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  Free Trade Area of the Americas - FTAA


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March 2, 2004

riginal: English - Spanish
Translation: non FTAA Secretariat




Name(s) Laura Páez, Trade and Development Analyst
Country Venezuela

FTAA ENTITIES (Please check the FTAA Entity(ies) addressed in the contribution)

Negotiating Group on Agriculture   Committee of Government Representatives on the Participation of Civil Society  
Negotiating Group on Competition Policy   Consultative Group on Smaller Economies X
Negotiating Group on Dispute Settlement   Technical Committee on Institutional Issues (general and institutional aspects of the FTAA Agreement)  
Negotiation Group on Government Procurement   FTAA Process (check if the contribution is of relevance to all the entities)  
Negotiating Group on Intellectual Property      
Negotiating Group on Investment X    
Negotiating Group on Market Access    
Negotiating Group on Services X  
Negotiating Group on Subsidies, Antidumping and Countervailing Rights    


The Legal, Economic and Policy Implications
of the Investment Chapter in the FTAA

Laura Páez
Rue des Lattes 59-3
Meyrin, 1217 Geneva
Tel: 00 41 (0)79 3223627
December 30, 2003.





a. Structural Reform and Adjustment

b. A Retrospective Scan of the Regional Institutional Framework

c. The Role of Regional Integration: motivations and shortcomings


a. Evolution of the Legal Treatment in the Americas

b. Regional Mechanisms

c. Multilateral Mechanisms


a. Legal Analysis

b. Proposed Legal Framework on Investment in the FTAA

c. Cross-comparison with Multilateral and Regional Mechanisms


a. Theoretical Analysis

b. Literary Review

c. Theoretical Foundations

d. Empirical Analysis


a. Policy Implications of the FTAA Investment Chapter

b. Final Observations and Recommendations



TABLE 1: Evolution of the FTAA Draft Chapter on Investment

TABLE 2: A Comparison of the Regional and Multilateral Regimes on Investments

TABLE 3: Gravity Model Estimation

TABLE 4: Subgroup Specification Test for Bolivia and Peru



The following paper analyses possible legal and economic arguments supporting the inclusion of an investment chapter in the Free Trade Area of the Americas (FTAA), which is currently on the negotiating agenda. In particular, by looking at some of the former integration efforts and their contribution to investment protection, it draw lessons from these previous experiences, in an attempt to determine what could realistically be expected from the FTAA. Further, provisions in existing FTAs are compared with the FTAA proposal on investment, in order to determine if the latter will either congest or genuinely enhance investment protection.

From a legal perspective, the cross-comparison of existing agreements reveals that the FTAA investment chapter could have the positive effect of raising protection and harmonizing treatment in the region. However, the economic rationale for the FTAA fostering investments is not so strong. Existing FTAs with investment provisions have promoted trade rather than investments, as the empirical analysis reveals.

In the particular case of Andean countries, evidence on substitution is found, where sourcing countries prefer to trade rather than invest. This means that the FTAA is likely to promote trade rather than investments in that region, as the previous experiences with the Andean Community of Nations (CAN), NAFTA and the Group of 3 suggests. Therefore, despite the inclusion of an investment chapter in the FTAA and its positive effect of raising legal certainty, FDI is not expected to increase as a result of higher protection.

Therefore, if countries are to benefit from the spillovers of greater capital flows they must focus on economic policy design in the FTAA context. In the light of the unsatisfactory reforms in South America, the negotiation outcome of the investment chapter will greatly determine the extent to which members may define their policy and development strategies.


The 1980s and 1990s evidenced a proliferation of both bilateral and regional integration efforts in South America, in a context of economic restructure and reform. Rapid changes in the international scene due to globalization, the experience of a debt crisis and the failed success of adopted development models, contributed to a reshaping of political, economic and social priorities in the region.

A new approach towards development translated into export-oriented growth strategies and trade liberalization, and with it an increased need for foreign capital and support. South American countries deepened integration by reforming the now extinct Latin American Association of Free Trade (ALALC)i, and Andean Community of Nations (ACN) by creating new regional groups, such as the Group of 3 (G-3) and Mercosur (Common Market of the South). Furthermore, bilateral trade agreements celebrated between countries of Latin America and other regions, such as North America and Europe, were very prolific.

In the field of attracting foreign capital, debt refinancing with the multilateral lending institutions and a “loss of faith” from foreign lending partners, reduced the possibility of a much-needed financial bailout. Further, an increased awareness that growth and development could only be achieved with the aid of long-term investments, paved the way for incorporating sections on investment protection in bilateral and regional free trade agreements, revived the enforcement of existing investment agreements, and promoted efforts to celebrate new ones.

The region experienced some important trade growth in the decade of the 90s’, because of integration and reform. More importantly, investment flows expanded, either directly or indirectly because of the numerous investment agreements, trade growth and other positive economic signals. This benefited the economies, though arguably not to the extent it could have been desirable, because inherent shortcomings arising from the former “lost decade” impeded a full capturing of positive spillovers.

In the context of present hemispheric integration efforts under the FTAA, it is necessary to assess if the economic environment favors FDI in tandem with trade liberalization and development objectives in South America. Most importantly, it is crucial to determine if the opportunity for capturing the spillovers deriving from the interactions between trade and FDI in the FTAA is given.

The present paper approaches these concerns from both a legal and economic perspective. Chapter I introduces a characterization of the economic environment in South America, since the 1980s, paying particular attention to the post-debt reform process crisis and its achievements. The evolution of regional integration and its importance in the last two decades as a relevant basis for both national and regional objectives, development strategies and policy design, is also explained, in order to understand the role of FDI in this context.

The second part of the present study focuses on the legal framework, which regulates FDI in the region. First, a close insight into existing regional and multilateral agreements is given. Chapter III then makes a cross-comparison between the legal provisions in the Andean Community of Nations (CAN), NAFTA and the FTAA Draft Proposal. The purpose is to establish if the FTAA will contribute to investment growth and legal certainty, or merely generate an overlap with the existing rules.

After establishing the legal arguments in favor of FDI provisions in the FTAA, Chapter IV deals with the assessment of an economic rationale supportive of these provisions. Here, a model for analyzing the relationship between trade and investment flows under the regional framework of the ACN, NAFTA and the Group of 3 (G-3) is developed and tested, based on existing empirical approaches. Results on what role regional agreements have played in promoting these flows in the past are analyzed to understand how a hemispheric project could affect FDI in the ACN.

Finally, conclusions and recommendations are given in Chapter V, based on the results of the empirical and legal arguments. In the light of existing policies, economic performance and shortcomings of the Andean region, recommendations on a more effective policy design for capturing positive spillovers and backward linkages resulting from trade and FDI in the context of the FTAA are provided.



a. Structural Reform and Adjustment

i. The Debt Crisis and its Impact on South America:

In the 1980s, South American countries experienced and increase in both government and private expenditure, spurred by excessive public spending in ambitious national development projects, inefficient allocation of resources and high inflation. Many looked for financing abroad, and resources were mainly provided by oil producing countries, which were experiencing a boom in oil revenue thanks to international prices and were willing to lend at low interest rates.

The situation eclipsed in 1982, when lenders could no longer offer credits under previous conditions. Indebted countries were unable to face their financial compromises due to increased interest rates and declared themselves in crisis. Along with the renegotiation of debt payments, there was the internal and external pressure pushing for a tightening of government expenditure together with a series of radical reforms at high costs.ii A first wave of pro liberalistic reform was undertaken, mainly focusing on devaluation, reduction of salaries and employment, increasing interest rates, and the shut down and sale of government enterprises and assets. Instead of improving, the situation worsened and retarded recovery. The economic and social cost was immense, and many countries have not yet been able to overcome the impact of these first reforms, which lead to a subutilization of productive capacity, increasing unemployment, and deterioration of salaries, among other maladies.

The events described above were known as the “debt crisis”, and were the result of foreign debt with private banks. Triggering a succession of badly chosen measures, this period of first reforms became a “lost decade”, as some prefer to call it, in the light of its unsatisfactory achievements.

ii. Economic Environment in the Context of Structural Reform:

Economic performance post debt crisis was also highly unsatisfactory, due in large part to the import substitution model adopted since the 1960s. This reform strategy, was a total contrast to Chilean and the SE Asian export promotion efforts of the time.

Low levels of capital formation, and underutilization of productive capacity and production, provoked an expected fall in productivity in the 80s. This recession further deepened because of a financial crisis, impoverishment of the terms of trade, and decreasing demand, resulting in a drastic fall of the GDP, a deterioration of income distribution and increased poverty. Thus, after the 80s, there was a need for a redefinition of economic policies together with a sound development proposal.

As mentioned, Chile became the exception by undertaking two reforms processes: the first between 1974 and 1979, and the second in the 80s. The first reform comprised of changes in commercial policy by eliminating non-tariff barriers, lowering tariffs and unifying the exchange rate. Non-traditional exports were promoted, import substitution industries were protected, the exchange rate was appreciated, a big inflow of foreign capital was welcomed and a uniform tariff of 10% became effective.

The second reform in 1982 corrected for the undesired appreciation, the increase in import consumption and disequilibria in the balance of payments. A triple external shock (increase in interest rates, fall in international copper prices -Chile’s main export-, and a suspension of foreign credit) pushed for a more flexible commercial policy. This policy foresaw the use of anti-dumping margins, a price band system in line with international standards in order to favour agriculture, and the fine-tuning of the drawback system of payments.

iii. Reform Evolution in Latin America: Evaluating the Adjustments:

South America underwent several reforms, since the 80s. The outcome has not been satisfactory, due to growing instability, poor socio-economic conditions, and a history of cyclic crisis. In the 90s, reforms were redesigned to favor macroeconomic stability. In particular, steps toward tightening government spending, promoting savings, controlling for inflation (often targeted at one digit-level), maintaining international reserves, and promoting exports, have been taken. Despite the more qualitative approach, in comparison with the first neo-liberalistic reforms, non-economic concerns such as judicial reform, social security and education have been left out.

Thus, the result has been a generalized disequilibrium, between the achievement of some goals and a lagging of others, creating more instability. Correcting for undesired effects whilst seeking equity, social development and democracy, has become necessary.

Poor reforms have also provoked an underutilization of productive capacity, increased vulnerability to external shocks and unsustainable macroeconomic policies. Instability has been distributive, especially affecting the more vulnerable ones, since the more resourceful sectors have adjusted to recessions by benefiting from growth periods.

An alternative proposal to the existing reforms is the creation of a market economy, generating a healthy equilibrium between market functioning and State governance. However, public policy design under ECLAC has avoided a neo-liberalistic policy approach, arguing the impact of liberalization on the more vulnerable sectors would be too harmful in the absence of government intervention.

Instead, reforms under the ECLAC propose “neo structuralism”,iii which takes into account the functioning of the markets and their interrelation with economic agents, seeking multiple equilibrium. Resources are oriented towards physical and human capital formation, where long-term investment plays a leading role. This is a radical shift away from the traditional import substitution model.

The new focus is toward a growth strategy based on export promotion, borrowing from the Chilean and SE Asian experience. However, international competitiveness not only represents a challenge from an economic view, such as stable exchange rates; access to inputs, market size and market penetration, and new products generation. Institutional support towards export activities (financing, capacity building, promotion, etc.) is also a crucial component, for developing a competitive edge in non-traditional exports.

b. A Retrospective Scan of the Regional Institutional Frameworkiv

i. Evolution of the Integration Process:

1) The Latin American Association of Integration (ALADI)

One of the first integration attempts was the Latin American Association of Free Trade (ALALC), originating from a series of interstate conferences under the patronage of ECLAC between 1959 and 1960. Established by the Treaty of Montevideo (1960), its objective was the creation of a common Latin American market, starting with a free trade area, which would gradually eliminate tariffs, and eventually become a customs union.

Despite the effort, delays in implementation and member disparities soon rendered ALALC a failure. The majority of ALALC members felt integration was only benefiting a subset of countries, namely Argentina, Brazil and Mexico. This provoked discontent among many, and there was little disposition to cooperate. Further, increasing political instability, lack of collective leadership and absence of a reform alternative, delayed the institutionalization and legitimization of this regional project.

In 1980, ALALC was relaunched as the Latin American Association of Integration (ALADI)v; in response to the former failed attempt. The new institution took into account former limitations by relaxing the implementation scheme, whilst maintaining the goal of creating a common market. Among its objectives, was the diversification of products, destinies and origins of trade, as well as strengthening democracy and increasing international negotiating power.

In the past decades, ALADI members have signed over 80 agreements (bilateral and subregional) in diverse fields, such as trade, tourism and transport. However, it is not until the 90s that “new generation” agreements became prolific, paving the way towards a FTA among all members by 2005. Currently, 11 “new generation” agreements exist, including 2 customs unions and 9 FTAs, with liberalization, cooperation and economic complementation as their main goal. These agreements are mainly characterized by:

- Phase-out of non-tariff barriers on trade between members

- Common trading rules (e.g. rules of origin, safeguards, and dispute settlement)

- Formal adoption of WTO rules on aspects of trade regional trade policy

- Common norms on investments, physical integration, energetic cooperation, transport and communications, intellectual property, tourism and others

These new era agreements broaden and deepen integration like never before. Further, they have been formally acknowledged in official country declarations and decisions, receiving recognition and support. Members have also stated a renewed will to seek development through integration, in line with WTO and FTAA compromises.

2) The Andean Community of Nations (ACN)

The Andean Pact originated from the Agreement of Cartagena (1969), under the auspices of ALALC, integrating the Andean countries into a common market. It later became the Andean Community of Nations (ACN) as of 1982, a subregional customs union of 5 Andean countries, namely Bolivia, Colombia, Ecuador, Peru and Venezuela. The main drive for the creation of the ACN was the disparities among the signatory countries of ALALC, described above.

Under the aim making the region apt for competition in world markets, achieve full employment and improve welfare, ACN has attempted to reduce its dependency and vulnerability from the rest of the world, and in particular, industrialized countries. Its main achievements are the creation of a common external tariff (CET), a common tariff classification (NABANDINA) and a system for the rules of origin.

ACN has a FTA among 4 members, which is to be fully implemented by 2005. A generalized system of preferences, for the less developed members (i.e. Bolivia and Ecuador) is also in place. Current perspectives of the ACN are summarized as follows:

- Physical, communication and transport integration

- Perfecting the Andean Price Band system

- Services sector liberalization by 2005

- Harmonization of macroeconomic policies

- Common safeguards towards third countries

- Amplify foreign relations, to deepen them regionally and adapt them to globalization

3) The North American Free Trade Area (NAFTA)

NAFTA came into being in 1995, and is the first FTA in the hemisphere where developed and developing members share a common market. Apart from promoting free trade and investment in the region, it also considers fair competition, intellectual property protection, solution of disputes, regional and multilateral cooperation, environmental laws and regulations on labor rights.

The agreement includes a comprehensive set of measures on goods, trade and tariffs; market access; a system of rules of origin and technical standards; health and phytosanitary standards, and common safeguards, among others. Further, services, investment, telecommunication, public procurement, competition rules, intellectual property rights and a dispute settlement mechanism, are also part of NAFTA. The agreement is very far-reaching and its implementation has resulted successful, considering trade and investment among its members has more than doubled in the last 9 years, also having significantly increased with the rest of the world.

Mexico, as part of this initiative, has benefited immensely from its membership, improving its economic situation through a series of reforms. Among the main macroeconomic achievements are low inflation, stable interest and exchange rates, sustained growth, higher employment and a more efficient public sector.

The implications for the rest of the region have also been very important. For the first time, a developing country can see its developed partners under equal terms in a FTA. NAFTA has also allowed to lock-in reforms and institutionalize change. This has had a considerable impact in the design of “new generation” FTAs and bilateral trade agreements, as well as bringing a new approach and rebalancing of power in multilateral trade negotiations in the WTO.

However, the initiative is far from complete. Some issues are still waiting to be incorporated. Further, domestic concerns, such as poverty and social inclusion, need to be addressed. Further, the tax system, and the energy and telecommunication sector are still pending reform in Mexico.

4) The Group of 3 (G-3)vi

The G-3 is an FTA between Colombia, Mexico and Venezuela, which came into effect in 1995. Its origins date back to the former “Contadora Group”, which gave rise to this permanent agreement, during the V Ministerial Conference of the Central American Countries, the European Community and the Contadora Group in 1989.

The organizational structure of the G-3 consist of a Pro-Tempore Secretariat (PTS), dedicated to coordinating the Group’s activities, being rotated every two years among the 3 members. Further, there are also High Level Groups (HLG), in the fields of trade, science and technology, energy, telecommunications, transport, finance, tourism, culture, environment, fishing and aquaculture, cooperation with Central America and the Caribbean, education and prevention of disasters and calamities.

Among the main objectives are promoting economic complementarity and cooperation. In particular, in the field of investment, the main objectives of the HLG of Finance are: i) exchange information on bilateral financial mechanisms, ii) identify activities that can best benefit from the subregional financing mechanism, iii) seek joint opportunities for investment among members, facilitating and promoting integration in the Andean, Caribbean and Central American regions, iv) establish a fiscal-financial cooperation program for analysis and information exchange, v) create a public procurement information exchange program for joint development projects, and vi) support energy cooperation programs developed by the HLG on Energy.

The agreement seeks reliable and ample market access through the gradual elimination of tariffs, whilst recognizing the sensitive sector in each country. It further establishes disciplines for country measures seeking to protect health and human, plant and animal life, without raising barriers to trade. Further, it also contains a dispute settlement mechanism and covers non-competitive practices. The agreement also has an accession clause, allowing entry of new Latin American members.

ii. Current Initiatives in the Region:

In ALADI, the new generation agreements have compromised members to integrate in other fields. Under this focus of broader and deeper integration, current initiatives seek to develop projects for the connection national infrastructure networks, such as energy, transport and communications, exploitation of natural resources.

The creation of new urban, economic, rural and mining spaces is also foreseen, as well as the promotion of economic and social private entrepreneurial initiatives, involving civil society. Further, total trade liberalization is foreseen by 2005, when 94% of the tariff lines of regional trade shall reach a zero tariff level.

Another important integration initiative is that between the ACN and Mercosur. Members of both institutions are signatories to ALADI, meaning that a unification of both common markets into a single one is a natural step. The objective is to expand these custom unions, given the impact of market expansion, since Mercosur and ACN are the second and third biggest markets in the hemisphere after NAFTA.

With regards to NAFTA, the issues under discussion are: a system of border control; increased coordination in macroeconomic policies (fiscal, monetary, exchange rate, and inflation); a single customs system and management; increased coordination in competition policy; communication, transport and energy under a single market approach; further harmonization of sanitary and phytosanitary standards; innovation and technology; and regional development, among others.

The G-3 was recently reinstated, in a summit held in Caracas in April 2001. Here it was agreed to strengthen the institution through 4 actions: i) increase efforts for deeper compromises, ii) review the commercial agenda of the Group, iii) inform entrepreneurs on results of the presidential meetings, and iv) promote use of trilateral economic complementation opportunities for SMEs. Further, the High Level Group on Finance recognized that reducing poverty and improving income distribution are primary objectives, which need the implementation of programs targeting the poor and raising human capital. A fund for cooperation in these fields was approved in conjunction with the IADB and the CAF.

Finally, the main project of integration in is that of the FTAA, which was launched during the Second Presidential Summit of the Americas held in Chile, in March 1998. It is a hemispheric project aiming to establish a free trade area among 34 countriesvii by 2005. It is probable that the FTAA will absorb all the existing agreements and regional accords in Latin America and The Caribbean. The process requires political agreement on diverse areas, such as investment, market access, services, public sector purchases, dispute settlement, agriculture, intellectual property, subsidies, antidumping, compensatory rights and competition. In order to achieve this, participants must converge their positions on macroeconomic performance, infrastructure, income distribution, trade rules, intellectual property rights, capital markets, poverty levels and unemployment, among other elements.

c. The Role of Regional Integration: motivations and shortcomings

There have been many motivations pushing for regionalism in South America. Some views have changed over time, as a result of the evolutionary nature of the integration projects. The following are the main economic and political arguments which shape integration policy today, and which will have weight in the region’s position in the FTAA negotiations.

It is important to stress from the outset, that Chile’s reform process, though inspiring in the 90s, was not seen as an option to the reforms of the 80s, because it’s unilateral liberalization component.viii South America sought regional integration since the 60s, and there was the formal compromise and historical traditionix to seek development through a unified hood of regionalism.

Regionalism has been redefined over the last two decades, in part because of the institutional evolution, described previously, and also due to changes in the lines of thinking and the world economy. South American nations view integration as a process that goes beyond economic liberalization; it is a crucial element to their development policies, political positions and social objectives.

A factor weighing heavily in favor of integration was the Asian wonder. The dynamism of Asian economies provoked a change in leading lines of economic thinking, and was seen as a formula of industrialization for export manufacturing, whilst reducing levels of trade protection. The Asian approach consisted in providing equal incentives for internal and export-oriented production, within a sector. There were also different levels of incentives for different industries (such as mature or infant industries), and flexibility in applying temporal promotion policies for reaching specific goals.

Seen as less drastic than a complete market economy model, this gradual liberalization allowed industrial reconversion and avoided the destruction of installed capacity, in line with the aims of ALADI members, requiring a concerted effort because of individual weaknesses.

Greater market Access and the elimination of trade barriers was one of the main economic reasons for pursuing integration. Most South American countries had highly protected consumer markets under the import substitution model, limiting industrial development and growth to the dimensions of their geographically close and natural markets. The desire to eradicate tariffs and other trade barriers among the countries was seen as crucial for the creation of an internal market, whilst keeping individual tariffs towards exports from third trading partners outside the agreements.

The increase in market size allows for a more efficient use of resources, a greater specialization and higher competitiveness. Economies of scale are viable when firms are able to lower their total average costs by increasing their size and thus raising production. Seen in tandem with market access benefits, higher competitiveness also attracts more investment brings on development and can generate greater levels of welfare.

Other integration projects, such as the European Union and NAFTA, also proved to be a major catalyst for integration in the region. The observable success of these two projects in terms of economic growth and stability, political coordination and social welfare, were seen as very attractive.

The benefits of negotiating as a bloc in a regional, hemispheric or multilateral field were also very compelling. Apart from benefiting from an increase in regional influence, it also helped diminish the vulnerability of trade relations with third countries. Greater negotiating power as a group could help each of the countries to achieve goals, which individually could not have been attained.

Another growing concern has been the repeated financial crisis in the ‘90sx, and their impact on destabilizing the region. Crisis can have devastating spillover effects, and joint action can help overcome such situations under better conditions, reducing the risk of vulnerability to external shocks.

An integrated market can have positive spillovers in other areas since the costs are relatively smaller because of the absence of trade barriers, promoting cooperation amongst the members. Economic integration has always been seen in the context of a broader regional effort in Latin America, and cooperation in areas such as investment, education and technology sharing have been incorporated in the existing framework.

This being said, the role of globalization has been fundamental to integration in Latin America. It has motivated countries to seek bilateral and regional articulation, through integration agreements, to guarantee a more effective participation in the world economy. Prove of this is the current revival of integration attempts between the ACN and Mercosur, as stated earlier. The FTAA in itself is another example, and is argued to be a counterbalancing response toward shaping of a new economic world order, with a tripartite leadership of the EU, China or Japan and the U.S., and a regionally fragmented world pivoting around these centres.

Even though Latin American integration is seen as an option for achieving national and regional objectives, results have not been satisfactory. Arguments against integration, based on political views and shortcomings of past efforts also shape regionalism.

First, the practical implementation of the ACN customs union has resulted in a preferential trading bloc. Lack of coordination of macroeconomic policies, is one of the main reasons. After over 20 years of existence, only Colombia, Venezuela and more recently Ecuador, have a Common External Tariff (CET), and there are still different adverse practices to trade.

Second, modernization and coordination of national customs has been slow. The lack of will from ACN members to implement a harmonized tariff system, apply an effective methodology for collecting tariff rights on imports, to facilitate documentation of foreign trade (i.e. through a “Single Customs Document”, for instance) and eliminate barriers on the mobilization of intra-Union factors prevail. These are the main impediments, where technical and administrative difficulties, transport and other barriers are common.

The situation reveals the existence of diverse protectionist measures, and not necessarily industrial policies fostering competitiveness and productivity in the region. This reduces opportunities of positive spillovers and backward linkages of any integration model and is further capped when economies of scale cannot develop due to technological lag and lack of entrepreneurial motivation.

Overcoming asymmetries and creating favorable conditions for competition is also a challenge. The differences in the levels of industrialization among members are a major concern and can weaken coordination, as seen with ALALC, where poorer members were reluctant to cooperate, seeing the wealthier and more competitive ones obtained most of the benefits of an integrated market, at their expense.

Asymmetries are also evident at a domestic level. The costs of trade liberalization are born by the inefficient sectors that are unable to compete with foreign industries, once the domestic market is open to trade. However, these potential “looser” sectors may count with strong lobbies and political clout shaping country decisions, and therefore integration outcomes.

In general, despite lack of coordination and the inherent problems, the region is still working toward further integration. A customs union per se is no guarantee of more efficiency and competitiveness; it is a medium to achieve development and growth objectives, if implemented correctly.



a. Evolution of the Legal Treatment in the Americas

Legal treatment of FDI in the Western hemisphere has evolved considerably in the last two decades. As of the 80s, a whole array of bilateral investment treaties (BITs) offering protection to investments and investors, as well as incentives, have come into force. Regional initiatives, such as Free Trade Areas (FTAs), have also gradually incorporated sections on investment, seeking to regulate and attract greater flows, as was the case of ACN Decisions 291 and 292, NAFTA and the G-3.

The decade also evidenced the promulgation of investment laws and measures in many countries, as a response to several forces. First, the increased need for external financing, as mentioned earlier in Chapter I, since local financial systems were either underdeveloped or did not have enough capital to invest in many of the ambitious national development projects. Second, the lack of trust from traditional international lending sources due to the debt crisis, asked for alternative ways of financing. Third, the change in policy design increased the relevance investment played in development strategies. Finally, an element revamping the whole legal framework in many countries was the creation of the WTO, and with it, the new set of obligations emerging from the multilateral agreements of TRIMS, GATS and TRIPS.

The present chapter focuses on some of the most relevant legal instruments governing investment in the Americas. The ACN Decision 291 and 292, NAFTA Chapter 11, G-3 Chapter XVII, and TRIMS and GATS from the WTO are carefully studied, by analyzing their approach on aspects such as the scope and coverage, treatment, admission, transfers, expropriation and dispute settlement.

Further, the elements evaluated in this chapter are used as inputs of the cross-comparison in the next chapter, when assessing the level of investment protection of the FTAA, and the policy implications this will have for the countries in the hemisphere.

b. Regional Mechanisms

i. The Andean Community: Decisions 291, 292 and 344

The ACN has three legal instruments regulating foreign investment, namely Decisions 291, 292 and 486 (ex. ante 344). Once adopted at community level, these are immediately effective, becoming part of national legislation and fully enforceable.

Decision 291xi is the Andean Community Regime for the Common Treatment of Foreign Capital and Trademarks, Patents, Licensing Agreements and Royalties. Adopted in 1991, it is the main legal instrument covering foreign investment at subregional level.

Attempting to harmonize the Community’s investment regime, the Decision has 5 chapters divided into 18 articles, dealing with definitions, rights and obligations of foreign investors, competent national agencies, importation of technology and treatment of investments considered neutral capital.

Scope of application:

Prior establishing its scope of application, the Decision defines the terms used throughout the text, as applied and intended in the regime. Thus, in Article 1, precise definitions on direct foreign investment, national, subregional and foreign investor, national, mixed and foreign enterprise, neutral capital, reinvestment, recipient country, commission, board and member country, are given.

The definition of direct foreign investment is very broad, and covers investments from natural or legal persons from abroad, either in the form of capital, or physical or tangible assets. It also provides for a non-exhaustive list of assets falling into the definition.xii Further, it also includes 2 other types of investments, provided these are considered in a member’s national legislation. The first is an investment made in local currency from resources destined for remittances abroad, defined as “reinvestment”. The second is an intangible technological contribution, such as trademarks, industrial models, technical assistance and patented or non-patented know-how, in the form of “physical goods, technical documents and instructions”.

Next, there are three definitions of investor: national, subregional and foreign investor. A national investor can either be the State or a natural or juridical entity, considered to be a national or a foreigner with no less than a year of residence in the member country, who has been granted permission to reexport and transfer capital by the competent national agency. Subregional investors receive the same treatment as national investors, these being investors from one of the member countries. Foreign investors on the other hand, are simply defined as the owners of foreign investment, and subject to the conditions for treatment as a national or subregional investor, as defined Article 1.

The definition further establishes the level of national treatment on the basis of origin, conferring subregional investment the same treatment as national investment, and offering the possibility of no less favorable treatment to foreign investment, subject to the fulfillment of certain requirements. Thus, foreign investors may be treated as national and subregional investors, upon receiving a waiver by the competent national agency, or if their contributions are generated within a member country. The Decision then establishes the same rights and obligations to foreign and national investors, reflecting the principle of national treatment, but allows for exceptions in the treatment if established in the legislation of member countries.

As with investors, there is a categorization of three types of enterprises, namely national, mixed and foreign. A national enterprise is defined as an enterprise established in the recipient country, with more than 80% equity capital belonging to national investors, so long it is also reflected in company assets such as technical, financial, administrative and commercial management, in the view of the competent national agency. A mixed enterprise has two variants. It either is an enterprise with 51-80% capital share owned by nationals, also observable in other company assets, or it is an enterprise where a semi-public or State-owned companyxiii has a minimum of 30% of equity capital, and has the decision-making authority, duly recognized by the national competent agency. Finally a foreign enterprise is a company established in one of the recipient countries where national investors hold less than 51% of equity capital or where a higher share is not reflected in the managerial company assets, as judged by the competent national agency.

Neutral capital is defined as the investments of public international financial institutions to which the Members belong to, and is treated exhaustively in Chapter V and in the annex to the Decision. This form of capital is excluded from the equity capital calculation of national, mixed or foreign enterprises. Contributions from the Andean Development fund are considered national investment, since it is the financial pillar of the Andean Community and is sourced by the member countries themselvesxiv


The only requirement for admission is the registry of FDI. For the purposes of ensuring compliance, Chapter III foresees the designation of a competent national agency or agencies responsible for registry, issuance of waivers to foreign investors and certifications of investment and investor classifications. This has eliminated considerable transactional costs, since prior the approval of the decision, investments often had to undergo an authorization procedure by national authorities, highly costly and slow.

The Decision further established the obligation of registry of investments, sales or reinvestments with the competent national agency, in the form of initial investment plus any increases, reinvestment minus net losses. Equity capital is to be registered reflecting the shares of joint stock companies.


The second chapter deals with rights and obligations, and confers the same rights and obligations to national and foreign investors, unless established differently in national legislation. Provisions for a preferential treatment are also included, based on origin requirements for goods produced by national, mixed or foreign enterprises, in the terms of the benefits established in the Cartagena Agreement Tariff Reduction Program. This is a considerable incentive, since formerly foreign enterprises had to become a national or joint enterprise to benefit from this arrangement.

Technology has a treatment of its own, as defined in chapter IV, Article 12:

“Technology licensing, technical assistance, technical service, basic and detail engineering and all other technological contracts shall, in accordance with the respective national legislation of the Member Countries, be registered with the competent national agency of the respective Member Country. The latter must evaluate the effective contribution of the imported technology by estimating the probable profits or the price of the goods that incorporate technology, or through other specific methods of quantifying the effect of the imported technology.”

Thus, not only technology transfers are subject to registry; they are further evaluated in terms of their effective contribution. Article 13 further establishes content requirements for contracts for the importation of technology, such as clauses containing information of nationality and residence of the parties, prices of the components and methods involved in the transfer, and the effective period of the contract.

Elements which technology transfer contracts should not contain are also listed in Article 14 as part of an obligation to the parties. These consist of clauses, which require exclusive sourcing; price fixing; restrictions on volume and structure of production; exclusivity of the technology prohibiting the use of other competing technologies; purchase options favoring the supplier; transfer obligations of any inventions or technology improvements to the supplier; and payment of royalties to the holder of expired patents or trademarks, among others. Further, export prohibitions on products using the technological import are forbidden. These provisions protect against common anti-competitive practices related to subregional and international trade.

The prohibitions are waived by exceptions which the national competent agency determines, abiding with the objectives of the decision, as stated in the preamble: “… in an effort to attain more efficient and competitive economies through the liberalization and the opening to trade and international investment… ”. Interestingly, these prohibitions on business restrictive practices protect the local party by setting obligations that restrict favoring the interest of the foreign partner in the contract content.


Article 4 establishes the right to transfer net profits resulting from foreign direct investment in free convertible currency, and Article 5 provides for the right to reexport the proceeds resulting from the sales of shares, equities or rights. The transfer of profits and funds are also considered, by eliminating restrictions and non-convertibility and non-transferability risks.


The decision does not offer provisions on expropriation, leaving it to national regulation and proceedings in the member States.

Dispute settlement:

In the even of disagreements, the provisions in national legislation are to be used in the resolution of disputes. Thus, no dispute resolution mechanism within the ACN is foreseen for investments. Further, there is no express statement of recourse to international dispute settlement mechanisms, such as the ICSID, even though all ACN countries are members and can use these arbitration procedures when a dispute arises.

Decision 292xv stablishes a special Regime of Uniform Provisions for Andean Multinational Enterprises (AMEs). Though not as general as Decision 291, it deals more specifically with investments in the form of affiliate presence in the member countries and offers a series of incentives to multinationals, upon the fulfilment of specific requirements. In doing so, it indirectly promotes the association of investors of the member countries, given the advantages of conferring equal treatment to that of national investors, access to sectors reserved to the State national companies, tax-free profit transfers and capital repatriation.

The Decision contains 5 chapters and 32 articles, on definitions and requirements, constitution and functioning, special treatment, final and transitory dispositions.


An Andean Multinational Enterprise (AME) is defined in Article 1, as an enterprise which is domiciled, or which has resulted from a merger or acquisition in one or several of the member countries. It must be an established business corporation with a trade name including the term Andean Multinational Enterprise (or its initials “AME”), and is subject to the following set of obligations:

1. Capital must be made up of registered stock, providing equal right and obligations to the shareholders.

2. Contributions of national investors of two or more member states have to represent more than 60% of the enterprise’s capital. If there are investors of only two member states, the sum of the investors’ contributions of each member should not represent less than 15% of the capital. Should there be more than two members, at least two of them should contribute with a minimum of 15% of the capital each.

3. Such companies must have at least one director of each member investors making at least 15% of the capital contributions originate, and subregional majority must also be reflected in the management of the company, in accordance with what the competent national authority may determine.

4. The exercise of right of preference must be assured to the stakeholders of the AME in the social statute of the enterprise.

5. The nominal value of shares must be defined in local currency of the domicile country or in another currency if allowed by national legislation.

Contributions by foreign or subregional investors must be in free convertible currency or physical or tangible goodsxvi originating in any country, except in the domicile country of the AME. In the case of reinvestment of remittances, these must be made in national currency, and intangible technological contributions can also be made.

If enterprises do not have the form of business corporations, they may either sell their shares to a subregional investor, increase their capital, merge with other national or joint enterprises, they must respect the capital requirements in article 1, and adapt their internal and statutory regulations to Decision 292, in order to become an AME.

The Decision also clearly states that matters falling out of its scope will either be regulated by the legislation of the country serving as the principal domicile, and the legislation of the country where the legal relationship and transactions of the AME are established.


Any contribution has to be registered in free convertible currency at the competent national agency, prior investment, as stated in article 13. The Legal entity is subject to certification of its national status by the competent national agency.


Chapter III is dedicated to the special treatment conferred to AMEs. Such enterprises are given no less favorable treatment than national enterprises. Investment in AMEs is considered national investment, and is subject to fiscal, tax and regulatory incentives. These are clearly spelled out in Articles 9 through 19, and can be summarized as follows: (1) national treatment for public sector purchases, such as public procurement of goods and services; (2) free circulation of capital contributions within the subregion; (3) contributions in physical or tangible goods, complying with the subregional rules of origin, are free of tariffs and restrictions; (4) access to export promotion schemes for national enterprises of the same economic activity, in accordance with legislation; (5) use of special import and export systems between member states, as stipulated in national legislation; (6) participation in restricted industries and sectors, usually reserved to national enterprises, according to a member’s legislation; (7) establishment of branches, in any member besides the country of principal domicile, allowing for transfer of the net profits from investments in free convertible currency from the branches to the principal domicile, subject to taxation; (8) same treatment as national enterprises in the payment of local taxes, according to the economic activity; (9) right of transfer of the total utilities in free convertible currency, and (10) double-taxation avoidance, where the member state serving as the principal domicile of the AME does not tax income, remittances or redistribution of the dividends resulting from profits obtained in branches in other member states, and so long as AMEs and their branches issue certificates of net profits after taxation, subject to verification by national tax administration.

Furthermore, members have the obligation of providing personnel of subregional origin to AMEs, and their branches, thereby considering subregional personnel as nationals. With regard to movement of persons, the Decision allows the entry and permanence of promoters, investors and executives, for the period necessary to carry out their tasks in relation to the formation and operation of the AME. National authorities must issue the necessary entry and residence documentation, upon verification of the status of such persons. These two obligations in Articles 21 and 22, respectively, offer protection to FDI “associated activities”, and secure the effective operation of AMEs.

Finally, in Article 26, members compromise themselves to stimulate the creation of AMEs fostering industrial development in the region, in line with industrial integration modalities of the Cartagena Agreements.


The transfer of profits, dividends and proceeds from sales is allowed, after tax payment in freely convertible currency. Further, incentives related to transfers were previously described in the section on treatment.


There are no provisions on expropriation or compensation in the agreement, and like in Decision 291, disputes arising due to AMEs related investment are to be treated under the provisions of national legislation and court system.

Dispute settlement:

As with Decision 291, no dispute settlement mechanism is provided for. Instead, article 28 only foresees the application of sanctions on AMEs violating a member’s law or committing an infraction. In such an event, the enterprise will loose its right to enjoy the benefits of the present regime, and legal provisions of the country would apply. Article 31 also stresses that an AME has to base its actions with due regard to Decision 291, and local norms of each member country.

Decision 344, recently replaced by Decision 486, establishes a Common Intellectual Property Regime. Approved by the Commission in October 1993, it regulates the emission of trademarks and patents, protects industrial secrets and denominations of origin, among others. With its adoption, members adjusted their internal laws to international standards, such as those contained in TRIPS and the Paris Convention. The decision also goes beyond international provisions, as it incorporates protection on food and beverages, microorganisms, biotechnology procedures and animal and plant varieties.

The decision deals with requirements and procedures for the registry of invention patents and utility models, licenses, denominations of origin, industrial designs, trademarks, logos and commercial names. It clearly establishes complementarity with national laws, the creation of a communitarian information system and the strengthening of the institutional framework. Even though rights and obligations are clearly established, sanctions have not been defined and other criteria needs to be incorporated, such as the protection of industrial designs for clothes and pharmaceutical patents.

ii. NAFTA: Chapter 11

The NAFTA has a whole chapter dedicated to foreign investment.xvii Chapter 11 contains 39 articles divided into 3 sections, dealing with investment, settlement of disputes and definitions. There are other provisions focusing on aspects of investment, such as financial services in Chapter 14, competition, monopolies and state enterprises in Chapter 15, and temporary entry of business persons in chapter 15.


Article 1101 clearly defines the scope and coverage of Chapter 11, by stating it applies to 3 types of measures: measures by a party relating to NAFTA partner investors, or to investments of another party in the territory of the party, or to all investment falling under Articles 1106 through to 1114. The recognition of exclusive rights of parties to reserve certain economic activities, listed in annex III, prohibiting investments in those sectors, is also included.

The chapter defines investment fairly narrowly in article 1139, focusing only on asset-based or capital investment, which is then clarified by a list of what are considered assets.xviii A further clarification of what are not considered to be investments, mainly related to money claims is present. Finally, the scope is further narrowed with two exceptions, namely financial services and the recognition that parties providing services or enforcing laws for social purposes can legitimately override obligations of the chapter.


Foreign direct investment has access to all sectors, except those expressly reserved to the State or national enterprises, as regulated by law. Though there are no pre-establishment requirements, parties may have special provisions in their laws requiring residence of investors, legal constitution of the investment or providing business information subject to disclosure upon request of the pertinent authorities, among others.


Articles 1102 through to 1105 contain provisions on the treatment of investments. These offer both National Treatment (NT) and Most-Favored Nation (MFN) treatment at pre- and post establishment level. Pre-establishment protection is provided through a negative list approach, where it is presumed that there is the right of establishment, except in the sectors, which are listed as exclusions. National laws may restrict certain activities, such as the energy sector, and it is in their discretion to open them to FDI.

The case of “fair and equitable treatment” also appears in tandem with MFN and NT provisions, and therefore offers the better of treatments to both foreign investors and investments of non-NAFTA members, depending on which of the two results more favorable. This guarantees the investor is not being discriminated, thanks to the direct reference to MFN and NT. This treatment is also extended to “associated activities”. Thus, the standard goes beyond protecting investment and includes actual business or specific firm activities, such as the organization, control, operation, maintenance and disposition of companies. Protection on establishment, acquisition, expansion, management, conduct, operation and sale or other dispositions is provided for in articles 1102-1104. Further, it requires the benchmark of the general practice in other States, in order to establish the level of treatment to be conferred.

Additionally, NAFTA members also have the obligation of ensuring a minimum standard of treatment in article 1105 as established by international law and custom. Similar to fair and equitable treatment, minimum standard of treatment needs a comparison based on the general practice of States in similar circumstances. This is an additional guarantee that foreign or domestic investment is not treated less favorably.

Further, the agreement also prohibits performance requirements to both party and third party investors, as listed in Article 1106(1). Requirements such as export contingency based on a certain level or percentage of either goods or services; domestic content; preference to local suppliers or purchases; trade and foreign exchange balancing; export contingent production or sales inside a territory; technology transfer or transfer of an intellectual property asset; exclusive supply of goods and services, restricted to an area or region, are prohibited if they condition the reception of a benefit of an advantage. Despite this, measures containing health, environmental or safety requirements are allowed, provided they do not result in discrimination among investors.


Transfers of an investor of one party to another party, such as profits, proceeds from sales, payments under contracts and loans are protected. Article 1109 covers the right of transfer, against non-convertibility and non-transferability. The agreement protects free movement of capital, apart from guaranteeing hard currency for transfers of profits, dividends, interest payments or principals on loans, payment of service contracts and compensation resulting from expropriation. It also allows preventing transfers in an “equitable” and “non-discriminatory” manner, and under the principle of good faith is justified, in the event of bankruptcy, insolvency, and criminal or penal offenses.


NAFTA also covers political risk of expropriation, by guaranteeing compensation in cases of indirect nationalization, expropriation or measures that amount to either of these actions. According to NAFTA Article 1110, there is direct expropriation, indirect expropriation and measures tantamount to expropriation.xix These actions are prohibited unless they have a public purpose, are non-discriminatory, follow due process of law and compensation is offered. Following the Hull formula,xx compensation should be equal the fair market value, and for this purpose, a set of valuation criteria is given.

Dispute Settlement:

In the event of a dispute arising from the foreign investment activity, NAFTA offers a dispute settlement mechanism, to both investors-to-state disputes and state-to-state disputes. Either a foreign investor or a State ACN bring a claim and initiate the procedures for dispute settlement. Articles 1115 through to 1138 rule on the procedures to submit a claim, upon the breach of the obligations in either section A of the chapter, or article 1502(3) on monopolies and State Enterprises by one of the parties, resulting in loss or damage to the claimant. Further, an investor of a party can also raise a claim on behalf of an enterprise of another party, if he enjoys control of such an enterprise.

The innovative aspect of this mechanism is that it is not optional. Parties have given their unconditional consent to accept claims, their prosecution and findings in NAFTA.xxi The agreement provides the option of submitting the claim under the International Centre for the Settlement of Investment Disputes (ICSID) Convention, the Additional Facility of the ICSID, or the United Nations Commission of International Trade Law (UNCITRAL) Arbitration Rules. Claims can also be filed in domestic courts, and would therefore undergo a party’s local appeal process. If this process is exhausted and the claiming part is not satisfied, it can still find recourse in the international arbitration procedure. Interestingly, investors are not compelled to first seek redress at a national level; they may immediately apply for arbitration, if they wish to do so.

iii. The Group of Three (G-3)

The G-3 has very NAFTA-like chapter on investments, offering a higher level of protection than that which exists in Decision 291 and 292. Chapter XVII of the G-3 agreement consists of two sections: Section A on “Investments” and Section B on “Investor-to-State Dispute Resolution” comprising a total of 24 articles, and also includes two annexes on reservations by the Parties and rules to be applied in junction with the dispute settlement mechanism.xxii


After defining what is understood as enterprise, investment and investor, in a very broad manner, the agreement offers NAFTA-like provisions on scope. These apply to investment and investors of the Parties, and all investment of both Parties and non-Parties, in relation to performance requirements. It also excludes financial measures, which fall under the rules of chapter XII, and allows Parties to adopt measures to protect national security or public order or the application of their penal laws.


There are no pre-establishment requirements in the agreement, though Parties are allowed to have registry, residence or other dispositions, as set out in their laws.


Like NAFTA, the G-3 offers MFN and NT treatment at pre and post- establishment level. It extends this obligation in the case of political risks such as armed conflict, public order disruption and force majeure events, but limits conferring the more favorable treatment in the case of double taxation treaties. Further, it prohibits performance requirements for Party and non-Party investments, and exempts geographic location, employment generation, capacity building or research and development requirements, as in NAFTA. Also, sector and subsectors that are to be exempted from treatment are listed, as well as any restrictive measures in force.

With regard to key personnel, as in NAFTA, director majority, nationality or domicile requirements may be applied, in accordance to national legislation; however, these requirements may not obstruct the control the investor has over the investment.

Finally, even though not expressly stated, incentives for regional investments are considered, in Article 17-14, which rules on a compromise among Parties to “diffuse, promote and exchange information” on investment opportunities, as envisaged in the objectives of the High Level Groups (HLG) on Finance.xxiii


Article 17-07 rules on transfers, covering non-transferability and non-convertibility risks by obliging free and without delay in freely convertible currency. It lists which transfers are to be protected, excepting Parties from the obligation in the cases of bankruptcy or insolvency, issuance, trade or operations of securities, penal or administrative violations and offenses, guaranteeing compliance with proceedings. Further, the article also allows a waiver on the obligations in the case of BOP difficulties.


As in NAFTA, legal and de facto expropriation is covered and is only allowed for public utility purposes, on a non-discriminatory basis and guaranteeing due process. Compensation is to be adjusted to the fair market value, according to certain valuation criteria and is to be given without delay, fully transferable in free convertible currency, in compliance with the transfer provisions of the agreement.

Dispute Settlement:

The chapter contains provisions as spelled out in NAFTA chapter 11, though only for investor-to-state disputes, based on existing commercial arbitration mechanism, namely UNCITRAL and ICSID procedures. It does not cover state-to-sate disputes.

c. Multilateral Mechanisms

The only existing multilateral investment agreements are part of the WTO framework, namely the agreement on Trade Related Investment Measures (TRIMS) and the General Agreement on Trade in Services (GATS), both resulting from the Uruguay Round in 1995. Two other agreements, dealing with some aspects of investment, are the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), the Agreement on Subsidies and Countervailing Measures (ASCM) and, at a plurilateral level, the Agreement on Government Procurement.

Even though there was a previous attempt to create a multilateral mechanism, under the initiative of the OECD in the mid 90s, the Multilateral Agreement on Investments (MAI) failed because of lack of consensus among participating countries. Currently, multilateral efforts were centered on the Cancun Ministerial, since the Doha Declaration expressly recognized the case for a multilateral framework on investment in Paragraph 20 and mandated the initiation of negotiations after the Fifth Ministerial, where members were expected to decide on modalities for negotiation on a consensus basis. Further, Paragraph 22 sets the tasks of clarifying 7 issuesxxiv related to foreign investment, as preparatory work towards the Fifth Ministerial.

Despite these efforts, countries were unable to reach an agreement on the Singapore issues in the Cancun Ministerial. Diverse country positions, mainly based on North-South debate and expectations of the cross-sectoral negotiations trumped the possibility of consensus on investment matters.


Comprising 9 articles and an annex, TRIMS regulates government measures that have an effect on trade, such as operation restrictions, local content requirements, export performance, trade and foreign exchange balancing, remittances, production limitations, joint-ventures, among others, causing violations of the GATT principles.

The main objectives of the agreement are enshrined in the preamble. The second paragraph as such, states:

“Desiring to promote the expansion and progressive liberalization of world trade and facilitate investment across international frontiers so as to increase the economic growth of all trading partners, particularly those of the least-developed country Members, while ensuring free competition;”

The first objective is “the expansion and progressive liberalization of world trade”, referring to the ongoing effort of liberalizing all types of trade, including trade related to investments in a gradual manner, according to country capabilities and realities.

The second relevant objective is with regard to facilitating “… investment across international frontiers”. Here, promoting investment flows as a means for development is recognized, since it is seen as a channel for economic growth, especially in the case of least-developed countries. In other words, designing policies for attracting foreign investment, as well as eliminating barriers to international capital is seen as a legitimate right of countries, seeking growth and development. However, it is important to stress that the term is ownership neutral, as the preamble only refers to “investment” and not “foreign investment”, and is expressed in hortatory language with no binding obligations.

The third objective is that of ensuring free competition, meaning WTO members recognize there is a link between investment and competition, and that anti-competitive practices, such as price fixing or market allocation may occur, either because of existing entry barriers to foreign investment, or because of discrimination among foreign investments or investors, particularly when the foreign investment comes in the form of affiliates competing in the market. Thus, the objective of guaranteeing free competition pursues the creation of a level playing field for the local and foreign investor.

TRIMS itself does not generate any additional obligations to those already existing in the multilateral system. It merely reinforces obligations in General Agreements on Tariffs and Trade (GATT). By requiring members to eliminate measures inconsistent with GATT rules. Specifically, any investment measure violating national treatment (Article III, GATT) and the general elimination of quantitative restrictions (Art. XI, GATT) in Article 2, are deemed to be withdrawn in a given period of time. The agreement provides a non-exhaustive list of measures deemed to be inconsistent in its annex, such as domestic content, and import-export balancing requirements. However, it does not cover export performance, joint–venture and technology sharing requirements, which were recently discussed in the V Ministerial.xxv

In the case of developing countries, balance of payments considerations allow them a temporary deviation from their obligations in Article 2. Further, the phase out period for notified measures under TRIMS is 2 years for developed countries, and 5 and 7 years for developing and least developed countries, respectively, both having the option of extending their phase-out period upon request.

TRIMS further has access to the dispute settlement mechanism, like all the other multilateral agreements of the WTO. Being a non-international commercial law mechanism, it only addresses state-to-state claims, and can ask a country to bring a measure into conformity, if found to be inconsistent. However, retroactive compensation cannot be requested, as opposed to commercial arbitration procedures.

ii. GATS

GATS together with GATT and TRIPS, forms the three pillars of the multilateral system. GATS regulates investments in the services sectors, under mode 3, known as “direct commercial presence”. The agreement consists of 6 parts and 29 articles.

GATS, as opposed to GATT, only has one non-discrimination principle as a general obligation, namely Most-favored Nation (MFN). Thus, members are obliged to extend any benefit or treatment accorded to a member in particular, to all WTO members, guaranteeing an equal treatment to all trading partners. This general obligation is subject to exemptions inscribed in the Annexes of the agreement.

National Treatment (NT), on the other hand eliminates discrimination between a foreign and national good; by ensuring no measure issued or applied locally results in a less favorable treatment toward imported goods, as enshrined in Article III of GATT. However, NT does not exist as a general obligation in GATS. It is a specific obligation the members may decide to adopt, inscribing it in their schedule of commitments, as opposed to GATT, which applies across the board to all goods. The schedule therefore, displays the extent to which countries offer NT and market access to investments and investors, in a particular sector or subsector and in each given mode. Thus, NT is accorded on a sector-by-sector basis, further conditioned by horizontal exceptions.

These types of commitments are known as “bottom-up” or “positive list” approach, whereby members only commit themselves to the sectors and modes that are bound in their schedules, providing more flexibility and freedom in trade liberalization.

Finally, GATS imposes transparency obligations in that members have to notify any measures or regulations affecting the services sectors inscribed in their schedules.

iii. TRIPS

Considered the third pillar of the multilateral trading system, TRIPS enshrines obligations for the protection of intellectual property in the member countries. Basing itself on existing international agreements, such as the Bern and Paris Convention, protecting copyrights and industrial property, respectively, TRIPS further incorporates the two non-discrimination principles of MFN and NT. In relation to investments, this protection targets intangible company assets such as patens, trademarks and industrial designs.



a. Legal Analysis

The last two decades have evidenced a proliferation of bilateral and regional trade and investment agreements, liberalizing markets, protecting and promoting capital flows. Together with the creation of a multilateral trading system under the auspices of the WTO; the legal framework for investments has gradually shaped itself on a regional and multilateral axis.

However, since this multilateral regime only offers a comprehensive set of rules on investment in services, and provides minimum provisions on trade related investment measures based on existing GATT commitments, the advances of regional investment regimes are more far reaching considering the achievements of agreements such as NAFTA and ACN. In this context, the debate centers on whether investment provisions in the FTAA could positively impact FDI. Further, since current negotiations of the FTAA also propose eliminating border measures and integrating services, the role of trade liberalization and deeper integration must also be part of the discussion.

To identify the extent to which the FTAA can promote FDI in South America, a legal analysis of the chapter on investments is necessary. The objective is to determine the extent to which the FTAA can contribute to existing levels of protection and promotion at a regional and multilateral level. In this sense, is the FTAA investment chapter consistent with the WTO provisions in TRIMS and GATS, and regional rules in NAFTA and ACN, or is it a legal framework of its own? More importantly; does it provide additional protection than the existing multilateral and regional provisions?

To facilitate an answer to these questions, the International Centre for Settlement of Investment Disputes (ICSID) has identified a comprehensive list of elements for an assessment of investment protection. These are: scope of application, admission, treatment, transfers, expropriation, and dispute settlement. Since these 7 elements are fairly standard in international agreements, the ICSID methodology is used in the study.

In the field of investment promotion, both UNCTAD and the OECD have studied the measures countries adopt for attracting investment. In particular, the OECD has issued guidelines on incentives, categorizing them into fiscal, financial and regulatory tools. This approach will also be used to determine if the agreements include incentives.

The first step of the legal analysis, which consists of describing all the elements of protection and promotion in each of the agreements considered in the present study (i.e. ACN, NAFTA, G-3, TRIMS, GATS and TRIPS) has already been undertaken in the former chapter. The second step entails a cross-comparison of all the previously analyzed agreements with the FTAA, in order to determine which one offers the most favorable conditions. More importantly, it will help assess whether the FTAA is a genuine contribution to existing legal framework, and determine its policy implications.

There are two final considerations on the limitations of the legal analysis that follows. First, it should be noted that comparing all existing investment-related arrangements in the hemisphere is impractical and beyond the scope of the present study. Agreements such as Mercosur and Caricom have not been included, since these have minor rules on investment and capital movement, rendering a cross-comparison disproportionate. BITs have also been left out, since they are considerable in number and vary greatly in content. Second, of the existing regional provisions on FDI, three FTAs have been selected, namely ACN, NAFTA and G-3, since these address investments comprehensively. Further, G-3 links ACN and NAFTA through a common membership, which is relevant to the empirical analysis on trade and FDI flows in chapter IV.

b. Proposed Legal Framework on Investment in the FTAA

i. Evolution of the negotiations on the FTAA investment regime

Considerable advances in negotiations of an investment chapter in the FTAA have been made, since the I Summit of the Americas in 1994. The working group on investment was first appointed for identifying and studying trade-related investment measures in the Denver Ministerial in 1995. One year later, under the Cartagena Ministerial, countries agreed on a list of elements the investment chapter should contain, in the Committee on Globalization of Production Processes, making considerable preparatory progress for negotiations.xxvi

The general view then was to create conditions that would promote investments from multinational enterprises (MNEs) taking advantage from regional integration, fostering employment and economic growth. The identified measures of structural reform addressing the business concerns of MNEs identified as objectives were:

- Achieve macroeconomic stability through economic stabilization programs

- Improve market access

- Simplify the taxing system

- Increase government transparency (deregulating, decentralizing and modernizing)

- Achieve predictability in existing investment regimes

- Foster innovation and technology, develop joint ventures and research centers

- Stimulate domestic savings and expand capital markets

- Improve human capital through educational and training programs

- Comply with TRIPS and TRIMS commitments on patents, dumping and subsidies

These considerations contributed to fine-tuning negotiations and it was agreed that a hemispheric investment regime should include: i) a dispute settlement mechanism; ii) an information sharing mechanism on subsidies and dumping, borrowing from previous bilateral and multilateral agreements; iii) national treatment as well as right of establishment; iv) repatriation of profits and capital; v) market access; vi) convertibility of currency; and vii) expropriation and compensation. Further, members agreed on establishing direct contact and cooperation with their private sectors, in order to sound for sector concerns, and also established private-public committees for consultations to advance in the hemispheric integration of the FTAA.xxvii

Formal negotiations on investments were launched in the II Summit, after creating the Negotiating Group on Investment (NGIN) in the preceding San Jose Ministerial of 1998. The I Draft Agreement was made public after the III Summit of the Americas in July 2002, and already contained a chapter on investment. More recently, several workshops of the VII American Business Forum were held in Ecuador in 2002, where different sector organizations shared their views on content and objectives of the investment provisions, and further advanced in streamlining positions.

In October 2002, the Trade and Negotiations Committee issued the “Methods and Modalities for Negotiations” of the FTAA, under the auspices of the Quito Ministerial.xxviii These mandate that negotiations shall be consistent with GATT Article XXIV and GATS Art. V, and that progressive liberalization is foreseen in the agricultural, non-agricultural, services, investment and government procurement sectors. Further, the agenda for negotiations was included, envisaging the presentation of offers between December 15th 2002 and February 15th 2003; the submission of requests of improvements from February 16th to June 15th, and the presentation of revised offers starting July 15th 2003.

In particular, the Negotiating Group on Investment (NGIN) has the mandate of negotiating under a negative list, incorporating services’ “commercial presence”. For the Negotiating Group on Services (NGSV), the modality states that negotiations should base themselves on “…existing levels of international obligations”, and that “commercial presence” may be negotiated in either NGIN or NGSV, or in both. However, these groups are to negotiate separately, only having common meetings if necessary. A positive list approach for services is not considered. Offers are deemed to be comprehensive and in accordance with current laws, only accessible to members upon presenting their own.

In November 2002, a month after establishing the modalities, the II Draft Agreement was issued. This draft is currently being negotiated, and the debate is mainly centered on either maintaining WTO principles or adopting NAFTA-like provisions, often termed as “WTO-plus”. Countries have already started making offers, listing sectors and areas to be excluded from the obligations. Further, this negative list approach is also a signal of the intra-hemispheric interest of an across the board liberalization, rather than the gradual positive or “bottom-up” approach of GATS, where commitments are sector and mode specific, as inscribed in the country schedules.

The proposed section on investment in the FTAA, occupies the third chapter of the II Draft Agreement,xxix and tentatively comprises 22 articles, focusing on: scope of application, various standards of treatment, performance requirements, key personnel, transfers, expropriation and compensation, general exceptions and reservations, dispute settlement, basic definitions, transparency and labor and environmental standards, investments in relationship with other chapters, extraterritorial application of laws on investment-related issues and special formalities and information requirements.

If approved, the FTAA will come into force in 2005 for 34 members, comprising 3 North American, 6 Central American, 12 South American and 13 Caribbean States.

ii. The Draft Chapter on Investment


All members, except onexxx, have submitted proposals on the scope of the chapter in its Article 1. The first paragraph contains provisions on applying the chapter to investors and investments of another Party, and all investments of either Party or non-Party investor, in accordance with article 7 on performance requirements. Judging from the changes on the text of the I Draft, members seem to have agreed on the first two objects of scope. If the chapter is to display relaxed rules on investments, they may not agree on the third element, namely “all investments”.

The second paragraph deals with the temporal notion of application, either admitting application on investments made both before and after the FTAA came into force, in accordance to laws and regulations of the host Party, or to investments made after the FTAA becomes effective.

There are several alternative proposals on scope. These include facts, situations or disputes prior the FTAA; measures in relation to financial services and claims; reserved and excepted sectors and activities contained in the Annex; investments made with illicit funds and measures on national security and public order; denial of benefits for investments of a non-Party; and special consideration for smaller economies, allowing discretion for exclusion on a case-by-case basis. Further there are also proposals on sovereign acts of State, relating to measures on education, environment, and social considerations, among others, which are not subject to the obligations whilst benefiting from the protection of the chapter. These proposals are broad, reflecting diverse interests and interpretations of what the chapter should apply to, in the view of the parties.


There are no explicit admission requirements in the chapter. Article 22 though, on Special Formalities and Information Requirements, expressly states:

“Nothing in Article (National Treatment) shall be construed to prevent a Party from adopting or maintaining a measure that prescribes special formalities in connection with the establishment of investments by investors of another Party, such as a requirement that investments be constituted pursuant to the legislation of the Party, provided that such formalities do not materially impair the protections afforded by a Party to investors of another Party and investments of investors of another Party pursuant to this Chapter.”

Therefore, if a party has pre-establishment requirements, these may be applicable to investment and investors so long as they do not amount to a violation of protection or obligations contained in the chapter. Further, performance requirements do not rule out admission or pre-establishment obligations such as registry or constitution of a legal entity, as may be defined in national law. Prohibitions to admission requirements are measures inconsistent with the chapter, such that result in discrimination among Party investments or investors, or those that would impair protection or obstruct business operations deriving from the investment.

This provision has recently been added on to the II Draft. It reflects the fact that many countries have admission requirements in their laws, and probably are concerned about the types and amounts of flows, the impact on the economy, aiming the avoidance of capital flight or crowding out of national industries or sectors. Therefore, seeing the need to regulate entry reflects due consideration to these concerns, but also narrows the discretion countries have in designing requirements, obliging them to enforce measures in a non-discriminatory manner.


Currently, proposals on national treatment (NT), most favored nation (MFN), exceptions, standard of treatment, fair and equitable treatment and performance requirements are ruled in articles 2 through 7, respectively.

Proposals define NT as according a treatment no less favorable to both investment and investors of another Party than that accorded to the nationals of the Party. It also extends protection to related business activitiesxxxi; under like circumstances. This definition is further clarified as treatment offered by a State, either to investments and investors of another Party; or natural persons residing in a Party or companies constituted under the laws of another Party. There is also a smaller economy exception of NT, allowing discrimination against foreign companies in measures affecting to business activities under special circumstances, such as avoiding the threat of economic instability.

MFN is defined as according no less favorable treatment to investment and investors from a Party than that which is accorded to another Party or non-Party under like circumstances. A smaller economy exception to MFN, allows discriminating in favor of other smaller economies, as in the case of NT.

These two standards are the least controversial and reflect a convergence in views of many members. In particular, MFN is likely to be narrower than NT, subject to the proposal on exceptions in Article 4. An alternative proposal on MFN definition was eliminated from the I Draft, conditioning a no less favorable treatment than that accorded to third States, upon admission of investments. Eliminating this provision extends the non-discrimination to pre-establishment, possibly reflecting the intent of attracting FDI.xxxii

Exceptions to these two standards follow in article 4. These relate to the right of notifying exceptions to NT or MFN, allowing Parties to override the obligation of conferring special treatment to other Parties, if these are not members of agreements governing double taxation, tax matters and regional trade. The coexistence with other bilateral and subregional agreements is recognized, so long as the obligations in these agreements do not go beyond what is provided in the FTAA. Exceptions to NT and MFN must be reserved, notified and included in the Annex. An add-on to the II Draft is the waiver on smaller economies on extending special arrangements deriving from the constitution of a common market.xxxiii

Standard of treatment in Article 5 relates to investment and investors, using NT and MFN as its benchmark. An exception that allows treatment favoring small and medium-size domestic enterprises has been introduced only in the II Draft.xxxiv This shows that some member countries have underlying concerns of crowding out effectsxxxv and have policies and measures in place promoting and confer benefiting small and medium sized enterprises. The size of the market may pay an important role, in that these measures are necessary to avoid anti-competitive practices, harming the consumer.

Fair and equitable treatment is offered to investments and investors of Party-members and is referenced to the concept of international law. It alternatively includes additional concepts, such as “full protection and security” and “juridical protection and security”, though these are still subject to discussion and offer less protection than NT and MFN. They use international law and State practice as benchmark for comparison.

A new proposal not incorporated in the I Draft confers investors and investments treatment according to customary international law, including fair and equitable treatment and full protection and security. This treatment need not go beyond the requirements of international law, as set by a newly included provision in the II Draft.xxxvi Discussion on this definition are centered on the definition of what is meant by “international law”, and evolve around agreeing on clarifying this term prior approving the article.

It exempts the assumption of violating the obligations from the article automatically, if there has been a breach of the agreement or other international agreements. Finally a new proposal on exceptions in treatment allowing for discrimination among smaller economies has also been included in the II Draft.xxxvii

One of the more complex issues is performance requirements. Hardly any advances on converging proposals have been made since the I Draft, showing lack of consensus. First, the obligation not to impose performance requirements to Party and non-Party investors and investments in either pre-establishment or post-establishment business activities is presented, followed by an exhaustive list of prohibited measures. The list includes export performance; domestic content; preference for purchases of local products or services; trade or foreign exchange balancing; technology transfers; production process or proprietary knowledge, except if enforced by a legal authority to remedy or avoid the violation of competition law and exclusive supplier or market allocation requirements.

There are less exhaustive proposals, including the prohibition of export contingent requirements, and those that are inconsistent with TRIMS, further conditioning the extent of prohibitions to WTO investment negotiations results. Exceptions on requirements of technology transfer for health, environmental and safety purposes are allowed, if applied in a non-discriminatory manner. Performance incentives are permitted if these do not condition benefiting from an incentive or advantage, to purchases of goods in the territory, domestic content, trade and foreign exchange balancing and export contingent production. Another proposal expressly states that requirements not listed will not be subject to the prohibition in the article, making it a closed and exhaustive approach.

An alternative proposal on exceptions states performance requirements for granting of advantages or benefits, export promotion and aid programs, government procurement, content requirements for preferential tariffs and quota schemes, technology transfer in accordance with the chapter on intellectual property rights or when a legal decision or competition authority is required to remedy a violation of competition laws. Other minor exceptions being considered are those relating to geographical location, labor and research and development, among others, in the style of NAFTA and G-3.

Finally, a proposal on exceptions, phrased in the style of article XX of GATT on General Exceptions has been submitted, using the chapeau language which requires for a necessity testxxxviii of measures undertaken, and then lists 3 types of exceptions that are qualifiers of the exception in its subparagraph, namely: i) to ensure compliance with this agreement, ii) to protect human, animal or plant life or iii) for the health or the conservation of living or non-living exhaustible natural resources. It is also important to note that in a footnote to this proposal, delegations have stressed that environmentally related measures apply to performance requirements only and not to any other section in the chapter. This means countries may have concerns on the imposition of environmental standards on investment that may constrain their ability to design and implement policies according to their objectives. Another proposal foresees the right of Parties to maintain measures necessary to enforce laws, reduce regional imbalances and carry out activities related to technological development and research.

Judging from the proposed alternatives on exceptions, the GATT Article XX style proposal would represent a smaller compromise, not contributing to FDI protection since members have already adopted these obligations in the WTO. Further, it could permeate the FTAA system, if the provision allows for a questioning of measures members undertake and would rule on their justifiability, trumping on the sovereign right to design measures they deem necessary.

Paragraph 5 recognizes the sovereign right of members to adopt or maintain measures to comply with the enforcement of laws, reduce regional imbalances and undertake technology related activities. In the case of measures adversely affecting trade and investment, a clause for directing the matter to an Investment Committee, in order to determine if the inconsistent measure should be withdrawn.

There is also the alternative of only applying the article to government measures, as in TRIMS, exempting private parties of obligations. Further, a small economies exception on development-related performance requirements, if compatible with WTO provisions, has recently been added.xxxix

As is evident, proposals on performance requirements and its exceptions are very broad. There seems to be general consensus on what should be prohibited, such as export contingencies and local content requirements. It is most probable that, in the absence of consensus, countries may only adopt minor provisions, keeping to WTO standards.

Finally, informing all standards of treatment are the General Exceptions and Reservations. Apart from the exceptions already included in Articles 2 through 7, Article 12 considers measures targeting public morality; crime and public order; national security interests, human, animal and plan life, balance of payments, deceptive and fraudulent practices, taxation, disadvantaged persons, minorities or regions, privacy and regional trade agreements. Further, it obliges Parties to present their reservations of the sectors and economic activities they wish to exclude from the obligations and rights deriving from the chapter. The provision requires the Parties to notify sector, subsector, specific obligations to be excluded, nature, specification and description of the measure.


Transfers are ruled on in article 9. The right of “free and without delay” transfer of investment and income of investors of Parties is foreseen, including the free movement of capital. A list of transferable assets follows, including contributions to capital, profits, dividends, interests, capital gains, royalty payments, management, technical assistance and other fees, returns, wages, other remuneration in connection with investment, proceeds from sale of the investment or from capital or liquidation, funds for the repayment of loans, payments arising from compensation, as established in the article on expropriation, and payments arising from intellectual property or intangible rights, among others. This list is alternatively complemented with closed definitions of what are not deemed transfers. Spot transactions in the financial markets at market exchange rate on the date of transfer are also covered.

Transfers in freely convertible currency at market rate are included, and are subject to compliance with exchange regulations or tax law. Thus the article covers both non-transferability and non-convertibility risks in a very broad manner, based on an extensive list of assets. Further, there are exceptions to the right of transfer in cases such as: (i) bankruptcy, insolvency, protection of the right of creditors; criminal or penal offenses; (ii) issuing, trading or dealing in securities; (iii) if there is a failure to comply with reports of transfers; (iv) to ensure the enforcement of judgments or judicial proceedings; (v) to ensure the payment of income tax; and (vi) in the case of violations of labor obligations and social security. Measures should be applied equitably, in a non-discriminatory manner, and in good faith. Other important exceptions are prohibitions of returns in kind; balance of payment difficulties, allowing for a temporary limit on transfer; and special consideration for small economies.

Consensus on this article seems to be taking up, when looking at the amendments of I Draft. On the other hand, paragraphs 1, 2, 7, and 9 have been discussed and modified, whilst paragraphs 4,5 and 8 have been kept intact, indicating their approval is quite probable. A greater difficulty in agreeing on paragraph 6 and 9 is also apparent. Paragraph 10 is a new addition on smaller economies considerations, allowing for discretion on the obligation of making transfers without delay, dependent on exchange rate movements and foreign reserves situation.xl


Nationalization, expropriation and measures that amount to nationalization or expropriation are only allowed if for public purposes, on a non-discriminatory basis and with due process of law. Prompt, adequate and effective compensation is also included, fulfilling the “Hull formula” requirementxli, a standard of public international law. Compensation is either to be negotiated between the affected investor and the Party concerned, as stated in one proposal, or established at a fair market value prior expropriation, under certain value criteria, in another submittal. Further, retroactive consideration of interests gathered between the date of expropriation and payment is given, and free transferability of the proceeds from compensation is protected. Further, investors may invoke prompt review of the case and valuation by competent authorities.

There are also submittals on exceptions, such as loans resulting in default of the debt due to costs to the debtor; compulsory licenses for intellectual property rights that are TRIPS consistent; monopolies serving a public or social interest; and a waiver for smaller economies of offering prompt, adequate and effective compensation and on payment of interests, if under a foreign exchange crisis.

Article 11 provides that in the event of losses because of war, armed conflict, national state of emergency, uprising, insurrection, and other political risk events, compensation, restitution or other forms indemnification are to be offered in a non-discriminatory manner, to both foreign and national investors. The same provision is further extended to acts of God or force majeure, such as natural disasters, in accordance with international law principles. Coverage in the event of destruction by the forces of the host country in offering compensation in a prompt, adequate and effective manner, except in the case of destruction of donations or subsidies, is also present. Among the less committed provisions are obligations to reinvest compensation in the host, and only offering compensation to investors of Parties based on treatment conferred to third States. Further, smaller economies considerations either allow for a delay in compensation, in the case of balance of payment crisis or national development objectives. They do not have the obligation to compensate foreign investors in the same way they compensate nationals, as newly incorporated in paragraph 3 of the II Draft.xlii

All the proposals are more or less standard in terms of content and vary only in the choice of words, as is the case with provisions on transfer, meaning an agreement could be reached with regard to expropriation and compensation.

Settlement of Disputes:

Disputes arising from investment activities are ruled in articles 13, 14, and 15. Article 13 limits the scope of application of dispute settlement only to events occurring after the entry into force of the FTAA, excluding disputes arising because of State actions if these are allowed by legislation of the Party and are non-discriminating. Further, smaller economies may make use of technical assistance in the event of disputes, as has been newly incorporated in the II Draft.xliii

There are provisions on state-to-state dispute and investor-to-state dispute. State-to-State dispute considers the use of diplomatic channels as a first step to settle disputes in a 6-month term, and subsequently, the submission of the dispute to the dispute settlement mechanism provided in FTAA, if these channels are not successful. There is also a provision on cost-sharing, where a developed State in conflict with a smaller member shall carry at least half of the financial burden of the procedure attributed to the smaller member, to be channeled through a Regional or hemispheric fund or scheme.

The investor-to-state provision is open to disputes between either nationals or companies of a Party investing in another Party, whose rights under the Agreement have allegedly been breached. As with State-to-State disputes, cost-sharing provisions favoring smaller economies and special and technical assistance are also provided.

Equal treatment among the investors of the parties is guaranteed, based on international reciprocity and due process. Investors are entitled to submit a dispute to arbitration on their behalf or on behalf of an enterprise of another Party, controlled directly or indirectly by the investor, if the other Party has breached an obligation contained in the chapter, causing a loss or damage, as in NAFTA and the G-3. The time frame for submitting a claim is limited up to 3 years after the investor acquired or should have acquired knowledge of the alleged breach and damage.

When two claims allegedly breach and damage arise from the same event, the arbitration mechanism provides for consolidation under paragraph 14, allowing a hearing of both claims together by the assigned Tribunal, thus promoting judicial economy.

As with state-to-state provisions, investor-to-state disputes arising should first undergo consultation and negotiation. For consultation, Parties also notify the dispute in written form and proceed on amicable grounds. If the dispute is not solved in a 6-month term, they may proceed to submit a claim to arbitration, either to a competent tribunal in the State, or to national or international arbitration procedures. Once they have chosen one of the mechanisms, parties may not have recourse to the others.

The claim may proceed under UNCITRAL arbitration rules, the ICSID Convention or its Additional Facility Rules. UNCITRAL arbitration rules address the setting of an ad hoc arbitration tribunal; the ICSID offers arbitration procedures to its members, whilst its Additional Facility Rules provides dispute resolution in disputes where a party is not an ICSID member. An investor may submit a claim to arbitration if he and the enterprise he represents agree to the procedures of the article. In doing so they waive their right to submit procedures to a national tribunal or other dispute settlement procedures, with the exception of a “petition for injunctive, declaratory or extraordinary relief”, upon written notice or request of arbitration.

Tribunals consist of 3 arbitrators, appointed by the parties in dispute, where each party chooses one arbitrator, and the third and presiding arbitrator is selected jointly. A roster of arbitrators either with experience in international law and investment matters, or meeting the qualification requirements of UNCITRAL or ICSID is foreseen.xliv

Finally, other provisions ruling on procedural aspects such as treatment of documents, place of arbitration, governing law, interpretation of annexes, expert reports, interim or precautionary measures, finality and enforcement of the award, general aspects, diplomatic protection and exclusions are included.

c. Cross-comparison with Multilateral and Regional Mechanisms

The FTAA, like many of the recent RTAs, has been drafted following the NAFTA model. Not only the structure and general architecture of the agreement resembles NAFTA, the content itself adopts similar if not identical provisions to chapter 11, as is the case with elements such as the scope, treatment of investment, expropriation and, in particular, dispute settlement.

It is important to note that provisions in the II Draft are far from being in their final form. All proposals are in brackets, meaning they are still subject to modification, and many articles contain numerous alternatives. By observing the evolution of amendments, in particular when comparing Drafts I and II, alternative proposals have been incorporated, denoting country and sector concerns which have gradually risen from the dynamics of the negotiating process, and from the streamlining of country positions.xlv

A cross-comparison of the existing legal provision and the II Draft of the chapter of investment is important, for several reasons. First, proposals reflect country and group positions, under the hood of agreements such as the ACN, G-3 or NAFTA. Second, it helps to understand the dynamics of negotiations and possible outcomes, by a balancing of negotiating power among regional or subregional interests, based on their scope of influence and relations with countries in the hemisphere.

Furthermore, by looking at the diversity of members, most have national legislations covering investments with a certain degree of resemblance. Issues such as treatment to investments and investors, private property, balance of payment exceptions, expropriation and compensation, are contained in most regimes, making negotiations in these aspects slightly easier. Further, in terms of dispute resolution, though few regional agreements may contain provisions, many countries are members of the ICSIDxlvi, facilitating convergence in treatment of disputes through defined arbitration procedures.

On the other hand, there are very different approaches on definitions and scope, admission and performance requirements, among others. It is on these aspects that the present negotiations may concentrate on, probably making agreement more complex.

With regard to definitions, both ACN and G-3 have broad based definitions, as opposed to NAFTA’s narrow, closed and asset-based definition. In the multilateral field, TRIMS does not provide for a definition on investment or investors, whilst GATS only relates to a form of investment in services, namely “commercial presence”.

The FTAA proposes an article on definitions, right after the dispute settlement provision, very much in the style of NAFTA, including a proposal on asset-based definitions first. It then lists what is not an investment, and as in NAFTA these exceptions are mainly in the form of claims. By contrast, the second proposal on definitions is rather, broad, more in the lines of Decision 291 and G-3. Varying proposals also follow, containing lists of what are deemed and not deemed to be investments. It is probable that an agreement on the broader and not exclusively asset-based definition is reached, together with a list of what is not considered as investments, probably including loans and debt instruments, as in the regional agreements.

The mere definition of the term investment will have harmonization implications, bringing greater legal certainty, considering the different approaches in the regions. As mentioned, NAFTA members have preferred a narrow asset-based approach, whilst CAN and G-3 adopt a broader terminology. If the 34 members agree on one sole definition for investment, intraregional flows will be subject to the same set of rules. Additionally, if investments from non-Parties were also included, these would enjoy the same level of protection and rights conferred intra-regionally. Further, if the term “investor” is not expressly or exclusively conditioned by nationality and ownership control, and instead demands more relaxed requirements, such as company establishment in the territory, as already envisaged in one proposal, the FTAA could attract greater flows.

Variations in the scope of application are also evident. The ACN Decisions, NAFTA and G-3 cover both investment and investors, whilst TRIMS only relates to investment measures and GATS may cover both investments under mode 3 and investors under the concept of “movement of persons” (mode 4), but only in committed services sectors. Relating this to the FTAA, all proposals contain coverage for investment and investors of Parties. The issue will be whether coverage could be extended to non-Parties and to those investments made retroactively, before the agreement came into force. In other words, if provisions on the FTAA are only post-establishment, the agreement will not have a far-reaching effect, nor will it enhance current protection levels.

As with NAFTA and G-3, the FTAA does not contain explicit admission requirements. When comparing this with Decisions 291 and 292 and the GATS positive list style, which allow for these types of requirements. The FTAA, would contribute to reducing transactional cost in the form of admission or pre-entry requirements in the services sectors of the Parties, as well as on all investments in the ACN and other regions with similar provisions. This would imply that information requirements would be uniform, and investors would only have to refer to national law for exceptions.

The additional legal certainty that measures are not being erected to impair rights deriving from the chapter affecting trade and investment is another important contribution. Further, if the newly included Article 22 is adopted, pre-establishment requirements that result in discrimination, or obstruct investor control over the investment, this could amount to a significant contribution will be prohibited. Such an outcome is probable since most registry requirements in national legislation are not formal authorization procedures and only fulfill information collection objectives.xlvii

Treatment is one of the more controversial issues. ACN Decisions only offer NT, whilst MFN is restricted to investments qualifying as AMEs. The G-3 offers both MFN and NT at pre and post-establishment level, whilst NAFTA additionally offers minimum standard and fair and equitable treatment, including business related activities in its protection.xlviii TRIMS only concentrates on investment measures which might impair the obligation of NT of GATT article III in goods, and GATS only has MFN as a general obligation, allowing for restriction on NT and market access on a non-discriminatory basis. Judging from the extent of variation, an overall agreement on treatment will be difficult. However, consensus on NT and MFN is probable. Ideally, if NAFTA-like provisions were adopted, the FTAA would signify a relevant contribution to the existing regime, especially for services, considering these are only subject to an MFN obligation under GATS. Thus, investment in services could increase thanks to higher protection.

Transfer provisions appear very uniformly across all of the analyzed agreements. Andean Decisions, NAFTA, G-3 and GATS, all cover non-convertibility and non-transferability risks. The FTAA includes these same elements, and allows for G-3, TRIMS and GATS-like exceptions in the event of BOP crisis and financial difficulties, particularly waiving smaller economies from these responsibilities. General agreement therefore exists, and negotiations will probably only amount to a choice of wording.

Most countries in the hemisphere have legislation ruling on expropriation and compensation, either in the form of laws on private property or existing international agreements. These however, vary considerably in their content. ACN Decisions do not have provisions on expropriation or compensation, leaving it to the national legislation of member countries. NAFTA and G-3 cover legal and de facto expropriation and compensation. If the NAFTA-like proposal is adopted, it could greatly contribute to harmonization of the regimes in the region and thereby increase legal certainty for investments. In case of a lesser commitment, it is probable that Parties at least agree on protection for legal expropriation, though complete coverage for measures amounting to expropriation affecting business related activities, as well as a set of rules for compensation and valuation, would be more desirable.

Regarding the origin of investment and investors, national laws, bilateral and regional agreements have a whole array of standards on nationality and rules of origin, which may greatly raise the costs and even impede investment. Decisions 291 and 292 require the residence of the investor and domicile of the company in the subregion, as well as local ownership control. NAFTA and the G-3 on the other hand, leave these rules to a country’s discretion, so long as they do not impair the control over the investment. Multilaterally, TRIMS by definition is ownership neutral, whilst GATS needs to be informed on a specific country schedule. If the FTAA were to develop a comprehensive set of rules of origin, these costs would decrease considerably, allowing foreign investors to identify locations on more economically driven considerations.

Dispute Settlement is one of the more controversial issues, together with performance requirements and treatment. The debate centers on whether the NAFTA-like rules governing both state-to-state dispute and investor-to-state dispute are likely to be adopted, or only a G-3 type of mechanism, offering investor-to-state provision is likely to be agreed upon. Whichever the end result, a dispute settlement mechanism guarantees due process, considering that countries like the ACN members do not even have an additional mechanism in place, either than recourse to national legislation. If the NAFTA-like proposal is approved, additional protection in the form investor-to-state dispute resolution will be incorporated. Still is open for discussion is the requirement of exhausting the national channel prior adopting international arbitration, versus opting for either local or international recourse, as provided in NAFTA chapter 11.

All the regional and multilateral agreements present reservation and exceptions. Andean Decisions stipulate these are established on a case-by-case basis by the national authority and according to the legislation. NAFTA and the G-3 have a negative list approach, where the excluded sectors and activities from the obligations in those agreements are specified. TRIMS allows developing countries a longer phase out period for the notified inconsistent measures and also gives due consideration to BOP exceptions. GATS exempts sectors of the general MFN obligation, and additionally excludes sectors from any NT and market access through its positive list, only committing to specific obligations set in its schedule. The FTAA investment chapter proposes a negative list approach. Countries are therefore assumed to be open to investments in sectors that are not listed. Parties must also define reservation to the provisions of the agreement, which is not the approach of a single undertaking in the WTO agreements. Further, the smaller economies are waived of complying with the obligation to list all reservations, having longer phase out periods for eliminating them, as in TRIMS and GATS. The chapter, if approved, will contribute in keeping uniformity and clarity, thanks to its negative list in all sectors, including services. The extent of this contribution though, will need to be assessed in the light of the listed reservations.

Prohibitions are mainly restrictive business practices in the FTAA, and are spelled out in the article on performance requirements. All the regional and multilateral agreements analyzed prohibit these, and include a list of what are deemed to be inconsistent requirements. If no consensus on the tighter provisions is reached, the probable outcome will be a general ban, only allowing TRIMS consistent requirements. The outcome will depend on how much leeway countries are given to apply measures addressing legitimate concerns and policy objectives. However, a general ban on export contingent, local contents and other such elements is clearly envisaged.

Incentives are not a comprehensive part of the investment chapter. Of the regional and multilateral regimes analyzed, only Decision 292 offers a comprehensive set of incentives based on an enterprise qualifying as an AME. The extent to which the FTAA will allow incentives is still under discussion, and depends on negotiations on performance requirements. ACN, Caribbean and Central American States are likely to favor fiscal, tax and regulatory incentives, since such provisions exist in their regimes. By contrast, NAFTA and Mercosur countries might agree on a narrow list of permitted incentives, that are not discriminatory and do not impair trade or investments.

Articles 17 through 22xlix, rule on transparency, commitments not to relax labor and environmental domestic laws, investment and its relationship with other chapters, extraterritorial application of laws on investment-related issues and special formalities and information requirements. Some of these issues are completely absent of in many FDI regimes of the FTAA members, except maybe for transparency (Art. 17) and special formalities and information requirements (Art. 22). The others are still under discussion, and approval will probably depend on the extent countries view these provisions as a threat or impeachment to their sovereignty, as might be the case with labor and environmental issues. Though these have been treated in GATT Art. XX and are part of NAFTA and G-3, they are always the center of a highly contentious debate.

Finally, it is also necessary to consider what has not been included in the chapter. There is no provision on denial of benefits, which is addressed in Andean Decisions, NAFTA, G-3 and GATS. It remains to be seen if these are to be picked up in future negotiations or if these are to be left out of the chapter.



a. Theoretical Analysis

In the former section, we observed there is a case for an investment chapter in the FTAA, particularly when assessing the extent of protection offered by existing regional and multilateral instruments. First, by avoiding conflict with these agreementsl and second, by covering aspects partly considered in the regional and multilateral provisions, the FTAA generates uniformity in its legal effect, revealing the pertinence of hemispheric investment framework.

Keeping this in mind, this section tries to answer whether there is also an economic case for FDI measures in the FTAA. Specifically, how could the FTAA impact FDI flows? More importantly, if there is a case for a strong relation observable between trade and FDI in the region, could there be an increase in trade as a result of FTAA protection?

Empirical evidence points out that trade can promote FDI. Thus, trade liberalization, which also incorporates investment protection, would not only increase trade, but also generate FDI.

It has been assumed that firms do not necessarily decide between trade and investment as alternative means to penetrate foreign markets, as a result of a cost-benefit analysis. Instead, firms may see both exporting and investing as a means to further boost their sales abroad. In order to establish whether this could be the case in the FTAA, trade and FDI flows are to be analyzed.

What follows is a general review of the former empirical research and findings concentrating on the relation between trade and FDI, emphasizing the main challenges and difficulties resulting from these approaches. Later, in the theoretical foundations, a focus on 3 main lines of thinking is given, namely substitution, complementarity and gravity models are given. These are the basis for the empirical analysis, in an attempt to explain FDI flows to the Andean Community, over the last two decades, from both intra-regional FTAA members and extra-regional, mainly European, countries. Finally, results of the empirical analysis will be contrasted with those of the legal section, seeking to establish if the FTAA could positively impact FDI flows.

b. Literary Review

Several authors concerned with the relation between trade and FDI have based their research on the theory of the multinational enterprise (MNE). Over time, this theory has been enriched by diverse contributions of empirical research. There are three lines of thinking, which help summarize the main approaches, namely: internalization theory, market structure and the eclectic paradigm, better known as OLI frameworkli.

Traditional internalization theory assumes substitution, where firms are seen to take decisions on location (either home or foreign markets) based on the level of transaction costs. MNEs, which traditionally export and then decide to locate production abroad and invest in a plant, sourcing their markets with this foreign production, are said to be substituting exports for FDI. This is known as “substitution”, and is often related to “tariff jumping” when tariff levels result in costs which are too high to justify exports.

Substitution vs. Complementarity

Several authors have undertaken empirical testing for substitution. Williamson (1975), for example, bases his study on internalization, and defines the level of export costs as decisive for MNEs to choose between either between exporting and investing in a plant abroad. Markusen (1995) uses the OLI framework to find substitutability when firm specific assets have a public good aspect that allows them to share output of different locations as a source of intrafirm inputs.

Belderbos and Sleuwaegen (1998) see changes in the level of trade barriers and protection as a determinant. In their study, Firms facing actual or threat of import protection in the destination market will substitute trade and locate production in their export market. Svensson (1996) sees a case for a displacing effect (i.e. substituibility) on exports, if the level of scale economies in host country, the volume of exports and affiliate sales are determinant for sustituibility to be found.

In this sense Head (2001), as will be described in detail later, develops a model for measuring sustituibility, considering, among others, intermediate products and the level of vertical integration. Results reveal intrafirm substitution of exports of finished goods, by production in foreign plants, which in turn import parts for manufactures.

On the other hand, firms may decide to not only source the market through export. They may also invest in a subsidiary, sourcing the local market (and third markets), or even import some of their foreign production home. This is known as “complementarity”.

As with substitution, empirical research on complementarity is rich. Lipsey and Weiss (1984) find complementarity where firms producing one good abroad, may increase demand in that market for all of its products, because of the positive aspects of local presence, such as sales & after-sales service, commitment to market effect on consumers, efficient and quick delivery and distribution, as well as the level of vertical integration, accounting for intrafirm export of intermediate goods. Brainard (1993, 1997) also comes up with complementarity when considering proximity advantages of a firm’s presence in foreign markets by establishing that lower transport cost and trade barriers and higher levels of scale economies relative to the home market, particularly when home and foreign are similar. Swenson (1997) focuses on vertical production as the drive for complementarity, when looking at Japanese and American auto production. In particular, she concludes that foreign sourcing of parts in firms is also determined by national identity considerations. Therefore, even though Japanese firms in the U.S. have increased the local content in auto manufactures, exports have not been totally eliminated and the elasticity of substitution is much lower than in U.S. firms.

Intertemporal Sequence

In some of these studies, there appears to be an intertemporal link between FDI and trade. For complementarity, a conditional sequence first requiring firm presence in the host country and then, as a result, trade of intermediates, or other firm’s goods and services is apparent. This has been another important element of scrutiny when analysing trade and FDI. Authors such as Blonigen (2000) have accounted for this by lagging FDI or trade in time, in order to neutralize any intertemporal bias, such as external shocks.

Independent variables

Another important element in many studies is controlling for the endogeneity bias. Given the nature of the variables. Both trade and investment may share the same determinants, making it difficult to assess the impact they may have on each other, if both act similarly in the presence of a common factor.

The underlying problem, according to Ries (2001) is that firms, finding a country attractive as an FDI location, will probably also want to export, due to the country’s features and market for other source products, especially if the firm is competitive in products or production methods. This bias is not accounted for if it is not controlled with an exogenous variable, which is generally only possible with firm-level data.

Grubert and Mutti (1991) for instance, control for endogeneity bias in affiliate sales and trade by using exogenous indicators of the level of relative attractiveness of investing abroad for American MNEs. By using data on intrafirm exports of intermediates, tariff levels, taxes on FDI and average employee compensation, they find net complementarity between investments and exports. Head and Ries (1997) also come up with a similar approach, finding strong complementarity in the Japanese car industry.

Since complementarity is likely to occur, in the absence of a control for endogeneity, identifying exogenous variables, which have a direct effect on FDI and not on trade is needed to eliminate the bias.

Blomstrom et al. (1987) control for endogeneity by using data on changes in export levels to each of the destinations instead of total U.S. and Swedish exports at industry level. Evidence shows complementarity, since affiliate presence abroad does not reduce exports, and tends to increase export levels, destinies and products over time.


Another problem often considered is aggregation. Similar to the endogeneity bias, some researchers, such as Blonigen (2001), control for aggregation bias taking product-level data of the Japanese car industry when studying complementarity or substitution. Head (2001) uses firm-level data, and considers it is effective for eliminating this bias.

Yet another approach for studying the relation between trade and FDI borrows from the gravity model, originally developed by Andersen (1979), for the purposes of studying trade flows. This model expresses trade flows as a function of the distance between trading countries, measured through variables such as transportation cost, GDP differences in trading partners and tariff and non-tariff barriers, among other determinants. Authors such as Eaton and Tamura (1994) base their approach on factor endowments, when studying at Japanese and U.S. trade and FDI. When incorporating measures of country features such as levels of education, land-labour ratios, income and regions in their gravity model, evidence of complementarity the between trade and FDI is found. Blonigen and Davis (2000) also propose a model where they assess the impact of bilateral tax treaties on FDI. Finally, Levy Yeyati, Daude and Stein (2001) also develop a specification with variables such as GDP from source and host, extended market effects and FTA membership. They determine the size of host and source extended markets by RTA membership can have a considerable effect on FDI generation or diversion.

c. Theoretical Foundations

The following is a detailed description of three of the main approaches toward the study of the relation between trade and FDI. The first, proposes a methodology for determining substituibility, the second offers an empirical analysis for complementarity and, alternatively, the third proposal focuses on the gravity model.

i. Sustituibility of Trade and FDI

Blonigen (2001) proposes a model for testing both complementarity and sustituibility of trade and investment. The data he uses is product-level data of the Japanese automobile and auto parts industry.

This model is related to the theory of a single product firm-level decision in order to account for changes in data resulting from demand complementarity across different products. He assumes that the level of vertical production relation between the production of the Japanese automobile industry located in the U.S. and auto parts industries in Japan will be indicative of complementarity, on a product-by-product basis. In the case of substitutability, he considers the relation between the production of the Japanese auto parts industry in the U.S. and the exports of the same industry in Japan as the measure.

Since Blonigen (2001) sees a case for complementarity and substituibility, he considers both should happen at the same time in the presence of vertically linked firms. He constructs a model based on a derived demand function of Japanese auto parts. Where there are two types of demanders of Japanese auto parts in the U.S.; Japanese-owned automobile plants and U.S.-owned automobile plants, as follows:


P represents a vector of input prices, YJ and YU are automobile production by Japanese and local producers in the U.S., respectively. Blonigen (2001) then accounts for Japanese import demand (X DJIMP) by expressing it as a function of total Japanese auto parts demand minus local Japanese parts production


It is assumed that Japanese imports are positively related to production in both U.S. and Japanese automobile plants located in the U.S., and also perfectly substitutable of local Japanese auto parts production, when controlling fluctuations in relative prices.lii

Further, firms must be producing at full capacity and if fluctuations in demand are to be reflected in Japanese imports to the U.S. market. Thus, if both Japanese firms and U.S-based affiliates alter production and export in the same direction, because of changes in demand, there is a case for complementarity, instead of substitution.

Blonigen (2001) then assumes that automobile production has 3 inputs, namely Japanese auto part production in the U.S., auto parts produced in U.S.-owned firms and capital, these have associated factor prices reflected as wj, wus and r respectively, where:


He then selects 10 auto partsliii and develops a linear version of the import demand function for each, where γ stands for parameters to be estimated and Єt is the normally distributed error term:


For the purposes of predicting substituibility, parameter γ5 is assumed to be –1, meaning that an increase in imports of Japanese auto parts will cause a decrease in U.S-based production of auto parts by Japanese affiliates. Because of data shortages, employment levels are used as a proxy for Japanese production in the U.S., and γ5 therefore cannot be expected to be –1, though it will still be significant and negative. By measuring prices (wJ) in US dollars, price and exchange rate fluctuations are controlled.

Then, a Seemingly Unrelated Regression (SUR) is run for each of the 10 auto parts equations. He finds both strong complementarity between imports of Japanese auto parts and U.S.-based Japanese car industry, and substitution of Japanese car parts imports by Japanese cars parts produced in the U.S.

For substitution, the data shows there is a 95% confidence level in 9 of the 10 equations, and a negative sign on all, confirming Blonigen’s negative relation prediction. In comparison with previous empirical work, the results are very strong, signaling the relevance of product-level data in a regression analysis.

Complementarity results also reveal a 95% confidence level on 9 of the 10 equations for Japanese car production in the U.S. and imports of auto parts, whilst showing a strong positive relation on all equations. Blonigen also finds parameters for the auto parts are high, meaning vertical integration is a positive and significant determinant. In U.S. firms complementarity is weaker, but still positive in 5 auto parts equations.

Blonigen (2001) raises several concerns regarding results. There may be a specification bias may be due to time-series characteristics of the data, endogeneity of the Japanese automobile production in the U.S., or demand growth. Specifically, substitution effect results of exports by U.S.-based production may be weaker, since exports decrease later and at a slower rate, probably because of growth in the U.S. auto industry. Thus, if there is a bias, it is towards complementarity, meaning that correcting for endogeneity would weaken substitution results.

Interestingly, substitutability in the Japanese car industry subject to Voluntary Export Restraints (VERs) in the 1980s U.S. is found. Blonigen (2001) considers this could be another explanation for substituibility, possibly counterbalancing the demand growth bias, since there was pressure towards the Japanese industry to increase local content. He further tests if substituibility is also observable in 11 Japanese consumer products, both exported and produced in the U.S. by Japanese firms which are not subject to restrictions, in order to discard the possibility of a bias.

Consumer products, which are not subject to high tariffs, controlling for “tariff jumping” by Japanese firms are chosen. Selecting consumer goods is also a control for derived demand on goods that are inputs in other industries, such as intermediate goods. Since the former demand formula is no applicable, Blonigen comes up with a demand equation for each product, as follows:


Here EX are Japanese exports to the U.S., LP is the production of Japanese U.S.-based firms, P stands for the price of the product, INC for the income of U.S. consumers in real GDP terms, and Єt is the normally distributed error term. As with the former derived demand formula, LP will reflect pure substitution with a coefficient of –1, if it is shifted to the right side of the formula.

Once again, data availability makes employment in Japanese firms in the U.S. the best proxy for production. Local employees (LE) are reflected as LPt =β3LEt, and the expected sign for β3 is negative if there is substitution. The demand equation becomes:


When running the SUR, results again reveal strong substitution for the selected consumer products, with 95% confidence level in 10 of the 11 items. The coefficients are also of the expected signs and statistical relevance. 9 out of 11 products reveal a strong negative relation between Japanese exports and U.S.–based products of Japanese firms. Blonigen also points that the specification bias may be the same as in the vertically integrated Japanese industry, but that correcting it reveals stronger substitution instead.

What stands out in the analysis is that an aggregation bias may favour complementarity in contrast with analysing product-level data, where there is evidence of substitution. Results also reveal substitution appear to be large, one-time changes, even though there is no complete replacement of exports by local production, possibly because of firms’ risk assessment and preferences. Further, the nature of causality in the relation between trade and FDI signal both complementarity and substituibility. The logic of a temporal sequence points that the imposition of an anti-dumping measure reduces exports of Japanese cars and triggers Japanese FDI in the form of U.S.-based car plants, revealing substitution. However, if after the affiliates are operating, there is an increase of intermediates exports, then complementarity is the result.

ii. Complementarity of Exports and FDI

Head (2001), studies the influence of FDI on exports. He establishes FDI displaces final good exports and raises exports of intermediates, depending on an increase in foreign demand. Complementarity is the net effect in presence of intermediates, whilst substitution will result if intermediates export is unlikely.

Head (2001) proposes and econometric model where effects that are not attributable to FDI are neutralized. First, he includes fixed effects to control for differences across firms. Second, FDI is lagged to account for intertemporal bias. Finally, dummies accounting for external shocks, affecting trade and FDI simultaneously are included. Japanese car and electronic industry export data at firm level is used, to observe effects on third countries, which bilateral trade data would not display. This data is relatively disaggregated, and considers the role of assembly plants and outsourcing companies as a measure of vertical integration when intermediate products are traded.

If it is assumed that a firm may be exporting and manufacturing overseas at the same time, and the total foreign sales of its final goods can be expressed as:

y + f = sα I                                                                                                (1)

Here y stands for foreign exports, f is sales abroad of the production of a firms’ overseas affiliates, I represents foreign income and α stands for the share of I spent on the industry’s final goods, whilst s represents the firm’s share of the total industry’s sale in the overseas market.

Since the firm also produces and intermediate good (z) that is exported to its overseas affiliate, total exports (x) can be expressed as the sum of intermediate and final good exports, as x ≡ y + z. Head then develops an accounting identity where percentage changes are denoted with circumflexes, as follows:


Keeping s, α and I in the original equation constant, the amount of final goods which are substituted with overseas production is given by:


Since, intermediate exports will grow as foreign production increases in the presence of vertical integration. If z has a constant share of θ of the value of foreign affiliate sales of final good (f), then the value of intermediate good can be expressed as a function of f, such that
z = θ f where 0≤ θ <1, implying there is a proportional relation between percentage changes, Placing this into the identity, it becomes:


Having established that the value of both θ and λ is >0 but <1, is negative, meaning foreign affiliate production will result in a net decrease of exports, supposing the fall final goods exports is greater than the increase in intermediate goods. Hence, as long as foreign production does not stimulate foreign demand, increasing total sales, exports and affiliate production are substitutes. On the other hand, complementarity will occur if exports of z provoke a rise in consumption of f. In other words, investment in an affiliate plant will increase total foreign sales, and can be expressed as , which represents the percentage change in total exports, as follows:


Head (2001) sees this as probable, considering production presence can increase demand of the foreign firm, either through servicing foreign clients, greater reputation of the firm on consumers, cheaper assembly in the presence of low cost factors, lower tariff and transportation costs.

He further notes that manufacturing from ancillary activitiesliv, could generate an aggregation bias if included in the manufacturing data toward complementarity results. He accounts for this bias by distinguishing between distribution and manufacturing affiliates and assumes that this will raise the probability of substitution presence.

By assuming a percentage increase in manufactures and distribution produce a proportional percentage rise in f and s, then:

Where m and d are share-weighted sums of manufacturing and distribution FDI, respectively. Head stresses that each variable is calculated on the basis of the parent firm equity share of each affiliate, placing the greater weight on those investments where the parent firm has substantial ownership (i.e. above a 62.2% and 84.7% average for manufacturing and sales affiliates, respectively). Weighting reflects the level of ownership control, allowing for more exports of intermediate products in vertically integrated firms and foreign sales growth, due to local presence.

Head also assumes that y1 y2, since greater overseas production might increase exports of final goods, not necessarily provoking an increase in the share of export sales of final goods in the host. By substituting f and s into the former expression, we obtain:


If elasticity of exports with respect to investments is expressed as for distribution, and for manufacturing, these ACN then be incorporated into (6), as follows:


Where C is a constant. Here, an increase in distribution investment is expected to generate an increase in exports, whilst a rise in manufacture investment has an ambiguous effect on exports. This is evidenced when a sales expansion (y2), is neutralized by the displacement effect , when y1>y2. However, if there is a higher share of intermediate exports (θ) in final good manufacture, then nm will increase. This implies complementarity or substituibility between export and manufacturing investment depends on the ability to supply intermediate goods abroad.

With this model, intermediate goods, in the presence of foreign affiliates, displace final goods exports stimulating foreign demand. To measure the effect an increase in FDI has on exports, a regression specification needs to be developed. First, accounting for the intertemporal bias where investments of a plant occur prior exporting, m and d are predetermined with respect to x. Second, heterogeneity among firms is neutralized through fixed effects (vi), using domestic employment as a firm size measure. Third, value added per worker and average firm wage serves as a proxy for capital intensity, and efficiency. These eliminate endogeneity since greater firm size and capital and labor intensity reflect firm productiveness. Finally, annual dummy variables (μt) account for external shocks, such as exchange rate fluctuations, world income and regulatory environment. The specification following:


Where i is the number of firms, t stands for years, and εit is the unrelated distributed error term. Here ln (1 +m) and ln(1+d) are used instead of lnm and lnd, reflecting the time lag, since overseas manufacturing and distribution only occur after investing in the affiliates. One is added to account for the first investment. Furthermore, fixed effects are reflected in the vector for firm variations in time (Fi,t-1). It includes firm size given by the number of employees (L), capital intensity (K/L), labor productivity, defined as the value added of domestic operations over labor (VA/L), and finally wages, defined as total expenses for sales abroad over labor (Pay/L).

Prior running the regression, Head (2001) plots the aggregate time series of investment and exports of the chosen Japanese firms in the period of study (1966-1990) and total export and FDI of Japan, to see how representative the sample is. Results reveal the sample represents 75% of the total of trade, and has a correlation of 0.99. In the case of FDI, the sample Head uses only reflects 9.5% growth of the chosen affiliates, whilst there was 30% growth on total FDI for the period (1970-90). The correlation still was found to be high, namely 0.94 between the two series and 0.53 on annual growth rates.

Results of the regression reveal very large coefficients for both manufacturing and distribution in the OLS specification, distribution being significantly larger. Thus an increase in either will spur an even greater increase in exports, showing a case for complementarity. Further, when controlling for endogeneity, results reveal there is a strong positive relation between FDI and exports, even though the coefficients are lower.

When including a control for firm size, results change significantly. The relation between exports and FDI can weaken and even become negative, signaling substitution. Head argues this is due to the bias employment may have in a firm size consideration, accounting only for the fall in exports when a new plant opens. Thus, only fixed effects are incorporated into the regression. When controlling for firm size, the coefficients for FDI in manufactures and distribution decrease, though they remain positive and significant, meaning, FDI causes a restructuring of exports in domestic firms, but it still generates an increase by 16.6% in distribution and 11% for manufacturing, signaling complementarity and showing the relevance of intermediates and vertical integration.

Vertical integration is accounted for by including a parameter reflecting the share of production costs, which is not part of material purchases. It is calculated as an average in the period of study. When testing this parameter, Head (2001) finds that investment does stimulate exports of intermediates, especially in more vertically integrated firms. Thus, substitution or complementarity will depend on the level of vertical integration, being the average level of 38% a measure for complementarity in Japanese firms.

iii. Gravity Model Approach

Another method for assessing the relation between trade and FDI is the use of a gravity model, borrowed from former studies on the nature of determinants of bilateral trade. Levy Yeyati et al. (2001), take this approach. Being the first ones to use it to study the impact the FTAA could have on investment, they use a dataset of 20 source countries (OECD members) and 60 host countries, which provide a total of 20400 observations.

By adding parameters to a simple gravity specification for measuring GDP per capita and dummies accounting for neighboring countries, a common language, or historical links, the authors account for proximity and expect it to be positively related to FDI. These are specific for each pair of countries and are subsumed into the fixed effects parameter, in order to study the impact of regional trade agreements on FDI.

The GDP of source and host are included as a proxy for size, and a time fixed effect controls for unexpected FDI growth. Among the dummies there are three integration variables, namely “Same FTA”, “Extended Market Host” and “Extended Market Source”.

Same FTA” considers pair countries under the same FTA and having the value of 1 if this is the case. This variable captures tariff jumping, vertical integration and investment provisions as channels for FDI. The “Extended Market Host” measures aggregate GDP of all FTA members to which the host country has zero tariff access. The coefficient of this variable is also expected to be positive.

The third integration variable, namely “Extended Market Source”, reflects the diversion or dilution effects of FDI when the source country has partners in another FTA, to which the host country is not member. As the former variable, it measures the log of aggregate GDP of all FTA partners to the source. It is expected to be negative; reflecting FDI to the host will shrink as the number of FTA partners to the source increase. The value of the dummy capturing this effect is also -1, when the source country has other FTA partners, other than the host.

Considering all of these variables, the authors develop the following specification:

Where FDIij stands for investment flows from country i to country j; lGDP stands for log of GDP and EM is for the extended market effect, in either host or source country. Dij represents the country pair; Yt stands for time fixed effects, and εijt is the error term.

To further complement this model, Levi Yeyati et al (2001) add some regression interaction, reflecting host FDI propensity, measuring the attractiveness of a location for FDI, such that the specification is:

Where the coefficients of the host dummies
(ΦHDij) reflect the country specific factors capturing the measure of FDI propensity. To further control for complementarity, bilateral trade flows are included, assuming that vertical integration in firms will promote exports of intermediate goods in the presence of FDI, evidencing a positive relation.

A problem with log specifications is that they often include a number of observations with zero values. These values have important information, which is concealed if they are logged, generating a bias in the results. The authors account for this bias by adding 1 unit to the logs (i.e. log (1+FDI)).

Results reveal that FTA partnership has a positive and substantial effect on bilateral FDI, increasing it by 31.3% if it is not logged. When adding log (1+FDI), the relation still remains positive though less significant, increasing FDI by 24%. Running the regression without this control, throws a 90% increase of FDI, showing there is effectively a calculation bias if zero observations are not included.

Yeyati et al. (2001) find that in all cases the relation is positive, meaning that a decrease in FDI, because of tariff-jumping being eliminated in the presence of an FTA, is more than offset by other effects in the regression, which work in the opposite direction.

Results for dilution reveal that effectively, if a source country acquires new partner in another FTA to which the host is not a member, FDI will be partly redirected to the new partners, provoking a fall of 15.5% of investments, evidencing diversion. If the host country joins an FTA to which the source country is not member, it will experience an increase of 31% of the source country, signaling also that the extended market effect increases the location’s attractiveness, by 6%. If the extended market doubles for the source, then bilateral FDI will decrease by 27%.

When looking at investment within the FTAA, the authors analyze how this agreement could alter current FDI in the region. In the case of Mexico, for instance, the dilution effect of U.S. investments redirected to Argentina is measured. Since Mexico became part of NAFTA, it has increased bilateral investment and trade with the, due to the extended market effect. In Argentina, a new FTAA partnership would increase U.S. FDI stocks by 116%. Further, its relative attractiveness thanks to Mercosur membership would generate a 921% FDI increase, and the extended market effect would account for another 53% growth. The source extended market effect would offset some of these magnitudes, leaving a net increase of 165% of U.S. FDI in Argentina. The source extended market effect for the U.S. would be 16%, and a dilution would account for 4.3%. Considering the U.S. is already partner to some countries in the region, a 13% increase in FDI would be explained by the extended market effect and 0.75% by bilateral FDI increase. U.S. FDI to Mexico would decrease by 3.5%, partly compensating but not offsetting the negative effect.

These findings are particularly important, since they signal the underlying asymmetries due to country differences. Furthermore, the FTAA brings a new element of North-South membership, as was the case with NAFTA, whilst no new North-North partnership is created. The authors argue that in the light of Mexico’s substantial trade and FDI growth, positive effects are likely to be expected for the new South members.

By looking at the interaction between the FTA dummy and a ratio of source-host GDP, and assuming that the greater the differences in income between host and source, the greater the increase in vertical FDI, the model is tested. In particular, in the more open economies in the case, the effect of openness is positive and significant on FDI, making a case for complementarity, rather than substitution.

Finally, by calculating the relative attractiveness of host countries, the reallocation effect on FDI flows is measured. Taking this as a propensity measure and relating it to the FTA dummy, the authors conclude that an FTA is expected to have a positive and significant effect on FDI, and particularly favoring those that are more attractive or investment-friendly. Therefore, the more attractive countries are expected to be net gainers whilst the less attractive ones might experience a net decrease in FDI.

d. Empirical Analysis

The relation between trade and investment can be explained in terms of complementarity, substituibility or a combination of both. Determining the nature of the relation is necessary, if we are to find an economic rationale for FTAA measures on FDI. The central question in the present research is if trade and FDI flows are complementary or substitutable in South America. Intuitively, if they are substitutable, a hemispheric free trade area will increase trade flows and negatively impact FDI. Under such a scenario, investment protection in the FTAA would not have much pertinence. On the other hand, if the relation were of complementarity, further trade under a liberalized regime would also promote FDI, making the regulatory framework of the FTAA relevant.

In order to answer these questions, what follows is the construction of a model seeking to explain what will happen with investment flows to ACN members if they adopt NAFTA-like protection in the FTAA.

i. Data Limitation and Description of Variables

Intra-regional FDI in South America has either not been recorded or has been too insignificant and random to indicate any clear trend. Reliable data has mainly been company-owned and subject to disclosure, making empirical research difficult. However, in the last decade, advances in registering and monitoring investments have succeeded. The collection of data by regional institutions, such as the IADB and ACN, and further compilation into statistical series by the IMF and UNCTAD, has significantly contributed to the study of these flows, from traditional sources such as the U.S. and Europe, but most significantly, from countries in the region.

In the present study, data availability also shapes the empirical approach. The sources available only provide for FDI by region, countries or economic activities.lvi There is no industry, or firm-specific country data readily available or complete, rendering the use of methodology proposed by Blonigen (2001) or Head (2001) impracticable.

In the light of the constraints, we propose a gravity model for studying FDI in the region. Since a straight application of the model as presented by Levy et al. (2001) is not viable due to data limitations, an adaptation of their specification has been made. Specifically, the study looks at bilateral flows between 31 source countries (including ACN members themselves), and 5 ACN hosts, for a 10-year period.

First, the model considers FDI flows, distance, GDP, oil prices and a series of dummies accounting for membership of regional trade agreements. At a second stage, a test for robustness is undertaken, alternatively dropping variables and including new ones. A final specification check-up is run for a subset of the ACN countries, namely Bolivia and Peru. By determining if including a variable accounting for political instability and a further control for possible price fluctuations affecting FDI, the explanatory power of the model is tested.

Considering the limitations, the following is a description of the available data to be used in the model:

FDI flows: Taken from the registers compiled by the General Secretariat of the Andean Community, these are presented as current flows measured in millions of US dollars.lvii The data is available for 10 years, between 1992 and 2001, a period relevant for this study, since it includes the years when Decisions 291 and 292 and also when the G3 and NAFTA came into effect.

The registries are a compilation of data submitted by the official sources in each of the member countries to the Secretariat, mainly being the central banks and in some cases also the official investment authority. These statistics may differ considerably in their presentation. In the case of Ecuador and Peru, for instance, investments from the UK and the Netherlands also include investments from their offshore dependencies, such as the Dutch Antilles, whereas, the other Andean countries have disaggregated them into separate registries. Further, some do not have comprehensive data on investment on Central American countries, presumably because these investments do no exist or are minor. Despite the absence, we have decided to include the existing data on Panama and Costa Rica, since some investment data in the five host countries exists.

Another important element is the statistical considerations behind this data selection. The Andean Community does not have a harmonized system for data collection and presentation. Each country has its own methodology. For instance, some only require the registry of investments above a certain threshold, or demand a notification prior the investment is made effective, whilst others may only register effective investments.

GDP: GDP of both the source and host country in current US dollars have been taken from World Development Indicators (WDI) database of the World Bank, as well as the current GDP per capita of the source countries. The US consumer price index with base year 1995 has also been obtained from the same database, and is used as a deflator for calculating the FDI and GDP variables in constant terms, as well as the oil and zinc prices used in the gravity specification.

Distance: This is the Haveman distance measure between the country pairs, which provides the Great Circle distance between capital cities of two countries in kilometers.lviii

FTA membership: Three dummies accounting for subregional FTAs between FTAA countries have been selected, namely NAFTA, ACN, and G-3. These three RTAs reflect extended market effect resulting from membership, investment protection and tariff jumping, as a result of zero barriers among the members.

Oil Price: The oil price is the nominal annual OPEC spot Reference Basket Price. This price was introduced in 1987, and is the arithmetic average of seven selected crudes, namely: Saharan Blend (Algerian); Minas (Indonesian); Bonny Light (Nigerian); Arab Light (Saudi Arabian); Dubai (from the United Arab Emirates), Tia Juana Light (Venezuelan), and Isthmus (Mexican).

International crude spot prices would be a less precise indicator, since they generally comprise other types of crude sold in world marketslix, discarding the effect the OPEC basket has on determining the oil price in the Andean countries, considering Venezuela is the main oil producer. The variable also serves as an indirect proxy for natural gas prices, since all Andean Community countries, except Colombia, produce natural gas, thus controlling for possible variations due to prices fluctuations.

Strikes and Lockouts: An important determinant of FDI in Andean countries appears to be political stability. A good measure, considering data availability, is the number of days there have been strikes and lockouts. The International Labour Office database on labour statistics operated by the International Labor Organization (ILO) Bureau of Statisticslx is a relevant source. However, only complete registries for the period of 1992-2001 for Bolivia and Peru exist. The rest of the ACN only has some minor registries or none at all.

Zinc Price: Bolivia is the only ACN country that is not and oil producer. Since it is heavily dependent on its mineral production, zinc prices have been included as a secondary specification for observing if there is any impact on investments in the event of fluctuations in international prices. These are quantified in cents per pound of zinc in current terms, and have been taken from the Bolivian National Institute of Statistics.lxi

As with oil, zinc prices are presumed to reflect volatility with regard to international markets and exchange rates, since investments to ACN countries have traditionally been resource driven. We include this as another proxy for international vulnerability in the case of Bolivia and Peru, since both are the main zinc exporters.

ii. The Model

The gravity model to be used in the present study is the following:

Where FDIACNi stands for investment flows from country i to the ACN (ACN) country of; αACN is defined as fixed effects of host country; lrGDPh and lrGDPs stand for log of host GDP and source real GDP, respectively; whilst lrGDPspc is defined as log of source GDP per capita. The distance between source and host is expressed as lDistACN; lroil is the log of real oil prices, and ACN, NAFTA and G3 are RTA dummies indicating ACN, NAFTA and G3 membership of source countries.

The specification we use is log of FDI + 1 as a function of a set of variables. This is done in order to account for all the investment registries that are zero. Since this is the case for many country pairs, adding 1 to the log, allows observing the impact these registries may have on results, thus eliminating an estimation bias if these were left out.

We represent FDI as a function of several determinants. First, a constant (αACN) is included, which captures the fixed effects of the host country, in order to control for time-invariant factors affecting investment. Second, FDI and GDP are included in constant terms, controlling for inflation. GDP per capita of source countries seek to explain possible differences in investment to Andean countries determined by the level of income. These variables are all logged in order and avoid an estimation bias, given the differences amongst source countries. Further, a variable for distance between source and host is part of the specification and captures tariff jumping; possibly indicating what type of FDI reaches ACN countries. Real logged oil prices are part of the specification and account for FDI variations in the event of price fluctuations.

Finally, three source dummies representing membership either to NAFTA, ACN or the G-3 are also included, which receive the value of one if the source country is member, and zero if it is a non-member.

We use the dataset of 31 source countries (including ACN members) and 5 host countries, which gives us a total of 155 country pairs and 1550 observations for the 10-year period between 1992-2001 in the gravity specification.

After running the model, a specification check-up is undertaken testing for robustness. First, each of the three FTA dummies and then the oil price is dropped in turn, to see how these particularly impact results. Alternatively, a year dummy to control for time fixed effects, accounting for possible spectacular changes in investments. Finally, we run the same gravity model for a subgroup of host countries, namely Bolivia and Peru. Here, a further validation is done, first by including an additional variable for strike and lockouts, and then log of inflation-adjusted zinc prices. The aim once again is to test the robustness of the regression, this time bringing in a political risk consideration and a further control for external shocks. The reason for limiting the check to these two countries is on the one hand data limitations, and on the other, using a better proxy for external vulnerability since of these two countries are mineral exporters.

iii. Results

Before running the regression, the data was estimated to provide 1550 observations. Some registries are inexistent, leaving the specification with 1431 estimations. However, since the model requires logs to account for numerous zeros, all negative FDI registries (i.e. disinvestments) are also dropped, leaving 1391 observations.

The results of the base regression are presented in Table 3, in its first (1) column. The specification checks can be appreciated in columns (2), (3), (4), (5) and (6). Table 4 displays the regression for the subgroup of host countries chosen, with the base regression results in column (1), and then political stability and zinc prices variables in columns (2) and (3), respectively.

As expected, the estimated effect of FTA membership on FDI is positive and significant. The r-squares shows that 35.97% of the variations in investment to the Andean Community is explained through the specification. This is considerable, taking into account the data constraints and the zeros.lxii Further, the F-statistic reveals that it is significant. It is noteworthy that even if simple FDI is used instead of logged FDI, though more observations are included (1431 versus 1391), the explanatory power is only 16.25%,lxiii which is less than half of the logged specification, though it is still significant. This indicates the need for controlling biases of an unlogged specification.

The results of each of the variables in the specification in Table 3 (1), display their individual contribution to explaining FDI. First, the relationship between FDI flows and host GDP is negative with a coefficient of –0.033 and insignificant, as the t-statistics points out (-0.19). By contrast, the coefficient of the source GDP is positive, signaling an implicit increase of FDI by 14.7%lxiv, though still insignificant. The source GDP per capita has a very meaningful explanatory power, with a coefficient of 2.4; translating into a spectacular ten-fold increase in FDI (1002.3%)lxv, and considerable t-stat significance. This suggests that FDI to ACN countries is highly determined by the level of income of source countries. A probable reason behind the higher explanatory power of GDP per capita might be that it captures the impact an increase in income level has on investment decisions of source countries, such as less risk adverseness, as opposed to simple GDP.

As expected, the distance between source and host has an important impact on FDI, given the magnitude of the point estimate (-5.75). The t-stat reveals that this coefficient is highly significant, also indicating that the greater the distance, the more prone investors will substitute investment for trade.lxvi On the other hand, oil prices, have a negative effect on FDI, of an estimated decrease of 77.89%,lxvii though hardly significant.

With regard to the RTA dummies, the coefficients of ACN, NAFTA and G3 are all negative, pointing to an inverse relation between RTA membership and FDI. In other words, if a source country is a member to the same RTA as the host, it has more incentives to trade than to invest. In the case of ACN membership, for example, the coefficient of –5.4334 translates into an indirect decrease of investments by –99.56%.lxviii These results probably show that tariff-jumping absence due to common membership offsets the relative attractiveness of investments, promoting export in almost perfect substitution. Prior the creation of the ACN, members were more prone to invest due to high tariff and non-tariff barriers, which were eliminated or significantly reduced.

NAFTA also has a significant negative relation, though with less explanatory power than the ACN dummy.lxix In this case however, substitution affects extra regional FDI, since NAFTA members are not part of the ACN. The explanation for substitution therefore must be slightly different than the tariff jumping argument. Prior the creation of NAFTA in 1995, the drive for substitution could have been relative attractiveness of uniformly reduced barriers to trade versus investment transactional costs under the ACN. After 1995, substitution may be also have been due to investment diversion to the new NAFTA partners.lxx Further, though the G-3 was also effective as of 1995, and could have partly offset investment diversion, the extended market effect of NAFTA is greater than that of G3, given the relative size of both FTAs, resulting in net substitution.

Finally, the G3 dummy, though insignificant, also reveals a negative coefficient, which is correspondent with the former dummy results, since it is a subset combination of both ACN and NAFTA membership.

In order to eliminate possible biases in the explanatory power of the FTA membership dummies, each one has been dropped in turn, as a first specification check. Results for ACN, NAFTA and G3 are shown in columns (2), (3) and (4) of Table 3, respectively. As can be appreciated, the explanatory power of the specification decreases slightly, but remains significant. R-squares are 32.84%, 35.80% and 35.97% when dropping ACN, NAFTA and G3, respectively, versus 35.97% of the base regression.

Dropping the ACN dummy weakens the specification results, whilst leaving NAFTA out does so in a lesser extent. Leaving G3 out does not alter the explanatory power whatsoever. The actual R2 and F remains the same as in the base regression, whilst the predictability of the other two dummies is highly improved (i.e. both have significant t-stats and greater coefficients), possibly indicating that including G3 does not improve the specification because of the overlap of the ACN and NAFTA dummies.

When dropping the oil prices as the next specification check, the explanatory power of the regression remains significant. Further, column (5) shows the coefficients of the variables that have weight in the base regression remain significant, as the t-stat of distance; GDP per capita and ACN are still relevant. This implies that oil prices are not determinant on investments in the present base regression.

A control for time variations is accounted for by including a year dummy in the specification. Results in column (6) reveal that R2 remains significant, with 32,1% of explanatory power. Further, all the significant variables in the base specification remain relevant and experience an increase in their coefficients, except for oil prices, which become insignificant.

Another important change occurs with the host GDP. When including the year dummy, this variable becomes positive and significant, having an estimated effect of raising investments by 79.26%.lxxi This change in results has several implications. First, the fact that the other variables remained more or less the same, seem to point out that income growth in the source countries is not the only determinant for attracting investment. Probably time effects influence long-term investment decisions, also based on economic performance of host countries, as the positive and significant coefficient of host GDP signals.

Results of a second specification test on a subset of ACN countries are displayed in table 4. Here, R2 is considerably lower, at 28.09% versus the 35.97% of the base regression with all ACN countries (see Table 3, Column (1)). The signs and variables with explanatory power in the base regression remain significant in the subgroup, though results are slightly weaker. This is the particular case of the GDP per capita variable, the distance and the ACN dummy. When controlling for political stability by including a strike and lockouts variable, column (2) reveals important changes in the results. First, source GDP per capita becomes insignificant. A possible explanation is that both political instability and economic growth defined by source GDP, determine investments better and capture the effect a change in income may have on FDI. This may be the case, since the strikes and lockouts variable is highly significant, and source GDP becomes relevant, whilst other significant variables such as distance and ACN are not affected.

Second, when including the strike and lockout variable, the oil price determinant becomes significant, having the indirect effect of decreasing investments by 98.82%.lxxii This change is particularly important, since oil prices were hardly significant and had weaker coefficients in the base regression and specification checks. This reveals that vulnerability to international oil markets is also a determinant of investment attraction in the region, if a measure for political risk is part of the specification.

Finally, the last robustness test is the inclusion of zinc prices, since Bolivia and Peru are mineral exporters. Including this variable does not generate an important increase in R2 or any of the specification variables. In itself, the zinc price variable is not significant, as shown in Table 4, Column (3).



a. Policy Implications of the FTAA Investment Chapter

The results of both the legal and economic analysis reveal there are several considerations Andean countries will have to take into account, if the FTAA investment chapter is to be approved.

First, from the legal perspective, the FTAA will harmonize investment protection across the 34 members, placing all of the countries on the same level playing field. In terms of relative attractiveness, legal security and incentives offered by FTAs such as the ACN or G3 may no longer be an advantage. What will have more importance when competing for foreign capital, are inherent country characteristics such as growth, economic performance, relative market size, production costs and infrastructure; and much of this in turn will depend on effective policy design.

The choice of wording of the Draft proposal, will determine the set of obligations on FDI. There are “WTO-like” and “WTO-plus” provisions. Depending on the negotiation outcome, the chapter could either maintain the status quo with “WTO-like” rules, or increase investment protection by adopting the “WTO-plus” proposal.

For instance, if are pre-establishment obligations are included, they will considerably reduce the sovereignty of countries to design their industrial policies. Thus, measures such as the requirement of joint ventures, which some countries see as necessary for the development of an industry or sector, would be prohibited. However, if the obligations apply at a post-establishment stage, countries having development considerations in mind could still place conditions upon entry, subject to non-discrimination, being more desirable from a policy choice perspective.

Another important element in this regard is performance requirements. If deeper liberalization is sought, then requirements such as technology transfers could be banned, affecting expectations of positive spillovers to the local industry or work force, such as raising human capital, upgrading of production methods or transferring know-how.

Though these requirements have been banned in NAFTA, they are frequent in the ACN and go hand in hand with incentives. Already, WTO members have prohibited performance contingent measures in TRIMS, such as trade balancing and local content requirements. If this general prohibition were further expanded to include incentives such as tax reductions in the FTAA, countries having these incentives in place to respond to business needs would need to redesign their investment policies and objectives.

In this sense, the terms for reservations and listings of exceptions are paramount for each individual country, since only listed sectors will be waived from the general obligations on investment in the FTAA. As established in the modalities for negotiations, exceptions have to be presented in the form of laws, regulations or policies. Therefore, members first have the imminent task of identifying the sensitive or national interest sectors and activities, where policy design matters. The failure of doing so will reduce the opportunities to capture benefits deriving from the FTAA membership.

Turning to negotiation outcomes, it is highly probable that the provisions on general exceptions and reservations will be readily accepted, if individual country realities are considered. These will include measures for health, environmental, national security and public interest, as well as balance of payment exceptions; since these are present in existing regional legal instruments and are also part of the Draft proposal. What remains to be seen is the extent to which members will have to prove the legitimacy of adopted measures in the event of a dispute. More importantly, the costs countries may bear if such measures violate obligations and have to be modified, is another consideration pending assessment. In this sense, the inclusion of special and differential treatment in the form of waivers, financial and technical support and longer time frames will be crucial for the poorer and more vulnerable countries, but not enough.

The core issues in the FTAA, such as standard of treatment and performance requirements, are also preponderant in the WTO. Indeed, much has been speculated on the spillover of the multilateral negotiations outcome on FTAA, because of the complementarity between the regional and multilateral sphere and especially due to the relevance investments has been given in both agendas.lxxiii

The Cancun Ministerial resulted in a postponement of a commitment of multilateral rules on investment, meaning regional efforts could be useful to pave the way for future negotiations, such as the FTAA initiative. This scenario is quite possible, considering the WTO has already borrowed from previous FTAs’ experiences.lxxiv

Though from a legal standpoint the creation of FTAs have favoured FDI protection, this has not been enough to increase investment flows. In the particular case of the Andean countries, empirical testing reveals that despite tighter investment provisions adopted in the 90s, ACN, NAFTA and G3 membership had a negative impact on FDI. As a result, investment flows decreased in this region, as Andean members and other source countries joined FTAs.

These findings also shed light on the type of FDI that has been attracted. As FTA membership became more frequent, the relative attractiveness of exporting in comparison to investing increased, evidencing substitutable FDI in the Andean countries. In other words, integration favours sourcing through trade, since tariffs and possibly other trade barriers are reduced. Therefore, even though incentives for FDI might be attractive, these are offset by trade liberalization, and become net costs for countries adopting them.

Another important determinant of investment in the ACN is income differences between source and host. FDI is positively related to changes in GDP per capita of source countries, meaning income fluctuations are determinant in investment decisions.

Since all of the FTAA members are developing countries, except for the U.S. and Canada, income differences will not be as stark as they were for Mexico when joining NAFTA. It is probable that investments from the two developed members will be “diluted” because of the hemispheric dimensions of the FTAA, where more than one country will compete for foreign capital. Therefore, even though GDP per capita of a source country explains and is positively related to FDI in the ACN, it may not account for spectacular flows in the FTAA. In fact, there is a possibility of FDI diversion of traditional flows to the ACN, considering harmonization of legal protection across 34 members and its effect on relative attractiveness.

In addition, the region is vulnerable to external shocks, which is why sourcing from abroad may be more attractive in the event of possible economic instability. Finally, even though investments have traditionally been resource driven, oil and zinc prices are not relevant and only show significance when correcting for political risk. This indicates that short-term price fluctuations are not part of investor considerations and only play a role under the probability of a sustained political uncertainty scenario.

b. Final Observations and Recommendations

In the economic analysis, data restrictions shaped results. If future research in the field is undertaken, it is necessary to consider these shortcomings and assess alternative approaches in dealing with these restrictions.

The model that has been tested shows high significance of F-statistic and good explanatory power of R2. In particular, eliminating the ACN and NAFTA dummies or the oil price do not increase the explanatory power of the specification, as opposed to dropping G3, which will improve the coefficient and t-statistics of NAFTA and ACN. Further, GDP of host changes its sign from negative to positive and becomes highly significant when a control for time invariant effects is included. It also improves the t-stats and explanatory power of other significant variables, such as distance, GDP per capita, and ACN and NAFTA dummies.

Further, the subgroup specification check also shows similar results, when compared with the base regression. If data on strikes and lockouts are included, these improve the predictability of other variables, namely source GDP and oil prices. Zinc prices, as opposed to oil prices, are not significant; possibly indicating that vulnerability to international zinc export prices does not determine investments. However, in conjunction with the political risk determinant, these contribute to raising the relevance of the source GDP and strikes and lockouts variables.

Considering the results of the specification check, the base regression is fairly robust. However, a more accurate specification should include a year dummy and a variable accounting for political instability, such as days lost on strikes and lockouts, and the overlapping dummy, which accounts for G3 membership, should be eliminated.

Finally, even though the specification test on the subgroup of countries improved predictability of the model by raising the explanatory power of some variables, the number of observations was limited. Ideally, data on strikes and lockouts for all the countries would have made the test more robust. Considering the zinc variable had a low significance, a basket of mineral prices, such as the OPEC crude basket in the case of the oil price variable, could provide more precise results for the subgroup.



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Article 1
Para. 1(c): Only Party investments, investors and all investments considered

Para. 3: No provisions on smaller economies
“All investments” also considers the possibility of non-Party investments.

Smaller economy considerations. These have a right to negotiate coverage on a case-by-case basis of pre-FTAA investment
Attract more FDI by offering the same level of protection.

Reflects the concern of waiving less able countries to control investments due to bigger country interest in pre and post-establishment coverage (only way the coverage could be approved)
Article 2
Para. 3: No provisions on smaller economies Smaller economy considerations, discretion to discriminate under “certain special circumstances”, such as economic instability and vulnerability, allowing for the application of prudential measures affecting NT of business related activities of foreign companies and waiving local ones Reflects valid country concerns of discriminating in favor of local investors (i.e. crowding out effect by FDI), but limits scope of action
Article 3
Para 1.: Conditioning MFN no less favorable treatment than that accorded to third States, upon admission of investments

Para. 2: No provision on smaller economies

MFN obligation is exempted where more favorable treatment is given to investors and investments of smaller economies
Subjecting MFN to admission may be seen as a leeway for discrimination or raise transaction cost and reduce FDI flows to the FTAA

S&D to existing RTAs between Smaller economies, to avoid conflicts with other RTA regimes
Article 4
Para. 4: No provision on smaller economies Smaller economies with common markets do not have the obligation to extend obligations on treatment to third parties S&D to existing RTAs between Smaller economies, to avoid conflicts with other RTA regimes
Article 5
Para. 2: No provision on special treatment toward domestic SMEs Exception in the case of treatment which favors small and medium-size enterprises Fear of crowding out effect by enterprises such as MNEs which ACN easily adapt production to consumer taste at minor costs because of economies of scale
Article 6
Para. 1: Referring fair and equitable treatment to “international law”

Para. 2: No provision on limits to the standard of fair and equitable treatment

Para. 3: No provision on presumptions of breach of the standard

Para. 4: No provision on smaller economies
Based on “customary international law” confers “standard of treatment of aliens”

“Fair and equitable treatment” and “Full Protection and security” are limited by customary international law
Presumption of breach of agreement or other agreements is not an automatic breach of this article

Smaller economy may discriminate in favor of other smaller economies
The concept of fair and equitable treatment is narrowed down, by defining “customary international law” as the benchmark instead of “international law”, but may raise transactions cost because of difficulty in agreeing on definitions and interpretation

Recognizes RTAs between smaller economies and harmonizes with Art. 4
Article 7
Para. 8: No provision on smaller economies Smaller economies may apply development-related performance requirements, WTO compatible Consideration of phase-out periods of developing and least developed countries of non-complying TRIMS to avoid clash
Article 8
Para 4.: No provisions on entry and stay of aliens

Para. 5: No provision on smaller economies
Pre and post-investment entry allowances necessary for the fulfillment of business operations and related activities, where a “substantial” amount of capital is involved

Smaller economies may impose the requirement of hiring of key personnel (executive and managerial)
Shows concern on the movement of persons that should be treated horizontally, such as in the services and other chapters. Concerns on impairment of investment because of restrictive migration and labor laws

Employment generation capacity building and training objectives, and maybe also linked with performance requirements or benefits, with a view to increase spillovers of know-how, organizational abilities and raise human capital
Article 9
Para. 10: No provision on smaller economies Waiving smaller economies of allowing transfers without delay, on a case-by-case basis, negotiating with the investor if under a foreign exchange or BOP crisis and considering foreign exchange control and possible reserves depletion Greater vulnerability and longer recuperation period if reserves are depleted through transfers.

Vulnerability depends on the magnitude of the FDI project and monetary policy considerations/concerns.
Article 10 and 11
Art. 10, para. 11: No provision on smaller economies

Art. 11, para. 3: No provision on smaller economies
Waiving smaller economies of offering prompt, adequate and effective compensation, as well as on payment of interests, if under a foreign exchange crisis

If there is a catastrophic loss, smaller economies do not have to compensate foreign investors to the same extent compensate national enterprises
Greater vulnerability and longer recuperation period if reserves are depleted through compensation payments.

ELEMENTS ACN DECISIONS 191, 192, 344 NAFTA Group of 3
Minor or relaxed commitments “WTO-plus” Commitments
Definitions Broad definition, including items such as tangible and intangible technological contributions Broad definition of FDI qualified under Andean Multilateral Enterprises (AMEs) Narrow, asset-based definition of investment, with a list of what is not considered as investments Broad definition, including definitions in Party legislations and a list of what are not investments No definition on investment is made. An illustrative list of trade related investment measures is given Investments fall under the definition of Mode 3 of “Commercial Presence”
Investments fall under the definition of Mode 3 of “Commercial Presence” No definition, subject to each country and their legislation, or a narrow and asset-based definition Broad based definition of investment, excluding credits and loans. Investor and enterprise are also defined
Scope Party and non-Party investments and investors Investments of investors of AMEs Party and non-Party investments and investors Party and non-Party investments and investors Only covers investment measures in goods issued by governments Covers investments in services relating to “commercial presence” (mode 3)
Investment and investors of Parties Investment, investors and all investments in pre/ post-establishment
Admission Registry is necessary, in accordance to national legislation at the competent national agency No additional requirements, except those contained in national legislation No additional requirements, except those contained in national legislation Allowed if not inconsistent with Articles III and XI of GATT As established in market access and NT columns by sectors committed in each country In accordance to national legislation requirements NAFTA-like provisions if applied in a non-discriminatory or impairing manner
Treatment National treatment NT and MFN treatment to investments that qualify as AMEs MFN and NT,
Minimum standard and fair and equitable treatment, right of establishment and business activities,
and pre and post-establishment level
MFN and national treatment at pre and post-establishment level National Treatment relating to Article III, GATT

Does not include right of establishment
MFN treatment. NT is not general, subject to sectoral inclusion and conditioned by market access and NT provisions in country schedules NT and MFN NT and MFN
NAFTA-like provisions for investors, investments and extended to “business related activities”
Transfers Covers non-transferability and non convertibility risks on investments, proceeds from sales liquidation, profits, etc. Covers non-convertibility and non-transferability risk, and free movement of capitals NAFTA-like provisions as well as exceptions in BOP or financial difficulties
BOP exceptions ACN waive the right to transfer for developing countries Covers non-transferability and non-convertibility risks and includes BOP exceptions BOP exceptions
Smaller economy waiver on BOP crisis grounds
Covers non-transferability and non-convertibility risks
Expropriation Does not contain measures on expropriation, leaving it to provision in national legislation Covers legal and de facto expropriation and compensation
NAFTA-like provisions Is not covered Only legal expropriation Covers legal and de facto expropriation
Rules of Origin
And Key Personnel Provisions
Investor nationality and residence are required to classify investments by discretion of the national competent authority. Principal domicile and director majority are necessary to qualify as an AME.
Director majority or nationality are allowed so long as it does not impair the control over the investment NAFTA-like provisions Ownership neutral, simply investment is stated in the preamble As established in the schedules committed sectors under mode 3 and 4 Nationality, domicile and ownership control requirements is left to the discretion of a Party Prohibition on impairing and discriminating requirements on Parties that may obstruct control
Reservations and Exceptions Exceptions as established by law, only reserved to the State or national companies, decided by the national competent authority on a case-to-case basis. Top down or negative list approach. Negative list approach of measures inconsistent with the obligations and sectors reserved to the State, such as energy, telecoms and finance NAFTA-like provisions Inconsistent measures must be notified. Negative list approach.
For developing countries, BOP consideration ACN waive obligations and extend phase out periods
Positive list approach with horizontal exceptions and specific reservations on NT and market access by sectors and modes. Sectors exempted from MFN are in Annex I Country exceptions are presented in a negative list, containing sectors, economic activities, measures and restrictions applying. Negative list approach, with exceptions and reservations, including the services sector. Smaller economies exceptions.
Dispute resolution No dispute settlement mechanism. Disputes arising from investments are to be channeled through local authorities and existing legislation in the host country Procedures for investor and state-to-state disputes, based on commercial arbitration law and mechanisms, such as UNCITRAL/ ICSID
NAFTA-like provisions, but only for investor-to-state disputes. DSU of the WTO. State-to-state dispute settlement mechanism, but only for cases relating to notified inconsistent measures (TRIMS) and services sector (GATS) Investor-to-State dispute mechanism, only ruling on commercial arbitration cases NAFTA-like dispute resolution
Performance requirements Performance requirements in the area of technology transfer that may result in anti-competitive practices is prohibited addressing both national, subregional and international investments Requirements are prohibited for both party and third party investments. Except geographic location, employment creation, capacity building or R&D
NAFTA-like provisions Performance requirements are listed. They only refer to government practices and measures, there are no restrictions on MNEs Performance requirements such as local content, trade balancing and export contingencies are expressly prohibited WTO consistent with both TRIMS and future dispositions deriving from negotiations of MFI NAFTA-like provisions
Smaller economy and performance incentives exceptions
Incentives Comprehensive set of incentives such as fiscal, tax and regulatory incentives to AMES No defined incentives No incentives. Joint investment promotion is foreseen Allowed if consistent with Art. III and XI of GATT As established in each country schedule Not a comprehensive part of the FTAA. Narrowed by performance requirements, and only allowed if non-discriminatory
Pre- and Post-establishment Pre-establishment is subject to national laws and regulations requirements, specially in the case of qualifying for a AME Pre and post-establishment protection. All sectors are covered, except those listed as exceptions NAFTA-like provisions Does not apply Post establishment, subject to the sectors committed in the schedules Only post-establishment is covered, determined by scope and definition of investments
Pre and post-establishment are both covered
Transparency Investments must be notified to the national competent authority. Transparency obligations are set on the investor under the supervision of the national competent authority A Party may require data and business information for statistical purposes, subject to disclosure. A Party may disclose information, with regard to its laws, in an equitable manner and good faith To increase Party investment, parties should diffuse, promote and exchange information on investment opportunities, and fiscal and tributary information Members must notify inconsistent TRIMS and shall consider requests of information and consultation of other members. Laws and law enforcement must be made public. Members are required to notify modification or promulgation of legislation or measures affecting the committed sectors Parties must ensure their laws, procedures and decisions on investments and investors are made publicly available, shall provide them to other Parties and publish them upon request



Dependent Variable (1) (2) (3) (4) (5) (6)
ln(FDI+1) Base reg. Drop AP Drop NAFTA Drop G3 Drop Oil Year dummy

GDP Host -0.0330 -0.0597 -0.0461 -0.0336 0.0100 0.5837
  (0.19) (0.34) (0.26) (0.19) (0.06) (4.81)***
GDP Source 0.1373 0.2809 0.1557 0.1291 0.1853 0.0506
  (0.45) (0.9) (0.51) -0.43 (0.61) (0.16)
GDP per capita of Source 2.4023 2.2215 2.3084 2.4102 2.3588 2.5122
  (7.43)*** (6.73)*** (7.22)*** (7.55)*** (7.31)*** (7.57)***
Distance -5.7535 -4.3632 -5.5945 -5.7488 -5.7695 -5.8995
  (17.49)*** (15.12)*** (17.57)*** (17.56)*** (17.54)*** (17.54)***
Oil prices -1.5092 -1.5068 -1.5303 -1.5107   -1.0759
  (1.74)* (1.7)* (1.76)* (1.74)*   (1.21)
AP Dummy -5.4334   -5.0810 -5.4650 -5.4330 -5.6328
  (8.2)***   (7.98)*** (8.66)*** (8.2)*** (8.29)***
NAFTA Dummy -1.4075 0.2909   -1.4484 -1.4240 -1.5797
  (1.9)* (0.4)   (2.09)** (1.92)* (2.08)**
G3 Dummy -0.1255 -2.1238 -0.6634   -0.1410 -0.2818
  (-0.16) (2.72)*** (0.88)   (0.18) (0.34)

Observations 1391 1391 1391 1391 1391 1391
R-squared 0.3597 0.3284 0.358 0.3597 0.3583 0.321
F-STAT 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000

Absolute values of t-statistics in brackets, where *** Significant at 1%, ** significant at 5%, * significant at 10%.  

Base reg.
Zinc prices
GDP Host -0.1823 0.0374 0.0416
  (0.95) (0.19) (0.21)
GDP Source 0.5457 1.1382 1.1514
  (0.97) (1.92)* (1.94)*
GDP per capita of Source 1.5185 0.9278 0.9224
  (2.49)** (1.45) (1.44)
Distance -6.1390 -6.3330 -6.3441
  (10.98)*** (10.96)*** (10.96)***
Oil prices -2.7248 -4.4410 -4.1815
  (1.81)* (2.64)** (2.38)**
AP Dummy -3.9042 -3.7053 -3.6948
  (3.17)*** (2.91)*** (2.9)***
NAFTA Dummy 0.1067 0.0272 -0.0086
  (0.08) (0.02) (0.01)
G3 Dummy -1.8941 -1.5901 -1.6264
  (1.43) (1.15) (1.17)
Strikes and Lockouts   1.6186 1.6644
    (3.27)*** (3.31)***
Zinc prices     -1.2459

Observations 522 466 466
R-squared 0.2809 0.3392 0.3396
Prob > F 0.0000 0.0000 0.0000

Absolute values of t-statistics in brackets, where *** Significant at 1%, ** significant at 5%, * significant at 10%.

i ALALC was the predecessor of the American Association of Integration (ALADI), a framework institution for the promotion and design Latin American integration.

ii The IMF, the World Bank, offering bailout support, compromised financial aid to country performance in reforms under tight supervision and cooperation with ECLAC and UNCTAD.

iii This ECLAC concept is also referred to as “growth with equity” or “productive transformation”.

iv For the purpose of brevity, some regional FTAs are not part of this section. Only those relevant to objectives and research parameters, used in the empirical proposal due to data availability, are mentioned.

v The Treaty of Montevideo (1980) creating ALADI was signed by 11 countries, namely Mexico, Chile, Colombia, Peru, Bolivia, Ecuador, Venezuela, Argentina, Brazil, Uruguay and Paraguay, accounting for 95% of GDP, 87% of the territory and 86% of the population in Latin America and the Caribbean.

vi Mainly taken from the information available on the webpage of the G-3:

vii These are: Antigua and Barbuda, Argentina, the Bahamas, Barbados, Belize, Bolivia, Brazil, Canada, Colombia, Chile, Costa Rica, Dominica, Dominican Republic, Ecuador, El Salvador, Grenada, Guatemala, Guyana, Haiti, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, St. Kitts and Nevis, Saint Lucia, St Vincent and the Grenadines, Suriname, Trinidad and Tobago, U.S.A., Uruguay and Venezuela.

viii Chile opted out of the ALALC in 1979, when initiating its reform process under a unilateral liberalization approach, provoking a general rejection of its growth strategy during the 80s by ALADI members.

ix Hemispheric integration objectives were first spelled out as far back as 1826, in what was known as the Congress of Panama and the Letter of Jamaica, written by Simon Bolivar in exile whilst preparing for independence battles, when South America was still under the Spanish and Portuguese domain.

x The 90s evidenced several financial crisis, first Mexico (1994), then SE Asia (1997) and Brazil (1998), and more recently Argentina (2001) with worldwide effects, especially harmful to developing countries.


xii Listed assets in the article are: “industrial plants, new and overhauled machines and equipment, new and overhauled equipment, spare parts and pieces, raw materials and intermediate products.”

xiii The decision defines a State-owned company as an established enterprise with more than 80% capital owned by the State, as well as the decision making authority.

xiv Currently, the list of governmental financial institutions listed in the annex are: the Inter-American Development Bank (IDB), International Finance Corporation (IFC), German Corporation for Economic Cooperation, Danish Industrialization Fund for developing Countries (IFU), Inter-American Investment Corporation (IIC), and more recently, also The Netherlands Finance Corporation (FMO).

xv Decision 292 is available in Spanish under:

xvi Tangible goods in the present Decision are defined like tangible assets in Decision 291.

xvii The chapter is included in part V of the agreement, which rules on investment and services.

xviii A closed list of what are considered investment in Article 1139 includes “... an enterprise, an equity security of and enterprise, a loan to an enterprise, an interest in an enterprise...” among others.

xix It refers to both legal expropriation and regulatory takings, and de facto expropriation, which occur when measures taken by government progressively impede the realization of specific firm activities, such as the organization, control, operation, maintenance and disposition of companies.
This standard extends itself beyond property of investment to actual business activities.

xx Hull formula foresees due process and adequate, prompt, and effective compensation as basic rights, covering the risk of expropriation and non-discrimination.

xxi See Article 1122 of NAFTA.

xxii See

xxiii See Chapter I, p.8, relative to G-3.

xxiv Issues considered for the clarification are: scope and definition; transparency; non-discrimination; modalities for pre-establishment commitments based on a GATS type, positive list approach; exceptions and balance of payments safeguards; development provisions; consultations and dispute settlement.

xxv When TRIMS was negotiated, many developing countries pushed for keeping these measures out; their impact on FDI then was unclear. Recent empirical studies, as some authors stress (Moran, 2001), show that these measures negatively impact development, which could justify their inclusion in current negotiations.

xxvi Reports and papers on the Cartagena Ministerial are online under:

xxvii Mainly taken from the Report to the Final Plenary of the Workshop “Corporation and Integration: Foreign Investment and Strategic Alliances”. Americas Business Forum, March 1996.

xxviii This document can be viewed online under:

xxix Other chapters verse on: agriculture; government procurement; tariff and non-tariff measures; safeguard measures; origin regime; customs procedures; rules of origin; technical barriers to trade; subsidies, anti-dumping and countervailing measures; dispute settlement; services; intellectual property and competition.

xxx The information on States making submissions is held confidential.

xxxi These are typically establishment, acquisition, expansion, management, conduct, operation and sale.

xxxii See Table 1 for a scan of all the amendments of I Draft, which have been included in II Draft.

xxxiii See Table 1.

xxxiv Idem.

xxxv Crowding out refers to the ability of foreign affiliates with more competitive products, services management or other assets to become dominant, by offering lower prices, preventing local companies to break even and eventually driving national firms out of the local market.

xxxvi See Table 1.

xxxvii Idem.

xxxviii The “necessity” test consists of first qualifying a measure to see if it fits in one of the subparagraphs, and then verify if the measure has not been applied in a arbitrarily or unjustifiably, and that it does not represent a disguised restriction to trade or investment, in countries where the same conditions prevail.

xxxix See Table 1.

xl See Table 1.

xli Hull formula foresees due process and adequate, prompt, and effective compensation as basic rights, covering the risk of expropriation and non-discrimination.

xlii See Table 1.

xliii See Table 1.

xliv There has not been an agreement on the number of arbitrators the roster should contain, but there is one proposal with 15 and another with 5 arbitrators.

xlv See Table 1.

xlvi Currently, 26 of the FTAA countries are members to the ICSID; Antigua and Barbuda, Brazil, Canada, Dominica, Mexico, Suriname are not members, having the alternative access to the Additional Facility Rules of ICSID for disputes between members and non-members. Further, many members have indicated they are in the process of joining the ICSID.

xlvii See Table 2 for a cross-comparison on Pre- and Post-establishment provisions in ACN, NAFTA, G-3, GATS, TRIPS, TRIMS and the FTAA.

xlviii See Table 2 for a cross-comparison on Treatment provisions in ACN, NAFTA, G-3, GATS, TRIPS, TRIMS and the FTAA.

xlix Articles 20 through 22, were not part of I Draft, and have been incorporated to the II Draft.

l Both subparagraph f of the General Principles in the Annex of the San Jose Ministerial Declaration and several proposals refer to this text or to “WTO consistency”, throughout the Draft Agreement. Further, there are various proposals on the reach of the chapter, limiting it to other existing subregional agreements.

li The OLI Framework stands for Ownership, Location and Internalisation. According to this paradigm, companies essentially decide between exporting and acquiring physical presence through foreign direct investment in the foreign market.

lii The author states the model is kept simple due to data limitations. A more complete approach would include cost considerations, as well as the trade off firms face between local production instead of imports.

liii The 10 auto parts are: toughened glass, laminated safety glass, automotive mirrors, radio-cassette players, radio receivers, engine starters, engine coils, door locks, bumpers and parts, and seats and parts.

liv Typical ancillary activities, which may also stimulate exports of finished products, are: distribution, repairs, technical assistance and the adaptation of products to consumer preferences.

lv Accumulated FDI has been estimated at 111.9 billion dollars, for the period 1994-2001, whilst trade increased by 181%, representing 329.8 billion dollars. According to the calculations of the model, Mexico’s extended market increased 18-fold, and FDI duplicated from countries outside NAFTA.

lvi The most comprehensive official source for the Andean Pact countries is the Andean Community, which comprises official individual FDI data.

lvii Available at:

lviii Downloadable from

lix Typically, Dubai, Brent and WTI spot crude prices are considered, as is the case of the IEA.

lx Available under

lxi Statistics can be looked up under the main page of the institute:

lxii Of the 1431 observations 443 are equal to zero.

lxiii This information is not provided for in the Annex, but is available upon request.

lxiv Exp(0.1372)-1=0.1470

lxv Exp(2.4)-1=10.0231

lxvi Exp(-5.7534)-1=-0.9968

lxvii Exp(-1.5091)-1=-0.7789

lxviii Exp(-5.4334)-1=-0.9956

lxix t-statistics of (1.9) versus (8.2).

lxx This argument has been empirically tested in Levy et al. (2001), where FDI diversion reduces investments by 15.5% to non-FTA members, when the source country joins a new RTA.

lxxi Exp(0.5837)-1=0.7926

lxxii Exp(-4.4409)-1=0.9882

lxxiii This complementarity is referred to as the “stepping stone argument”, where regional integration efforts are considered a previous and necessary stage to achieve higher levels of integration at a multilateral level.

lxxiv GATS has borrowed from the NAFTA rules on movement of service providers, known as mode 4.


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