MULTINATIONAL CORPORATIONS: BALANCING RIGHTS AND RESPONSIBILITIES


v\:* {behavior:url(#default#VML);}
o\:* {behavior:url(#default#VML);}
w\:* {behavior:url(#default#VML);}
.shape {behavior:url(#default#VML);}


st1\:*{behavior:url(#ieooui) }
<!– /* Style Definitions */ p.MsoNormal, li.MsoNormal, div.MsoNormal {mso-style-parent:””; margin:0cm; margin-bottom:.0001pt; mso-pagination:widow-orphan; font-size:12.0pt; font-family:”Times New Roman”; mso-fareast-font-family:”Times New Roman”;} a:link, span.MsoHyperlink {color:blue; text-decoration:underline; text-underline:single;} a:visited, span.MsoHyperlinkFollowed {color:purple; text-decoration:underline; text-underline:single;} p {mso-margin-top-alt:auto; margin-right:0cm; mso-margin-bottom-alt:auto; margin-left:0cm; mso-pagination:widow-orphan; font-size:12.0pt; font-family:”Times New Roman”; mso-fareast-font-family:”Times New Roman”;} span.googtitle {mso-style-name:goog_title;} span.googdesc {mso-style-name:goog_desc;} @page Section1 {size:612.0pt 792.0pt; margin:72.0pt 90.0pt 72.0pt 90.0pt; mso-header-margin:36.0pt; mso-footer-margin:36.0pt; mso-paper-source:0;} div.Section1 {page:Section1;} –>


/* Style Definitions */
table.MsoNormalTable
{mso-style-name:”Table Normal”;
mso-tstyle-rowband-size:0;
mso-tstyle-colband-size:0;
mso-style-noshow:yes;
mso-style-parent:””;
mso-padding-alt:0cm 5.4pt 0cm 5.4pt;
mso-para-margin:0cm;
mso-para-margin-bottom:.0001pt;
mso-pagination:widow-orphan;
font-size:10.0pt;
font-family:”Times New Roman”;
mso-ansi-language:#0400;
mso-fareast-language:#0400;
mso-bidi-language:#0400;}
By Joseph E. Stiglitz *

THE IMPORTANCE OF CORPORATIONS AND THE PROBLEMS THEY PRESENT

An increasing fraction of commerce within each country is conducted by corporations which are owned and controlled from outside its borders and which often conduct business in dozens of countries. These corporations have brought enormous benefits–indeed, many of the benefits attributed to globalization, such as the closing of the knowledge gap, the gap between developing and developed countries which is even more important than the gap in resources, is due in no small measure to multinational corporations. More important than the capital which corporations bring (1) are the transfer of technology, the training of human resources, and the access to international markets.

In recent years, especially following the collapse of the initiative to create a Multilateral Agreement on Investment (MAI) within the OECD, (2) there has been a proliferation of bilateral investment treaties (BITs) and investment provisions within bilateral free trade agreements. (3,4) (Some countries (such as Indonesia) have even passed laws providing similar investment guarantees, on their own.)

These agreements are purportedly designed to provide greater protection for investors, thereby encouraging cross-border investment. There is, to date, little evidence that they have done so. (5) Part of the reason is that they may in fact curtail development strategies, in ways which are adverse to growth. As the ECLAC (The UN Economic Commission on Latin America and the Caribbean) concluded, “countries often find that they have assumed obligations which, further down the road, will place limitations on their own development program.” (6)

This paper is concerned with a set of more fundamental issues. Even if it could be established that BITs lead to increased investment, and even if that investment could be shown to lead to higher growth, as measured by increased GDP (gross domestic product), (7) it does not mean that societal welfare has been increased, especially once account is taken of resource depletion and environmental degradation. These agreements are designed to impose restraints on what governments can do–or at least to impose a high cost to their undertaking certain actions. Some of the activities which may be constrained may be important for promoting general societal well-being–even if profits of particular firms are affected adversely. It is this possibility which has made these agreements a subject of such concern and debate.

These agreements are, of course, not all identical; what they do is itself a subject of some controversy. Like any agreement, it depends on the interpretations of particular words, and the judicial processes through which these words are given meaning are one of the sources of dissatisfaction with the agreements. Different arbitration panels have interpreted even the same words differently, creating a high level of uncertainty, both among governments and investors, about exactly what these agreements do. (8) This article is focused not on any specific agreement but on the general thrust of these agreements, which goes substantially beyond protection against expropriation.

Many of the agreements–including some of their most controversial aspects–are concerned with the far broader issue of what happens when changes in regulations or other government policies adversely affect the value of a foreign-owned asset. (9) The agreements do not, of course, stop governments from changing regulations, taxes, or other government polices; but they may require that the government compensate those that are adversely affected, and in doing so, they increase the costs of governments changing regulations and or other government policies. (It should be clear that these agreements are not symmetric: many government policies and investments lead to unanticipated increases in the value of assets. But while companies demand compensation when there is a change that lowers asset values, they do not offer to give the government back the increase in value from these positive changes. Indeed, attempts by the government to capture the increase in value that results from government actions that might positively impact the value of the assets might themselves be subject to investor suits, unless such recapture is guaranteed in the treaty itself. (10)

Governments, of course, are constantly changing regulations, taxes, and other policies, and making investments which have a variety of impacts on firms. The general stance in all sovereigns, especially in democracies, is that it should be the right of each government to make these changes, without paying compensation for any resulting changes in the value of assets. In the United States, the debate has centered on regulatory takings, with anti-environmentalists arguing for compensation. They know that by increasing the cost of environmental regulations, they will reduce their scope. (11) They have argued that the Constitution protects against the arbitrary taking of property without full compensation, and they have contended that such takings should even then be highly restricted, e.g. to the construction of roads. However, courts have consistently rejected that view. (12) Indeed, in a highly controversial case, the Supreme Court sustained the right of eminent domain to takings of land for developmental purposes, in which the land taken would subsequently be used by private parties. (13) Disappointed with these Court rulings, conservatives and anti-environmentalists have turned elsewhere. In some states, they have successfully passed initiatives to provide compensation for regulatory takings, (14) though such initiatives have not yet been fully tested in the courts. They have introduced legislation into Congress, but so far, such legislation has failed to pass, though legislation requiring the Administration to provide a cost benefit analysis of any regulatory taking has been approved. (15) I was in the Clinton Administration (as a member, and later, Chairman, of the Council of Economic Advisers, CEA) during a period of particularly intensive efforts by some in Congress to have such legislation adopted. There was remarkable agreement among all the offices of the White House–the Council of Economic Advisers (CEA), the Office of Science and Technology (OSTP), the Office of Information and Regulatory Affairs (OIRA) (of the Office of Management and Budget, OMB) and the Council on Environmental Quality (CEP). We all believed that such legislation would unduly circumscribe the ability to legislate needed regulations for protecting the environment, workers, consumers, and investors, and we were supported in this by President Clinton and Vice-President Gore. We successfully defeated all such efforts to provide compensation for “regulatory takings.”

My interest in the subject at hand arose partly because at the same time that we were fighting back–successfully–these regulatory takings initiatives, we were also working hard for the passage of NAFTA (the North American Free Trade Agreement), which, in its Chapter 11, contained language which has subsequently been interpreted (at least in some cases (16)) as a regulatory takings provisions. Had President Clinton known about this, I feel confident that he would, at a minimum, have demanded a side-letter providing an interpretation of Chapter 11 that precluded such an interpretation. But we never had a discussion on the topic in the White House, and I am convinced that President Clinton was not apprised of the risk of such an interpretation. (17) In the subsequent fast track passage in Congress, the issue too did not get much, if any, discussion. This highlights one of the main criticisms of these agreements–that they are, in their nature, not democratic; that, indeed, that may be their main rationale: to circumvent normal democratic processes and to get protections for investors that they would never have obtained had there been an open and public discussion. (18) If the U.S., in adopting such an agreement, was not fully aware of its import, this is even more likely to be the case in developing countries. (19,20)

The consequences are just becoming apparent, as the number of suits under these agreements has soared. One recent count has the number of cases under arbitration as exceeding 200 since the mid 1980s–entailing claims of tens of billions of dollars. (21)

In this paper, I want to focus on some foundational issues:

a) Is there a need for international economic agreements concerning the regulation of multinational corporations?

b) If there is, what should be the scope for such multinational agreements, and what global institutional arrangements might be most effective?

c) In particular, should governments have the right to restrict entry of corporations (as opposed to people or capital) from abroad? Should they have the right to insist on incorporation inside their own country?

d) Who should be protected by such agreements?

e) What should be the extent of protection of property against changes in regulation, taxation, or other government policies? What should be the standard of compensation?

f) Should these agreements be more balanced, imposing responsibilities as well as rights, and enhancing the ability of host countries to impose sanctions against those that fail to live up to their responsibilities?

g) Are there legitimate reasons that a country might wish to discriminate between foreign and domestic firms? Should investment treaties be limited to prohibiting such discrimination? What are the costs and benefits of such a restriction?

h) If the requisite global institutional arrangements can not be created (at least in the short run), what can or should individual countries do?

i) When there are disputes–as there inevitably be–how should such disputes be resolved?

The entire discussion is informed by modem economic theory, which has helped clarify the role of markets and of government, including the importance, and limitations, of property rights. In this sense, this paper is a contribution to the general theory of law and economics, but it lies on foundations that are markedly different from the predominant Chicago “Law and Economics” school, (22) which sees legal institutions as part of a system designed to ensure efficiency, promoted most effectively through free market competition combined with secure property rights. (23) The last quarter century has seen a re-examination, and a rejection, of the economic foundations on which this theory rests, and the creation of a new paradigm, based on imperfect information and incomplete markets. In this new paradigm, (24) markets by themselves are not, in general, efficient, and government intervention (sometimes even quite limited interventions, such as circumscribing conflicts of interests, as in the case of anditing (25)) can lead to welfare improvements. (26) Laws and regulation are, however, not only directed at improving efficiency but also at promoting social justice more broadly defined, including protecting those who might otherwise not fare so well in the market economy if left to themselves. This helps explain legislation and regulation designed to protect consumers, workers, and investors. In addition, there are some areas in which rules are essential: every game, including the market game, requires rules and referees. There may be more than one set of “efficient” rules, but different rules have different distributional consequences. Society, in selecting a set of rules to regulate economic behavior, has to be mindful of these distributional consequences.

n the international setting, seeming symmetric (or “fair”) rules or agreements may have asymmetric (or “unfair”) effects, because of the differences in circumstances of the countries to which they apply, including differences in their political or economic powers in enforcement, or their ability to use political powers to extract further terms in another context. When Antigua won major batter against U.S. restrictions on on-line gambling in the WTO, there was no way it could effectively enforce it: imposing trade sanctions would have hurt Antigua far more than it would have hurt the U.S. By contrast, had Antigua engaged in an unfair trade action against the U.S., any sanctions granted to the U.S. against Antigua would have been powerful. (27) After developed and less developed countries have agreed to a trade liberalization agreement, for instance, the IMF and the World Bank may insist that the developing country engage in further liberalization, if it is to receive a requested grant or loan. A drug company in the U.S. will successfully pressure the U.S. government to put pressure on a foreign country that considers issuing a compulsory license not to do so, even when the issuance of that license is totally within the framework of the WTO. This implies that one cannot look at the reasonableness of any particular agreement in isolation from a broader context–or even assess its true impact.

We look at the laws relating to corporate governance and bankruptcy through this perspective. We argue that even a narrow focus on efficiency requires going beyond frameworks that ensure shareholder value maximization, but that when a broader perspective incorporating equity as well as efficiency is taken, the case for alternative frameworks becomes even more compelling. We argue that BITs may interfere with a country’s ability to develop a legal framework maximizing society’s social welfare.

We view BITs through two different lenses–as imposing restrictions on the ability of governments to impose certain regulations (or to change certain polices), and as providing insurance to those establishing businesses within a jurisdiction against losses that might occur in the event of such changes . Imposing restrictions on their behavior may reduce regulatory uncertainty (although at a high cost), but it may not be the best way to reduce risk. As an alternative, should the market provide insurance? Normally, free market advocates think of markets as more efficient than government in providing insurance. Is there a rationale, in this case, to rely on publicly provided insurance? We will argue, however, that the way that most BITs have been designed may actually be increasing at least some aspects of risk: if risk mitigation were their primary objective, they have failed to do so in either an efficient or fair way.

Basic Perspectives

The basic perspective I take in this paper is the following: it is hard to think of a successful American economy with only state laws and no way of dealing with cross-border disputes. We have developed a finely honed system (although not without its flaws) defining what states may do. The system is designed to ensure that states do not interfere with interstate commerce and that they do not give business privileges to their residents at the expense of outsiders, but, at the same time, to provide them latitude to pass regulations and laws to protect their citizens. A host of complicated issues are raised: do minimum wage laws interfere with interstate commerce or otherwise restrict basic rights? (28) Do state environmental laws do so? There is, implicitly, a careful balancing. Obviously, any law can affect commerce, and any law restricts actions which individuals might otherwise undertake. Clearly, laws designed to interfere with interstate commerce are not allowed, but how far can or should one go in striking down laws for which this is some incidental effect? Should it be a matter of principle, which might, for instance, restrict any minimum wage legislation or any labor legislation? Or a matter of judging the magnitude of the effect? Similar questions arise in assessing whether such laws violate basic rights to contract. As we debate the question inside the United States, there are democratic processes at play at all levels. In principle, if states are enjoined from passing minimum wage laws, then the Federal government might be able to do so. So too for other pieces of regulation. But serious problems may arise when higher level bodies impose restrictions on lower level authorities, but those higher level authorities do not themselves have the right to take action. A regulatory gap may arise. (29)

Similarly, as we move to a global economy, we will need to have legal frameworks governing cross border disputes,. There will be a need to assess what regulations constitute an unfair restriction on trade. But unfortunately, economic globalization has outpaced political globalization: we have not developed the requisite democratic international institutions, either for drawing up agreements or adjudicating disputes. The international agreements we have, for instance, in trade are the result of hard bargaining behind closed doors, with the interests of special interests in the large and economically dominant countries (Europe and the U.S.) prevailing. (30)

BITs and the investment provisions of PTAs have attempted to fill in the gap, but they have done so in a way which is far from satisfactory. They are based on an incoherent set of economic principles, which leads to a failed understanding of the appropriate role of national regulation. We argue further that there is a fundamental difference between the rights of labor and capital to move across borders and the rights of a corporation incorporated in one jurisdiction to operate in another, and that it is a legitimate prerogative of governments to require that those wishing to engage in material business within their borders to be incorporated (e.g. through the establishment of a subsidiary) within the country. As the discussion below will make clear, however, these requirements are necessary, but not sufficient: there are far deeper problems with the investment agreements.

One of the problems of the BITs is that they are one-sided and unbalanced: they give corporations rights without responsibilities, compensation for adverse treatment, but not recovery of capital gains from positive treatment; they have given foreign firms protections not afforded to domestic firms, thereby creating an unlevel playing field, with perverse incentives. (31) There are good reasons that governments have not provided these guarantees to domestic firms–and there are good reasons that they should not be provided to international firms.

I approach these issues from the perspective of an economist, an economist that sees institutions like “corporations” and “property rights” as social constructions, to be evaluated on how well they serve broader public interests. Individuals have rights–the kinds of rights inscribed in the Bill of Rights. Individuals may have certain rights to act together collectively, but there is no inherent right, for instance, to limited liability, which defines corporations. Limited liability is a social construction which has proven very useful; indeed, without it, it would be hard to imagine modern capitalism. (32) But the circumstances in which the corporate veil can be pierced, the “rights” which ought to be granted to these limited liability institutions (including the right to enter a country), or the extent to which the officers of these institutions should be held liable for the actions which these institutions take, is a matter of economic and social policy. To repeat, they have no inherent rights. (33)

Thus, an analysis of the desirability of extending to corporations certain rights is quintessentially a matter of economic and social analysis–to ascertain what are the consequences of one set of provisions or another. The intent of this paper is to provide this analysis.

Readers will see a close parallel between the approach taken here and that taken by Adolf A. Berle and Gardiner C. Means in their classic work, The Modern Corporation and Private Property. (34) They called attention to the separation of ownership and control and explored the implications for property fights. My 1985 (35) paper helped put Berle and Means on solid footings; it provided information theoretic foundations for the separation of ownership and control and helped explain why effective control is not exercised by shareholders. (36) It also helped begin the modero discussion of corporate governance. (37)

One more preliminary caveat: one of the problems with the bilateral investment agreements is that they invoke inherently ambiguous terms (“fair and equitable treatment”); the adjudication process often invokes standards of commercial secrecy, even though one of the parties to the suit is a public entity in which there should be high standards of transparency; different arbitration panels can come to opposite conclusions in almost identical cases; (38) and there is typically no way in which such differences get resolved. Since a large fraction of the agreements are of recent vintage, there is considerable uncertainty about what they may imply. In the long run, greater balance may be achieved than has sometimes been the case in the past; (39) and the fears expressed here may prove unwarranted. Part of the intent of this paper is to influence the evolution of this critical area of law.

Outline of the paper.

The second section, “Problems Posed for Multinationals,” provides a brief reprise of the important contributions of multinationals–and of the special problems that they pose, problems that may be somewhat different from those posed by domestic firms; it describes the benefits they have brought but also explains why they have been subject to such criticism. The third section provides the core of the economic analysis. It articulates the market fundamentalism position underlying many of the arguments of free market advocates, including those stressing the importance of property rights protection (sometimes referred to as the Chicago school). It explains (a) why under those perspectives there would be no need for bilateral trade agreements; but (b) why these ideas have been rejected by modern economic analysis. On the basis of this, it explains why government regulation is required and applies that analysis to explain the need for government rules governing corporate governance and bankruptcy.

A key question is whether there is a single “best” set of legal institutions–for instance, a single Pareto Optimal (40) set of corporate governance and bankruptcy laws. If there is, then it would make sense to standardize legal frameworks; but it there is not, it does not. In the fourth section, we explain why there is not a single Pareto dominant legal framework, and accordingly why standardization may be undesirable. (41)

The following sections then apply this analysis to several of the central issues under dispute in the controversy over investment treaties:

(a) What rights should foreign firms have to establish themselves? We argue in “Implications for Bilateral Trade Agreements: Rights of Establishment” against even the limited rights to establishment embodied in many of the recent investment treaties.

But the various problems with BITs will not be solved merely by requiring foreigners to incorporate local subsidiaries in the host state. Rather, the treaties themselves need to be restructured. (42)

(b) Who should be protected and against what “measures” (actions)? With what “standards”? For instance, should there be protection simply against discrimination, or against actions which are inconsistent with principles of “fair and equitable”? If the latter, what is to be meant by such words? What should be the standard of compensation?

There is little dispute about the issue of protection from explicit expropriation. (43) “What Gets Protected? Regulatory Takings” looks at one of the critical ways that the BITs go well beyond protecting against expropriation, to protecting against changes in regulations–or even the effect of existing regulations. We argue that such protections can undermine economic efficiency and can be contrary to basic principles of social justice, particularly given the standards that have sometimes been invoked.

Of course, the bilateral agreements do not prohibit governments from undertaking various actions; they simply require the government to provide compensation. But for cash strapped governments, the effect may be much the same. The seventh section, “Standards of Compensation”, addresses the issue of compensation, arguing strongly against the broader compensation sometimes required (which includes lost profits (44)) but also suggesting that even compensation for reduced value of investments may be problematic.

“Rights and Responsibilities” argues that the investment agreements have been one-sided, that they have given foreign companies rights without imposing responsibilities, or without even facilitating the ability of developing countries to ensure that the multinational corporations live up to their obligations.

One of the most criticized aspects of these agreements is the dispute resolution mechanisms: the use of arbitration courts, designed to settle commercial disputes, to enforce an agreement on a government. The processes often lack the openness and transparency that we have come to expect from judicial proceedings in a democratic society and have often shown little regard to broader societal concerns, as they focus exclusively on the rights of investors. The section titled “Dispute Resolution” argues that there is much merit in these criticisms and proposes reforms in the adjudication process, including the creation of an international commercial court.

The problems in regulation uncovered in previous sections highlight the need for a better international framework for governing cross-border economic activities, a subject taken up in “Towards Regulating Multinational Corporations Globally.” We emphasize two core principles: (a) minimizing the scope of such agreements to standards that are viewed as absolutely essential for the conduct of cross border business; and (b) non-discrimination (“Non-Discrimination”).

The next sections take up two of the key criticisms of the bilateral agreements: they are not designed in ways that make the appropriate legal evolution possible. It is difficult to correct “mistakes” either in the design of the treaties or the interpretation of the provisions (further reinforcing the argument for a limited scope for such agreements). Furthermore, the political processes underlying these investment agreements are fundamentally undemocratic.

The final section provides concluding remarks: balance needs to be restored to the governance of cross border economic relations. Countries should be extremely cautious in signing bilateral investment treaties (especially the more expansive agreements that go beyond nondiscrimination). And it provides support for the initiatives of several countries (Ecuador, Bolivia, Czech Republic) and others for revising existing agreements. There needs to be a serious rollback in the agreements already signed.

PROBLEMS POSED BY MULTINATIONALS

For all the reasons given earlier, multinationals have brought enormous benefits. Today, countries around the world compete to attract multinationals; they boast of having a business-friendly environment. And foreign capital has poured in to developing countries, increasing six fold between 1990 and 1997, before it slowed (and reversed) as a result of the East Asian and global financial crisis. (45)

But for all the benefits they bring, multinationals have been vilified–and often for good reason.

In some cases they take a country’s natural resources, paying but a pittance while leaving behind an environmental disaster. (46) When called upon by the government to clean up the mess, they announce that they are bankrupt: all the revenues have already been paid out to shareholders. They take advantage of limited liability. (47)

In some cases, when the adverse consequences of their actions are criticized, the MNCs plead that they are simply following the law; but such defenses are disingenuous, for they often work hard to make sure that the law is the law that suits them well and maximizes their profits.

Consider, for instance, the regulation of cigarettes. We–and I include in the “we” the cigarette companies (48)–have known for decades that cigarettes are bad for one’s health, but the cigarette companies have deliberately tried to create confusion about the scientific evidence. While they have worked hard to stop regulation, they have also worked hard to make sure that they do not bear any liability for the enormous costs that result from their dangerous products. (More recently, Exxon has engaged in a similar attempt to discredit the science of global warming. (49) When BP owned up to the risks of global warming, it was castigated by the other members of the oil club, for a while almost treated as a pariah.)

The lecture began at 4:15 p.m., Wednesday, March 28, and was given by Joseph Stiglitz of Columbia University; the discussant was Rachel Kyte of the International Finance Corporation.

MULTINATIONAL CORPORATIONS: BALANCING RIGHTS AND RESPONSIBILITIES

By Joseph E. Stiglitz *

// Setup structure to be passed thru to javascript
var googleAdSense = new Object();
googleAdSense.adsByGoogleText = “Ads By Google”;
googleAdSense.componentID = 1876630;
googleAdSense.config = [{“LINK”:{“STYLE”:””,”CLASS”:”goog_url”},”TITLE”:{“STYLE”:””,”CLASS”:”goog_title”},”DESCRIPTION”:{“STYLE”:””,”CLASS”:”goog_desc”},”CONTAINER”:{“STYLE”:””,”CLASS”:”goog_one_ad”},”TITLELINK”:{“STYLE”:””,”CLASS”:”bd_googad”},”LISTTITLE”:{“STYLE”:””,”CLASS”:”google_ads_by”}},{“LINK”:{“STYLE”:””,”CLASS”:”goog_url”},”TITLE”:{“STYLE”:””,”CLASS”:”goog_title”},”DESCRIPTION”:{“STYLE”:””,”CLASS”:”goog_desc”},”CONTAINER”:{“STYLE”:””,”CLASS”:”goog_two_ads”},”TITLELINK”:{“STYLE”:””,”CLASS”:”bd_googad”},”LISTTITLE”:{“STYLE”:””,”CLASS”:”google_ads_by”}},{“LINK”:{“STYLE”:””,”CLASS”:”goog_url”},”TITLE”:{“STYLE”:””,”CLASS”:”goog_title”},”DESCRIPTION”:{“STYLE”:””,”CLASS”:”goog_desc”},”CONTAINER”:{“STYLE”:””,”CLASS”:””},”TITLELINK”:{“STYLE”:””,”CLASS”:”bd_googad”},”LISTTITLE”:{“STYLE”:””,”CLASS”:”google_ads_by”}}];

// Lookup previously registered instance of component and set google_skip value
var componentRegistered = false;
if (typeof(adComponentRegistry) == “undefined”)
{
adComponentRegistry = new Array();
}
else
{
for (var i=0; i<adComponentRegistry.length; i++)
{
if (adComponentRegistry[i].id == ‘1876630’)
{
google_adnum = adComponentRegistry[i].adNum;
componentRegistered = true;
break;
}
}
}

// Add new entry. Use config.id as key
if (!componentRegistered)
{
adComponentRegistry[adComponentRegistry.length] = {id:”1876630″, adNum:0};
google_adnum = 0;
}

// Setup call to google adsense
google_ad_client = ‘ca-pub-8755651974531138’;
google_ad_output = ‘js’;
google_feedback = ‘on’;
google_max_num_ads = ‘3’;
google_image_size = “300×250”;
google_targeting = ‘site_content’;
google_ad_channel = ‘6378487193+6247480671’;
google_ad_type = ‘text’;
google_adtest = ‘off’;
google_hints = ”;
google_skip = google_adnum;

window.google_render_ad();

Ads By Google

RBS – Commercial Banking
SME business – Cash Mgt, Trade & Supply Chain solutions. Enquire now
www.rbs.co.id/commercialbanking

THE IMPORTANCE OF CORPORATIONS AND THE PROBLEMS THEY PRESENT

An increasing fraction of commerce within each country is conducted by corporations which are owned and controlled from outside its borders and which often conduct business in dozens of countries. These corporations have brought enormous benefits–indeed, many of the benefits attributed to globalization, such as the closing of the knowledge gap, the gap between developing and developed countries which is even more important than the gap in resources, is due in no small measure to multinational corporations. More important than the capital which corporations bring (1) are the transfer of technology, the training of human resources, and the access to international markets.

In recent years, especially following the collapse of the initiative to create a Multilateral Agreement on Investment (MAI) within the OECD, (2) there has been a proliferation of bilateral investment treaties (BITs) and investment provisions within bilateral free trade agreements. (3,4) (Some countries (such as Indonesia) have even passed laws providing similar investment guarantees, on their own.)

These agreements are purportedly designed to provide greater protection for investors, thereby encouraging cross-border investment. There is, to date, little evidence that they have done so. (5) Part of the reason is that they may in fact curtail development strategies, in ways which are adverse to growth. As the ECLAC (The UN Economic Commission on Latin America and the Caribbean) concluded, “countries often find that they have assumed obligations which, further down the road, will place limitations on their own development program.” (6)

This paper is concerned with a set of more fundamental issues. Even if it could be established that BITs lead to increased investment, and even if that investment could be shown to lead to higher growth, as measured by increased GDP (gross domestic product), (7) it does not mean that societal welfare has been increased, especially once account is taken of resource depletion and environmental degradation. These agreements are designed to impose restraints on what governments can do–or at least to impose a high cost to their undertaking certain actions. Some of the activities which may be constrained may be important for promoting general societal well-being–even if profits of particular firms are affected adversely. It is this possibility which has made these agreements a subject of such concern and debate.

These agreements are, of course, not all identical; what they do is itself a subject of some controversy. Like any agreement, it depends on the interpretations of particular words, and the judicial processes through which these words are given meaning are one of the sources of dissatisfaction with the agreements. Different arbitration panels have interpreted even the same words differently, creating a high level of uncertainty, both among governments and investors, about exactly what these agreements do. (8) This article is focused not on any specific agreement but on the general thrust of these agreements, which goes substantially beyond protection against expropriation.

Many of the agreements–including some of their most controversial aspects–are concerned with the far broader issue of what happens when changes in regulations or other government policies adversely affect the value of a foreign-owned asset. (9) The agreements do not, of course, stop governments from changing regulations, taxes, or other government polices; but they may require that the government compensate those that are adversely affected, and in doing so, they increase the costs of governments changing regulations and or other government policies. (It should be clear that these agreements are not symmetric: many government policies and investments lead to unanticipated increases in the value of assets. But while companies demand compensation when there is a change that lowers asset values, they do not offer to give the government back the increase in value from these positive changes. Indeed, attempts by the government to capture the increase in value that results from government actions that might positively impact the value of the assets might themselves be subject to investor suits, unless such recapture is guaranteed in the treaty itself. (10)

Governments, of course, are constantly changing regulations, taxes, and other policies, and making investments which have a variety of impacts on firms. The general stance in all sovereigns, especially in democracies, is that it should be the right of each government to make these changes, without paying compensation for any resulting changes in the value of assets. In the United States, the debate has centered on regulatory takings, with anti-environmentalists arguing for compensation. They know that by increasing the cost of environmental regulations, they will reduce their scope. (11) They have argued that the Constitution protects against the arbitrary taking of property without full compensation, and they have contended that such takings should even then be highly restricted, e.g. to the construction of roads. However, courts have consistently rejected that view. (12) Indeed, in a highly controversial case, the Supreme Court sustained the right of eminent domain to takings of land for developmental purposes, in which the land taken would subsequently be used by private parties. (13) Disappointed with these Court rulings, conservatives and anti-environmentalists have turned elsewhere. In some states, they have successfully passed initiatives to provide compensation for regulatory takings, (14) though such initiatives have not yet been fully tested in the courts. They have introduced legislation into Congress, but so far, such legislation has failed to pass, though legislation requiring the Administration to provide a cost benefit analysis of any regulatory taking has been approved. (15) I was in the Clinton Administration (as a member, and later, Chairman, of the Council of Economic Advisers, CEA) during a period of particularly intensive efforts by some in Congress to have such legislation adopted. There was remarkable agreement among all the offices of the White House–the Council of Economic Advisers (CEA), the Office of Science and Technology (OSTP), the Office of Information and Regulatory Affairs (OIRA) (of the Office of Management and Budget, OMB) and the Council on Environmental Quality (CEP). We all believed that such legislation would unduly circumscribe the ability to legislate needed regulations for protecting the environment, workers, consumers, and investors, and we were supported in this by President Clinton and Vice-President Gore. We successfully defeated all such efforts to provide compensation for “regulatory takings.”

My interest in the subject at hand arose partly because at the same time that we were fighting back–successfully–these regulatory takings initiatives, we were also working hard for the passage of NAFTA (the North American Free Trade Agreement), which, in its Chapter 11, contained language which has subsequently been interpreted (at least in some cases (16)) as a regulatory takings provisions. Had President Clinton known about this, I feel confident that he would, at a minimum, have demanded a side-letter providing an interpretation of Chapter 11 that precluded such an interpretation. But we never had a discussion on the topic in the White House, and I am convinced that President Clinton was not apprised of the risk of such an interpretation. (17) In the subsequent fast track passage in Congress, the issue too did not get much, if any, discussion. This highlights one of the main criticisms of these agreements–that they are, in their nature, not democratic; that, indeed, that may be their main rationale: to circumvent normal democratic processes and to get protections for investors that they would never have obtained had there been an open and public discussion. (18) If the U.S., in adopting such an agreement, was not fully aware of its import, this is even more likely to be the case in developing countries. (19,20)

The consequences are just becoming apparent, as the number of suits under these agreements has soared. One recent count has the number of cases under arbitration as exceeding 200 since the mid 1980s–entailing claims of tens of billions of dollars. (21)

In this paper, I want to focus on some foundational issues:

a) Is there a need for international economic agreements concerning the regulation of multinational corporations?

b) If there is, what should be the scope for such multinational agreements, and what global institutional arrangements might be most effective?

c) In particular, should governments have the right to restrict entry of corporations (as opposed to people or capital) from abroad? Should they have the right to insist on incorporation inside their own country?

d) Who should be protected by such agreements?

e) What should be the extent of protection of property against changes in regulation, taxation, or other government policies? What should be the standard of compensation?

f) Should these agreements be more balanced, imposing responsibilities as well as rights, and enhancing the ability of host countries to impose sanctions against those that fail to live up to their responsibilities?

g) Are there legitimate reasons that a country might wish to discriminate between foreign and domestic firms? Should investment treaties be limited to prohibiting such discrimination? What are the costs and benefits of such a restriction?

h) If the requisite global institutional arrangements can not be created (at least in the short run), what can or should individual countries do?

i) When there are disputes–as there inevitably be–how should such disputes be resolved?

The entire discussion is informed by modem economic theory, which has helped clarify the role of markets and of government, including the importance, and limitations, of property rights. In this sense, this paper is a contribution to the general theory of law and economics, but it lies on foundations that are markedly different from the predominant Chicago “Law and Economics” school, (22) which sees legal institutions as part of a system designed to ensure efficiency, promoted most effectively through free market competition combined with secure property rights. (23) The last quarter century has seen a re-examination, and a rejection, of the economic foundations on which this theory rests, and the creation of a new paradigm, based on imperfect information and incomplete markets. In this new paradigm, (24) markets by themselves are not, in general, efficient, and government intervention (sometimes even quite limited interventions, such as circumscribing conflicts of interests, as in the case of anditing (25)) can lead to welfare improvements. (26) Laws and regulation are, however, not only directed at improving efficiency but also at promoting social justice more broadly defined, including protecting those who might otherwise not fare so well in the market economy if left to themselves. This helps explain legislation and regulation designed to protect consumers, workers, and investors. In addition, there are some areas in which rules are essential: every game, including the market game, requires rules and referees. There may be more than one set of “efficient” rules, but different rules have different distributional consequences. Society, in selecting a set of rules to regulate economic behavior, has to be mindful of these distributional consequences.

In the international setting, seeming symmetric (or “fair”) rules or agreements may have asymmetric (or “unfair”) effects, because of the differences in circumstances of the countries to which they apply, including differences in their political or economic powers in enforcement, or their ability to use political powers to extract further terms in another context. When Antigua won major batter against U.S. restrictions on on-line gambling in the WTO, there was no way it could effectively enforce it: imposing trade sanctions would have hurt Antigua far more than it would have hurt the U.S. By contrast, had Antigua engaged in an unfair trade action against the U.S., any sanctions granted to the U.S. against Antigua would have been powerful. (27) After developed and less developed countries have agreed to a trade liberalization agreement, for instance, the IMF and the World Bank may insist that the developing country engage in further liberalization, if it is to receive a requested grant or loan. A drug company in the U.S. will successfully pressure the U.S. government to put pressure on a foreign country that considers issuing a compulsory license not to do so, even when the issuance of that license is totally within the framework of the WTO. This implies that one cannot look at the reasonableness of any particular agreement in isolation from a broader context–or even assess its true impact.

We look at the laws relating to corporate governance and bankruptcy through this perspective. We argue that even a narrow focus on efficiency requires going beyond frameworks that ensure shareholder value maximization, but that when a broader perspective incorporating equity as well as efficiency is taken, the case for alternative frameworks becomes even more compelling. We argue that BITs may interfere with a country’s ability to develop a legal framework maximizing society’s social welfare.

We view BITs through two different lenses–as imposing restrictions on the ability of governments to impose certain regulations (or to change certain polices), and as providing insurance to those establishing businesses within a jurisdiction against losses that might occur in the event of such changes . Imposing restrictions on their behavior may reduce regulatory uncertainty (although at a high cost), but it may not be the best way to reduce risk. As an alternative, should the market provide insurance? Normally, free market advocates think of markets as more efficient than government in providing insurance. Is there a rationale, in this case, to rely on publicly provided insurance? We will argue, however, that the way that most BITs have been designed may actually be increasing at least some aspects of risk: if risk mitigation were their primary objective, they have failed to do so in either an efficient or fair way.

Basic Perspectives

The basic perspective I take in this paper is the following: it is hard to think of a successful American economy with only state laws and no way of dealing with cross-border disputes. We have developed a finely honed system (although not without its flaws) defining what states may do. The system is designed to ensure that states do not interfere with interstate commerce and that they do not give business privileges to their residents at the expense of outsiders, but, at the same time, to provide them latitude to pass regulations and laws to protect their citizens. A host of complicated issues are raised: do minimum wage laws interfere with interstate commerce or otherwise restrict basic rights? (28) Do state environmental laws do so? There is, implicitly, a careful balancing. Obviously, any law can affect commerce, and any law restricts actions which individuals might otherwise undertake. Clearly, laws designed to interfere with interstate commerce are not allowed, but how far can or should one go in striking down laws for which this is some incidental effect? Should it be a matter of principle, which might, for instance, restrict any minimum wage legislation or any labor legislation? Or a matter of judging the magnitude of the effect? Similar questions arise in assessing whether such laws violate basic rights to contract. As we debate the question inside the United States, there are democratic processes at play at all levels. In principle, if states are enjoined from passing minimum wage laws, then the Federal government might be able to do so. So too for other pieces of regulation. But serious problems may arise when higher level bodies impose restrictions on lower level authorities, but those higher level authorities do not themselves have the right to take action. A regulatory gap may arise. (29)

Similarly, as we move to a global economy, we will need to have legal frameworks governing cross border disputes,. There will be a need to assess what regulations constitute an unfair restriction on trade. But unfortunately, economic globalization has outpaced political globalization: we have not developed the requisite democratic international institutions, either for drawing up agreements or adjudicating disputes. The international agreements we have, for instance, in trade are the result of hard bargaining behind closed doors, with the interests of special interests in the large and economically dominant countries (Europe and the U.S.) prevailing. (30)

BITs and the investment provisions of PTAs have attempted to fill in the gap, but they have done so in a way which is far from satisfactory. They are based on an incoherent set of economic principles, which leads to a failed understanding of the appropriate role of national regulation. We argue further that there is a fundamental difference between the rights of labor and capital to move across borders and the rights of a corporation incorporated in one jurisdiction to operate in another, and that it is a legitimate prerogative of governments to require that those wishing to engage in material business within their borders to be incorporated (e.g. through the establishment of a subsidiary) within the country. As the discussion below will make clear, however, these requirements are necessary, but not sufficient: there are far deeper problems with the investment agreements.

One of the problems of the BITs is that they are one-sided and unbalanced: they give corporations rights without responsibilities, compensation for adverse treatment, but not recovery of capital gains from positive treatment; they have given foreign firms protections not afforded to domestic firms, thereby creating an unlevel playing field, with perverse incentives. (31) There are good reasons that governments have not provided these guarantees to domestic firms–and there are good reasons that they should not be provided to international firms.

I approach these issues from the perspective of an economist, an economist that sees institutions like “corporations” and “property rights” as social constructions, to be evaluated on how well they serve broader public interests. Individuals have rights–the kinds of rights inscribed in the Bill of Rights. Individuals may have certain rights to act together collectively, but there is no inherent right, for instance, to limited liability, which defines corporations. Limited liability is a social construction which has proven very useful; indeed, without it, it would be hard to imagine modern capitalism. (32) But the circumstances in which the corporate veil can be pierced, the “rights” which ought to be granted to these limited liability institutions (including the right to enter a country), or the extent to which the officers of these institutions should be held liable for the actions which these institutions take, is a matter of economic and social policy. To repeat, they have no inherent rights. (33)

Thus, an analysis of the desirability of extending to corporations certain rights is quintessentially a matter of economic and social analysis–to ascertain what are the consequences of one set of provisions or another. The intent of this paper is to provide this analysis.

Readers will see a close parallel between the approach taken here and that taken by Adolf A. Berle and Gardiner C. Means in their classic work, The Modern Corporation and Private Property. (34) They called attention to the separation of ownership and control and explored the implications for property fights. My 1985 (35) paper helped put Berle and Means on solid footings; it provided information theoretic foundations for the separation of ownership and control and helped explain why effective control is not exercised by shareholders. (36) It also helped begin the modero discussion of corporate governance. (37)

One more preliminary caveat: one of the problems with the bilateral investment agreements is that they invoke inherently ambiguous terms (“fair and equitable treatment”); the adjudication process often invokes standards of commercial secrecy, even though one of the parties to the suit is a public entity in which there should be high standards of transparency; different arbitration panels can come to opposite conclusions in almost identical cases; (38) and there is typically no way in which such differences get resolved. Since a large fraction of the agreements are of recent vintage, there is considerable uncertainty about what they may imply. In the long run, greater balance may be achieved than has sometimes been the case in the past; (39) and the fears expressed here may prove unwarranted. Part of the intent of this paper is to influence the evolution of this critical area of law.

Outline of the paper.

The second section, “Problems Posed for Multinationals,” provides a brief reprise of the important contributions of multinationals–and of the special problems that they pose, problems that may be somewhat different from those posed by domestic firms; it describes the benefits they have brought but also explains why they have been subject to such criticism. The third section provides the core of the economic analysis. It articulates the market fundamentalism position underlying many of the arguments of free market advocates, including those stressing the importance of property rights protection (sometimes referred to as the Chicago school). It explains (a) why under those perspectives there would be no need for bilateral trade agreements; but (b) why these ideas have been rejected by modern economic analysis. On the basis of this, it explains why government regulation is required and applies that analysis to explain the need for government rules governing corporate governance and bankruptcy.

A key question is whether there is a single “best” set of legal institutions–for instance, a single Pareto Optimal (40) set of corporate governance and bankruptcy laws. If there is, then it would make sense to standardize legal frameworks; but it there is not, it does not. In the fourth section, we explain why there is not a single Pareto dominant legal framework, and accordingly why standardization may be undesirable. (41)

The following sections then apply this analysis to several of the central issues under dispute in the controversy over investment treaties:

(a) What rights should foreign firms have to establish themselves? We argue in “Implications for Bilateral Trade Agreements: Rights of Establishment” against even the limited rights to establishment embodied in many of the recent investment treaties.

But the various problems with BITs will not be solved merely by requiring foreigners to incorporate local subsidiaries in the host state. Rather, the treaties themselves need to be restructured. (42)

(b) Who should be protected and against what “measures” (actions)? With what “standards”? For instance, should there be protection simply against discrimination, or against actions which are inconsistent with principles of “fair and equitable”? If the latter, what is to be meant by such words? What should be the standard of compensation?

There is little dispute about the issue of protection from explicit expropriation. (43) “What Gets Protected? Regulatory Takings” looks at one of the critical ways that the BITs go well beyond protecting against expropriation, to protecting against changes in regulations–or even the effect of existing regulations. We argue that such protections can undermine economic efficiency and can be contrary to basic principles of social justice, particularly given the standards that have sometimes been invoked.

Of course, the bilateral agreements do not prohibit governments from undertaking various actions; they simply require the government to provide compensation. But for cash strapped governments, the effect may be much the same. The seventh section, “Standards of Compensation”, addresses the issue of compensation, arguing strongly against the broader compensation sometimes required (which includes lost profits (44)) but also suggesting that even compensation for reduced value of investments may be problematic.

“Rights and Responsibilities” argues that the investment agreements have been one-sided, that they have given foreign companies rights without imposing responsibilities, or without even facilitating the ability of developing countries to ensure that the multinational corporations live up to their obligations.

One of the most criticized aspects of these agreements is the dispute resolution mechanisms: the use of arbitration courts, designed to settle commercial disputes, to enforce an agreement on a government. The processes often lack the openness and transparency that we have come to expect from judicial proceedings in a democratic society and have often shown little regard to broader societal concerns, as they focus exclusively on the rights of investors. The section titled “Dispute Resolution” argues that there is much merit in these criticisms and proposes reforms in the adjudication process, including the creation of an international commercial court.

The problems in regulation uncovered in previous sections highlight the need for a better international framework for governing cross-border economic activities, a subject taken up in “Towards Regulating Multinational Corporations Globally.” We emphasize two core principles: (a) minimizing the scope of such agreements to standards that are viewed as absolutely essential for the conduct of cross border business; and (b) non-discrimination (“Non-Discrimination”).

The next sections take up two of the key criticisms of the bilateral agreements: they are not designed in ways that make the appropriate legal evolution possible. It is difficult to correct “mistakes” either in the design of the treaties or the interpretation of the provisions (further reinforcing the argument for a limited scope for such agreements). Furthermore, the political processes underlying these investment agreements are fundamentally undemocratic.

The final section provides concluding remarks: balance needs to be restored to the governance of cross border economic relations. Countries should be extremely cautious in signing bilateral investment treaties (especially the more expansive agreements that go beyond nondiscrimination). And it provides support for the initiatives of several countries (Ecuador, Bolivia, Czech Republic) and others for revising existing agreements. There needs to be a serious rollback in the agreements already signed.

PROBLEMS POSED BY MULTINATIONALS

For all the reasons given earlier, multinationals have brought enormous benefits. Today, countries around the world compete to attract multinationals; they boast of having a business-friendly environment. And foreign capital has poured in to developing countries, increasing six fold between 1990 and 1997, before it slowed (and reversed) as a result of the East Asian and global financial crisis. (45)

But for all the benefits they bring, multinationals have been vilified–and often for good reason.

In some cases they take a country’s natural resources, paying but a pittance while leaving behind an environmental disaster. (46) When called upon by the government to clean up the mess, they announce that they are bankrupt: all the revenues have already been paid out to shareholders. They take advantage of limited liability. (47)

In some cases, when the adverse consequences of their actions are criticized, the MNCs plead that they are simply following the law; but such defenses are disingenuous, for they often work hard to make sure that the law is the law that suits them well and maximizes their profits.

Consider, for instance, the regulation of cigarettes. We–and I include in the “we” the cigarette companies (48)–have known for decades that cigarettes are bad for one’s health, but the cigarette companies have deliberately tried to create confusion about the scientific evidence. While they have worked hard to stop regulation, they have also worked hard to make sure that they do not bear any liability for the enormous costs that result from their dangerous products. (More recently, Exxon has engaged in a similar attempt to discredit the science of global warming. (49) When BP owned up to the risks of global warming, it was castigated by the other members of the oil club, for a while almost treated as a pariah.)

In developing countries, there are widespread allegations of corruption–and many contracts that only make sense when seen in that context. For years, many countries provided tax deductions for bribes; in effect, Western governments were subsidizing them, even though they undermined democratic governance abroad (and even as they lectured them about the importance of governance). I was the U.S. representative to the OECD ministerial meeting in the mid-1990s, when the U.S. was pushing for the anti-bribery Convention. I was shocked by the resistance.

The problem is more pervasive. Companies, like BP and Hydro, that have made ah effort to make their transactions more transparent, have not met with support from their colleagues. (50) This puts the “good” guys at a competitive disadvantage.

Why Foreign Multinationals May Present a Worse Problem than Domestic Corporations

Problems of corporations taking advantage of limited liability, to escape, for instance, responsibility for their environmental damage, (51) and using their enormous financial powers to frame legislation to their advantage arise with domesticas well as multinational corporations. What then is distinctive about multinationals?

First, their economic powers are huge—often far larger than that of the countries with which they are dealing. The revenues of GM are greater than the GDP of more than 148 countries; while Walmart’s revenues exceed the combined GDP of sub-Saharan Africa. It is an unfair playing field. Not surprisingly, they often try to use their economic power to create a playing field that is even more unlevel, getting for themselves special tax or regulatory treatment.

Sometimes, they do this in ways that are above board, such as through campaign contributions (which have proven so corrosive of democratic processes even in strongly established democracies, such as the United States, but whose adverse effects are likely even greater in the nascent democracies of much of the developing world).

Sometimes, they exert their influence simply through the threat of leaving: if environmental of worker safety regulations are enforced, or if they are asked to pay their fair share of taxes, they will go elsewhere, where governments are more compliant with their wishes. (The asymmetries in liberalization–with capital markets being far more liberalized than labor markets—have enhanced the effectiveness of such threats.)

But sometimes, they engage in corruption (bribery): the developing countries with which they deal are often weak, and salaries of government officials are generally very low, making these countries particularly susceptible to corruption.

Secondly, these companies often leverage their own economic power with the power of their governments, to get even better terms. A drug company in the U.S. will successfully pressure the U.S. government to put pressure on a foreign country that considers issuing a compulsory license, even when the issuance of that license is totally within the framework of the WTO. (52) Poor aid-dependent countries are particularly susceptible to such political pressures, for there is always a (veiled or unveiled) threat to reduce the assistance which is necessary for their survival. (53)

Companies will get their governments to force a renegotiation of a contract, when it turns out unfavorable to their companies, e.g. as a result of underbidding, (as was the case of some of Argentine’s water concessions) but, not surprisingly, they will put pressure on the country not to renegotiate when it turns vastly unfavorable to the country, e.g. as a result of overbidding. (54)

This is even true when there is evidence that the unfavorable provisions were the result of corruption (as in the case of Suharto’s Indonesian contracts). (55) Corruption (at least in appearances) does not, however, seem to be limited to the developing countries: In more than one case, it has turned out that the Western ambassadors that put pressure on the countries not to renegotiate wind up on the Boards of Directors of the Western companies whose interests they served.

Thirdly, sometimes multinational corporations

Thirdly, sometimes multinational corporations take advantage of the lack of administrative capacities and technical expertise in developing countries, to get away with things that they could not get away with in developed countries. Of course, even in developed countries, they try: several oil companies systematically cheated on their contracts with Alaska, hoping that their shaving off just a few pennies on every barrel would not get detected; but a few pennies a barrel times billions of barrels adds up. Through sophisticated detection techniques, costing millions of dollars, they were caught and prosecuted; the oil firms eventually agreed to pay more than a billion dollars to Alaska. (56) But this was not the only such case: Exxon similarly cheated on its contract with Alabama, assuming again that they could just get away with it. (57’58) But if the oil companies attempt to get away with such practices in the U.S., what must be the case in developing countries?

Worse still, some multinationals are using the lack of administrative capacity as a basis of making claims against developing countries (even though they should have been fully aware of these limitations at the time they made the investments) under Investment Treaty provisions providing for “fair and equitable treatment.” Governments have been held liable for not providing “fair and equitable treatment” by virtue of not offering foreign investors an administrative apparatus which is sufficiently transparent, competent, responsive, and efficient; arbitration panels have set very high levels of obligations for developing countries. (59)

Fourthly, sometimes multinationals, and the governments of advanced industrial countries who represent their interests, take advantage not only of asymmetries of power (60), but also of information. The U.S. has bargained with dozens of countries. It knows what are likely to be sensitive clauses, provisions can have large effects, either in terms of benefits or costs. It has large staffs which can write, review, and analyze such agreements, clause by clause. And if these advantages were not enough, it is assisted by well paid corporate lobbyists and lawyers, who are even more sensitive to the consequences of each provision. Because of the size of its economy, it has virtually every industry that might be affected by the agreement, and they are, in effect, at the table. By contrast, the developing country has a small staff. What is at stake are not just the industries that are currently present, but those that might be established in the future; but these industries have neither lobbyists or lawyers to represent their interests. And even when the developing country does realize that some provision proposed by the U.S. is bad for it, or identifies a provision that might be favorable to its growth prospects, chances of it persuading the U.S. (or any other advanced industrial country) to change the “template,” the standard agreement is nil, especially if the provision touches on any important U.S. interest. Trade negotiators from several developing countries engaged in “negotiations” with the U.S. have repeatedly said, these are not negotiations in any meaningful sense. There can be some negotiations around the edges–whether the transition period will be two or three months or a year. But on any core issue, there is no give. America will say: if we give you better terms, we will have to give it to everyone other country. (61)

Fifthly, multinationals sometimes take advantage of their cross-border activities to insulate themselves from accountability. In old cowboy movies, the sheriff chases the bandits to the state border–the bandit knows that once he crosses the border he is safe. So too for the modern corporation: the U.S. has refused (without explanation) to extradite the Union Carbide officials, so that they could be held responsible for the mass loss of life at Bhopal, India.. Even when economic judgments are reached against corporations in one jurisdiction, it may be difficult to enforce them in another. Smart multinationals know this and move assets out of jurisdictions where claims might be brought against them.

The lecture began at 4:15 p.m., Wednesday, March 28, and was given by Joseph Stiglitz of Columbia University; the discussant was Rachel Kyte of the International Finance Corporation.

MULTINATIONAL CORPORATIONS: BALANCING RIGHTS AND RESPONSIBILITIES

By Joseph E. Stiglitz *

// Setup structure to be passed thru to javascript
var googleAdSense = new Object();
googleAdSense.adsByGoogleText = “Ads By Google”;
googleAdSense.componentID = 1876630;
googleAdSense.config = [{“LINK”:{“STYLE”:””,”CLASS”:”goog_url”},”TITLE”:{“STYLE”:””,”CLASS”:”goog_title”},”DESCRIPTION”:{“STYLE”:””,”CLASS”:”goog_desc”},”CONTAINER”:{“STYLE”:””,”CLASS”:”goog_one_ad”},”TITLELINK”:{“STYLE”:””,”CLASS”:”bd_googad”},”LISTTITLE”:{“STYLE”:””,”CLASS”:”google_ads_by”}},{“LINK”:{“STYLE”:””,”CLASS”:”goog_url”},”TITLE”:{“STYLE”:””,”CLASS”:”goog_title”},”DESCRIPTION”:{“STYLE”:””,”CLASS”:”goog_desc”},”CONTAINER”:{“STYLE”:””,”CLASS”:”goog_two_ads”},”TITLELINK”:{“STYLE”:””,”CLASS”:”bd_googad”},”LISTTITLE”:{“STYLE”:””,”CLASS”:”google_ads_by”}},{“LINK”:{“STYLE”:””,”CLASS”:”goog_url”},”TITLE”:{“STYLE”:””,”CLASS”:”goog_title”},”DESCRIPTION”:{“STYLE”:””,”CLASS”:”goog_desc”},”CONTAINER”:{“STYLE”:””,”CLASS”:””},”TITLELINK”:{“STYLE”:””,”CLASS”:”bd_googad”},”LISTTITLE”:{“STYLE”:””,”CLASS”:”google_ads_by”}}];

// Lookup previously registered instance of component and set google_skip value
var componentRegistered = false;
if (typeof(adComponentRegistry) == “undefined”)
{
adComponentRegistry = new Array();
}
else
{
for (var i=0; i<adComponentRegistry.length; i++)
{
if (adComponentRegistry[i].id == ‘1876630’)
{
google_adnum = adComponentRegistry[i].adNum;
componentRegistered = true;
break;
}
}
}

// Add new entry. Use config.id as key
if (!componentRegistered)
{
adComponentRegistry[adComponentRegistry.length] = {id:”1876630″, adNum:0};
google_adnum = 0;
}

// Setup call to google adsense
google_ad_client = ‘ca-pub-8755651974531138’;
google_ad_output = ‘js’;
google_feedback = ‘on’;
google_max_num_ads = ‘3’;
google_image_size = “300×250”;
google_targeting = ‘site_content’;
google_ad_channel = ‘6378487193+6247480671’;
google_ad_type = ‘text’;
google_adtest = ‘off’;
google_hints = ”;
google_skip = google_adnum;

window.google_render_ad();

Ads By Google

RBS – Commercial Banking
SME business – Cash Mgt, Trade & Supply Chain solutions. Enquire now
www.rbs.co.id/commercialbanking

THE IMPORTANCE OF CORPORATIONS AND THE PROBLEMS THEY PRESENT

An increasing fraction of commerce within each country is conducted by corporations which are owned and controlled from outside its borders and which often conduct business in dozens of countries. These corporations have brought enormous benefits–indeed, many of the benefits attributed to globalization, such as the closing of the knowledge gap, the gap between developing and developed countries which is even more important than the gap in resources, is due in no small measure to multinational corporations. More important than the capital which corporations bring (1) are the transfer of technology, the training of human resources, and the access to international markets.

In recent years, especially following the collapse of the initiative to create a Multilateral Agreement on Investment (MAI) within the OECD, (2) there has been a proliferation of bilateral investment treaties (BITs) and investment provisions within bilateral free trade agreements. (3,4) (Some countries (such as Indonesia) have even passed laws providing similar investment guarantees, on their own.)

These agreements are purportedly designed to provide greater protection for investors, thereby encouraging cross-border investment. There is, to date, little evidence that they have done so. (5) Part of the reason is that they may in fact curtail development strategies, in ways which are adverse to growth. As the ECLAC (The UN Economic Commission on Latin America and the Caribbean) concluded, “countries often find that they have assumed obligations which, further down the road, will place limitations on their own development program.” (6)

This paper is concerned with a set of more fundamental issues. Even if it could be established that BITs lead to increased investment, and even if that investment could be shown to lead to higher growth, as measured by increased GDP (gross domestic product), (7) it does not mean that societal welfare has been increased, especially once account is taken of resource depletion and environmental degradation. These agreements are designed to impose restraints on what governments can do–or at least to impose a high cost to their undertaking certain actions. Some of the activities which may be constrained may be important for promoting general societal well-being–even if profits of particular firms are affected adversely. It is this possibility which has made these agreements a subject of such concern and debate.

These agreements are, of course, not all identical; what they do is itself a subject of some controversy. Like any agreement, it depends on the interpretations of particular words, and the judicial processes through which these words are given meaning are one of the sources of dissatisfaction with the agreements. Different arbitration panels have interpreted even the same words differently, creating a high level of uncertainty, both among governments and investors, about exactly what these agreements do. (8) This article is focused not on any specific agreement but on the general thrust of these agreements, which goes substantially beyond protection against expropriation.

Many of the agreements–including some of their most controversial aspects–are concerned with the far broader issue of what happens when changes in regulations or other government policies adversely affect the value of a foreign-owned asset. (9) The agreements do not, of course, stop governments from changing regulations, taxes, or other government polices; but they may require that the government compensate those that are adversely affected, and in doing so, they increase the costs of governments changing regulations and or other government policies. (It should be clear that these agreements are not symmetric: many government policies and investments lead to unanticipated increases in the value of assets. But while companies demand compensation when there is a change that lowers asset values, they do not offer to give the government back the increase in value from these positive changes. Indeed, attempts by the government to capture the increase in value that results from government actions that might positively impact the value of the assets might themselves be subject to investor suits, unless such recapture is guaranteed in the treaty itself. (10)

Governments, of course, are constantly changing regulations, taxes, and other policies, and making investments which have a variety of impacts on firms. The general stance in all sovereigns, especially in democracies, is that it should be the right of each government to make these changes, without paying compensation for any resulting changes in the value of assets. In the United States, the debate has centered on regulatory takings, with anti-environmentalists arguing for compensation. They know that by increasing the cost of environmental regulations, they will reduce their scope. (11) They have argued that the Constitution protects against the arbitrary taking of property without full compensation, and they have contended that such takings should even then be highly restricted, e.g. to the construction of roads. However, courts have consistently rejected that view. (12) Indeed, in a highly controversial case, the Supreme Court sustained the right of eminent domain to takings of land for developmental purposes, in which the land taken would subsequently be used by private parties. (13) Disappointed with these Court rulings, conservatives and anti-environmentalists have turned elsewhere. In some states, they have successfully passed initiatives to provide compensation for regulatory takings, (14) though such initiatives have not yet been fully tested in the courts. They have introduced legislation into Congress, but so far, such legislation has failed to pass, though legislation requiring the Administration to provide a cost benefit analysis of any regulatory taking has been approved. (15) I was in the Clinton Administration (as a member, and later, Chairman, of the Council of Economic Advisers, CEA) during a period of particularly intensive efforts by some in Congress to have such legislation adopted. There was remarkable agreement among all the offices of the White House–the Council of Economic Advisers (CEA), the Office of Science and Technology (OSTP), the Office of Information and Regulatory Affairs (OIRA) (of the Office of Management and Budget, OMB) and the Council on Environmental Quality (CEP). We all believed that such legislation would unduly circumscribe the ability to legislate needed regulations for protecting the environment, workers, consumers, and investors, and we were supported in this by President Clinton and Vice-President Gore. We successfully defeated all such efforts to provide compensation for “regulatory takings.”

My interest in the subject at hand arose partly because at the same time that we were fighting back–successfully–these regulatory takings initiatives, we were also working hard for the passage of NAFTA (the North American Free Trade Agreement), which, in its Chapter 11, contained language which has subsequently been interpreted (at least in some cases (16)) as a regulatory takings provisions. Had President Clinton known about this, I feel confident that he would, at a minimum, have demanded a side-letter providing an interpretation of Chapter 11 that precluded such an interpretation. But we never had a discussion on the topic in the White House, and I am convinced that President Clinton was not apprised of the risk of such an interpretation. (17) In the subsequent fast track passage in Congress, the issue too did not get much, if any, discussion. This highlights one of the main criticisms of these agreements–that they are, in their nature, not democratic; that, indeed, that may be their main rationale: to circumvent normal democratic processes and to get protections for investors that they would never have obtained had there been an open and public discussion. (18) If the U.S., in adopting such an agreement, was not fully aware of its import, this is even more likely to be the case in developing countries. (19,20)

The consequences are just becoming apparent, as the number of suits under these agreements has soared. One recent count has the number of cases under arbitration as exceeding 200 since the mid 1980s–entailing claims of tens of billions of dollars. (21)

In this paper, I want to focus on some foundational issues:

a) Is there a need for international economic agreements concerning the regulation of multinational corporations?

b) If there is, what should be the scope for such multinational agreements, and what global institutional arrangements might be most effective?

c) In particular, should governments have the right to restrict entry of corporations (as opposed to people or capital) from abroad? Should they have the right to insist on incorporation inside their own country?

d) Who should be protected by such agreements?

e) What should be the extent of protection of property against changes in regulation, taxation, or other government policies? What should be the standard of compensation?

f) Should these agreements be more balanced, imposing responsibilities as well as rights, and enhancing the ability of host countries to impose sanctions against those that fail to live up to their responsibilities?

g) Are there legitimate reasons that a country might wish to discriminate between foreign and domestic firms? Should investment treaties be limited to prohibiting such discrimination? What are the costs and benefits of such a restriction?

h) If the requisite global institutional arrangements can not be created (at least in the short run), what can or should individual countries do?

i) When there are disputes–as there inevitably be–how should such disputes be resolved?

The entire discussion is informed by modem economic theory, which has helped clarify the role of markets and of government, including the importance, and limitations, of property rights. In this sense, this paper is a contribution to the general theory of law and economics, but it lies on foundations that are markedly different from the predominant Chicago “Law and Economics” school, (22) which sees legal institutions as part of a system designed to ensure efficiency, promoted most effectively through free market competition combined with secure property rights. (23) The last quarter century has seen a re-examination, and a rejection, of the economic foundations on which this theory rests, and the creation of a new paradigm, based on imperfect information and incomplete markets. In this new paradigm, (24) markets by themselves are not, in general, efficient, and government intervention (sometimes even quite limited interventions, such as circumscribing conflicts of interests, as in the case of anditing (25)) can lead to welfare improvements. (26) Laws and regulation are, however, not only directed at improving efficiency but also at promoting social justice more broadly defined, including protecting those who might otherwise not fare so well in the market economy if left to themselves. This helps explain legislation and regulation designed to protect consumers, workers, and investors. In addition, there are some areas in which rules are essential: every game, including the market game, requires rules and referees. There may be more than one set of “efficient” rules, but different rules have different distributional consequences. Society, in selecting a set of rules to regulate economic behavior, has to be mindful of these distributional consequences.

In the international setting, seeming symmetric (or “fair”) rules or agreements may have asymmetric (or “unfair”) effects, because of the differences in circumstances of the countries to which they apply, including differences in their political or economic powers in enforcement, or their ability to use political powers to extract further terms in another context. When Antigua won major batter against U.S. restrictions on on-line gambling in the WTO, there was no way it could effectively enforce it: imposing trade sanctions would have hurt Antigua far more than it would have hurt the U.S. By contrast, had Antigua engaged in an unfair trade action against the U.S., any sanctions granted to the U.S. against Antigua would have been powerful. (27) After developed and less developed countries have agreed to a trade liberalization agreement, for instance, the IMF and the World Bank may insist that the developing country engage in further liberalization, if it is to receive a requested grant or loan. A drug company in the U.S. will successfully pressure the U.S. government to put pressure on a foreign country that considers issuing a compulsory license not to do so, even when the issuance of that license is totally within the framework of the WTO. This implies that one cannot look at the reasonableness of any particular agreement in isolation from a broader context–or even assess its true impact.

We look at the laws relating to corporate governance and bankruptcy through this perspective. We argue that even a narrow focus on efficiency requires going beyond frameworks that ensure shareholder value maximization, but that when a broader perspective incorporating equity as well as efficiency is taken, the case for alternative frameworks becomes even more compelling. We argue that BITs may interfere with a country’s ability to develop a legal framework maximizing society’s social welfare.

We view BITs through two different lenses–as imposing restrictions on the ability of governments to impose certain regulations (or to change certain polices), and as providing insurance to those establishing businesses within a jurisdiction against losses that might occur in the event of such changes . Imposing restrictions on their behavior may reduce regulatory uncertainty (although at a high cost), but it may not be the best way to reduce risk. As an alternative, should the market provide insurance? Normally, free market advocates think of markets as more efficient than government in providing insurance. Is there a rationale, in this case, to rely on publicly provided insurance? We will argue, however, that the way that most BITs have been designed may actually be increasing at least some aspects of risk: if risk mitigation were their primary objective, they have failed to do so in either an efficient or fair way.

Basic Perspectives

The basic perspective I take in this paper is the following: it is hard to think of a successful American economy with only state laws and no way of dealing with cross-border disputes. We have developed a finely honed system (although not without its flaws) defining what states may do. The system is designed to ensure that states do not interfere with interstate commerce and that they do not give business privileges to their residents at the expense of outsiders, but, at the same time, to provide them latitude to pass regulations and laws to protect their citizens. A host of complicated issues are raised: do minimum wage laws interfere with interstate commerce or otherwise restrict basic rights? (28) Do state environmental laws do so? There is, implicitly, a careful balancing. Obviously, any law can affect commerce, and any law restricts actions which individuals might otherwise undertake. Clearly, laws designed to interfere with interstate commerce are not allowed, but how far can or should one go in striking down laws for which this is some incidental effect? Should it be a matter of principle, which might, for instance, restrict any minimum wage legislation or any labor legislation? Or a matter of judging the magnitude of the effect? Similar questions arise in assessing whether such laws violate basic rights to contract. As we debate the question inside the United States, there are democratic processes at play at all levels. In principle, if states are enjoined from passing minimum wage laws, then the Federal government might be able to do so. So too for other pieces of regulation. But serious problems may arise when higher level bodies impose restrictions on lower level authorities, but those higher level authorities do not themselves have the right to take action. A regulatory gap may arise. (29)

Similarly, as we move to a global economy, we will need to have legal frameworks governing cross border disputes,. There will be a need to assess what regulations constitute an unfair restriction on trade. But unfortunately, economic globalization has outpaced political globalization: we have not developed the requisite democratic international institutions, either for drawing up agreements or adjudicating disputes. The international agreements we have, for instance, in trade are the result of hard bargaining behind closed doors, with the interests of special interests in the large and economically dominant countries (Europe and the U.S.) prevailing. (30)

BITs and the investment provisions of PTAs have attempted to fill in the gap, but they have done so in a way which is far from satisfactory. They are based on an incoherent set of economic principles, which leads to a failed understanding of the appropriate role of national regulation. We argue further that there is a fundamental difference between the rights of labor and capital to move across borders and the rights of a corporation incorporated in one jurisdiction to operate in another, and that it is a legitimate prerogative of governments to require that those wishing to engage in material business within their borders to be incorporated (e.g. through the establishment of a subsidiary) within the country. As the discussion below will make clear, however, these requirements are necessary, but not sufficient: there are far deeper problems with the investment agreements.

One of the problems of the BITs is that they are one-sided and unbalanced: they give corporations rights without responsibilities, compensation for adverse treatment, but not recovery of capital gains from positive treatment; they have given foreign firms protections not afforded to domestic firms, thereby creating an unlevel playing field, with perverse incentives. (31) There are good reasons that governments have not provided these guarantees to domestic firms–and there are good reasons that they should not be provided to international firms.

I approach these issues from the perspective of an economist, an economist that sees institutions like “corporations” and “property rights” as social constructions, to be evaluated on how well they serve broader public interests. Individuals have rights–the kinds of rights inscribed in the Bill of Rights. Individuals may have certain rights to act together collectively, but there is no inherent right, for instance, to limited liability, which defines corporations. Limited liability is a social construction which has proven very useful; indeed, without it, it would be hard to imagine modern capitalism. (32) But the circumstances in which the corporate veil can be pierced, the “rights” which ought to be granted to these limited liability institutions (including the right to enter a country), or the extent to which the officers of these institutions should be held liable for the actions which these institutions take, is a matter of economic and social policy. To repeat, they have no inherent rights. (33)

Thus, an analysis of the desirability of extending to corporations certain rights is quintessentially a matter of economic and social analysis–to ascertain what are the consequences of one set of provisions or another. The intent of this paper is to provide this analysis.

Readers will see a close parallel between the approach taken here and that taken by Adolf A. Berle and Gardiner C. Means in their classic work, The Modern Corporation and Private Property. (34) They called attention to the separation of ownership and control and explored the implications for property fights. My 1985 (35) paper helped put Berle and Means on solid footings; it provided information theoretic foundations for the separation of ownership and control and helped explain why effective control is not exercised by shareholders. (36) It also helped begin the modero discussion of corporate governance. (37)

One more preliminary caveat: one of the problems with the bilateral investment agreements is that they invoke inherently ambiguous terms (“fair and equitable treatment”); the adjudication process often invokes standards of commercial secrecy, even though one of the parties to the suit is a public entity in which there should be high standards of transparency; different arbitration panels can come to opposite conclusions in almost identical cases; (38) and there is typically no way in which such differences get resolved. Since a large fraction of the agreements are of recent vintage, there is considerable uncertainty about what they may imply. In the long run, greater balance may be achieved than has sometimes been the case in the past; (39) and the fears expressed here may prove unwarranted. Part of the intent of this paper is to influence the evolution of this critical area of law.

Outline of the paper.

The second section, “Problems Posed for Multinationals,” provides a brief reprise of the important contributions of multinationals–and of the special problems that they pose, problems that may be somewhat different from those posed by domestic firms; it describes the benefits they have brought but also explains why they have been subject to such criticism. The third section provides the core of the economic analysis. It articulates the market fundamentalism position underlying many of the arguments of free market advocates, including those stressing the importance of property rights protection (sometimes referred to as the Chicago school). It explains (a) why under those perspectives there would be no need for bilateral trade agreements; but (b) why these ideas have been rejected by modern economic analysis. On the basis of this, it explains why government regulation is required and applies that analysis to explain the need for government rules governing corporate governance and bankruptcy.

A key question is whether there is a single “best” set of legal institutions–for instance, a single Pareto Optimal (40) set of corporate governance and bankruptcy laws. If there is, then it would make sense to standardize legal frameworks; but it there is not, it does not. In the fourth section, we explain why there is not a single Pareto dominant legal framework, and accordingly why standardization may be undesirable. (41)

The following sections then apply this analysis to several of the central issues under dispute in the controversy over investment treaties:

(a) What rights should foreign firms have to establish themselves? We argue in “Implications for Bilateral Trade Agreements: Rights of Establishment” against even the limited rights to establishment embodied in many of the recent investment treaties.

But the various problems with BITs will not be solved merely by requiring foreigners to incorporate local subsidiaries in the host state. Rather, the treaties themselves need to be restructured. (42)

(b) Who should be protected and against what “measures” (actions)? With what “standards”? For instance, should there be protection simply against discrimination, or against actions which are inconsistent with principles of “fair and equitable”? If the latter, what is to be meant by such words? What should be the standard of compensation?

There is little dispute about the issue of protection from explicit expropriation. (43) “What Gets Protected? Regulatory Takings” looks at one of the critical ways that the BITs go well beyond protecting against expropriation, to protecting against changes in regulations–or even the effect of existing regulations. We argue that such protections can undermine economic efficiency and can be contrary to basic principles of social justice, particularly given the standards that have sometimes been invoked.

Of course, the bilateral agreements do not prohibit governments from undertaking various actions; they simply require the government to provide compensation. But for cash strapped governments, the effect may be much the same. The seventh section, “Standards of Compensation”, addresses the issue of compensation, arguing strongly against the broader compensation sometimes required (which includes lost profits (44)) but also suggesting that even compensation for reduced value of investments may be problematic.

“Rights and Responsibilities” argues that the investment agreements have been one-sided, that they have given foreign companies rights without imposing responsibilities, or without even facilitating the ability of developing countries to ensure that the multinational corporations live up to their obligations.

One of the most criticized aspects of these agreements is the dispute resolution mechanisms: the use of arbitration courts, designed to settle commercial disputes, to enforce an agreement on a government. The processes often lack the openness and transparency that we have come to expect from judicial proceedings in a democratic society and have often shown little regard to broader societal concerns, as they focus exclusively on the rights of investors. The section titled “Dispute Resolution” argues that there is much merit in these criticisms and proposes reforms in the adjudication process, including the creation of an international commercial court.

The problems in regulation uncovered in previous sections highlight the need for a better international framework for governing cross-border economic activities, a subject taken up in “Towards Regulating Multinational Corporations Globally.” We emphasize two core principles: (a) minimizing the scope of such agreements to standards that are viewed as absolutely essential for the conduct of cross border business; and (b) non-discrimination (“Non-Discrimination”).

The next sections take up two of the key criticisms of the bilateral agreements: they are not designed in ways that make the appropriate legal evolution possible. It is difficult to correct “mistakes” either in the design of the treaties or the interpretation of the provisions (further reinforcing the argument for a limited scope for such agreements). Furthermore, the political processes underlying these investment agreements are fundamentally undemocratic.

The final section provides concluding remarks: balance needs to be restored to the governance of cross border economic relations. Countries should be extremely cautious in signing bilateral investment treaties (especially the more expansive agreements that go beyond nondiscrimination). And it provides support for the initiatives of several countries (Ecuador, Bolivia, Czech Republic) and others for revising existing agreements. There needs to be a serious rollback in the agreements already signed.

PROBLEMS POSED BY MULTINATIONALS

For all the reasons given earlier, multinationals have brought enormous benefits. Today, countries around the world compete to attract multinationals; they boast of having a business-friendly environment. And foreign capital has poured in to developing countries, increasing six fold between 1990 and 1997, before it slowed (and reversed) as a result of the East Asian and global financial crisis. (45)

But for all the benefits they bring, multinationals have been vilified–and often for good reason.

In some cases they take a country’s natural resources, paying but a pittance while leaving behind an environmental disaster. (46) When called upon by the government to clean up the mess, they announce that they are bankrupt: all the revenues have already been paid out to shareholders. They take advantage of limited liability. (47)

In some cases, when the adverse consequences of their actions are criticized, the MNCs plead that they are simply following the law; but such defenses are disingenuous, for they often work hard to make sure that the law is the law that suits them well and maximizes their profits.

Consider, for instance, the regulation of cigarettes. We–and I include in the “we” the cigarette companies (48)–have known for decades that cigarettes are bad for one’s health, but the cigarette companies have deliberately tried to create confusion about the scientific evidence. While they have worked hard to stop regulation, they have also worked hard to make sure that they do not bear any liability for the enormous costs that result from their dangerous products. (More recently, Exxon has engaged in a similar attempt to discredit the science of global warming. (49) When BP owned up to the risks of global warming, it was castigated by the other members of the oil club, for a while almost treated as a pariah.)

In developing countries, there are widespread allegations of corruption–and many contracts that only make sense when seen in that context. For years, many countries provided tax deductions for bribes; in effect, Western governments were subsidizing them, even though they undermined democratic governance abroad (and even as they lectured them about the importance of governance). I was the U.S. representative to the OECD ministerial meeting in the mid-1990s, when the U.S. was pushing for the anti-bribery Convention. I was shocked by the resistance.

The problem is more pervasive. Companies, like BP and Hydro, that have made ah effort to make their transactions more transparent, have not met with support from their colleagues. (50) This puts the “good” guys at a competitive disadvantage.

Why Foreign Multinationals May Present a Worse Problem than Domestic Corporations

Problems of corporations taking advantage of limited liability, to escape, for instance, responsibility for their environmental damage, (51) and using their enormous financial powers to frame legislation to their advantage arise with domesticas well as multinational corporations. What then is distinctive about multinationals?

First, their economic powers are huge—often far larger than that of the countries with which they are dealing. The revenues of GM are greater than the GDP of more than 148 countries; while Walmart’s revenues exceed the combined GDP of sub-Saharan Africa. It is an unfair playing field. Not surprisingly, they often try to use their economic power to create a playing field that is even more unlevel, getting for themselves special tax or regulatory treatment.

Sometimes, they do this in ways that are above board, such as through campaign contributions (which have proven so corrosive of democratic processes even in strongly established democracies, such as the United States, but whose adverse effects are likely even greater in the nascent democracies of much of the developing world).

Sometimes, they exert their influence simply through the threat of leaving: if environmental of worker safety regulations are enforced, or if they are asked to pay their fair share of taxes, they will go elsewhere, where governments are more compliant with their wishes. (The asymmetries in liberalization–with capital markets being far more liberalized than labor markets—have enhanced the effectiveness of such threats.)

But sometimes, they engage in corruption (bribery): the developing countries with which they deal are often weak, and salaries of government officials are generally very low, making these countries particularly susceptible to corruption.

Secondly, these companies often leverage their own economic power with the power of their governments, to get even better terms. A drug company in the U.S. will successfully pressure the U.S. government to put pressure on a foreign country that considers issuing a compulsory license, even when the issuance of that license is totally within the framework of the WTO. (52) Poor aid-dependent countries are particularly susceptible to such political pressures, for there is always a (veiled or unveiled) threat to reduce the assistance which is necessary for their survival. (53)

Companies will get their governments to force a renegotiation of a contract, when it turns out unfavorable to their companies, e.g. as a result of underbidding, (as was the case of some of Argentine’s water concessions) but, not surprisingly, they will put pressure on the country not to renegotiate when it turns vastly unfavorable to the country, e.g. as a result of overbidding. (54)

This is even true when there is evidence that the unfavorable provisions were the result of corruption (as in the case of Suharto’s Indonesian contracts). (55) Corruption (at least in appearances) does not, however, seem to be limited to the developing countries: In more than one case, it has turned out that the Western ambassadors that put pressure on the countries not to renegotiate wind up on the Boards of Directors of the Western companies whose interests they served.

Thirdly, sometimes multinational corporations take advantage of the lack of administrative capacities and technical expertise in developing countries, to get away with things that they could not get away with in developed countries. Of course, even in developed countries, they try: several oil companies systematically cheated on their contracts with Alaska, hoping that their shaving off just a few pennies on every barrel would not get detected; but a few pennies a barrel times billions of barrels adds up. Through sophisticated detection techniques, costing millions of dollars, they were caught and prosecuted; the oil firms eventually agreed to pay more than a billion dollars to Alaska. (56) But this was not the only such case: Exxon similarly cheated on its contract with Alabama, assuming again that they could just get away with it. (57’58) But if the oil companies attempt to get away with such practices in the U.S., what must be the case in developing countries?

Worse still, some multinationals are using the lack of administrative capacity as a basis of making claims against developing countries (even though they should have been fully aware of these limitations at the time they made the investments) under Investment Treaty provisions providing for “fair and equitable treatment.” Governments have been held liable for not providing “fair and equitable treatment” by virtue of not offering foreign investors an administrative apparatus which is sufficiently transparent, competent, responsive, and efficient; arbitration panels have set very high levels of obligations for developing countries. (59)

Fourthly, sometimes multinationals, and the governments of advanced industrial countries who represent their interests, take advantage not only of asymmetries of power (60), but also of information. The U.S. has bargained with dozens of countries. It knows what are likely to be sensitive clauses, provisions can have large effects, either in terms of benefits or costs. It has large staffs which can write, review, and analyze such agreements, clause by clause. And if these advantages were not enough, it is assisted by well paid corporate lobbyists and lawyers, who are even more sensitive to the consequences of each provision. Because of the size of its economy, it has virtually every industry that might be affected by the agreement, and they are, in effect, at the table. By contrast, the developing country has a small staff. What is at stake are not just the industries that are currently present, but those that might be established in the future; but these industries have neither lobbyists or lawyers to represent their interests. And even when the developing country does realize that some provision proposed by the U.S. is bad for it, or identifies a provision that might be favorable to its growth prospects, chances of it persuading the U.S. (or any other advanced industrial country) to change the “template,” the standard agreement is nil, especially if the provision touches on any important U.S. interest. Trade negotiators from several developing countries engaged in “negotiations” with the U.S. have repeatedly said, these are not negotiations in any meaningful sense. There can be some negotiations around the edges–whether the transition period will be two or three months or a year. But on any core issue, there is no give. America will say: if we give you better terms, we will have to give it to everyone other country. (61)

Fifthly, multinationals sometimes take advantage of their cross-border activities to insulate themselves from accountability. In old cowboy movies, the sheriff chases the bandits to the state border–the bandit knows that once he crosses the border he is safe. So too for the modern corporation: the U.S. has refused (without explanation) to extradite the Union Carbide officials, so that they could be held responsible for the mass loss of life at Bhopal, India.. Even when economic judgments are reached against corporations in one jurisdiction, it may be difficult to enforce them in another. Smart multinationals know this and move assets out of jurisdictions where claims might be brought against them.

Finally, and perhaps most importantly, companies often act differently abroad than they do at home, a result perhaps of beliefs of differences in public sensitivities, perhaps of differences in moral sensibilities to foreigners (rationalized with arguments like, “they are lucky to have a job”); moreover, individuals are always more sensitive to peer pressure from those they view as their peers.

While advanced industrial countries have been adamant about developing countries opening up their economies to investors from abroad, western countries have not fully reciprocated. More recently, the U.S. has shown anxiety concerning China’s purchase of a relatively small American oil company, UNOCAL, much of whose assets lie outside the U.S. (including in Asia.) It expressed concern too about the purchase of ports by a firm owned in Dubai. Europeans have expressed worries about the purchase of gas transmission companies by Gazprom, the Russian gas company. The G-7, as a group, expressed concern over the growth of sovereign funds, pools of money owned by foreign governments that are investing substantial amounts of money in their countries. Are these attempts to bloc foreign investors just another example of Western hypocrisy, so evident in the sphere of trade? Are these anxieties reasonable? If so, they suggest a broader set of protections that home countries need to take against foreign investors that have typically been incorporated in the Investment Agreements foisted on developing countries. As we shall see at the end of the next section, the debate about sovereign funds helps highlight important limitations which should be imposed on the investment agreements.

Conflicting Demands for Legal Frameworks

The perceptions (and reality) that multinationals bring problems as well as benefits has put them in the center of enormous controversy. Demands for more regulation have been met with demands for stronger protection. Multinationals have put forth a list of demands that they want of countries where they operate–for instance, low taxes and regulation, rights to move employees and capital in and out–but citizen groups have also put forth a list of demands of foreign companies that operate within their boundaries (making contributions to national development efforts, acting in ways consistent with domestic laws and regulations, and the absence of special treatment). Worried about these demands, in recent years, multinational corporations have sought to achieve a greater degree of protection for their investments abroad through international treaties. (Of course, as a formal matter, it is the governments of the home countries of these multinationals that have sought and signed these agreements. But trade ministries (in the U.S., it is the US Trade Representative) typically represent the interests of the large multinationals; indeed, their lobbyists even accompany the USTR as it engages in negotiations, to ensure that the outcomes reflect their interests. (62))

Corporations have, in addition, sought uniformity–but the uniform terms which they have sought are those that are favorable to their interests. The desire for greater protection of property and greater uniformity is understandable–uniformity may lead to lower costs, and greater protection may lead to lower risk premia, and in a competitive world, both may lead to lower prices and higher output.

The failed attempt at a multilateral investment treaty described earlier–and the many successful bilateral agreements—-can be seen as a response to these concerns. Before turning to an analysis of what is wrong with these agreements, we need to put the broad issue of corporate regulation in perspective.

ECONOMIC THEORY AND THE REGULATION OF INVESTMENT

Free Market ideology

Free market ideologies which have provided what passes for as the intellectual foundations of much of the recent global economic legislation would suggest that no global agreements are in fact needed. Countries, competing with each other, pursuing their own self-interest, would presumably arrive at a set of policies (regulations) which are globally efficient. They would provide the optimal degree of property rights protection. If there are advantages in standards, standardization–around the right standards–would emerge, on its own. The most that would be required is some mechanism for contract enforcement; but modern theories of reputation would suggest that even this may not be required: countries that did not live up to their commitments would lose their reputation and would be unable to recruit capital.

There is a curious–but hardly surprising–inconsistency on the part of the advocates of strong international economic agreements providing investor protections: they often seem to believe in free market ideologies, yet want strong government intervention in setting standards (often, however, only in some directions, not in others), including standards for property protection (as in the multilateral investment agreements). I say hardly surprising, because when I served as Chairman of the Council of Economic Advisers, I was continually beset by pleas from business interests for protection and subsidies: everybody believed competition was good in general–but in their industry, they would complain about unfair or destructive competition; everybody believed that subsidies were bad (especially hand-outs for the poor)-but that their industry needed help, often in the form of tax breaks or loan guarantees, for one of a myriad of reasons.

There is a second curious–but again hardly surprising–inconsistency on the part of the advocates of those who want strong “rights of establishment,” the rights of foreign companies to open up business in any country. This position is typically taken by those who believe that free markets and full competition is necessary (and almost sufficient) to attain economic efficiency. But in the perfect markets views which underlie such presuppositions, ownership and control simply do not matter. Any owner would do exactly the same thing; indeed, it would make no difference whether the firms were controlled by workers, maximizing their wage income, subject to the constraint of being able to raise capital, or by shareholders, maximizing their profit, subject to the constraint of being able to get workers. (63)

To be sure, few people (on either side of these debates) believe that to be the case; but that simply means that few people–including strong advocates of market based solutions-believe in the assumptions that must be satisfied if markets, by themselves, are to yield efficient outcomes.

Central ideas of free-market economics underpinning the theory of regulation. Three key ideas underlie much of current thinking about free-market economics, and much of the law and economics literature is predicated on these ideas:

Myth 1: Adam Smith’s invisible hand. Adam Smith’s notion is that individuals and firms in the pursuit of their self-interest, guided only by competitively determined prices, lead the economy, as if by an invisible hand, to economic efficiency. (64) There is only limited need for government intervention, e.g. dealing with externalities.

Myth 2. Coasian bargaining But Ronald Coase (65) suggested that even when there were externalities, one shouldn’t worry: all we need to do is assign clear property rights, and market participants will, through a process of bargaining, arrive at an efficient outcome.

There is a grain of truth in both of these ideas, but unfortunately, only a grain. Research over the past 30 years has shown that these propositions hold only under highly restrictive conditions—conditions not satisfied by any modern economy. (66) Economists had long recognized that markets are not efficient when there are externalities and public goods (though, as noted, Coase had suggested that even then government intervention was not required). But the major shift in the economic paradigm (67) resulting from the economics of information established that markets do not lead to efficient outcomes whenever information is imperfect (asymmetric) and when risk and capital markets are incomplete (68)–that is always; more precisely, it can be shown that the market allocation is not, in general, constrained Pareto efficient. (69) (Pareto efficiency simply means that no one can be made better off without making someone worse off; it embraces not only production efficiency–more of one good can only be produced if less of some other good is produced–but also exchange efficiency, ensuring that goods go to those who value them relatively the most. Constrained Pareto Efficiency simply means that no one can be made better off without making some one else worse off, taking into account the imperfections of information and the limitations in markets, and the cost of obtaining information and creating markets.) In short, there is no longer a presumption that markets, by themselves, will lead to efficient outcomes. Indeed, the presumption is the opposite.

When information is imperfect, markets are rife wit

When information is imperfect, markets are rife with externalities. For instance, if some individuals smoke more, it will drive up health insurance premiums. When insurance companies cannot observe whether individuals smoke or not, part of the costs of individuals who smoke is borne by non-smokers. There is an economic inefficiency, a market failure, which judicious government intervention (taxes on cigarettes or regulations) can help ameliorate.

Unfortunately, Coasian bargaining simply cannot deal with these market imperfections, because of the underlying problem of lack of information: non-smokers cannot tell who the smokers are, to force them to compensate them for smoking. But even in simpler contexts of ordinary externalities, Coasian bargaining will not lead to Pareto efficiency, so long as there are transactions costs and information asymmetries. (70) The externalities associated with imperfect information (and incomplete markets) are so diffuse and pervasive that it is inconceivable that they could be addressed through Coasian bargaining; but the information imperfections themselves mean that the kind of compensation envisioned in Coasian bargaining (where, in a world with well-defined property rights, those imposing external costs on others compensate them for the damage they suffer) is impossible. (71)

Equity. Of course, even if markets were efficient, efficiency is not everything: in particular, the market may result in a distribution of income which does not comport with any system of social justice, and accordingly governments might want to intervene in the market allocation. But the “free market” school has an easy answer:

Myth 3. The Neoclassical dichotomy. Issues of efficiency and equity can be separated. The government can achieve any distribution of income it wants (any Pareto efficient outcome) simply by redistributing initial endowments. (72) In designing regulation, the government should simply focus on efficiency.

But redistributions are costly. The modern information paradigm has explained why that is the case, and why the distribution of income itself may have consequences for efficiency. The implication of this, in turn, is that distributional objectives need to be taken into account in the design of regulatory regimes. (73)

The important conclusion of this subsection is that giving greater security to unfettered property rights does not necessarily lead either to greater efficiency or higher levels of social welfare. If bilateral trade agreements are to be seen as part of a welfare enhancing agenda-and not just as a means by which rich and powerful countries exploit weak developing countries–this perspective must be taken on board in interpreting the provisions of bilateral investment agreements.

The need for international regulation. Even if there is a need for government regulation, it does not mean that there is a need for international regulation, agreements that bind what a government can do. Indeed, standard beliefs in the efficacy of competition among communities would argue the opposite.

Myth 4. Tiebout competition. Communities competing against each other would ensure that the legal environment which ensured economic efficiency would be established. People would migrate to communities (countries) with strong property rights, and away from those without it. (74)

In a sense, Tiebout’s argument is more robust than that of Smith and Coase; because in Tiebout’s world, there might be imperfections in markets that necessitated government intervention. But each country would have an incentive to adopt the optimal regulatory system. But given the restrictive conditions under which market competition ensures economic efficiency within a country, it is not surprising that competition among communities does not in general result in efficiency globally. (75)

It should be clear, however, that much of the demand for international regulation is not related to failures of Tiebout competition, and virtually none of the argumentation for such regulation is based on this analytic framework. Rather, the argument seems to be that the business community in the advanced industrial countries believes that developing countries have not provided as strong of property rights protection as they would like, and they use their political leverage to get in developing countries protections that they have not been able to get themselves in their own countries. (76) In short, it is a distributive motive, though cloaked in an efficiency rationale: it is argued that it would be good for the developing countries. But if it were good for developing countries, presumably they would have adopted such regulations on their own.

About Widya Setiabudi Sumadinata

I'am a lecturer at Department of International Relations, University of Padjadjaran, Bandung, Indonesia.
This entry was posted in Multinational Corporation in World Politics. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s