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Certain policy decisions of potential target countries of investment receive close scrutiny from international investors. Consequently, a number of international agreements have been written to specifically address those concerns. They include the following issues:
National treatment: This has been a core element of most agreements on trade in goods and services, and is also a critical issue pertaining to international investment. Typically, these provisions ensure that foreign investors and their subsidiary companies are “treated at least as well as their domestic counterparts,” or “no less favorably” than domestic industries. A law which taxed foreign-owned entities at a higher rate than domestically owned entities would therefore violate these provisions. However, if a government wishes to give foreign-owned companies an incentive to invest, such as tax-free treatment of manufacturing in an export processing zone (EPZ), this would not generally constitute a violation of these agreements. Thus countries may treat foreign corporations and nationals with better or more favorable regulations, but not poorer ones.
Domestic Content: Another limitation sometimes imposed on foreign investors is “domestic content requirements.” These require foreign investors to purchase a certain percentage of intermediate goods from the host country. Domestic content requirements are perhaps the most common form of interventions by governments on foreign investment, and many economists believe they are the most harmful to economic development. Rules on investment developed among all 147 members of the World Trade Organization (WTO) have limited substantially the opportunity for imposition of such requirements.
Expropriation: The seizure of foreign assets by governments has historically been a major concern for international investors. Changes in governments in developing countries, or sometimes just changes in policies, have led to government takeovers of foreign assets. In the past, these expropriations have nationalized key industries (e.g. oil, electric power, mines, or telecommunications), often providing little or no compensation to the original owner. This has long been a significant deterrent to foreign investment. Hence, provisions on expropriation both in U.S. law and in bilateral and regional agreements, as well as in customary international law seek to ensure that any losses by investors must be fairly compensated without delay.
But the “expropriation” issue has come to hold new meaning in legal disputes over property. Although the actual seizure of assets by governments is relatively uncommon today, the use of the term has been broadened to include other kinds of regulatory activities.
Consider the following example: an investor purchases property overseas with the intention of building a manufacturing plant there. She may have even begun construction on the facility, spending millions of dollars. However, in the midst of this construction process, the host country government introduces new regulations, declaring the location of the facility unsuitable for industrial use, perhaps re-zoning it for exclusively residential purposes or declaring that it is an environmentally protected area that cannot be developed.
As a result of this ruling, the investor has not only lost the money that was spent on building a factory on the site, but the real estate probably cannot even be resold for the purchase price because no other investor would want it given the new limitations on its use. In economic terms, the government regulation has therefore reduced substantially the value of the property to the investor. The investor may seek to claim that this new regulation constitutes an expropriation of property and that she therefore is entitled to compensation by the government for the loss she has suffered.
Environmental activists have especially serious concerns about this interpretation of the meaning of expropriation. If provisions seeking to give investors protection from such “takings” are not carefully and properly implemented, argues a report by the International Institute for Sustainable Development and the World Wildlife Fund, “any environmental law worth adopting will affect business operations and may often end the use of, or trade in, certain products, and therefore will have a significant impact on the business in question.”
Free transfer of funds: Another practice that has historically been of serious concern to foreign investors is the limitations on the transfers of funds—especially out of a country. During periods of economic crisis, foreign investors may wish to withdraw their assets, and have often found that foreign governments have imposed rules blocking their ability to do so. The wisdom of government policies restricting capital outflows, particularly of short-term portfolio investments, is still a matter of widespread debate among economists and public officials as well as individual investors, for the liquidity of funds and capital are important issues. .
Dispute settlement: These provisions typically spell out clear procedures that must be followed in the event of disputes between investors and host governments, to ensure that rules are adhered to and that arbitration may be established by mutual consent.
Most Favored Nation treatment: To ensure that nations do not disadvantage foreign investment from certain nations in favor of investment from other ones, this basic concept of international trade agreements—and now the key provision in international agreements on investment—seeks to prevent discrimination among investors from different countries. The phrase “most favored nation” refers to the obligation of the country receiving the investment to give that investment the same treatment as it gives to investments from its “most favored” trading partner.
The case for reducing these kinds of barriers to investment are well-grounded in economic facts. Obstacles to investment prevent countries from making optimal use of their own and other countries’ resources. Countless billions of dollars of potential wealth—for investors in the form of profits, for workers in the form of wages, and for consumers in the form of lower prices—are lost every year due to barriers to trade and investment.
Countries may impose these kinds of measures with the intention of protecting domestic industries from international competition and promoting their economic development, but this usually leads to misallocation of resources away from the natural economic capabilities of nations.