The Potential Impact of Multilateral Framework on Investments (MFIs)

The development of an Multilateral Framework on Investment (MFI), if such a framework were to be negotiated, would represent a change in the policy-framework cluster of determinants. Although such a framework might also affect some elements of business facilitation (such as investment incentives), it would not involve significant and direct changes in the principal economic determinants. Indeed, by making Foreign Direct Investment (FDI) policies potentially more similar, an MFI would underline the importance of economic (and business facilitation) factors in determining FDI flows. The precise effect of an MFI on the policy-framework cluster of determinants would depend on its content, including definitions, scope and safeguards. Because an MFI is only a hypothesis, three scenarios, based on differing assumptions, are discussed below for purely analytical purposes. The specific implications of each scenario would vary from country to country in accordance with specific economic and developmental conditions and specific national stances vis-a-vis FDI. If there were an MFI, how would it affect the volume and pattern of FDI flows?

  1. One conceivable outcome of an MFI is that, it would help to increase FDI flows and perhaps affect other features of such flows as well. Such an outcome is based in part on the assumption that a multilateral agreement would not only consolidate recent changes towards more liberal policies by many countries but would incorporate “rollback” provisions requiring countries to commit themselves to reducing or eliminating existing barriers to FDI and strengthening investment protection and the proper functioning of markets. Even in the absence of further liberalization  a multilateral framework could facilitate investment by providing stronger assurances as compared with unilateral or even bilateral measures when it comes to the protection of FDI and the stability of domestic FDI regimes. The presumably greater stability, predictability and transparency resulting from an MFI would create a generally more favorable climate for investors. The impact on inflows might be greatest for those countries that we not already signatories to bilateral, regional, multilateral or multilateral investment agreements, and countries whose current policies, even if favorable to FDI are not considered sufficiently predictable by investors. At the same time, whether or not FDI flows would actually increase and whether there would be a change in the quality and patterns of flows would depend on the precise content of an agreement, the nature of national commitments and exceptions to the generalized multilateral rules and, of course, the other FDI determinants that would come into play at that point.
  2. A second conceivable outcome of an MFI is that it could actually reduce the quantity and quality of FDI flows, because the negotiation of an MFI would take several years creating uncertainties about the investment climate worldwide and thereby discouraging foreign investors. Further, even if negotiations did produce an agreement, the MFI that would result could conceivably enshrine a less liberal multilateral environment than has already evolved unilaterally or regionally. Such an MFI could also alter the patterns of FDI flows across geographic regions and industries. In particular, an MFI might reduce FDI flows to countries that gain from the currently restrictive policies of their competitors for such investment and increase flows to otherwise desirable locations that are receiving little inward FDI because of uncertainties about policies.
  3. A third conceivable outcome of a possible MFI is that it would have little or no impact on the quantity and quality of FDI flows, as it would not materially alter the policy framework for FDI. One reason why this might be the result is that there has already been significant liberalization in many countries, in particular in many developing countries and countries in transition, and this liberalization has contributed to surge of FDI flows that reached a new record. Therefore, an MFI that contains, for example, standstill provisions requiring countries to commit themselves not to introduce new barriers to FDI, lower standards of investment treatment or measures likely to impair the proper functioning of markets would essentially maintain the status quo, as far as the openness of economies to FDI, their treatment of foreign affiliates and the functioning of their markets are concerned. Moreover the extensive network of bilateral investment treaties would provide protection for investors and could be easily extended to additional countries. Finally, on this view, there would be no significant effects on the geographic patterns of FDI flows, as they are largely influenced by other FDI determinants.

On balance, these considerations suggest that an Multilateral Framework on Investment (MFI) would improve the enabling environment for FDI, to the extent that it would contribute to greater security for investors and greater stability, predictability and transparency in investment policies an rules. This, in turn, could encourage higher FDI flows and potentially some redistribution of those flows particularly to countries whose investment climates would newly reflect the multilateral framework. How much difference an MFI would make, however in terms of the quantity, quality and patterns of actual FDI flows difficult to predict and is precisely the function of enabling framework to allow other determinants, and especially economic determinants to assert their influence.

Multilateral Framework on Investment (MFI) in International Trade

Expectations about the impact of an MFI on FDI flows (if it were indeed to be negotiated) in comparison to the current regulatory framework and the direction in which it is developing should, therefore, not be exaggerated. There are, of course, other issues that need to be considered in connection with a possible MFI especially the possible role of such an agreement in providing a framework for intergovernmental cooperation in the area of investment.

Although the most profound shifts among FDI determinants result from integrated international strategies, especially complex strategies, the traditional economic determinants related to large markets, trade barriers and non-tradable services are still at work, and account for a large share of worldwide FDI flows. Data on the distribution of sales of foreign affiliates of United States TNCs in host countries are indicative in this regard: two-thirds of TNC activity is still of this type. These figures are higher in the services sector, including trading affiliates, and lower in manufacturing bat they do not change the overall outcome. Some of the largest national markets remain unmatched in size by the largest regional markets or even by entire continents. For example, the market the European Union during most of its existence has been smaller than the United States market; the market of the African continent (without South Africa) is smaller than that of the Republic of Korea; and the combined markets of the 14 Central and Eastern European countries are smaller than the market of Brazil.

As regards trade barriers, even though the general trend has been towards the reduction or even abolition of tariffs and quotas, they continue to remain in force in several (especially developing) countries and in some industries in a much wider group of countries, These continue to generate import FDI and discourage efficiency-seeking FDI. In non-tradable services, as well as goods that are perishable or need to be adapted to consumer preferences or local standards, the market-seeking motivation, and the corresponding locational attractiveness of host countries, remain as strong as ever. In fact, there has been an explosion of FDI in the services sector as a result of the general trend towards the liberalization of FDI frameworks for services.

Still, although FDI remains strongly driven by its traditional determinants, the relative importance of different locational determinants for competitiveness enhancing FDI is shifting. For example, again using United States data for foreign affiliates in manufacturing though it is still true that these affiliates are predominantly oriented towards domestic markets, their domestic sales have dropped from 64 per cent in 1982 to 60 per cent in 1993. A similar trend can be observed in tradable services (e.g. computer and data-processing services) in which domestic sales declined from 85 to 81 per cent over the same period. Perhaps more telling are data for United States foreign affiliates in the European Union, as the evolving policy framework there is more indicative of the FDI policy framework emerging globally, sales to local markets in that region declined from 76 per cent to 64 per cent between 1966 and 1993, while exports increased from 24 per cent to 36 per cent.

In their quest for competitiveness, TNCs assign a particularly important role to obtaining access to created (or strategic) assets, the principal wealth-creating assets and a key source of competitiveness for firms. Created assets can be tangible like the stock of financial and physical assets such as the communication infrastructure or marketing networks, or intangible. The list of intangible assets is long, but they have a common denominator knowledge. They include skills, attitudes (e.g. attitudes to wealth creation and business culture), capabilities (technological, innovatory, managerial and leading capabilities), competencies (e.g. to organize income-generating assets productively), relationships (such as interpersonal relationships forged by individuals or contacts with governments), as well as the stock of information, trade marks, goodwill and brainpower. These assets can be embodied in both individuals and firms and the can sometimes be enhanced by clusters of firms and economic activities. The importance of created intangible assets in production and other economic activities has increased considerably. A large proportion of the costs of many final goods and services, ranging from simple products such as cereals through books computers to automobiles, consists of the costs of such created assets as R&D, design, advertising, distribution and legal work. Less than 10 per cent of the production of automobiles now consists of labor costs; the rest relates to the contributions various created assets. Moreover, international competition increasingly takes place through new products and processes and these are often knowledge based. R&D activities leading to new products and processes are costly and risky. At the same time, markets for knowledge-based resources and assets are becoming more open and enterprises embodying these assets can be bought and sold. The result is that TNCs have taken advantage of these opportunities and used FDI as a major means of acquiring created assets and enhancing corporate competitiveness.