The Importance of Foreign Direct Investment

| by Dr. Ruwantissa Abeyratne

( January 17, Montreal , Sri Lanka Guardian) One of the determinants of a country’s growth is the extent to which it attracts and allows Foreign Direct Investment (FDI). FDI promotes economic growth and facilitates competition. As Michael Spence, Nobel Laureate and Professor of Economics at New York University observes in his book The Next Convergence of India “India’s earlier slow growth was partly attributable to a distrust of foreign investors and a relatively low level of foreign investment by multinational firms. If you look at the data for India and China for example, the differences are dramatic. Of course this is changing now with India’s growing options”.

Niall Ferguson, Professor of Business Administration at Harvard University,. In his book Civilization- The West and the Rest draws the interesting parallel of Marco Polo’s visit to China in the 1270s when he was impressed by the volume of traffic in the Yangzi. Polo observed that the quantity of merchandize carried up and down made the Yangzi looked like a sea rather than a river. In comparison to this Ferguson argues that the Thames in the early fifteenth century was the backwater. Ferguson goes on to suggest that one of the reasons for the success of European States in the 16th Century onwards was its opening out to commerce and competition.

Principles of customary international law recognize that there is no obligation on any State to admit foreign investment in its territory in whole or part thereof. However, if a State admits foreign investment, a host of legal principles come into play, mainly to protect the investor under minimum standards required of the host State. Firstly, property of a foreign investor is protected by the principles of international law. It has been argued that the extent of this protection is directly proportionate to the extent of guarantees afforded by the host state to the property of its own nationals. Foreign investment is usually effected by treaty which often imposes more than minimum standards on the host State. Studies suggest that foreign investment treaties have positive effects on the economy of a host State by increasing foreign direct investments therein.

Usually, unless agreed between the parties to a foreign investment treaty or agreement, the investor has to be constituted under the laws of the country of registration. The company of a foreign investor is a corporation, partnership or business association incorporated under the laws in force in the territory of any contracting party wherein the place of effective management is situated. One of the fundamental requirements of investment is that investment regimes are required to define their respective jurisdictions ratione materiae. It has been judicially recognized that jurisdiction cannot be invoked by a claimant on the basis of an investment in the instance of a bank guarantee offered by him for performance of equipment on the basis that the guarantee was an ordinary feature of a sales contract.

An investment is a complex transaction. A transaction which per se might not qualify for definition as an investment could be classified an investment if it were part of an overall operation that could be considered an investment. However, a claimant cannot categorize as an investment expenses unilaterally incurred in preparation of an investment. Investments need not be territorially entrenched in a physical sense. In the 1998 case of Felix v. Venezuela, where the investor acquired promissory notes issued by the host country, the Court held that while usually an investment may involve a transfer of some kind of funds or other property to the host country, it was not an inflexible rule and that funds need not be physically transferred to a host country but could be put at its disposal elsewhere.

In the instance of an investment which is governed by two instruments such as an international Convention and national agreement, usually the Convention has entrenched what is known as the “most favourable” principle, where the Convention would include a provision to the effect that nothing in the Convention will preclude a Party who holds property in the territory of another Party from benefitting from the provisions that are most favourable to him.

The investor cannot be treated arbitrarily or discriminatively. The word “arbitrary” has been associated with measures by the host State that affect the investments of foreign nationals where that State does not engage in a rational decision-making process. Such processes may include a consideration of the effect of a measure on foreign investments and a balance of the interests of the State with any burden imposed on such investments. In the case of discrimination, a discriminatory measure need not necessary have to violate domestic law, particularly when such a law may contain discriminatory measures against foreign investors.

The North American Free Trade Agreement (NAFTA) provides a good example of fair treatment of foreign investors. NAFTA provides that each Party shall accord national treatment to the goods of another Party in accordance with Article III of the General Agreement on Tariffs and Trade (GATT, now WTO), including its interpretative notes and to this end Article III of GATT and its interpretative provisions form an integral part of NAFTA. Article 304 of NAFTA precludes any Party from setting arbitrary and self imposed standards and duties pertaining to customs. Furthermore, Article 1103 stipulates that a Party to the agreement shall grant investors of another Party treatment no less favourable than it accords, in like circumstances, to investors of any other Party or of a non Party with respect to the establishment, acquisition, expansion, management, conduct, operation and sale or other disposition of investments. NAFTA therefore creates duties upon its Parties in two areas: a) protection and security by one Party of investments of investors of other Parties to the Agreement according to the principles of international law, and fair and equitable treatment; and b) treatment by one Party, of investors, their investments, financial institutions and cross-border financial service providers of other Parties to the Agreement on a basis no less favourable than accorded to others, whether they are Parties to the Agreement or not. This principle endorses and confirms the most-favoured-nation treatment principle of GATT.

Another significant provision in NAFTA is Article 1406 which requires each Party to accord to investors of another Party, financial institutions of another Party, investments of investors in financial institutions and cross-border financial service providers of another Party treatment no less favourable than that it accords to the investors, financial institutions, investments of investors in financial institutions and cross-border financial service providers of any other Party or of a non Party in like circumstances.

NAFTA therefore creates responsibility on the part of a Party to the Agreement towards investments, investors and financial institutions of other Parties.

Another effective protective tool is the “umbrella clause” that appears in many investment agreements that protect the interests of the investor. Such a clause guarantees the investor of obligations to be kept by the host State by covering all obligations contained in the treaty by the use of such words as “each contracting party shall observe any obligation it may have entered into with regard to investments of nationals or companies of the other Contracting Party”. A more useful text is found in the Investment Protection Treaty between France and Hong Kong of 1995 which states: “Without prejudice to the provisions of this Agreement, each Contracting Party shall observe any particular obligation it may have entered into with regard to investments of investors of the other Contracting Party, including provisions more favourable than those of this Agreement”.

From the foregoing discussion it is clear that the legal regime applicable to FDI, while offering considerable protection to the investor, also contributes to the growth of an economy offering increased opportunity to move forward.