ECONOMIC INTEGRATION &

PROTECTION STRATEGIES

Prof David K. Linnan

USC LAW # 783

Unit 13

OLD & NEW FORMSPROTECTION OF ALIEN ECONOMIC

INTERESTS: CUSTOMARY VS NEWER TREATY LAW

1. Traditional protection of aliens vs.

2. Newer bilateral (investment) treaty & regional free trade agreements (e.g., NAFTA)

UNDERLYING ECONOMIC ISSUE IS DEGREE OF DESIRED INTEGRATION, WITNESS DIFFERENCES FOR EXAMPLE IN NAFTA VS EU

ECONOMIC INTEGRATION I

GLOBALIZATION OR WHAT?

1. Economic integration plays a role in so-called globalization, but is more the

economist’s way of approaching the idea that “states” as legal jurisdictions are not natural or sole economic units and have porous borders

2. Practical examples include burgeoning regional trade agreements (NAFTA,

MERCOSUR, APEC, EU, etc.)

ECONOMIC INTEGRATION II

GLOBALIZATION OR WHAT? (CONT’D)

3. Different from the multilateral trading system (GATT/WTO, but

Art XXIV recognition), but now going beyond goods to services with accompanying legal integration

4. Distinguishing different views/legal approaches under trade & int’l economic law as multilateral vs something less

STATE RESPONSES IECONOMIC INTEGRATION AS A GIVEN

1. Subject to treaty obligation, states have absolute right to close borders economically

a. But who wants to be poor autarky like North Korea?

b. Economic integration is a choice, in practice for trade in goods,

legal result is linking trade & investment

c. In practice for trade in services, less well understood (e.g., call

centers in India) but involves now GATS but also merging regulation for services

STATE RESPONSES IIECONOMIC INTEGRATION AS A GIVEN (CONT’D)

2. The problem of economic integration is visible legally in both investment and

FTA treaty explosion, but is clearer to the clients than the lawyers who specialize traditionally in the law of a single jurisdiction

a. Separate sovereigns & borders visible as non-

commercial riskb. Different developing county

problem (NAFTA for first time included developing &

industrialized states)?

c. Remaking global production chains

US GOVT FOCUSWHERE IS ECONOMIC INTEGRATION WORKED ON IN US

GOVT?

1. US Trade Representative’s Office now in de facto control of all int’l economic integration (aka treaty) negotiations in US government, includinga. GATT/WTO Doha Round Negotiationsb. FTA negotiations as earlier NAFTA, more

recently US-Singapore FTAc. Int’l environmental & labor aspects of such

agmts

2. “Subsidiary” departments/agency with seniority but less voice due to negotiating functions being

centered in USTR include State, EPA, Commerce & Labor (but Commerce has kept part of trade administration machinery)

CHANGING LAWHOW HAVE CHANGING ECONOMIC STRUCTURES & IDEAS LIKE

ECONOMIC INTEGRATION FOUND EXPRESSION IN LEGAL STRUCTURES/VIEWS?

1. Remember, traditional protection of alien economic interests tied to customary law with inherent limits like nationality limitations (e.g., Barcelona Traction in conjunction with capital importing countries often requiring locally incorporated subsidiaries) & dispute about appropriate compensation following expropriation, Calvo clause arguments, etc.

2. The legal answer to ambiguous protection under the customary law would normally be treaty, but then what

kind of treaty?

3. Since mid-1980s BIT treaties pursued, but since 1990s free trade agreements (FTAs) aka regional trade agreements (RTAs) have been pursued alongside multilateral trade in goods liberalization (GATT/WTO)

CHANGING ECONHOW HAVE CHANGING ECONOMIC STRUCTURES & IDEAS LIKE

ECONOMIC INTEGRATION FOUND EXPRESSION IN LEGAL STRUCTURES/VIEWS? (CONT’D)

4. Trade economists analyze FTAs as second-best alternative over multilateral trade liberalization (analysis based on efficiency implications), but seem to downplay the investment guaranty & service liberalization functions

5. Private sector may prefer investment guaranty aspects, while others may have a greater interest in service sector

liberalization anyway (given general develop of industrialized nations’ economies towards services and away from goods production; plus TNCs remaking global production chains)

6. In practice, increasingly look towards not just treaties but rather treaties with access and investment guaranty elements tilted towards economic integration so that the result is not just a tendency towards treaty for newer law

but also kind of treaty & form of economic integration (Singapore issues in Doha round negotiations)

PRIVATE RISK ONLY?WHO CARES ABOUT PRIVATE RISK OVERSEAS & WHY?

From private sector viewpoint, higher (moderate) risk is acceptable but potential return must be higher

1. Excessive risk leads to no investment, for example, in the absence of which no economic development/turmoil (remember two emphases in UN

Charter?)

2. Portfolio versus direct investment differences most recently with financial sector & capital account deregulation

3. Whose agenda drives such developments (private sector vs anti-globalization folks)?

CAPITAL IMPORTING IWHO CARES ABOUT NON-COMMERCIAL RISK &

WHY? (CONTD)

From viewpoint of states importing capital, development models have moved away from direct state borrowings to finance development to attracting private capital

1. Hidden ideological & economic policy issue of role of state in development

2. States and state enterprises (agents of development), e.g., Indonesian Const Art 33 representative of common pattern in Asia/Africa

CAPITAL IMPORTING IIWHO CARES ABOUT NON-COMMERCIAL RISK & WHY?

(CONTD, CAPITAL IMPORTING COUNTRIES)

1. Non-market limitations on official development assistance and subsidized lending by

multilateral institutions (World Bank, Asian Development Bank, etc.), different world than 1980s

2. Conditionality (Washington Consensus, incorporating economic views)

a. Control arguments at multilateral level, payers versus users in int’l financial institutions

b. Voting control based on capital contributions

3. Arguments about social right (human rights issues) of “right to development”

CAPITAL IMPORTING III WHO CARES ABOUT NON-COMMERCIAL RISK &

WHY? (CONTD, CAPITAL IMPORTING COUNTRIES)

1. Market-based limitations on direct state borrowingsa. Overindebtedness, creditworthiness

problems raising the cost of capital

b. Competitiveness problem for products so funded

2. Problem of financing intermediate “infrastructure” that is harder to recover direct costs on (e.g., education)

CAPITAL EXPORTING IWHO CARES ABOUT NON-COMMERCIAL RISK & WHY?

(CAPITAL EXPORTING COUNTRIES)

1. From viewpoint of states exporting capital, basic issue of what is at risk if little or no economic improvement/development in capital importing states

a. Current claims re war on terror and lack of development progress in Islamic world

b. Absent viable economies, political unrest more broadly (parallel 1945 UN Charter motivation in seeing conflict & economic turmoil as linked)

2. Via state sponsored political risk insurancea. Protection of private party citizens’ investment

involves capital-exporting state in nominally private (investment) activity as guarantor

b. When state must pay, follow up is as state exercising retorsion, including IFI voting, etc.

CAPITAL EXPORTING IIWHAT IS SPECIAL RISK IN DEALING WITH NON-PRIVATE

ENTITIES?

1. State-owned enterprises (SOEs) not only in developing world and socialist countries, but Europe too

a. Theoretically, different economic viewsb. US has own problematic examples in

mortage market entities (Fannie Mae, Freddie Mac)

2. Issue of framework of laws under control of business party (legislative or regulatory problem) vs judiciary favoring executive (home court advantage)

ex: PLN example in Indonesia with arguments about arbitration outside country for

shelved power projects (Karya Bodas)

CAPITAL EXPORTING IIIWHAT ARE PRACTICAL STRATEGIES TO AMELIORATE/LIMIT

RISK?

1. Traditional law of expropriation and nationalization

2. Voluntary investment incentive programs, but what if withdrawn?

3. Insurance such as US OPIC, German Hermes, Japanese Import-Export Bank, etc. programs to

insure against expropriation and convertibility risks, Multilateral Investment Guaranty Agency (MIGA) of World Bank, some private insurance

4. Bilateral treaties (traditionally FCN, now investment BITs, FTA/RTA examples such as NAFTA too) essentially having capital importing states accept capital exporting states’ views re traditional law of expropriation

DIFFERING PERSPECTIVESHOW DO DIFFERENT STATE GROUPS VIEW

EXPROPRIATION & NATIONALIZATION?

1. Traditional sovereignty claims, now less important often with move from primary industries to manufacturing to services (focus on HR as economic views change)

2. Neocolonialism claims (control of resources as control of economy in traditional primary industries, NIEO revisited but fewer voices)

3. Ideological issues if no or limited recognition of private property (but heart of market

economy, but social functions argument on spectrum from US inverse condemnation to Indonesian Const art 33 arguments)

NON-COMMERCIAL RISK IWHAT ARE NON-COMMERCIAL RISKS?

1. Expropriation without adequate compensation

2. Violation by foreign governments of concession or agreement

3. Foreign exchange restrictions &interfering with profit repatriations

NON-COMMERCIAL RISK IIWHAT ARE NON-COMMERCIAL RISKS? (CONTD)

4. Import restrictions (interfering with parts supply)

5. General regulatory issues (labor, property use, etc.)

6. Discrimination tax/retaliation

NON-COMMERCIAL RISKS TIED POSSIBLY TO SOVEREIGN CHARACTER OF CERTAIN ACTIONS, BUT ALSO SPECIAL FAVORITISM PROBLEM WITH SOEs (ECONOMIC ORGANIZATION ISSUE ELSEWHERE)

TRAD TREATY PATTERNSECONOMIC INTEREST PROTECTION & NON-COMMERCIAL

RISKS

1. Tradition of Friendship, Commerce & Navigation or FCN treaties (already common in 19th century)

2. US Bilateral Investment Treaty Program (since 1980s, under USTR control)

[Off the record]

3. Relationship between trade & investment law (remaking global production chains), regional trade arrangements or RTAs of which NAFTA is one & NAFTA Chapter 11 its embodiment

[Off the record] [Off the record]

NAFTA PATTERNECONOMIC INTEREST PROTECTION & NON-COMMERCIAL

RISKS (CONT’D)

1. NAFTA investment protection Chapter 11 not that far off Restatement substantively, but clear rejection of traditional Calvo challenges from Mexican standpoint

a. non-discriminationb. minimum standard of treatment in

accordance with international lawc. limitations on the use of

“performance requirements” (such as local content rules; really a trade law element, not traditional alien protection)

d. freedom to repatriate profits and other returns

e. fair market value compensation for expropriated property

WHERE NAFTA CLEARLY EXCEEDS TRADITIONAL ALIEN PROTECTION LAW SUBSTANTIVELY IS IN RIGHT TO INVEST (OPENING INDUSTRIES) [Off the record]

NAFTA FURTHERECONOMIC INTEREST PROTECTION & NON-COMMERCIAL

RISKS (CONT’D)

2. Current NAFTA Chapter 11 issuesClaim is that “neutral” investment protection

approach of state to individual arbitration may undercut local law making, particularly in environmental area, (idea of replacing diplomatic protection with direct proceedings as thorn in side, not substantive standard)

a. Methanex proceedings

b. Broader issue in extent to which NAFTA is now USTR gold standard for investment treaties

[Off the record] [Opposing view] [Do you agree?]

RISKS REVISITED ILEGAL APPROACHES TO NON-COMMERCIAL RISK

1. Expropriation without adequate compensation

a. Customary law alien economic interests protection

b. BIT or FTA treaties (e.g., NAFTA)

c. Political insurance (quasi-governmental, e.g.,

OPIC)

2. Violation by foreign governments of concession or agreement

a. Arbitration

b. Political insurance

RISKS REVISITED IILEGAL APPROACHES TO NON-COMMERCIAL RISK

(CONTD)

3. Foreign exchange restrictions & interfering with profit repatriations

a. Normally only political insurance

4. Import restrictions (interfering with parts supply)

a. Unless in contract, picked up perhaps then in political insurance

b. IFI conditionality, retorsion in effect on Washington Consensus

c. Chief recourse beyond investment destination reputation

RISKS REVISITED IIILEGAL APPROACHES TO NON-COMMERCIAL RISK

(CONTD)

5. General regulatory issues (labor, property use, etc.)

a. Short of expropriation, chief recourse beyond investment destination

reputationb. IFI conditionality, retorsion in effect on

Washington Consensus

6. Discriminatory tax/retaliationa. Customary law alien economic

interestsb. BIT or FTA treaties quasi-national

treatment (e.g., NAFTA)

MODERN PRACTICEROLE OF FOREIGN STATES ACTIVELY PROTECTING

ECONOMIC INTERESTS

1. How has traditional view of diplomatic protection changed or stayed the same with the addition of political risk insurance (e.g., OPIC) for economic interests, beyond treaty & customary law?

2. How does Barcelona Traction look in terms of determining nationality for entities, and why do capital importing & exporting states differ on this?

3. What are the collateral effects of asserting such protection strategies on state/private level?