MADRID – Economic globalization, together with a rebalancing of power between the world’s north and south, has made developing countries, and many companies within them, key global economic actors. This provides a new rationale for strengthening the international framework to protect foreign investment.
Once upon a time, global foreign direct investment flowed from only a few sources: the traditionally wealthy states of Europe, North America, and Japan. But cross-border investment from countries such as Brazil, India, and China is now flowing not just to other emerging and transitional economies, but also to the “old” FDI-exporting states.
These changes have increased the complexity of the international investment regime, and should broaden interest in developing a more effective investment-protection framework. But just the opposite is happening: a progressive weakening of protection, with states increasingly flouting their treaty obligations and skirting or ignoring the outcomes of international dispute-resolution proceedings.
At the heart of the current system of investment protection is the World Bank, which created the International Center for Settlement of Investment Disputes (ICSID) in 1966 in response to requests for arbitration by the Bank’s president. But, institutionally, the ICSID has developed less successfully than other members of the World Bank Group – particularly the International Finance Corporation – owing to a deeply rooted organizational culture at the Bank that perceives the ICSID as an instrument serving Western companies’ efforts to prevail over developing states.
This internal fissure was a non-issue during the World Bank’s first decades, when the ICSID itself was a non-factor, with only 38 registered cases between 1966 and 1996. This began to change with the rapid proliferation of bilateral investment treaties (BITs), which typically granted private investors standing before the ICSID. This led to a corresponding rise in registered cases – 386 since 1996.
The ICSID and its jurisprudence thus became a central part of international investment law and policy. Yet the World Bank’s attitude toward the ICSID remained ambivalent. This was especially evident concerning compliance and enforcement, and matters came to a head with the deluge of cases brought against Argentina stemming from its 2001-2002 economic crisis.
Faced with a large number of claims, Argentina chose to draw out the process by systematically using annulment proceedings against any unfavorable decision, and linked any payment to domestic judicial review – a procedure that violates the language and intent of the ICSID Convention and the BITs themselves. The strategy worked; Argentina has avoided making any payments to its creditors.
But Argentina’s short-term gain came at a steep price. A perceived lack of enforceability weakens compliance with investment treaties and rewards repeat offenders, such as Argentina, which has appeared in more ICSID cases than any other state. Indeed, Argentina has developed a general attitude of impunity, the latest example being the expropriation of energy company YPF from Spain’s Repsol one year ago. Moreover, the devaluation of the reputational benefit of being a party to the ICSID encourages countries to leave the system, as Bolivia, Ecuador, and Venezuela have recently done.
The unfortunate byproduct of this self-reinforcing cycle of non-compliance and delegitimation is damage to the global economy in general, and, in particular, to the developing countries that are most in need of foreign investment. These countries are being denied a useful tool for attracting FDI, with recent evidence suggesting that signing a BIT by itself does not lead to increased inflows.
For the moment, the only country that has taken real action is the United States, which last year suspended its trade-preference scheme with Argentina, owing to the country’s failure to pay ICSID-adjudicated awards to two US companies. As for Europe, the Lisbon Treaty gives the European Union exclusive competence in investment-related matters, but no mechanisms have been implemented to exercise this authority.
The upcoming start of Transatlantic Trade and Investment Partnership talks offer a key opportunity to advance the cause of stronger investment protection. As the two largest sources and destinations for foreign investment, accounting for a combined 56% of global FDI outflows and 42% of inflows, the US and EU have a particular interest in ensuring a well-functioning international investment regime.
An emphasis on investment protection could establish de facto international standards that ensure legal security for investors while providing sufficient scope for governments’ legitimate regulatory interests. The talks would have an even greater impact if the parties agreed on a unified approach to dealing with states that fail to meet their obligations.
In thinking of ways to strengthen the ICSID, it would be helpful to consider the World Trade Organization’s dispute settlement mechanism (DSM), which enjoys a remarkably strong compliance record. Beyond the obvious availability of countervailing duties as an enforcement tool, several of the DSM’s institutional characteristics, which are absent in the ICSID, help to create and sustain legitimacy.
For example, the existence of a permanent Appellate Body has led to significantly more consistent and predictable jurisprudence. But, most important, the ICSID would greatly benefit from the level of institutional support that the DSM has at the WTO.
Reinforcing the ICSID is one of the biggest current challenges facing the World Bank and the international community. Without FDI, there cannot be development; and, without legal security, there will be no FDI. If we are to see truly global FDI flows, particularly to those countries that need them the most, we must begin to address the institutional deficiencies of the investment-protection regime.
Copyright: Project Syndicate, 2013.