CHAPTER 13:
INVESTMENT

[A] mechanism that has caused fiscal stress is the intensification of bidding wars among governments - national and subnational - to offer subsidies and tax and regulatory incentives to transnational investors. This has also increased the pressure to crowd out social spending. [Bruce Campbell, 27:1555]

Foreign Direct Investment Developments

International investment, particularly direct investment, has increased dramatically over the past decade and, as a result, the global stock of foreign direct investment (FDI) has risen from US$1 trillion in 1987 to US$3.5 trillion in 1997. This investment activity primarily involves about 53,000 multinational enterprises with almost 450,000 affiliates. Since this growth has substantially outperformed that of both the world's gross domestic product (GDP) and world trade, the ratio of inward plus outward FDI stocks to global GDP is now 21% and foreign affiliate exports make up one-third of world exports.

These statistics make for a very telling story: the businesses of developed countries have, in general, internationalized their activities, weaving an intricate web of linked corporate activities around the globe in pursuit of being a more competitive player. The source of increased competitiveness would be the unique location and production advantages offered by the host country, but both the host and home country also gain from this cross-border investment:

[B]oth inward and outward foreign direct investment is conveying substantial economic benefits on both the host and home country. These benefits stem from increased specialization with resulting productivity gains, the faster spread of new technology to host countries, the salutory effects of increased competition on domestic companies and the ability to realize scale and scope economies for smaller companies. [Steven Globerman, Submission, p. 2]

The economic effects of these new global strategies extend beyond corporate competitiveness. They have significantly transformed the international trading scene in two major ways. First, the international economy of the postwar years, which largely featured cross-border transactions of goods and services between unrelated firms or individual residents of different countries, has given way to a much more integrated trading environment. Parts or components of the more complex manufactured products are increasingly being traded across political borders between non-arm's length corporate entities for assembly nearer to their points of consumption. Second, trade and investment, which at one time were thought to be strictly alternative means of accessing foreign markets - the latter to get around trade barriers - have proven to be complements now that these barriers have come down. Together, these two facts mean that a country's trade performance is increasingly dependent on its FDI activity.

Canada has been no stranger to these developments. Indeed, FDI is of increasing importance to Canada both as a host country and especially as an outward investor. The outward stock of FDI originating from Canada has risen fivefold from US$22.6 billion in 1980 to US$137.7 billion in 1997, while its inward stock has risen more than two and a half times from US$54.2 billion to US$137.1 billion over the same period. Most of this investment, highlighted in Table 2.1, takes place within the Americas, with the United States partaking in the lion's share. The result has been a hemispheric hub-and-spoke investment network, whereby the United States is the primary hub and Canada is a secondary hub in exporting capital to Latin America and the Caribbean.

An FTAA Investment Agreement

The investors of developed countries are, as was demonstrated by the Organization for Economic Co-operation and Development's Multilateral Agreement on Investment (MAI) initiative, looking for greater institutional protection of their foreign-based assets - protection beyond that afforded them by the Agreement on Trade-Related Investment Measures (TRIMs) and the General Agreement on Trade in Services (GATS) which are administered by the World Trade Organization (WTO). Canada, as a net FDI exporter, is also seeking additional investment rules - fair and equitable rules, given that they are reciprocally conferred - to complement existing trade rules.

In the context of the Americas, Canada would logically seek to rationalize its foreign investment protection agreements (FIPAs) with countries in the region, as well as expand coverage of their provisions to countries with which it does not have an investment treaty. Box 13.1 provides the general sorts of protection measures that Canada would be seeking.

To assess the incremental protection that these provisions would provide Canada's foreign investors, the Committee made use of the Inter-American Development Bank's study on foreign investment laws and policies of the region. By way of summary, almost all countries have constitutions that guarantee private property, free enterprise and equal treatment of nationals and foreigners. Although all countries place limits on these property rights, most importantly they provide grounds for expropriation in cases where there is a public necessity, public utility, social purpose for property, promotion of agrarian reform, national security, etc. The regulations on compensation for expropriation differ substantially, but as a general rule it is set at market value or loss incurred either by legal proceedings in the absence of an agreement or by administrative mechanisms; though the definitions of "market value" and "loss incurred" themselves are a source of uncertainty. In some cases, for reason of equity, no compensation may be offered. Compensation is usually paid in advance of taking possession.

Almost all countries have a statute on foreign investment that has been modified since 1990, with a government agency responsible for administering its provisions. Most countries do not place restrictions on remittances, though in exceptional cases they are imposed on capital repatriation. Transfers of foreign investment capital could take several forms. In general, the modalities are: freely convertible foreign currency, tangible property, technology, loans associated with foreign investment, intangible goods, and capitalization of credits or profits. Every country has some sectors of the economy reserved exclusively for the state and are, therefore, not subject to foreign participation; on a hemispheric basis, the list is long.

It is not news to claim that the lowering of political risks to foreign investors would lead them to be less demanding in the returns on investment they seek and thereby stimulate greater cross-border capital flows. What is news is that, since discarding their import-substitution strategies, Latin American countries have through free trade and customs union agreements realized greater flows of FDI. Some countries have adopted special investment incentives to attract even more foreign capital.

Latin American officials repeatedly link the existence of trade agreements of different kinds - such as free trade areas, customs unions, and common markets - ... and the inflow of foreign direct investments to a particular region. For instance, ... the Communidade Andina ... have a list of results ... and I quote, "The considerable increase in FDIs, more than 8 times going from U.S.$1.14 billion in 1990 to U.S.$9.792 billion in 1997..." Another example is found in a paper written to ALADI by the Brazilian ambassador, José Artur Denot Medeiros. ... [H]e states that "the increase in the capacity to attract FDIs" - foreign direct investments - "and the growing importance of inter Latin American countries' investment flows" are acting, in conjunction with trade agreements, as "integrating factors." Clearly, the predominant view is that these agreements are generating both trade and investments. [Annette Hester, 31:1610]

The danger here is in going too far in terms of providing incentives to attract foreign investment, most often it takes the form of subsidies and special tax breaks. Should things get out of hand and bidding wars take place, a "race to the bottom" scenario in social program spending could indeed come to fruition.

Since an FTAA agreement would mean extending protection rights to investors of other signatory members and that these rights to some extent involve a loss in national sovereignty, the Committee is well aware that their conveyance is not simply to be maximized. A careful balance must be struck between what is fair to multinationals and what is fair to the state. Indeed, the Committee was advised many times by the public, as was the case in its deliberations on the MAI and the WTO Millennium Round, to make sure we do not turn an investment agreement into a "charter of corporate rights."

In many ways they strengthen the power of corporations. In fact, in many ways the rules are designed by international corporations. They strengthen the power of investments. They give them the tools to challenge democratic governments, undermining governments that are acting in the public interest. [Bob White, 122:1025]

There are at least two issues here. First, it has been argued that the inclusion of an investor-state dispute settlement mechanism, such as is provided in Chapter 11 of the NAFTA, arms foreign investors with an additional legal vehicle not available to domestic investors. Second, some suggest that such an investor-state mechanism undermines the ability of governments to maintain public services, such as health care on a non-commercial basis, the environment, and health and safety.

In terms of foreign direct investment, this has been mentioned before, but the NAFTA dispute-settlement mechanism, chapter 11, has raised a number of problems. I think those stem from the application of commercial arbitration rules on issues of public policy, which is probably not the best way to arbitrate issues of public policy. This isn't necessarily an indictment of direct access on the part of non-state actors to dispute settlement, but rather the suggestion that a closer look be taken at process issues such as transparency. [Julie Soloway, 122:950]

Yet others insist that these assertions of a "race to the bottom" scenario in social program spending by way of an investor-state dispute settlement clause are unfounded. While Chapter 11 of the NAFTA is currently undergoing several challenges, not one case has yet been decided one way or the other. The Committee reminds those who cited the Ethyl Corporation's case against the Government of Canada that the MMT legislative ban violated Canada's interprovincial agreements and, therefore, the proverbial NAFTA jury is still out. Moreover, the representatives of corporate interests are not totally in disagreement with these opponents on the intended purpose of an investor-state dispute settlement clause. They have consistently argued the position that any investor-state dispute settlement process should not be a source of government paralysis on important matters of public interest.

[T]he critical concept of `expropriation' of foreign investment which triggers the binding dispute settlement mechanism needs to be better defined. Bona fide and legitimate areas of regulation and law-making by governments, where there is no real taking away of an asset involved, should be carved out from the agreement. Other aspects of the investor-state provisions, including issues of secrecy and lack of openness in the process, as under the current rules in the NAFTA, must also be addressed. [Jayson Myers, Submission]

The Committee agrees and recommends:

25. In view of the concerns arising from the interpretation of `expropriation' in the investor-state provisions of the North American Free Trade Agreement (Chapter 11), the Government of Canada should ensure the incorporation of a narrowly-defined concept of expropriation in any negotiations on investment in the Free Trade Area of the Americas agreement.

Given the tremendous growth in FDI over the past two decades, it is worth questioning the need to seek greater protection beyond that extended in Canada's FIPAs. Some net benefit analysis is required before such steps are taken. At the same time, since most of this growth has occurred between developed countries and an FTAA would primarily be made up developing countries, the Committee sees the FTAA as an opportunity to extend the coverage of existing investment protections, as contained in Canada's current FIPAs, in the Americas beyond the seven countries where they are in force today. The Committee recommends:

26. That the Government of Canada seek a Free Trade Area of the Americas agreement that includes investment provisions modelled on Canada's current Foreign Investment Protection Agreements with Latin American and Caribbean countries.