Course 03: Comparative Public Law

SUMMARY- CPL- MODULE 3

Module 3: Domestic Public Law Framework for International Investment

● All national legal systems implicitly or explicitly address two fundamental issues with
respect to international investment: (1) the extent to which foreign capital in its
various forms is permitted to enter and exit national territory and (2) the treatment to
be given to foreign capital once it enters national territory.
● The content of national laws and regulations on these two issues is shaped by the
interests, attitudes, and ideologies of countries’ governing authorities. At any
particular time, governmental positions on questions relating to the entry, exit, and
treatment of international investment are in turn influenced by domestic interest
groups, such as labour unions and business associations, as well as by external forces
such as diplomatic pressure from allies and from international institutions like the
International Monetary Fund and the World Bank. Moreover, changes in countries’
governing regimes can lead to abrupt and far reaching alterations in their national
frameworks for international investment.
● Despite its economic implications, the subject of international investment is
fundamentally political. It is political in the sense that governmental officials,
community leaders, civic groups, and populations generally view it as having
important consequences for the governance of their countries; therefore, they usually
have strongly held positions and beliefs on its role in national life. Political attitudes
in a particular country toward foreign investment depend on many factors, including
general economic conditions, the kind of investment projects being undertaken, and
the nationality of the foreign investors in the particular case. Thus, for example, while
certain developed countries such as the United States and Australia may be generally
favourable to the inflow of foreign investment from other western countries, their
populations often have deep misgivings about investment that will lead to foreign
control of major companies and economic sectors or that comes from countries with
which they have uneasy relations, such as China or the Arab world.
● Thus, we need to first examine the four dominant attitudes—sometimes referred to as
“theories,” “schools of thought” or “approaches” about foreign investment,
particularly direct foreign investment, and then consider how resulting economic
systems and development models adopted by countries influence their policies and
laws toward foreign investment.

The theories:-

(a) Pro-international Investment Theories

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● The prevailing view among capital-exporting governments, multinational corporate

executives, and counsel to foreign investors is that international investment is
beneficial, fosters economic growth and prosperity, and yields significant benefits to
capital-importing states (i.e. host countries), capital-exporting states (ie home
countries) and foreign investors. Proponents of this view invariably point to the
benefits of international investment and its associated technology, including the
creation of new industries and enterprises in the host country, the growth of
employment opportunities for nationals, the transfer of new technologies, the
introduction of management skills and other forms of know-how, the creation of
export-oriented enterprises with the resulting advantages of international trade and
improved balance of payments, the production of new and better goods and services
in the host country, and the construction of needed infrastructure.
● Pro‐investment attitudes about the benefits of foreign investment have resulted in
national legal frameworks that allow foreign capital relative freedom of entry, that
avoid special restrictions on the activities of foreign investors, and that place foreign
investments at least in a position of legal parity with national enterprises. The United
States, for example, has adopted a pro-international investment attitude and an open-
door policy toward foreign capital since its creation as a developing country at the end
of the eighteenth century.

(b) Anti-international Investment Theories

● Some scholars, civic leaders, and government officials, unconvinced of the alleged
benefits of international investment, have developed theories and approaches that
challenge the pro–international investment view, particularly with respect to foreign
direct equity investment. They argue that foreign investment, instead of promoting
economic growth, actually inhibits real development and places host countries in a
position of permanent dependence on multinational corporations and their home
states.

● According to this view, multinational corporations, which for the most part are based
in western capital-exporting states, devise their business strategies and conduct their
operations so as to maximize their profits, preserve their economic dominance, and
advance the interests of their home countries. Indeed, proponents of anti-foreign
investment theories argue that multinationals have no real concern for the
development of the countries in which they invest since it is usually in a
multinational’s interest to make every effort to keep developing host states in a
permanent position of dependence on the multinational enterprise and on the
multinational’s home state.
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● Influenced by these views, certain scholars founded a school of thought known as

“dependency theory” to justify this position. Often referred to as “dependencia,”
dependency theory had its origins in the 1950s in Latin America, the first region to
gain its independence from European colonialism and an area that historically has
struggled to resist the powerful economic and political efforts of the United States to
dominate that part of the world. Anti-foreign investment theories argue that foreign
investors in developing countries harm host countries by mobilizing local capital for
their activities, rather than transferring new resources, by introducing inappropriate
technologies that reduce employment opportunities, and by driving local producers
out of business through destructive and unfair methods of competition.

● In a more recent application of anti-foreign investment attitudes, Ecuador, in an effort

to establish greater control over its petroleum resources, passed a law in July 2010
authorizing the president to nationalize those foreign oil companies in the country that
failed to follow Ecuadorian laws and government policies.

Negotiation Theories of International Investment

● Proponents of this third view argue that whether or not foreign investment is
beneficial to a particular country depends on the bargain that is negotiated
between the investor and the host country with respect to the distribution of an
investment’s benefits and costs between the foreign investor and the host country.

● This theory is founded on two important insights. The first is that an international
investment is not simply a transfer of assets from one country to another but is
instead essentially a bargain, a “deal,” between the investor and the host country, a
bargain that allocates the benefits and costs of the transaction between the two
sides. The ability of a host country to secure net positive gains from foreign
capital therefore depends on its ability to negotiate a good deal with the investor.
The terms of the deal are to be found in the investment legislation, regulatory
framework, and contracts affecting that transaction.
● The goal of the national legal framework should be to maximize the benefits and
minimize the costs to the host country of any foreign investment project. In order
to achieve this goal, the national legal frameworks should establish a careful
screening and monitoring system for all foreign investments and should specify in
detail the contribution to the country that such projects must provide.
● Negotiations between the investor and the host government do not end once the
investor has made its investment. On the contrary, the relationship between the
two sides thereafter is a continuing negotiation as each side seeks to gain greater
advantages from the investment, often at the expense of the other.
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Structural Theories of International Investment

● While acknowledging that the advantages of a foreign investment to host

countries depends on the nature of the bargain they strike with foreign investors,
certain scholars and officials argue that because of asymmetries of power many
countries, particularly small developing countries, do not have the power to
negotiate satisfactory investment bargains with foreign investors generally and
multinational corporations in particular.

● They point to the fact that multinational corporations are able to maintain their
power advantage through the control of technology whose source is the investor’s
home country and through the alliances that they make with political and business
elites in the host country.
● As a result of these factors, many governments influenced by structural theories
have adopted two basic strategies in an attempt to correct the perceived power
imbalance in their relations with international investors. First, they are extremely
cautious in negotiating foreign investment transactions and are alert to power
differentials that might result in disadvantageous bargains. Second, they have
sought ways to increase their negotiating power.

Models and Systems in the Developing World

● For most of the second half of the twentieth century, the developing countries,
sometimes called “the Third World,” consisted of a disparate and amorphous group of
over 120 African, Asian, and Latin American countries that together accounted for
about seventy percent of the world’s population.
● Since the late 1980s, most developing countries, in varying degrees, have abandoned
that first model of development (which one might call Development Model I) and
have evolved a new model (which one might call Development Model II) that
supersedes it. This fundamental change in development models was in many ways as
significant a transformation for developing countries as was the movement in the
1950s and 1960s from dependent to independent political status.

First Development Model (Development Model I)

Probably all developing countries became independent with a fundamental belief that their
governments had the primary responsibility for bringing about economic development. By
government, of course, one meant the executive branch, for legislatures and judiciaries in
most developing countries were generally considered weak and lacking the technical
expertise to play a significant developmental role. This model had four basic elements: (1)
public ordering and state planning of the economy and society; (2) reliance on state
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enterprises as economic actors; (3) restriction and regulation of private enterprise; and (4)
limitation and control of the country’s economic relations with the outside world.

Second Development Model (Development Model II)

The elements of Development Model II are in many ways the exact opposites of those in
Development Model I. Let us consider the four most important ones:-

(i) Reliance on Markets and Private Ordering

Acknowledging the failure of state planning, many developing countries, in varying degrees,
turned to markets as mechanisms to allocate society’s resources. Thus, decisions on
investments, commodity prices, and credit allocation were increasingly to be made by private
actors in the market rather than by bureaucrats in government agencies and state planning
departments.

(ii) Privatization

● The developing countries’ emphasis on the public sector to develop their economies
resulted by the 1980s in a plethora of inefficient state enterprises whose existence
depended on continued government subsidies.
● The extent of privatization in the emerging market nations varied from country to
country. In many nations, it has been rapid and massive. In other countries, internal
political conflict has made the process slow and halting. Globally, the transfer of
assets from the public to the private sector has been staggering. Between 1990 and
1994 alone, proceeds from privatization by developing countries as a group totalled
over $100 billion.

(iii) Deregulation

The abandonment of Model I, the consequent reduction in state planning, and the new
reliance on private ordering and private actors in the economy necessitated a reduction in
economic regulation. Developing countries eased or abolished many of the regulations
enacted during the era of Development Model I. Mexico, for example, appointed a
“deregulation czar,” reporting directly to the President and Council of Ministers, and his
efforts served to accelerate the process of Mexican reform.

(iv) Opening up the economy

The economies of developing countries in this new era exhibited a new openness to the rest
of the world, particularly with regard to trade and investment. The failure of closed
economies and economic self-reliance to bring about higher standards of living, improved
health conditions, and other development goals, coupled with a need for new capital and
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advanced technology, led Third World countries to adopt a more open and outward
orientation toward the rest of the world. Import substitution as a policy yielded to export
orientation, and tariffs on imports were reduced. The result was an expanded role for foreign
trade in the developing world.

Regulating the Entry and Exit of Capital through Domestic Public Law

The Authority of Domestic Public Law to Regulate International Capital

● A fundamental principle of the international system is that states are sovereign and
equal. As a result, states exercise sovereignty over their territories. Sovereignty in this
sense means the supreme and independent authority of the nation state within its own
territory. The consequence of a state’s sovereignty is that a state has exclusive
jurisdiction to prescribe, enforce, and adjudicate laws for its territory and the
population living there. A corollary of the principle of sovereign equality of states is
that a state also has a duty of non-intervention in the areas of exclusive jurisdiction of
other states.
● The exit of capital from a state is subject to its exclusive sovereignty. Unless there is a
specific treaty to the contrary, a home state may prevent or impose conditions on the
exit of capital from its territory for purposes of foreign investment, and a host state
may prohibit or impose conditions on the movement of that capital into its territory.
● A country may impose controls on monetary exchanges and payments in connection
with capital transactions. Thus, government authorities may require licenses for
capital transfers and impose various taxes and restrictions to inhibit the exit of capital
from their territories. Usually, the primary reason for employing such capital controls
on the exit of capital is to correct balance of payments problems and to preserve
capital for domestic purposes.

Regulation of Capital Outflows

● Through their national legal systems, countries impose a variety of measures for
different purposes to control the outflow of capital, both real and financial, from their
territories. With respect to the export of real assets, governments may levy export
taxes as a means to raise revenues, impose quantitative restrictions to make sure that
the domestic market is adequately served, and require the issuance of an export
license as a means to prevent strategic technology from falling into the hands of an
adversary.
● States also control the outward flow of financial assets, both with regard to capital
transactions and often, with IMF approval, payments in connection with current
transactions. Three of the most used types of instruments of control that states employ
are (1) taxes, (2) price or quantity controls, and (3) outright prohibitions. Three of the
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most used types of instruments of control that states employ are (1) taxes, (2) price or
quantity controls, and (3) outright prohibitions.
● In employing restrictions on the outward flow of funds, states are motivated to attain
certain goals such as: (a) to preserve savings for domestic use; (b) to generate revenue
so as to finance an important national task such as a war; (c) to manage and direct the
allocation of credit within a country; (d) to correct a balance of payments deficit; and
(e) to achieve certain foreign policy purposes.

Regulation of Capital Inflows

The importation of capital goods to be used in connection with an investment enterprise is

generally subject to the national system of import regulations and tariffs. Often, foreign
investors and the host government negotiate special rules relating to the importation of capital
goods, for example that they may be allowed into the country without payment of customs
duties. Similarly, if an investor’s home country has a trade treaty with the host country, the
investor is entitled to the treaty benefits.

Regulation of Foreign Investment through Domestic Public Law

● The ability of a foreign investor to commit capital to a particular purpose in a given

country depends on the laws and regulations of that country. Unless a treaty provides
otherwise, each state has complete sovereignty to control the movement of capital into
its territory, to regulate all matters pertaining to the acquisition and transfer of
property within its national boundaries, to determine the conditions for the exercise of
economic activity by natural or legal persons, and to control the entry and activities of
aliens.
● On the one hand, some countries—particularly those with a strong statist or socialist
orientation—severely limit equity investment by foreigners in their economies while
allowing significant international borrowing by governmental agencies and
corporations. On the other hand, numerous other countries have structured their
legislation and policies to encourage the entry of direct foreign investment and even
to provide it with special incentives not normally available to local investors.

Role of Domestic Public Law to regulate FDI

● A foreign direct investment usually seeks to create or acquire a productive enterprise

in a host country. Within individual countries, numerous laws and regulations may
have an impact on the feasibility of undertaking a particular investment transaction by
a given foreign investor.
● The national legal systems of virtually all countries have special legal rules that apply
to foreign direct investments within their territories. Known variously as “investment
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laws,” “investment promotion statutes,” “joint venture laws” and “foreign investment
codes,” such legislation now seems to be a basic element in the legal systems of
almost every developing country in the world. One may also find similar foreign
investment laws in such developed countries as Canada, Australia, and Japan.
● Basically, all host country legislation governing direct foreign investment has two
general purposes: to control and to encourage foreign investment within its territory.
In countries actively seeking foreign investment because of a shortage of local capital
and technology, the investment codes or laws tend to emphasize the promotion or
encouragement function. But, in countries sceptical of the benefits of foreign
investment by reason of ideology or historical experience, the law at times has tended
to emphasize control rather than promotion.
● In creating a legal framework for foreign investment, national foreign investment laws
almost always treat four major issues:

(1) the definition of permitted foreign investment transactions

● Despite the occasional proclaimed “open-door policies” by governments, probably no

country allows foreign nationals to invest in any and all types of economic activity. In
defining the types of foreign investments permitted or desired, national laws rely on
some or all of the following devices: (1) sector prohibitions and restrictions; (2)
specification of favoured sectors; (3) provisions on desired substantive contributions
to the economy; (4) joint venture requirements; (5) performance requirements; and (6)
rules on the acquisition of land and natural resources.

(2) the incentives and guarantees offered to desired foreign investment:-

In order to attract foreign investment, countries offer foreign investors certain incentives and
guarantees. Such incentives and guarantees arise from three sources: (1) the economic and
political attributes of the country; (2) the strength and quality of the host country’s legal
system; and (3) special provisions in the legal framework designed to encourage foreign
investment directly.

(3) the controls applicable to foreign investment:-

Controls over FDI Operations

In an effort to minimize the costs to the host country of a foreign investment as well as to
maximize the benefits, national legal frameworks impose certain controls on investment
projects and on investors themselves. The nature of those controls varies from country to
country and usually reflects the peculiarities of the host country economy, its development
objectives, and the government’s social and political policies.
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a) Price Controls

In cases in which the investor by virtue of its investment has obtained a monopoly over the
provision of an important product, such as food or a public service like water, electricity, or
communications, the prices it may charge the public for such product or service will
invariably be subject to some type of governmental regulation so as to prevent the investor
from abusing its monopolistic position in the economy. Ordinarily, the maximum price to be
charged is fixed by an order of a government ministry or some designated administrative
agency.

b) Foreign Exchange Controls

In countries where foreign exchange is often in short supply, controls on the acquisition and
use of foreign exchange by the investment project often constitute one of the most powerful
means of regulating and influencing its activities. Thus, limitations on the availability of
foreign exchange for foreign debt servicing, repatriation of profits, and acquisition of spare
parts and raw materials can significantly affect, and indeed ultimately curtail, the operations
of the project itself. Normally, the rules on these matters are set down in the host country’s
foreign exchange laws and regulations; however, the investment law will ordinarily include
special provisions for foreign investment projects.

(4) the system for administering the foreign investment process.

● The implementation of a system to regulate foreign investment requires some kind of

administrative apparatus; consequently, virtually all host countries have created
governmental agencies for this purpose. Foreign investors and their counsel spend
much time with such agencies to work out the arrangements for undertaking and
implementing international investment projects and transactions. The specific body
charged with administering the investment law varies from country to country;
however, three basic organizational patterns have emerged.
● First, in some countries, a specific ministry or governmental department, such as the
ministry of planning, has full responsibility for administering the foreign investment
law.
● In a second approach, national legislation entrusts the process of regulating
investment to an inter-ministerial committee composed of representatives from
concerned ministries.
● A third approach is to create an independent agency, separate from individual
ministries but responsible to the President or the Prime Minister, with full powers to
approve foreign investments and regulate the activities of investors.

Regulation of International Debt Investments through Domestic Public Law

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(a) International Debt Investments in General

● In purely quantitative terms, the largest amount of international investment takes the
form of debt, rather than equity. For example, while direct foreign investments
undertaken in 2010 amounted to US$1.24 trillion, international bonds alone in 2006
totalled US$3.1 trillion. Whereas direct and portfolio equity investment gives the
investor an ownership interest in an asset or enterprise, debt investments result in the
investor having a legal claim to be repaid the principal amount of the debt plus agreed
upon interest on that principal. Debt investors have a right to be paid money by their
debtors, but they do not have an ownership interest in the entity to which they have
provided debt financing.
● International debt investments, both bonds and loans, fall into two further categories:
(1) “sovereign” debt in which a state or a state-owned entity is the debtor and (2) non-
sovereign debt in which the debtor is not a state or a state-owned entity, but rather a
private person or organization, such as a multinational corporation. The distinction
between the two types of debt investments lies essentially in the fact that the
effectiveness of legal protection of creditors is less with respect to sovereign debt than
with respect to non-sovereign debt. Effectiveness of creditor rights has two
dimensions: (1) the ability of the creditor to impose conditions on the conduct of the
debtor and (2) the effectiveness of creditor remedies in the event the debtor fails to
make agreed-upon payments.

(b) Public Law Frameworks for International Debt Investments

● A consideration of the regulatory framework of debt investments must take account of

the regulations in the country that is the source of the capital—i.e., the creditor
country—and the national regulations in the country that is to receive the capital, that
is, the debtor country. National regulation in the source country may pursue a variety
of policy goals, some of which we have discussed already when we spoke about
capital and exchange controls. A country that is concerned to preserve its financial
resources for domestic development or is worried about the negative impact on its
balance of payments of loans to foreign countries may seek to inhibit foreign debt
investments through a variety of means.

Special Nature of Sovereign Debt Investments

Governments borrow from foreign creditors for many reasons, including the need to finance
specific projects and to meet general budget deficits, which, for whatever reason, cannot be
filled by tax revenues. Individual countries often have complex laws and regulations to
govern the borrowing process.

Making Sovereign Debt Obligations

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● A sovereign debt is incurred by a particular government or government agency. An

initial question for any investor in foreign sovereign debt is therefore to determine
whether the state represented by that government or government agency will be
legally liable for the debt once the investor has transferred its funds to that
government or government agency. In incurring the debt obligation on behalf of the
state, that government or government agency is acting as an agent of the state, which
is its principal. Like any agent, a government can only obligate a principal if it is
authorized to do so.
● A threshold issue is therefore to determine whether the government or agency is
authorized to incur the debt obligation on behalf of the state. A country’s constitution
or its laws will almost always determine the rules by which such authority is
determined. In some countries, the constitution may entrust authority to borrow to the
legislature; in others, the government may have such authority subject to approval by
the legislature. In addition, national law will usually specify which particular
government department or agency may borrow on behalf of the government.
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