Trade Policy and WTO Accession for Economic Development:
Application to Russia and the CIS
Module 15
TRIMS and investment climate
by
Giorgio Barba Navaretti and Angelica Salvi del Pero
First draft, April 19, 2004
Table of Contents
1. Trade Liberalisation and FDI Flows _________________________________________ 4
2. Measures Regulating Foreign Owned Activities and their Effects on Trade __________ 5
3. The WTO Trade Related Investment Measures (TRIMs) Agreement ________________ 7
4. Welfare Effects of TRIMs in the Host Country _________________________________ 8
5. International Policy Coordination on FDI: Why Needed? _______________________ 10
6. Russia’s investment climate: FDI flows and compliance to TRIMs (Summary of Harry G.
Broadman’s et al. work) ____________________________________________________ 13
Appendix 1. Features of the TRIMs Agreement _________________________________ 20
Appendix 2. Other Investment Agreements _____________________________________ 22
References _______________________________________________________________ 23
1
This chapter examines the links between foreign direct investments (FDI) and trade and how
this link may be affected by trade policies and by measures regulating the activities of foreign
firms. It addresses the following questions.

Does trade liberalization affect inflows of Foreign Direct Investment (FDI)?

Do measures regulating the activities of foreign owned firms (TRIMs) hinder
trade?

What is the TRIMs agreement within the WTO?

Can TRIMs be justified for domestic welfare reasons?

Is there scope for international policy coordination on measures and
regulations concerning foreign direct investment beyond the domain of the
TRIMs agreement?

What is the investment climate in Russia?
It derives the following main lessons.
Lesson 1. Trade liberalization favours FDI flows. The liberalization of trade flows and the
adoption of a stable trade policy environment through entry into the WTO is expected to have
a positive effect on FDI flows. The activities of most multinational enterprises (MNEs)
involve an increasing degree of geographical fragmentation of production, particularly when
investments are carried out in countries with relatively cheap labour. Investments of this type
have become overwhelming in the Nineties. They generate trade flows and are severely
hindered by high trade costs. Therefore, trade liberalization is a likely preconditions for
increasing investment flows into Russia.
Lesson 2. TRIMs may likely hinder trade flows. On the other flip of the coin, policies
regulating FDI, particularly requirements imposed on investors by host countries seeking to
protect and foster domestic industries or to redistribute profits generated by foreign investors
towards domestic residents, hinder both FDI and potential trade flows. Measures with
particular perverse effects on trade are defined Trade Related Investment Measures (TRIMs)
and are explicitly regulated by the WTO under the TRIM agreement.
2
Lesson 3. TRIMs are rarely welfare improving. TRIMs introduce distortions in the domestic
economy and often impede an efficient allocation of resources. They are also rarely effective
as ‘second best’ instruments to correct existing distortions.
Lesson 4. There is much scope for international rules on TRIMs.
The inclusion of TRIMs
within WTO prevents countries from raising indirect trade barriers in conflict with the process
of global trade liberalization negotiated under the WTO. Furthermore, it creates a
commitment to avoid bad outcomes of domestic policy games and it favours the international
harmonisation of rules so as to increase transparency and reduce transaction costs.
Lesson 5. A multilateral agreement on FDI extending beyond the scope of the TRIMs
agreement has proven extremely difficult to negotiate. Particularly developing countries have
resisted even starting the negotiations for an agreement on FDI, as they fear such an
agreement would reduce their margin of maneuver in dealing with foreign investors. Such an
agreement should probably be negotiated outside the WTO negotiating process
NOTE, LESSONS ON RUSSIA’S INVESTMENT CLIMATE STRICTLY DERIVED
FROM BROADMAN’S VARIOUS PAPER (DATING 2000 AND 2001)
Lesson 6. Since the start of transition Russia has attracted a limited amount of FDI. Although
FDI inflows have been growing since the early Nineties, they are still of a limited amount, if
compared to other developing economies and transition countries. They are also small with
respect to the size of the Russian economy. Russia has the lowest ratio of FDI inflows on
GDP of all the European transition countries
Lesson 7: FDI in Russia are mostly concentrated in few urban areas. FDI in Russia are
mostly concentrated in the urban areas of Moscow and St. Petersburg. This allocation is
partly explained by the size of the local market and by standard agglomeration effects, but
also by differences in regional regulations and institutions
Lesson 8 The overall policy and regulatory framework is not conducive for FDI. The policy
mix towards FDI includes both restrictions and preferential treatments, contributing to an
often contradictory investment climate. At the general level, although the macroeconomic
framework has now been stabilized since the late Nineties, the overall policy environment is
characterized by overlapping and confusing legislation with large margins of discretion and
3
no efficient dispute settlement mechanism. Red tape and relatively high trade barriers are all
discouraging factors for foreign investors.
Lesson 9 Several measures are in conflict with TRIMs. There are several instances of policy in
conflict with TRIMs, particularly ‘local content’ and supply to local market requirements. As
Russia has requested to accede the WTO as a developed country, these inconsistencies will
have to be phased out in two years following accession.
1. Trade Liberalisation and FDI Flows


Key question: Does trade liberalization enhance inflows of FDI?
Lesson 1 : Trade liberalisation can have a favourable effect on FDI flows
An important share of FDI occurs to take advantage of local cost conditions or local expertise.
In this case production is fragmented and different parts of the production process take place
in different countries. The profitability of fragmentation requires that relative factor prices
differ significantly between regions, and that trade, transaction and monitoring costs of
shipping parts and components between locations are not too high. Trade policies play an
important role here. With high trade barriers, international fragmentation would simply not
be profitable, while low trade costs and stable trade relations, on the other hand, typically
encourage networking, in particular if these conditions apply between countries with
significant differences in factor prices.
4
BOX 1: Production fragmentation between the European Union and central Eastern
European Countries
A very good example of how changes in trade and market conditions may give new
opportunities for production networking, is the development between central and eastern
European countries (CEEC) and the EU. With geographical proximity and very significant
differences in relative factor prices, the relationship between CEEC and EU has proven to be
ideal for production fragmentation and networking. While high trade costs and lack of a
long-term commitment to stable market conditions in CEEC previously prevented such
investment, the development towards market economies with a strong commitment to market
integration with the EU has opened up new opportunities. And there are also clear
indications that such networking has indeed grown over the 1990s. Kaminski and NG
(2001), for example, show that the importance of what they label “production fragmentation
exports” (exports of parts and components) from CEEC to the EU increased significantly for
most countries between 1993 and 1998 – for several countries the share of such trade more
than doubled.
Source: Barba Navaretti, Venables et al., 2004
Also when FDI aim at entering the market of the host country, rather than at saving on factor
costs, trade barriers may play a discouraging role. In principle, if the host market is protected
by high trade barriers, it could be more profitable to supply it through local production, by
setting up a foreign subsidiary, rather than through export. However, this ‘trade cost jumping’
motive is often ineffective. In fact, firms generally do not transfer the whole production
process, but just part of it, those stages closer to the final market. The consequent cost of
importing necessary components is raised by trade barriers, offsetting the benefit of higher
prices for the final product.
2. Measures Regulating Foreign Owned Activities and their Effects on
Trade

Key Question: do measures regulating the activities of foreign firms hinder trade
flows?

Lesson 2: Many measures regulating the activities of foreign firms in the host country
hinder trade flows
Several countries adopt measures regulating the activities of foreign firms. These measures,
listed in Table 1, limit implicitly or explicitly the firm’s choice concerning inputs and the
output market.
5
Table 1: The most common measures regulating the activities of foreign firms
Measures concerning the choice of inputs
Local content requirements
Some proportion of values added or intermediate inputs has to be
locally sourced
Trade balancing requirements
Imports of one product are linked to export performance so some
other product
Laws of similars
Investors have to use local substitutes for imported inputs if a similar
component is locally manufactured
Limitations on imports
The amount of goods and services that an investor can import for the
production process are limited
Foreign exchange restrictions
Restrict the inflow of foreign exchange attributable to an investor in
order to constrain the amount of imported intermediate goods
Local equity participation
Some proportion of equity must be held locally
Local hiring targets
Specified employment targets have to be met
Expatriate quotas
A maximum number of expatriate staff is specified
National participation in management
Certain staff has to be nationals or a schedule for “indigenization” of
management has to be set
R&D requirements
Investors have to commit to investment in research and development
Technology transfers
Specified foreign technology has to be used locally
Measures concerning output markets
Minimum export requirements
Certain proportion of output have to be exported
Trade balancing requirements
Imports have to be a certain proportion of locally produced exports,
either in terms of volume or in terms of value
Export controls
Certain product may not be exported
Market reserve policy
Some markets are reserved for local production
Product mandating requirements
Some products have to be exported by the hosting country only
Licensing requirements
Investors have to obtain license for production in the host country
Technology transfer
Investors are committed to a specified embodied technology
Source: Greenaway (1992) from Mc Culloch, Winters and Cirera (2002).
Many of these measures limit the ability of foreign firms to interact with the international
market, to import and export. These measures are defined Trade Related Investment Measures
(TRIMs) and they are often equivalent to trade policy measures like tariffs or quotas. Local
content requirements, for example, have a similar effect on production costs than tariffs on
intermediates or quotas. By forcing firms to use domestic components, they raise the domestic
price of these inputs. Trade balancing and foreign exchange balancing requirements, on the
other hand, restrain the amount of intermediates that firms can import and are namely
equivalent to quantitative restrictions (and also to tariffs as long as they raise the home price
of these inputs).
Consequently many TRIMs are in conflict with the GATT disciplines and are regulated by the
WTO, under the TRIMs agreement.
6
3. The WTO Trade Related Investment Measures (TRIMs) Agreement

Key question: what is the TRIM agreement within the WTO and which are its main
features?
TRIMs violate GATT provisions under two articles (Mc Culloch, Winters and Cirera, 2002).
Article III (National Treatment), which requires that domestic and foreign goods are treated
equally within national borders, is violated by measures imposing local content (part or all the
inputs must be purchased in the domestic market) and trade balancing requirements (imported
input cannot be more than a given share of exports). Article XI which prohibits quantitative
restrictions is violated by measures which are considered equivalent to quantitative
restrictions like trade balancing, foreign exchange requirements (restriction on the amount of
foreign exchange foreign investors can keep or buy), domestic sales requirements.
The TRIM agreement covers regulations directly violating articles III and XI1. It includes a
time-table for the abolition of these measures, which varies depending on the type of country
(two years for developed countries, five for developing countries and seven for the least
developed countries); the obligation to report any measure regulating the activities of foreign
firms 90 days before its adoption, to verify its compatibility with WTO rules; the
establishment of a committee to monitor the implementation of the agreement.
The Trade Related Investment Measures (TRIMs) Agreement is one of the WTO multilateral
agreements on trade and goods. Its objectives, as defined in its preamble, are “the expansion
and progressive liberalization of world trade and to facilitate investment across international
frontiers so as to increase the economic growth of all trading partners, particularly developing
country members, while ensuring free competition”. Being based on existing GATT
disciplines on trade in goods, the TRIMs Agreement is not concerned with the regulation of
foreign investment as such. It strictly focuses on the discriminatory treatment of imported and
exported products and it does not cover entry and treatment of foreign investment. Indeed, the
TRIMs agreement does not impose new obligations but it clarifies the pre-existing GATT
1947 obligations.
1
. With the exception of export performance requirements
7
Also, the TRIM agreement does not cover other measures with a potential distortionary effect,
but which do not violate the GATT agreement, like provisions on transfer of technology on
training, on hiring of local labour.
The adoption of a broader investment agreement has been at the heart of WTO negotiations
since the 1996 Singapore Ministerial Conference. At the 2001 Doha Ministerial Conference, it
was recognized “the case for constructing a multilateral framework to secure transparent,
stable and predictable conditions for long-term cross-border investment, particularly facing
foreign direct investment”. However negotiations failed at the following Ministerial
Conference in Cancun 2003, essentially because of the opposition of many large developing
countries to even start negotiation to such an agreement. These countries argue that the
existing bilateral investment treaties already provide adequate legal protection to investors,
and question whether a WTO agreement would indeed increase investment flows. They are
concerned by the possibility that a multilateral agreement would limit their ability to align
investment inflows with national development objectives.
To better understand the scope for an international agreement on rules for foreign investment
and for its extension beyond of TRIMs’domain, it is useful to discuss two further issues. The
first one is the welfare effect of such measures on the economy introducing them. The second
one is the scope for an international agreement on FDI regulations extending beyond the
domain of the TRIMs agreement.
4. Welfare Effects of TRIMs in the Host Country

Key question: what are the effects of TRIMs on the welfare of the countries
introducing them?

Lesson 3. TRIMs rarely improve domestic welfare of the country imposing them,
rather they generally worsen it.
These measures are normally justified on the ground that they alleviate balance of payment
constraints and that they foster the development of domestic activities. Several successful
Asian countries have adopted similar measures and based their development strategy on FDI.
However, they are rarely effective, besides for a combination of very special conditions, not
generally found in developing countries, and anyway they introduce severe ‘distortions’ in the
domestic economy. We examine both issues in turns.
8
As for their effectiveness, the key concern is that these measures discourage FDI, thus the net
stock of FDI available to any given country is lower if TRIMs are in place. Very simply, if
there is a requirement for local content in the use of components, production costs will be
higher. Several firms, those with an expected return from the investment lower than these
higher costs, will then be deterred from investing. Moreover, the deterring effect of TRIMs is
strengthened by a context where several countries compete to attract the same investment.
But, even if they were not deterring foreign investment, these measures are rarely effective in
achieving the stated objectives. The substitution of cheaper imported inputs with more
expensive or lower quality domestic ones makes output less competitive on the export market,
thus it does not alleviate balance of payment requirements. The interaction between foreign
firms and domestic suppliers works only under specific circumstances. In principle, any
foreign investor would choose local suppliers if these were competitive. Indeed, there would
be indeed savings in transport costs and a frequent and thorough interaction between different
stages of production There is evidence in the literature that multinational firms invest in
training local suppliers and that these links generate spillovers and raise the efficiency of local
firms. However, these virtuous links can rarely be induced by policy measures or regulatory
requirements. For example, effective transfers of knowledge and technology only take place
when local firms are sufficiently skilled and technologically advanced to interact with foreign
counterparts. Local content requirements can affect firms’ decision at the margin, i.e. of those
firms nearly indifferent between local and foreign supply, but these accounts for a limited
share of foreign investment.
Let us now discuss the issue of distortions. Economic theory postulates that international
capital flows should be driven by differences in factor returns and move where the return to
capital is the highest. Although an optimal allocation of resources can only be achieved if
there are no market imperfections, under many circumstances TRIMs introduce further
distortions in the domestic economy. As argued, TRIMs have similar effects than trade
barriers, altering the relative price of different types of goods. Moreover, given their
discriminatory nature, they introduce a further distortion than barriers like tariffs or
quantitative restrictions, as they affect only certain types of firms and not others.
Also, TRIMs are generally ineffective as ‘second best’ measures to correct existing
distortions. For example, they could be seen as ways of transferring to locals part of the rents
multinationals derive from operating in scarcely competitive environments, the extreme
9
example being when multinationals are given the exclusive rights to the exploitation of
natural resources. However, most of the time, a better way of reducing distortions is to
directly eliminate those policies or other factors creating such distortions.
As rightly argued by Mc Culloch, Winters and Cirera, the role of TRIMs is often
ambiguous. Indeed most countries compete to attract FDI, by granting foreign firms hefty
benefits and subsidies. TRIMs are then introduced to claim back part of the rents generated by
such incentives. In other words to claim back with one hand what is given with the other.
Thus, perversely TRIMs are not set up to discourage foreign investors, but as compensations
for the large costs countries face to attract them.
The fact that TRIMs emerge in a context of international policy competition provides
a further reason of why they have to be regulated by an international agreement, besides for
their being in breach of the GATT agreement. This is the argument o the coming section.
5. International Policy Coordination on FDI: Why Needed?

Key question. Why should rules on FDI and TRIMs be regulated by an international
agreement?

Lesson 4. The benefits of an international agreement on FDI are i) to avoid
international policy competition; ii) to counteract domestic vested interests favourable
to the adoption of distortionary policies; iii) to increase transparency and transaction
costs; iv) to balance the bargaining position of developing countries vs. advanced
ones.

Lesson 5. However, up to now it has proven extremely difficult to negotiate a
multilateral agreement on FDI extending beyond the scope of the TRIMs agreement
TRIMs is a collateral agreement of GATT. Thus, although it concerns FDI, its aim is
avoiding measures violating GATT’s discipline and the objective of trade liberalisation.
Strictly speaking, its rationale is the same as the one of a global trade agreement. However,
we have seen that many measures on foreign firms are part of a process of international
competition to attract FDI. For this reason it is useful to discuss also the rationale for a
broader international agreement on FDI, that could extend beyond the scope of the TRIMs
agreement.
10
Note that over 2100 bilateral treaties regulating FDI are already in place today (see
appendix 2). Therefore, why coordinating policies at the global level? In general there are
four distinct types of arguments that could call for international policy coordination: 2
i)
avoiding international policy competition and races to the bottom;
ii)
avoiding the perverse effects of vested interests in favour of protection;
iii)
increasing transparency and reducing transaction costs;
iv)
balancing the bargaining position of individual countries
Let us start with the first argument. If policy competition (e.g. subsidies or tax rebates)
reduces or eliminates overall benefits that would otherwise accrue to one of the potential host
countries, then at least some of the countries would be better off if there was a binding
agreement not to use such policies. A policy competition game may lead to a prisoners’
dilemma game, where no country has an incentive to unilaterally leave the race, even if all
countries know that they would be better off with no subsidies or tax preferences. It is
therefore difficult to reach the common best solution in a non cooperative way; there is a need
for international co-operation to ensure efficient outcomes.
The second reason for policy coordination is to tie the hands of governments faced with
domestic lobbies.
For example, barriers to inward FDI could be introduced to protect
domestic producers at the expense of consumers. Hence, an international policy agreement –
limiting the possibilities to protect local producers – could be welfare improving.
Focussing on developing countries, Hoekman and Saggi (1999) also emphasise how
international coordination of investment policies could provide an important signal to
potential investors that the political environment is stable and policy commitments are
credible in the host country. Such issues are of special significance when it comes to
investments. A foreign direct investment is a long-term commitment to engage in economic
activities in a country, and among the key factors in deciding whether or where to invest
2
This discussion is derived from Barba Navaretti, Venables et al., 2004, chapter 10. Also see
Hoekman and Saggi (1999) for a discussion of a number of reasons for policy coordination
11
would be the expectations about future market conditions and political conditions.
International coordination and agreements may be one way of reducing the uncertainty; in
particular for countries with a history of unstable political conditions.
Third, an argument for policy coordination is that it could reduce transaction costs and make
all policies more transparent and coherent. The wide set of national and bilateral policy
regimes that exists today (see below) could in itself be a barrier to investments that would
otherwise be efficient and beneficial for the parties involved. From the MNEs’ point of view,
the question of transaction costs and transparency, and maybe also common rules for
performance requirements (local content, export requirements, technology transfers and so
on) are among the most important potential benefits of a multilateral agreement on
investment.
The final argument looks at the point of view of developing countries. Their bargaining
position would be much stronger within a multilateral agreement like the WTO, than in
bilateral agreements with any advanced country
Although welfare improving, as argued earlier, any attempt to negotiate such an agreement within
and outside the WTO framework has failed up to now. Indeed, a common framework covering
FDI beyond the TRIMs Agreement is unlikely to be accepted and implemented by parties,
like developing and high income countries, with very asymmetric positions in the matter.
Therefore, the attempt to extend the scope of WTO to the regulation of FDI (and the other so
called Singapore issues) is unlikely to succeed. Moreover, and this is a more general point,
enlarging the domain of WTO beyond trade issues runs the risk of slowing down the process
of trade liberalisation itself. Given that issues pertaining to trade are already covered by the
TRIMs agreement, if an all encompassing FDI agreement has to be negotiated, this should
probably be done outside the WTO negotiating framework.
12
6. Russia’s investment climate: FDI flows and compliance to TRIMs
(Summary of Harry G. Broadman’s et al. work)
Lesson 6. Since the start of transition Russia has attracted a limited amount of FDI, much less
than other transition countries, even with respect to the size of the domestic economy
Inflows and outflows of Russian FDI have been growing throughout the Nineties, with peaks
in 1997 and then averaging between 2.5 and 3 billion US$ (Figure 1). Notwithstanding this
rise, these numbers are small. Focus on inflows. Table 1 tells us that Russia in 1999
accounted for just 0.3 percent of world inflows, a much smaller share than other transition
economies like Poland, which accounted for 0.8 percent, and even a small share of the total
CIS and Central and Eastern European countries which totaled 2.8 percent. These numbers
are dismal if compared to China (4.6 percent and even Brazil 3.6 percent).
Figure 1: The Russian inflows and outflows of FDI (billions US $ )
Source: UNCTAD, 2003.
13
Table 1: Global gross inward FDI flows (billions of dollars and percentages) UPDATE TO
2000 ??
World
Developed countries
Developing & transition countries
CEE and CIS (including Russia)
Russia
Hungary
Poland
China
India
Brazil
1985-95
Annual average
182.6
(100%)
129.3
(71%)
50.1
(27%)
3.6
(2.0%)
0.4
(0.2%)
1.1
(0.6%)
0.8
(0.4%)
11.7
(6.4%)
0.5
(0.2%)
1.8
(1%)
1996
1997
1998
377.5
219.8
145.0
15.2
2.5
2.3
4.5
40.2
2.4
10.5
473.1
275.2
178.8
22.1
6.6
2.2
4.9
44.2
3.6
18.7
680.1
480.6
179.5
23.1
2.8
2.0
6.4
43.8
2.6
28.5
1999
865.5
636.4
207.6
24.2
2.9
1.9
7.5
40.4
2.2
31.4
(100%)
(73%)
(24%)
(2.8%)
(0.3%)
(0.2%)
(0.8%)
(4.6%)
(0.25%)
(3.6%)
Source: UNCTAD (2000) From Broadman and Recanatini (2001)
Obviously, shares of FDI inflows mean little if not related to the size of the domestic
economy. Then, the Russian shortfall is even clearer: on a per capita basis, net FDI inflows to
Russia from 1992 to 1999 were US $ 71 million compared to US $ 511 for Poland, 1493 for
the Czech Republic and 1581 for Hungary. If we compute the ratio of FDI stocks on GDP in
2001, Russia ranks last of all Central and Eastern European Transition countries and even of
some other CIS republics like Ukraine and Belarus.
14
Figure 2: Inward FDI stock as a percentage of GDP in Central and Eastern Europe3
Country/region
1995
2001
Estonia
14.4
65.9
Czech republic
14.1
64.3
Moldova, republic of
6.5
45.0
Slovakia
4.4
43.2
Hungary
26.7
38.2
Latvia
12.5
32.4
Lithuania
5.8
28.9
Croatia
2.5
28.4
Bulgaria
3.4
25.0
Poland
6.2
24.0
Macedonia
0.8
23.9
Slovenia
9.4
23.1
Albania
8.3
21.0
Romania
2.3
20.5
Serbia and Montenegro
2.7
20.1
Bosnia and Herzegovina
1.1
15.8
Ukraine
2.5
12.9
Belarus
Russia
0.5
1.6
8.7
6.5
Memorandum:
Central and Eastern Europe
World
5.3
10.3
20.9
22.5
Source: UNCTAD, 2003.
In 2003 there are encouraging signs that FDI are picking up (Unctad, 2003). For example,
British Petroleum has announced a joint venture with a Russian oil company (Tyumen Oil
Company); once completed, this will be the largest FDI project in the Russian Federation
since the break up of the Soviet Union. Also, in the first four months of 2003, 160 new
greenfield projects were announced (see table 3 for a list of the most important ones).
Nevertheless, it may be too early to anticipate a rapid takeoff. As we will see below, FDI
inflows have been small because the overall macro and regulatory environment do not
contribute to creating a conducive investment climate. Whereas some of the country’s macro
3
Ranked on the basis of the magnitude of 2001 Inward FDI stock as a percentage of gross domestic product
15
imbalances have been stabilized in the last few years, severe shortfalls remain in the policy
and regulatory environment governing the activities of firms and foreign investors.
Table 3: Key greenfield FDI projects started in the Russian federation, January-April
2003
Lesson 7: FDI in Russia are mostly concentrated in few urban areas.
FDI in Russia, besides for being small, is mostly concentrated in few areas. According to
Broadman and Recanatini, 2001, roughly 60 percent of FDI flows into the country go to
Moscow and St. Petersburg and their neighbouring areas. Broadman and Recanatini carry out
an econometric study to explain this geographical allocation of FDI. They find that this is
explained by differences in standard factors, like the size of the market, infrastructure, human
capital, but also, and very much so, by differences in the policy and the institutional
environment. Indeed, there is quite large variation in these factors across Russian regions,
particularly in terms of the prices charged by regulated utililties, tax rates, custom clearance,
16
access to financial services etc. But the policy and institutional frameworks are extremely
important in affecting FDI flows at the national level too. We now turn at discussing how.
Lesson 8 The overall policy and regulatory framework is not particularly conducive for FDI
Since the start of reforms in 1992, progress has been made in many areas of the economy.
Yet, the Russian economy is still characterized by scarcely competitive markets. Regional
fragmentation, horizontal and vertical dominance of incumbent firms as well as barriers to
entry by new businesses (domestic and foreign) are still widespread, even compared to other
transition economies.
As for the FDI regime, this is characterized by three (often contradictory) sets of measures:
restrictions limiting the activities of FDI; several instances of preferential treatment; general
features of the business environment that directly affect the activities of foreign firms. The
fact that restrictions are combined with incentives confirms, also for the case of Russia, that
TRIMs often emerge within a framework where countries compete to attract FDI. The
combination of these three factors creates a particularly distorsive investment framework,
more based on exceptions than on general rules. Let us discuss each of them in turns.
Restrictions on FDI. The federal law establishes various activities where foreign ownership is
either prohibited or restricted. These include sectors which are obviously of national interest
and from which foreigners are excluded in most other countries, like defense, but others
where there is not a strong rationale for excluding foreign interests, like infrastructural
projects, alcoholic beverages, specialized investment funds, land research and development
and auditing.
Preferential treatment of FDI. These restrictions are eased by other rules granting a
preferential treatment to foreign investors. These include, import duty exemptions and other
special tax treatments.
General features of the business environment. Other general features of the business
environment directly affect the activities of foreign firms. The first problem is the number of
overlapping regulations and inconsistencies between various laws and normative acts, like
Presidential Decrees, Internal Directives of the Government and Ministries, federal and local
17
procedures. Because of these overlaps and inconsistencies, there is not an efficient dispute
settlement mechanism. The lack of independent and efficient arbitration creates rooms for
discretionary behaviour and it is one of the major constraints to FDI in Russia.
Another general impediment is the amount of Red Tape and bureaucracy faced by foreign
firms. According to Bergsman, Broadman and Drebentsov, 2000 registration procedures are
considered by investors themselves as one of the most cumbersome in the world. An investor
facing government approval needs clearance from at least 5 to 6 ministries.
Finally, the Russian domestic market is still protected by relatively high tariffs and
quantitative restrictions. Whereas this factor might attract some investments strictly focused
on the domestic market, it discourages other investments which are complementary to trade
flows, as they involve the international shipment of components and finished products. This
type of investment has become very frequent in the Nineties and it only takes place in
countries where trade costs are low.
According to Broadman, to achieve a more conducive investment climate, it is necessary ‘to even
out’ the field, abolishing both restrictions and preferential measures towards FDI and move
towards a simplified, rule based regulatory system. Specifically, this implies the following sets of
measures: first, eliminate part of the restrictions affecting foreign investors (some of these will
have to be lifted anyway because of the TRIMs agreement – see below); second, phase out
preferential measures , particularly tax incentives that are costly and not particularly effective and
replace it with a transparent and simple broad based system. Third, correct the major distortions
affecting the general business environment by implementing an efficient dispute resolution
mechanisms; strengthen property rights protection; simplify bureaucratic procedures. Finally,
trade protection should be considerably reduced.
Lesson 9 Several measures are in conflict with TRIMs and needs to be phased out in two
years following accession into the WTO
The TRIMs agreement has a direct impact on the FDI regime. As of May 2000, Russia’s
regime did not impose ‘trade balancing requirements’ nor ‘foreign exchange balancing
requirements’. On the other hand, it did impose local content requirements and ‘supply to
local market requirements’, and is thus non-compliant with the TRIMs agreement.
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In particular, the Federal Law on Production Sharing Agreements (PSA) ‘grants Russian legal
entities (…) a preferential right to participate in the performance operations under the PSA as
contractors, suppliers, carriers or otherwise….The Parties shall stipulate in the agreement that at
least a certain portion of the basic equipment for mineral production and processing…to be
purchased by the investor….shall be manufactured within the Russian Federation’. Even though
the government has notified to the WTO in 1997 that ‘for full implementation of this law, the
adoption of additional normative legal acts is required’, at least three additional TRIMs
Agreement inconsistent measures have been contemplated by the Russian authorities in 1998.
Examples are two production sharing agreements regarding oil field projects (the
Prirazlomnoye and Sakhalin-1 oil field projects) in which the Russian government, in one
case, explicitly named a Russian producer as the main equipment supplier for the project and,
in the other case, imposed a local content requirement.
Also the federal Law ‘On Privatization of the State Property and on Principles of Privatization
of Municipality’s owned property in the Russian Federation’ approved in July 1997 states that
‘while selling privatization objects at a commercial tender, there might be established an
investment condition in a form of a winner’s obligation to carry out prescribed measures for
tariff and non-tariff protectionism of the Russian raw commodities, materials and semiprocessed goods’.
Other breaches can be found in the 1998 Government’s resolution on ‘Additional measures to
attract investment for the development of domestic automobile industry’ and in another
resolution concerning Aeroflot’s purchases of foreign aircrafts. Under such resolutions ‘local
content’ restrictions are pre-requisites for obtaining advantages, like exemptions in import
duties.
Another example of inconsistency with the TRIMs agreement is the case of Sberbank, which
announced a lending policy that granted preferential interest rates on commercial loans to
companies purchasing Russian-made products. Finally other inconsistent resolutions are also
issued from time to time; the most recent examples here were resolutions establishing an
export quota or a temporary export tax on exports of fuel oil.
Russia chose to access the WTO as a developed country; as a consequence, it will have a twoyear transition period to abolish TRIMs inconsistent with the TRIMs agreement
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Appendix 1. Features of the TRIMs Agreement
The TRIMS agreement was inserted as an annex to the GATT at the conclusion of the Uruguay
Round,The text of the Agreement includes nine articles and an annex.
Article 1. It describes the coverage of the TRIMs Agreement, stating that it only applies to
measures affecting trade in goods. Investment measures relating to trade in services are thus not
covered. The text of the agreement does not provide a definition for the term “trade related
investment measure”. Even though an illustrative list is provided in the annex, the lack of a
definition has given place to ambiguity on the issue and there has been considerable disagreement
as to whether or not certain measures are covered by the Agreement.
Article 2. It presents the substantive obligations involved by the TRIMs Agreement. The
Agreement prohibits trade-related investment measures that are inconsistent with the basic
propositions of GATT 1994. Recognizing that certain investment measures can have traderestrictive and distorting effects, it states that no WTO member shall apply measures
prohibited by paragraph 4 of Article III (national treatment) or paragraph 1 of Article XI
(quantitative restrictions). TRIMs forbidden by the agreement include those which are
mandatory or enforceable under domestic law and those which are required in order to obtain
to obtain an advantage, such as subsidies or tax breaks.
The annex to article 2 presents an illustrative list of TRIMs covered by the agreement. TRIMs
listed in the first paragraph are those inconsistent with the national treatment obligation in
Article III:4 of GATT 1994. The first part of this paragraph – paragraph 1(a) – deals with
local content requirements, that is the requirement for an enterprise to purchase or use
products of domestic origin or domestic source. The second part of this paragraph –
paragraph 1(b) – covers trade-balancing, which consists of limiting the purchase or use of
imported products by an enterprise to an amount related to the volume or value of local
products that it exports. Both types of measures violate GATT principles as the use of
imported products is made less favorable than the use of domestic products.
The second paragraph of the appendix deals with TRIMs inconsistent with the prohibition of
quantitative restrictions in Article XI:1 of GATT 1994. Paragraph 2(a) – covers measures by
which the importation of products used by an enterprise in local production is limited in
general terms or to an amount related to the volume or value of local production exported.
Both paragraph 1(b) and this paragraph deal with trade-balancing measures; the difference is
that the former deals with internal measures affecting the use of products after they have been
imported, while the latter deals with border measures affecting the importation of products.
Paragraph 2(b) – covers foreign exchange balancing requirement, whereby a firm's access to
foreign exchange is restricted thus limiting the ability to import. Paragraph 2 (c) covers
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restrictions on the exportation of or sale for export (whether in terms of particular products,
volume, value)4.
Article 3. It provides that all exceptions under GATT 1994 shall apply, as appropriate, to the
provisions of the TRIMs Agreement.
Article 4. It defines the exceptions for developing countries. Developing countries are
permitted to retain TRIMs in violation of GATT Articles III and XI, provided that such
measures meet the conditions of GATT Article XVIII that allows for specific derogations
from the GATT 1994 provisions by virtue of economic development needs.
Article 5. It settles the rules for Notification and it provides for Transitional Arrangements.
Member countries are required to notify the WTO of any existing trade-related investment
measure within 90 days5. Countries maintaining TRIMs were expected to amend their
domestic laws and institutional rules within the appropriate transitional period. The length of
the transitional period is based on a country's level of development. Developed countries are
given 2 years, developing countries 5 years, and least-developed countries 7 years. An
extension of such transition periods is permitted for developing and least-developed countries.
Article 6. It introduces obligations on transparency. Members commit to comply with Article
X of GATT 1994, regarding Notification, Consultation, Dispute Settlement and Surveillance.
Members must notify the Secretariat of the publications in which TRIMs may be found,
including those applied by regional and local governments. Adequate opportunity for
consultation should be granted by members to any request for information raised by any other
member.
Article 7. This article establishes a Committee on Trade-Related Investment Measures
responsible for the monitoring of operations and the implementation of the Agreement’s
commitments. The committee –open to all members– reports annually to the Council for
Trade in Goods and it meets at least twice a year and at the request of any member.
Article 8. In this article, the Agreement establishes that the provisions of Articles XXII and
XXIII of GATT 1994, as elaborated and applied by the Dispute Settlement Understanding,
also apply to consultation and dispute settlement concerning the TRIMs Agreement.
Article 9. According to this article, the operations of the Agreement were scheduled to come up
for review by the Council for Trade in Goods within five years of the date of entry into
force of the Agreement. If appropriate, the Council is to propose amendments to the
Ministerial Conference.
4 Note that other measures relating to exports, such as export incentives and export performance requirements, are
not covered by the TRIMs Agreement.
5
There were 43 notifications by 24 developing countries (19 related to the auto industry and 10 to the agri-food
industry).
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Appendix 2. Other Investment Agreements
Before the TRIMs Agreement came into effect, discipline for measures restricting foreign
investments was provided only by a few international agreements fairly limited in terms of
content and country coverage.
One of such agreements was the Havana Charter for an International Trade Organization,
which contained provisions on the treatment of foreign investment as part of a chapter on
economic development. This Charter was never ratified and only its provisions on commercial
policy were incorporated into the General Agreement on Tariffs and Trade (GATT).
Another agreement was the 1955 Resolution on International Investment for Economic
Development, adopted by the GATT contracting parties that urged WTO members to
conclude bilateral agreements to provide protection and security for foreign investment.
The FIRA Panel was perhaps the most significant development with respect to investment
prior to the Uruguay round. It was a 1984 ruling in a dispute settlement proceeding between
the United States and Canada; it found that certain undertakings pertaining the purchase of
some products from domestic sources were not consistent with the GATT national treatment
obligation. The panel decision in the FIRA case was significant in that it confirmed that
existing obligations under the GATT were applicable to performance requirements imposed
by governments in an investment context in so far as such requirements involved tradedistorting measures.
Presently, matters relating to foreign investment are regulated by a multiplicity of instruments
including:
-
Bilateral Investment Agreements or BITs. This is the main
instrument for regulating foreign direct investments at present.
UNCTAD estimates that over 2100 bilateral treaties are in place
today. Most of these treaties were signed between developed and
developing countries but recently, the number of treaties among
developing countries has been increasing
-
Regional Investment Agreements which exist either as separate
instruments or are incorporated in a broader framework of a
regional preferential trade agreement, such as the EU, NAFTA, and
many other regional groupings.
-
Multilateral Instruments, such as the APEC (non-binding)
Investment Principles, and the Code of Capital Movements or the
Declaration on Investment and the Multilateral Enterprise (OECD).
The WTO agreement includes “limited provisions on certain trade aspects of foreign
investment6”. Two major agreements directly address investment issues:
-
6
the Agreements on Trade-Related Investment Measures (TRIMs)
WTO, “CANCÚN WTO MINISTERIAL 2003: BRIEFING NOTES”, www.wto.org
22
-
the General Agreement on Trade in Services (GATS).
The TRIMs agreement is already discussed above The GATS agreement concerns foreign
investments in the services sector, insofar as they represents a mode of supply of services
through “direct commercial presence” in a member state. GATS imposes transparency and
MFN treatment on all members, subject to derogations (See Module 9).
Three further agreements arguably have indirect effects on investment, although this is not the
primary focus of any of them:
-
the Agreement on Subsidies and Countervailing Measures (ASCM)
(see Module 6)
-
the Agreement on Trade-Related Aspects of Intellectual Property
Rights (TRIPS) (see Module 8)
-
the government Procurement Agreement.
References
Barba Navaretti, G, Venables, A.J. et al., 2004, ‘Multinationals in the World Economy’,
Princeton University Press, forthcoming
Broadman, H. G. and F. Recanatini, 2001 ‘Where Has All the Foreign Investment Gone in
Russia?’ World Bank Policy Research Working Paper 2641
Bergsman, J, Broadman, H.G., Drebentsov, V, 2000, ‘Improving Russia’s Policy on Direct
Foreign Investment’, World Bank, Policy Research Working Paper 2329
Hoekman, B. and K. Saggi (1999), “Multilateral Discipline for Investment-Related Policies?”,
paper presented at the Conference Global Regionalism, Rome.
Mc Culloch, Winters and Cirera, 2002 ‘Trade Liberalisation and Poverty: a Handbook’,
CEPR, London
Unctad, 2003, ‘World Investment Report’
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