Columbia FDI Perspectives
Perspectives on topical foreign direct investment issues
Editor-in-Chief: Karl P. Sauvant (Karl.Sauvant@law.columbia.edu)
Managing Editor: Riccardo Loschi (Riccardo.firstname.lastname@example.org)
The Columbia FDI Perspectives are a forum for public debate. The views expressed by the authors do not reflect the opinions of CCSI or our partners and supporters.
No. 306 May 31, 2021
Amid the backlash against globalization, policy uncertainty has been a key concern for investors over the past few years. As the COVID-19 crisis continues, fear of contagion and uncertainty over trade and investment policies will further dampen investment activities. Estimates indicate that global FDI flows could decline by 30-40% during 2020-2021. Boosting investor confidence to attract and retain FDI is critical as countries move toward economic recovery.
One important response by countries is to reform their regulatory regimes to reduce risks for investors, while preserving countries’ right to regulate in the public interest. Qualitative findings from recent investor surveys consistently show that MNE executives rank countries’ legal and regulatory environments as one of the top three factors shaping investment decisions, along with political and macroeconomic stability. Further, investors indicate that exposure to regulatory risks (e.g., expropriation, breach of contract) in host countries can and has triggered withdrawals of investments or the cancelling of planned investments.
A new quantitative measure of regulatory risk—which links directly to specific elements of countries’ legal framework—helps gauge the progress of such reforms.It draws on existing and newly collected data sources, including the content of international investment agreements and investment laws, and evaluates them along three dimensions: transparency, investment protection and access to effective recourse mechanisms. Evidence using a database of 14,335 parent companies investing in 159 host countries suggests that this new measure of regulatory risk is correlated with country risk premium and matters for FDI.
Higher regulatory risk—that is, lower levels of transparency, protection and less effective recourse—deters MNEs’ decisions to enter or expand in host countries. In aggregate, it is associated with lower FDI inflows. The effect of regulatory risk on investors’ location decision is sizeable: if the median country improves its performance to the level of a top 25th percentile performer on the regulatory risk measure, investors will be 5.5–22% more likely to locate in the country.
These results highlight specific policy actions that governments should take to minimize regulatory risk. It is important to note that countries are already implementing these actions: the newly constructed regulatory risk measure helps explore the link between these actions and FDI outcomes.
The effects of the current pandemic require that governments pursue various avenues to remain successful in attracting and retaining FDI in the highly competitive world FDI market. Reducing regulatory risk is one such avenue.
- To improve transparency and predictability, countries should ensure the systematic publication of, and public consultation on, laws and regulations. Availability of portals and other mechanisms to allow investors to find updated information about relevant laws and regulations can help. In addition, specificity and clarity in legal provisions can reduce room for discretion. For example, where investment approval is required under investment laws, countries can reduce regulatory risk by specifying the approval criteria and time-periods within which such approval should be granted.
- Investment protection against arbitrary government conduct, provided in countries’ investment laws or international investment agreements, in accordance with well-established good practices can further reduce regulatory risk. An example is legal provisions on protection against both direct and indirect expropriation and requiring payment of timely and adequate compensation. Equally important is the ability to freely transfer funds in a timely manner and in a freely convertible or freely usable currency. Of course, the drafting of any legal provisions entails not just considerations of well-established principles of investor protection, but the overall context, legal traditions and political economy realities of countries (including flexibility clauses needed to reflect and protect countries’ right to regulate).
- Legal provisions are only as good as their implementation. The challenges around lack of implementation across countries are well known. To strengthen the implementation of laws and regulations and balance the risk of potential costly disputes, countries can institute formal mechanisms to systematically address investor grievances and prevent their escalation into investor-state disputes. Overall, strengthening judicial processes (e.g., by promoting specialized commercial courts, stipulating precise time-ranges for judicial processes, reinforcing efficient case-management systems) can further improve effective access to recourse.
* Priyanka Kher (email@example.com) is a Private Sector Specialist in the Investment Climate unit of the World Bank; Trang Thu Tran (firstname.lastname@example.org) is a Senior Economist in the Firms and Entrepreneurship unit of the World Bank; Sarah Hebous (email@example.com) is a consultant at the World Bank. The authors would like to thank Persephone Economou, Peter Muchlinski and an anonymous peer reviewer for their helpful peer reviews.
|The material in this Perspective may be reprinted if accompanied by the following acknowledgment: “Priyanka Kher, Trang Thu Tran, Sarah Hebous, ‘Reducing regulatory risk to attract and retain FDI,’ Columbia FDI Perspectives No. 306, May 31, 2021. Reprinted with permission from the Columbia Center on Sustainable Investment (http://ccsi.columbia.edu).” A copy should kindly be sent to the Columbia Center on Sustainable Investment at firstname.lastname@example.org.|
For further information, including information regarding submission to the Perspectives, please contact: Columbia Center on Sustainable Investment, Riccardo Loschi, email@example.com. Most recent Columbia FDI Perspectives
- No. 305, Munir Akram, “Mobilizing FDI for sustainable infrastructure investment,” Columbia FDI Perspectives, May 17, 2021
- No. 304, Anne van Aaken and Diane Desierto, “The Hague Rules on Business and Human Rights Arbitration,” Columbia FDI Perspectives, May 3, 2021
- No. 303, Gary Clyde Hufbauer, “Dangers lurking in the OECD tax proposals,” Columbia FDI Perspectives,April 19, 2021
All previous FDI Perspectives are available at https://ccsi.columbia.edu/content/columbia-fdi-perspectives.
Other relevant CCSI news and announcements
- On June 10, CCSI will host Compensation under Investment Treaties: A Pareto-Improving Proposal. Emma Aisbett and Jonathan Bonnitcha use a law-and-economics approach to propose a new rule for compensation that limits compensation to that required to prevent investment deterring effects of opportunistic host behavior, thus seeking to better ensure treaty participation benefits both source and host countries. In this online event, Emma will present the proposal; Jeffrey Sachs and Kekeletso Mashigo will discuss it; and we will then open the event for questions and answers from participants. Please register here.
- On May 26, CCSI, ASIL, and the Rutgers Center for Transnational Law hosted Investment Treaties and a New Legal Imagination. In the recently published book, Investment Treaties and the Legal Imagination, Nicolás M. Perrone excavates the origins and evolution of the legal thinking underpinning the investment treaty regime and ISDS practice. Kathleen Claussen (University of Miami School of Law), Mélida Hodgson (Jenner & Block LLP), and Chantal Ononaiwu (CARICOM Secretariat) discussed with the author the implications of these findings for the future of international investment law. CCSI’s Brooke Guven moderated, and Jorge Contesse (Rutgers Law School) provided an introduction. View the video here.
Karl P. Sauvant, Ph.D.
Resident Senior Fellow
Columbia Center on Sustainable Investment
Columbia Law School - Earth Institute
Ph: (212) 854-0689
Fax: (212) 854-7946
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