Foreign Direct Investment and the Multi-lateral Agreement on Investment - The Hidden Agenda

This paper will begin by outlining the nature of multinational companies and describing recent trends in foreign direct investment flows (FDI). It will then explore the costs and benefits of FDI, from the host country's point of view. Host countries' policies towards multinational companies, and the effects of those policies, will then be briefly discussed. The need for international co-ordination of investment policies will be assessed. Finally, this paper will look at the Multilateral Agreement on Investment (MAI), and its likely effects. It will be argued that the multilateral agreement is inappropriate, that it addresses the wrong areas, and that it will have devastating effects on the ability of sovereign governments to regulate their economic, social, and political environments.

Multinational companies (MNCs, which can be defined simply as companies which have operations in more than one country) account for over 70% of world trade. Multinational investment has grown at 13% per annum for the last two decades - twice the rate of growth of world trade. Large corporations now rival nation states in terms of influence - in 1993, 86 of the 150 largest economic entities in the world were corporations, while 64 were countries.

The vast majority of MNCs originate in the United States, Japan, and the EU. These countries are also the main hosts to MNCs, although the share of less developed countries in FDI has doubled in the early 1990's to 39%. Most of this new investment flowed to China and the 'tiger' economies of South-east Asia.

Many people have quite strong opinions about multinational companies. International institutions such as the World Bank, IMF, and WTO tend to see MNCs as champions of free trade and mechanisms by which national economies will be forced to open up. Many others, however, have expressed reservations about whether the benefits of FDI are as great as its proponents claim, or whether they even exist in the first place. The benefits and costs of FDI will now be examined.

Proponents of foreign direct investment tend to focus on four effects of FDI on host countries:

A country's growth rate is strongly influenced by past investment levels. Therefore, if the level of investment in a country is increased, future output will be higher.

However, FDI may not raise the aggregate level of output in the host country. Because MNCs aim to maximise profits, they will often be attracted to the same sectors as indigenous investors. Multinationals operating on a global scale have greater scope to engage in anti-competitive practices. Predatory pricing, combined with large grants and subsidies from host governments, allow multinationals to offer lower prices and higher wages than indigenous competitors. As a result, MNCs often displace existing companies, or prevent the emergence of new competitors. By buying intermediate products from overseas affiliates, MNCs may also prevent the natural emergence or expansion of indigenous suppliers. Profits that would otherwise have accrued to local entrepreneurs, and probably been reinvested locally, are instead repatriated abroad. The host country becomes more dependent on multinational companies for employment and output.

Furthermore, MNCs often use local capital to fund their activities (US multinationals in Latin America, for example, finance 80% of their activities from local sources). Instead of supplementing indigenous ventures, they often displace them. Moreover, profits repatriated by foreign companies usually exceed long-term international interest rates. Loans from international banks would therefore make a less expensive source of finance for capital ventures, from the host country's point of view.

Many developing countries face a very precarious balance of payments' situation, especially countries with deteriorating terms of trade, high debt servicing costs and huge capital outflows. The initial flow of capital into the host country and the (presumed) increase in exports caused by the presence of multinationals have beneficial effects on the host country's balance of payments. The inflow of foreign exchange helps to reduce balance of payments deficits and allows host countries to import more goods and services from abroad.

Neo-classical economic theory stresses the importance of technological advancement for economic development. However, to advance technology independently of other countries would require vast amounts of research and development expenditure on the part of indigenous companies. It is much cheaper and easier to allow MNCs to 'transfer' their technology by establishing subsidiaries, employing and training local people and forming linkages with the domestic economy.

There is, however, little evidence to suggest that MNCs facilitate the technological advancement of their host nations. Multinational companies are naturally reluctant to share their knowledge. They have, as one commentator observed, 'no commercial interest in diffusing [their] knowledge to potential native competitors'. The multinational company's technical knowledge is often of little (external) benefit to the host economy.

When technology is transferred to the host country, it is often inappropriate - that is, it is incompatible with the needs of the host economy. For example, technologies used by multinationals are usually developed in richer countries, where capital is relatively abundant. The introduction of this labour-shedding technology to developing economies can lead to increases in unemployment and deprivation.

Opponents of multinationals highlight several costs of foreign direct investment to the host country:

MNCs that produce luxury goods (for example, processed foods) in developing countries often try to sell them locally. They advertise their products in order to create demand. The result is that people on very low incomes often find themselves compelled to buy luxury foodstuffs and other 'modern' goods when they should be concentrating on fulfilling their more immediate needs. Those who cannot afford these luxury goods become dissatisfied. Moreover, the consequences can be lethal, as when food companies from the North encouraged Third World mothers, many of whom had no access to clean water, to feed their children with powdered milk instead of breast milk.

It is argued, however, that these changes in demand patterns of host countries are the result of economic development and increased prosperity, rather than MNC activity. Multinational companies merely respond to changing demand patterns - they do not cause them.

MNCs may pay high wages relative to the host country average. Consequently, a very small proportion of the population is on high income, while the rest struggle to earn a subsistence income. Because multinational companies often require host countries to finance part of their investments, they draw resources away from other areas, including agriculture, which can lead to increased unemployment. Perceptions that workers in the city are earning high wages contribute to the problem of urbanisation. As Michael Todaro observes, 'despite their insignificance in terms of the overall employment picture, these corporations often exert a disproportionate influence on urban salary scales and migrant worker perceptions'.

Multinationals often make decisions which affect the long term welfare of citizens in host countries, particularly about environmental matters. Multinationals often have no incentive to consult host governments about the use of non-renewable resources, for example.

Furthermore, multinationals often influence the political processes of host countries. In 1973, for example, American multinational, International Telephone and Telegraph, backed a military coup in Chile, during which the democratically elected president, Salvador Allende, was assassinated and replaced by the notorious General Pinochet. IT&T's continued financial support allowed Pinochet's dictatorship to survive until 1990, much as Shell's generosity is facilitating the present military dictatorship in Nigeria.

Not only do multinationals themselves influence the political processes, but home country governments often become involved, too. The United States, for example, backed General Pinochet's coup in 1973, largely because President Allende's plans to nationalise the Chilean telecommunications industry would have threatened IT&T's profits.

FDI clearly has the potential to benefit host countries. It can lead to increased economic output and increased prosperity. There is little doubt that MNCs are the engine behind the 'Celtic Tiger', although one Irish economist has suggested that 'a great part of Ireland's so called economic growth is illusory, being derived from the accountants' pens rather than the effort of Irish workers'. Another concludes that 'the contribution of new [MNCs] to growth is practically restricted to the activities of [MNCs] themselves. Foreign investment creates few multipliers that lead to the growth of domestic investment'.

Because MNCs often displace (or prevent the emergence of) indigenous enterprise, distort consumption patterns, and exacerbate inequality and other social problems in the host country, it is unclear in practice whether FDI benefits the host economy.

Most governments simultaneously adopt policies aimed at both encouraging and discouraging inward FDI. They offer incentives (such as financial and tax incentives as well as market preferences) and they place restrictions on MNC activity. These policies can severely distort economic activity and reduce the efficiency of international investment. Furthermore, gains arising from them tend to be at the expense of other countries.

There are quite a number of incentives that a government can offer to multinational investors. Fiscal incentives include tax reductions, accelerated depreciation, investment and reinvestment allowances, and exemptions from import and export duties. Financial incentives include subsidies, grants and loan guarantees. Market preferences include monopoly rights, protection from import competition and preferential government contracts. Governments also offer low-cost infrastructure (electricity for example).

As an advertisement placed in Fortune in 1995 by the Philippine government proclaimed:

There is a certain beggar-thy-neighbour aspect to all of these policies - the gains to the country offering them are usually at the expense of another potential host country. Furthermore, a 1985 World Bank study found that an increase in one country's investment incentives tended to lead to increases in other countries' incentives. Because investment incentives usually benefit companies that would have made their investment anyway, the result is wasteful competitive bidding among nations. This leads to a prisoner's dilemma-type situation, where every country would be better off if each country reduced its incentives by the same amount. This is only possible through multilateral policy co-ordination, which could lead to huge welfare gains for all host countries.

Host countries tend to restrict multinational companies' activities in a number of ways. They often restrict entry to certain sectors, or require that firms operating in those sectors are owned primarily by domestic investors. This is usually done for cultural reasons or for reasons of national security. More importantly, national governments impose performance requirements on foreign firms operating in their territory.

Traditionally, the most widespread performance requirements were trade related - governments insisted that MNCs exported a minimum proportion of their output, or sourced a minimum proportion of their inputs locally. The Uruguay Round of GATT banned all trade related investment measures, however, because they were essentially beggar-thy-neighbour policies.

Host countries can still implement a number of performance requirements, however. For example, they can require that MNCs employ a minimum number of local workers or that they do not excessively repatriate profits. They often require MNCs to agree that they will eventually licence their technology to indigenous firms.

While these requirements discourage FDI and reduce the efficiency of international investment, they enable the host country to maximise the benefits of FDI. There is no reason for multilateral policy co-ordination in this area, as one country's restrictions do not adversely affect any other country's welfare.

The Multilateral Agreement on Investment is currently being negotiated by representatives of the OECD governments and the European Commission. It aims to provide greater security for international investors.

The negotiations began in May 1995 and were expected to be completed two years later but the negotiating parties failed to reach an agreement in time. The European Commission hopes that the treaty will be ready for ratification by May 1998, but sources within the negotiations say that this is unlikely.

When negotiations began, NGOs, environmental groups, trade unions and consumer groups were not informed. It was only months later that information began to filter through about the planned agreement. When these bodies did find out about it, they were excluded from the negotiations for a long time. By contrast, groups representing multinational corporations have been involved in the negotiations from the beginning. Their influence is clearly visible in the treaty.

Despite being hailed as the 'constitution of a single global economy', and in spite of the fact that multinational corporations arouse strong feelings in many quarters, the MAI has been the subject of very little public debate, largely because of a lack of awareness of its existence (unlike the Uruguay Round, for example).

Although only OECD countries (and the European Commission) are participating in the negotiations, it is expected that a number of other countries will be invited to join, once the negotiations are complete. Argentina, Brazil, Slovenia, Estonia, Latvia, Lithuania and Hong Kong have all expressed an interest in becoming party to the treaty at an early stage. Many other countries are expected to follow suit, for fear of losing their share of FDI if they do not. It is quite likely that the IMF and the World Bank will require other countries to sign the MAI if they are to receive aid and financial rescue packages in the future.

The MAI's main provisions are as follows:

• It ensures that all multinational companies receive national treatment, or most-favoured-nation treatment (whichever is better) in every member country;
• It prohibits any performance requirements on MNCs even if the same requirements apply to domestic companies. It prohibits host nations from any 'unreasonable or discriminatory measures' which would impair the 'operation, management, maintenance, use, enjoyment or disposal of investments';
• It provides for a state-to-state and investor-to-state dispute settlement mechanism;
• It is a stand-still and roll-back treaty. Once a country ratifies the treaty, it cannot withdraw from the MAI for a minimum of five years. Having announced its intention to withdraw from the MAI, a country will continue to be bound by its provisions for 15 years.

There are several weaknesses in the proposed wording of the MAI:

The treaty prevents governments from any act which would reduce the ability of foreign investors to 'enjoy' their investments. By raising environmental or labour standards, governments could be accused of 'expropriating' profits from multinationals. Similar provisions in North American Free Trade Association led to the situation where Ethyl Corp., a petroleum producer, sued Canada for 'expropriation of profits' after the Canadian government introduced legislation to ban MMT, a toxic fuel additive. Ethyl Corp. even argued that, by debating the prohibition of MMT, the Canadian parliament was damaging the firm's reputation, which was tantamount to expropriation of profits.

If the MAI is passed in its current form, legislators will be extremely reluctant to introduce bills which would reduce any foreign company's 'enjoyment' of its investments, for fear of similar litigation. The negotiating parties are considering the inclusion of a clause in the treaty text to exempt any legislation resulting from member countries' obligations to implement the Kyoto Agreement. Any other social, environmental or labour standards which are introduced after the MAI is ratified are likely to lead to litigation.

The OECD argued that the MAI should not burden MNCs with any further responsibilities as they are already subject to codes of conduct from the UN and the OECD. However, these codes of conduct are voluntary - it is assumed that peer pressure and public scrutiny is enough to deter companies from breaching the guidelines even where large profits are involved. P&O (Australia) recently announced plans to construct the world's largest industrial port at Vadhavan, India. Its plans are in direct conflict with the OECD's guidelines, but objections have fallen on deaf ears.

Any multilateral investment agreement must match increased rights for corporations with increased responsibilities.

Perhaps the greatest welfare loss associated with FDI is the large sums of money spent by governments to attract MNCs. Because it is a prisoner's dilemma-type situation, this is one issue where multilateral policy co-ordination is required. However, the MAI completely ignores this issue.

By removing restrictions on foreign investors, the Multilateral Agreement on Investment will result in an increase in foreign direct investment, but also a redistribution of its benefits from host countries to multinational corporations and their shareholders. It increases the rights and opportunities of multinationals but does not burden them with any increased responsibilities, or restrict the investment incentives offered by host countries. This is largely because of the influence of MNCs on the negotiations.

The MAI will dramatically reduce the ability of sovereign states to adopt environmental and labour standards. It will further shift the balance of power from democratically elected governments to large corporations.

Once the treaty is ratified, its provisions will hold for a minimum of 20 years. There is a great need, therefore, for close examination of its implications before it is too late.