Foreign Direct Investment, Human Rights, INGOs

One of the major areas of underdeveloped research within political science is the interaction between non-state actors. From an international political economy perspective, the literature has largely ignored the interaction of various non-state actors that are growing in importance, and its effects on different forms of trade. In a recently published article "Avoiding the Spotlight: Human Rights Shaming and Foreign Direct Investment" by Colin Barry, Chad Clay and Michael Flynn, they lay the foundation for examining this interaction. They examine the interaction between non-state actors (INGOs) and multinational corporations (MNCs) and the extent to which private actors' choices to invest in countries are affected by the reputational costs of doing business in those countries who have been targeted by human rights activists. In particular, they analyze how INGOs "naming and shaming" actions affect the level of FDI. Their results suggest that the naming and shaming approach by INGOs tends to reduce the amount of FDI received by developing states, thus providing evidence for INGO efforts affecting the behavior of MNCs.

While this research is certainly innovative it does leave open a couple of issues regarding the type of human rights needing to be examined. First, when focusing on foreign direct investment and human rights in general, is physical integrity rights the correct "form" of human rights abuse to look at in-depth. In particular, why is there no labor rights measure incorporated into the research design? If we are trying to determine the conditions under which multinational corporations will become concerned with a country's human rights record, it would certainly make sense that labor rights is probably the most important human rights issue to MNCs. That is, these would be the types of issues that MNCs would be cited and given numerous media attention by the international community.

As a human rights researcher from a political economy perspective, I am very excited to see the direction of our field moving down this route and examining the interactions between different non-state actors. I think these interactions will certainly reveal more of the underlying mechanisms at work in determining the conditions under which MNCs and other non-state actors choose to invest abroad.

Verizon, Vodafone, and Measuring FDI

Recently back from APSA in Chicago, I've been reflecting on the state of our knowledge about FDI (or perhaps more accurately, cross-border management stakes in enterprises). That, and working on my dissertation, applying for academic jobs, and teaching. Oh, and telling everyone who'll listen about my Optimus Prime sighting on Michigan Ave.

Anyway, I find a post-conference review of the discipline is generally a good way to consider potentially fruitful lines of new inquiry. In my experience, the quality of papers at conferences can be rather hit-or-miss. This generally fits into my view of conferences as important sources of external deadlines for getting drafts done as well as interacting with other scholars in more informal settings such as the hotel bar/lobby/over-crowded coffee shop. And, I think that's enough to ask out of a conference.

However, there are generally one or two papers every conference that catch my eye in meaningful ways. They are often more conceptual pieces that challenge traditional approaches to measurement or quantitative analysis. Andrew Kerner's "What we talk about when we talk about foreign direct investment" was the stand out paper for me this year. According to his website the paper is under review and I'm not sure if he's widely circulating a draft at this time. Hopefully this piece will be published somewhere good soon because its well worth the read. The gist is that measures of FDI derived from balance of payment measures are grossly inadequate measures of the kinds of economic activity political scientists are generally interested in when we study the phenomenon frequently referred to as FDI. Not only do countries often have different definitions of FDI, but FDI flows bounce around for all sorts of reasons that are far removed from decision over making fixed, long-term investments in capital stock. Even worse, FDI flow data are reported in net terms, which makes it impossible to differentiate between a country that experienced a lot of inward direct investment concurrent with an equal amount of outward investment and a country that experienced no direct investment flows at all.

The recent news about Verizon's buy-out of Vodafone nicely illustrates some of the problems with current measures of FDI. Vodafone is a British company, so Verizon's decision to buy out Vodafone's share will register as a massive repatriation to the UK. The size of the deal is so large ($130B!) that it's going to influence measures of global FDI flows for 2013. For context, UNCTAD reports global FDI inflows last year were $1.35 trillion. That means this one mega deal is worth 10% of all total FDI net inflows last year! I doubt any political scientists would argue the Verizon-Vodafone deal reflects any underlying change in assessment of political risk in the US. But, that one deal will dominate 2013 measures of global FDI.

Kerner's entreaty is to use data sources that differentiate between flows of cash and real fixed capital investments. One limitation of such as strategy is that it limits us to modeling the investment decisions of either US or Japanese firms (since the US and Japan are really the only countries that make available such detailed data about the investment decisions of their foreign affiliates), and the investment behavior of firms from these countries might differ in important ways from firms headquartered in other countries.

Given the tendencies of those writing on this blog, as well as our co-authored academic work elsewhere, it may not be surprising that I'm partial to another tactic. It seems that all this semi-liquid investment caught up in measures of FDI might not be so easily captured through an obsolescing bargaining mechanisms (though, as Rachel Wellhausen pointed out in discussion, even cash can be effectively illiquid if there are restrictions on repatriation), but the flow of these investments across borders does influence banking systems, the growth of the money supply, the availability of credit both globally and domestically, and therefore the propensity for crisis. Perhaps one way forward here is to consider more explicitly the relationship between different kinds of financial flows and how their interaction affects both political and economic outcomes.

Another ISD Follow Up

Since I seem to only blog about investor-state dispute related issues, I thought I pass along a recent UNCTAD policy note about reforming the ISD system.

UNCTAD's summary of the report's key findings:

Concerns with the current ISDS system relate, among others things, to a perceived deficit of legitimacy and transparency; contradictions between arbitral awards; difficulties in correcting erroneous arbitral decisions; questions about the independence and impartiality of arbitrators; and the length and the costs of arbitral procedures. These challenges have given rise to a broad discussion about the need to reform the current system of investment arbitration. To give shape to this debate, the Note puts forward five main reform paths:

1. Promoting alternative dispute resolution.
2. Tailoring the existing system through individual IIAs.
3. Limiting investor access to ISDS.
4. Introducing an appeals facility.
5. Creating a standing investment court.

Each of the five proposed reform options comes with its specific advantages and disadvantages and responds to the main concerns in a distinctive way. Some of the options can be implemented via actions by individual governments, while others require joint action by a larger group. The options that require collective action would go further in addressing the existing problems, but would also face more difficulties in implementation. The Note calls for a multilateral policy dialogue on ISDS to search for a consensus about the preferred course for reform and ways to put it into action.

Argentina Withdraws From ICSID

In a follow up to my previous post, Argentina has announced its intention to withdraw from ICSID. In this clip, government officials and commentators emphasize favoritism of firms over governments in ICSID rules. It bears mentioning that, according to ICSID case statistics, 48% of all cases ever referred to ICSID resulted in a monetary judgement in favor of investors. In 2012, 60% of all referred cases resulted in a similar monetary judgement. So, perhaps opinions on whether ICSID is biased toward investors depend in part on whether you look at levels vs. change. And, it bears repeating, Argentina has (probably) never paid an arbitral award.

HT Rob Galantucci

New Investment Trend Data for 2012 Released

UNCTAD released new figures for 2012 FDI flows. Despite previous projections for a modest FDI increase, 2012 saw FDI flows decline by 18%. The aggregate numbers, however, conceal the fact that investment flow trends vary widely based on: investment source, investment destination, and investment type.

The EU and the US saw steep declines in FDI inflows; developed economies saw FDI decreases of 32%. Meanwhile, Investment flows to developing countries saw only modest declines of 3%. Africa and Latin America actually saw investment flow increases. Much of the decline in FDI is attributable to a stall in cross-boarder M&As, which were off 41%. Developed economies typically saw a divestment trend in their MNEs while MNEs headquartered in developing economies expanded through M&As. Greenfield investments are off 34%, but still accounted for over 66% of FDI flows for 2012.

You can read more here.

What Might a US-EU FTA Mean for International Investment Treaties?

In a previous post, Will discussed how a potential US-EU free trade agreement might effect widespread trade liberalization through inclusive institutions such as the UN. Indeed, many commentators are wary of the possible deal, believing it to signal the end of inclusive negotiations that characterize the WTO (though Will provides a nice counter to such alarmist claims).

A ratified US-EU FTA also has the capacity to change international investment law quite fundamentally. At stake is whether an agreement would have an investor-state dispute clause (ISD). Unlike traditional dispute settlement mechanisms, ISDs allow firms to sue states directly, usually within the context of an international arbital board such as the International Centre for the Settlement of Investment Disputes (ICSID). ISDs are controversial primarily because there is a widespread fear that MNC with deep pockets will engage in litigation wars of attrition. Furthermore, when investors can sue states directly, governments no longer have access to diplomatic tools to smooth over disputes. And, to the extent that the long term viability of open goods and capital markets requires some flexibility to deal with domestic push-back, the removal of states as arbiters of which investment disputes are worth pursuing and which are better left ignored could have lasting negative implications for the political viability of economic openness.

Unlike some other aspects of FTAs, ISDs can actually become salient issues. In South Korea there were a series of protests against the ISD provision of the recently ratified US-South Korea FTA. Other countries, including India, South Africa, and Australia, have recently decided to nullify portions of trade and investment treaties that include ISD provisions. Still, ISDs are widespread. The model US Bilateral Investment Treaty includes an ISD provision and ISD clauses are standard in US FTAs. However, the types of treaties that contain ISD clauses tend to be signed between states characterized by economic asymmetries.* BITs are a prime example - while over 2000 such treaties exist, there are no BITs between two advanced industrial economies.

So, the question then is whether a US-EU FTA agreement will include an ISD clause. Generally, advanced industrial countries have shown they are more interested in promoting legal regimes that protect "their" MNEs while less willing to cede jurisdiction over investment disputes in which they might be a defendant. For instance, Australia has decided to drop ISD clauses from its BIT and FTA regime after it was sued by Philip Morris; Philip Morris used Australia's BIT with Hong Kong to establish ICSID jurisdiction. Given growing dissatisfaction with the costs of ISD, it will be interesting to see if such clauses would persist if the US and EU decide to not subject themselves to such extra-territorial juridical measures.

My quick, speculative take is that ISDs will be less widely used in the future. As advanced industrial economies begin to receive more FDI from emerging economies with which they have such dispute clauses, they will seek to extract themselves from such agreements. Moreover, a movement away from ISDs may be a good thing. First, ISDs tend to create duplicated layers of juridical authority that generate confusion. Second, as mentioned above, ISDs make it harder for governments to intercede in investor-state disputes in ways that allow for flexibility necessary to maintain broad coalitions of support for deep economic integration. Finally, there is some evidence that states with ISDs tend not to pursue meaningful domestic legal reforms, and thus ISDs can contribute to the persistence of partial economic reforms that ultimately impede broad-based growth.** Removing ISDs may help overcome some of these problems.

*An important semi-exception is that NAFTA includes ISD provisions. However, this clause remains quite controversial in Canada. Canada has not yet ratified the ICSID convention, reiterating the extent to which countries are quite resistant to ceding final arbital authority to an international tribunal. Additionally, the US-Australia FTA suggests, but does not require, dispute settlements between investors and states.
** A place to start reading about this: Ginsburg, Tom (2005) "International Substitutes for Domestic Institutions: Bilateral Investment Treaties and Governance" International Review of Law and Economics 25:107-123.

FDI Undeterred: Argentina's Messy Investment Climate

Argentina's investment policies certainly have been in the news recently. In this past Monday's (Dec 17) WTO Dispute Settlement Body's meeting, the US, EU, and Japan requested an establishment of a dispute panel against Argentina. Concurrently, Argentina sought to establish dispute panels against the EU (Spain in particular) and the US. Australia and Turkey lodged a formal complaint that Argentina was trying to use the DSB for inappropriate purposes. (See more here)

For more context, the Kirshner government wrested control of YPL from Spanish energy giant Repsol this past May. In the ensuing fall out, Repsol sued the Argentine government in a U.S. court, President Obama revoked Argentina's preferential trade privileges, and Repsol filed arbitration paperwork at ICSID earlier this month. No one is too confident that Repsol is going to recoup any of its $10 billion investment, especially since Argentina probably hasn't paid out a single arbitorial award. Spain is also threatening to sanction Argentina and Repsol has publically stated it will seek damages from any corporation that subsequently enters production and exploration agreements with YPL.

Standard political theories of foreign direct investment rest on a central insight from obsolescing bargaining (OBM) - FDI is limited by the political risk that firms face when they sink investment in a foreign jurisdiction, thus becoming "captive" to a potentially predatory state that faces incentives to promise contract sanctity ex ante and then renege on these promises ex post. From this perspective, no multinational should want to invest in Argentina - the risk of expropriation is just too high. Tools designed to mitigate the problems associated with time inconsistency of preferences just are not working in the Argentinian case (i.e. - Argentina is not compensating firms for contract breach, despite rulings against it). Yet, my weekly update from the Economist Intelligence Unit includes a discussion about how large oil multinationals are rushing to invest in Patagonia's shale deposits. Multiple oil giants are in contract negotiations with the Argentine government to undertake production sharing agreements with the newly nationalized YPL. And, they are doing this despite Repsol's threat to go after these private corporations for damages associated with nationalization.

So, what is the standard OBM missing? Of course, firms have to care about many things besides political risk. Economic factors are the primary drivers of investment decisions; political considerations are largely secondary. In this context, big countries with large domestic markets and with rich endowments of lucrative natural resources typically can get away with a lot of things small countries without energy reserves cannot. This economic/geographic argument underpins Rachel Wellhausen's recent post on the permissive environment for Argentina's nationalistic investment policies. And, understanding the economic factors that provide governments' more bargaining power vis-a-vie investors certainly explains much of the deviation away from what OBM-based theories predict.

But, I think there is something else we need to consider - how firm and investment characteristics modify OBM dynamics. Some of my current research considers how firms are heterogenous in both the amount of political risk they will accept and how they define political risk. What do I mean by this? First, firm characteristics matter for how risk acceptant they will be. Some of the most interesting current work on FDI focuses on explaining these systematic variations. Daniel Blake argues multinationals view their subsidiaries as a portfolio of potential revenue streams, and within this holistic management conception, MNEs might be willing to sustain losses in one location as part of a larger strategy of gaining market share. Ben Graham argues that firms can learn how to manage political risk, and that some firms are uniquely positioned to manage such risks and therefore may specialize in locating in high risk countries. Together, both of these arguments fit nicely with EIU’s assertion that large oil companies are willing to take large bets in Argentina’s shale fields despite threats of nationalization. Indeed, such threats may benefit large energy multinationals because small firms are less able to manage these risks, depressing acquisition prices. This is an important point because it indicates that certain multinational firms will actually benefit from nationalistic policies!

While a bit further afield from the Argentine case, I also argue firms vary in how exposed they are to the threat of government interference. Firms that enter countries through privatization of utilities and infrastructure as well as firms that engage in resource extraction on government land are more vulnerable to government interference than are manufacturing firms. Right now, I'm working on a project that shows that bilateral investment treaties (treaties specifically designed to overcome OBM problems) have differential effects on different modes of entry for FDI. The point here is that BITs may help attract FDI for privatization much more than FDI for private sector M&As or greenfield investment. Since there is some evidence that mode of entry matters for contributions to economic growth, this insight has important investment and development policy implications.

IPE Everywhere: Soliciting Capital in Macedonia

(ht: Besir Ceka)

Why do governments buy companies when they could just steal them?

The WSJ reports Venezuela is negotiating to purchase a majority stake in French company Casino Guichard-Perrachon SA's local subsidiary, Cativen. Casino offered to sell a few weeks after Venezuela seized Casino's local grocery chain. So, the obvious (but ignored by the WSJ) question is why would Venezuela pay for a company it can seize?

Of course, international institutions could pay a role. Several multinationals are currently pursuing international arbitration to dispute what they deem unfair payouts, and Venezuela needs new FDI. Negotiating a buyout may be a way for Venezuela to reestablish a pro-investment reputation (though, given Chavez's domestic agenda, investors probably need a bit more than news of a fair buyout to make them more willing to invest in the country). But, if Venezuela is trying to reestablish its reputation, it probably wouldn't have seized Casino's grocery chain in the first place.

Perhaps there's a domestic interest group story at work here. I wouldn't be surprised if influential constituents of Chavez's have some sort of stake in a negotiated buyout.

The recent Venezuelan example highlights a failure of IPE scholarship in explaining political determinants of FDI and investment expropriation. Most of this literature (my MA thesis-in-progress included) focuses on institutional solutions to incomplete contracting problems associated with foreign investing. But, this framework for analysis often forgets that domestic constituents often have real interests in protecting the investments of certain foreign firms. The Casino-Venezuela case is particularly interesting because Venezuela has consistently refused to be constrained by international investment treaties in recent years. Yet, at least some firms can get some sort of compensation for expropriation even in an environment devoid of institutional constraints.

Institutions often matter, but there's another layer to the story.

FDI, Regulation, and Shifting Power Centers: China and Rio Tinto

On July 5th, without warning or explanation, Chinese officials arrested four Rio Tinto employees, one of them an executive and Australian citizen.  Later, China's state run media reported the arrests were connected with allegations that Rio Tinto obtained confidential documents revealing China's bargaining strategy for negotiating iron ore prices with the multinational mining firm.  Australian officials are particularly concerned since the detainees were given no access to outside communication and Chinese officials did not divulge any information about their whereabouts or the charges they face to Rio Tinto or the Australian government.

The ensuing diplomatic breakdown between China and Australia illustrates two points about the nature of foreign direct investment (FDI) today.

1) Power asymmetries are shifting.  

Most academic work on FDI treats developed (read OECD) countries as price makers and developing countries as price takers.  In other words, highly developed countries act on behalf of their multinationals by securing legal protection for multinationals' FDI in other countries.  This is mainly done through the use of Bilateral Investment Treaties (BITs).  The literature treats developing countries (China included) as grateful for whatever FDI they can get, and therefore willing to submit to OECD standards of legal protection for businesses.  

The problem with this view is that FDI sourcing patterns are shifting.  As the Chinese economy can support regional trade and FDI growth as well as export FDI to Africa and elsewhere, China doesn't need to cower to western demands for business protection.  Indeed, China never really has.  

Bottom line: predictions of convergence towards one standard of FDI legal protections depends upon the preferred regulatory level of key players.  China's rise underscores the possibility of multiple and competing regulatory regimes.

2)  The link between home country and multinational must be tested:

The focus on regulatory regimes like BITs assumes that home countries act as agents for their multinationals and that home countries discriminate against multinationals based on the multinational's home countries.  Talk that the recent events in China will lead to a backlash against Chinese multinationals looking to directly invest abroad depends upon the idea that countries will retaliate against Chinese-owned firms as well as the Chinese government.  And, the Chinese experience is an easy test of this link because many Chinese firms are in part owned by the Chinese government.  It is not entirely clear that this link holds more generally or consistently.

Big Win for Russia? Nyet.

(red line: U.S. stock index S&P 500; blue line: Russian stock index RTSI)

The Russia/Georgia conflict has gotten a lot of attention from IR scholars and public commentators. Some have noted that Friedman's "Golden Arches Theory of Conflict Prevention" has now been definitively disproved, others have questioned whether or not "democratic peace" theories should also be cast aside. Still others see a return to the Cold War on the horizon, and think that the redux may be a bit hotter than the original.

But not very many people are talking about the economic consequences of the conflict for Russia and Georgia. They are... not good. The Financial Times has been doing a lot of good reporting on the Russian side, and things are not going well:

An exodus of foreign capital is forcing Russian banks to slash lending as the international reaction to the country’s military standoff with Georgia starts to affect the real economy.

Bankers say Russia is facing its worst crisis since the August 1998 default. The Russian stock market has plummeted more than 40 per cent since May. A flight of capital estimated by analysts at up to $20bn (€14bn, £11bn) since the start of the conflict is drying up liquidity. The Russian Trading System index fell another 7.5 per cent on Tuesday to its lowest level since June 2006.

The rouble fell to its lowest point since the Russian financial crisis of 1998. Putin and Medvedev are in a public squabble over whether this trouble is related to the Russia-Georgia conflict, but I know of no neutral observer which doesn't think that some, not all, of the recent financial and economic trouble in Russia can be blamed on a lack of investor confidence caused in part by the Caucasian Conflict.

What's striking is that this is going on while the price of oil is still fairly high and while there are major concerns about the safety of U.S. bonds and securities. Russia, along with other commodity-rich countries, should be benefitting from the U.S.'s troubles. Indeed, some of them are, but Russia isn't. Georgia isn't doing very well, either.

What does it all mean? Daniel Drezner thinks that a more globalized world makes war more costly, and therefore less likely. Russia and Georgia both acted belligerently, and both are paying a big price, despite the fact that there have been no economic sanctions placed on either. It is true that wars are more costly if the opportunity costs (i.e. lost trade and investment) are greater, but is that enough to prevent wars that might otherwise occur? A wiser man that I will have to answer that question.