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Retention and Expansion of Foreign Direct Investment Public Disclosure Authorized Public Disclosure Authorized Retention and Expansion of Foreign Direct Investment Political Risk and Policy Responses Public Disclosure Authorized Public Disclosure Authorized © 2019 The World Bank Group 1818 H Street NW Washington, DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved. This volume is a product of the staff of the World Bank Group. The World Bank Group refers to the member institutions of the World Bank Group: The World Bank (International Bank for Reconstruction and Development); International Finance Corporation (IFC); and Multilateral Investment Guarantee Agency (MIGA), which are separate and distinct legal entities each organized under its respective Articles of Agreement. We encourage use for educational and non-commercial purposes. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Directors or Executive Directors of the respective institutions of the World Bank Group or the governments they represent. The World Bank Group does not guarantee the accuracy of the data included in this work. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The World Bank encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. All queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: [email protected]. Cover Photo: Shutterstock.com TABLE OF CONTENTS ACKNOWLEDGEMENTS V ABBREVIATIONS AND ACRONYMS VII EXECUTIVE SUMMARY IX PART I – BEYOND INVESTMENT ATTRACTION: IMPACT OF GOVERNMENT BEHAVIOR ON FDI RETENTION AND EXPANSION XVI INTRODUCTION 1 THE IMPORTANCE OF FDI RETENTION AND EXPANSION 4 Main Considerations for FDI Retention and Expansion 4 Investment Retention 5 Investment Expansion 7 Definition of Political Risk and Historical Overview 10 Political Risk and FDI Retention and Expansion 12 INVESTOR SURVEYS ON POLITICAL RISKS AND THEIR IMPACT 19 Influence of Political Risks Arising from Government Conduct 19 Types of Government Conduct Causing FDI Withdrawal or Cancellation 23 Mechanisms to Deal with Grievances 27 EMPIRICAL EVIDENCE ON ISDS 29 Types of Government Conduct 30 Sectors 31 Patterns of Investors’ Reactions 32 CONCLUSIONS AND POLICY IMPLICATIONS 35 TABLE OF CONTENTS I PART II – PROOF OF CONCEPT: FOSTERING RETENTION AND EXPANSION OF FDI BY ENABLING GOVERNMENTS TO ADDRESS INVESTOR-STATE GRIEVANCES 38 INTRODUCTION 39 SYSTEMIC INVESTMENT RESPONSE MECHANISM 41 Concept 41 Key Elements 43 Operation 44 SIRM PILOT PROJECTS 46 Selection of Pilots 46 Project Components 47 Initial Diagnostics 47 Country-Specific Customization 48 Lead Agency 49 Tracking and Monitoring Tools 51 Filtering and Assessment of Grievances 51 Interagency Problem-Solving 53 Political Decision Making 55 Validation and Capacity Building 55 Monitoring and Evaluation 55 PILOT FINDINGS 57 Key Findings 57 Lessons from Experience 60 CONCLUSION 67 ANNEXES A. MIGA-EIU SURVEY METHODOLOGIES 69 B. REGULATORY RISK AND FDI 71 C. GLOBAL GOOD PRACTICE IN THE REPUBLIC OF KOREA 73 ENDNOTES 76 BIBLIOGRAPHY 79 II RETENTION AND EXPANSION OF FOREIGN DIRECT INVESTMENT LIST OF BOXES 1. Typology of Foreign Direct Investment 3 2. Typology of Political Risk 12 3. Evolution of Political Risk 13 4. SIRM Pilots: Preliminary Estimates of Investment Retained and Expanded 57 5. Sudden/Arbitrary Regulatory Changes 59 LIST OF FIGURES 1. FDI Inflows and Regulatory Risk 6 2. Worldwide Reinvested Earnings: Total 8 3. Worldwide Reinvested Earnings: Share of FDI Inflows 8 4. Reinvested Earnings and GDP Growth 9 5. Reinvested Earnings and Level of Development 10 6. Average Share of Fixed Assets Financed by Internal Funds or Retained Earnings by FDI Firms in Developing Countries 11 7. More Than a Third of Investors Reinvest All Their Affiliate-Generated Profits Back into the Affiliate 11 8. Correlation between Balance of Payments Reinvestment as a Share of GDP and Different Measures of Risk 16 9. Capital Expenditure of U.S. Foreign Affiliates and Country Risk 17 10. R&D Expenditure, Employment Growth, and Country Risk 18 11. Investors Prospects: Ranking the Most Important Constraints to FDI in Developing Economies, 2009–13 20 12. Factors Affecting Investment Decisions 20 13. Investors’ Perceptions: Types of Prospective Political Risks of Most Concern to Investors in Developing Countries, 2009–13 21 14. Importance of Investment Climate Factors Affecting Investment Decisions 22 15. Importance of Investment Climate Factors by Developed versus Developing Source Economies 23 16. Proportion of Companies That Have Withdrawn and/or Canceled Expansion of FDI Projects Due to Specific Types of Regulatory Risk, 2010–13 24 17. Most Frequent Political Risks Derived from Government Conduct Affecting FDI 25 18. Impact of Political Risks Derived from Government Conduct on FDI 25 19. Withdrawal of Existing Investments or Cancelation of Planned Investments over the Past Twelve Months Due to Political Risks (% of Respondents) 26 20. Mechanisms Used by Investors to Mitigate Political Risk in Emerging Markets, 2009 27 21. Mechanisms Used by Investors to Mitigate Political Risk in Emerging Markets, 2013 28 22. Investors’ Perceptions of Existing Mechanisms to Address Grievances 28 23. Breaches Most Frequently Alleged and Found in Treaty-Based ISDS Cases, 1987–2017 30 TABLE OF CONTENTS III 24. ICSID Cases, by Economic Sector, 1987–2017 31 25. Treaty-Based ISDS Cases: Respondents Classified by Income Level, 1987–2017 34 26. SIRM within the Investor-State Conflict Continuum 42 27. SIRM Diagnostic Phase 49 28. SIRM Tracking Tool 52 B.1. Countries with higher regulatory risk tend to have higher expropriation risk premium 72 B.2. Marginal effect of country regulatory risk 72 C.1. History of the Office of the Foreign Investment Ombudsman 73 C.2. Activities of the Office of the Foreign Investment Ombudsman 74 C.3. Investment Grievance Cases, by Type 75 LIST OF TABLES 1. Types of Factors Inducing Discontinuation of FDI Projects 5 2. Government Conduct Comparison 30 3. SIRM Pilots 47 4. Types of SIRM Lead Agencies 50 5. SIRM Capacity-Building Activities 56 6. Preliminary Data from the SIRM Pilots 58 7. Main Challenges in Selected SIRM Pilots 60 C.1. Grievance Resolution Performance 75 IV RETENTION AND EXPANSION OF FOREIGN DIRECT INVESTMENT ACKNOWLEDGEMENTS The research and writing of this report was led by Trang Thu Tran. The authors are very grateful to Roberto Echandi and finalized by Ivan Anton Nimac the internal and external reviewers who provided and Dongwook Chun. The report’s preparation thoughtful insights and guidance, including Jennifer was supervised by Christine Zhenwei Qiang and Tobin, Michele Ruta, and Pierre Sauve. The team supported by Priyanka Kher, Maximilian Philip would like to thank Carlo Pettinato and Anca Radu Eltgen, and Julia Alexandra Craig Muir. of the European Commission for the support and technical advice. The team would like to thank to colleagues of Investment Policy and Promotion team for pilot A special thank you goes to Sandra Lynne Gain for implementation and data collection, including editing, Lidia Panarello for editorial assistance, and Daniela Gomez Altamirano, Eloise Obadia, Aichin Jones and Amy Quach for providing design, Harald Jedlicka, Laura Dachner, Lina Sawaqed, layout, and production services. Philippe Armand De Bonneval, Ramprakash Sethuramasubbu, and Xavier Forneris. The team are The team acknowledges the many formal and also grateful to WBG colleagues in the regional team informal contributions of individuals, groups, and for overseeing pilot projects, including Alejandro organizations that provided meaningful comments Espinosa-Wang, Ekaterine Avaliani, Fantu Farris, and inputs to enable the successful publication of Hamidou Sorgo, Hilina Getachew, Lien Anh this report. Keeping in mind these contributions, Pham, Jigjidmaa Dugeree, Mendsaikhan Ganbat, the team apologizes if it has inadvertently omitted Mohamed Abdulkader, Narantuya Jambalsuren, formally acknowledging any such valuable Olivia Zank, Sabina Dervisefendic, and Tarik contributions. Sahovic. The team is also grateful for the valuable research from Applied Research Team, including This report has been produced with the support of Peter Kusek, Daniel Reyes, Sarah Hebous, and the European Commission. ACKNOWLEDGEMENTS V ACRONYMS AND ABBREVIATIONS BEA Bureau of Economic Analysis BOO Business Ombudsman’s Office BOP Balance of Payments CI Confidence Interval EIU Economist Intelligence Unit FDI Foreign Direct Investment FE Fixed Effects FET Fair and Equitable Treatment GDP Gross Domestic Product GDPPC Gross Domestic Product Per Capita GIC Global Investment Competitiveness ICRG International Country Risk Guide ICSID International Centre for Settlement of Investment Disputes ICT Information and Communication Technology IGM Investment Grievance Management IIA International Investment Agreement IIP International Investment Position IMF International Monetary Fund IPA Investment Promotion Agency IPP Investment Policy and Promotion ISDS Investor-state Dispute Settlement MIGA Multilateral Investment Guarantee Agency MNE Multinational Enterprise OECD Organisation for Economic Co-operation and Development OFIO Foreign Investment Ombudsman Office (Republic of Korea)
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