Toward New Rules on International Investment...In the case of Japan, for example, it is claimed that...

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Toward New Rules on InternationalInvestment

This chapter explores the possible substance of an international accordon foreign direct investment (FDI) and global corporations. The pro-posal is framed normatively; that is, it lays out basic principles of anoptimum optimorum of accords and largely ignores whether internationalagreement on such an accord can actually be achieved. At the level ofdetail, however, points at which major disagreements among negotiat-ing 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 jus-tified in the name of national security or some other overriding prin-ciple. Thus, the accord outlined here is not meant to unduly increaseregulation of FDI or the activities of multinational firms; rather, it isintended to provide a basis for liberalization of restrictive policies thatcurrently exist and to reduce government interventions that might leadto income-reducing inefficiencies.

This is not to say that there should be no regulation whatsoever ofmultinational firms. Governments, for example, must continue to ensurethat markets remain competitive and that multinational firms are notexempt from competition policies. As is argued later in this chapter,competition policy is one domain where a more international approachis needed in the face of the globalization of business. More generally,one of the central tenets of an accord on investment should be thataffiliates of multinational firms obey the laws of the host nations inwhich they operate.

Chapter 5 surveys the extent to which the principles outlined in thischapter have actually been achieved in existing agreements on invest-

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48 GLOBAL CORPORATIONS AND NATIONAL GOVERNMENTS

ment. The reader is cautioned to pay attention to nuance; many of theprinciples enumerated in this chapter do in fact appear�in name, atleast�in international agreements that have been struck. But often, theaccompanying language diminishes their content significantly.

An Accord on FDI

The ideal accord would grant specific rights to, and simultaneously placecertain obligations on, three sets of factors:

n governments of nations that are host to FDI (including subnationalentities);

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 settledisputes both between governments and between direct investors andgovernments that might arise over interpretation or enforcement of theserights and obligations. The accord might also be supplemented by ancil-lary codes. The main ingredients of such an accord are described below.

Host-Nation Government Obligations

These fall into three categories: right of establishment, national treat-ment, and state intervention. Obligations for all three categories wouldenunciate normative principles and a list of acceptable exceptions andderogations to these normative principles.1

Right of Establishment

The subsection on right of establishment would spell out both obliga-tions to apply to host governments and rights to apply to foreign directinvestors. The underlying normative principle should be that nationalmarkets must be open to entry by foreign direct investors via the routeof foreign direct investment (including acquisition of ongoing enterprises

1. The difference between an �exception� and a �derogation,� following standard inter-national legal usage, is that the former is considered more or less without time limitwhereas the latter is considered to be a temporary measure.


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TOWARD NEW RULES ON INTERNATIONAL INVESTMENT 49

already operating within the market) and that any exceptions or dero-gations must be completely transparent.2

No nation now grants full, unimpeded right of establishment toforeign-owned or foreign-controlled enterprises. For example, the UnitedStates traditionally prides itself on its degree of openness to FDI but haslong imposed restrictions on foreign ownership of activities in certainsectors. Foreign interests cannot wholly own or exercise control overenterprises operating in the US broadcasting, coastal shipping, nuclearenergy, oil pipeline, or domestic air transport industries. All countrieshave sectoral restrictions, and among the OECD nations, lists of restrictedindustries tend to be strikingly similar to the US list (OECD 1993; therestrictions listed in this somewhat dated document still exist, with littlechange).

Most nations can also block foreign takeovers of domestic firms, oreven �greenfield� establishment of foreign-controlled operations, on groundsof national security. The United States made such power explicit in theExon-Florio amendment to the 1988 Omnibus Trade and Competitive-ness Act, and most nations give themselves similar powers.3 Further,many nations screen FDI on economic grounds. Others reserve the powerto do so, even though in recent years they have allowed these powersto fall into disuse. The issue of whether governments should screen FDIthus remains a contentious issue.

A more subtle establishment issue encompasses intangible barriers toentry, which are widely viewed as existing in Japan and certain othercountries whose regimes are less open or less transparent than in America.In the case of Japan, for example, it is claimed that cross-holdings ofequity in firms by other firms within the so-called financial keiretsu makeit impossible for non-Japanese firms to acquire Japanese firms. (see, e.g.,Bergsten and Noland 1993; Lawrence 1993) This has led to proposals forstrict reciprocity in extending the right of establishment (or national treat-ment, see below) to particular countries.

What exceptions to the principle of openness are to be allowed? Thereare numerous justifications given for exceptions: national security, con-trol of national patrimony, and various shades of mercantilism. Thenegotiation of exceptions would be very difficult because there is noconsensus on the merit of these justifications. As was explored in theprevious chapter, many of these issues boil down to a question of theextent 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 thatthe affected parties can discern the direct and indirect consequences of the measure orpolicy (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 organi-zation or is simply an ordinary, national entity that happens to haveforeign owners. Nations that limit right of entry tend toward the viewthat the international corporation is an integrated entity potentially pur-suing strategies or goals incongruent with national interests. Nationsthat maintain relatively open official policies toward direct investmenttend to see the issue merely in terms of what activities should andshould not be subject to foreign ownership, without much regard to themeans by which the foreign ownership is exercised (e.g., US restrictionson 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, shouldnations be allowed to close to FDI? Should governments screen FDI,and if so, on what grounds? With respect to structural impedimentsto establishment (generally termed the �Japan problem,� even thoughJapan is not the only country where such a situation may exist), howshould openness be defined and maintained when there are opaquebarriers? Should equity restrictions on foreign investors be allowed? (Forexample, should host governments be allowed to require local equityparticipation in domestic affiliates of international corporations?) Andif so, to what categories of commercial enterprise would they apply?Should nations be allowed to �grandfather� existing sectoral restric-tions and other limitations on right of establishment (as did the UnitedStates in the NAFTA), even if these do not fall on the list of acceptableexceptions?

Because some exceptions are inevitable, an overriding goal would beto achieve a high degree of transparency. That is, whatever the rulesregarding right of establishment, countries should administer them in away that is clear and unambiguous. Official exceptions to right of estab-lishment should be published, or, where countries exercise adminis-trative discretion in determining whether a particular case would beallowed or not, both the criteria for judging the case and the proceduresfor making a determination should be public information. Indeed, a uni-versal benefit of an international accord on direct investment would beto make exceptions to right of establishment transparent and thereby toincrease the likelihood that such exceptions would be subject to futureliberalization.

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


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National Treatment

The subsection of the accord on national treatment for foreign investorswould closely parallel that on right of establishment and would alsosimultaneously spell out obligations on host-nation governments andrights of foreign direct investors. The normative principles would be thatforeign-controlled enterprises operating in a national economy should besubject to exactly the same laws and policies as domestically owned rivalfirms operating in the same sectors, and that any exceptions or dero-gations should be completely transparent. In many countries, foreign-controlled enterprises are in practice subject to different laws or policiesthan domestically owned ones, so an alternative articulation of thenational treatment principle that has found acceptance may be called for:foreign-controlled enterprises should be subject to laws and policies noless favorable than those applied to domestically owned firms operating inthe same sectors. This phrasing allows a host nation to apply laws to theforeign-controlled enterprise that are more favorable than those appliedto domestic rivals.

National-treatment provisions should be augmented by a general pro-vision for most-favored nation (MFN) status. In the context of inter-national investment, MFN implies that if a nation that is party to theaccord grants to investors (or their affiliates) from some nation treat-ment that is more favorable than that required under the national treat-ment obligation of the accord, that same treatment would be accordedto the investors (or their affiliates) of all nations party to the accord.

One sticky issue is whether exceptions to MFN should be allowed. Theexception most likely to be accepted is one for so-called regional economicintegration organizations such as the EU and NAFTA.

Another difficult, more general issue would be allowable exceptionsto national treatment. For example, should government procurement policiesfor defense industries prohibit foreign-controlled enterprises from beingcontractors for certain goods? Should special requirements on foreign-controlled defense contractors that do not apply to domestically con-trolled ones be deemed acceptable exceptions from national treatment?Are there sectors in which foreign-controlled firms should be regulateddifferently from domestically controlled competitors for reasons otherthan national defense? Should foreign-controlled firms have the samerights to contribute to election campaigns as do domestically controlledfirms?

There is little consensus among nations (or, for that matter, amongthe policy analysts of most nations, including the United States) on howextensive national security and other exceptions to national treatmentshould be. Therefore, negotiating an agreement on allowable deroga-tions and exceptions to right of entry and national treatment wouldprobably be difficult. Most likely, any future accord would include ratheropen-ended provisions regarding derogations and exceptions; that is to


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say, pragmatic considerations would dictate that countries be allowed tomake pretty much all the derogations and exceptions they see fit. Other-wise expressed, lists of allowable derogations and exceptions wouldalmost surely include all possibilities that any negotiating party seriouslywanted to be on such a list.

Thus, transparency again becomes a very important issue. To ensureit, a procedure along the lines of the current process followed in prin-ciple by OECD members might be applied. Under this process, coun-tries publicly state what derogations and exceptions are in effect andenforced and are prepared to periodically justify these derogations andexceptions before an international body.5 Such a process would not onlypromote transparency but would bring pressure on countries whosederogations and exceptions are excessive by international norms.

State Intervention

The third set of obligations applying to host-nation governments en-compasses the issues addressed in the Uruguay Round Agreement onTrade-Related Investment Measures (TRIMs)�namely, which nationaland subnational government interventions into the behavior of interna-tional corporations should be allowed and which should be prohibited.Prime on the list of these interventions are investment incentives andperformance requirements, some aspects of which were discussed in chapter3 and others that were tackled in the Uruguay Round are covered inthe following chapter. Two brief notes will suffice here. First, most per-formance requirements on MNC subsidiaries have distortive effects bothon allocation of investment resources and on international trade flowsgenerated by direct investment. Hence, most such requirements shouldsimply be banned. Second, prohibitions or other disciplines on theserequirements should be linked with restrictions on investment incen-tives, which also have distortive effects.

The Uruguay Round TRIMs agreement has fallen short of establishingwholly effective rules in this area; only certain performance requirementsare addressed. Those practices that are addressed are banned, as are thesubsidies (which have the nature of investment incentives) linked tothese. Some regional arrangements cover more. For example, NAFTAcovers more categories of performance requirements but leaves invest-ment incentives untouched. Articles 92 and 93 of the Treaty of Rome�thebasic document of the European Union�potentially caps most invest-ment incentives. These arrangements are covered in the next chapter, andall that we shall say here is that stronger agreements on both investmentincentives and performance requirements would be useful at the globallevel.

5. This process is described in more detail in the following chapter (see also OECD 1993).


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Again, what exceptions ought to be permitted? Would nations beallowed to impose performance requirements deemed necessary for na-tional security? Are there classes of performance requirements that shouldbe permitted? For example, should governments be allowed to requirethat foreign-controlled enterprises perform certain levels of research anddevelopment? (On this issue, while NAFTA bans most categories of newperformance requirements, it apparently does not ban R&D requirements.)Would existing performance requirements be grandfathered? If so, shouldthere be a schedule for rollback and elimination of these?

Other obligations of host governments would pertain to fund trans-fers and payments, expropriation, and sojournment (temporary residency)of personnel.

Under an accord on investment, international firms would have theright to transfer funds and to make payments in and out of jurisdictionswhere they operate. These transfers and payments would include thoseof profits, dividends, interest, realized capital gains, royalty and licens-ing fees, technical assistance fees, management fees, proceeds from thesale of assets, payments for material inputs (e.g., imported raw materialsor semifinished products for further processing), and other transfers andpayments associated with the normal conduct of business. Host- andhome-nation governments could not restrict these, except insofar as re-strictions related to judicial proceedings (e.g., the firm in question werebankrupt or in a state of insolvency) or were imposed pursuant to criminalinvestigations. An exception would be allowed where a nation sufferedextreme balance of payments difficulties, in which case restrictions couldbe imposed consistent with the Articles of Agreement of the Interna-tional Monetary Fund (IMF).

The businesses and properties of an international firm would not besubject to expropriation or nationalization unless it were to be conductedon a nondiscriminatory basis and subject to due process of law. If busi-ness and property were expropriated, the investors would be entitled toprompt compensation for their fair market value in an international cur-rency (e.g., US dollars, Japanese yen, or German marks).

With respect to sojournment of personnel, global corporation affiliatesshould have the right to employ technical and other personnel desig-nated by the parent organization, and these personnel should be able toobtain nonpermanent resident status in the host country. Host govern-ments should create special visa categories for personnel requiring visas.Staffing decisions would be at the discretion of the subsidiary and itsparent organization�that is, not subject to host-nation requirements toemploy local nationals in key positions.6

6. The company might nonetheless wish to do so; indeed, there is a trend worldwide forglobal corporations to employ local nationals at all levels in their overseas subsidiaries.Nonetheless, explicit rights of sojournment would be desirable to provide against unduestate 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 invest-ment accord would spell out certain rights of these governments:

n The host government should have the right to regulate the activitiesof foreign-controlled enterprises operating within its sovereign ter-ritory, consistent with the principles of right of establishment andnational treatment discussed above. In particular, the host nation shouldhave the right to force a subsidiary of an international firm legallyincorporated in that nation�s territory to follow host-nation law andpolicy, even if these should conflict with the law and policy ofanother sovereign state�s jurisdictional claims over the subsidiary, suchas those of the corporation�s home-nation government.

n The host government should be able to tax the earnings of the sub-sidiary, again consistent with obligations set down elsewhere in theaccord. In particular, the host-nation government should have theright to adjust reported earnings of a local subsidiary to correct forunderreporting via constructed transfer prices. However, there shouldbe uniform standards for transfer pricing to which all host nationswould subscribe (see the discussion below pertaining to an ancillarycode on taxation).

Home-Nation Rights and Obligations

At least two rights of, and one obligation on, home-nation governmentsshould be made explicit. These governments should have the right totax its citizens, including corporate citizens, on worldwide income. Thiswould include the right to choose how to treat host-nation taxes onincome earned abroad (e.g., whether to grant credits for these taxes, toallow them to be deducted from taxable income as expenses, or to treatthem in some other fashion) and the right to adjust earnings for pos-sible distortions caused by transfer pricing (again, see discussion of anancillary code on taxation below). However, it would be desirable fornations to agree to refrain from exercising this right and tax instead onthe basis of residence (�territorial� taxation), whereby the earnings ofoverseas affiliates would not be deemed taxable.7

The second right of home governments is the power to otherwiseregulate the activities of their citizens. But home governments should

7. A complete discussion of the taxation of multinational corporations and a series ofrecommendations for reform is contained in Hufbauer and van Rooij (1992). See alsoHufbauer and Gabyzon (1996).


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also accept as an obligation the right of host-nation governments to regu-late economic activities of citizens (including affiliates of firms that arebased in the home nation) operating within the host territories. Thereshould be no exceptions to this obligation, although governments mightseek international mechanisms for implementing needed regulations indomains such as taxation and competition policy (antitrust); see discus-sion below. Host nations might sometimes voluntarily cede rights ofregulation to home governments. For instance, a host-nation govern-ment might recognize another government as supervisor of banking opera-tions that are conducted in the host nation�s territory but are controlledby banks based in the other government�s territory.

Under this right, combined with the right of host-nation governmentsto regulate the activities of foreign-controlled firms operating on theirshores, contradictory policies could be aimed at the same corporation.For example, one nation might embargo sales of goods and services toa second nation, but a third nation might not honor the embargo. Whatought to be the position of a multinational corporation with affiliates inboth the first and the third countries, each of which does business withthe second? (In this case, the �affiliate� could be the parent organiza-tion.) According to the principles enumerated here, the affiliate in thefirst country could be required by that country�s government to complywith the embargo, but that government could not require the affiliatein the third country to honor the embargo. But even so, the issues arenot wholly clear-cut. For example, can the first country�s governmentprevent the affiliate in the first country from selling goods and servicesto the affiliate in the third if this were likely to result in resale to theembargoed country? If technologies are transferred from the first-country subsidiary to the latter, does the first country�s government havethe 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 ofhome and host nations are constructed, it will not always be clear whichgovernment can regulate a particular transaction or activity. Thus, animportant adjunct to the rules will be a means by which jurisdictionaldisputes between home and host governments can be settled. Just sucha scheme is discussed later in this chapter.

The industrialized nations, especially the United States, have long re-sisted obligations upon business enterprises through international law,arguing that such obligations would invariably discriminate against in-ternational corporations. This rationale was buttressed during the 1970sby the rather extreme positions taken by the Group of 77 developing

Rights and Obligations of Global Corporations


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nations in UN discussions on codes of conduct to regulate internationalcorporations 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 inves-tors if these investors themselves were not subject to obligations at theinternational level. Multinational firms do often have objectives that areat variance with the laws or policies of the nations in which they oper-ate, and these governments have a right to expect that local affiliateswill comply with local law or policy.

Second, clearly stated international rules could save international cor-porations from situations in which they otherwise would be �damned ifthey did and damned if they didn�t,� as when they face conflicts be-tween policies of home and host governments. Clearly, these firms canbenefit from rules indicating which government was to be obeyed�under the principles enumerated here, this would almost always be thehost government.

Third, these rules could provide a standard against which the con-duct of a specific firm could be gauged. Such standards could very muchbe in the firm�s own interests. Say, for example, a firm believes that itfaces unfair or discriminatory treatment under the law or policy of ahost government that is in contravention of obligations of an accord oninvestment. The host government, for its part, counters that the firm�sconduct necessitated the discrimination. If there were dispute settlementprocedures in place, the firm could plead its case before an internationalpanel and argue that its conduct was acceptable by the standards of theaccord and hence did not warrant government intervention.

Specific obligations on international corporations would fall into twocategories. First would be rules specifying whose laws and policies suchcorporations must follow under what circumstances. The underlyingprinciple should be that entities operating in host countries should fol-low host-government law while entities operating in home countries shouldfollow home-government law. When, as in the example above, two gov-ernments claim jurisdiction over a transaction or activity and these par-allel 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 wouldprohibit or discourage �restrictive business practices.� Some such prac-tices should be banned entirely�for example, central office policies re-quiring subsidiaries to source inputs from specific overseas suppliers wherethese inputs could be economically obtained from local suppliers. Thesepolicies are analogous to host-nation performance requirements, and theGroup of 77 long ago rightly sought international sanctions against them.

There is widespread disagreement among nations with respect to ex-actly what practices might fall into this category. Pragmatism therefore


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suggests that an accord on investment likely would contain two lists ofrestrictive business practices: those that all signatory countries could agreeto prohibit, and those that all signatory countries could agree to discour-age. The latter list could include practices that some but not all nationsbelieved should be prohibited.

Practices falling on the first list would be banned per se. Practices onthe second list could be banned by individual nations, but the prohibi-tions would apply only to operations conducted on this nation�s sover-eign soil.

In addition to these basic obligations on international corporations,there could be other obligations linked to ancillary codes; these are dis-cussed later in this chapter.

Dispute Settlement

Two generic types of dispute can be envisaged under the proposed ac-cord: �state-to-state� disputes between governments (e.g., between a homeand a host government over one or the other�s policies as they bearupon a particular international corporation) and �enterprise-to-state� dis-putes, where the government may be home or host to the corporation.

For state-to-state disputes, a modified settlement mechanism similarto but stronger than the current WTO Dispute Settlement Body wouldbe desirable. Appropriate measures to strengthen the WTO mechanismare embodied in the Canada-US Free Trade Agreement (Horlick, Oliver,and Steger 1988); a model for enterprise-to-state dispute settlement is tobe found in the chapter 11 provisions of NAFTA (Graham and Wilkie1994).

Borrowing from the FTA and current WTO procedures, the essentialelements of a mechanism to settle state-to-state disputes are as follows:

n The party initiating an action must notify the other party or partiesof its intentions in writing.

n The parties must attempt to work out the problem via mutual consul-tation.

n If consultation fails, the parties can submit the dispute to a panel ofexperts 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 inWTO procedures is, however, quite different. A WTO �panel� cannotarbitrate a dispute. If mutual consultation fails to resolve a dispute withina specified time, the dispute may be brought before a panel, which canthen recommend by majority vote whether the action of the �defen-dant� state in the dispute violated its WTO obligations. The panel also


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recommends remedial action. Its decisions may be appealed to an Ap-pellate Body, whose findings are adopted automatically unless the Dis-pute Settlement Body decides by consensus to block the adoption. Ifupon appeal the defendant does not take the recommended remedialaction within some reasonable period (which is decided case by case),the �plaintiff� government is then entitled to initiate trade-related sanc-tions against the �defendant.�

For enterprise-to-state disputes, somewhat different procedures arewarranted. International corporations are not sovereign states and hencedo not have the rights accorded to such states. Generally, issues be-tween an international corporation and a nation state are (and shouldbe) settled within the legal system of the state. Indeed, under the ac-cord described above, international corporations and their affiliates wouldbe bound to obey the law and policy of governments in the territoriesover which these governments hold jurisdiction. However, three gen-eral cases can be identified where the legal system of a nation-statecould prove unsatisfactory as a means of settling a dispute:

n where a government believed that an international corporation�s prac-tices outside national territory harmed its interests and that the firmhad violated its obligations under the accord;

n where a firm believed that government regulations or policies affect-ing its operations were inconsistent with the government�s obliga-tions under the accord and where efforts to resolve the matter withgovernment agencies failed to resolve the issue;

n where a firm believed that one government�s laws, regulations, orpolicies contravened those of another so that the firm could not fol-low both. In such a case, the firm might initiate dispute resolutionproceedings with both governments.

For these situations in which the firm is party to a dispute, a differentdispute settlement mechanism should be established. A two-step proce-dure is envisaged:

n One of the parties to the dispute appeals to a panel, the sole role ofwhich would be to determine if there were merit to the appeal. �Merit�here would be decided largely on procedural grounds, perhaps bythe following criteria: Were efforts made to resolve the dispute viaconsultation between the affected parties or via the established legalprocedures of the affected government? Did the dispute involve in-terpretation of the investment accord, and in particular, did it appearprima facie that a party to the dispute could be in violation of someprovision of it?


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n If this panel were to judge that the appeal had merit, a second panelwould hear the substantive issues of the dispute. This panel wouldbe empowered to recommend a solution, which could entail award-ing of damages to the firm, a recommendation that the relevant gov-ernment or governments cease or desist from a particular practice, ora recommendation that the firm take (or cease or desist from) a par-ticular action.

One purpose of this two-stage dispute settlement approach is to filterout frivolous or nuisance cases. A second purpose is to induce parties tosettle disputes via consultation: The first panel could require the dis-puting parties to engage in further consultation if it believed that allpossibility of a mutually satisfactory resolution had not been exhausted.Thus arbitration in the second panel could be restricted only to thosesubstantive cases where resolution was impossible.

This procedure clearly raises issues of nation-state sovereignty. Whatwould be the legal status of any recommendation of this second panel?Would the recommendation be binding upon firms? If the procedure isto have any meaning, the answer would have to be yes. But then wouldthe recommendation be binding upon nation-states? If the answer wereno, the whole procedure would be asymmetric and corporations likelywould view it as latently punitive. If the answer were yes, signatories ofthe accord would have to yield a certain amount of sovereign power.

The NAFTA chapter 11 dispute settlement procedures�discussed insome detail in chapter 5�offer a partial precedent for these proposals.8Under these procedures, NAFTA member-country investors (but not theirinvestments such as a subsidiary) as well as the member governmentsthemselves can submit certain types of disputes to binding arbitration.9Consultation and negotiation must be tried first. An investor can seekarbitration if consultation and negotiation fails and if the investor canclaim monetary loss or damages resulting from an alleged breach ofobligations under section A of chapter 11 of the NAFTA agreement (orcertain other articles).

Under NAFTA procedures, a tribunal would then fulfill both steps ofthe arbitration procedure outlined above unless the disputing party as-serts that the measure at issue falls under any of the stated exceptionsto NAFTA (set forth in annexes I through IV of the agreement). In thislast case, the NAFTA commission can make a ruling on this interpreta-

8. The federal governments of Mexico, the United States, and Canada, as well as thestate and provincial governments of these nations and investors from them, are partiesto the agreement and thus have recourse in these procedures.

9. In particular, an investor can request arbitration of a government measure that isalleged to violate subchapter A of chapter 11 or of Articles 1502(3)(a) or 1503(2) of theNAFTA (see discussion in chapter 3).


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tion that would be binding on the tribunal. If the commission makes noruling, the interpretation is left in the hands of the tribunal. The tribu-nal then proceeds under either the rules of the International Center forthe Settlement of Investment Disputes (ICSID) Convention or those ofthe UN Commission on International Trade Law (UNCITRAL). If it findsin favor of the company, the tribunal can make a monetary award, whicheach party agrees to enforce in its own territory, but the tribunal cannotorder a party to cease or desist from a practice, policy, or law that itdetermines to be in contravention of NAFTA obligations.10 If a membergovernment is alleged to not enforce the award, the commission canestablish 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 NAFTAchapter 11 procedures and the outcomes of the resolution proceduresare narrower than what is envisaged in the dispute settlement mecha-nism in the ideal accord on international direct investment. The mainweakness of the NAFTA procedures is the fact that arbitration is pos-sible only if monetary damages can be established by the investor. How-ever, in some situations, it might be difficult to establish such damages�as with those resulting a government�s failure to adhere strictly to anational-treatment standard. Nonetheless, the NAFTA procedures go sub-stantially beyond any thus far created and serve as an important prece-dent for any future multilateral investment accord.

On the matter of the ceding of national sovereignty, the EuropeanCourt of Justice provides another precedent. The Court can hear issuesarising between firms and EU member nations where the issue involvesa possible conflict between EU rules and national laws or policies bear-ing upon the operations of the firm. The Court�s decisions are bindingupon both the firm and the member-nation government. To date, Euro-pean governments have abided by the Court�s rulings. However, thepower of this court goes far beyond anything that has been envisagedat a worldwide multilateral level, and it is almost surely politically im-possible that such power would be granted to an institution at this level.

Arbitration and Sanctions

10. In certain circumstances, instead of awarding monetary damages, the tribunal canaward restitution of property, but in this case, the disputing party can pay monetarydamages in lieu of the restitution.

Nation-states could accept the obligations outlined above in principle butfail to live up to them in practice. Or they might not heed the recommen-dations of a dispute resolution panel. Such failures do indeed lie atthe heart of the international trading system�s weaknesses. Before the


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creation of the WTO, GATT law was particularly weak in enforcing obli-gations, and its working thus largely depended upon voluntary compli-ance. The new dispute settlement procedures described above strengthenthe WTO�s enforcement powers significantly in principle, but these pro-cedures are largely untested in practice. As already noted, enforcement ofan investment accord would in some ways be more problematic thanenforcement of trade agreements. For example, the accord would affectcorporations whose activities span the jurisdictions of multiple nation-states; if the dispute settlement panel were to recommend that such a firmcease and desist from an activity and local authorities were disinclined toenforce the recommendation, what would be the recourse?

The usual (but historically weak) mechanism for enforcement is somesort of sanction, including so-called countervailing measures. Should aninvestment accord make provision for sanctions? If so, what forms shouldthese take? Are there alternative means to ensure compliance?

The answer to this last question is almost surely no. Thus one has toask whether the sanction-based system can be improved upon. Moderngame theory suggests one approach that derives from the observationthat, to be effective, sanctions must have �bite.�11 The right amount ofbite is not easily determined, but possible means of increasing it includecross-retaliation, reciprocity, and �ganging up.� In the context of aninvestment agreement, cross-retaliation would imply that governmentswould ultimately be empowered to use trade measures to retaliate againstfailure of a nation to implement the investment rules. Under reciprocity,one nation would be allowed to withhold right of establishment or na-tional treatment to firms controlled by investors in a nation that deniessimilar treatment to the investors of the first nation. And �ganging up�means a group of nations might jointly and collectively impose sanc-tions on a nation whose policies were deemed out of line.

Ancillary Codes

11. A brief description of this approach and the rationale behind it is provided in appen-dix B.

A number of ancillary codes should be negotiated alongside (or attachedto) an international investment accord. The primary objective would beto harmonize conflicting national practices that affect business activitiesrelated to international investment. The issues discussed here do nothave to be part of an accord on investment per se; in many instances,they might be dealt with separately. Likewise, inclusion in the followinglist does not imply that they ought to be part of the accord. Rather, theeffort here is to summarize all of the major issues that have been raisedas potentially ancillary to international investment.


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Taxation and Transfer Pricing

There are numerous issues involving taxation of the income of interna-tional corporations and their affiliates that might be usefully addressed.An international code on taxation could, for example, set standards fortransfer pricing and delimit options for governments for adjusting re-ported earnings to reflect possible transfer pricing discrepancies. Trans-fer pricing refers to the prices one affiliate (which could be the parentfirm) charges another for intermediate goods or services. In decidingwhat prices to charge, the global corporation seeks to shift its incomeout of high-tax countries and into low-tax ones, to the detriment of thehigh-tax countries� revenue base. Transfer pricing disputes typically in-volve two governments (those of the exporting and importing coun-tries) as well as the firm itself. Resolution of such disputes, where theycould not be solved via consultation, could be referred to the disputesettlement procedures outlined earlier, but only if there were interna-tional standards for transfer pricing to which reference could be made.

A further objective might be creation of a central clearinghouse forintergovernmental sharing of information on taxation to provide a meansby which tax authorities could check the consistency of tax returns filedin various countries. Such information would be useful to determinewhether transfer prices were consistently reported to all affected taxauthorities. If authorities could make such checks easily, disputes overtransfer pricing might then be minimized.

An ultimate objective might be harmonization of tax law among sig-natories. OECD member nations have achieved some limited progressalong these lines through a series of mostly bilateral tax treaties thatstrive to eliminate double taxation. A more far-reaching approach wouldbe an agreement by governments to give up the right to tax income ona worldwide basis and to instead tax on a territorial basis. Under such asystem, governments would no longer tax income on overseas affiliatesof corporations based in their territories (although not necessarily ondividends deriving from this income). The rationale for such a move isdetailed in Hufbauer and van Rooij (1992).

Worthy of consideration along these lines would be adoption of asystem of worldwide unitary taxation. Worldwide unitary taxation ad-dresses an almost intractable problem in taxing international firms� op-erations: notably, that it is all but impossible to determine what profitoriginates in one country versus some other when the firms� operationsin these two countries can be interlinked in so many ways (e.g., bydirect transfer of product or service or by transfer of intangible assetssuch as technology or managerial know-how). Unitary taxation wouldallow a national (or a regional, state, or provincial) tax authority to pro-rate the percentage of the total profits of the firm worldwide on thebasis of a formula that takes into account the percentage of the firm�s


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total sales, assets, or employees that are located within its jurisdictionand to assess a tax on the basis of this prorated share.

The firms themselves oppose worldwide unitary taxation, largely be-cause of the efforts by certain governments (especially those of the USstates; see Graham and Krugman 1995) to impose it unilaterally. Thesegovernments typically have done so because they believe that such asystem would increase local tax revenue. Not surprisingly, governmentsthat would lose revenue from such a system have not joined these gov-ernments. Firms might not, however, oppose universal adoption of world-wide unitary taxation, if they were to be reasonably assured that theirworldwide tax assessments would not significantly rise. The OECD, itshould be noted, has indicated that worldwide unitary taxation does notviolate principles of national treatment as long as the local operations ofinternational firms are not, as a result, taxed at rates higher than similardomestically-controlled firms.

Competition Policy

Competition policy encompasses antitrust (antimonopoly) and restrictivebusiness practices issues but also extends into such areas as state aids toenterprises. Both legal and economics scholars have argued that, in anera of global businesses, the regulation of competition should be globalin scale, and some proposals have already emerged (e.g., Scherer 1994;Fox 1995). Some aspects of the regulation of competition are very inter-national. Transborder mergers and acquisitions have become common-place, and the question naturally arises as to which authorities shouldreview them. Allegations abound of the existence of international car-tels.

However, there are significant substantive and procedural differencesamong national competition policies (Graham and Richardson 1996), andsome nations do not even have formal policies. In the United States, forexample, certain violations of competition statutes carry criminal penal-ties, whereas in most nations violation of competition laws is a matter ofcivil law only. Both the United States and Europe scrutinize large merg-ers and acquisitions, but under quite different criteria. In the UnitedStates, a so-called �efficiency defense� can be used to justify a mergerthat would significantly increase seller concentration in a market (i.e.,the merger might be allowed if significant cost savings were to be real-ized that would result in savings to consumers); in Europe, an efficiencydefense is not allowable. However, in Europe, whole industries can beroutinely granted �block exemptions� that immunize them from certainaspects of competition law, whereas with one exception (major leaguebaseball!) such exemptions are unheard of in the United States. Japanhas what appears on paper a tough antimonopolies law, but critics al-


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lege that Japanese enforcement is so weak that the law effectively doesnot apply to many large corporations (see, e.g., Bergsten and Noland1993).

In recent years several nations that previously did not have competi-tion laws have enacted them. This includes China, which now has a lawon restrictive business practices but not yet one on monopolies (such alaw is contemplated, however). The new Chinese law has been criti-cized as being ineffectively enforced and not capable of dealing withsome of the most salient competition-related issues in China (Liu 1994;Li 1996; Ma 1995; Song 1996). Other nations that have passed competi-tion laws during the past 10 years include Russia, Poland, the CzechRepublic, France, Italy, Taiwan, Mexico, Colombia, and Argentina. Koreahas substantially modified an existing law in order to strengthen en-forcement procedures. Malaysia, Indonesia, and a number of other countriesare considering such laws.

A spectrum of global approaches to the problem can be envisaged: atone end, creation of a worldwide authority, perhaps within the WTO; amiddle 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 implementa-tion of such an authority would be bedeviled by an almost endless stringof problems: Without consensus among nations on the appropriate sub-stantive standards for competition policy, what would be the standardsat worldwide level? What would be the powers of discovery of a world-wide authority�for example, would it have independent powers or wouldit work through national agencies? What remedies could it propose, andhow would these be enforced?

Harmonization of competition laws also makes substantive sense (world-wide operations of global corporations would probably be more efficientif subjected to consistent competition standards), but again, differencesin substance and procedures are probably too great to enable effectiveharmonization in the near future.

Probably the best shot for improvement in international competitionpolicy therefore lies somewhere in the domain of new or better mecha-nisms for cooperation among national (and European) authorities (seeGraham and Richardson 1996).

Accounting and Reporting Standards

The development of common accounting and reporting standards for allinternational corporations has long been discussed. Common standardswould be exceedingly useful for a variety of reasons. First, if all inter-national corporations meeting threshold requirements were required to


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disclose basic balance sheet and income statement requirements at thelevels 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 obvi-ated. Second, it would then be possible to create a data bank for suchcorporations from which information for research and regulatory pur-poses could be drawn. Third, and perhaps most important, because mar-kets work best when participants are well-informed, it would be desir-able, 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 othernations, and one step toward controlling this damage would be uniformstandards for meeting environmental objectives. While an internationalenvironmental code would surely depend upon national authorities forits enforcement, it would nonetheless be useful for nations to agree uponminimal acceptable standards (see Esty 1994; Cline 1992). National treat-ment considerations (and common sense) would argue that such stan-dards would be binding upon locally controlled enterprises as well assubsidiaries of international corporations. The existence of a code wouldnot preclude that national (or supranational or subnational) authoritiesin certain nations might choose to enforce a higher level of standardthan that called for in the code.

Intellectual Property

International rules in this domain have already been agreed upon andembodied in the Trade-Related Aspects of Intellectual Property (TRIPs)agreement in the Uruguay Round (see chapter 5). The relevant issue forthis chapter is whether stronger and more comprehensive rules areneeded. Beyond this, there might be a case for harmonization of na-tional laws and mutual recognition across boundaries of patents, trade-marks, and other forms of intellectual property protection. Intellectualproperty issues pervade the area of international investment as much asthe area of international trade, and greater enforcement of intellectualproperty rights is a priority of multinational firms.

The main provisions of the TRIPs agreement call upon countries toenact and enforce effective laws to protect intellectual property rights.Developing minimum standards for IPR was a priority in the UruguayRound both because multinational firms found the coverage or enforce-ment of such laws in many countries inadequate and because countriesfound that the lack of such laws and enforcement was often a deterrent


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to technology transfer. Whether TRIPs actually improves protection forintellectual property is an issue to watch.

As just suggested, TRIPs could be expanded to cover such issues asharmonization and mutual recognition. If nations could agree to recog-nize each other�s patents, trademarks, and other forms of intellectualproperty protection, firms could make fewer filings to obtain such pro-tection. This would result in lower costs and greater efficiency.

Mutual recognition would require at least some degree of harmoniza-tion of intellectual property laws. At a minimum, nations would have tofirst agree on minimally acceptable standards, and certain proceduraldifferences would have to be resolved. (For example, the United Statesgrants patents on a first-to-invent basis, whereas most other nations grantthese on a first-to-file basis. So if the United States and one of thesenations agree to recognize each other�s patents, legal problems couldarise when a patent challenger shows that it invented the relevant productor service ahead of the patent holder. Such challenges presumably wouldbe unacceptable to other nations.)

It is premature, however, to recommend that nations harmonize theirintellectual property laws and grant each other mutual recognition. Thecosts and benefits of such a system would first have to be assessed. Allthat is suggested here is that such a system ought to be at least con-sidered.

Labor Standards

A number of labor unions around the world, especially in the UnitedStates and Europe, have expressed concern that multinational firms seekto locate activities in areas where labor standards are below those thatare considered internationally acceptable as per existing internationalagreements (most especially, those of the International Labor Organiza-tion, which ban, among other things, child labor, slave labor, and unsafeworking environments). It has been suggested that some sort of newinstrument is necessary to ensure that global corporations follow suchstandards. Thus, labor standards has been raised as a potential �new�issue for future multilateral trade talks under the WTO aegis. This issuecould equally (and perhaps more effectively) be dealt with in the con-text of an investment agreement if consensus on the need to addressthe issue multilaterally could be achieved.

Corruption and Illicit Payments

Likewise, there is sentiment (coming largely from within the US busi-ness community) that there should be standards to regulate illicit pay-ments to corrupt government officials (Elliott, forthcoming). Corruption


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is doubtlessly a fact of life virtually everywhere, and the main issue iswhether corruption could be curtailed via multilateral agreement. USbusiness executives are particularly galled by the fact that illicit pay-ments to foreign governments and their agents are essentially forbiddenunder the US Foreign Corrupt Practices act, whereas certain other ad-vanced countries not only fail to forbid such payments but in somecases even allow home-country tax benefits to offset or partially offsetsuch payments. The case thus has been most forcefully argued that thereshould 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 virtuallyevery nation at some level, excessive levels of it can significantly retardthe economic advance of a whole nation. There is thus a good case tobe made on grounds of economic efficiency and equity for a mechanismthat would curtail corruption. The issue is whether an effective mecha-nism can be designed and implemented on a multilateral basis.

Conclusion

This chapter has laid out principles that should be at the heart of aninternational accord on international investment. Also, the chapter haspresented outlines of some areas ancillary to international investmentwhere international agreement at some level might be desirable andfeasible. The next chapter explores the extent to which progress has orhas not been made in achieving these principles.


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Toward New Rules on International Investment...In the case of Japan, for example, it is claimed that...

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