Promise and Pitfalls of the WTO and FTAs: Investment and Trade in Services

I am pleased to exchange some thoughts with you on the subject of the apparent difficulties we are having in placing the issue of investment on the multilateral trade agenda. I would like to investigate the sources of these difficulties and draw some lessons from the recent failure in the Doha Round to include investment as one of the issues to be negotiated, and to suggest ways of keeping this issue alive in fora other than the World Trade Organization (WTO). Japan is pursuing a large number of free trade agreements - bilateral and regional preferential trade agreements, having joined the regional bandwagon later than its other Quad partners.

The question is: How can we embrace regionalism in a manner that is forward-looking and that prepares groundwork for future rule-making on investment? There is a very nice process of interaction between bilateral, regional and multilateral agreements, and we have to think about how to make bilateral and regional investment disciplines building blocks toward subsequent multilateral disciplines. But I will also talk about services because it is another issue on the negotiating agenda. In the Doha Round, we will discuss investment in services, which is a very large share of world foreign direct investment (FDI). So I will say a few words about the services negotiations under the GATS, and then perhaps try to draw some lessons from my own experience as a North American Free Trade Agreement (NAFTA) negotiator for Canada, looking back on 10 years of implementation of NAFTA in services, and to give you some ideas about what regional agreements in services can and cannot do.

A discussion of services is important for Japan because service sector reform remains a challenge in your country. Japan has the lowest share of services as a percentage of gross domestic product (GDP) of any Organisation for Economic Co-operation and Development (OECD) member-country. It is still an economy where manufacturing accounts for a very large share of domestic product given the country's income level. So service sector reforms are going to have consequences for employment, productivity and incomes that you have to pay attention to. So I would like to put services in the context of some of Japan's challenges.

The first issue we must ask about investment is why we need a multilateral agreement at all. We have an extraordinarily sophisticated system of multilateral disciplines on trade, which has grown in sophistication since the Uruguay Round. Yet we have nothing for investment that is remotely comparable. Over the last 20-25 years, we have seen growth in cross-border investment activity, a move in the direction of more open investment rules, and unilateral liberalization becoming a significant feature of the world economic landscape when it comes to investment. Maybe the reason we do not have a multilateral agreement on investment is that we do not need one. What is happening in the world that may accredit or discredit this notion that we do not have rules because we do not need them?

I have outlined five reasons that may explain why we do not have, and perhaps do not need, a multilateral agreement on investment. The first is that the world, on its own, is moving toward more liberal treatment of foreign investment. Every year, the World Investment Report, published by the United Nations Conference on Trade and Development (UNCTAD), provides a table summarizing the evolution of domestic investment regimes. Since 1986, the direction of change in domestic policy toward foreign investment has been unidirectional toward a more liberal, generous and hospitable treatment of foreign investors: For every restrictive move that countries implement, they implement 9.5 liberal moves, and this trend does not vary much from year to year. Very often we do not have rules because there is no demand for them in the private sector. Partly this is because the world in which businesses operate is a world in which, silently and for the most part autonomously, policy is moving in the right direction.

Second, over the last 15 years, we have seen an explosion in the number of bilateral investment treaties (BITs) from 400 in the early 1990s to almost 2,300 in 2003. BITs focus on the protection of property rights of foreign investors. This change tells us that countries that are recipients of FDI are prepared to reassure foreign investors through international treaties and to send signals that investors' property will not be confiscated without proper compensation. The rise in BITs is good news as it suggests countries are willing to send the signals of an open, predictable investment regime, providing foreign investors with the ultimate right to sue host governments in international courts if the host government behaves in an improper, confiscatory, manner. Together with the first point, this makes policy reversal costly and even if there is reversal there is an insurance policy for foreign investors in the form of a BIT. Along with the rising number of BITs is the increased use of these treaties to enforce property rights infractions. There are a number of public and private arbitral mechanisms that handle investor-state arbitration in such cases.

Third, there has been a steep rise in the number of regional and bilateral FTAs that feature extensive disciplines on investment. The first agreement to do that in a very significant way was NAFTA in 1994. Since then, the number of free trade agreements covering investment in a meaningful, comprehensive way has increased significantly. I do not know of any recent FTA that Japan has concluded that does not feature NAFTA-like disciplines on investment, and that is the trend pretty much everywhere in the Western Hemisphere and increasingly in Asia. Herein lies a troubling paradox: We seem to be able to do bilaterally and regionally what we are incapable of doing multilaterally. Developing countries are prepared to involve themselves in highly asymmetrical bilateral negotiations. Why would developing countries prefer the bilateral and regional asymmetry of power and negotiating capacity and say no in the WTO, where they can build coalitions where they are much more likely to get a more balanced agreement than they would bilaterally?

The fourth point is a statistical element that is troubling. Econometric studies tend to show that BITs do not have much of an effect on FDI activity, which is driven by other factors. Investment in recent decades has gone to many countries that do not have BITs or have not ratified them, such as Brazil. China has only recently begun signing and passing BITs, and everybody knows how much investment China is receiving.

Lastly, the fact that when we negotiate investment in the WTO we are not starting from a blank page complicates and explains what we observe. We are starting from a lot of existing disciplines that already cover investment in many different areas, most importantly in services under the General Agreement on Trade in Services (GATS), but also in other agreements. Any new disciplines in the WTO are going to have to coexist in an intelligent and coherent manner with these rules. To some extent, the failure of the Doha Round on investment rule-making is that Japan, Korea and the European Union (EU) proposed something that tended to skirt this coherence argument. When you do that and take too many shortcuts in policy- and rule-making, you pay a big price in terms of value added. Not surprisingly, when presented with a proposal in a sensitive area that offered little value-added - in effect a multilateral agreement on investment in non-services, there were few takers among WTO Members.

There are two important additional facts to consider: first, two-thirds of FDI today - and this is not a new phenomenon - is in services, yet the discussions we were having in Geneva were about the scope for a multilateral agreement on investment in non-services. Proponents of an investment agreement did not want to deal with GATS and reopen the existing WTO agreements relating to investment. A multilateral agreement on less than a third of world FDI is already a weak argument in favor of a multilateral regime. Second is the question of where the barriers are. Some empirical work I have done recently with UNCTAD shows that some 85% of investment restrictions signaled in international investment agreements are in services. What this means is 85% of the potential theater of investment regime liberalization is already covered by GATS. So the Doha Round in effect covered less than a third of world FDI activity and less than 15% of investment barriers. These facts did not come up very significantly in the Doha Round negotiations, so it is not even on those grounds that the proposed negotiations failed to garner support. But if people had exchanged views on this, if they had looked at it in this way, they would have likely said, "There is not a lot meat on the table." As I will argue later, of the 15% of barriers that a Multilateral Framework on Investment (MFI) in non-services could address, there are many barriers that are either already addressed by other multilateral agreements, or of a nature that governments are not interested in tackling and were off the agenda in Doha in any event.

Another important aspect of this story is the nature of the proponents of a WTO investment regime and what can be inferred from their positions? Who were the main proponents of a multilateral agreement on investment in the WTO? Japan, Korea, Chinese Taipei, the EU, and Switzerland. The countries in favor of investment - the "anything-but-agriculture coalition" - share one thing in common: an aversion to agricultural trade liberalization. I will not deny the interest that Japan has as a major capital exporting country in securing access for its investments and making the investment climate more predictable where it invests. But negotiations also follow tactical interests and it is impossible for these countries to deny that there was an element of tactical bargaining in the way the Singapore Issues - of which investment was one - were linked, bundled and played against agriculture. In Cancun, some countries simply refused to unbundle those four issues and their position was inflexible on the issue of agricultural liberalization. To some extent, the investment negotiations in the Doha Round were a victim of the perception that countries were advancing the issue of investment as a bargaining chip for the final tradeoffs, especially for the difficult commitments that would need to be made in agriculture. The behavior of the EU and Korea in Cancun - not so much Japan - lent credence to this perception.

Finally, it was not just tactical considerations but the motivation, as in the EU, to have bureaucratic authority over investment. There was a bureaucratic rent-seeking argument for pursuing negotiations in new areas so that the European Commission could build and extend its bureaucratic competence over member states.

However, the "who" also extends to the private sector. Apart from Keidanren, there was not a lot of cheerleading for investment rules: U.S. lobbies were against it, and Canadian and European businesses were broadly indifferent. But non-governmental organizations (NGOs) were very agitated by the (erroneous) idea that investment goes to countries that have weak environmental standards and exploit labor. (Of course such a view is a caricature: 85% of investment goes from one rich country to another.) In any case, the NGOs have been generally opposed to multilateral agreements on investment since they successfully fought to undermine the OECD attempt to negotiate a multilateral agreement on investment in the late 1990s. They have also been negative about the impact of NAFTA on investment because of investor-state arbitration. So there is a lack demand from private-sector or NGO constituencies, and the agenda has very little value added.

The key elements of failure are thus in place. One additional reason is that the Doha Round is a big undertaking, with many cross-sectoral considerations, and there are issues for developing countries that are simply more important than investment. A great many developing countries continue to feel strongly that the Uruguay Round was very unfair to them; and there is lingering frustration that negotiations respond primarily to the demands of rich countries. Moreover, countries today wish to preserve some policy flexibility. The rigid bundling of the Singapore Issues was deemed suspicious by many developing countries and was clearly a problem. Also, memories and the policy legacy of the failure of the Multilateral Agreement on Investment (MAI) in the OECD are still fresh in many people's minds. There are still some lingering concerns about an issue that is complex, reaches deeply behind borders, and is often seen as a possible menace to domestic regulatory autonomy. Finally, the proposed negotiating package simply did not add a lot of value over what we already had, and embedding investment rules in the WTO would require more effort than its proponents were prepared to make. They basically avoided the difficult work because they were in a hurry to get an agreement to negotiate, primarily for tactical rather than substantive reasons.

So what can be done by way of multilateral investment rules? Investment rule-making has basically four components that we have to think about if we are considering a multilateral agreement on investment. First is the matter of investment protection. My conclusion is that bilateral solutions will remain prevalent because rich countries want to negotiate from a position of strength and can extract more concessions than capital-importing countries can. Moreover, the scope for embedding investor-state arbitration, without which BITs lose much of their attractiveness for foreign investors, is not feasible in a WTO setting. The second issue is investment liberalization. To eliminate obstacles to investment you need to focus energy on making GATS a more compelling instrument, as it covers an area where 85% of impediments are found. Indeed, very few countries hamper inward FDI in manufacturing, as foreign investors often receive better than national treatment. Investment liberalization in sectors other than services is less challenging because in manufacturing what we encounter are not so much barriers to entry but measures that distort investment decisions. If investment liberalization is primarily about services; investment distortions - which comprise performance requirements, investment incentives, and a host of investment-related trade measures (such as tariff peaks, tariff escalation, preferential rules of origin in FTAs, anti-dumping regimes) are very much about manufacturing FDI. The investment distortion agenda is either already addressed (under the TRIMs Agreement for performance requirements); not likely to be addressed (in the case of investment incentives); or possibly addressed in various non-investment dimensions of the Doha Round (in negotiations on rules, market access or WTO disciplines governing regional trade agreements). There is a lot the Doha Round can do in addressing investment distortions without establishing a multilateral agreement on investment.

There is, finally, a good-governance agenda in investment rule-making, covering issues such as transparency, corruption, corporate social responsibility, best practices in investment promotion, and home country measures. All these issues are germane to how you extract benefits from foreign direct investment. However, none of them, in my view, need to (or can readily) be pursued in the WTO. If we keep asking the WTO to do more and more things that lie outside its sphere of competence, and where compliance with such objectives is not best secured through traditional reliance on instruments of trade disputes and retaliation, we risk undermining the very capacity of the multilateral trading system to discharge its core duties. So we need a cosmopolitan, multi-institution, multi-policy approach combining hard law with soft law; combining elements of bilateralism with elements of multilateralism; and above all distinguishing development from trade or investment policy, as the former simply beats to a different drum and takes place over a different (and longer) time horizon.

A multilateral bargain on investment, in my view, is still possible. To be feasible, such a bargain would need to address developing-country objectives. If we wanted to have a coherent, value-adding, multilateral set of disciplines on investment, how could we do it? We can do it if we are prepared to reconsider the existing architecture of the WTO and to propose an agreement that would basically do three things. First, create a multilateral platform for investment that is generic in scope and does not distinguish between goods and services and intellectual property. Second, next to a multilateral agreement on investment, we should aim to establish an equivalent multilateral agreement on the movement of people. The movement of people - with aging societies and worsening demographics in the OECD area - is going to gain greater policy prominence in the years to come. Let us think about shifting to Geneva in the future, the best practices being considered in FTAs. Japan should try to do something innovative and useful on the mobility of people in its FTAs, starting with its current discussions with Thailand and the Philippines.

The third element of this mosaic would be a GATS revamped to deal with cross-border trade in services only. In other words, the services agreement would no longer deal with the movement of capital and people, but would address the regulatory challenge of cross-border trade in services and would cover issues like impediments to business-process outsourcing and the convergence of regulations required to facilitate e-commerce and cross-border service transactions. There is a lot OECD countries can do to reassure developing countries that we are not going to raise barriers to outsourcing. It is economically efficient for multinationals to outsource part of their back-office and other more sophisticated operations to developing countries. Such a revamped WTO architecture requires some retooling. We have to reopen some agreements; that is messy, and is likely to be resisted by bureaucracies (notably by services officials), but it can be done.

I gave a talk in Paris two weeks ago on what has been achieved after 10 years of NAFTA. My response, in services, was "almost nothing." NAFTA was a great success on tariff liberalization, of shallow integration, but it has achieved far less behind the border. And the NAFTA is hardly alone in this respect. So we should not expect too much from FTAs on services if we are not really prepared to liberalize, which was the case for the NAFTA partners for the most part. We were prepared only to consolidate the status quo. In 10 years that dynamic has not changed much despite the fact that our countries are highly integrated. Still, when it comes to services, there is a fragmented North American landscape. The challenge of service liberalization remains daunting regardless of the negotiating setting. There are indeed sectors - such as air transport, maritime transport, education, health, audio-visual services - that seem more or less immune to liberalization whether you negotiate them regionally or multilaterally. So do not expect miracles if there is not a strong commitment to reform domestically.

Japan is in a unique situation. Because of Japan's structural weakness in services, liberalization could be painful in employment terms, even if it is useful in economy-wide efficiency terms. So the challenge you must face is to determine where you are going to get the biggest results for making liberalization commitments that you know are going to be painful. I think, for Japan, it must be in the WTO because service sector liberalization is about domestic reforms. If your point of view is to say we must tackle the structural rigidities that make the service economy in Japan slightly inefficient, then the WTO is the proper place to consider concessions. FTAs can address your export interests for the most part, but they will not do much because you are going to be integrating with countries that are relatively inefficient in the provision of services. Their ability to put pressure on your producers is limited. Services negotiations are a wonderful means of promoting coherence in domestic coordination. Japan has a somewhat bizarre bureaucratic culture. If you want to negotiate services effectively, there is going to have to be some overriding force that looks at service sector reform from an efficiency perspective and not from the selfish, narrow perspective of sectoral ministries and their industry clients. Japan has often relied on international negotiations to help get the job done domestically. I think those pressures are going to be more useful in the WTO to you as reformers than they would be in the context of FTAs with developing countries.

That said, FTAs can allow creative things to be pursued on investment, labor mobility and cross-border trade in services. There is scope in FTAs to address these issues in a way that sets the direction of future multilateral disciplines. Countries like Japan, which are interested in keeping investment alive multilaterally, need to make special use of that space to do something good for development that gives tangible benefits to its trading partners and helps you reach your final destination of putting in place rules in an area that matters to you.

Q: I am interested in what you said about GATS. Although you say that the WTO is better for negotiations on liberalization, I am skeptical about what you can get from the developing countries, and I believe that bilateral FTAs will be more successful. Also, NAFTA was concluded before GATS Article 5, and so is not bound by its restrictions, as compared to agreements now. Could you please comment?

A: You may be right that future agreements bilaterally will give you more. Japan is a powerful country bilaterally - more so than in the WTO. Japan is not always the most effective player in the WTO given the size of its economy and the importance of its trading interests. But you are right. Bilateral negotiations give you more, and therein lies the paradox: Developing countries, in saying no to multilateral agreements, are shooting themselves in the foot.

As for Article 5, which is the multilateral discipline that governs regional agreements on services, it is an extraordinarily weak discipline. You can almost violate Article 5 at will. For example, the U.S. signed an FTA with the countries of Central America - CAFTA, that features no chapter on labor mobility. Under Article 5 you are not allowed to exclude a mode of supply, but the U.S. is likely to get away with this. This is one concrete illustration of the asymmetries that developing countries encounter when they negotiate bilaterally. I think we have to do a better job of offering developing countries incentives to come back to the table. And if we are prepared to do something about Mode 4, instead of treating it as a footnote of GATS, then we may be able to make progress.

Q: Can you say a bit more about the differences between positive versus negative list approaches to liberalization?

A: The GATS is a very development-friendly agreement. Experience teaches me that you can achieve the same liberalization outcome using a positive or negative list approach, but a negative list approach allows you to secure that objective in a much more transparent manner by listing all non-conforming measures. We took that decision in NAFTA on grounds of transparency. My view is that a negative list approach is preferable on governance grounds and that the process of disclosure is very cleansing domestically. But it has the drawback that all future measures, including sectors that are not known today, are automatically bound and you give up the right to introduce future discriminatory measures. This problem can also arise under GATS when commitments are open-ended. For example, the U.S. just lost a WTO dispute to Antigua and Barbuda in a ruling over online gambling. The problem arose largely because e-commerce as a reality did not exist in 1994 when the U.S. undertook full commitments on entertainment services. Governments today are generally more concerned about the regulatory implications of making such sweeping commitments than was the case when NAFTA was being negotiated and the Uruguay Round concluded. For the above reasons, I think it is unlikely that reliance on negative listing will ever be contemplated at the WTO level, and countries should perhaps be more careful in how they approach the matter in their FTAs.

Q: I think your idea of having a multilateral agreement on capital and labor mobility is interesting. Having said that, when you look at the U.S. position, they are relatively happy with the GATS. What would be the best way to bring the U.S. back into such an agreement, which may jeopardize the achievements of the GATS?

A: I wish I had an answer. The U.S. position has generally not been very helpful. They consider multilateral disciplines on investment to be value-subtracting from the high standard of rules and commitments they extract from bilateral agreements with developing countries. The U.S. treatment of labor mobility issues in its recent FTAs is troubling and I think WTO Members should consider challenging the WTO-consistency of such rules. But Japan and Thailand recently agreed to drop rice from their FTA negotiations in agriculture, so who are you to give lessons to the U.S.?

Q: Developing countries are very keen on Mode 4 issues. It is a very delicate issue for developed countries and I was wondering how the developed countries will satisfy the request from developing countries in this area?

A: We (developed countries) can give a lot of things that are meaningful from a development perspective. First, in all our countries, we maintain economics needs tests that are extraordinarily opaque in terms of eligibility criteria. They give regulators excessive discretion in limiting the movement of people. We need to exercise discipline in this area.

Secondly, we need to broaden the professional and skill categories eligible for contract-based temporary entry privileges. At the same time, it is important to realize that there are some issues that cannot easily be liberalized in a bilateral setting. So we need the WTO for some hard issues and Mode 4 is one of those issues. Canada has come up with an approach that tries to address skill categories of interested developing countries. It is very difficult in the WTO to deal with unskilled labor because that can have disruptive effects on host country labor markets and encourage illegal migration. So you can focus on specific skill categories where your partners from developing countries have genuine capacity to add value and tailor specific programs of temporary entry for those categories. Labor mobility restrictions can nullify the value of the market access, for example in construction services.

Finally, I think we need to focus on a fifth category of potential winners from Mode 4 trade. Labor mobility provisions in trade agreements typically deal with four types of people: professionals who have a university degree, intra-corporate transferees, traders and investors who come across the border to establish a corporation, and business visitors. Trade agreements have covered those categories, but within each of those categories you can do better. The fifth category is what I call non-professional essential personnel - non-professional people who are essential for the provision of a service. So you need to look at specific sectors where you have the possibility of liberalizing your market access regime for those categories. I am not advocating full market opening in all skill categories. Still, we must come up with incentives and negotiating structures that provide developing countries with more of a sense that they are making gains under these agreements. If we negotiate bilaterally in a selfish way, or if we say no to anything that has meaning in for development Geneva, then we should just forget about the WTO. There is also the risk that the private sector will lose interest if we do not pursue meaningful commercial matters in real time. The DDA will succeed if there is a political will to craft an agenda that is balanced, thereby putting behind us some of the so-called development deficit of the Uruguay Round.