Event 1. Module 3. Key Elements of IIAs and their impact ... · 1) Agreement on Trade-related Investment Measures (TRIMs) and the General Agreement on Tariffs and Trade (GATT) –the

Context: understanding the political economy of

investment incentives

The limits on conditions to offer incentives

Lessons from experience

Tools to support countries in modernizing their

incentives’ frameworks

Presenter: Arthur Appleton

Resource person: Roberto Echandi

Event 1. Module 3. Key Elements of IIAs and their impact on domestic reform Session Two: The rules of the game on investment incentives

Investment Incentives: The Rules of the Game

Day 2Arthur E. Appleton

ViennaOctober 13, 2015

INVESTMENT POLICY AND PROMOTION WEEK

OUTLINE

C. Regional Disciplines

B. International Disciplines

1. The TRIMs Agreement (Articles III and XI GATT)

2. The SCM Agreement

3. The AoA Agreement

1. Overview

2. Example: NAFTA Rules Governing Performance Requirements

A. Introduction – Political Economy of Investment Incentives

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1. Debate exists on the efficacy of investment incentives

2. Many countries nevertheless use incentives as a means to attract investment

3. Many States fear that if they do not use incentives, they will lose out to the competition

4. Incentives can take many forms: tax holidays, cheap land, relief from requirements to hire local workers, etc.

5. Not all “incentives” raise issues: most States build roads, airports, infrastructure, schools, hospitals, etc.

6. Most Investment incentives go unchallenged: The glass house syndrome (exceptions exist)

A. The Context: Political Economy of Investment Incentives

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7. States able to attract investment sometimes impose conditions on investment (performance requirements such as job creation, export requirements or local content requirements)

8. States need to examine which incentives and performance requirements are appropriate, effective (economically sensible) and legal in a given case

9. In this session, Roberto and I will discuss:

a) Legal limits on incentives / performance requirements

b) Lessons from experience

c) Tools to support States that want to modernize their incentive framework

A. Political Economy Considerations

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The most important WTO rules affecting investment are found in the following agreements:

1) Agreement on Trade-related Investment Measures (TRIMs) and the General Agreement on Tariffs and Trade (GATT) – the disciplines are similar

2) Agreement on Subsidies and Countervailing Measures (SCM)

3) Agreement on Agriculture (AoA)

B. Legal Limits on Incentives and Performance Requirements: WTO Rules

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The TRIMs Agreement largely repeats obligations in:

- GATT Article III (national treatment)

- GATT Article XI (quantitative restrictions)

- Canada — Administration of the Foreign Investment Review Act (“FIRA”) (BISD 30S/140, 1984)

• local content requirements violate Article III:4

• Certain export performance requirements are OK

1) TRIMs and GATT

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a. Only applies to trade in goods – not to trade in services

b. Does not limit entry of investors or investment

c. Applies to foreign and domestic investors

d. Applies to measures designed to provide an advantage (“advantage” is not defined) but includes SUBSIDIES

e. All TRIMS that are inconsistent with GATT Article III or Article XI of the GATT are prohibited

f. GATT exceptions are fully applicable

g. The Annex to the TRIMs Agreement contains an illustrative list of prohibited measure (NOT exhaustive)

TRIMs Agreement

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Based on Article III:4 (GATT) – deals with purchase or use:

a) LOCAL CONTENT: TRIMS that require purchase or useof domestic products whether specified in terms of particular products, in terms of volume or value of products, or in terms of a proportion of volume or value of its local production

b) LOCAL CONTENT / TRADE BALANCING: Limiting the purchase or use of imported products to amounts related to the volume or value of exports

TRIMs Annex: Prohibited Measures

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Based on Article XI (GATT) – deals with import or export:

a) TRADE BALANCING: Restricting the import of products used in or related to local production (usually to an amount related to the volume or value of local production exported)

b) EXCHANGE BALANCING: Restrict the importation by an enterprise of products used in or related to its local production by restricting its access to foreign exchange to an amount related to the foreign exchange inflows attributable to the enterprise

c) EXPORT RESTRICTIONS: Restrict the export or sale for export of products, whether specified in terms of particular products, volume or value of products, or proportion of volume or value of local production.

TRIMs ANNEX: PROHIBITED MEASURES

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• Performance requirements condition investment based on factors such as technology transfer, import substitution and export performance. The Illustrative List covers a subset of Performance Requirements used by Members to condition investment.

• Performance requirements not tied to local content or trade balancing are not covered by the TRIMs Agreement

• Takeaway: Avoid conditioning investment on local content requirements, and trade and exchange balancing requirements.

TRIMs Agreement: Performance Requirements

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• Subsidies are sometimes applied as an investment incentive

• Subsidy defined:

(1) Financial Contribution

(2) By a Government Body

(3) That Confers a Benefit

2) Subsidies and Countervailing Measures (SCM)

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A subsidy Must be specific to violate SCM – specificity can take many forms:

•Enterprise specificity (particular company / companies)

•Industry specificity (particular sector)

•Regional specificity (particular region)

Subsidies: Specificity

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– Use objective criteria or conditions for eligibility and amount of the subsidy that are automatic, neutral, which do not favour certain enterprises over others, and which are economic in nature and horizontal in application

– Must be spelled out in law and strictly adhered to

– Possible example: base subsidies on number of employees or size of enterprise (without running afoul of conditions specified in this and other slides)

- Avoid enterprise, industry or regional specificity

- Watch out for de facto benefits

SCM: How to Avoid specificity:

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1. PROHIBITED (Red Light)

2. ACTIONABLE (Amber Light)

3. NON-ACTIONABLE (Green Light) lapsed in 2000 !!

a. Research & Development Subsidies

b. Disadvantaged Region Subsidies

c. Environmental Subsidies

The Three Types of Subsidies

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Prohibited Subsidies (Article 3 and Annex I ) are all deemed to be specific (can be de jure or de facto). No need to prove adverse effects

- Contingent on export performance

- Targeting use of domestic over imported goods (Export and import substitution subsidies – i.e. local content)

- This should sound familiar (TRIMs, GATT, FIRA)

•De facto specificity

- Limited number of enterprises

- Predominant use by certain enterprises

- Disproportionate large subsidies to certain enterprises

- Manner in which discretion exercised by granting authority (to grant or refuse a subsidy)

SCM: Prohibited Subsidies (Red Light)

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How to avoid Actionable subsidies:

•Avoid specificity

•Limit adverse effects to the economic interests of trading partners if there is specificity

•Takeaway: Many WTO Members use various forms of subsidies. If not based on fulfillment of local content or export performance requirements and if not otherwise specific – some policy space exists for subsidies

SCM: Actionable Subsidies (Amber Light)

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• Agricultural subsidies: the SCM Agreement applies to subsidies for agricultural products subject to Article 21 of the AoA (which gives the AoA precedence).

• Domestic Support (pillar 2 of the AoA): The AoA allows Members to use certain subsidies that would otherwise violate the SCM Agreement but seeks to discipline these subsidies (which supposedly do not distort trade)

3) Agreement on Agriculture (AoA)

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• Three categories of domestic support:

– Amber Box – market price support, non-exempt direct payments and input subsidies Trade distorting but possibly legal (or illegal!) Scheduled and were subject to reduction commitments.

– Blue Box – Unlimited. Designed to reduce distortion. Possibly trade distorting but permitted. Designed to reduce production. (Production limiting programmes) (Now actionable under the SCM) (See Art.6.5 AoA)

– Green Box – Unlimited. Not trade distorting so allowed. (See Annex 2 AoA) (Now actionable under the SCM)

• If it is not green or blue, it’s amber.

AoA: Domestic Support (Subsidies)

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• The SCM Agreement prohibits all export subsidies not allowed by the AoA (SCM definition of subsidy applies)

• AoA prohibits a Member from providing export subsidies in excess of its scheduled commitments

• Article 9 of the AoA lists six types of export subsidies and subjects them to reduction commitments:

1. Cash payments contingent on export performance2. Disposal through export of gov’t stocks below domestic market price3. Export subsidies paid by producers and processors financed by

government action (taxes and levies)4. Marketing subsidies (except widely available promotional subsidies)5. Transport and freight subsidies on better terms than domestic rates6. Subsidies for agricultural products contingent on their incorporation

into exported products

AoA: Export Subsidies

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• The AoA takes precedence over the SCM

• Pay attention to scheduled AoA commitments if you intend to use export subsidies or domestic support programs to attract agricultural investment

• Green Box programs offer the safest alternatives. They are unlimited if in accord with Annex 2 AoA. They include:

• Programs that not targeted at specific products; • Income support decoupled from production or prices; • Environmental and regional development programs.(Note similarity with now expired non-actionable/Green Light subsidies under SCM)

AoA: Takeaways

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• Most BITs do not cover investment incentives

• Some BITs include limitations on performance requirements– Some limit obligations to TRIMs Agreement (BIT Canada and

Costa Rica)– Other BITS go beyond TRIMs • 2004 Canada Model BIT, Chapter on Investment in U.S.

FTAs• Apply also to investment in services• Obligations to abstain from imposing a specific list of

banned performance requirements• Includes exceptions• May apply the same rules and disciplines vis-à-vis all other

countries that are not a Party to the Agreement

C. Regional Disciplines on Investment Incentives

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• The investment and services chapters of Preferential Trade Agreements (PTAs) often exclude National Treatment obligations from applying to subsidies

• PTAs frequently include more detailed disciplines on performance requirements

• NAFTA provides an excellent example

Regional Disciplines on Investment Incentives

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1. No Party may impose or enforce any of the following requirements, or enforce any commitment or undertaking, in connection with the establishment, acquisition, expansion, management, conduct or operation of an investment of an investor of a Party or of a non-Party in its territory:

(a) to export a given level or percentage of goods or services;

(b) to achieve a given level or percentage of domestic content;

(c) to purchase, use or accord a preference to goods produced or services provided in its territory, or to purchase goods or services from persons in its territory;

(d) to relate in any way the volume or value of imports to the volume or value of exports or to the amount of foreign exchange inflows associated with such investment;

NAFTA Example (An FTA) – Article 1106

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(e) to restrict sales of goods or services in its territory that such investment produces or provides by relating such sales in any way to the volume or value of its exports or foreign exchange earnings;

(f) to transfer technology, a production process or other proprietary knowledge to a person in its territory, except when the requirement is imposed or the commitment or undertaking is enforced by a court, administrative tribunal or competition authority to remedy an alleged violation of competition laws or to act in a manner not inconsistent with other provisions of this Agreement; or

(g) to act as the exclusive supplier of the goods it produces or services it provides to a specific region or world market.

NAFTA Example (An FTA) – Article 1106

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• Heard under ICSID’s Additional Facility Rules

• The Tribunal ruled that a Canadian Petroleum Board’s imposition of a new requirement that foreign investors must spend millions of dollars per year on R&D and education and training (E&T) breached NAFTA Chapter 1106(1)(c).

• Tribunal found that R&D and E&T are services, and that the Board’s measure was mandatory

• Tribunal found that a Canadian treaty reservation permitting performance requirements for its crude petroleum and natural gas industries was not applicable

2012 NAFTA Dispute: Mobil Investments Canada Inc. and Murphy Oil Corporation v Government of Canada

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1) Avoid conditioning private sector investment on local

content requirements

2) Avoid trade balancing and exchange balancing

requirements

3) Avoid export subsidies or import substitution

subsidies (prohibited subsidies)

4) Avoid “subsidies” that are “specific” (targeted at an

enterprise, industry or region)

5) Act consistently with scheduled commitments under

the AoA

6) Make good use of the Green Box

7) Act in accord with obligations under bilaterals, RTAs…

D. Conclusions

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• Lessons learned from experience

• World Bank tools to support States that want to modernize their incentive framework

• Strategies for investment attraction (incentives) that do not violate international and regional commitments

DISCUSSION

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THANK YOU

[email protected]

INVESTMENT POLICY AND PROMOTION WEEK

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