, it is not really a new phenomenon. The globalization of significant numbers of corporations began during the 19th century (Wilkins 1970, 1974, and 1989), and significant cases can be found where firms “globalized” their activities even earlier (e.g., the East Indies Company during the 18th century). Indeed, during the late 19th and early 20th centuries, enormous sums of long-term capital investment flowed across national boundaries. By some measures, the world economy was more integrated on the eve of World War I than it is today (Krugman 1989). It is not known how much of the long-term capital flow of this era was direct investment. A Brookings Institution study published during the 1930s (Lewis 1938) estimated that about 90 percent of these flows represented portfolio rather than direct investment, and economic historians accepted this for about 40 years. However, beginning in the middle 1970s, the evidence was reexamined (see, e.g., Houston and Dunning 1976). It was found that in 1913 stocks of UK direct investment abroad represented almost 35 percent of UK long-term foreign assets. At that time, the United Kingdom was the largest international investor nation, and hence the new estimates for the composition of UK overseas assets cast some doubt on the accuracy of the 90 percent estimate. More recent research suggests that even the 35 percent figure might be low. For example, Corley (1994) estimates that, of the accumulated overseas assets of £4,165 million the United Kingdom held in 1913, £1,681 million—or about 45 percent of the total—represented direct investment.18 18. At exchange rates then prevailing, £1,681 million equaled about $8 billion. This represented a higher fraction of the total domestic net worth of Britons at that time than Britain’s current portfolio of direct investment now represents, despite the fact that the UK stock of outward direct investment today is, relative to the size of the economy, the highest in the world. 24

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Other recent work has resulted in upwardly revised figures for other countries.19 British corporations operating overseas fell into two basic categories: those whose overseas operations were essentially an extension of homebased ones (e.g., J.& P. Coats Ltd, which set up a US subsidiary in 1869) and those established primarily to operate overseas, (e.g., the holdings of Thomas Lipton in the tea industry; see Stopford 1974). The first highly international American manufacturing firm was the Singer Manufacturing Company, whose operations in Europe date from the 1860s and which by the 1880s had manufacturing operations in four countries and sales offices in dozens (Wilkins 1970). Resource-based firms of the United States also established extensive overseas operations during the 19th century. Leading the list was the Standard Oil Company, which established operations in numerous countries. Indeed, when the Standard Oil trust was broken up under court order in 1911, 9 of the 34 successor firms were themselves multinational in extent. By 1914, at least 37 US manufacturing firms operated in three or more foreign nations, and a number of US financial institutions, especially insurance firms, had established multinational operations. Foreign-controlled business activity in the United States before World War I was also very significant. Most such businesses were held by British or continental European investors, including some that are today household names (e.g., Rolls Royce, Daimler-Benz). However, substantial numbers of these foreign-controlled operations in the United States ceased to exist (or to be under foreign control) following World War I. Nationalization of German properties during and after this war, the closing or selling of businesses during the Great Depression, and the sell-off of certain British-controlled properties under the terms of the Lend-Lease Act after the outbreak of World War II in Europe all contributed to the attrition of foreign-controlled business in the United States. Although manufacturing-sector MNCs did exist before World War II, the bulk of MNC activity was concentrated in resource-based (extractive and agricultural) industries and in the utilities and transportation sectors.20 Also, the bulk of direct investment in these industries was NorthSouth in nature—that is, the host nations were predominantly developing countries. In 1914 more than 53 percent of British FDI was in the resource-based industries, and another 31 percent was in utilities and 19. Schröter (1984, cited in Jones 1994), for example, calculates that the direct investment Germany held in 1914 was about $2.6 billion, in contrast to the Houston and Dunning (1976) estimate of $1.5 billion. Likewise, Gales and Sluyterman (1989) estimate that the direct investment of the Netherlands in 1914 was about $925 million, almost twice the Houston and Dunning estimate. 20. ‘’Transportation’’ in this case means the provision of transport services (e.g., railroads) rather than the manufacture of transportation-related goods (e.g., auto manufacturing).

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transportation (Houston and Dunning 1976). At least 59 percent of British FDI was in developing countries (Corley 1994). The stock of US FDI was also concentrated in the resource-based industries (68 percent), utilities, and transportation while only slightly over 18 percent was in manufacturing industries; over 54 percent of this stock was in developing countries (Wilkins 1970). By 1929, however, the share of total US FDI in resources, utilities, and transportation had shrunk slightly to about 61 percent as the result of rapid expansion of manufacturing affiliates of US firms during the 1920s, especially in Canada, Europe, and South America (Wilkins 1974). During these years, Ford established extensive operations in the United Kingdom and used these as a base for entering the rest of Europe, and General Motors responded by acquiring firms in Germany (Opel) and the United Kingdom (Vauxhall). However, the bulk of US FDI remained in developing countries; indeed, the share of these countries in the total stock of US FDI rose to 59 percent, mostly because the holdings of US petroleum firms in Latin America, Asia, and Oceania were expanded greatly. In contrast to the 1920s, the years of the Great Depression witnessed the virtual halt of the international expansion of most MNCs, except for that of the international oil companies. During the 1930s, much of the world economic landscape came to be characterized by international cartel arrangements in many industries, often with government encouragement (Hexner 1945). Many of these cartel agreements contained territory-splitting provisions whereby firms agreed not to operate in certain geographic areas, reserving these for competing firms. Some MNCs even sold or closed foreign subsidiaries to comply with these agreements. The outbreak of World War II in 1939 further subdued international business activities. The overall result was that by 1949 MNCs accounted for a substantially smaller fraction of world economic activity than in 1929. During the 1950s, international business activity resumed its rapid expansion, which continued for about 20 years (Vernon 1971). The leading foreign direct investors of this period were mostly US-based firms in the manufacturing sector, although the major petroleum firms (both US and non-US) also expanded their international activities significantly. Many new firms entered the ranks of the MNCs during this period. By 1967, three-fourths of Fortune magazine’s list of the 500 largest US industrial firms had manufacturing operations in at least one country other than the United States, and 187 of these had manufacturing operations in six or more foreign countries. Unlike earlier times, the bulk of the postwar US FDI went to advanced countries, especially the European nations and, to a lesser extent, Canada. Between 1950 and 1970, the stock of US manufacturing direct investment in Europe increased almost 15-fold. Consequently, the share of US FDI in developing coun26

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tries declined dramatically. By 1970, less than 40 percent of the stock of US FDI was located in these countries. Also the share of resource-based industries, utilities, and transportation in the US stock of outward FDI had fallen to less than 40 percent, the bulk of which was in the petroleum sector. Given this short history of the globalization of business, what was new to the surge in globalization of the 1980s was that both the number of firms that created international operations and the number of nations that became “home” to such firms increased dramatically.21 As recently as 1970, two leading scholars of multinational enterprises predicted that, over the following 20 years, about 300 firms would become truly multinational and that the home nations of these would overwhelmingly be either the United States or the nations of Western Europe (Hymer and Rowthorne 1970). Some scholars criticized Hymer and Rowthorne at the time for overstating the likely spread of multinational business. But by the early 1990s, there were at least 1,000 firms that could meaningfully be called multinational (Julius 1991) and perhaps many times this.22 The home nations included the United States and most of the nations of Europe but also Japan, Korea, Taiwan, Brazil, Mexico, India, Israel, and numerous others. Hymer and Rowthorne worried that many sectors of the world economy would fall under the dominance of tightly knit oligopolies composed of stateless firms that would be accountable to no one. By and large, this has not happened. Indeed, one of the benefits of the globalization of the 1980s is an increase in competition in many sectors and national markets, with attendant benefits to consumers. Whereas in 1970 the term “global” might have applied to less than 200 corporations that called the United States home (Vernon 1971) and a handful of firms with European homes (Tugendhat 1970), the greatest change since that time has been the growth of international operations of non-US-headquartered firms. One important consequence is that such firms greatly expanded their operations in the United States during the 1980s to the point where, as noted earlier in this chapter, the inward direct investment position of the United States in terms of book value does not now greatly differ from its outward direct investment position. The United States, long the largest home to global corporations, has also become one of the largest host countries, even when measures are ad21. The “home” country of a firm is the country in which the firm maintains its headquarters. In most cases, this coincides with the country in which the firm was founded. A number of firms maintain headquarters in two or more nations—for example, Unilever and the Royal Dutch/Shell group—but their numbers are small and pose no great difficulty to this definition of “home” country. 22. As noted earlier, the UN counts upward of 37,000 multinational firms but admits to some double counting. Also, many of these firms are quite small.

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Table 2.4 United States: total employment accounted for by US affiliates of foreign-controlled firms (1992) All Industries Manufacturing Chemicals Petroleum Stone, clay, glass Electric and electronic Primary metals Rubber and plastics Food Instruments Motor vehicles Machinery except electrical Fabricated metal Paper and allied Printing and publishing

5.1 11.6 32.0 31.0 21.0 17.2 16.1 14.8 11.9 11.8 11.1 10.8 7.3 6.6

Textiles Other transportation Apparel Lumber and wood Other mfg. Mining Insurance Finance & banking Wholesale trade Transportation services Retail trade Other services Real estate Communication and public utilities Agriculture and related Construction

6.9 4.9 2.8 2.4 9.9 12.3 6.4 6.3 5.7 5.1 4.0 2.4 2.2 2.2 1.7 1.5

Source: US Department of Commerce, Survey of Current Business, July 1994, 161, table 7.

justed to account for the size of the US economy—a stunning reversal of the conditions of only one decade ago. Indeed, FDI in the United States represents perhaps the most important example of globalization of business that occurred during the 1980s. Despite the extent of the globalization of business, the world economy is still very imperfectly integrated. For example, the extent of globalization varies a great deal across industries. Some of the most telling evidence is to be had from FDI in the United States. The percentage of employment in major industries accounted for by US affiliates of foreigncontrolled firms varies from more than 30 percent in petroleum and chemicals to 1.5 in construction (table 2.4). Manufacturing is more “globalized” by this measure than most other sectors, but within the manufacturing sector there is much variance. In those industries in which foreign-controlled firms play a major role in the United States, UScontrolled firms often play a major role outside the United States. Such industries include petroleum, chemicals, electric and electronic equipment, and motor vehicles. They thus seem to be characterized by significant amounts of intra-industry FDI. But this is not true of all industries. For example, foreign-controlled firms account for 21 percent of US employment in the stone, clay, and glass industry, but US firms are not major outward direct investors in this sector. 28

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Table 2.5

Outward foreign direct investment of major investor nations or regions by major host region, 1990 (percentages)

North Investor nation or region America North America United States Europe Germany United Kingdom East Asia Japan

24 17 34 28 47 42 44

Latin America

Europe East Asia Other

16 18 6 6 7 13 13

44 48 49 59 27 21 19

14 15 8 5 15 22 21

2 2 3 2 4 2 3

Source: Petrie 1994, from data in UNCTAD, World Investment Report 1993.

Just as reported stocks of FDI are concentrated in certain industries, there is some evidence that FDI by individual enterprises is concentrated in the regions in which these enterprises’ home nations are located (Petrie 1994). Thus, for example, a firm whose home nation is Japan tends on average to hold greater shares of its direct investment in other Asian nations than does a firm whose home nation is in North America or Europe. There is also some correlation between clustering of FDI and clustering of trade flows, but this would naturally follow if trade and FDI are net complements. It should be noted that the evidence for regional bias in FDI as reported by Petrie is in fact rather weak in the sense that the bias does not hold for all nations that are home to significant direct investment. Data for the United Kingdom, for example, indicate that its direct investment in Europe is a lower percentage of total outward direct investment than is the case for the United States (table 2.5). The overall picture, then, is that the world economy in the mid-1990s is still far from perfectly integrated but that the globalization of business activities is quite extensive.

Regionalism and the Global Firm In the last chapter, we sketched a long-term trend toward increased globalization, marked by periods of ebb and flow. One hypothesis is that this trend will continue into the next century. The major competing hypothesis is that, rather than globalization, protectionist regional trading blocs will be the wave of the future (see, e.g., Lawrence 1994). It has been hypothesized in particular that the world economy will devolve into at least three such blocs, generally assumed to be the European RECENT TRENDS IN THE GLOBALIZATION OF BUSINESS

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Union, North America (or perhaps the Western Hemisphere), and East Asia, with many countries that are now outside these groups joining a particular bloc. Identification of these blocs poses some conceptual issues. For example, the European Union exists as a formal grouping of European nations, complete with administrative and legal institutions while a treaty formally creates NAFTA but without any administrative organization. No functioning association of East Asian nations exists, save for the rather dysfunctional Association of Southeast Asian Nations (ASEAN) and the yet-to-coalesce East Asian Economic Caucus (EAEC). Furthermore, there are international economic organizations that transcend the three blocs just identified, notably APEC, which links East Asia and North America (and certain other Western Hemisphere nations) and the Organization for Economic Cooperation and Development (OECD), whose membership includes nations in all of Europe, North America, and East Asia. Nonetheless, the devolution of the world economy into three protectionist trading blocs is not so wild a possibility that it defies imagination. Some authors have postulated a two-bloc world (Bergsten 1993; Whalley 1996)—one encompassing East Asia and the Americas, the other Europe and perhaps Africa. Perhaps the first thing to be said about a three-bloc or two-bloc world is that, if either were to come about, many of the world’s multinational corporations would be well-prepared. The operations of most very large MNCs already extend into virtually every conceivable trading bloc. These firms could thus continue to function effectively even if interbloc trade were greatly restricted. Representatives of these firms often claim that a world of protectionist trading blocs would therefore make very little difference to them. While these firms might prefer that the world trading system remain open, they could survive and even prosper in a protectionist world, especially if they could still transfer technology and other intangible assets among their operations in different blocs. Having said this, however, it must be stressed that most MNCs prefer an open world economy. In a provocative paper, Raymond Vernon (1995) argues that this preference is likely to grow as these enterprises continue to enlarge their horizons. In particular, these firms increasingly make their decisions on the basis of what is good for their global networks of operations. One result is the growth of intrafirm trade. Aware of their need to compete with rival firms that are often based in countries other than their own home countries, these firms are driven constantly to seek new sources of vital inputs, including both tangible ones such as raw materials and intangible ones such as technology. Vernon notes that the result is a strong propensity of these firms to reach beyond the existing boundaries of their networks. Vernon notes further that this tendency coexists with the propensities of nations that are members of preferential trading arrangements to pursue 30

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special ties with nonmembers. The reasons for this are several. National governments do not want the most powerful nation in the bloc (say, Germany within the European Union and the United States within NAFTA) to dominate them, and they would like to exploit the competitive advantages of producers outside of the arrangement (and thus to reduce the costs of imported goods and services). In turn, nonmember nations of preferential arrangements seek these ties in large part to circumvent the discriminatory features of the arrangements. The discriminatory aspects of the arrangements thereby erode over time, as the “loopholes” are extended to an increasing set of nations.23 Only time will tell what the future course of globalization will be. Trends toward regional groups certainly can be discerned, but whether these will prove to be Lawrence’s “stumbling blocks” toward an integrated global economy remains to be seen. The best guess of this author is that globalization will indeed continue, though the actual course of events will zig and zag around this trend. It is an easy guess, given that it describes so well the history of the past century or so and that the past is almost always the most reliable guide to the future. The real question is how great and how enduring will be the zigs and the zags, and the answer to this is almost surely unknowable. One thing can be said for sure. For at least the next few years, the most rapid expansion will continue to center on the dynamic, newly industrializing nations, spurred in large part by policy liberalization in these nations. In turn, the nations have sought to reap the benefits from inward transfer of technology and other intangible assets of global firms, to the end of furthering the already rapid growth taking place in their economies (see appendix A, a survey of scholarship on the impact of “technological spillovers”).

23. The European Union is the prime example of this trend, with its special relations with several sets of nonmember countries (i.e., the EFTA nations, those of the Maghreb, and a large number of nations that formerly were colonies of EU members). Also, and perhaps more important, the European Union has over time simply enlarged its membership. Vernon notes that in 1994, of those nations that have substantial trade with the European Union, only 12 do not have some sort of preferential arrangement. (These 12 “complete outsiders” include both the United States and Japan.) APEC, to the extent it could be called a regional group, has gone out of its way to avoid discriminatory features. As called for in the various blueprints of the APEC Eminent Persons Group reports (APEC 1993, 1994, and 1995), APEC holds out for “open regionalism,” seeing its cooperative arrangements essentially as the leading edge of more global arrangements.

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Why Does Business Globalize?

3

Chapter 2 surveyed recent trends in the globalization of business without really addressing two key questions: why do businesses expand their operations across national boundaries, and what are the implications of this expansion? This chapter examines these questions in light of a rather vast body of ideas on why FDI takes place. Perhaps the place to begin is to examine exactly what a “global” firm is, and specifically, is there any difference between a “global” firm and a “multinational” one? This question, although seemingly only taxonomical in nature, leads to more fundamental issues about the basic nature of the large, international firm.

What Is a Global Firm? National Identity versus Stateless Entity Throughout this book, the terms “global” and “multinational” firm have been used interchangeably. However, many writers have attempted to distinguish between the two. One leading authority on corporate management, Michael Porter (1990), argues that a multinational firm is one that holds and operates business activities in a number of nations but makes little or no effort to link these operations strategically, while a global firm pursues a unified strategy by which the various national operations are coordinated. When the latter strategy works well, the whole firm achieves synergy; the whole is greater than the sum of the parts. 33

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Kenichi Ohmae, an often-quoted expert on corporate management, goes a step further. Ohmae (1990) sees global corporations as ones that have shed their home-nation identity and operate as essentially stateless entities on a global scale. In Ohmae’s view, the nation-state is largely irrelevant to these firms. To the extent that it is relevant at all, the nationstate serves largely as an impediment to these firms’ achieving maximum efficiency. That is, government regulatory powers reflect parochial interests and create barriers that hamper the global firm’s ability to do what it does best: minimizing costs and maximizing consumer choice. The best of these firms, however, find ways to circumvent or neutralize these powers and achieve near-maximization of global benefits despite what are (in Ohmae’s view) the misguided efforts of governments. Another often-quoted authority, US Secretary of Labor Robert Reich (1990), agrees that corporations operate on a global basis but sees a continuing major role for national governments. He argues that governments should pursue policies to maximize economic benefits within their borders, regardless of whether the firms that create the benefits are headquartered domestically or abroad. Indeed, he argues that the United States may derive more benefit from a Japanese-based firm that creates significant numbers of high-paying American jobs than an Americanbased firm that locates its production offshore. Porter’s views (at least as expressed in his 1990 book, which are sometimes at variance with views in earlier works) do not wholly coincide with either Ohmae’s or Reich’s regarding national identity. To Porter, even the global firm retains a large measure of national identity. The home-market environment is a source of strength (or weakness) to the firm as a whole. Porter thus believes that one reason Japanese-based global firms have been so dynamic and successful is that Japan itself has been dynamic and successful, at least until the bursting of the “bubble” economy during the early 1990s, in which land prices collapsed following a sharp rise that had been fueled by speculation. Likewise, by Porter’s reasoning, US-based firms lost ground internationally during the 1980s precisely because the US home market itself lost much of its vitality during the decade. On this last point, a great debate rages on how much or even whether US firms actually lost ground. One major research project carried on over a number of years reveals that US-based multinational firms in the manufacturing sector have largely maintained their worldwide export shares even when US exports of manufactures were declining as a percentage of world totals (Lipsey and Kravis 1987; Kravis and Lipsey 1992). Hence, Porter’s thesis is hotly disputed. However, there is growing evidence of a US renaissance in manufacturing during the 1990s, with US-based firms in industries as diverse as automobiles and semiconductors showing much greater competitive strength relative to overseas rivals than was perceived as recently as 34

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1990. Furthermore, the US-based firms have clearly commanded the leading edge in newer, technologically dynamic industries such as microcomputers and software. One possible explanation is that Porter greatly underestimated the underlying vitality of the US economy. But another is that a global firm, as per Ohmae, might not be tied to the fortunes of any one particular country, even the country that the firm calls “home.” Nor is Porter’s distinction between multinational and global corporations universally agreed. Numerous authors—including some mentioned below—have used “multinational” to describe much the same behavior that Porter terms “global.” Nevertheless, the distinction Porter makes can be useful, even if it is not made quite in the way he intended it. In fact, most international corporations have something of a dual personality. One facet of the character of such a corporation is “global” in Porter’s sense—that is, the international corporation is a distinctive supranational entity that differs in important ways from purely national enterprises. Most international corporations do strive for something like a common strategy that encompasses all their operations. Indeed, few international corporations would characterize themselves as multinational by Porter’s definition. And given that national subsidiaries must conform to this strategy to a greater or lesser extent, their responses to stimuli in their national markets might be markedly different from those of noninternational rivals. But the second facet of the international corporation is a collection of subsidiaries, which typically cast themselves in the role of national firms operating in national markets. Thus, German subsidiaries of US-headquartered firms typically like to depict themselves (locally at least) as German companies. Likewise, US subsidiaries of Japanese firms go to great lengths to depict themselves as being American. To some extent, the depictions are correct. The subsidiaries must obey local laws, are subject to local regulatory authorities, and must often tailor their products and advertising to the local environment. Therefore, to a degree, the subsidiaries can be viewed simply as local firms whose owners happen to be foreigners. Thus, every international firm to some degree fits Porter’s description of a multinational firm. But most if not all to some degree fit the description of a global firm as well. Indeed, this dual identity poses dilemmas for public policy. The appropriate policy as regards a “global” firm might not be quite the same as that appropriate to a local operation that happens to be the property of foreign owners. Any discussion of relations between these firms and national governments must therefore address this duality.

Ohmae versus Porter in the Context of a Long-Standing Debate The Ohmae-Porter debate is in fact but a recent (and somewhat popularized) continuation of a debate that has been ongoing since at least WHY DOES BUSINESS GLOBALIZE?

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the late 1950s, when two seminal studies on the multinational spread of firms were released, one by John Dunning (1958) and the other by Stephen Hymer (1959). Dunning examined the operations of British affiliates of US-headquartered firms relative to their British-owned counterparts. His main conclusions were that the US-affiliated operations were more successful and that their success stemmed from their abilities to transfer technologies and other “intangible assets” (e.g., marketing and other managerial skills) from the United States to the United Kingdom and effectively to adapt these to the British environment. At least initially, the British rivals were typically unable to match the advantages accruing to the US-affiliated firms as a result of these transfers.1 Dunning also discovered that over time the British rivals were able to catch up to the US-affiliated firms. He concluded that the overall effect of the presence of the US-affiliated firms in the United Kingdom was to raise British productivity levels in all firms and not just the affiliates themselves—clearly a net blessing for the British economy. But he also noted the dual personality of these subsidiaries; their strengths came from strategic links with their American parents, and these links gave them a status that was not just that of another British firm. Hymer’s work was more theoretical than Dunning’s. Whereas Dunning investigated empirically the differences between affiliates of foreign firms and their domestic competitors, Hymer attempted to explain why a firm would internationalize its operations. In particular, Hymer noted that, for a firm to operate internationally, it must have some special advantages over its noninternational rivals.2 He identified these as “economies of scale” and “special management skills” such as marketing, especially the development of brand loyalty. These advantages would, according to Hymer, compensate for certain disadvantages faced by international firms—for example, the extra costs associated with managing operations over long distances and crossing national boundaries. Hymer believed that these advantages constituted for society a twoedged sword. On the one side, firms holding these advantages were likely to be efficient and well-managed (and, indeed, were they to lose their efficiency-generating advantages and managerial prowess, they likely would be forced to retreat from their international operations). On the other side, these firms often possessed enormous market power, and from this could gain political power without accountability. Hymer himself tended to see the second (bad) side as dominating the first (good) side. 1. These findings suggested that “technological spillovers” are associated with FDI and that they bring tangible benefits to the host economy; see appendix A for a more extensive treatment of this issue. 2. Hymer used the term “international” firm but seemed to have in mind much the same concept as Porter’s “global” firm. 36

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Whether one agrees or disagrees with this assessment, one cannot dispute that Hymer largely led the way in articulating the key issues of the debate on the multinational firm during the 1960s and 1970s. Indeed, his work and that of academics who followed his lead account for much of the outpouring of negative writings about multinational firms that characterized the 1970s. (See, e.g., Vaitsos 1974; Wionczek 1977, along with references therein. For surveys of this literature, see Stewart 1981; Chudnovsky 1993. For a popularized version of these arguments, Barnet and Müller 1974). These authors saw the global corporation essentially as a predatory monopolist that overcharged for the product it sold in local markets while suppressing any locally owned competitors by restricting the flow of technology to indigenous firms. This view was probably not unwarranted in many Latin American countries, where policy for many years was to erect enormous barriers to trade in order to protect the local market from external competition but then to invite selected multinational firms to establish local production within the protected enclave of the domestic market. Often the scale of local operations was less than minimally efficient, and multinationals thus would bargain to obtain what were essentially statesanctioned monopolies (typically shared with local interests) to compensate them for inefficient and hence uncompetitive operations. This state of affairs was the result of policies deliberately pursued by certain governments and not, as the critics of the global corporation would have it, due to intrinsic and unavoidable tendencies of these firms themselves. Today, many Latin American nations—Chile, Argentina, Colombia, and Mexico, to name several—recognize this and consequently have greatly liberalized their policies so as to reduce barriers to inward direct investment. The case of Mexico is dealt with in chapter 5 under the discussion of the North American Free Trade Agreement (NAFTA). In addition to developing nations, some industrialized nations have from time to time adopted policies that have been largely antagonistic toward multinational firms. For example, the governments of Canada during the Trudeau years and France during the de Gaulle and Pompidou years were generally perceived as hostile toward multinational firms, and both nations closely screened inward foreign direct investment (FDI) during those years. Both have since liberalized these policies. Hostility toward global firms and FDI in general has not been limited to constituencies in host countries. In the United States during the 1970s, for example, which was at the time largely a home country to these firms, organized labor strongly opposed outward FDI by US firms (and to a large extent still does). The position of the US labor movement has been that outward FDI is largely a substitute for exports and that the overseas activities of US firms thus contribute to a loss of jobs within the domestic United States. A sophisticated variant on this claim is that outward FDI may not cause a net loss of jobs economywide but may WHY DOES BUSINESS GLOBALIZE?

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redistribute the demand for labor from higher skill to lower skill categories (to stylize, high-paying, manufacturing jobs with high marginal productivities shrink as a consequence of outward FDI, while low-paying jobs in the service sector expand). As noted in chapter 2, whether or not FDI is a substitute for exports, the premise behind the labor unions’ opposition to FDI is at root an unresolved issue. Much evidence in fact suggests that in net they are complements. But a thorough resolution of the question depends upon the so-called counterfactual—that is, if FDI in a specific instance did not take place, would the demand for the relevant products or services have been met via exporting from the home market or from a “third” source? Global firms often claim that FDI is needed in order to defend markets from alternative suppliers. Thus, while home-nation exports might initially meet demand for a particular product or service, over time and with the growth of demand, other suppliers enter so that the initial supplier is at a competitive disadvantage without local production. There is without doubt at least some complementarity between FDI and trade in at least some sectors—the ones where products are transshipped across national boundaries as they pass down vertical chains of production. Some analysts (e.g., Porter 1990; Encarnation 1992) suggest that the complementarities go much further than this and, indeed, that in some sectors FDI might actually be a prerequisite for international trade. Analysts took exception to the criticism of FDI that followed from Hymer’s analysis on other grounds as well. For example, Raymond Vernon emphasized the importance of technology development as a determinant both of international trade and investment (1966) and the role of factors specific to firms’ home markets as a determinant of how this technology gets created and diffused (1974). Vernon in particular attempted to explain why US-based firms undertook the preponderance of FDI in the 1960s and why these firms concentrated their new technology development activities (i.e., research and development) in the US market. His hypothesis was that high per capita incomes in the United States generated a demand for labor-saving capital and consumer goods that embodied leading-edge technologies. Demand for such goods lagged in other countries but tended to become significant over time as per capita income in these nations grew. The special advantage of US firms in non-US markets then was the relatively early experience in developing and marketing these goods for the US home market. Local rivals in these markets simply did not have the capabilities to produce such products, although as demand in the local market rose, these rivals tended to develop or acquire such capabilities. Vernon’s hypotheses were consistent with the observed fact that nations that are home to significant outward direct investment tend to have high per capita income. The predominance of the United States as home to such investment has, as documented in chapter 2, declined significantly in recent years, but those 38

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countries that have come to figure importantly as home nations are mostly ones with per capita incomes equaling or surpassing that of the United States. Vernon’s work was complemented by the theoretical work of Magee (1977a and 1977b) and the empirical work of Mansfield, Romeo, and Wagner (1979). Magee argued that the international operations of multinational firms would increase the appropriable returns to the investment in the creation of technologies and hence would induce these firms to invest more in technological innovation than would otherwise be the case. Mansfield, Romeo, and Wagner provided limited evidence in support of Magee by showing that US multinational networks did in fact increase the returns to new technologies significantly. Two former students of John Dunning, Peter Buckley and Mark Casson (1976), noted that international exploitation of scale economies, brand loyalty, or proprietary technology requires a firm to actually own and manage international operations. Scale economies can be achieved in operations located solely in home markets with part of the output exported, while brand loyalty or proprietary technology can be exploited via licensing agreements with firms based in nations outside the home market. Thus, Buckley and Casson argued that while Hymer and Vernon’s explanations as to why firms become international might embody certain necessary conditions, these explanations were not sufficient to explain why firms chose FDI over other means of servicing foreign markets. Thus, to explain the existence of international operations, Buckley and Casson turned to the organizational theory of the firm as originally developed by Ronald Coase (1937) and expanded upon by Oliver Williamson (1975). The core of this theory holds that firms expand their organizations in order to capture internal economies. These economies are achieved mostly because transactions costs are reduced. For example, a firm typically finds it economical to hire workers on a long-term basis rather than to contract for workers’ services on a short-term, arm’s-length basis. This is because short-term services entail significant and recurring transactions costs (including training costs) that could be avoided (or incurred less frequently) if the workers were granted some degree of job security in exchange for loss of some personal flexibility. Williamson predicted that a firm will expand until the marginal cost of controlling a larger organization equals the marginal transactional cost of contracting with an outside agent to perform the same function as was internalized within the firm. Buckley and Casson suggested that there are economies to be had via internalization of production and marketing across national boundaries (that is, keeping it all within one organizational roof, even if this roof extends across continents and oceans) versus arm’s-length transactions such as exporting and licensing. John Cantwell, a younger colleague of WHY DOES BUSINESS GLOBALIZE?

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Buckley and Casson, combined internalization theory with the observation that there is much rivalry among global firms and concluded that this would lead to more rapid development and diffusion of desirable new technologies than would occur in a world where there were no economies of internalization (Cantwell 1989). All of these “post-Hymer” authors have done much to spark a reevaluation of the critical appraisal of the global corporation that characterized much of the 1970s policy debate. In particular, Buckley and Casson triggered a cascade of studies applying the organizational theory of the firm (a theory that itself has seen considerable refinement in recent years) to the multinational firm. Most of this work has suggested that the spread of global corporations is very positive in terms of their effect on economic efficiency and growth, thus reinforcing the work of Dunning. For a survey, see Cantwell (1991). Cantwell’s variants reinforce the contention that the global firm is an efficient organization with respect to creation and diffusion of technology, a contention buttressed by the earlier work of Vernon, Magee, Mansfield, and others. Cantwell’s work in particular would suggest that local government policies to foster technological development that restrict the ability of multinationals to operate locally are likely to be futile or counterproductive. Dennis Encarnation (1992) casts further doubt on the contention, long held by US labor unions, that US-based global corporations’ overseas activities displace domestic exports and thereby destroy US jobs. He argues that direct investment is a prerequisite for exports, especially for technologically sophisticated products or services, because only through direct investment can a corporation selling such products or services create and maintain links with the relevant customers. Encarnation notes in particular that US firms’ direct investment in Japan is low and that US exports’ market penetration in Japanese markets for most technically advanced goods and services is also low. He builds a convincing case that the low direct investment causes the low export penetration rather than the other way around. On the whole, the legacy of the works of Dunning, Hymer, Vernon, Buckley and Casson, and a host of other is much more supportive of Porter’s views of the global corporation than of Ohmae’s. That is, the global firm is rooted in its home nation’s culture and derives many of its strengths (and possibly also its weaknesses) from it. Ohmae’s view might be seen as forward-looking: large global corporations may indeed be shedding this national identity and becoming stateless entities. For the moment, however, the following observation still seems to hold: In our still imperfectly integrated world, firms by and large continue to have different centers of gravity that give them a more or less definable national identity. To call General Motors an American company, and Honda a Japanese one, does some violence to the fact that each is a multinational concern pro40

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ducing in several countries, yet Honda is clearly more Japanese, in terms of the weight of its interests and economic stake, and General Motors more American. (Graham and Krugman 1995, 8)

Impacts of National Policy on Globalization Whereas the literature just discussed has focused on the characteristics of the global corporation itself that might aid understanding of what gives impetus to globalization, other analysts emphasize the relationship between firms and governments. For instance, nations impose tariff and nontariff trade barriers that could preclude a firm from exporting from its home country and lead it to establish “second-best” international operations—that is, the manufacturing of import substitutes at higher social cost than that of the imports themselves. (If the import substitution operations were not “second-best,” they presumably would be established anyway, in which case the trade barriers would be largely irrelevant.) Other factors are unstable, unpredictable exchange rates and the development of regional blocs, which have led a growing number of firms to locate deliberately redundant production within each of the main financial and trading areas (dollar, Europe, and yen). But other, more subtle national actions can also alter locational decisions: the granting of investment incentives (including out-and-out subsidies, but also including indirect subsidies such as monopoly rights) and the imposition of performance requirements (e.g., local-content requirements or domestic manufacture as a condition of entry). Such national policies may reduce world welfare (largely via the creation of inefficiencies via misallocation of resources) but will not necessarily reduce the welfare of the affected firm nor of every country. For example, a firm structures its worldwide operations in order to comply with performance requirements (rather than to achieve global cost minimization) and furthermore receives incentives to do so because the value of the incentives to the firm exceeds the value lost due to costs that are higher than they otherwise would be. Presumably in such a case the host government believes that its country achieves some net advantage as well. Overall, however, there is a net welfare loss. In effect, the costs of the incentives and performance requirements are scattered—if the nation knows what it is doing, the rest of the world bears them—while benefits accrue to the firm and the nation alike. However, even the country that extends incentives may lose if many other countries emulate its offer; in that case, the countries collectively transfer added benefits to the firms. And the insistence on performance requirements may deter enough investment altogether to offset any gains achieved by successful levying of such requirements on firms that accept them. WHY DOES BUSINESS GLOBALIZE?

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Two main points emerge. First, national governments affect the operations of global firms. This holds true whether one accepts Porter’s or Ohmae’s perspective. However, Ohmae’s assertion that nation-states are becoming irrelevant is no more accurate today than were similar views expressed by Kindleberger and Vernon almost three decades ago. Second, certain of these national regulatory actions (as well as those by subnational governmental entities, such as US state governments) may dovetail with individual firms’ objectives. Companies may gain from some governmental intervention (e.g., tax incentives) and at the same time hedge against those that threaten them (e.g., currency changes and trade barriers). But the effects of all these interventions may still be suboptimal in global (and usually national) welfare terms, raising the issue of whether new devices are needed to check them. Relations between global corporations and governments have been the subject of numerous studies for more than 20 years (e.g., ServanSchreiber 1967; Kindleberger 1969; Vernon 1971; Barnet and Müller 1974; Bergsten 1974; Bergsten, Horst, and Moran 1978; Gilpin 1979; Tolchin and Tolchin 1988; Glickman and Woodward 1989; Reich 1990; Dunning 1991; Graham and Krugman 1995). A theme that runs through many of these works is that global firms impinge on the prerogatives of governments or, perhaps more accurately, that the very existence of global firms weaken certain aspects of government policy or even make them irrelevant. Most of these works defend the rights of governments to enact policies to promote national interests over those of global firms, and some authors (e.g., Barnet and Müller 1974; Tolchin and Tolchin 1988) cast these firms as a menace to society in the face of which governments are largely impotent. But most studies note the potential benefits deriving from global firms and note that national policies can interfere with, and even negate, this potential. Four possibilities have been raised for conceptualizing the relationship between global corporations and national governments under current institutional arrangements. First, global firms may dominate both home and host governments for the better, given the welfare benefits the firms generate (Vernon 1971). Second, global firms may dominate governments with adverse effects on both home and host countries, but particularly the latter (Barnet and Müller 1974). Third, the firms may be tools of their home governments’ traditionally imperialistic or more modern mercantilist policies (Gilpin 1975). Fourth, the firms may ally with governments of host countries to maximize the gains for both without much regard for the impact on their home countries (Bergsten, Horst, and Moran 1978). Much of today’s debate revolves around the question of which of these views is more correct or, more precisely, which of these outcomes prevail under what circumstances in particular industries in particular countries. What are the conflicts between global firms and national governments 42

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and why do they occur? It helps to first ask what the legitimate functions of national governments are as regards their role in the world political and economic system.

National Defense One such function, of course, is to provide for national defense. National defense is a highly legitimate objective of any national government but one that is easily perverted. With respect to global corporations, the issue can be presented starkly. To what extent should a local affiliate of such a corporation that is owned by foreigners be treated as a national entity of the country in which it operates, and to what extent should it be treated as an enemy agent? (In a sense, this is simply a recasting of Porter’s distinction between a “global” and a “multinational” firm.) From a government’s point of view, it would be foolhardy with respect to matters of national defense to treat the local subsidiary exactly as though it were just another national entity. After all, only one facet of its dual character is statelessness; the local subsidiary must to some extent respond to headquarters management and strategy. But this does not make the firm an enemy agent; if it were, it likely would be expropriated or dissolved. The placement of local subsidiaries of global corporations along the spectrum between local-national and enemy agent is a real dilemma. It is clear that national security considerations of governments can clash with the “global” character of the international corporation.

Labor Another function of a national government is to protect the interests of local factors of production that are immobile (or largely immobile) internationally. Most important, governments take it upon themselves to protect the interests of local workers. There is much debate over the appropriate extent of this role. In the United States, the accepted role of government is to enforce safety standards, to prohibit most child labor, to enforce the rights of workers to union representation, to require that a minimum wage be paid, and to set some limits on the numbers of hours that employers can require workers to be on the job. In most Western European nations, governments see their role as being much more extensive. In both the United States and Europe, government regulations to protect the interests of workers pose constraints on all corporations. But global corporations are viewed almost universally with greater suspicion than are national firms because of their ability to move operations across WHY DOES BUSINESS GLOBALIZE?

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jurisdictions. An abiding fear of host countries is that the multilateral firm, faced with a cutback in global demand for its products, will shed workers first.

Taxation Governments must finance their operations, and to do so they must of course tax their constituents. Few would question that local subsidiaries of global corporations must meet their share of the tax burden and that it is fair that they be taxed at rates commensurate with those levied upon similar firms under local control. (We shall here bypass the issue of whether taxation of corporations makes sense; we simply assume that all governments will continue to do it.) But governments of both home and host countries fear that multinationals will evade paying their fair share by allocating their profits in ways that maximize them—often ignoring the fact that it is patently impossible for a company to do so vis-à-vis all jurisdictions in which it operates. Moreover, governments frequently attempt to tax local subsidiaries of global corporations at higher rates than local entities pay. Foreign shareholders do not vote in local elections, and no voter in the world is immune to the promise that his tax burden will be shifted to someone else.

Defense of National Currencies National governments also defend national currencies. Hence they must concern themselves with exchange rates, whose determinants include the national current account and balance of trade positions. For this reason alone, Ohmae’s injunction to ignore trade balances is obviously fatuous in a world of nation-states. The overall objective of a government with respect to the trade balance should be to maximize its country’s terms of trade subject to balance of trade constraints so as to maximize national income. Often, however, this goal is achieved through policies that are based more on mercantilist reasoning than sophisticated optimization rationale. Almost all countries thus pursue policies to encourage exports: for example, export performance requirements on local subsidiaries of global corporations. (These can also be imposed on grounds of creating jobs, especially by linking the performance requirement to an investment incentive. Local authorities may then see the goal as both protection of workers’ interests and improvement in the balance of trade.) Virtually all governments support the R&D activities of their private sectors, but many have been unsure whether to permit foreign-based companies to participate in government-supported R&D consortia (such as Sematech in the United States and JESSI in Europe). Whatever the justification for the policies, 44

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they are invoked in an effort to harness the global corporation to the achievement of local objectives.

Implications of the Clash between Government and Global Business Why is any of this of concern? There are at least three reasons, and they underlie the whole rationale for this book. First, as noted above, certain actions that governments take to pursue national goals can reduce global welfare. Even if these actions bring tangible benefits to the local economy, their imposition ultimately entails a net cost, which someone must bear. The cumulative effects of such actions can be that everyone loses; this can happen, for example, if one government takes actions designed to offset the actions of some other nation and this process repeats itself so that no nation receives any benefits but all pay the costs of other nations’ actions. Game theory tells us that the only way to prevent the “everyone loses” outcome in such situations is for governments to cooperatively end the actions that are causing the outcome and that this cooperation must be implemented via rules that participants break only at their own peril (Fudenberg and Maskin 1986). (In the language of game theory, the rules must be “self-enforcing” or “subgame perfect.”) Second, nations have legitimate functions, and the exercise of some of these will necessarily constrain global corporations. The issue is how to differentiate between legitimate government functions that constrain the global corporation while maximizing global welfare and those that collectively do no good and are even likely to do harm. Third, conflicts of two types—between governments, and between a government and a company—will inevitably arise from the interplay of differing national policies and different corporate strategies. As the sheer magnitude of such conflicts rises with the increasing globalization of industry and the growing anxiety of many governments over its impact on their own efficacy, new rules and modes of dispute settlement may be needed to order the process. Under all three of these headings, there may be domains—including taxation, reporting standards, competition policy incentives, performance requirements, and other areas—where nations need to cooperate to provide constructive regulation of global corporations. For example, some governments may agree to avoid welfare-reducing intervention only if other governments agree to do so as well. Likewise, some governments may believe they are unable to effectively pursue legitimate national goals vis-à-vis multinationals unless other governments are doing so as well. Many governments may be unwilling to abandon, or even limit, their jurisdiction over multinationals unless the firms are subjected to WHY DOES BUSINESS GLOBALIZE?

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acceptable rules through other means, such as an effective international agreement. Thus, in the following chapter, the specifics of such an international agreement are laid out. Then chapter 5 recounts the progress of international forums (the WTO at global level, as well as regional entities such as the EU, NAFTA, and the Asia Pacific Economic Cooperation, or APEC, forum) in developing such an agreement—at least pieces of it. Considerable progress has in fact been made, much of it in just the past few years. But there is a long ways to go, so the final chapter outlines a course for future progress in achieving international agreement.

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Toward New Rules on International Investment

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This chapter explores the possible substance of an international accord on foreign direct investment (FDI) and global corporations. The proposal is framed normatively; that is, it lays out basic principles of an optimum optimorum of accords and largely ignores whether international agreement on such an accord can actually be achieved. At the level of detail, however, points at which major disagreements among negotiating parties will likely occur are noted. At the level of principles, open investment policies should be the norm, with limited (and clearly articulated) exceptions allowed only when justified in the name of national security or some other overriding principle. Thus, the accord outlined here is not meant to unduly increase regulation of FDI or the activities of multinational firms; rather, it is intended to provide a basis for liberalization of restrictive policies that currently exist and to reduce government interventions that might lead to income-reducing inefficiencies. This is not to say that there should be no regulation whatsoever of multinational firms. Governments, for example, must continue to ensure that markets remain competitive and that multinational firms are not exempt from competition policies. As is argued later in this chapter, competition policy is one domain where a more international approach is needed in the face of the globalization of business. More generally, one of the central tenets of an accord on investment should be that affiliates of multinational firms obey the laws of the host nations in which they operate. Chapter 5 surveys the extent to which the principles outlined in this chapter have actually been achieved in existing agreements on invest47

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ment. The reader is cautioned to pay attention to nuance; many of the principles enumerated in this chapter do in fact appear—in name, at least—in international agreements that have been struck. But often, the accompanying language diminishes their content significantly.

An Accord on FDI The ideal accord would grant specific rights to, and simultaneously place certain obligations on, three sets of factors: n governments of nations that are host to FDI (including subnational entities); n governments of nations that are home to international corporations (again including, where relevant, subnational entities); n foreign direct investors and the international operations thereof— that is, the global corporations themselves and their overseas affiliates (whether these be subsidiaries, branches, or other organizational forms). In addition, the accord must also provide for an effective means to settle disputes both between governments and between direct investors and governments that might arise over interpretation or enforcement of these rights and obligations. The accord might also be supplemented by ancillary codes. The main ingredients of such an accord are described below.

Host-Nation Government Obligations These fall into three categories: right of establishment, national treatment, and state intervention. Obligations for all three categories would enunciate normative principles and a list of acceptable exceptions and derogations to these normative principles.1

Right of Establishment The subsection on right of establishment would spell out both obligations to apply to host governments and rights to apply to foreign direct investors. The underlying normative principle should be that national markets must be open to entry by foreign direct investors via the route of foreign direct investment (including acquisition of ongoing enterprises

1. The difference between an “exception” and a “derogation,” following standard international legal usage, is that the former is considered more or less without time limit whereas the latter is considered to be a temporary measure. 48

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already operating within the market) and that any exceptions or derogations must be completely transparent.2 No nation now grants full, unimpeded right of establishment to foreign-owned or foreign-controlled enterprises. For example, the United States traditionally prides itself on its degree of openness to FDI but has long imposed restrictions on foreign ownership of activities in certain sectors. Foreign interests cannot wholly own or exercise control over enterprises operating in the US broadcasting, coastal shipping, nuclear energy, oil pipeline, or domestic air transport industries. All countries have sectoral restrictions, and among the OECD nations, lists of restricted industries tend to be strikingly similar to the US list (OECD 1993; the restrictions listed in this somewhat dated document still exist, with little change). Most nations can also block foreign takeovers of domestic firms, or even “greenfield” establishment of foreign-controlled operations, on grounds of national security. The United States made such power explicit in the Exon-Florio amendment to the 1988 Omnibus Trade and Competitiveness Act, and most nations give themselves similar powers.3 Further, many nations screen FDI on economic grounds. Others reserve the power to do so, even though in recent years they have allowed these powers to fall into disuse. The issue of whether governments should screen FDI thus remains a contentious issue. A more subtle establishment issue encompasses intangible barriers to entry, which are widely viewed as existing in Japan and certain other countries whose regimes are less open or less transparent than in America. In the case of Japan, for example, it is claimed that cross-holdings of equity in firms by other firms within the so-called financial keiretsu make it impossible for non-Japanese firms to acquire Japanese firms. (see, e.g., Bergsten and Noland 1993; Lawrence 1993) This has led to proposals for strict reciprocity in extending the right of establishment (or national treatment, see below) to particular countries. What exceptions to the principle of openness are to be allowed? There are numerous justifications given for exceptions: national security, control of national patrimony, and various shades of mercantilism. The negotiation of exceptions would be very difficult because there is no consensus on the merit of these justifications. As was explored in the previous chapter, many of these issues boil down to a question of the extent to which a local subsidiary of an international corporation is an 2. Transparent means that the measure or policy is a matter of public record and that the affected parties can discern the direct and indirect consequences of the measure or policy (OECD 1983). 3. Interestingly, there are some nations that do not. Under the Investment Canada Act, the government of Canada, for example, can screen FDI on economic grounds but not, in the opinion of most Canadian legal scholars, on security grounds.

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entity different from any locally owned and controlled business organization or is simply an ordinary, national entity that happens to have foreign owners. Nations that limit right of entry tend toward the view that the international corporation is an integrated entity potentially pursuing strategies or goals incongruent with national interests. Nations that maintain relatively open official policies toward direct investment tend to see the issue merely in terms of what activities should and should not be subject to foreign ownership, without much regard to the means by which the foreign ownership is exercised (e.g., US restrictions on foreign ownership typically apply equally to ownership by foreign “global” corporations and passive investors).4 The specific issues include the following: What sectors, if any, should nations be allowed to close to FDI? Should governments screen FDI, and if so, on what grounds? With respect to structural impediments to establishment (generally termed the “Japan problem,” even though Japan is not the only country where such a situation may exist), how should openness be defined and maintained when there are opaque barriers? Should equity restrictions on foreign investors be allowed? (For example, should host governments be allowed to require local equity participation in domestic affiliates of international corporations?) And if so, to what categories of commercial enterprise would they apply? Should nations be allowed to “grandfather” existing sectoral restrictions and other limitations on right of establishment (as did the United States in the NAFTA), even if these do not fall on the list of acceptable exceptions? Because some exceptions are inevitable, an overriding goal would be to achieve a high degree of transparency. That is, whatever the rules regarding right of establishment, countries should administer them in a way that is clear and unambiguous. Official exceptions to right of establishment should be published, or, where countries exercise administrative discretion in determining whether a particular case would be allowed or not, both the criteria for judging the case and the procedures for making a determination should be public information. Indeed, a universal benefit of an international accord on direct investment would be to make exceptions to right of establishment transparent and thereby to increase the likelihood that such exceptions would be subject to future liberalization.

4. Barriers to entry can, however, reflect private assessments of the merit or lack thereof of foreign ownership as well as official assessments. Again, to use Japan as an example, it is often said that a major barrier to direct investment in Japan is a distrust of foreigners that is deeply embedded in the local culture and is reflected in the unwillingness of private Japanese shareholders to sell controlling interests in local firms to foreign investors. 50

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National Treatment The subsection of the accord on national treatment for foreign investors would closely parallel that on right of establishment and would also simultaneously spell out obligations on host-nation governments and rights of foreign direct investors. The normative principles would be that foreign-controlled enterprises operating in a national economy should be subject to exactly the same laws and policies as domestically owned rival firms operating in the same sectors, and that any exceptions or derogations should be completely transparent. In many countries, foreigncontrolled enterprises are in practice subject to different laws or policies than domestically owned ones, so an alternative articulation of the national treatment principle that has found acceptance may be called for: foreign-controlled enterprises should be subject to laws and policies no less favorable than those applied to domestically owned firms operating in the same sectors. This phrasing allows a host nation to apply laws to the foreign-controlled enterprise that are more favorable than those applied to domestic rivals. National-treatment provisions should be augmented by a general provision for most-favored nation (MFN) status. In the context of international investment, MFN implies that if a nation that is party to the accord grants to investors (or their affiliates) from some nation treatment that is more favorable than that required under the national treatment obligation of the accord, that same treatment would be accorded to the investors (or their affiliates) of all nations party to the accord. One sticky issue is whether exceptions to MFN should be allowed. The exception most likely to be accepted is one for so-called regional economic integration organizations such as the EU and NAFTA. Another difficult, more general issue would be allowable exceptions to national treatment. For example, should government procurement policies for defense industries prohibit foreign-controlled enterprises from being contractors for certain goods? Should special requirements on foreigncontrolled defense contractors that do not apply to domestically controlled ones be deemed acceptable exceptions from national treatment? Are there sectors in which foreign-controlled firms should be regulated differently from domestically controlled competitors for reasons other than national defense? Should foreign-controlled firms have the same rights to contribute to election campaigns as do domestically controlled firms? There is little consensus among nations (or, for that matter, among the policy analysts of most nations, including the United States) on how extensive national security and other exceptions to national treatment should be. Therefore, negotiating an agreement on allowable derogations and exceptions to right of entry and national treatment would probably be difficult. Most likely, any future accord would include rather open-ended provisions regarding derogations and exceptions; that is to TOWARD NEW RULES ON INTERNATIONAL INVESTMENT

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say, pragmatic considerations would dictate that countries be allowed to make pretty much all the derogations and exceptions they see fit. Otherwise expressed, lists of allowable derogations and exceptions would almost surely include all possibilities that any negotiating party seriously wanted to be on such a list. Thus, transparency again becomes a very important issue. To ensure it, a procedure along the lines of the current process followed in principle by OECD members might be applied. Under this process, countries publicly state what derogations and exceptions are in effect and enforced and are prepared to periodically justify these derogations and exceptions before an international body.5 Such a process would not only promote transparency but would bring pressure on countries whose derogations and exceptions are excessive by international norms.

State Intervention The third set of obligations applying to host-nation governments encompasses the issues addressed in the Uruguay Round Agreement on Trade-Related Investment Measures (TRIMs)—namely, which national and subnational government interventions into the behavior of international corporations should be allowed and which should be prohibited. Prime on the list of these interventions are investment incentives and performance requirements, some aspects of which were discussed in chapter 3 and others that were tackled in the Uruguay Round are covered in the following chapter. Two brief notes will suffice here. First, most performance requirements on MNC subsidiaries have distortive effects both on allocation of investment resources and on international trade flows generated by direct investment. Hence, most such requirements should simply be banned. Second, prohibitions or other disciplines on these requirements should be linked with restrictions on investment incentives, which also have distortive effects. The Uruguay Round TRIMs agreement has fallen short of establishing wholly effective rules in this area; only certain performance requirements are addressed. Those practices that are addressed are banned, as are the subsidies (which have the nature of investment incentives) linked to these. Some regional arrangements cover more. For example, NAFTA covers more categories of performance requirements but leaves investment incentives untouched. Articles 92 and 93 of the Treaty of Rome—the basic document of the European Union—potentially caps most investment incentives. These arrangements are covered in the next chapter, and all that we shall say here is that stronger agreements on both investment incentives and performance requirements would be useful at the global level. 5. This process is described in more detail in the following chapter (see also OECD 1993). 52

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Again, what exceptions ought to be permitted? Would nations be allowed to impose performance requirements deemed necessary for national security? Are there classes of performance requirements that should be permitted? For example, should governments be allowed to require that foreign-controlled enterprises perform certain levels of research and development? (On this issue, while NAFTA bans most categories of new performance requirements, it apparently does not ban R&D requirements.) Would existing performance requirements be grandfathered? If so, should there be a schedule for rollback and elimination of these? Other obligations of host governments would pertain to fund transfers and payments, expropriation, and sojournment (temporary residency) of personnel. Under an accord on investment, international firms would have the right to transfer funds and to make payments in and out of jurisdictions where they operate. These transfers and payments would include those of profits, dividends, interest, realized capital gains, royalty and licensing fees, technical assistance fees, management fees, proceeds from the sale of assets, payments for material inputs (e.g., imported raw materials or semifinished products for further processing), and other transfers and payments associated with the normal conduct of business. Host- and home-nation governments could not restrict these, except insofar as restrictions related to judicial proceedings (e.g., the firm in question were bankrupt or in a state of insolvency) or were imposed pursuant to criminal investigations. An exception would be allowed where a nation suffered extreme balance of payments difficulties, in which case restrictions could be imposed consistent with the Articles of Agreement of the International Monetary Fund (IMF). The businesses and properties of an international firm would not be subject to expropriation or nationalization unless it were to be conducted on a nondiscriminatory basis and subject to due process of law. If business and property were expropriated, the investors would be entitled to prompt compensation for their fair market value in an international currency (e.g., US dollars, Japanese yen, or German marks). With respect to sojournment of personnel, global corporation affiliates should have the right to employ technical and other personnel designated by the parent organization, and these personnel should be able to obtain nonpermanent resident status in the host country. Host governments should create special visa categories for personnel requiring visas. Staffing decisions would be at the discretion of the subsidiary and its parent organization—that is, not subject to host-nation requirements to employ local nationals in key positions.6 6. The company might nonetheless wish to do so; indeed, there is a trend worldwide for global corporations to employ local nationals at all levels in their overseas subsidiaries. Nonetheless, explicit rights of sojournment would be desirable to provide against undue state intervention into an individual firm’s management practices.

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Host-Nation Government Rights In addition to obligations on host-nation governments, the ideal investment accord would spell out certain rights of these governments: n The host government should have the right to regulate the activities of foreign-controlled enterprises operating within its sovereign territory, consistent with the principles of right of establishment and national treatment discussed above. In particular, the host nation should have the right to force a subsidiary of an international firm legally incorporated in that nation’s territory to follow host-nation law and policy, even if these should conflict with the law and policy of another sovereign state’s jurisdictional claims over the subsidiary, such as those of the corporation’s home-nation government. n The host government should be able to tax the earnings of the subsidiary, again consistent with obligations set down elsewhere in the accord. In particular, the host-nation government should have the right to adjust reported earnings of a local subsidiary to correct for underreporting via constructed transfer prices. However, there should be uniform standards for transfer pricing to which all host nations would subscribe (see the discussion below pertaining to an ancillary code on taxation).

Home-Nation Rights and Obligations At least two rights of, and one obligation on, home-nation governments should be made explicit. These governments should have the right to tax its citizens, including corporate citizens, on worldwide income. This would include the right to choose how to treat host-nation taxes on income earned abroad (e.g., whether to grant credits for these taxes, to allow them to be deducted from taxable income as expenses, or to treat them in some other fashion) and the right to adjust earnings for possible distortions caused by transfer pricing (again, see discussion of an ancillary code on taxation below). However, it would be desirable for nations to agree to refrain from exercising this right and tax instead on the basis of residence (“territorial” taxation), whereby the earnings of overseas affiliates would not be deemed taxable.7 The second right of home governments is the power to otherwise regulate the activities of their citizens. But home governments should 7. A complete discussion of the taxation of multinational corporations and a series of recommendations for reform is contained in Hufbauer and van Rooij (1992). See also Hufbauer and Gabyzon (1996). 54

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also accept as an obligation the right of host-nation governments to regulate economic activities of citizens (including affiliates of firms that are based in the home nation) operating within the host territories. There should be no exceptions to this obligation, although governments might seek international mechanisms for implementing needed regulations in domains such as taxation and competition policy (antitrust); see discussion below. Host nations might sometimes voluntarily cede rights of regulation to home governments. For instance, a host-nation government might recognize another government as supervisor of banking operations that are conducted in the host nation’s territory but are controlled by banks based in the other government’s territory. Under this right, combined with the right of host-nation governments to regulate the activities of foreign-controlled firms operating on their shores, contradictory policies could be aimed at the same corporation. For example, one nation might embargo sales of goods and services to a second nation, but a third nation might not honor the embargo. What ought to be the position of a multinational corporation with affiliates in both the first and the third countries, each of which does business with the second? (In this case, the “affiliate” could be the parent organization.) According to the principles enumerated here, the affiliate in the first country could be required by that country’s government to comply with the embargo, but that government could not require the affiliate in the third country to honor the embargo. But even so, the issues are not wholly clear-cut. For example, can the first country’s government prevent the affiliate in the first country from selling goods and services to the affiliate in the third if this were likely to result in resale to the embargoed country? If technologies are transferred from the firstcountry subsidiary to the latter, does the first country’s government have the right to require that these not be further transferred to the second (embargoed) country? The point is that no matter how tightly the rights and obligations of home and host nations are constructed, it will not always be clear which government can regulate a particular transaction or activity. Thus, an important adjunct to the rules will be a means by which jurisdictional disputes between home and host governments can be settled. Just such a scheme is discussed later in this chapter.

Rights and Obligations of Global Corporations The industrialized nations, especially the United States, have long resisted obligations upon business enterprises through international law, arguing that such obligations would invariably discriminate against international corporations. This rationale was buttressed during the 1970s by the rather extreme positions taken by the Group of 77 developing TOWARD NEW RULES ON INTERNATIONAL INVESTMENT

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nations in UN discussions on codes of conduct to regulate international corporations and restrictive business practices (discussed in chapter 5). Yet such provisions are desirable for at least three reasons. First, it is difficult to imagine all host-nation governments accepting significant limitations on their abilities to regulate foreign direct investors if these investors themselves were not subject to obligations at the international level. Multinational firms do often have objectives that are at variance with the laws or policies of the nations in which they operate, and these governments have a right to expect that local affiliates will comply with local law or policy. Second, clearly stated international rules could save international corporations from situations in which they otherwise would be “damned if they did and damned if they didn’t,” as when they face conflicts between policies of home and host governments. Clearly, these firms can benefit from rules indicating which government was to be obeyed— under the principles enumerated here, this would almost always be the host government. Third, these rules could provide a standard against which the conduct of a specific firm could be gauged. Such standards could very much be in the firm’s own interests. Say, for example, a firm believes that it faces unfair or discriminatory treatment under the law or policy of a host government that is in contravention of obligations of an accord on investment. The host government, for its part, counters that the firm’s conduct necessitated the discrimination. If there were dispute settlement procedures in place, the firm could plead its case before an international panel and argue that its conduct was acceptable by the standards of the accord and hence did not warrant government intervention. Specific obligations on international corporations would fall into two categories. First would be rules specifying whose laws and policies such corporations must follow under what circumstances. The underlying principle should be that entities operating in host countries should follow host-government law while entities operating in home countries should follow home-government law. When, as in the example above, two governments claim jurisdiction over a transaction or activity and these parallel claims put conflicting demands upon an international corporation, the situation would be resolved via the dispute settlement mechanism. The second category of obligations on international corporations would prohibit or discourage “restrictive business practices.” Some such practices should be banned entirely—for example, central office policies requiring subsidiaries to source inputs from specific overseas suppliers where these inputs could be economically obtained from local suppliers. These policies are analogous to host-nation performance requirements, and the Group of 77 long ago rightly sought international sanctions against them. There is widespread disagreement among nations with respect to exactly what practices might fall into this category. Pragmatism therefore 56

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suggests that an accord on investment likely would contain two lists of restrictive business practices: those that all signatory countries could agree to prohibit, and those that all signatory countries could agree to discourage. The latter list could include practices that some but not all nations believed should be prohibited. Practices falling on the first list would be banned per se. Practices on the second list could be banned by individual nations, but the prohibitions would apply only to operations conducted on this nation’s sovereign soil. In addition to these basic obligations on international corporations, there could be other obligations linked to ancillary codes; these are discussed later in this chapter.

Dispute Settlement Two generic types of dispute can be envisaged under the proposed accord: “state-to-state” disputes between governments (e.g., between a home and a host government over one or the other’s policies as they bear upon a particular international corporation) and “enterprise-to-state” disputes, where the government may be home or host to the corporation. For state-to-state disputes, a modified settlement mechanism similar to but stronger than the current WTO Dispute Settlement Body would be desirable. Appropriate measures to strengthen the WTO mechanism are embodied in the Canada-US Free Trade Agreement (Horlick, Oliver, and Steger 1988); a model for enterprise-to-state dispute settlement is to be found in the chapter 11 provisions of NAFTA (Graham and Wilkie 1994). Borrowing from the FTA and current WTO procedures, the essential elements of a mechanism to settle state-to-state disputes are as follows: n The party initiating an action must notify the other party or parties of its intentions in writing. n The parties must attempt to work out the problem via mutual consultation. n If consultation fails, the parties can submit the dispute to a panel of experts with powers to arbitrate the dispute. On this panel would sit, inter alia, representatives that the parties themselves select. WTO procedures follow the first two of these steps. The third step in WTO procedures is, however, quite different. A WTO “panel” cannot arbitrate a dispute. If mutual consultation fails to resolve a dispute within a specified time, the dispute may be brought before a panel, which can then recommend by majority vote whether the action of the “defendant” state in the dispute violated its WTO obligations. The panel also TOWARD NEW RULES ON INTERNATIONAL INVESTMENT

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recommends remedial action. Its decisions may be appealed to an Appellate Body, whose findings are adopted automatically unless the Dispute Settlement Body decides by consensus to block the adoption. If upon appeal the defendant does not take the recommended remedial action within some reasonable period (which is decided case by case), the “plaintiff” government is then entitled to initiate trade-related sanctions against the “defendant.” For enterprise-to-state disputes, somewhat different procedures are warranted. International corporations are not sovereign states and hence do not have the rights accorded to such states. Generally, issues between an international corporation and a nation state are (and should be) settled within the legal system of the state. Indeed, under the accord described above, international corporations and their affiliates would be bound to obey the law and policy of governments in the territories over which these governments hold jurisdiction. However, three general cases can be identified where the legal system of a nation-state could prove unsatisfactory as a means of settling a dispute: n where a government believed that an international corporation’s practices outside national territory harmed its interests and that the firm had violated its obligations under the accord; n where a firm believed that government regulations or policies affecting its operations were inconsistent with the government’s obligations under the accord and where efforts to resolve the matter with government agencies failed to resolve the issue; n where a firm believed that one government’s laws, regulations, or policies contravened those of another so that the firm could not follow both. In such a case, the firm might initiate dispute resolution proceedings with both governments. For these situations in which the firm is party to a dispute, a different dispute settlement mechanism should be established. A two-step procedure is envisaged: n One of the parties to the dispute appeals to a panel, the sole role of which would be to determine if there were merit to the appeal. “Merit” here would be decided largely on procedural grounds, perhaps by the following criteria: Were efforts made to resolve the dispute via consultation between the affected parties or via the established legal procedures of the affected government? Did the dispute involve interpretation of the investment accord, and in particular, did it appear prima facie that a party to the dispute could be in violation of some provision of it? 58

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n If this panel were to judge that the appeal had merit, a second panel would hear the substantive issues of the dispute. This panel would be empowered to recommend a solution, which could entail awarding of damages to the firm, a recommendation that the relevant government or governments cease or desist from a particular practice, or a recommendation that the firm take (or cease or desist from) a particular action. One purpose of this two-stage dispute settlement approach is to filter out frivolous or nuisance cases. A second purpose is to induce parties to settle disputes via consultation: The first panel could require the disputing parties to engage in further consultation if it believed that all possibility of a mutually satisfactory resolution had not been exhausted. Thus arbitration in the second panel could be restricted only to those substantive cases where resolution was impossible. This procedure clearly raises issues of nation-state sovereignty. What would be the legal status of any recommendation of this second panel? Would the recommendation be binding upon firms? If the procedure is to have any meaning, the answer would have to be yes. But then would the recommendation be binding upon nation-states? If the answer were no, the whole procedure would be asymmetric and corporations likely would view it as latently punitive. If the answer were yes, signatories of the accord would have to yield a certain amount of sovereign power. The NAFTA chapter 11 dispute settlement procedures—discussed in some detail in chapter 5—offer a partial precedent for these proposals.8 Under these procedures, NAFTA member-country investors (but not their investments such as a subsidiary) as well as the member governments themselves can submit certain types of disputes to binding arbitration.9 Consultation and negotiation must be tried first. An investor can seek arbitration if consultation and negotiation fails and if the investor can claim monetary loss or damages resulting from an alleged breach of obligations under section A of chapter 11 of the NAFTA agreement (or certain other articles). Under NAFTA procedures, a tribunal would then fulfill both steps of the arbitration procedure outlined above unless the disputing party asserts that the measure at issue falls under any of the stated exceptions to NAFTA (set forth in annexes I through IV of the agreement). In this last case, the NAFTA commission can make a ruling on this interpreta8. The federal governments of Mexico, the United States, and Canada, as well as the state and provincial governments of these nations and investors from them, are parties to the agreement and thus have recourse in these procedures. 9. In particular, an investor can request arbitration of a government measure that is alleged to violate subchapter A of chapter 11 or of Articles 1502(3)(a) or 1503(2) of the NAFTA (see discussion in chapter 3).

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tion that would be binding on the tribunal. If the commission makes no ruling, the interpretation is left in the hands of the tribunal. The tribunal then proceeds under either the rules of the International Center for the Settlement of Investment Disputes (ICSID) Convention or those of the UN Commission on International Trade Law (UNCITRAL). If it finds in favor of the company, the tribunal can make a monetary award, which each party agrees to enforce in its own territory, but the tribunal cannot order a party to cease or desist from a practice, policy, or law that it determines to be in contravention of NAFTA obligations.10 If a member government is alleged to not enforce the award, the commission can establish a panel to determine whether this is so and, if it is so found, to recommend that the defaulting government comply. Thus, both the scope of disputes that can be resolved under NAFTA chapter 11 procedures and the outcomes of the resolution procedures are narrower than what is envisaged in the dispute settlement mechanism in the ideal accord on international direct investment. The main weakness of the NAFTA procedures is the fact that arbitration is possible only if monetary damages can be established by the investor. However, in some situations, it might be difficult to establish such damages— as with those resulting a government’s failure to adhere strictly to a national-treatment standard. Nonetheless, the NAFTA procedures go substantially beyond any thus far created and serve as an important precedent for any future multilateral investment accord. On the matter of the ceding of national sovereignty, the European Court of Justice provides another precedent. The Court can hear issues arising between firms and EU member nations where the issue involves a possible conflict between EU rules and national laws or policies bearing upon the operations of the firm. The Court’s decisions are binding upon both the firm and the member-nation government. To date, European governments have abided by the Court’s rulings. However, the power of this court goes far beyond anything that has been envisaged at a worldwide multilateral level, and it is almost surely politically impossible that such power would be granted to an institution at this level.

Arbitration and Sanctions Nation-states could accept the obligations outlined above in principle but fail to live up to them in practice. Or they might not heed the recommendations of a dispute resolution panel. Such failures do indeed lie at the heart of the international trading system’s weaknesses. Before the 10. In certain circumstances, instead of awarding monetary damages, the tribunal can award restitution of property, but in this case, the disputing party can pay monetary damages in lieu of the restitution. 60

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creation of the WTO, GATT law was particularly weak in enforcing obligations, and its working thus largely depended upon voluntary compliance. The new dispute settlement procedures described above strengthen the WTO’s enforcement powers significantly in principle, but these procedures are largely untested in practice. As already noted, enforcement of an investment accord would in some ways be more problematic than enforcement of trade agreements. For example, the accord would affect corporations whose activities span the jurisdictions of multiple nationstates; if the dispute settlement panel were to recommend that such a firm cease and desist from an activity and local authorities were disinclined to enforce the recommendation, what would be the recourse? The usual (but historically weak) mechanism for enforcement is some sort of sanction, including so-called countervailing measures. Should an investment accord make provision for sanctions? If so, what forms should these take? Are there alternative means to ensure compliance? The answer to this last question is almost surely no. Thus one has to ask whether the sanction-based system can be improved upon. Modern game theory suggests one approach that derives from the observation that, to be effective, sanctions must have “bite.”11 The right amount of bite is not easily determined, but possible means of increasing it include cross-retaliation, reciprocity, and “ganging up.” In the context of an investment agreement, cross-retaliation would imply that governments would ultimately be empowered to use trade measures to retaliate against failure of a nation to implement the investment rules. Under reciprocity, one nation would be allowed to withhold right of establishment or national treatment to firms controlled by investors in a nation that denies similar treatment to the investors of the first nation. And “ganging up” means a group of nations might jointly and collectively impose sanctions on a nation whose policies were deemed out of line.

Ancillary Codes A number of ancillary codes should be negotiated alongside (or attached to) an international investment accord. The primary objective would be to harmonize conflicting national practices that affect business activities related to international investment. The issues discussed here do not have to be part of an accord on investment per se; in many instances, they might be dealt with separately. Likewise, inclusion in the following list does not imply that they ought to be part of the accord. Rather, the effort here is to summarize all of the major issues that have been raised as potentially ancillary to international investment. 11. A brief description of this approach and the rationale behind it is provided in appendix B.

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Taxation and Transfer Pricing There are numerous issues involving taxation of the income of international corporations and their affiliates that might be usefully addressed. An international code on taxation could, for example, set standards for transfer pricing and delimit options for governments for adjusting reported earnings to reflect possible transfer pricing discrepancies. Transfer pricing refers to the prices one affiliate (which could be the parent firm) charges another for intermediate goods or services. In deciding what prices to charge, the global corporation seeks to shift its income out of high-tax countries and into low-tax ones, to the detriment of the high-tax countries’ revenue base. Transfer pricing disputes typically involve two governments (those of the exporting and importing countries) as well as the firm itself. Resolution of such disputes, where they could not be solved via consultation, could be referred to the dispute settlement procedures outlined earlier, but only if there were international standards for transfer pricing to which reference could be made. A further objective might be creation of a central clearinghouse for intergovernmental sharing of information on taxation to provide a means by which tax authorities could check the consistency of tax returns filed in various countries. Such information would be useful to determine whether transfer prices were consistently reported to all affected tax authorities. If authorities could make such checks easily, disputes over transfer pricing might then be minimized. An ultimate objective might be harmonization of tax law among signatories. OECD member nations have achieved some limited progress along these lines through a series of mostly bilateral tax treaties that strive to eliminate double taxation. A more far-reaching approach would be an agreement by governments to give up the right to tax income on a worldwide basis and to instead tax on a territorial basis. Under such a system, governments would no longer tax income on overseas affiliates of corporations based in their territories (although not necessarily on dividends deriving from this income). The rationale for such a move is detailed in Hufbauer and van Rooij (1992). Worthy of consideration along these lines would be adoption of a system of worldwide unitary taxation. Worldwide unitary taxation addresses an almost intractable problem in taxing international firms’ operations: notably, that it is all but impossible to determine what profit originates in one country versus some other when the firms’ operations in these two countries can be interlinked in so many ways (e.g., by direct transfer of product or service or by transfer of intangible assets such as technology or managerial know-how). Unitary taxation would allow a national (or a regional, state, or provincial) tax authority to prorate the percentage of the total profits of the firm worldwide on the basis of a formula that takes into account the percentage of the firm’s 62

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total sales, assets, or employees that are located within its jurisdiction and to assess a tax on the basis of this prorated share. The firms themselves oppose worldwide unitary taxation, largely because of the efforts by certain governments (especially those of the US states; see Graham and Krugman 1995) to impose it unilaterally. These governments typically have done so because they believe that such a system would increase local tax revenue. Not surprisingly, governments that would lose revenue from such a system have not joined these governments. Firms might not, however, oppose universal adoption of worldwide unitary taxation, if they were to be reasonably assured that their worldwide tax assessments would not significantly rise. The OECD, it should be noted, has indicated that worldwide unitary taxation does not violate principles of national treatment as long as the local operations of international firms are not, as a result, taxed at rates higher than similar domestically-controlled firms.

Competition Policy Competition policy encompasses antitrust (antimonopoly) and restrictive business practices issues but also extends into such areas as state aids to enterprises. Both legal and economics scholars have argued that, in an era of global businesses, the regulation of competition should be global in scale, and some proposals have already emerged (e.g., Scherer 1994; Fox 1995). Some aspects of the regulation of competition are very international. Transborder mergers and acquisitions have become commonplace, and the question naturally arises as to which authorities should review them. Allegations abound of the existence of international cartels. However, there are significant substantive and procedural differences among national competition policies (Graham and Richardson 1996), and some nations do not even have formal policies. In the United States, for example, certain violations of competition statutes carry criminal penalties, whereas in most nations violation of competition laws is a matter of civil law only. Both the United States and Europe scrutinize large mergers and acquisitions, but under quite different criteria. In the United States, a so-called “efficiency defense” can be used to justify a merger that would significantly increase seller concentration in a market (i.e., the merger might be allowed if significant cost savings were to be realized that would result in savings to consumers); in Europe, an efficiency defense is not allowable. However, in Europe, whole industries can be routinely granted “block exemptions” that immunize them from certain aspects of competition law, whereas with one exception (major league baseball!) such exemptions are unheard of in the United States. Japan has what appears on paper a tough antimonopolies law, but critics alTOWARD NEW RULES ON INTERNATIONAL INVESTMENT

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lege that Japanese enforcement is so weak that the law effectively does not apply to many large corporations (see, e.g., Bergsten and Noland 1993). In recent years several nations that previously did not have competition laws have enacted them. This includes China, which now has a law on restrictive business practices but not yet one on monopolies (such a law is contemplated, however). The new Chinese law has been criticized as being ineffectively enforced and not capable of dealing with some of the most salient competition-related issues in China (Liu 1994; Li 1996; Ma 1995; Song 1996). Other nations that have passed competition laws during the past 10 years include Russia, Poland, the Czech Republic, France, Italy, Taiwan, Mexico, Colombia, and Argentina. Korea has substantially modified an existing law in order to strengthen enforcement procedures. Malaysia, Indonesia, and a number of other countries are considering such laws. A spectrum of global approaches to the problem can be envisaged: at one end, creation of a worldwide authority, perhaps within the WTO; a middle ground of harmonization of national laws; and at the other end, creation of better means by which national (and in the case of Europe, the supranational DG IV) authorities could consult and cooperate. A worldwide authority has a certain appeal, but actual implementation of such an authority would be bedeviled by an almost endless string of problems: Without consensus among nations on the appropriate substantive standards for competition policy, what would be the standards at worldwide level? What would be the powers of discovery of a worldwide authority—for example, would it have independent powers or would it work through national agencies? What remedies could it propose, and how would these be enforced? Harmonization of competition laws also makes substantive sense (worldwide operations of global corporations would probably be more efficient if subjected to consistent competition standards), but again, differences in substance and procedures are probably too great to enable effective harmonization in the near future. Probably the best shot for improvement in international competition policy therefore lies somewhere in the domain of new or better mechanisms for cooperation among national (and European) authorities (see Graham and Richardson 1996).

Accounting and Reporting Standards The development of common accounting and reporting standards for all international corporations has long been discussed. Common standards would be exceedingly useful for a variety of reasons. First, if all international corporations meeting threshold requirements were required to 64

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disclose basic balance sheet and income statement requirements at the levels of both the consolidated corporation and the national subsidiary, most of the pressure for unilateral national reporting requirements (e.g., the failed “Bryant amendment” to the US 1988 trade act) would be obviated. Second, it would then be possible to create a data bank for such corporations from which information for research and regulatory purposes could be drawn. Third, and perhaps most important, because markets work best when participants are well-informed, it would be desirable, simply on market efficiency grounds, to have uniformly prepared, publicly disclosed information about the activities of multinational firms.

Environment Environmental damage done in one nation can undoubtedly harm other nations, and one step toward controlling this damage would be uniform standards for meeting environmental objectives. While an international environmental code would surely depend upon national authorities for its enforcement, it would nonetheless be useful for nations to agree upon minimal acceptable standards (see Esty 1994; Cline 1992). National treatment considerations (and common sense) would argue that such standards would be binding upon locally controlled enterprises as well as subsidiaries of international corporations. The existence of a code would not preclude that national (or supranational or subnational) authorities in certain nations might choose to enforce a higher level of standard than that called for in the code.

Intellectual Property International rules in this domain have already been agreed upon and embodied in the Trade-Related Aspects of Intellectual Property (TRIPs) agreement in the Uruguay Round (see chapter 5). The relevant issue for this chapter is whether stronger and more comprehensive rules are needed. Beyond this, there might be a case for harmonization of national laws and mutual recognition across boundaries of patents, trademarks, and other forms of intellectual property protection. Intellectual property issues pervade the area of international investment as much as the area of international trade, and greater enforcement of intellectual property rights is a priority of multinational firms. The main provisions of the TRIPs agreement call upon countries to enact and enforce effective laws to protect intellectual property rights. Developing minimum standards for IPR was a priority in the Uruguay Round both because multinational firms found the coverage or enforcement of such laws in many countries inadequate and because countries found that the lack of such laws and enforcement was often a deterrent TOWARD NEW RULES ON INTERNATIONAL INVESTMENT

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to technology transfer. Whether TRIPs actually improves protection for intellectual property is an issue to watch. As just suggested, TRIPs could be expanded to cover such issues as harmonization and mutual recognition. If nations could agree to recognize each other’s patents, trademarks, and other forms of intellectual property protection, firms could make fewer filings to obtain such protection. This would result in lower costs and greater efficiency. Mutual recognition would require at least some degree of harmonization of intellectual property laws. At a minimum, nations would have to first agree on minimally acceptable standards, and certain procedural differences would have to be resolved. (For example, the United States grants patents on a first-to-invent basis, whereas most other nations grant these on a first-to-file basis. So if the United States and one of these nations agree to recognize each other’s patents, legal problems could arise when a patent challenger shows that it invented the relevant product or service ahead of the patent holder. Such challenges presumably would be unacceptable to other nations.) It is premature, however, to recommend that nations harmonize their intellectual property laws and grant each other mutual recognition. The costs and benefits of such a system would first have to be assessed. All that is suggested here is that such a system ought to be at least considered.

Labor Standards A number of labor unions around the world, especially in the United States and Europe, have expressed concern that multinational firms seek to locate activities in areas where labor standards are below those that are considered internationally acceptable as per existing international agreements (most especially, those of the International Labor Organization, which ban, among other things, child labor, slave labor, and unsafe working environments). It has been suggested that some sort of new instrument is necessary to ensure that global corporations follow such standards. Thus, labor standards has been raised as a potential “new” issue for future multilateral trade talks under the WTO aegis. This issue could equally (and perhaps more effectively) be dealt with in the context of an investment agreement if consensus on the need to address the issue multilaterally could be achieved.

Corruption and Illicit Payments Likewise, there is sentiment (coming largely from within the US business community) that there should be standards to regulate illicit payments to corrupt government officials (Elliott, forthcoming). Corruption 66

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is doubtlessly a fact of life virtually everywhere, and the main issue is whether corruption could be curtailed via multilateral agreement. US business executives are particularly galled by the fact that illicit payments to foreign governments and their agents are essentially forbidden under the US Foreign Corrupt Practices act, whereas certain other advanced countries not only fail to forbid such payments but in some cases even allow home-country tax benefits to offset or partially offset such payments. The case thus has been most forcefully argued that there should be common rules for home-country treatment of such payments, and the OECD has in fact launched an effort to achieve such rules. Although corruption is probably a fact of life occurring in virtually every nation at some level, excessive levels of it can significantly retard the economic advance of a whole nation. There is thus a good case to be made on grounds of economic efficiency and equity for a mechanism that would curtail corruption. The issue is whether an effective mechanism can be designed and implemented on a multilateral basis.

Conclusion This chapter has laid out principles that should be at the heart of an international accord on international investment. Also, the chapter has presented outlines of some areas ancillary to international investment where international agreement at some level might be desirable and feasible. The next chapter explores the extent to which progress has or has not been made in achieving these principles.

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Postwar Efforts at Rule Making

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There is no comprehensive, international set of rules on foreign direct investment (FDI) or the operations of global corporations parallel to the international trade rules embodied in the World Trade Organization (WTO). However, there are rules that partially cover FDI—that is, they are either incomplete or apply only to a few nations. These include certain of the “new issues” agreements negotiated in the Uruguay Round and now administered by the WTO, as well as those struck in other bodies. In this section, all of these rules are surveyed, organized by the international organization or agreement in which they are codified: the WTO (including the predecessor General Agreement on Tariffs and Trade, or GATT), the Organization for Economic Cooperation and Development (OECD), the United Nations, the Bretton Woods institutions—the World Bank and the International Monetary Fund (IMF)—and the Asia Pacific Economic Cooperation (APEC) forum. The investment-related provisions of the two important regional trading regimes, notably the European Union and the North American Free Trade Agreement (NAFTA), are subsequently surveyed. In chapter 1 it was argued that new international rules on FDI are needed. Chapter 4 outlined what these rules should be. This chapter attempts two tasks. The first is to provide a history of existing rules, with an emphasis on why no comprehensive rules have yet been agreed upon. The second task is to outline relevant ongoing activities in international forums and the positions of key nations and groups of nations. 69

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Multilateral Efforts to Create FDI Rules WTO and the GATT The Havana Charter of 1948, which was to have launched the International Trade Organization (ITO) to supplant the temporary GATT arrangement, covered some investment issues. Unlike the GATT, the Havana Charter addressed both international direct investment activities under Articles 11 and 12 and competition policies (antitrust policies) under chapter V. Had it been ratified, the ITO thus would have had some competence over both government policies and actions affecting global corporations and the conduct of corporations themselves. The language of Articles 11 and 12, however, was rather weak and would not have per se provided for strong governance of host-nation policies and practices. For example, ITO member nations would have been exhorted “to give due regard to the desirability of avoiding discrimination as between foreign investments.” But member nations would not have been required to commit to nondiscrimination nor to right of establishment or national treatment. The Havana Charter was silent on many of today’s salient issues: for example, it laid out no rules such as on host- or home-nation investment incentives or performance requirements (most of which had not emerged as issues by 1947). Likewise, the Havana Charter contained no binding procedure to arbitrate disputes between investors and governments. All of these elements, as argued in the previous chapter, are requirements of a satisfactory international accord on investment. Under chapter V of the Havana Charter, the ITO would have had some powers to regulate the restrictive business practices of global corporations. Thus, it would have had much more authority to regulate the activities of international firms than to regulate government actions affecting these firms. This asymmetry represented a major flaw in the charter; effective international rules on direct investment should obligate governments as well as international firms to certain standards of behavior, with the rights and obligations of each set of parties explicitly spelled out. Thus, the Havana Charter really does not provide a model for what is needed now. Nor could it be expected to do so. The globalization of business was not then as large a phenomenon as it is today, and many of the issues discussed in the previous chapter had not yet become prominent. In the late 1940s, the charter’s drafters most wanted to ensure that restrictive business practices, such as international cartels to fix prices or to restrict territories in which member firms could sell, did not negate the gains from trade liberalization. Such cartels had figured significantly in world trade in the Great Depression years (Edwards 1942; Hexner 1945). Thus, the restrictive business practices provisions of the Havana 70

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Charter were meant primarily to deal with international trade issues rather than international investment issues per se. The Havana Charter was never ratified largely because of resistance from the US Congress (Diebold 1952; Schott 1990). Thus, the GATT became the major international instrument to guide world commerce. But, where the investment provisions of the Havana Charter were rather inadequate from today’s perspective, the GATT as originally drafted was totally useless: it did not deal with international investment or competition issues at all. Furthermore, until the Uruguay Round of multilateral trade negotiations that were begun in 1986, GATT rounds (and other negotiations under the GATT aegis) largely steered clear of these issues. Drawing on a report of the Joint Development Committee of the International Monetary Fund and the World Bank,1 the United States in 1981 began to raise the issues of host-government policies toward FDI and MNEs in GATT discussions. At the Punta del Este meeting launching the Uruguay Round, discussion of “trade-related investment measures,” or TRIMs, were included (see Graham and Krugman 1990 for an extensive treatment), partly to clarify ambiguities left in the wake of the GATT decision on the Canadian Foreign Investment Review Agency. The following mandate was established for the TRIMs exercise at Punta del Este: Following an examination of the operation of the 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. (GATT 1986)

The FIRA decision was the outcome of a dispute the United States brought to the GATT in 1982 over Canadian legislation that gave FIRA, a Canadian government agency that was later renamed Investment Canada and is now part of Industry Canada, authority to impose certain types of performance requirements on local subsidiaries of non-Canadian firms.2 A GATT panel ruled that FIRA’s imposition of local-content requirements was inconsistent with GATT Article III.4 (national treatment) on grounds that such requirements had the effect of discriminating against imported goods relative to locally produced substitutes. But the panel noted that countries could in principle invoke Article XVIII.C to justify these requirements. Canada accepted the panel’s ruling, but developing 1. This report was drafted by Dale Wiegel, now head of the Foreign Investment Advisory Service (FIAS) of the World Bank, and the author under the supervision of C. Fred Bergsten, then-acting undersecretary for international monetary affairs at the US Treasury Department and chair of the task force appointed to prepare this study. 2. Investment Canada as a separate agency of the Canadian government was dissolved in June 1993; part of the functions of Investment Canada were transferred to the Ministry of Foreign Affairs and part to the Department of Industry and Science.

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countries took the statement on Article XVIII.C to mean that their own local-content requirements were consistent with GATT law and that the FIRA ruling therefore did not apply to them. The TRIMs negotiations quickly bogged down over two issues. The first was defining a TRIM, and the second was determining whether the negotiating mandate covered TRIMs only as a condition of entry for the firm or TRIMs as a condition for receipt of investment incentives as well. On the second issue, the Negotiating Committee on TRIMs early on decided that investment incentives per se should fall under the jurisdiction of the GATT Committee on Subsidies. The United States, however, interpreted this to mean that both committees were to discuss TRIMs tied to investment incentives, while other nations held that this issue was reserved for the Committee on Subsidies. Given that investment incentive and performance requirements are often linked, the US position is intellectually defensible. However, TRIMs tied to investment incentives were doubtlessly put into the subsidies negotiations to reduce the scope of agreement in this domain; indeed, only limited restrictions on investment incentives tied to certain TRIMs emerged from the Uruguay Round (see below). With respect to what types of measures should be considered as “traderelated” conditions for entry, the United States proposed eight types of measures to be prohibited: local-content requirements, export performance requirements, local manufacturing requirements, trade-balancing requirements, production mandates, foreign exchange restrictions (other than those consistent with existing GATT articles), mandatory technology transfer, and limits on equity participation and on remittances. Japan supported the United States on the first seven of these measures (as conditions for entry) and the European Union on the first six. Other developed countries (e.g., the Nordic group) proposed shorter and more specific lists. However, when the Uruguay Round was completed in early 1994, only local-content and trade-balancing requirements and foreign exchange restrictions appeared in the final TRIMs agreement. In seeking an agreement to which all nations could subscribe, the negotiating committee bowed to the wishes of “hard-line” national governments, which resisted any discipline on TRIMs whatsoever. Thus, all but what were perceived to be the most egregious violations of existing GATT articles were removed from the list. This outcome did little more than codify the results of the FIRA decision and require nations to phase out GATTinconsistent policies. In the end all nations agreed to notify the WTO, within 90 days of its entering into force, of all TRIMs that were inconsistent with the GATT. Developed nations have two years to phase these out; countries categorized as “developing” or “least developed” have five and seven years, respectively. The phase-out period does not apply to TRIMs that were introduced within 180 days of the WTO entering into force; such TRIMs 72

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must be ended immediately, subject to one exception—countries are allowed to introduce new TRIMs during the relevant phase-out period if they are necessary to avoid disadvantaging existing investments currently subject to TRIMs. The whole issue of TRIMs is to be revisited before 2000 to determine if complementary provisions on investment or competition policy are warranted. As noted, the Committee on Subsidies was charged with looking at investment incentives. In the end, a small step was taken: subsidies contingent upon export performance or domestic sourcing were banned. Because export performance or domestic sourcing requirements themselves are banned under the TRIMs agreement, these categories of banned subsidies reinforce this agreement. The Uruguay Round also dealt with other issues that bear upon international investment. One of these was trade-related intellectual property (TRIPs) policies, of relevance to FDI because multinational firms are often the conduit of technology transfer to developing nations. The ultimate objective of the industrial nations was to encourage developing nations to strengthen their patent and copyright laws and enforcement. Many developing nations, especially in Latin America, had already been unilaterally doing so in order to lure inward technology transfer by multinational firms. Certain developing nations raised objections to overzealous enforcement of the TRIPs policies. They referred in particular to industrial nations’ use of border measures to block the imports of “clone” products from developing nations on grounds that these violate patent or copyright laws, when in fact no violation could be established in a legal proceeding. Unlike in the TRIMs exercise, the developed-nation position largely prevailed in the TRIPs negotiation, doubtless because most of the larger and more rapidly growing developing nations were also shifting to greater legal protection for intellectual property. These nations have recognized that foreign suppliers of advanced technology are increasingly unwilling to transfer the technology (or even in some cases to sell products embodying it) in the absence of strong intellectual property protection. The TRIPs agreement has several key provisions: n National treatment. A nation must grant to the nationals of all GATT member nations treatment with respect to intellectual property no less favorable than the nationals of that nation. n Most-favored nation. Any advantage a nation might grant to the nationals of another nation must be extended immediately to the nationals of all members. n Detailed rules on patents, copyrights, trademarks, service marks, etc. There are also provisions protecting trade secrets and industrial dePOSTWAR EFFORTS AT RULE MAKING

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signs; integrated circuits are granted special protection. Additionally, there is a provision that prohibits any “indication” on a product that would mislead a consumer with respect to its true origin. n Ban on anticompetitive practices in licensing of intellectual property. The main provision calls for intergovernmental consultation where licensing practices might hinder competition. n Enforcement and dispute settlement procedures. Minimum obligations of governments with respect to procedures for enforcing intellectual property rights within their territories are established. Foreign holders of intellectual property rights must have access to these procedures. Disputes under the TRIPs agreement are to be settled under WTO dispute settlement procedures. Developed nations had one year from entry into force to accept the obligations of the TRIPs agreement and to bring their laws and practices into compliance with it. Developing nations would have five years to do so and least-developed nations eleven years. Developing nations are allowed five additional years (to bring the total to ten) to implement laws and policies affecting pharmaceuticals and agricultural products that comply with the TRIPs agreement. A third area taken up in the Uruguay Round and bearing upon international investment was the General Agreement on Trade in Services (GATS). In many service industries, it is difficult to disentangle international trade from international investment. For example, in insurance, international trade is generated when insurance policies for individuals in one nation are written by a firm based in another. But such a transaction cannot on practical grounds take place unless the firm has offices and staff in place in the host as well as the home nation, and for legal reasons these offices and staff typically must be organized as a local subsidiary of the firm (and hence direct investment must take place). Indeed, in this industry, it is often difficult to determine on tangible grounds exactly where, geographically speaking, the creation of the service takes place, and hence difficult (and possibly moot from any but a legal perspective) to disentangle “local” provision of services by affiliates of multinationals from international trade in these services. For example, if the US office of a German insurer writes a policy for a party in the United States, this would be a sale associated with direct investment. But if the company’s home office in Germany writes an identical insurance policy, this would be considered an import of services into the United States from Germany. And, if the US subsidiary wrote the policy but the home office paid claims on it, the policy would have aspects both of a sale associated with direct investment and international trade in a service. Similar statements can be made about financial services industries (e.g., 74

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banking, investment banking, and securities brokerage). In some service industries, international trade is virtually synonymous with FDI; for example, international hotel chains cannot exist without FDI. Correspondingly, GATS’ provisions for services are as much investment-related as trade-related. Part I of the basic agreement on services defines its scope, differentiating among (1) services provided in one member’s territory to consumers in another member’s territory, (2) services provided by affiliates of one member’s nationals inside another member’s territory, and (3) services the nationals of one member provide within another member’s territory. This last distinction comes into play, for instance, in banking: If a subsidiary of a bank domiciled in country 1 provides a banking service in country 2, GATS provisions in category 2 apply. But if a local branch of the country 1 bank provides the service in country 2, category 3 provisions come into play. Parts II and III of the GATS thus contain a number of provisions that could be placed in the more general investment accord this book proposes. For example, the draft agreement contains a most-favored nation (MFN) obligation whereby each signatory nation “shall accord immediately and unconditionally to services and service providers of any other party, treatment no less favorable than that it accords to like services and services providers of any other country.” (Countries, however, may specify exceptions for MFN.) Part II requires transparency in relevant national laws and regulations and requires that they be objectively and impartially administered. Further, parties must ensure that state-sanctioned exclusive service providers do not abuse their positions and that restrictive business practices are subject to consultations between parties with a view to their elimination. Finally, part II contains both general and security exemptions from obligations. Part III pertains to market access and national treatment. Under the GATS, however, these are not general but rather sector-specific obligations, specified in individual national schedules. Thus, for example, a foreign-controlled insurance company is not entitled under the GATS to national treatment in any given nation unless the schedule of that nation lists the insurance sector. This “positive list” approach is anything but positive because a service activity does not benefit from its government’s obligations unless that activity is explicitly listed. Under the market-access provisions, barriers to market access by non-national services providers would be reduced over time, providing of course that the specific industry is listed. Also, the national-treatment provision is of rather strange construction. Unlike under a general concept of national treatment as would pertain to foreign investors, domestic suppliers and those of nationals of other members are not necessarily accorded substantially the same treatment under national laws and regulations under the GATS. Rather, POSTWAR EFFORTS AT RULE MAKING

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nations are merely obliged not to modify conditions of competition in order to favor domestic suppliers. A number of annexes to the draft agreement spell out provisions for specific service sectors. Overall, the Uruguay Round agreements introduce a number of new measures into international trade law that bear substantially upon FDI and the operations of multinational firms. Most of these constitute positive steps in that they are designed to liberalize the environment in which multinational firms operate. However, they fall far short of constituting a comprehensive set of rules for international direct investment.

OECD During the 1960s, the member nations of the OECD created two codes— the Code of Liberalization of Capital Movements and the Code of Liberalization of Current Invisible Operations—under which each nation pledged to remove barriers to inward or outward investment (including but not limited to direct investment), to allow free transfer of capital following liquidation of assets or the obtaining of long-term loans, and to allow current transactions (payments of dividends, interest payments, royalties, etc.). Although in principle OECD member nations have accepted these codes as binding, there is no mechanism in place by which they can actually be enforced, and national law or policy can override them. Under the first of these codes, member nations are exhorted (but not required) to avoid introducing new exchange restrictions on capital movements or making existing regulations more restrictive. In principle, OECD members agreed when they adopted the Code on Capital Movements to accept the obligations therein in toto, although they would be phased in. However, member governments were allowed “to lodge reservations” (Article 2b) relating to Article 2a obligations when an item on list A, annex A (capital movement items) became applicable to them or when an item was added or an obligation extended to list A. Members could also lodge reservations at any time regarding items on list B, annex A (transfer items). These reservations are in annex B of the code, a glance at which reveals that Australia, Austria, Finland, Greece, Ireland, Italy, Japan, New Zealand, Norway, Portugal, Spain, and the United States all have listed at least some reservations with respect to inward direct investment. Many of these were sector-specific. In addition, all OECD nations can, under Article 3, take actions affecting international capital flows to maintain public order or public health, protect essential national security interests, or fulfill international obligations relating to peace and security without filing reservations. An OECD member country can also lodge a “derogation,” the distinction being that the former is a long-term exception and the latter is in principle a temporary measure. The two codes in principle bind each member country to 76

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a “standstill” on new reservations and derogations—that is, it has an obligation not to enlarge its list of exceptions.3 Under OECD procedures, the standing Committee on Capital Movements and Invisible Transactions (CMIT) regularly reviews the practices of each member country to determine if these obligations are being met. In principle, any member country can demand that the country under review or any other country explain and justify any new measure that might violate code obligations. Also, the code calls for these governments to permit liquidation of nonresident-owned assets and the transfer of the assets or the proceeds of the liquidation, including capital gains thereon (Articles 1b and 2c). How well the reviews have actually functioned is open to some debate. On one hand, reviews are scheduled regularly basis, and objections to individual countries’ policies and practices are raised (but because the record of the sessions is not made public, it is difficult to know how often this happens). On the other hand, knowledgeable individuals have claimed that certain OECD nations have made no effort to bring national policies into line with the obligations of the code despite regular findings that reviewed policies violated these obligations. In addition to the two codes discussed above, which do not provide for full national treatment for foreign-controlled enterprises in member countries, the OECD in 1976 drafted a nonbinding “national treatment instrument” (NTI). OECD nations choosing to adhere to the NTI (all currently do) must in principle grant national treatment to enterprises that are controlled by investors from another member country, subject to reservations and derogations. A number of efforts have been mounted over the years to make the NTI binding and to make OECD countries subject to reviews similar to those conducted under the codes, but these have to date foundered over specifics.4 In particular, a US-led effort to significantly strengthen the NTI failed in 1990 over the issue of whether these provisions would be binding on local governmental entities. The European Union maintained they should apply to the individual states of the United States and the provinces of Canada, a proposition to which neither the US nor Canadian governments were willing to subscribe at the time. When the Declaration on International Investment and Multinational Enterprise was issued in 1976, the OECD nations also agreed to publish voluntary Guidelines for Multinational Enterprises, which were seen as an alternative to the UN code then under negotiation (see below). These 3. The codes also commit each member nation over time to “roll back” its exceptions— that is, reduce these in number or scope. However, in recent years, there has de facto been very little such reduction. 4. The OECD Committee on International Investment and Multinational Enterprise (CIME) is the organ that debates how to strengthen the NTI.

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guidelines attempted to establish new norms for disclosure requirements and plant closure procedures. Otherwise, they were largely an attempt to codify policies and practices that most OECD nations (and firms based in these nations) were already following. The United States indicated that it would accept the guidelines as a hortatory declaration only, one that had no standing in any actual situation involving US-based international firms. In 1979 the OECD nations agreed to take limited steps to make investment incentives that member governments offered to global firms more transparent. This was in response to a nascent US effort to bring some discipline to bear on investment incentives and performance requirements (see discussion on World Bank and IMF below). The OECD issued declarations and related measures, but again, these were not binding on either member governments or firms. In the fall of 1994, the OECD Secretariat began to prepare for creation of a “multilateral agreement on investment” (MAI) that would consolidate and strengthen existing codes and instruments. In June 1995, the annual meeting of OECD ministers endorsed this effort, and actual discussions among governments began in September. At the time of this writing, these discussions were just beginning, and no information was available on the outcome. Discussion of the MAI is taken up in chapter 6.

United Nations As already noted, the 1976 OECD guidelines were largely a response to negotiations within the United Nation that were driven by a bloc of developing nations. At the time, scholars of mostly leftist leanings, who believed the multinational firm a malevolent entity, heavily influenced the thinking in developing nations about these firms and their direct investment and bred a largely hostile response among national leaders. From about the time of the first oil crisis in 1974 until the debt crisis of 1982, these nations as a bloc (the Group of 77) lobbied the United Nations to create a “new international economic order” to foster developing nations’ interests (see essays in Bhagwati 1977). Two keystones of the “new international economic order” were to be a mandatory code of conduct for multinational firms and a code to regulate restrictive business practices of these firms. Although negotiating committees were formed, none of the major industrial nations saw these as serious exercises, and no international agreements resulted. The drafting of the code of conduct was begun in 1977 and originally was to cover only the conduct of firms. In 1980 it was agreed that the draft should be expanded to cover the conduct of governments as well. A completed draft was presented to the UN Commission on Transnational Corporations in 1982, but there was no consensus on whether to implement it. In 1988-90 certain developing nations and the UN Secretariat 78

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tried to revive the then-moribund negotiations on this code, and a revised draft was submitted to the Economic and Social Council, which forwarded it to the General Assembly. In 1992 the General Assembly failed to reach a consensus on the code, and a special intragovernmental group was convened to suggest further action. This group recommended that an alternative be found, in effect terminating the whole exercise.

International Bank for Reconstruction and Development (World Bank) and the IMF In 1979 the United States opened discussions with a group of developing and industrialized nations under the Joint Development Committee of the IMF and World Bank on possible discipline of host countries’ use of measures with potentially antidevelopmental effects. A Task Force on International Investment was constituted to explore this issue in tandem with OECD discussions on investment incentives and performance requirements. (See previous discussion on TRIMs in this chapter.) The task force also considered performance requirements on global corporations. The United States emphasized the distorting (and thus antidevelopmental) effects of these requirements when they became a condition either for entry by foreign firms or receipt of investment incentives. The result of these discussions was an interim internal report that said performance requirements could distort both development and world trade. A number of academic works subsequently bolstered this conclusion (e.g., Grossman 1981; Davidson, Matusz, and Kreinen 1985), one of which was a direct result of a study commissioned by the development committee (Guisinger 1985). More recent work has been done on the possible distorting effects of investment incentives (OECD 1989; Moran 1990; Loree and Guisinger 1995). Although neither the World Bank nor the IMF acted on these conclusions, as already noted, the report nonetheless was an important impetus toward launching of the TRIMs exercise. Within the World Bank, the International Center for the Settlement of Investment Disputes (ICSID) is designed to facilitate settlements of disputes between investor firms and host nations. There are 130 nations that are signatories to the ICSID. However, it has not been frequently used for this intended purpose. During 1994, for example, it handled only five cases. The ICSID could become more active in the future if it is used, as envisaged, as the principal arbitral body for the settlement of investment disputes under the NAFTA dispute settlement mechanism (see discussion below). Also within the World Bank is the Multilateral Investment Guarantee Agency (MIGA), an institution designed to supplement and perhaps eventually supplant national investment insurance programs such as the OverPOSTWAR EFFORTS AT RULE MAKING

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seas Private Investment Corporation (OPIC) in the United States. Like its national counterparts, MIGA was designed to encourage FDI specifically in developing economies. But, like ICSID, MIGA has been underused so far. In 1994, although 147 countries were signatories to MIGA, only slightly more than 100 total such contracts were outstanding, with contingent liabilities of about $1 billion. However, the demand for MIGA guarantees has been rising; in 1992 there were 244 applications for these guarantees, and in 1994 the number of applications more than doubled, to 574. Much of the demand for guarantees is associated with investment in the formerly socialist nations. MIGA also provides technical assistance to developing countries through its Foreign Investment Advisory Service (FIAS). In 1994, FIAS completed 29 projects in 26 countries.

Regional Approaches to FDI In addition to multilateral institutions, certain regional international groups have instituted rules on international investment and multinational enterprises. The most significant of these are the European Union and NAFTA, but APEC is also of interest. Interestingly, there is almost no overlap between EU and NAFTA rules. Whereas the European Union has built up a substantial body of law and policy in competition policy, which can affect international investment and multinational enterprises, there is little EU law and policy on international investment per se. By contrast, the NAFTA lacks competition law or policy but breaks new ground with rules explicitly directed toward FDI and multinational firms’ conduct.

European Union The Havana Charter, though never enacted, did raise concerns about international cartels. This concern was also reflected in several articles of the Treaty of Rome, which was drafted in the middle 1950s and established the European Common Market. Articles 85 and 86 deal with cartels and monopolistic business practices (or, “abuse of a dominant firm position”), and Articles 92 and 93 deal with state aids to industry or regions that might distort competition or intra-European trade. Significantly, the European Commission’s powers to deal with these practices exceeded those granted it in almost any other domain. There are no other Europe-wide rules or policy explicitly dealing with FDI or multinational enterprises in the Treaty of Rome, and it is an unsettled issue as to whether the European Commission can implement such rules or must negotiate them in international forums. 80

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Nonetheless, because of its rather broad powers to deal with cartels and abuse of dominant position, the Commission holds limited but significant power to regulate the European activities of global corporations. These powers, administered by Directorate General IV (DG IV) of the European Commission,5 the Competition Directorate, indeed have been used on occasion to regulate global firms, especially mergers. An early milestone in DG IV efforts to apply Articles 85 and 86 to mergers was the successful blockage in 1972 of an attempt by Continental Can Company of the United States to attain a dominant position in the European industry via acquisition (Brittan 1992). But the European Union did not have a merger regulation until 21 December 1989.6 Under the regulation, DG IV can review a merger or acquisition involving two firms that meet minimum size criteria and criteria for minimum involvement in the European Union. If these criteria are met, the Commission can block a merger or acquisition involving one or more firms not domiciled in or controlled by EU nationals. In fact, the first blockage of a major merger involved a non-EU firm—the proposed merger in 1992 of de Havilland, a Canadian-based aircraft firm under the control of the US aerospace giant Boeing, and Aerospatiale, the French partner in the European Airbus consortium. The European Commission has limited powers over governments as well as global corporations. The most important of these are powers to curb national governments’ subsidies to enterprises (including state-owned enterprises) under Articles 92 and 93. In particular, Article 92 states that “any aid granted by a Member state in any form whatsoever which distorts or threatens to distort competition by favoring certain undertakings or the production of certain goods shall, insofar as it affects trade between Member States, be incompatible with the Common Market.” Any measure that is deemed to be “incompatible with the Common Market” is, in principle, banned. This provision gives the Commission power to curb investment subsidies and other, subsidy-like investment incentives to multinational corporations. In practice, however, investment subsidies in Europe are rife, and little has been done at the level of the European Union to stem them. Rather, Article 92 allows for a number of exceptions to the basic principle (as do a number of other articles of the Treaty of Rome), and many investment subsidies fall into these exceptions. These include aid to regions where the standard of living is considered to be abnormally low and aid “to promote the execution of an important project of common European interest or to remedy a serious disturbance in the economy of a Member state.” In 19885. Article 3 of the Treaty of Rome requires that “the activities of the Community shall include . . . the institution of a system ensuring that competition in the common market is not distorted.” 6. This regulation actually entered into force in September 1990.

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90 the total state aid in Europe averaged $103 billion per year, of which about 40 percent went to manufacturing industries. In recent years, the European Commission has tried to toughen up its oversight of state aid to industry. Article 93 calls for the Commission to “keep under constant review” all systems of aid in the European Union, and it empowers the Commission to order such aid abolished if it is deemed incompatible with the common market. 7 In particular, under the tenure of Sir Leon Brittan as competition commissioner, DG IV attempted to abolish subsidies to many manufacturing firms, going so far as to order repayment of the subsidies in some cases, including subsidies paid as investment incentives to some multinational enterprises. However, member nations frequently questioned whether or not DG IV was overstepping its authority in doing so, and some of the cases were referred to the European Court of Justice. As of this writing, the Commission postponed a decision on whether to take action against the government of Austria, which reportedly paid as subsidies one-third the cost of a new Chrysler factory in Austria to produce minivans (The Economist, 8-14 August 1992; for an overview of EU state-aid policy, see European Economy, September 1991). The current competition commissioner, Karel van Miert, has continued to espouse Brittan’s policies on subsidies in principle, but many observers believe that DG IV under van Miert has in practice significantly softened its line.

NAFTA In contrast to EU law and policy, NAFTA does explicitly address direct investment (for analysis, see Graham and Wilkie 1994; Gestrin and Rugman 1993). Most of these provisions are in chapter 11. They include the following: n National treatment for investors from other NAFTA countries on the part of national, state, provincial, and local governments. Any such government must accord to investors (and their investments) from other NAFTA members treatment that is “no less favorable than that it accords, in like circumstances, to its own investors with respect to the establishment, acquisition, expansion, management, conduct, operation, and sale or other disposition of investments” (Article 1102.1).8 Thus, national treatment in the context of NAFTA includes right of establishment. 7. The relevant authority is also administered by DG IV. Under a 1972 treaty, the Commission can take measures against Austria if its policies are found to be incompatible with a free trade agreement with Austria. 8. Under NAFTA parlance, the term “investment” generally would include a subsidiary or other legal affiliate of a multinational firm and “investor” the parent organization of that subsidiary. 82

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n Most-favored nation and minimum standard of treatment provisions (Articles 1103-1105). These are designed to ensure that any treatment a NAFTA government accords to investors and investments from NAFTA countries is no less favorable than treatment granted to investors and investments from non-NAFTA countries. n Most new performance requirements on investments in NAFTA countries are banned, and old performance requirements must be phased out (Article 1106). Also, most linking of performance requirements to receipt of subsidies is prohibited. These prohibitions apply to all investments, and not just those of NAFTA investors. n NAFTA investors can convert earnings, proceeds of sales, loan repayments, or other capital transactions into any foreign currency at prevailing market rates of exchange (Article 1109). n No NAFTA country can expropriate investments of NAFTA investors, except for a public purpose, on a nondiscriminatory basis. Where countries do so, expropriations must follow due process and investors must be paid at the fair market value of the investment and without delay (Article 1110). NAFTA chapter 11 sets new procedures for the resolution of investment disputes (Articles 1115-1138) that go beyond any other existing or proposed mechanism. Under these procedures, most investors (but not the entities created with the investments) may seek arbitration of a dispute against a member country. In most other international agreements (e.g., those of the GATT), only governments have standing to use the dispute settlement mechanism, and hence an investor must be represented by a government in dispute proceedings, even if the government is not a direct party to the dispute. Under NAFTA chapter 11, however, investors can pursue claims against a NAFTA government on their own behalf or on behalf of their investments (e.g., a subsidiary) if they can claim monetary loss or damages resulting from alleged breaches of chapter 11 obligations (or certain other obligations) by that government. An effort must be first made to resolve the dispute through consultation and negotiation (Article 1118). If these fail, the dispute can be submitted to binding arbitration under the rules of the ICSID (see above) or the UN Commission on International Trade Law (UNCITRAL). Under either set of rules, an arbitration panel can order interim measures to protect the rights of the disputing investor and order that an award be made to the investor in the form of monetary (but not punitive) damages and/or restitution of property with applicable interest. This tribunal cannot, however, order a government to revoke or rescind a measure deemed to be in violation of NAFTA obligations. Any award the tribunal grants does not prejudice that investment’s right to relief under domestic law. POSTWAR EFFORTS AT RULE MAKING

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Although the NAFTA chapter 11 dispute settlement procedures break new ground, they still fall somewhat short of an ideal mechanism. These issues are taken up in chapter 7. One further note is that investors may avail themselves of other NAFTA dispute settlement procedures. Indeed, the chapter 11 procedures complement rather than substitute for more traditional ones. NAFTA members may take numerous exceptions to the chapter 11 obligations, including general exceptions (e.g., national security) and country- and sector-specific ones, spelled out in the annexes to chapter 11 (discussed in detail in Gestrin and Rugman 1993; Graham and Wilkie 1994). The environmental accord negotiated as a “sidebar” to NAFTA includes a provision that no country will lower its environmental standards in order to attract a new investment undertaking. NAFTA also contains provisions on competition policy and the regulation of state enterprises and state-sanctioned monopolies, as well as measures to liberalize trade in financial services, which inter alia grant right of establishment to financial service providers of one NAFTA country in the territories of others. Somewhat offsetting the liberalizing provisions of the NAFTA in the view of many are complex rules of origin. These prescribe complex and legalistic procedures for calculating local content, which, in the view of at least some analysts, favor incumbent firms over new entrants from outside North America. It is too soon to assess the effectiveness of the NAFTA provisions on direct investment. In principle NAFTA investment provisions represent a significant net step forward. Indeed, many of these provisions parallel the description of an ideal international accord on direct investment, described in the previous chapter.

APEC The APEC Ministerial Declaration of the meeting in Jakarta, Indonesia, in November 1994 endorsed a set of nonbinding investment principles. The APEC Eminent Persons Group had suggested just such a course at the 1993 ministerial meeting in Seattle. The APEC Committee on Trade and Investment (CTI) developed the APEC principles for consideration at Jakarta, following instructions of the APEC heads of state, who met at Blake Island, Washington, just after the Seattle ministerial meeting.9 The CTI experts group on investment principles met several times 9. Also, the Pacific Economic Cooperation Council (PECC), through its Trade Policy Forum, had developed a similar set of principles in the form of a model voluntary code for direct investment. This code was presented for APEC members’ consideration at the Seattle meeting. 84

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during 1994 to draft the principles. It was agreed that the objective of these principles would be to facilitate, rather than to inhibit, FDI and technology transfer. The principles would be strictly nonbinding and thus, inter alia, would not prejudice existing applicable international instruments, including bilateral investment treaties. The representatives of the various APEC nations expressed considerable diversity at the CTI meetings on what policy regimes toward FDI were desirable, and in the end many compromises were struck. As a result, they emphasized principles to which the APEC nations as host nations to direct investment might aspire rather than be bound: n Transparency. Member countries are to make all laws, regulations, administrative guidelines, and other instruments of policy (including those instruments by which policy is actually implemented) publicly available in a readily accessible form. n Nondiscrimination between source economies. Member countries are to extend to investors from any nation treatment in relation to the establishment, expansion, or operation of the investors’ investments (e.g., subsidiaries) that is no less favorable than that accorded to investors from any other nation in like circumstances. n National treatment. With exceptions as provided for in domestic laws, regulations, and policies, member nations are to accord to foreign investors, in relation to the establishment, expansion, operation, and protection of their investments, treatment no less favorable than that accorded in like situations to domestic investors. n Investment incentives. Member nations should not relax health, safety, and/or environmental regulations as an incentive to foreign investments. n Performance requirements. Member countries are to minimize placing of performance requirements on foreign investors as a means of achieving policy objectives in circumstances where these would distort or limit expansion of trade and investment.10 n Expropriation and compensation. Member nations should not expropriate foreign investments or take measures that have the effect of expropriation on a nondiscriminatory basis, except for a public purpose and in accordance with the laws of the country and principles of international law. If an investment were expropriated, the investor would be adequately and effectively compensated. 10. It should be noted that member nations of the WTO will be subject to the TRIMs agreement, which will disallow the use of certain types of performance requirements such as domestic-content or trade-balancing requirements. Because most APEC member nations are WTO members, some believe the APEC agreement represents retrogression.

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n Repatriation and convertibility of funds. Member nations are to 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. n Dispute settlement. Disputes arising in connection with a foreign investment are to be settled promptly through consultations and negotiations between the parties to the dispute (the investor and the hostnation government) or, failing this, through procedures for arbitration in accordance with members’ international commitments or through other arbitration procedures acceptable to both parties. n Entry and sojourn of personnel. Member countries are to permit the temporary entry and sojourn of key foreign technical and managerial personnel connected with foreign investment, subject to relevant laws and regulations. n Avoidance of double taxation. Member countries are to avoid double taxation of FDI-related income. n Investor behavior. Foreign investors should facilitate acceptance of investment by abiding by the host nation’s laws, regulations, administrative guidelines, and policies. n Removal of barriers to foreign capital. Regulatory and institutional barriers to the outflow of investment are to be minimized. One question that might be legitimately asked: if these principles are not binding, of what value are they? Do they, for example, protect investors in any meaningful way from arbitrary or capricious actions by host or home governments? Given that governments are not bound by the principles, a violation of any of them could not be challenged in national courts because these principles would have no standing in domestic law. Likewise, it is hard to conceive of a government being willing to enter into arbitration of a dispute involving alleged breach of one of the principles under the ICSID or UNCITRAL rules. Thus, in a legalistic sense, the principles provide no protection. The principles could be of value, however, if APEC governments were inclined to bring national law and policy into conformity with the principles or even simply that in the de facto exercise of law and policy they elected to observe the spirit of the principles. Western lawyers might be somewhat discomfited by the rather imprecise language of the principles. But in the legal tradition of many of the East Asian nations—as far as civil law goes, at least—the letter of the law is somewhat loosely or even ambiguously stated and the law is interpreted according to rules of reason. Also, the East Asian approach to dispute 86

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settlement is to seek resolution through informal means as much as possible and in a fashion where neither party “wins” or “loses” but where both parties accept an outcome that is fair to both. Such an approach requires a common understanding of what is fair. The APEC investment principles might thus help establish such an understanding in the national policy domain. Whether or not this comes to pass, the APEC experience in crafting investment principles demonstrated two things. The first is that a diverse group of nations, including some of the most dynamic of the newly industrializing economies, were willing to discuss an international convention on direct investment embodying the principles recommended in the previous chapter. The second, alas, is that while these nations are willing to talk about principles, they are not yet prepared to bind themselves to act on them. At the end of the day, the APEC investment principles were nothing but a hortatory declaration, and in language that is often ambiguous as well. The principles represent the beginning of a dialogue, but not a satisfactory end product.

Bilateral Treaties In addition to the multilateral efforts just described, there have been bilateral treaties to advance international agreement on investment. Perhaps the most successful have been those governing the tax treatment of global corporations. A key object of many of these treaties is preventing double taxation by host and home country. In some cases, bilateral treaties have resulted in a small degree of tax law harmonization. Of more limited success have been bilateral investment treaties (BITs) struck between European and developing nations, as well as similar treaties between the United States and a few developing nations. BITs typically provide for national treatment, freedom of capital movement, and some protection against expropriation. In principle, full global liberalization of investment policy could be achieved via a large network of BITs. In practice, this would be difficult to achieve. If BITs were to be written between each pair of the nations, the total number of such treaties would exceed 7,000. Simply to negotiate these would require a virtual army of lawyers, and BITs now link relatively few pairs of nations. It is sometimes argued that until the world is ready for a multilateral investment accord, BITs can fill some of the role such an accord would play. But most nations willing to enter into a BIT with, say, the United States probably would be willing to consider entering into a multilateral investment accord. Accordingly, BITs would seem to be something of a stopgap measure at best. POSTWAR EFFORTS AT RULE MAKING

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Changing Positions of Major Home and Host Nations As this survey indicates, existing international rules on direct investment are incomplete both in terms of geographic and substantive scope. But why has international agreement in this area proved so difficult to achieve? In answering this question, we shall also explore why some of these difficulties may be waning.

Industrial versus Developing Nation Perspectives One reason for these difficulties has been disagreement between industrialized and developing nations on exactly what investment rules might be necessary. The United States, home to a majority of the world’s FDI throughout much of the postwar era but now also the world’s largest host nation, has historically viewed any accord that might be achieved on international investment as something that would apply principally to host-nation governments. US leaders believe, in essence, that outcomes of international trade and investment should be market-driven in order to be welfare-maximizing and that interventionist host-government policies are globally welfare-reducing, even if they increase local welfare. If one accepts this rationale, one accepts ipso facto the need for disciplines to limit interventionist policies. This explains why the TRIMs exercise was US-led and oriented almost exclusively to host-nation policies and practices. Policymakers in most developing countries by contrast have perceived global corporations as powerful monopolists in the host-nation market that also tend to act as agents of home-nation policies. Thus, these nations have seen global firms as not necessarily serving developing nations’ own interests. Leftist economists long argued that selective government intervention could reduce both the total rents these firms captured and the percentage of rents transferred back to the home nation. Governments of developing nations therefore have tended to view any international direct investment disciplines as something that should be brought to bear first on the global corporations themselves and second on their home nations. These perceptions explain why the UN code of conduct exercise, initiated by the Group of 77 developing nations, focused largely on the regulation of the global corporations themselves (in UN parlance, “transnational corporations,” or TNCs) rather than host nations. National interest groups, as well as economic reasoning, has shaped industrialized and developing nations’ stances on investment policy. In the United States, for example, the two most prominent groups have been the US-based global corporations themselves and organized labor. 88

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Global firms have largely supported official US efforts to discipline hostnation policies but have often differed with official priorities at the level of specific policy measures. In particular, the global firms would accord greater priority than has the US government to right of establishment and equity limitation issues and less to investment incentives or performance requirements. Off the record, representatives of global corporations have indicated that when right of establishment was taken “off the table” in the GATT TRIMs negotiations, most US global corporations lost interest in the outcome of these negotiations, and that this is one reason for the comparatively weak outcome that characterizes the agreement. The US labor movement in contrast has generally opposed outward investment by US-based firms, claiming that it leads to domestic US job loss. Organized labor has thus supported US efforts to discipline performance requirements. But the labor movement on the whole sees this discipline as at most a second-best solution. In their eyes, the best solution would be unilateral US policies limiting the ability of US firms to place direct investment abroad. Thus, although both of these interest groups supported US efforts to create GATT disciplines on TRIMs (with lukewarm enthusiasm at best), the congruence between their interests and the official position has been by no means total. And on other issues (e.g., right of establishment), US global corporations and organized labor diverge. Developing-country positions also to some extent mirror the interests of local constituencies. In particular, in many developing nations, local industries have grown up as protected monopolies.11 One source of pressure in these countries for international regulation of global firms comes from local monopoly suppliers seeking both to maintain their protected status and to gain access to global firms’ technologies and markets. Performance requirements, such as local-content and export requirements, can serve the interests of local producers who resist efforts to liberalize economic policies. In some cases, these requirements can also serve the interests of incumbent operations of multinational firms that have carved out dominant positions in certain markets. Again, local interests have not been the only force behind developing countries’ policy preferences, as enunciated by the Group of 77. Many policymakers still uphold the long tradition of intellectual support for interventionist policies to protect small nations from the putative market power of global corporations. Yet one of the ironies of modern economic life is that intervention to protect these nations from international monopoly may help perpetuate local monopoly. Certain developing countries, however, have adopted a more accom11. The local monopolists in some cases include subsidiaries of international firms that entered the developing-nation markets under preferential arrangements.

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modating stance toward multinationals. These nations have recognized and sought the many benefits of FDI (e.g., technology transfer) but have simultaneously enacted policies, performance requirements in particular, to maximize the local economic benefit of this investment.

Europe What about nations that neither follow the increasingly distant drumbeat of the Group of 77 nor fully subscribe to the total reliance on the free of the United States? The European Union is both home and host to multinational firms, and most member governments have been both somewhat more sympathetic to the developing-nation perspective with respect to discipline on these firms than has the United States and somewhat less willing to impose strong discipline on host governments. Part of the reason for this doubtlessly derives from European nations’ postwar status as host governments themselves. During the late 1960s and early 1970s, there was a groundswell of fear in Europe that the European economic landscape would be dominated by US-based global firms (see, e.g., ServanSchreiber 1967).12 Fear of US domination has largely subsided in Europe, to be replaced to some extent by fear of Japan. Overall, many European nations have thus been somewhat ambivalent regarding international rules on FDI. At least some of the ambivalence has its roots in politics. Certain constituencies in Europe, for example, have opposed any effort to discipline host-country policy. These have included bureaucracies within national governments in Europe that have liberally used both investment incentives and performance requirements to lure new FDI projects to their territories. Ireland stands out in this regard. But even in countries where national policy has not been especially oriented toward attracting FDI, antidiscipline constituencies can be found. For example, most regional development authorities in Europe have used investment incentives and performance requirements, including those that were ideologically committed to free trade (e.g., the Thatcher and Major governments in the United Kingdom and certain of the Länder in Germany). Indeed, even governments critical of global corporations (e.g., France under Gaullist governments) have used these measures quite liberally to attract FDI on terms favorable to the domestic economy. Thus, these authorities are themselves a constituency for subsidies. And of course it stands to reason that the recipients—both firms and regions— would also lobby for continued subsidies. 12. However, interestingly, within Western Europe (and not just the European Union) sympathy for the developing-nation perspective has been strongest in the Scandinavian countries, not themselves major hosts to US-based firms. 90

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There have been European constituencies on the other side. Finance ministries throughout Europe have criticized regional policies and the accompanying subsidies. Officials have often questioned the policy of using subsidies to lure activities to regions where they have not been viable and then, for political reasons, continuing to subsidize them (see, e.g., Financial Times, 10 July 1992; The Economist, 10 June 1995, 70, and 16 December 1995, 73). Further, the finance ministries have noted that investment incentives to non-European global firms have often simply prodded new business activities to relocate from one region of Europe to another with no net gain to Europe as a whole. Europe may in the aggregate have even experienced net losses because the subsidies may have resulted in a transfer of resources to foreign shareholders. Thus, when Europe stood in favor of the TRIMs during the Uruguay Round, it harkened to the collective voice of European finance ministries. But at other times other constituencies have drowned out this voice. Because it comprises more than one sovereign state, Europe, of course, does not speak with a single voice on FDI. Of the large European nations, Germany has most consistently favored restrictions on government interventions affecting FDI; this has been true under both Christian Democratic and Social Democratic governments. By contrast, France has at times pursued highly interventionist policies toward direct investment and multinational firms; interestingly, intervention was far more frequent under Gaullist governments than under the Socialists. The United Kingdom has conditioned receipt of investment incentives on adherence to performance requirements, a practice initiated under Labor governments but virtually unchecked under the Thatcher and Major governments. The European Commission has sought restrictions on this type of practice and generally has stood for greater discipline on international investment, in part to increase its overall authority over the granting of state aids to industry. However, this has been done under the Article 92 authority of the Treaty of Rome, as discussed above, rather than as part of an overall policy on direct investment. Indeed, as discussed earlier, it is an unresolved issue whether the European Commission has competence over direct investment. On the whole, Europe until quite recently has been unprepared to support international rules on international investment, due in part to the political clout of those who give and receive the subsidies. But the European Union has been shifting its stance to come more into line with the US position, as is discussed below.

Japan Until recently, Japan has been neither major home nor host to much FDI. Thus, Japan has not historically been much involved in the debate POSTWAR EFFORTS AT RULE MAKING

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over the global corporation or on international discipline on FDI. However, since the late 1980s, Japan has emerged as home nation to a huge amount of FDI. As a result, Japan’s position is changing: worried about the asymmetry of its direct investment position, the government of Japan has been attempting to encourage inward investment. And in the meantime, Japan has been increasingly attempting to take a leadership role in multilateral initiatives, especially the OECD Multilateral Agreement on Investment.

United States Indeed, almost all nations have made major changes in their positions in recent years. One striking reversal was sparked by the rapid buildup of FDI in the United States during the 1980s, which made it the largest host to FDI in the world as well as the largest home nation. Beginning in the second Reagan administration and continuing through 1996, some US congressmen and senators have routinely decried a loss of “economic sovereignty” resulting from non-US firms extending their control over domestic industry and demanded that something be done to regain it. Consequently, a number of legislative changes have been enacted or proposed that have altered the liberal policy position of the US government toward FDI. Neither the Bush nor the Clinton administrations backed the most radical proposals, and thus these have failed to be enacted. Nevertheless, some of the changes do represent a retreat from the principle of national treatment for foreign-owned firms (see discussion below). The most important measure to be passed, the Exon-Florio provision of the Omnibus Trade and Competitiveness Act of 1988, gave the US president greater authority to block foreign takeovers of US domestic enterprises.13 The measure applies only to cases where national security is “impaired or threatened to be impaired” by the establishment of an affiliate of a foreign-controlled firm on US soil through a merger, acquisition, or takeover of an existing US operation. Thus, national security is marked as a legitimate “carve-out” for national governments in exercising obligations under international law. However, implementation of ExonFlorio has been characterized by moderation. In fact, the Bush administration chose to implement Exon-Florio in consonance with what it perceived to be the minimalist objectives of the original legislation (Graham and Ebert 1991). Of several hundred cases notified to the Committee on Foreign Investment in the United States 13. The original measure was linked to the Defense Appropriation Act and had to be renewed with this act. However, in late 1991, the measure was made part of permanent US law. (See Graham and Krugman 1995 for a fuller treatment of Exon-Florio.) 92

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(CFIUS) during 1988-92, only fourteen were subject to a full investigation, and only one actually was blocked. This one case was the proposed takeover of a minor firm in the US aerospace industry by a state-owned enterprise of the People’s Republic of China, and the block was seen as a largely politically motivated reaction to the events in Tiananmen Square in 1989. However, in the summer of 1992 state-owned French firm Thomson CSF withdrew a proposed takeover of the missiles and aerospace division of LTV almost surely because the deal would have been blocked under Exon-Florio. Some observers have seen this as a slight hardening of the administration’s position on foreign takeovers of defense-sensitive US properties, and the deal led to changes in the administration of Exon-Florio that tilt in this direction. Some analysts expected the Clinton administration to pursue a more activist enforcement of Exon-Florio than did the Bush administration. During the first three years of the Clinton administration, however, there were no controversial acquisitions of US high-technology firms, and thus it is difficult to distinguish any change in the level of activism. Indeed, what is most striking is that there is no evidence of a harder line.14 To be sure, the Clinton administration has promulgated administrative changes to Exon-Florio, but these were in fact formulated during the last year of the Bush administration. These are the new provisions: n Investors controlled by a foreign government may not acquire US defense contractors with Department of Defense or Department of Energy contracts totaling more than $500 million in any one fiscal year. n Entities under foreign government control cannot receive contracts involving access to information classified as “top secret” or higher, unless a waiver is granted by the secretary of defense. n All cases where an investor under the control of a foreign government seeks to acquire or merge with a US firm producing defenserelated technologies (including dual-use technologies) are subject to a mandatory Exon-Florio investigation. n The president’s science and national security advisers are added to CFIUS, the interagency group that conducts Exon-Florio reviews. n Detailed reports must be presented to Congress of all cases CFIUS reviews. 14. To many observers, the strongest indication of the Clinton administration’s policies toward FDI lies not in its implementation of Exon-Florio but in its acceptance of NAFTA, with its strong investment chapter.

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n The secretary of defense can require that analysis of the potential for diversion of critical technology be part of a CFIUS investigation. n In an investigation, CFIUS must consider a transaction’s impact upon US “international technological leadership in areas affecting US national security” and also consider the potential effect of the transaction upon proliferation of nuclear, chemical, and biological weapons and upon the capabilities of countries that support terrorism. n The Departments of Defense and Energy are required to create data bases to identify entities controlled by foreign governments that might pose risks to national security and to report to Congress on these. The net effect is to produce an assumption against acquisition of US firms engaged in anything remotely high-tech by investors controlled by foreign governments (even friendly ones) and to move toward more specific criteria for determining what is in the interest of “national security.” Other laws besides Exon-Florio have been enacted since 1988 that place some restrictions on the participation of foreign firms in US hightech activities (Warner and Rugman 1994). For example, the Energy Policy Act of 1992 allows a foreign-controlled firm to be eligible for Title XX through XXIII programs (which involve mostly programs for research, development, and commercialization of new energy-related technologies) only if certain reciprocity tests are met—basically, that US firms are afforded “comparable” participation in similar programs in the home country, have right of establishment in that country, and are afforded “adequate and effective protection” through home-country intellectual property rights laws. Also, the Department of Energy, before allowing participation in one of these programs by a foreign-controlled firm, must determine that such participation is in the economic interests of the United States. Similar requirements must be met before a foreign-controlled firm can participate in the Department of Commerce’s Advanced Technology Program (ATP), originally established under the 1988 Trade Act but amended in 1991 to include reciprocity requirements by the American Technology Preeminence Act. Likewise, similar requirements must be met if a foreign-controlled firm is to be allowed to participate in certain projects related to defense conversion, as specified in the 1993 defense appropriations bill. Responsibility for certification of eligibility for both the ATP and the defense conversion projects is given to the secretary of commerce.The National Cooperative Productions Act amendments of 1993, which exempt some manufacturing and R&D joint ventures from certain US antitrust provisions, also contain reciprocity requirements, most notably that the foreign-owned company’s home country must grant national treatment to US firms. However, national treatment is to be 94

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assumed if the country participates in an international treaty requiring national treatment for US investors. Amendments to the Stevenson-Wydler Technology Innovation Act of 1980, passed in 1993, require that foreigncontrolled firms participating in collaborative R&D arrangements with US national laboratories be from countries that allow US firms access to similar programs in those countries. Additional reciprocity measures were contemplated in a number of bills before the 103rd Congress, including the Aeronautical Technology Consortium Act, the National Environmental Technology Act, the National Competitiveness Act, defense authorization legislation, the Hydrogen Future Act, the National Aeronautical and Space Administration Authorization Act, and the Omnibus Space Commercialization Act. None of these measures actually passed, but they did reflect the mood of the Congress before the November 1994 elections and are thus detailed here. The most controversial of these were the Manton and Collins amendments to the National Competitiveness Act. This act itself would have amended and greatly expanded a number of existing acts, including the Stevenson-Wydler Act and the provisions of the 1988 Trade Act that established the ATP. The National Competitiveness Act would have authorized a wide range of government-funded or -organized consortia in R&D and commercialization of advanced technologies. Under the Manton amendment (sponsored by Representative Thomas Manton, D-NY), participation in these would be limited to “US companies.” A foreign-controlled company could qualify as a “US company” if reciprocity standards were met. Specifically, the amendment would have required a finding by the secretary of commerce that the country of the parent company provides US companies with “comparable” opportunities, offering them “access to resources and information equivalent to the opportunities offered under this legislation,” and has an “open and transparent standards-setting process.” Under the Collins amendment (sponsored by Representative Michael Collins, R-GA), the US government would be prohibited from providing any direct financial aid to anyone not a US citizen, national, or legal alien. Critics feared that the Manton amendment would have violated precisely those national-treatment standards that the United States has long advocated as part of international law and, in doing so, set reciprocity standards that would have been difficult for most countries, even those that adhere to national-treatment standards, to meet. The Collins amendment, in turn, could have (under some interpretations) prevented any foreign-owned or -controlled company from participating in the relevant programs, no matter how well the reciprocity standards were met. None of these measures actually passed into law in 1994. The Clinton administration opposed the Manton and Collins amendments, as did a number of large US business groupings, and as a result the National POSTWAR EFFORTS AT RULE MAKING

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Competitiveness Act failed to pass.15 But some analysts claim that some other aspects of current US policy implicitly violate national-treatment principles. The partnership between the US government and the US auto industry to develop a new generation of fuel-efficient automobiles is cited as one example because foreign-owned firms are apparently (though not explicitly) excluded from this partnership. Whether the actual working of the partnership de facto violates national-treatment principles is difficult to determine.16 None of the measures just discussed were resuscitated during the Republican-controlled 104th Congress, currently in session at the time of this writing, despite the fact that there is a wing of the party (represented by Patrick Buchanan among others) that might favor such measures. Thus, for the moment, the furor over foreign participation in government-sponsored or government-funded R&D consortia that fueled the Manton Amendment has calmed down. Whether this will continue to be the case should the Democratic Party regain control of one or both houses of Congress or should the current Republican majority move further to the right is uncertain, however. In some contrast to the US Congress, individual US state governments tend to be wildly pro-FDI. Most of these governments in 1992 were actively courting inward direct investment, often offering potential investors large investment incentives to locate within their jurisdictions.

The Effect on Europe and Japan of US Shift Overall, the United States has shifted its policy on FDI toward a little more conditionality in the application of national-treatment standards to some foreign-controlled firms operating in the United States. On balance, this has really not been a very great change. Nonetheless, Europe and Japan understandably view any change in US policy, however slight or subtle, toward less liberalization with alarm because they are major home countries to FDI in the United States. Consequently, the shift in US policy has led to subtle shifts in the positions of both the European Union and Japan. For example, the European Union was a lukewarm US ally during the early 1980s on the issue of bringing GATT disciplines to bear on host-nation policy toward FDI. The EU position became apparent when 15. Letter to Representative John Dingell, chairman of the US House of Representatives Committee on Energy and Commerce, from US Secretary of Commerce Ronald H. Brown, 15 June 1994; letter to Secretary Ronald H. Brown, 27 July 1994, signed by heads of several prominent US business organizations. 16. This is just the sort of issue an international investment dispute settlement mechanism could usefully address (see discussion in chapters 4). 96

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the United States proposed, at a 1981 meeting of the GATT Consultative Group of 18 (CG-18), that the GATT Secretariat compile an inventory of trade-related investment measures. The European Union indicated support for the modest proposal in principle but then effectively killed it by indicating that resource constraints prevented it from being given priority. Since then, Europe has moved much closer to the US position. For example, by 1990, as previously indicated, the EU and US positions in the TRIMs negotiations were virtually identical. Why did Europe modify its position in favor of such discipline? Almost surely leading the list would be pressures from European-based global corporations. These firms have seen their stakes in their overseas affiliates rise enormously in the last decade, and thus their awareness of the detrimental effects of host-nation policies on their affiliates’ interests has risen as well. Indeed, the host nation these European firms are most wary of in this regard is the United States. Consequently, European officials have expressed great concern over the shift toward conditional national treatment exhibited in the proposed US laws outlined above. Their shift toward support of international discipline on host nations thus partly reflects their desire to secure a more liberal US policy. But the shift probably also reflects the growing scope of the European Commission’s jurisdiction in determining EU trade policies. As noted earlier, the Commission has long favored greater discipline on international investment and is claiming that international investment issues fall under EU competence rather than that of member-nation governments. Where this competence actually will reside, as it happens, will depend upon the venue in which new arrangements are negotiated (see chapter 6). Firms based in Japan have even more cause to be wary of the United States. Much of the US furor over foreign-controlled enterprises is an offshoot of a larger hostility toward Japan, which was reflected in congressional attitudes in the late 1980s and early 1990s. Most probably in response to pressures from Japanese industry, the Japanese government has hardened its position in favor of increased discipline on host countries.

Latin America But nowhere have attitudes toward FDI and multinational enterprises shifted more than among many of the developing nations. In many of these countries, the debt crisis of the early 1980s led to a reevaluation of their opposition to FDI as a means of drawing foreign capital into their economies. Under the de la Madrid administration, Mexico opened its economy to attract foreign direct investors. Mexico’s participation in the drafting POSTWAR EFFORTS AT RULE MAKING

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of NAFTA, with its pioneering provisions on direct investment, followed substantial unilateral liberalizing measures (Graham and Wilkie 1994). In June 1993, Mexico announced that it would incorporate its obligations under chapter 11 of the NAFTA into domestic law and extend mostfavored nation (MFN) status to all foreign direct investors and investments in Mexico, thus effectively extending the NAFTA obligations to all nations and all investors.17 Other Latin American nations have also unilaterally liberalized their policies toward FDI, most notably Chile, Argentina, Venezuela, and Colombia (Hufbauer, Schott, and Clark 1994). Chile began to reform its FDI regime in the late 1970s, well before the other countries, but a number of restrictions remain, such as those on profit repatriation, where other Latin American nations have dropped them. In addition, Chile continues to screen new inward FDI. Chile will likely be required to liberalize its policies further as a condition of joining NAFTA, as it seeks to do. Argentina began in 1989 to liberalize its policies, abolishing most performance requirements, freeing capital movement, and providing national treatment for foreign-owned firms. The reforms were fully codified in a 1993 decree. In 1989 Colombia issued a decree to implement reforms along lines similar to those of Argentina (i.e., to provide for national treatment, free movement of capital, and abolition of performance requirements). Colombian officials have claimed that its policies toward inward FDI were by 1993 even more liberal than those of Mexico. However, many significant sector-specific restrictions remain. Venezuela’s reforms are less extensive, with some performance requirements and many sector-specific exceptions to right of establishment and/or national treatment remaining. Not all Latin American nations have put FDI reforms in place. The major exception is Brazil, which still maintains a quite restrictive regime, including numerous sectoral restrictions on foreign ownership, restrictions on capital movement, and a plethora of performance requirements. The movement toward investment liberalization in Latin America must be evaluated in light of historic perceptions of these nations: FDI has long implied to them loss of control over their own destiny. But the debt crisis brought home to a number of these nations the fact that sovereign debt to international banks can imply even greater loss of control. In addition, the experiences of a number of Asian nations, especially Taiwan, Singapore, Hong Kong, and several other of the fastgrowing Southeast Asian countries have also demonstrated that a degree of openness to FDI can bring many developmental benefits. 17. ‘’Obligations’’ in this instance is to be interpreted as those in NAFTA chapter 11, part A. Non-NAFTA investors do not have recourse to the dispute settlement procedures (and the host-nation obligations under these procedures) of NAFTA chapter 11, part B. 98

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East Asia Will this lead to greater support among other developing nations for multilateral discipline on FDI? The answer may lie in those Asian countries that have used FDI to advantage. Singapore, Hong Kong, Malaysia, Thailand, and, to a lesser degree, Taiwan generally welcome FDI, but with strings attached. The strings are in the form of performance requirements, especially those designed to increase local value added and exports (and thus are prohibited under the terms of the final TRIMs agreement). These countries showed considerable reluctance to give up these policies during the TRIMs negotiations. This reluctance was further borne out in discussions held during 1994 leading to APEC’s adoption of its nonbinding investment principles, which, as noted earlier, were substantively weak as well as nonbinding. But officials of these countries are worried about trade restrictions in the industrialized world that can be invoked as sanctions for performance requirements (e.g., the United States has taken action against Taiwanese performance requirements under section 301 of the trade act on grounds that their effect is to nullify the benefits of liberalized trade to the US economy). With the implementation of the Uruguay Round, these countries almost surely will have to phase out performance requirements that are inconsistent with the TRIMs agreement or face the near certainty of sanctions. They might thus be willing to exchange new rules restricting performance requirements on foreign investors for a stronger multilateral discipline on bilateral sanctions. But perhaps an even bigger impetus to these nations’ acceptance of international rules is the opening of China to FDI. Since 1990, China has become quite open to FDI, where before it was virtually closed. With a home market potentially larger than any other in the world, China has received a large and growing amount of FDI (see chapter 2). China’s policies are not wholly unrestrictive. Direct investors in China often must meet performance requirements, but they have often received investment incentives.18 A number of basic issues remain unresolved in China: property rights, including intellectual property rights, are often ill-defined or poorly enforced, and affiliates of foreign firms operating in China are often denied national treatment. However, the attraction of the Chinese market, and the desire of many multinational firms to establish foothold operations there, has resulted in substantial numbers of foreign firms entering China, often in joint venture with Chinese partners, with no indication that the flow of FDI into China will abate significantly in the near future. The interest of foreign investors in China has proved worrisome to a 18. At the time of this writing, China was taking steps to reduce the number and magnitudes of investment incentives being offered.

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number of its Asian neighbors, who fear possible diversion of investment from their markets. These fears do not seem well founded. For example, Urata (1995) demonstrates that FDI into China by Japanese electronics firms has not displaced the activities of these firms in other Asian nations. Nonetheless, this fear of diversion has encouraged Asian officials to at least enter into dialogues about whether international rules might be useful. The APEC nonbinding investment principles represent one manifestation of this willingness. As little as five years ago, even this limited agreement would have not been feasible.

Other Developing Nations Even some developing countries that continued to take a hard line on rules on FDI during the 1980s and to espouse the “new international economic order” have shown some inclination toward liberalization in the 1990s. Leading the list is India, whose policy stance in international forums did not change during the 1980s, despite some internal liberalizing reforms attempted under the Rajeev Ghandi administration. However, in the 1990s India has begun to recognize the benefits of FDI and accordingly has loosened its regulations regarding inward direct investment. It would be premature to announce that a major policy shift has been effected there—in international forums India still clings to its hardline position—but the beginnings of such a shift are clearly evident.

Conclusion This chapter demonstrates that most of the elements of an international accord on direct investment outlined in the previous chapter exist in one international agreement or another. However, the myriad international agreements on direct investment amount to something of a crazy quilt. Coverage of existing agreements is partial both in terms of geography (different nations participate in different agreements, and some nations participate in several) and substance. Provisions of some agreements are nonbinding, as in the case of the APEC investment principles, or unenforceable as in the case of the OECD codes and instruments. Wouldn’t it make sense to convert this crazy quilt into one coherent agreement that operated worldwide? This question is addressed in the next chapter.

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Finding the Right Forum Once negotiated, any accord on international direct investment and multinational enterprise must be implemented and administered. This entails empowering an organization to take on the task, including the dispute settlement mechanism. In this chapter, two alternative venues for the negotiation, implementation, and administration of an accord on FDI are explored: through the World Trade Organization, or WTO (Jackson 1990; Julius 1994) or through a more limited group of nations such as the Organization for Economic Cooperation and Development (OECD). Other alternatives can be envisaged—for example, an entirely new international organization to deal only with investment issues—but these two are probably the most likely candidates. During the fall of 1995, the OECD nations in fact began negotiations on a Multilateral Agreement on Investment (MAI), and so this chapter focuses largely on specific issues that are likely to arise in the context of these negotiations. However, other accords with limited participation can be envisaged: for example, via regional economic groups such as the North American Free Trade Agreement (NAFTA), which already contains extensive provisions relating to foreign direct investment (FDI), the Mercado Común del Sur (Mercosur), the Asia Pacific Economic Cooperation (APEC) forum, the European Union, and/ or other regional arrangements. Because of their immediacy, the OECD negotiations warrant close examination. However, whether the OECD either will be or even should 101

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be the ultimate venue for an accord on FDI is not a settled issue. Direct investment has also been suggested as a “new issue” for the WTO and will almost surely be included on the agenda for the WTO ministerial meeting to be held in Singapore in late 1996. Therefore, both the WTO and the OECD (as well as regional arrangements other than the OECD) must be considered as viable alternatives, and thus arguments for and against each are laid out here.

The World Trade Organization (WTO) A strong case for implementing a future accord on FDI through the WTO can be advanced on both substantive and institutional grounds. The main substantive argument for electing the WTO is that trade and investment policy issues are inextricably linked (Julius 1994). In services, trade and investment are especially linked, a fact that motivated the Uruguay Round negotiators to construct the General Agreement on Trade in Services (GATS), which is as much an investment agreement as it is a trade agreement.1 International trade and direct investment are also intimately related in many manufacturing industries, though the GATS agreement is not designed to apply to them. Global corporations handle a large percentage of world trade (more than one-third of merchandise trade), and its share in some nations is even higher (e.g., as high as one-half in the United States; see chapter 2). And, as has been covered in earlier chapters, the overall scope of WTO rules pertaining to direct investment in manufacturing is narrow and inadequate, despite the creation of the Trade-Related Investment Measures (TRIMs) and Trade-Related Aspects of Intellectual Property Rights (TRIPs) agreements, which do apply to this sector as well as to services. On the institutional side, the principal case for including a direct investment accord in the WTO is that its membership includes most of the world’s nations and will likely be enlarged to include the few that are not (such as China). OECD membership, by contrast, includes but a handful of developing nations. But developing nations are increasingly important both as host and home nations to direct investment. The barriers to FDI in these nations are typically higher than in the developedcountry OECD nations, and thus the potential benefit of an investment accord is significantly greater if it were to cover many if not all developing nations. The fact that most of the world’s nations are presently members of WTO is both a plus and a minus. If a satisfactory accord on investment 1. But, as noted in chapter 5, the “positive list” approach to implementation of GATS constrains the coverage of the key national-treatment provision. 102

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could be negotiated and implemented within the WTO, it would involve most of the nations of the world, a very desirable goal. But to be effective, any such accord would necessarily cover new ground beyond the competence that at present is granted to the WTO and hence would require extensive new negotiations. Even a minority of WTO members could hamstring such negotiations at the outset. Such obstacles could be serious even in an ongoing negotiation that on the surface appeared to be heading in the right direction. For example, many of the shortcomings of the TRIMs agreement can be traced to the original negotiating mandate that all measures covered in this agreement be directly and explicitly trade-linked and that any new measure, to the greatest extent possible, be placed in the context of existing GATT articles. This narrow mandate virtually precluded creative thinking or indeed even a thorough consideration of the relevant issues involving investment. If an issue was determined to not be “trade linked,” it could not be considered, no matter how relevant or urgent it might have been in a broader context. This has led certain prominent authors to wonder if the WTO is a suitable vehicle for dealing with global issues such as investment and technology policy. Ostry (1990, 89) notes, for example, that “the rules-based GATT is not appropriate to deal with the innovation policy set [of issues].” Indeed, the WTO’s own procedures prevent it from doing so. An effective investment accord within the WTO would require major rethinking and redirection of this organization’s role. APEC’s struggle to negotiate nonbinding investment principles attests to the difficulties the WTO could expect on this score. The APEC exercise, involving a number of important WTO member countries (and one important prospective member, China), demonstrated that a number of these countries are not at present prepared to take on binding new obligations regarding direct investment. Many of the dynamic, newly industrializing nations of East Asia are among the most reluctant, despite their efforts over the past 10 years to liberalize policies toward direct investment. However, as is noted later, the APEC experience might not be the definitive word on what might happen if investment issues were included in a future round of comprehensive negotiations under WTO auspices. Because of the multiple issues a large multilateral round covers, progress can be made on all fronts through compromises and trade-offs across areas, where negotiations dealt with one by one would have stalled. It is also possible that the reluctance to adopt investment rules will erode as policy liberalization continues. As discussed in chapter 5, reevaluation and liberalization of policies toward direct investment have taken place in many nations, including the East Asian nations, with a resulting overall trend toward greater openness. Even if this trend has not now reached the point where a strong investment accord can be achieved, NEGOTIATING AND IMPLEMENTING AN INVESTMENT ACCORD

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it may yet. For example, 10 years ago, consensus on even the relatively weak, nonbinding principles that were agreed in the APEC would not have been possible. If liberalization continues apace, a meaningful WTO investment accord may become politically feasible in another 10 years. Furthermore, a plurilateral agreement within the WTO is not out of the question—that is, an agreement could be constructed to which only a subset of member nations would sign on. There are precedents to such agreements (e.g., the Agreement on Government Procurement negotiated originally in the Tokyo Round). Of course, for such an agreement to have meaning, a majority of the largest host and home nations to FDI would have to be signatories. However, all of the nations that would sign an OECD agreement would presumably also sign such a plurilateral agreement, and some nations not party to the OECD agreement might sign on as well. In such a case, a plurilateral WTO agreement would definitely be preferable to an OECD-only agreement. It is also possible that an effective investment accord might be more feasibly negotiated in the context of new, comprehensive negotiations to further modernize international trade law, rather than as a stand-alone exercise aimed exclusively at FDI. This, again, is because there would be more scope for “give and take” (as there was in the Uruguay Round) than is possible in more narrowly focused talks. Thus, for example, developing countries might be more willing to enter into an agreement granting strong rights of national treatment to direct investors if these countries were to receive greater access to developed nations’ markets for goods and services in products for which they hold comparative advantage. Finally, a case for the WTO can be made on grounds of the increased leverage that can be gained vis-à-vis the ongoing accession talks with nonmember nations, especially China and Russia. In both of these nations, issues of national treatment for foreign-controlled enterprises loom large. In recent discussions over future Chinese membership, it has been made clear that improvements in the treatment of foreign-controlled enterprise will be one condition for this membership. An investment code within the WTO thus could motivate policy reform within both nations. Alas, although this means of promoting investment policy liberalization would be of utility now, negotiations at the WTO level could not begin until 1997 and would presumably not be concluded for at least a year or two. Until then, the OECD MAI is the “main show in town” with respect to investment policy.

Organization for Economic Cooperation and Development There are two main arguments for creating an agreement on investment within the context of the OECD: first, such an accord could be 104

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freed from the current WTO constraint that all issues be explicitly tradelinked, and second, the OECD nations have relatively common goals respecting what the rules governing international trade and investment should be. Thus, these nations ought to be in a better position to create an effective agreement than is the WTO. Whether this is in fact the case is, of course, an untested proposition. Whether or not the OECD can achieve an investment agreement embodying significantly higher substantive standards than the WTO might rest on how well the MAI does in terms of national treatment. No OECD nation has openly opposed granting national treatment to foreigncontrolled enterprises, both as it applies to existing businesses and to right of establishment, as long as reservations and derogations are allowed. But a number of questions naturally arise. Should there be restrictions on the scope of these reservations and derogations? Would signatory countries to an MAI be allowed to retain all existing reservations and derogations? Would these countries be allowed to add new reservations and derogations once the MAI came into force? Should there existing reservations and derogations be rolled back? Interviews with officials from a number of countries have led this author to conclude that the OECD countries probably could agree to treating most (but not all) reservations and derogations in much the same manner as they were treated in the drafting of the NAFTA:2 n national treatment obligations are binding on all NAFTA governments, including state, provincial, and local governments; n all existing reservations and derogations are “grandfathered”—that is, allowed to remain in effect (but certain Mexican reservations are to be phased out over time); n all existing reservations and derogations at national, state, and provincial levels are to be listed item by item; n under a “standstill” provision, the lists may not be expanded. But is the “grandfathering” and “standstill” outcome good enough? OECD member countries have many such reservations in place (including but not limited to sector-specific ones) that are more than irritants. One objective of the MAI must therefore be to identify these and to resolve the difficulties that they pose. In the following, these reservations are identified by major category and an effort is made to determine where major difficulties lie.3 2. OECD terminology is maintained here; the NAFTA refers to “reservations and exceptions.” 3. There is some overlap in the categories presented here, but this is necessary to illustrate the facets of various problem areas.

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Potential Thorns in Negotiations over National Treatment A number of issues including national treatment will arise in MAI negotiations. The most salient of these are discussed in this section. The same issues would arise if the accord were negotiated elsewhere; hence, the following discussion is relevant regardless of whether they are negotiated within OECD, the WTO, or, indeed, some other group.

Screening of Inward Investment A number of member countries (e.g., Japan, Canada, Mexico, France, and Belgium) have on the books laws that permit government screening of inward foreign investments on economic or public-interest criteria (in the case of France, only acquisitions and not new “greenfield” investments can be screened). US government officials have indicated informally that, in their view, screening authority on any but national security criteria constitutes an unacceptable denial of full right of establishment and that the MAI should bar this screening on any except national security grounds. One would hope that this largely anachronistic issue can be resolved. Those countries that legally can screen inward investment no longer exercise the authority particularly aggressively (if at all). Also, most countries that have screened investment can accomplish the same objectives through other, nondiscriminatory means (e.g., application of competition policy, especially merger control, which poses no national-treatment objections). The easy solution would be for countries simply to allow such authority to lapse de jure in order to bring national law and policy into conformity with an MAI. But will this happen? One OECD member, Mexico, reportedly was willing to allow its authority to lapse as part of the NAFTA negotiations but decided to hang on to it in the face of Canadian determination to retain the Investment Canada Act, which establishes Canadian screening authority. Consequently, NAFTA permits screening of FDI. Where other relevant nations come out on this matter is yet to be revealed, but one would hope in the context of an MAI that Mexican sensibility would prevail in Canada and other nations that still have this authority.

National Security Exceptions Almost all OECD nations agree that nations must be allowed to maintain national security exceptions to national treatment, but there is considerable variance as to how encompassing these should be. In the offthe-record interviews, officials of certain OECD nations said they thought the US Exon-Florio provision oversteps the bounds of what a legitimate national security exception ought to be. As is covered in some detail in 106

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chapter 5, this law gives the US president the authority to block a takeover of a US firm by foreign investors if the takeover threatens to impair the national security and if no other remedy to the threat is available in law. Such decisions are final and not subject to court challenge. Most OECD member nations have some means to block takeovers of domestic economic activity by foreign interests for national security reasons. The US authority is exceptional in that it explicitly applies specifically (and only) to takeovers by foreigners. Also, because the Exon-Florio authority leaves very open the question of exactly what constitutes a threat “to impair the national security,” a xenophobic US president could use the authority to block virtually any takeover of a US firm by any foreign investor for any reason whatsoever. Although objections to the discriminatory nature of the Exon-Florio law (and the fact that it is not subject to judicial review) could be raised in the context of an MAI, most OECD members most likely see the objective of this law as legitimate. What MAI negotiations could usefully address is the appropriate bounds of national security exceptions to national treatment. As one senior US official explained, at the extremes it is easy to see where exceptions do and do not apply: a foreign takeover of a hotel chain does not threaten national security whereas a takeover of a major aerospace firm may pose such a risk. But many cases that come before the Committee for Foreign Investment in the United States (CFIUS), the interagency committee that administers Exon-Florio, fall into a gray area. For example, should the government, on national security grounds, mandate that a producer of specialized capital goods for manufacturing advanced integrated circuits maintain domestic ownership? In one celebrated case, the acquisition of the US-owned firm Semi-Gas by the Japanese firm Nippon Sanso, the US president ruled “no,” but many in the US Congress (and, apparently, in the US Defense Department) criticized the decision. Clearly, the definition of boundaries for these exceptions need examination and clarification.

Exceptions for Cultural Activities or Industries The problem largely arises in the context of the video broadcasting and motion picture industries, where France, Italy, and Canada reserve a certain percentage of capacity (i.e., broadcast time, film showings) for domestic produced or, in the case of the EU, regionally produced material. These nations argue that without such set-asides, foreign-made productions (especially US-made ones) would dominate available capacity, thus undermining the cultural identity of the local populace. The counterargument is that people should be allowed to view what they wish, irrespective of its origin. Technology will likely make the whole issue moot. The expression NEGOTIATING AND IMPLEMENTING AN INVESTMENT ACCORD

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“information superhighway” has become something of a cliché, but underlying it is a very real phenomenon, notably an explosion in the number of modes by which a high volume of information can be conveyed. Fiber-optic communications networks can now or soon will give households access to hundreds of video channels, including movies. Millions of books, documents, and data bases can be accessed via the Internet or written onto compact discs (and households commonly possess desktop computers that can access on-line services and read these discs). What point is there, then, in attempting to reserve some portion of information transmission capacity for local content? It is likely that households will eventually have ready access to virtually every “cultural” product ever made. If governments then attempt to restrict household access to foreign-produced products, circumvention of will be increasingly easy and costless. Governments worried about preservation of local culture would be far better advised simply to make sure that local cultural activities survive and that the products of these activities are accessible (even by subsidizing them, if there is a consensus that this is a wise use of taxpayer money). Also, governments should recognize that expansion of the channels and modes of information transmission will almost surely in the long run help make these activities viable.4 Also, efforts of nations to limit expansion of the “information superhighway,” or to put burdensome controls on the data that flow along it, are likely to be detrimental to the competitiveness of firms within those nations that depend upon information flow. Government review and permission is required for data transmitted in and out of Singapore, for example. Consequently, certain major financial institutions have located data processing operations elsewhere, to the detriment of the growth of Singapore as a major financial center. Nonetheless, reservations to national treatment for cultural activities and sectors will remain an issue in the MAI negotiations. But the issue can be resolved via bargaining. The United States, which objects to such reservations, will likely accept some such reservations (or, at least, will mute its objections) if these are sufficiently small in scope and coverage. Certain European nations and Canada will seek reservations of greater scope. A compromise likely can be reached such that none of the concerned governments will be particularly happy with the outcome. And 4. The proliferation of modes of information transmission might indeed bring new prosperity to local culture because of a widening of the market for products embodying this culture. For example, this author has recently taken to viewing films made in China that are available on videocassette, an activity that would have been unlikely before the advent of this technology. By viewing them (and paying for the privilege), the author is doing his part to ensure that the Chinese film industry remains viable. And, when such films can be obtained via on-line access, as is almost sure to happen, this will expand the market for such films. 108

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in the end, the day will come when these governments realize that technology has made the issue truly moot. Closely related to this issue is that of restrictions on participation by foreign-controlled firms in information transmission sectors; these restrictions are mostly created by government-sanctioned monopolies and associated practices. These are discussed separately below.

Technology Support Programs As noted in the previous chapter, concerns over this issue have flared in recent years because of legislation proposed before the 103rd US Congress (the Democratic-controlled Congress of 1993-94) that would limit participation by firms under foreign control in certain US governmentsponsored programs. The European Union was particularly vigorous in its opposition to the proposed legislation—none of which actually passed into law. Canada, Japan, and other OECD member nations also expressed concerns through a number of official channels. At the top of the list of objections have been the Manton and Collins amendments to the National Competitiveness Act—the Manton amendment for its impossibly high reciprocity standards and the Collins amendment for prohibiting European participation in key programs, regardless of reciprocity standards (see chapter 5). On the other hand, the Manton amendment was a response to perceptions of some members of the US Congress that US firms and their subsidiaries were excluded from technology programs sponsored by foreign governments and/or were barred from selling technologically sophisticated goods in certain foreign countries. Furthermore, these practices and barriers were perceived as not always transparent. Congressional ire centered mostly on Japan, but certain European programs (e.g., the ESPRIT information-technology R&D program and the JESSI semiconductor research program) also evoked concerns. Likewise, foreign firm participation has been restricted in certain US R&D consortia, such as Sematech. This is another issue that is liable to fade with time. The Manton and Collins amendments did not become law, nor has the Republican Congress shown interest in reviving them. Both Europe and Japan have eased strictures against admitting foreign-controlled firms into technology consortia receiving public assistance. Nonetheless, participation of foreign-controlled firms in governmentsponsored R&D consortia and other technology programs is a valid issue for MAI discussions. Technology consortia are likely to grow in scope and importance, and more of these will involve participants of more than one nationality. They should be subject to unconditional national treatment except where a valid national security issue is involved. Technological development is, after all, very much a positive-sum game, and NEGOTIATING AND IMPLEMENTING AN INVESTMENT ACCORD

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the long record of history reveals that it is pointless to try to contain commercially useful technology within a national boundary. Furthermore, in the relatively few cases where overriding national security considerations demand that certain technologies not be transferred (e.g, those associated with the production of nuclear weapons), it is best that all countries holding these technologies limit the transfer in concert. Governments must, of course, set criteria for choosing participants in government-funded technology consortia. Not all applicants will be chosen, whether the applicants are domestically or foreign-owned. Thus, a useful exercise would be an examination of whether a truly “nationality-neutral,” transparent national benefits test—or other criteria for selection—can be devised. If so, perhaps it could become the norm within the MAI: all countries would agree to use such tests and criteria in selecting program participants.

State-Sanctioned Monopolies and Other Sector-Specific Reservations Certain sector-specific reservations, and especially those involving statesanctioned monopolies as exceptions to national treatment, are likely to be among the most contentious of all issues raised in the context of an MAI.5 Some of the sectors involved (e.g., telecommunications services) are among the most dynamic in terms of both growth potential and pace of technological development. Alas, there is a high potential for impasse on this set of issues. In the NAFTA negotiations, for example, neither Canada nor the United States rolled back any sectoral exceptions to national treatment. Mexico agreed to roll back some of its restrictions, but had a much longer list to start from, and these sectoral “concessions” involved sectors that officials had already decided should be at least partially liberalized (e.g., petrochemicals, where much modernization of the Mexican industry is needed). Discussions in this area thus are likely to be characterized by aggressive efforts on the part of some nations to reduce others’ reservations while retaining their own. For example, as already suggested, the US government will push hard for liberalization in information industries such as telecommunications services but will defend its own anachronistic Jones Act restricting foreign participation in intra-US maritime shipping. In such an environment, few if any sectoral reservations will likely be removed. This would be a shame. To be sure, some of these reservations, the 5. The effect of state-sanctioned monopolies is to deny right of establishment to foreigncontrolled firms. Although it could be argued that no national-treatment issue is involved because domestically controlled firms also lack right of establishment, this would seem disingenuous, given that some domestic firm (often state-controlled) does have access to the sector. 110

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Jones Act among them, are little more than irritants, but they are irritants with little contemporary justification. They should be reduced or eliminated. Most contentious will be those associated with the transmission and processing of information; the relevant sectors center around (but are not limited to) the computer and telecommunications industries. The telecommunications industry in many OECD nations is characterized by state-sanctioned monopoly in the provision of services and preferential relations between the service provider and capital goods suppliers.6 The industries are undergoing rapid technological change, and new technologies are creating market opportunities, some of which overlap other industries that increasingly must be viewed not as separate sectors but as different domains in one large industrial complex (as in fiber-optic network services to transmit products of the film, television, or publishing industries). The issues involved in “mega-sectors” go well beyond investment reservations, and, indeed, these issues illustrate better than any other example the intertwining of trade and investment. Is cross-border data transmission a trade issue or an investment issue? It has to date been categorized as a trade issue, but if one starts to examine who has the right to construct and operate fiber-optic “loops,” the investment component enters the picture quickly. The transformations in this sector are so profound the whole issue of state-sanctioned monopoly probably ought to be reexamined more or less from the beginning. Do the preconditions originally used to justify monopoly (e.g., the existence of “natural monopoly”) still exist, and if so, in what subsectors of the industry? In what subsectors can competition be of most benefit? Will MAI discussions proceed to sort out these issues rationally? Probably not. Nonetheless, countries should recognize that there is much intellectual basis for reexamining sectoral restrictions in the name of national interest. Such a recognition could go a long ways toward liberalization of existing sectoral reservations.

Other Issues Related to National Treatment There are additional issues related to national treatment, three of which are discussed here: most-favored nation (MFN), corporate governance, and privatization.

Most-Favored Nation (MFN) In the context of OECD, agreement on language for a most-favored nation clause should be easily attained. 6. However, deregulation and privatization are changing the structure of the industry in some of these countries.

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What will not be easy, however, is agreement on whether there should be any exceptions (or, as they are termed, “carve-outs”) for “regional economic integration organizations” (the European Union and NAFTA are examples of REIOs). If an REIO is granted such a carve-out, a member state could offer better treatment for regional investors (and the entities in which they invest) than the MAI offers; that is, it would not have to extend this treatment to MAI signatories outside the REIO. In the NAFTA, non-MFN treatment to NAFTA members is largely confined to use of the dispute settlement procedures of chapter 11, part B (see chapter 5). In the case of the European Union, the carve-out would likely extend to sectoral exceptions to national treatment. This would imply an end to sectoral reservations among REIO members but that they would remain in effect with respect to other MAI participants. Fearful that intra-European sectoral liberalization (e.g., telecommunications and other common carrier activities) would not be extended to US-based or other multinationals based outside the European Union, the US business community opposes a REIO carve-out, and the US government position will likely reflect this opposition. The European Union maintains that the carve-out is necessary. In the case of banking, for example, EU members have agreed on minimum standards in the EU Second Banking Directive to allow home countries to supervise certain activities of multinational banks owned and domiciled in the European Union, and non-EU nations might not meet these standards. Thus, in the OECD negotiations, EU member nations almost surely will demand a carve-out, and the NAFTA member states will almost surely seek to prevent it. Further, this demand extends beyond EU membership to include countries with which the European Union has association agreements. A possible compromise might be an MFN carve-out that would apply to banking alone. But whether either EU member states or the United States is prepared to commit to this idea specifically (a banking MFN carve out) or even the generic idea (sector-specific MFN carve outs) is a matter to be determined. It is safe to say that the carve-out issue will be contentious and that the potential for deadlock is quite high. If such a carve-out is allowed, it might open the door for future carve-outs for other regional groups such as APEC.

Corporate Governance It is widely acknowledged that differences in

corporate governance among countries affect the ease with which takeovers can be achieved. For example, cross-holdings of equity within and across large financial keiretsu in Japan make it very difficult or impossible for a firm to achieve an unfriendly takeover of a keiretsu member (regardless of whether a foreign or domestic investor mounts the take112

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over bid; see Lawrence 1993).7 Similarly, large-scale holdings of equities in German companies by the largest German banks make it difficult to mount unfriendly takeovers in that country. In other countries, such as the United Kingdom and the United States, the equity shares of many major firms are widely held, such that it is relatively easy to achieve unfriendly takeovers.8 There is a long-standing and largely unresolved debate over whether a relatively easy unfriendly takeover is socially preferable to a relatively difficult or impossible takeover. To distill the debate (and thereby risk oversimplifying), many financial economists argue that prohibitively high barriers to unfriendly takeovers prevent corporate “raiders” from taking control and removing the old management of an underperforming firm. But it is also argued that a constant threat of unfriendly takeovers can lead to “short-term” outlook—that is, management is inclined to increase reported current earnings at the expense of longer term performance. In Germany and Japan, it is argued, the major institutional shareholders, who have a major stake in the firm’s performance, will act against managerial malfeasance and thus fill some of the positive role of the corporate raider. An emerging empirical literature does, however, lend credence to the hypothesis that unfriendly takeovers improve managerial performance and that major institutional shareholders are often slow to respond to managerial problems even where they have a major stake. Whatever the outcome of this debate, there is little question that the ease or difficulty of achieving unfriendly takeovers varies from nation to nation. The issue for the MAI is whether to address these asymmetries. On this issue, two additional points must be made. First, existing asymmetries do not constitute de jure exceptions to national treatment—that is, in countries where unfriendly takeovers cannot be successfully mounted, the barrier applies to domestic as well as to international investors. Second, there are private practices in some countries, regarding mergers and acquisitions, that lead to de facto discrimination against foreign investors. This would be the case, for example, if all foreign bids to acquire control of a firm under financial duress were to be treated as “unfriendly” whereas the domestic bids were viewed somehow as “friendly.” Concerns about such private practices are valid. But whether these concerns should be addressed in the MAI is open to question. They could also be addressed as part of competition policy and, indeed, such concerns might be better handled substantively by experts in this field than by direct investment experts. And, on grounds of Realpolitik, there 7. The “financial” keiretsu are sometimes termed “horizontal” keiretsu; examples include the Mitsui and Mitsubishi groups. 8. It should be underscored that the claim is that in these countries an unfriendly takeover is relatively easy. High absolute barriers to such takeovers may still be present.

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is little hope at present that any of the relevant nations would make changes in corporate governance in response to an MAI.

Privatization There seems to be some consensus among OECD member nations, or at least a large subset of them, that when publicly owned firms are privatized, the share offerings should be structured and conducted so as not to discriminate against potential foreign investors. Whether this consensus is wide enough to permit incorporation of an explicit provision in the MAI is not yet clear.

Issues Other than National Treatment National treatment and issues related to it will not be the only difficult issues in MAI negotiations. The OECD will have to also address performance requirements and investment incentives.

Performance Requirements The challenge for the MAI, it would seem, is to do at least as well in restricting performance requirements as NAFTA did (see chapter 5). It should be relatively easy to ban performance requirements, at least as conditions of entry, in six of the categories on the original list of those the Uruguay Round negotiators considered in the Trade Related Investment Measures (TRIMs) negotiations.9 After all, the United States, the European Union, and Japan all favored such a ban during the TRIMs negotiations. But can a longer list be agreed upon? On this, a list prepared by the OECD Business and Industry Advisory Committee (BIAC)—which includes all eight items on the original TRIMs list plus one additional item, manufacturing limitations—is the right place to start (BIAC 1995). All nine items should be treated in an MAI just as they were in TRIMs— that is, nonconforming measures should be first listed and then rolled back according to an agreed-upon schedule.

Investment Incentives While the prospects of a satisfactory agreement on performance requirements are quite promising, the same cannot be said for investment incentives. Investment incentives—which are, at root, a form of subsidy— are in many OECD countries granted mostly by nonfederal governments, such as individual states in the United States and Australia, the prov9. These six were local-content requirements, export performance requirements, local manufacturing requirements, trade-balancing requirements, production mandates, and foreign exchange restrictions (other than those consistent with existing GATT articles). 114

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inces in Canada, and the Länder in Germany. The federal governments are reluctant to restrict investment incentives or other subsidies granted at the subnational level. In some OECD countries where federalism is less pronounced, the central government actively uses subsidies (including investment incentives) as instruments of industrial policy. These governments also are unwilling to give them up. Many analysts believe the upshot is that the issue of curbing investment incentives in MAI is “dead on arrival”—it won’t be taken up, let alone resolved. This would be unfortunate for two reasons. The first is that if participation in the MAI is to be broadened to include developing countries, and if these countries are to be asked to give up performance requirements, their governments are almost sure to ask as a quid pro quo that the industrialized countries accept disciplines on investment incentives. Developing-country governments widely perceive investment incentives as the industrialized countries’ instrument of choice to offset developing-country performance requirements (and, in some cases, to offset investment incentives in the developing world). That is, they fear that these investment incentives divert investment away from developing nations. Thus, a widening of the MAI (including ultimate implementation at the WTO level) demands that it cover investment incentives. Indeed, many developing countries would see the MAI as a less-than-serious exercise if it does not provide such coverage.

Regional Arrangements Other than the OECD As noted in the previous chapter, there are regional agreements on FDI such as APEC and NAFTA. Regional accords on investment can contribute to investment liberalization, but they are not the ideal approach. Each regional arrangement by definition involves only a subset of the nations in which the multilateral corporations operate. By their very nature, regional arrangements will deal with parochial issues that a more global arrangement might avoid (e.g., rules to determine which entities qualify for benefits under the accord and which do not, including the “rules of origin” that are ubiquitous to free trade areas). Nonetheless, regional accords might have a strong role to play as stepping stones toward more global arrangements. Regional accords might provide experience regarding which measures are beneficial and which are not. Positive experience in one region might lead to liberalization in other regions, or even a policy competition among regions that “ratchets up” substantive standards. For example, if APEC were to revisit direct investment issues and develop a code with substantively stronger provisions than those of its current, nonbinding principles, this might in turn NEGOTIATING AND IMPLEMENTING AN INVESTMENT ACCORD

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put pressure on WTO negotiators to create a strong investment instrument. In the end, if such “ratcheting up” were set in motion, one would expect substantial similarity among regional agreements. When and if this state of affairs comes to pass, it would be a relatively easy task to pull the common elements of these agreements together into a global code (Bergsten 1996). Thus, regional investment agreements are probably best viewed as a means to a global accord on investment rather than an end in themselves. NAFTA has already demonstrated that an investment instrument can be embodied within a regional agreement that involves a developing country—that is, one that has historically been outside the ranks of the OECD.10 Can the NAFTA precedent be extended to cover other nations or other regions? One obvious possibility, already being pursued in talks with Chile, is NAFTA enlargement. But another possibility would be enlargement of the substantive scope of existing regional agreements to include investment issues. A candidate would be Mercosur, the common market arrangement between Argentina, Brazil, Paraguay, and Uruguay. Mercosur has no investment chapter now, but given the scope and pace of investment liberalization in many of the member nations, this could change. Mercosur itself might in the future be enlarged into a free trade and investment area that encompassed all of Latin America and even eventually joined with the NAFTA, a goal embodied in the vision of a future Free Trade Area of the Americas (FTAA) as put forth at the 1995 Summit of the Americas in Miami. As noted in the previous chapter, APEC agreed on a set of nonbinding investment principles at the 1994 APEC ministerial meeting at Jakarta, Indonesia. These principles could be the basis for an investment accord within APEC. However, as also noted previously, the existing principles would first have to be strengthened as well as made binding. Another candidate for an investment agreement is the European Union. The original Treaty of Rome establishing a European Common Market did not contain a comprehensive set of principles regarding direct investment, although the founders envisaged free movement of labor and capital among the member nations. The various EU acts and directives since enactment of the Treaty of Rome (including the almost 300 directives that constituted the “Europe 1992” effort, as well as capitalmovement liberalization measures associated with the Maastricht Treaty) have subsequently created something of a de facto direct investment accord within Europe. However, the European Commission and the governments of the member states share authority over many FDI-related

10. Mexico did, however, join the OECD in 1994. 116

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issues, while individual member states retain competencies over certain aspects of direct investment policy (e.g., the right to screen inward investment, including on national security grounds, and the right to impose performance requirements and/or link these to investment incentives).11 While FDI flows within the European Union are relatively unfettered, Europe might still benefit from a common (and liberalized) policy on FDI, especially with regard to FDI from nations that are not EU members. However, the shared competence of the EU and national on FDIrelated issues constitutes a serious obstacle. Consequently, the European Union will likely continue to move toward a de facto common policy while its member governments retain specific competencies.

Where Do We Go from Here? The main policy question posed by the globalization of business is whether remaining barriers to direct investment (and other forms of commercial activity of multinational firms conducted outside their home countries) are to be lowered further. These barriers will never disappear altogether. However strong the case that direct investment enhances economic welfare, there are interests of national governments that are not wholly congruent with those of multinational firms—those involving issues of national defense being the most obvious example. An international accord on direct investment could encourage national governments to regulate multinational activity in a uniform manner, as well as prohibit or at least discourage certain government actions that collectively reduce welfare. Can a consensus among nations be developed with respect to what, if any, standards should be embodied in such an accord? Although no such consensus has yet been achieved, it is more likely today than at any time in the postwar period. For example, within APEC, officials have been able to agree on principles to which nations might eventually aspire; one suspects that even this degree of consensus could not have been reached five years ago, and certainly not ten years ago. If the ultimate objective is an effective accord on investment that would be global (or nearly global) in coverage, then the two alternatives discussed in this chapter are really but two different means to this end. Agreements among limited sets of nations, including regional agreements and the OECD MAI, might in this light simply be seen as stepping 11. One important implication, relevant to negotiation of a multilateral accord on direct investment, is that neither the Commission alone (as it does on matters of international trade) nor the governments of the EU member nations alone can negotiate on behalf of the other.

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stones toward an accord that eventually could be embodied in the WTO. Thus, the question becomes, which of the two alternatives is the more promising? In a world of global corporations, an accord on direct investment should itself be global in scope. Inevitably, this suggests that the WTO is the ultimate venue for such an accord. But how soon could it be achieved? Should limited agreements such as that in NAFTA or those that are soon to be negotiated such as the MAI be allowed to run their course in the interest of “experimentation” before the WTO takes up the issue, or should the WTO move into this domain quickly following the 1996 ministerial? Obviously, the world community must decide the answer before the 1996 WTO ministerial meeting in Singapore. And they should decide to act. The WTO should begin negotiation of an investment accord immediately following this meeting, and the MAI negotiations should be terminated in deference to the WTO negotiation. Although useful in the absence of WTO talks, the MAI negotiations involve too few nations to accomplish very much. Indeed, much of the value of an international accord on direct investment lies in getting non-OECD nations to sign on. For this to happen, these developing nations must actually participate in the creation of the accord, something that is not possible as long as the main negotiation takes place within the OECD. Even if the WTO outcome were to be an agreement of somewhat less substance than can be achieved in the OECD, the value of greater global coverage outweighs the risk of lesser substance.

Conclusions The ultimate goal of an international accord on direct investment is to foster the free flow of capital, technology, and managerial expertise across national boundaries. Such rules should be subject to minimal limitations necessary to maintain national defense capabilities, to assure that investment flows do not endanger human health or vitality, and to assure that global firms do not attain monopoly status or otherwise engage in practices that reduce competition. The free flow of capital, technology, and know-how will enhance the efficiency of economic activity everywhere, due to both direct effects, such as technology transfer, and indirect effects, such as increased competition and spillovers. This goal would be best met if nations were to extend the law and policy of the WTO further into the investment domain by adopting an accord embodying the provisions laid out in chapter 4. This would be preferable to other alternatives, such as the OECD’s Multilateral Agreement on Investment (MAI), for two reasons: First, the WTO accord would cover the most territory—most of the world’s nations are already mem118

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bers and most of those that are not now seek membership. Second, the substantive provisions of such an accord could be linked to and made consistent with other WTO agreements, a desirable end because of the inextricable links between direct investment and international trade. Is the world ready for an investment accord of the sort proposed here? The economic case for such an accord is compelling. As detailed in chapter 2, the scope of globalized business is large and growing. Direct-investment-related activity figures at least as much in the globalization of the world economy. Equally important are the pervasive links between this activity and international trade. The main obstacles to a global investment accord are political. At root is the clash between the objectives of sovereign nations and those of global corporations. Such clashes makes the need for an effective enterprise-to-state dispute settlement mechanism paramount: creating such a mechanism (or upgrading existing ones) would be a chief end of an international investment accord. At the time of this writing, negotiations for the OECD MAI are ongoing and the Singapore summit meeting of the WTO was set for December 1996. The Singapore meeting will likely reveal how much weight the WTO intends to give to investment issues. Two things can be said about the current situation: First, the existence of the OECD negotiations should not deter the WTO from launching its own effort to create an effective investment instrument. Second, if continued, the OECD effort should be conducted with an eye to the possibility that it will be melded into a future WTO negotiation. Should the WTO negotiate an investment accord in isolation from other trade issues (as the OECD now seems to be doing)? The answer is clearly no. The Uruguay Round left numerous trade and trade-related issues as “unfinished business”(Bergsten 1996; Feketekuty 1996). The reasonable thing for the WTO to do would be to launch a series of exercises to address all of these issues. In this context, an investment accord would be one of several parallel undertakings. This might sound like a call for a new round of multilateral trade and investment negotiations. It is. The agenda of the WTO was left unfinished with the end of the Uruguay Round, and the global economy is developing too fast for this unfinished business to remain unfinished.

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I

APPENDICES

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A

Foreign Direct Investment and Technological Spillovers in the Developing Nations

One of the themes of this book is that developing nations have been liberalizing their policies toward FDI over the last 10 years. A principal reason has been the promise of accompanying “technological spillovers.” This appendix surveys what exactly these are and to what extent the evidence shows that FDI in developing nations does in fact create such spillovers. A technological spillover is a special case of a positive externality, which is a benefit generated by an economic activity that is captured neither within the activity itself (i.e., owners or workers do not directly benefit in the form of higher profits or wages) nor directly by users of the activity’s output—in other words, the benefit is external to the activity.1 Thus, for example, the benefits to customers of lower prices for a product or service that a new technology makes possible are not externalities. If, by contrast, a firm creates a useful new technology that is subsequently copied or learned by competing firms, such that all products or services in the relevant market embody the technology, then the benefits to users of those products and services would be externalities. 1. Likewise, if an economic activity creates a cost that is neither born by the activity nor by users of the output, this would be a negative externality. An example of a negative externality is pollution, which generates a cost in the form of reduced health of those living near its source. More generally, an externality is any benefit or cost received or borne by agents external to the activity that creates the benefit or cost. Direct users of the output of the activity are considered “internal” agents, as are all agents associated directly with the activity (including shareholders). 123

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If, for example, the benefits take the form of lower prices, these lower prices would be the product of both the new technology and competition among firms employing the technology.2 The relevant “economic activity” in this instance is the research and development (R&D) that produced the technology. The foregoing is an example of a “horizontal” technological spillover because the firms that realize or generate the benefits compete with the firm that created the technology.3 In practice, it will be difficult to divine what exactly is a gain from the horizontal spillover and what is simply a gain from internally generated improvements in the technological efficiency of a firm. For example, if firm X introduces a product embodying a new technology in response to a similar new technology previously introduced by firm Y, is this a spillover? In principle, firm X’s technology is a spillover if the underlying knowledge was gleaned from firm Y; but in fact, firm X’s technology is likely to be the outcome of some combination of its own R&D inputs plus incorporation of knowledge gleaned from firm Y. This ambiguity, among other reasons, bedevils the empirical measurement of spillover effects. Vertical as well as horizontal technological spillovers can occur. For example, if a manufacturing firm transfers technology to firms supplying inputs that enable these firms to deliver their inputs at a lower cost and these lower costs are then passed on to customers other than the original firm, then a spillover has occurred. There is no spillover, strictly speaking, from the supply of lowercost inputs to the firm that originally transferred the technology, these being internal rather than external benefits. However, most developing countries consider the enhancement of locally owned suppliers’ efficiency to be an unmitigated blessing, whether or not spillovers in the strict sense occur. Indeed, increased efficiency of local firms through technology transfer is one of the main reasons developing countries seek FDI. To enhance this transfer, as well as simply to encourage the growth of indigenous suppliers, developing countries have often imposed “local-content” requirements on multinational firms. However, the World Trade Organization (WTO) now bans imposition of most new local-content requirements under the Agreement on Trade-Related Investment Measures (TRIMs; 2. Strictly speaking, those benefits that would have accrued to users of the product had the product been offered solely by the original innovator (who presumably would have charged monopoly prices) should be deducted from the total, as these benefits would be captured internally. 3. The externality must be distinguished from the benefits that accrue simply from additional competition. For example, suppose that a new firm enters a market and brings with it new technology. Prices subsequently fall. The fall in prices might be attributable to the new technology, including spillover of this technology to competing firms. But it might also be simply the result of more competition. 124

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see chapter 5), and developing countries having such requirements must phase them out. Vertical spillovers can also be achieved via technology transfer from a multinational firm to “downstream” operations servicing that firm (for example, distribution and retailing). Once again, in principle, a spillover occurs only if external agents realize at least some of the benefits from the technology. This would occur, for example, if the efficiencyenhancing technologies that distributors absorbed from a multinational firm could be applied to products and services sourced from firms other than the multinational itself. However, again, most developing countries seek such technology transfer as an end in itself, whether or not spillovers result. As already suggested, technological spillovers are difficult to measure, as are all externalities. Externalities generally do not, as it were, leave a “paper trail” that is easily detected. Thus, most evidence that such spillovers from multinational firms’ direct investment exist is circumstantial— if it can be established that technology transfer occurs, spillovers are assumed to accompany this transfer. Among the earliest published evidence of spillovers was John H. Dunning’s now-classic work (1958) on manufacturing direct investment by US firms in the United Kingdom (discussed extensively in the main text of chapter 3). While the United Kingdom is hardly a developing country, the efficiency of UK manufacturing firms over a wide range of industries was significantly lower than that of US firms (at least at the time of the study), and so arguably the results have some relevance to developing countries, where much the same thing can be said about relative efficiencies. Dunning showed that UK affiliates of US firms were more efficient in terms of labor productivity than domestically owned rivals, evidence that US firms were transferring to their affiliates technologies (including perhaps managerial prowess) that were not available to locally owned firms.4 Moreover, Dunning demonstrated that local rivals were eventually able to catch up to the US firms in terms of productivity, thus suggesting that horizontal spillovers in fact did occur. There was also evidence of vertical spillovers, achieved largely via transfer of technology or other information from the US-affiliated firms to local suppliers. The vertical spillovers varied from industry to industry and included reductions in unit cost (sometimes resulting from expansion and/or greater specialization in output and associated scale economies as well as from technology transfer), improvements in the product itself, and improvements in management, including in logistics. While Dunning was able to quantify the productivity differences as

4. Dunning also showed that the productivity of the US affiliates in Britain was typically less than that of the operations of the same firms in the United States itself.

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between US-affiliated firms and local horizontal rivals, much of the evidence on vertical spillovers was based on supplier firms’ qualitative responses to questionnaires. These firms typically indicated whether or not their dealings with US-affiliated firms had resulted in tangible changes (e.g., unit-cost reductions or product improvements) without indicating the magnitude of the changes. Much the same can be said about later evidence regarding vertical spillovers: the evidence often is of a qualitative rather than a quantitative sort. The Dunning study, although limited in focus and by now quite dated, nonetheless remains unique in terms of its thoroughness. It also established substantial direct and indirect evidence that FDI does generate technological spillovers even in relatively advanced economies. More recent studies compile largely indirect evidence that these spillovers occur in developing nations as well. We next turn to some of this evidence. In a very recent study, Borenszstein, De Gregorio, and Lee (1994) present indirect but compelling evidence that FDI does generate technological spillovers. Their methodology is to use panel data from 69 developing countries to test the effects of FDI from the OECD nations upon growth of these nations. They first develop a model based on concepts of endogenous economic growth, wherein FDI is treated as a source of new varieties of capital embodying growth-enhancing technologies. They then test the following equation, derived from the endogenous growth model: g = C0 + C1FDI + C2FDI × H + C3H + C4Y0 + C6X where g is growth in a particular developing country, FDI is inflow of FDI into that country from the OECD countries, H is a measure of human capital, Y0 is income at the beginning of the period, and X is a vector of other variables that might act as determinants of growth. Because the data are pooled cross-sectional/time series (“panel data”), each variable implicitly bears a country and time subscript. Only FDI from the OECD nations is considered because these nations perform most of the world’s R&D, much of which is in fact performed by multinational firms based in these nations. The implicit assumption is that if FDI from the OECD nations into the developing nations is positively associated with higher growth, the link between the growth and the FDI is the technology that foreign investors transfer into the local economy.5 The chief empirical findings are (1) that FDI contributes positively to economic growth and that the effect of FDI on growth is higher than 5. The endogenous growth model developed by the authors provides a theoretical framework under which this might happen, but the mechanics of this model are, in the view of this author, somewhat unrealistic. Fortunately, the tests they provide do not depend upon the mechanics of the endogenous growth model being exactly correct. 126

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that of domestic investment, (2) that FDI interacts with human capital— in particular, a minimum threshold of human capital must be obtained before FDI makes a positive contribution to growth,6 and (3) that FDI does not displace (“crowd out”) domestic investment but rather seems to supplement it. Finding (1) is consistent with other recent studies indicating that FDI to developing countries is associated with technology transfer (e.g., Blomström, Lipsey, and Zejan 1992; De Gregorio 1992). Findings (2) and especially (3) provide indirect evidence of technological spillovers, for two reasons. First, if spillovers do occur, one would expect that the country must have “absorptive capacity”—that is, trained people able to learn and apply the knowledge flowing out of the multinational firm and into external firms. Finding (2) is consistent with this expectation. Second, if multinational firms and their customers internalized all of the benefits of technology transfer to developing countries, it might be expected that local affiliates of these firms would “crowd out” domestic investment because their greater efficiency would enable them to expand at the expense of less efficient rivals. While finding (3) does not necessarily negate the idea that local affiliates of multinational firms displace domestic rivals, the complementarity between FDI and local investment shows that, to the extent that such “horizontal” crowding out does happen, it is dominated by the capital investment activity of other local firms whose operations expand with those of the multinational enterprises. One can deduce that these other local firms are probably suppliers, distributors, and retailers whose operations are linked to those of the multinational firm and, indeed, that these local firms benefit from technology transferred by the firm. At the end of the day, however, the results of Borenszstein et al. do not conclusively demonstrate that these links do exist. The best that can be said is that these results are consistent with such linkages and provide circumstantial evidence of spillovers.7 The Borenszstein et al. findings are consistent with those of another recent study by Coe, Helpman, and Hoffmaister 1994. Their basic finding is that productivity tends to be higher in developing countries with strong trade links to OECD countries than in developing countries without such links. The authors attribute this to the fact that high-productivity 6. In the regressions, using the seemingly unrelated technique, FDI appeared positive and significant when the interactive (FDI x H) variable was omitted. When FDI was omitted but the interactive term included, the interactive term is positive and significant. And when both terms are included, the FDI term is negative but insignificant, whereas the interactive term is positive and significant, indicating the interaction is critical. 7. Missing from their tests is whether domestic capital is more efficient in the presence of FDI than otherwise; such a test, if positive, would be even more suggestive of spillovers than the evidence presented.

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developing countries import products embodying technology from the OECD countries. However, because FDI to developing countries from the OECD countries is highly correlated with trade flows, the higher productivities could be associated with technology transfer brought about by FDI rather than trade.8 Thus, two of the authors, Coe and Hoffmaister, are attempting to separate trade and FDI effects, but their results had not been reported at the time of this writing. Wei (1996) provides evidence that FDI in China has produced technological spillovers. Wei’s data are specific to urban areas in China, covering 434 of them over 1988-90. He first shows that of three types of firms in China—notably, state owned enterprises (SOEs), township and village enterprises (TVEs), and foreign-invested firms—foreign-invested firms grew faster than other categories. The total share of these firms in industrial output is rather small, however, growing from less than 1 percent in 1988 to about 1.7 percent at the end of 1990. But, across the urban areas, this share ranges from as low as zero to as high as 62 percent. Thus, what Wei sought to do was to determine if the share of foreign-invested firms was a significant explanatory variable for growth differentials among the urban areas after accounting for other factors that might explain these differentials. These other factors included growths of population, the capital stock, and human capital. Wei used three variables to capture the effect of foreign-invested firms: unadjusted stock of FDI as a percentage of total capital stock, an adjusted stock of FDI as a percentage of total capital stock (where the adjustment accounted for differences in treatment of depreciation between the two aggregates), and share of foreign-invested firms’ output in total output. The regression coefficients of the second two (but not the first) measures are statistically significant, indicating that FDI does seem to be an explanator of growth differentials among Chinese urban areas. These results hold when Wei introduces dummy variables to account for certain urban areas being either “special economic zones” and “open coastal cities” or “comprehensive reform experimenting cities.” In earlier work, Wei showed that although all three of these categories of cities have grown at above average rates in China, the differences in growth of output per capita between the first of these two subsets and other cities is well explained by differences in growth of capital inputs, while the second subset has not grown at faster rates after controlling for labor input. These results are all consistent with the existence of technological spillovers, but, again, they hardly prove that such spillovers exist. However, Wei presents additional empirical results that provide stronger, albeit still circumstantial, evidence. In regressions with the growth rate of town8. Likewise, it is possible that the growth effects Borenszstein et al. attributed to FDI are in fact the consequence of importation of goods embodying new technologies. 128

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ship and village enterprises’ output by urban area as the dependent variable, he finds that two of his FDI measures—adjusted stock of FDI as a percentage of total capital stock and share of foreign-invested firms’ output in total output—are statistically significant as explanators of differences in TVE growth. He notes that this positive association could be the result of additional competition created by the presence of foreigncontrolled firms, but he believes that the more likely possibility is technological spillovers. Wei’s findings on growth rates are consistent with those in several earlier studies performed cross-sectionally within countries. For example, Blomström (1986) showed that labor productivity across industries in Mexico was correlated with the presence of foreign-owned firms after controlling for classical determinants of productivity such as capital intensity, quality of human capital, industrial structure, and existence of scale economies. More recently, similar results for Morocco have been reported by Hannad and Harrison (1993), who note that in sectors with a high presence of foreign-controlled firms there also tends to be lower variance of productivity, a fact suggesting the existence of horizontal spillovers. Each of the studies examined above is essentially a cross-sectional investigation—that is, they investigate differences across countries (or, in the case of Wei, across urban areas). It would be helpful to the study of spillovers if it could be established in a time-series analysis whether FDI is associated with any of the characteristics of spillovers within a single nation. For example, has productivity growth in any given sector in a developing country accelerated following the entry of multinational firms? Alas, such quantitative analysis has not been performed in developing countries. There have been qualitative case studies involving specific industries and a time dimension that bear on the issue of spillovers. One of the earliest of these was of the automotive industry in India, Peru, and Morocco by Lall (1980), who showed that the local content (the percentage of value added originating locally) of automobiles produced in India tended to rise over time, indicating that the multinational firms producing the autos increased the extent of their vertical integration with local suppliers. Lall attributed this rise to governmental policies that encouraged local content. However, his investigation did not cover whether vertical spillovers actually occurred as a result of the linkages. Several subsequent studies have been performed—for example, of the automotive industry in Nigeria by Landi 1986 and of six manufacturing industries in several developing countries by Halbach (1988). These tend to confirm Lall’s observation that global firms in these countries tend to extend their vertical linkages over time. Halbach in particular reports that the amount of local subcontracting (i.e., purchasing of inputs from local suppliers) depends upon the level of indigenous technology and APPENDIX A

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the skill of the local work force, findings roughly consistent with those of Borenszstein, De Gregorio, and Lee (1994). Halbach also reports that government policy had a significant impact on the extent of vertical linkages, consistent with the Lall finding. In two studies of the consumer electronics industry in Singapore and other southeast Asian nations performed five years apart, Lim and Pang (1977 and 1982) report that vertical linkages between multinational firms and local suppliers were not significant at the time of the earlier study but had grown substantially just five years later. The Lim and Pang results are of special interest because they concern an industry that was very export-oriented (unlike the industries studied by Lall, Landi, and Halbach; multinational firms in these industries in fact were operating behind high protectionist walls and served local markets only). Presumably firms in an export-oriented industry will source components from the most efficient producers they can find or create. The fact that multinational firms operating in the electronics industry in Southeast Asia turned increasingly to local suppliers suggests that these suppliers were highly efficient. It is not unreasonable to surmise that part of the story behind the efficiency was technology transfer from the multinationals. Indeed, in subsequent years, the electronics industry in Southeast Asia has become very competitive internationally, and the structure of the industry is characterized by numerous linkages among large networks of firms, some foreign-controlled and others under local ownership. The linkages these networks create cross national boundaries, with Singapore largely serving as the hub. The development of the network of firms is highly suggestive that significant spillovers occurred as the result of linkages between the multinational firms and local suppliers. What can be said, in conclusion, about technological spillovers resulting from FDI in the developing countries? It is certainly safe to say that these positive externalities are elusive: they are difficult to observe, let alone measure. But it is probably also safe to say that they do exist. While the evidence is hardly conclusive, it is all consistent with the idea that spillovers do occur and points toward likely yield positive, significant benefits to the countries in which they happen. Thus, developing nations that encourage inward FDI in the hopes of capturing spillovers almost surely are not chasing a will-o’-the-wisp.

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A Game Theoretic Approach to Sanctions

B

Game theory offers one explanation for the weakness of the old GATT procedures—and by extension, for a potential weakness of an international investment accord enforced by sanctions. Although termed a “cooperative arrangement,” the WTO mechanism can be thought of in the jargon of game theory as an arrangement whereby “players” (the signatories) play a repeated noncooperative game. The game is “noncooperative” because there is no external agent with powers to enforce the rules. The institutional arrangement nonetheless has some potential to be “self-enforcing” because the game has something of the structure of the “prisoner’s dilemma.” In a prisoner’s dilemma, if each player plays noncooperatively—that is, tries to maximize unilateral gains subject only to the observed strategies of other players—the outcome will be (Pareto) dominated by any number of cooperative solutions. What does this mean? The essence is that if each player attempts to assess the likely strategy of other players and then to play a strategy that maximizes unilateral interests, the result will be that all players collectively fail to maximize the total payoff that they could otherwise achieve. The simplest case is a game wherein each of two players can each play one of two moves. Figure B.1 indicates the payoff to each of two players (player “A” and player “B”) of such a game for each pair of possible moves. The cells inside the matrix indicate the payoffs to A and B from cooperative and noncooperative moves, with the payoff to A on the left of each cell and the payoff to B on the right. Thus, if A seeks to maximize unilateral payoff, A will choose a noncooperative move irrespective of which move B makes. That is, if B also chooses the noncoop131

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Figure B.1

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5

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erative move, A receives 8 units of reward whereas if A had chosen the cooperative move, A would receive only 5 units. But if B chooses the cooperative solution, then A receives 15 units of reward for choosing noncooperation but only 12 units for choosing cooperation. Because B faces an exactly similar payoff structure, B is driven to choose a noncooperative move, and thus each player would receive a payoff of 8. The paradox is that if both players had chosen cooperative moves, they would each have received 12 units of reward, and hence both would have done better. The secret seems to be for them to devise an enforceable agreement in which each would choose the cooperative move and which would penalize either party if that party attempted to cheat on the other by selecting the noncooperative move on the assumption that the other stuck to the agreement (in which case, the cheating party would raise the payoff to 15, whereas the payoff to the honest party would be reduced to 5). In terms of game theory, the objective of international rules on trade or investment is to force countries (the “players”) to play a cooperative strategy whereby an optimal outcome can be achieved. For this argument to make sense, it must be established that international trade or investment has the character of a “prisoner’s dilemma” game. Whether this is truly the case is open to some question, but what seems to count is that nations tend to think that it is. That is, nations the world over seem to think that they can benefit from some sort of unilateral implementation of policies that selectively close their markets to trade or investment or regulate these in ways contrary to the interests of other nations. Likewise, there is wide consensus that all nations can achieve a 132

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“Pareto-dominant” outcome (the 12-12 outcome in the illustration above) if they can collectively agree never to carry out such policies. The trick is enforcement of such an agreement when each nation believes it could do a little better by welshing. One means of enforcement would be to hire an outside agent (some sort of “policeman”) to compel each player to live by the rules. But, in the world today, no such policeman is available, at least not for the enforcement of commercial law. So, the alternative is some sort of self-enforcing agreement. The literature on game theory has firmly established that a selfenforcing agreement is achievable if the game has no known termination and a punishment scheme can be constructed in which it would always be in the interests of all nondeviant parties to cooperatively punish a deviant player and the punishment is sufficiently harsh that no player would choose to deviate given the certainty of punishment (Fudenberg and Maskin 1986). Such a punishment scheme is termed “subgame perfect.” Even under reformed WTO dispute settlement procedures, sanctions would rarely if ever qualify as subgame perfect. When a country that takes a dispute to the Dispute Settlement Board, after failure to resolve it via consultation, there is some chance the board will rule that the “defendant” country has violated an obligation. Then the country that brought the dispute may apply sanctions. But no other countries are obliged to apply them, and, for the sanctions to have “bite,” they must be initiated by a large country. Hence, the “deviant player” cannot be sure of certain and stiff punishment. Other international agreements also fail to produce subgame-perfect punishment strategies. For example, NAFTA provides for no sanctions (or any other form of punishment) in the event that a member nation fails to uphold or enforce awards a tribunal makes against it under the dispute settlement procedure of chapter 11 on investment. The NAFTA commission can advise a member that it has violated its obligations but cannot penalize that member for it. In this regard, NAFTA is a purely voluntary agreement. Can a subgame-perfect strategy, or something reasonably close to it, be devised and implemented in an international investment accord? One possibility game theory suggests would be for parties to such an agreement to obligate themselves to punish one of their number that violated an obligation, but it seems unlikely that nations would ever bind themselves in this way. Another possibility might be to empower the dispute resolution body to fine a party in violation of a basic obligation, the value of which should be equal to or greater than the value to the offending party of continuing the violation. Because these parties are sovereign states, there would be no means to compel payment. Furthermore, it would be tricky at best to calculate what was the value of continuing misbehavior. NoneAPPENDIX B

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theless, imposing a fine would doubtless increase the opprobrium associated with violations and thus might enhance the moral suasion of a dispute settlement board or panel. Furthermore, the amount of the fine would signal the world what the board believed to be the cost of the violation in monetary terms, allowing the general public (including that of the violating country) to judge the severity of the violation. In the end, it remains difficult to devise a sanctioning procedure that is subgame perfect. And thus international agreements, including the proposed accord on investment, will continue to be difficult to enforce. The prime value of such agreements rests, and will continue to rest, in setting standards for proper international commercial behavior and not in the creation of tightly enforceable legal instruments.

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Index

Absorptive capacity, 127 Accounting and reporting standards, 64 -65 Advanced Technology Program (ATP), 94 Aeronautical Technology Consortium Act, 95 Africa, rates of return on US direct investment abroad, 23 t American Technology Preeminence Act (1991), 94 Ancillary codes, 61 -67 Antitrust policy, 63, 70 APEC. See Asia Pacific Economic Cooperation Argentina competition law passed, 64 liberalization of investment policy, 37, 98 Asia Pacific Economic Cooperation (APEC) changing consensus, 117 Chinese membership, 103 Committee on Trade and Investment (CTI), 84 Eminent Persons Group, 84 FDI approach, 84 -87, 115 fears of Chinese diversion of FDI, 100 nonbinding investment principles, 99, 103 -04 possibility of carve -outs, 112 proposed investment accord and, 101, 116 as regional trading bloc, 30, 31 n role in liberalization, 115 -16 Asset values of global corporations estimated, 12 13 Association of Southeast Asian Nations (ASEAN), 30 Australia rates of return on US direct investment abroad, 23 t reservations on inward direct investment, 76 subsidies, 114 Austria reservations on inward direct investment, 76 subsidies paid by government, 82 Automotive industry alliance to develop fuel -efficient autos, 96 EC quotas on Japanese cars, 21 studied in India, Peru, and Morocco, 129 Banking, 112 Belgium, 106

Bergsten, C. Fred on investment rules and efficiency, 6 on Japanese antimonopolies law, 63 -64 on ratcheting up substantive standards, 116 on relationship between national governments and global corporations, 42 report on host -government policies toward FDI and MNEs, 71 n on two major trading blocs, 30 on unresolved trade issues of Uruguay Round, 119 Bilateral investment treaties (BITs), 87 Block exemptions, 63 Borenszstein, Eduardo, 126 -27, 128 n, 130 Brazil, 18 -19, 98 Brittan, Leon, 82 Bryant amendment to US 1988 trade act, 65 Buckley, Peter J., 39 Burke -Hartke legislation, 4 Bush administration on foreign takeovers of US firms, 92 -93 Business and Industry Advisory Committee (BIAC), 114 Business, international expansion in 1981 -93 period, 10 t nontraditional, 11 Canada cultural set -asides, 107 -08 de Havilland aircraft firm, 81 FDI flows, 16 Foreign Investment Review Agency (FIRA), 71 Investment Canada, 49 n, 71 inward investment screening, 106 local -content requirements, 71 national treatment instrument issue, 77 postwar US FDI, 26 rates of return on US direct investment abroad, 23 t state -sanctioned monopolies, 110 Canada (Cont.) subsidies, 115 technology support programs, 109

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Canada -US Free Trade Agreement (FTA), 57 Cantwell, John, 39 -40 Capital, removal of barriers, 86 Capital movements, theory of, 23 -24 Cartels, international history of, 26 under Havana Charter, 70 -71, 80 -81 “Carve -outs,” 112 Casson, Mark C., 39 CG -18. See General Agreement on Tariffs and Trade, Consultative Group of 18 Chile liberalization of investment policy, 37, 98 NAFTA membership, 116 China, People’s Republic of APEC and, 103 FDI opening, 99 foreign -invested firms, 19 -20, 128 -29 gross fixed capital formation (GFCF), 3 motion picture industry, 108n national treatment for foreign -controlled enterprises, 104 regulation in, 20 restrictive business practices, 64 shift to welcoming FDI, 19 -20 special urban zones, 128 spectacular growth of FDI, 17, 18 t takeover of US firm blocked, 93 technological spillovers, 128 -29 WTO membership, 102 Clearinghouse for intergovernmental sharing of information on taxation proposed, 62 Clinton administration on foreign takeovers of US firms, 93 Coase, Ronald H., 39 Code of Liberalization of Capital Movements (OECD), 76 Code of Liberalization of Current Invisible Operations (OECD), 76 Coe, David T., 127 -28 Collins, Michael (R -GA), 95, 109 Colombia competition law passed, 64 liberalization of investment policy, 37, 98 Committee on Capital Movements and Invisible Transactions (CMIT), 77 Committee on Foreign Investment in the United States (CFIUS), 92 -94, 107 Committee on Trade and Investment (APEC), 84 Competition policy, 63 -64, 70 -71, 80 -81 Computers, 111 Continental Can Company, 81 Copyrights, 73 Corporate governance, 112 -14 Corruption, 66 -67 Cultural activities or industries, 107 -09 Currency, defense of national, 3, 44 -45 Czech Republic, 64 De Gregorio, José, 126 -27, 128 n, 130 Debt crisis of early 1980s, 97, 98 Declaration on International Investment and Multinational Enterprise (1976), 77 Defense contracting foreign investment in, 93 -94 issues, 51 Derogations

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concept of, 48 n OECD rules, 76 -77 OECD accord possible on, 105 Developing countries advocate new international economic order, 78 “clone” products, 73 European perspective toward, 90 gross fixed capital formation (GFCF), 3 as host nations, 88 -100 intellectual property rights, 73 investment incentives issue, 115 liberalize foreign investment policies, 19 local monopolies, 89 local -content requirements, 71 -72 OECD links and productivity, 127 -28 performance requirements, 89 -90 postwar US FDI, 26 -27 shift to liberalization, 100 slow FDI growth in, 18 -19 view of global corporations, 1, 88 -90 DG IV. See European Community, Directorate General IV Dispute settlement under APEC, 86 conflicting jurisdictions, 56 East Asian approach, 86 -87 game theory and, 133 -34 globalization and, 45 mechanisms proposed, 57 -61, 119 NAFTA, 79, 83 -84 non -NAFTA investors and, 98 n TRIPs agreement procedures for, 74 World Bank Center for (ICSID), 79 Domestic markets, protectionism and, 5 Dunning, John H., 36, 125 -26 East Asia. See also individual countries attitudes to China, 99 -100 FDI flows to, 18 -19 gross fixed capital formation (GFCF), 3 outward FDI, 29 t shifts to FDI, 99 -100 as trading bloc, 29 -30 East Asian Economic Caucus (EAEC), 30 Economies of scale, 36, 39 EFTA. See European Free Trade Association Efficiency defense, 63 Election campaigns, 51 Embargoes, 55 Employment of nationals, 53 Encarnation, Dennis S., 40 Endogenous growth model, 126 Energy Policy Act (1992), 94 Enforcement mechanisms for disputes, 60 61 Environmental issues, 65, 84 Equity limitation issues, 89 ESPRIT information -technology program, 109 Establishment, right of as host -nation government obligation, 48 -50 state -sanctioned monopolies and, 110 n under NAFTA, 82 US view of, 106 US -based global firms on, 89 Venezuela, 98 Europe antitrust laws, 63

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FDI flows, 15 -19 intra -European FDI, 17 -18 outward FDI, 29 t as part of triad, 15 postwar US FDI, 26 European Airbus consortium, 81 European Community (EC). See also European Union Directorate General IV (DG IV), 64, 81, 82 economic integration accomplished, 18 FDI issues, 21 -22, 116 -17 jurisdiction in trade policies, 97 on performance requirements, 91 power to regulate cartels, 80 -81 quotas on Japanese autos, 21 semiconductor industry, 21 European Court of Justice, 60, 82 European Free Trade Association (EFTA), 18 rates of return on Dutch investment, 22 t rates of return on US direct investment abroad, 23 t, 23 European Union (EU) approach to regulating FDI, 80 -82 compared to Japanese FDI, 17 cultural set -asides, 107 -09 dispute settlement, 60 gross fixed capital formation (GFCF), 3 as host nations, 90 -92 investment incentives as subsidies, 82 mergers and acquisitions, 81 national treatment instrument, 77 performance requirements, 52, 114 possible investment agreement, 101, 116 rates of return on Dutch investment, 22 t rates of return on US direct investment abroad, 23 t, 23 REIO carve -outs, 112 Second Banking Directive, 112 stocks and flows of inward and outward FDI, 16 t subsidy issues, 82, 90 -91 technology support programs, 109 as trading bloc, 29 -31, 31 n TRIMs discussion at GATT, 72 US as host nation, 97 US policy on national standards, 96 -97 Exception, versus derogation, 48 n Exchange rates, 41, 44 Exon -Florio provision of the Omnibus Trade and Competitiveness Act blocking foreign takeovers, 49, 92 -94 passage of, 20 questioned, 106 -07 Expropriation, 53, 83, 85 Externality, concept of, 123 n Factors of production, immobile, 3 FDI. See Foreign direct investment Fiber -optic communications networks, 108 Financial services, 5, 74 -75, 84 Finland, 76 Ford Motor Company, 26 Foreign direct investment (FDI) concept of, 9 contributions calculated, 1 n in European Community, 116 -17 historic versus market value estimates of world

stock, 10 -11 hostility toward, 37 -38 inward, 16 t liberalization proposed, 2 outward, 16 t, 29 t proposed accord on, 48 -67 rates of return, 22 -24 regional aspects, 29, 80 -87 technological spillovers of, 126 -30 trade compared to, 13 -14 US figures, 9 n Foreign investment, national treatment of. See National treatment of foreign -controlled firms Foreign Investment Advisory Service (FIAS), 80 Foreign Investment Review Agency (FIRA, Canada), 71, 72 Foreign -invested enterprises (China), 19 -20, 128 29 France Aerospatiale, 81 competition laws, 64 cultural set -asides, 107 -08 growth of outward FDI, 10 as host country, 90, 91 inward investment screening, 106 policy to global firms, 90 proposed takeover of US firm, 93 Free trade, 90 Free Trade Area of the Americas (FTAA), 116 Fund transfers and payments, 53 G -5 nations, growth of outward FDI, 10 Game theory “everyone loses” outcome, 45 GATT procedures, 131 -34 sanctions, 61 Gaster, Robin, 21 GATT. See General Agreement on Tariffs and Trade General Agreement on Tariffs and Trade (GATT) Committee on Subsidies, 72, 73 Consultative Group of 18 (CG -18), 97 dispute settlement, 83 enforcement powers, 61 European Union on host -nation policy, 96 -97 Havana Charter and, 70, 71 General Agreement on Trade in Services (GATS), 74 -76, 102 Germany corporate takeovers, 113 free trade proponents, 90 growth of outward FDI, 10 as host country, 91 outward foreign direct investment, 29 t subsidies, 115 Global corporations conduct code proposed, 78 developing nations’ view of, 88 -90, 97 -100 estimated net worth, 12 home nations, 27, 29 Global corporations (Cont.) hostility to, 37 -38 host nations, 27 -28, 29 t industrial nations’ view of, 88 -97 intrafirm trade, 14, 30 manufacturing, 25 -26 obligations of, 55 -57 Ohmae versus Porter definition of, 33 -35

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rationale for, 35 -41 relationship to national governments conceptualized, 42 terminology, 12 total sales of foreign affiliates, 4 Globalization extent of, 2 -3 history of, 24 -29 national policy effects of, 41 -46 recent trends in, 9 -31 Great Depression, 26 Greece, 76 Gross domestic product for 1981 -93 period, 10 t Gross fixed capital formation (GFCF), 2 -3 Group of 77, 55 -56, 78, 88, 89 -90 Havana Charter (1948), 70 -71, 80 Helpman, Elhanan, 127 -28 Hoffmaister, Alexander W., 127 -28 Home nations concept of home country, 27 n obligations of, 55 rights of, 54 -55 rights of regulation, 54 -55 rights of taxation, 54 shifts in position of, 88 -100 Hong Kong, FDI approach, 98 -100 Horizontal crowding, 127 Host nations rights of government, 54 shifts in positions of, 88 -100 Human capital, 128 Hydrogen Future Act, 95 Hymer, Stephen H., 27, 36 -37 Illicit payments, 66 -67 Inflation in 1986 -90 period, 10 Information superhighway, 108 Innovation, WTO procedures and, 103 Insurance industry, 74 Intellectual property rights, 65 -66, 99 Internalization theory, 39 -40 International Bank for Reconstruction and Development. See World Bank International Center for the Settlement of Investment Disputes (ICSID), 60, 79, 83 International Labor Organization (ILO), 66 International Monetary Fund (IMF) fund transfers and payments, 53 Joint Development Committee, 71 International Trade Organization (ITO), 70 Intrafirm trade, growth of, 30 Investment accord proposed, 101 -19 “Investment,” concept according to NAFTA, 82 n Investment major issues associated with international, 61 -67 reasons for new international rules for, 2 -7 Investment Canada, 71, 106 Investment incentives under APEC, 85 Committee on Subsidies recommendations, 73 distorting effects possible, 79 EC nations and, 21 -22, 90 global firms on, 89 globalization and, 41 OECD, 114 -15 Investor behavior, 86

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Ireland investment incentives, 22, 90 reservations on inward direct investment, 76 Italy competition laws, 64 cultural set -asides, 107 -08 reservations on inward direct investment, 76 J. & P. Coats Ltd, 25 Japan antimonopolies law, 63 -64 electronics firms in China, 100 exclusion of US from technology programs, 109 FDI stocks, 16 -17 FDI growth rates, 21 foreign acquisitions in, 49 global firms based in, 34 as host country, 91 -92 inward investment screening, 106 “Japan problem,” 50 Nippon Sanso, 107 outward FDI, 10, 17, 29 t performance requirements ban, 114 rates of return on Dutch investment, 22 t on US direct investment abroad, 23 t reservations on inward FDI, 76 role in OECD Multilateral Agreement on Investment, 92 takeover practices, 112 -13 technology support programs, 109 TRIMs discussion at GATT, 72 US hostility to, 97 US policy on national standards, 96, 97 JESSI semiconductor research program, 44, 109 Joint ventures, 19, 99 Jones Act, 110 -11 Keiretsu, 49, 112 -13, 113 n Labor, government’s role with, 43 Labor unions concerns over global firms’ labor standards, 66 as interest groups, 88, 89 position on FDI, 37 -38, 40 Latin America. See also individual countries behavior of multinationals in, 37 intellectual property rights issue, 73 shift toward FDI, 97 -98 Law Concerning Enterprises with Sole Foreign Investment (1986), 19 Law on Joint Ventures Using Chinese and Foreign Investment (1979), 19 LDCs. See Developing Countries Lee, Jong -wha, 126 -27, 128 n, 130 Legal traditions, Eastern and Western compared, 86 -87 Lend -Lease Act, 25 Liberalization in developing nations, 19 trends in, 103 -04 Local subcontracting, 129 -30 Maastricht Treaty, 116 Magee, Stephen P., 39 MAI. See Multilateral Agreement on Investment Malaysia, 99

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Management skills, 36 Mansfield, E., 39 Manton, Thomas (D -NY), 95, 109 Manufacturing, US -based firms, 34 -35 Mega -sectors, 111 Mercado Común del Sur (Mercosur), 101, 116 Mercosur. See Mercado Común del Sur Mergers and acquisitions antitrust laws and, 63 control by national governments, 106 European Union on, 81 unfriendly takeovers, 112 -14 Mexico competition law passed, 64 FDI flows to, 18 -19 inward investment screening, 106 labor productivity studied, 129 liberalization of investment policy, 37 liberalization of trade, 97 -98 NAFTA, 97 -98, 105 OECD membership, 116 n petrochemicals, 110 rates of return on US direct investment abroad, 23 t shift to market incentives, 19 Miert, Karel van, 82 Monopolies, state -sanctioned, 84, 110 -11 Morocco, 129 Most -favored nation (MFN) concept of, 51 in GATS draft agreement, 75 Mexico extends status, 98 under NAFTA, 83, 98 national treatment provisions and, 51 TRIPs agreement, 73 Motion picture industries, 107 -09 Multilateral Agreement on Investment (MAI) carve -outs for REIOs, 112 corporate takeovers, 113 -14 developing nations’ participation in negotiations, 118 investment incentives, 114 -15 inward investment screening, 106 Japan’s role in, 92 national benefits test, 110 national security exceptions issue, 107 national treatment for cultural activities, 108 national treatment issues, 105 OECD’s effort to develop, 7 performance requirements, 114 preparation for, 78 privatization, 114 reservations, 105 state -sanctioned monopolies, 110 as stepping stone, 116 -17 WTO accord preferable to, 118 -19 Multilateral Investment Guarantee Agency (MIGA, World Bank), 79 -80 Multinational corporations. See Global corporations Multinational enterprises (MNEs). See Global corporations NAFTA. See North American Free Trade Agreement National Aeronautical and Space Administration Authorization Act, 95 National Competitiveness Act, 95, 96, 109

National Cooperatives Production Act, 94 National defense as function of government, 43 government interest in, 117 National Environmental Technology Act, 95 National government proposed host -nation obligations, 48 -53 relationship to global corporations conceptualized, 42 roles of, 43 -46 National security globalization and, 3, 106 right of establishment and, 49 takeovers of US firms and, 92 -93 technology support programs and, 110 National treatment of foreign -controlled firms under APEC, 85 Argentina, 98 China, 99, 104 Colombia, 98 corporate governance, 112 -14 host -nation government obligations, 51 -52 Manton amendment and, 95 -96 most -favored nation (MFN), 111 -12 national security exceptions, 106 -07 privatization, 114 problem areas in negotiations, 106 -11 Russia, 104 technology support programs, 109 -10 traditional US policy of, 20 US policy shifts, 94 -97 US retreat from principle of, 92 -96 Venezuela, 98 National treatment instrument (NTI), 77 Netherlands, rates of return on outward direct investment, 22 t New international economic order, 78 New Zealand rates of return on US direct investment abroad, 23 t reservations on inward direct investment, 76 Newly industrializing economies (NIEs), 19, 31, 87 Nigeria, 129 Nondiscrimination between source economies, 85 Nordic nations, 72, 90 n North America FDI flows, 15 -16 outward FDI, 29 t rates of return on Dutch investment, 22 t as trading bloc, 29 -31 North American Free Trade Agreement (NAFTA) binding arbitration, 59 Chile’s membership, 116 Clinton administration on, 93 -94 competition policy, 84 conceptual issues, 30 currency exchange, 83 dispute settlement provisions, 57, 83 -84 environmental “sidebar,” 84 exceptions to Chapter 11, 84 expropriation, 83 FDI agreements, 115 FDI approach, 82 -84 “grandfathering” sectoral restrictions, 50 lack of sanctions, 133 Mexico liberalizes, 97 -98 monopolies, 84

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most -favored nation, 83 national treatment obligations, 105 performance requirements, 52, 83, 114 proposed investment accord and, 101 REIO carve -outs, 112 reservations and derogations “grand -fathered,” 105 “standstill” provision, 105 state -sanctioned monopolies, 110 Norway, 76 OECD. See Organization for Economic Cooperation and Development Ohmae, Kenichi, 33 -35, 40, 42, 44 Oil sector, international holdings expanded, 26 Oligopolies, failure to materialize, 27 Omnibus Space Commercialization Act, 95 Omnibus Trade and Competitiveness Act. See also Exon -Florio provision of the Omnibus Trade and Competitiveness Act, 65, 94, 95 Organization for Economic Cooperation and Development (OECD) Business and Industry Advisory Committee (BIAC), 114 Committee on Capital Movements and Invisible Transactions (CMIT), 77 Committee on International Investment and Multinational Enterprise (CIME), 77 n conceptual issues, 30 development of MAI, 7, 104 FDI effects studied, 126 -28 illicit payments to foreign governments, 67 investment agreement arguments reviewed, 104 05 investment incentives, 114 -15 liberalization codes, 76 -78 membership, 102 Mexico’s membership, 116 n most -favored nation clause, 111 -12 Multilateral Agreement on Investment (MAI), 101, 105, 117 -18 national security issue, 107 national treatment, 105 performance requirements, 114 privatization, 114 REIO carve -outs, 112 reservations, 105 restricted industries, 49 Task Force on International Development, 79 on taxation, 62, 63 telecommunication monopolies, 111 transparency issue, 52 as venue for investment accord, 101 -04. See also Multilateral Agreement on Investment (MAI) Organizational theory of the firm, 39 -40 Overseas Private Investment Corporation (OPIC), 79 -80 Pacific Economic Cooperation Council (PECC), 84 n Pareto -suboptimal effects, 3 n Patents, 65 -66, 73 Performance requirements under APEC, 85 Argentina, 98 Brazil, 98 Canada, 71

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China, 99 Colombia, 98 distortive effects, 52 East Asia, 99 under EU, 90 global firms on, 89 globalization and, 41 listed, 114 n local -content, 71 -72, 124 under NAFTA, 83 OECD, 114 organized labor on, 89 United Kingdom view of, 91 US view of, 79 Poland, 64 Porter, Michael, 33, 34 -35, 40, 42 Portugal, 76 Preferential trading agreements, 30 -31 Privatization, 114 Profit repatriation restrictions, 98 Property rights, 99 Protectionism, globalization and, 3 Reciprocity requirements tied to research and development funds, 94 -95 Regional economic integration organizations (REIOs), 112 Regional stocks and flows of FDI, 16 t Regional trading blocs. See also Regional economic integration organizations (REIOs) FDI agreements, 115 FDI approaches discussed, 80 -87 most -favored nation status and, 51 performance requirements, 52 proposed investment accord and, 101 as protectionist, 29 -31 redundant production and, 41 role in liberalization, 115 -16 as stepping stones, 117 -18 Regulation in China, 20 competition and, 47 constructive, 45 EC attracts high -tech FDI, 21 of FDI by developing nations, 18 globalization and, 42 as host -nation government right, 54 protecting worker health and safety, 43 protection of domestic markets, 5 Reich, Robert, 34 REIOs. See Regional economic integration organizations Repatriation and convertibility of funds, 83, 86, 98 Research and development (R&D) foreign consortia with public funding, 109 -10 FDI and, 14 -15 foreign -controlled firm eligibility, 94 -95, 96 global firms dominate, 15 government support of, 44 reciprocity requirements, 94 -95 technological spillovers and, 124 US multinational firms, 15 US preponderance in, 38 Reservations OECD accord possible on, 105 OECD rules, 76 -77 Restrictive business practices

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China, 64 code proposed to regulate, 78 competition policy and, 63 Group of 77 on, 56 under Havana Charter, 70 -71 Romeo, A., 39 Rowthorne, Robert, 27 Russia competition laws, 64 national treatment for foreign -controlled enterprises, 104 Sanctions, 61 Scandinavia. See Nordic nations Sematech, 44, 109 Semi -Gas, 107 Semiconductor manufacturing, EC incentives for, 21 -22 Service marks, 73 Singapore data transmission restrictions, 108 electronics industry, 130 FDI approach, 98 -100 gross fixed capital formation (GFCF), 3 Singapore summit meeting of WTO (December 1996), 118, 119 Singer Manufacturing Company, 25 Sino -Foreign Cooperative Joint Venture Law (1988), 19 Sojournment of personnel, 53, 86 South Africa, rates of return on US FDI, 23 t South America, rates of return on US FDI, 23 t. See also Latin America Southeast Asia electronics industry, 130 rates of return on Dutch investment, 22t Sovereignty, national, 59 Spain, 76 Standard Oil Company, 25 Stevenson -Wydler Technology Innovation Act (1980), 95 Strategic alliances, 11 -12 Subsidiaries behavior of, 35 taxation of, 54 Subsidies in EU member states, 81 -82, 90 -91 GATT Committee on Subsidies, 72, 73 indirect, 41 investment incentives as, 114 OECD, 114 -15 to state -owned enterprises, 81 -82 under TRIMs Agreement, 52 Summit of the Americas (Miami 1995), 116 Taiwan competition law passed, 64 FDI approach, 98 -100 Taxation under APEC, 86 double, 86 function of government with regard to, 44 issues discussed, 52 of subsidiaries by host -nation government, 54 worldwide unitary, 62 -63 Technical assistance, Foreign Investment Advisory Service, 80

Technological spillovers, 36 n, 123 -30 concept of, 123 horizontal, 124, 125 vertical, 124, 125 -26 Technology development Advanced Technology Program, 94 foreign takeovers of US firms, 93, 94 technology support programs, 109 -10 US preponderance in, 38 Technology transfer to developing countries, 90 to “downstream” operations, 125 efficiency of local firms and, 124, 130 FDI and, 14 -15, 123 -30 intellectual property rights issue, 73 Telecommunications fiber -optic communications networks, 108 regulation of, 5 sector -specific reservations, 110 -11 Thailand, 99 Tokyo Round, 104 Trade for 1981 -93 period, 10 t compared to FDI, 13 -14 FDI and, 38 government policies, 44 Trade Act (1988), 65, 94, 95 Trade -Related Aspects of Intellectual Property (TRIPs), 65 -66, 73 -74 direct investment in manufacturing, 102 Trade -Related Investment Measures (TRIMs) APEC and, 85 n, 99 East Asia, 99 Europe favors, 91, 97 local -content requirements, 124 -25 manufacturing, 102, 114 negotiations at Punta del Este, 71 -73 negotiations weakened, 89 organized labor supports, 89 performance requirements, 6, 14 shortcomings, 103 US position on, 88, 97 US -based global firm support for, 89 Trademarks, 65 -66, 73 Transfer pricing concept of, 62 manipulation of, 23 -24 taxation and, 54 Transparency under APEC, 85 derogations and exceptions and, 52 exceptions to principle of openness, 49, 50 in GATS draft agreement, 75 Treaty of Rome Article 92, 52, 91 Article 93, 52 FDI, 116 exceptions, 81 international cartels, 80 -81 Triad, FDI flows and, 15 -19, 22 United Kingdom colonial investments, 24 -26 corporate takeovers, 113 FDI in Europe compared to FDI in US, 29 free trade proponents, 90 growth of outward FDI, 10

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as host country, 91 labor productivity, 125 outward FDI, 29 t US -based firms, 125 United Nations assets of largest global firms, 12 n, 13 codes of conduct for global firms, 55 -56, 78 -79, 88 Commission on International Trade Law (UNCITRAL), 60, 83 Commission on Transnational Corporations, 78 dispute settlement, 60 FDI estimates of, 10 -11 General Assembly, 79 intrafirm trade of global firms, 14 United States antitrust laws, 63 Burke -Hartke legislation, 4 business community opposition to REIO carve out, 112 corporate takeovers, 113 Department of Energy, 94 domination feared, 90 FDI compared to Japanese FDI, 17 FDI growth rates, 10, 11, 20 Foreign Corrupt Practices act, 67 foreign -controlled firms in, 28, 49 gross fixed capital formation (GFCF), 3 Havana Charter resisted, 71 history of international firms, 25 -27 as host country, 27 -28, 88, 92 -96 hostility to Japan, 97 illicit payments issue, 66 -67 interest groups in, 88 inward FDI, 11 inward investment screening, 106 Jones Act, 110 -11 labor legislation, 43 national treatment instrument issue, 77 outward FDI, 29 t Overseas Private Investment Corporation (OPIC), 79 -80 patent issues, 66 performance requirements ban, 114 rates of return on Dutch investment, 22t, 23 -24 on FDI, 23 -24 on investment abroad, 23 t research and development by multinational firms, 15 home markets and, 38 reservations on inward FDI, 76 restrictive FDI policies, 20 right of establishment, 49 Semi -Gas, 107 sources for export and import figures, 14 n state -sanctioned monopolies, 110 subsidies, 114 Taiwanese performance requirements, 99 TRIMs discussion at GATT, 72 United Kingdom affiliates of US firms, 125 Uruguay Round expansion of WTO role, 6 -7 intellectual property rights provisions, 73 international service industries, 74 -76 investment incentives, 72 “new issues” agreements, 69 phase -out of performance requirements, 99, 114

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significance of, 71 Trade -Related Aspects of Intellectual Property (TRIPs), 65 -66 Trade -Related Investment Measures (TRIMs), 52, 72 “unfinished business,” 119 Venezuela, liberalization of investment policy, 98 Vernon, Raymond, 30 -31, 38 -39, 42 Video broadcasting, 107 -09 Wagner, S., 39 Wei, Shang -jin, 128 -29 Williamson, Oliver E., 39 World Bank (International Bank for Reconstruction and Development) International Center for the Settlement of Investment Disputes (ICSID), 79, 83 Joint Development Committee, 71 Multilateral Investment Guarantee Agency (MIGA), 79 -80 Task Force on International Development, 79 World Trade Organization (WTO). See also Trade Related Investment Measures (TRIMs) Agreement bans new local -content requirements, 124 -25 competition policy and, 64 dispute settlement body, 57 -58 disputes over intellectual property rights, 74 enforcement powers of, 61 expansion of role of, 6 -7 game theory analysis, 131 -34 innovation and, 103 membership, 102 -03 ministerial meeting in Singapore (1996), 118 performance requirements, 85 n phase -out of TRIMs, 72 -73 plurilateral agreement possibility, 104 trade policy constraints, 3 -4 trade rules administered, 69 as venue for investment accord, 101 -04, 118 -19

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