WORLD TRADE - Documents Online Home page · Web viewWorld Trade Organization G/C/W/307/Add.1 8 February 2002 (02-0600) Council for Trade in Goods Original: English TRADE-RELATED INVESTMENT

WORLD TRADE

ORGANIZATIONG/C/W/307/Add.18 February 2002(02-0600)

Council for Trade in Goods Original: English

TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS

Joint Study by the WTO and UNCTAD Secretariats1

Addendum

PART II

Evidence on the Use, the Policy Objectives, and the Impact ofTrade-Related Investment Measures and Other Performance Requirements

1 The terms of reference are as follows: "To assist WTO Members to carry out the review called for in Article 9 of the TRIMs Agreement, the WTO and UNCTAD Secretariats are requested to prepare a joint study for the WTO Council for Trade in Goods. The study should provide a factual and objective examination of the use that governments have made of trade-related investment measures and other performance requirements as policy tools for industrial development, their effects on international trade and investment flows and on economic growth and development, and the treatment of them in other international agreements and instruments. The study should be based on a thorough review of the available literature, including the results of analysis carried out on this subject by other intergovernmental organisations." (G/C/W/266).

G/C/W/307/Add.1Page i

TABLE OF CONTENTS

I. INTRODUCTION.......................................................................................................1

II. EVIDENCE ON THE USE OF TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS......................1

A. TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS APPLIED IN SPECIFIC SECTORS: MOTOR VEHICLES............................2

B. TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS APPLIED IN THE CONTEXT OF THE REGULATION OF FDI....................7

III. POLICY OBJECTIVES OF TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS...........................................19

IV. THE IMPACT OF TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS.....................................................21

A. IMPACT ON INTERNATIONAL TRADE FLOWS................................................................21

1. Local content requirements......................................................................................21

2. Export performance requirements...........................................................................22

3. Trade balancing requirements.................................................................................23

B. IMPACT ON INTERNATIONAL INVESTMENT FLOWS......................................................24

1. Local content requirements......................................................................................24

2. Export performance requirements...........................................................................25

3. Trade balancing requirements.................................................................................25

C. IMPACT ON GROWTH AND DEVELOPMENT...................................................................26

1. Impact on resource allocation and growth..............................................................26

2. Impact on technology transfer..................................................................................29

3. Impact on employment and wages...........................................................................30

4. Impact on competition...............................................................................................31

REFERENCES.........................................................................................................................32

G/C/W/307/Add.1Page 1

I. INTRODUCTION

1. This is Part II of the joint study which the WTO and UNCTAD Secretariats were asked to prepare by the Council for Trade in Goods. Part I (G/C/W/307) covered the issue of scope and definition, and provided an overview of relevant provisions of existing international agreements. Part II reviews the use that governments have made of trade-related investment measures and other performance requirements, and their effects on trade and investment flows and on economic growth and development.2

II. EVIDENCE ON THE USE OF TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS

2. This section surveys the use that governments have made of trade-related investment measures and other performance requirements, first as sector-specific industrial policies where in the main the measures have been of general application, regardless of the ownership of the firms affected by them, and second in the context of the regulation of FDI where the measures have been targeted specifically at the activities of the subsidiaries of foreign-owned firms.

3. The survey is not comprehensive. The information has been drawn from a variety of official and non-official sources. It is believed to be accurate, but since it has not been verified by the Members concerned it should be regarded as illustrative of the range of policy settings in which the measures have been applied, and not as an authoritative statement of laws or regulations. In several instances it has not been possible to verify whether the measures described are still in force.

4. A number of studies has addressed the overall incidence of trade-related investment measures and other performance requirements.3 There are limitations to the accuracy and comparability of data4, but even so the following broad observations seem valid.

Certain measures have been used relatively intensively by both developed and developing countries, in particular in the motor vehicle industry.

The OECD found a trend toward the removal of the measures in many OECD member countries in the late-1980s5, and since then it would appear that there has also been a significant decline in their use by developing countries.6

The measures have been applied in different contexts, including generic laws and regulations on the entry of FDI, in combination with investment incentive schemes, and as general or sector-specific industrial development policies.

Significant differences exist among specific industries regarding the incidence of trade-related investment measures and other performance requirements, and the type of measure used.7

2 It draws in particular from Caves (1996), Moran (1998, 2001), OECD (1998) UNCTC (1991), WTO (1998), UNCTAD (2001), and Bora (2001), and from material in annual UNCTAD World Investment Reports.

3 See, for example OECD (1989) and UNCTC (1991b), and the summary of empirical studies contained in a Note by the Secretariat prepared for the Working Group on the Relationship between Trade and Investment (WT/WGTI/W/56) pp. 17-20.

4 Safarian (1993) p. 435.5 OECD (1989) p. 40.6 UNCTC (1983a) p. 81 and (1991b) p. 27; OECD (1989) pp. 21-24.7 For example, one study found that: "In automobiles and chemicals, local content TRIMs are generally

more prevalent than export minimums. In computers and office equipment, export minimums are more prevalent." UNCTC (1991b) p. 26.


A. TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS APPLIED IN SPECIFIC SECTORS: MOTOR VEHICLES

5. This sub-section illustrates the use that has been made by developed and developing countries of trade-related investment measures and other performance requirements in the motor vehicle industry. Evidence suggests that this is the sector in which these measures have been applied most extensively, by both developed and developing countries. Other sectors where TRIMs have been applied include oil, petrochemical, resource-based manufacturing and electronic manufacturing.

6. As part of a comprehensive policy aimed at the development of a domestic automobile industry, Argentina adopted an Automotive Decree in 1959 that aimed at increasing levels of local content by the end of 1965 to 80 per cent for commercial vehicles and 93 per cent for passenger vehicles. In the early 1970s, export performance requirements and export incentive schemes for certain categories of vehicles were also introduced.8 In 1991, Argentina adopted an Automotive Regime which contained local content and trade-balancing requirements as conditions for the importation, at reduced tariff rates, of finished vehicles and parts and components by automotive assemblers and parts manufacturers.9 This regime was implemented in the context of complementarity arrangements concluded by Argentina with its MERCOSUR partners, whereby parts and components imported from other MERCOSUR countries have been treated as local content.

7. Australia introduced policies in the mid-1930s to attract foreign investment to produce automobiles with substantial local content. From 1965 until the mid-1980s, Australia applied a series of Motor Vehicle Manufacturing Plans which provided for the importation by local producers of components at reduced tariff rates on condition that they meet specified levels of local content in the production of cars. Initially, the level of local content differed between low volume and high volume producers, but in 1985 a single local content requirement of 85 per cent was established. This policy was accompanied by increased tariffs on imports of finished vehicles, from 35 per cent to 45 per cent in 1966, and to 57.5 per cent in 1978. In addition, quantitative restrictions introduced in 1975 limited imports of cars to a market share of 20 per cent. In 1982, an export facilitation scheme was introduced which allowed for exports of cars and components to be offset against the local content requirement. Since the mid-1980s, tariff and non-tariff protection has been reduced. The local content requirement was eliminated in 1991. The export facilitation scheme was replaced recently by an Automotive Competitiveness and Investment Scheme.10

8. Brazil adopted a five-year plan in 1956 which prohibited the importation of finished cars and provided tax benefits and privileged access to foreign exchange to domestic and foreign-owned firms which would attain by 1969 local content requirements of 90 per cent for trucks and vehicles and 95 per cent for jeeps and cars.11 Responding to balance-of-payments problems in the 1970s following the first oil crisis, Brazil began to place greater emphasis on developing the export capacity of the industry. Under the BIEX (Special Benefits for Exports) programme, firms received exemptions from payments of taxes on imports of capital goods, raw materials and parts and components if their exports and foreign exchange earnings reached certain specified values.12 Tax incentives were also available to firms that reached increasing levels of local content which, according to one source, ranged from 80 to 90 per cent.13 The BIEX programme was terminated in 1990.14 In 1995, Brazil raised the tariff on motor vehicles to 70 per cent and introduced domestic content and trade-balancing requirements. Firms assembling or manufacturing cars in Brazil were entitled to benefits in the form

8 UNCTC (1983c) pp. 105 and 116.9 WTO (1999a) pp. 76-77, 87 and 126-130; G/TRIMS/N/1/Arg/1/1 and Add.1.10 Pursell (2001); GATT (1994) pp. 68 and 161-163; WTO (1998a) pp. 120-123.11 Bergsman (1970) pp. 125-127; Shapiro (1993) pp. 203-206.12 OECD (1988) p. 10; GATT (1992a) pp. 258-259; Shapiro (1993) pp. 212-216. 13 OECD (1988) p. 10.14 GATT (1992a) pp. 161-164.


of reductions of import duties on raw materials, parts and components, capital goods and certain categories of finished vehicles if they reached a domestic content ratio of 60 per cent; maintained a one-to-one ratio of purchases of domestic capital goods and raw materials to imported capital goods and raw materials; and did not exceed a specified ratio of imports to exports. In 1997, another incentive programme, limited to certain regions of Brazil, provided tariff and tax concessions conditional upon domestic content and export performance. Both programmes expired in 1999.15

9. The development of an automobile industry in Canada began with high import tariffs that were aimed inter alia at encouraging US automobile manufacturers to locate in Canada. During the 1920s, the Government responded to concern about the impact of the tariffs on domestic prices by instituting a local content scheme involving a reduction of tariffs on imports of components on the condition that manufacturers achieve a level of 50 per cent of Canadian content. The required level of local content was increased to 60 per cent in 1936. In 1965, Canada and the United States concluded a bilateral agreement on free trade in automotive products, which was implemented in Canada by introducing an exemption from payment of customs duties on the importation of motor vehicles by manufacturers who had produced motor vehicles in Canada in 1963 and who complied with requirements to maintain a specified level of Canadian value added and to reach a certain ratio between the sales value of cars produced in Canada and the sales value of vehicles sold in Canada.16 Other foreign-based produces were also able to operate under similar preferential tariff conditions to those applicable to North American producers.17 Canada recently repealed the measure.18

10. Chile adopted local content requirements for passenger cars in 1962 and for commercial vehicles in 1966. The local content levels were increased in the early 1970s to 70 per cent for passenger cars and 60 per cent for commercial vehicles, but lowered again in 1975 along with a significant reduction of tariff protection for imported finished vehicles.19 Under legislation adopted in 1985, assemblers of vehicles meeting specified local content levels were entitled to an exemption from customs duties on imports of completely knocked down units (CKD) and semi-knocked down units (SKD), to the extent that such imports were offset by exports, and to a tax credit.20 The tax credit expired in 1998 while the tariff exemption was to have been eliminated by the end of 2001.21

11. China adopted an Industrial Policy for the Automotive Sector in 1994 which required domestic content to increase from 40 per cent in the first year of production to 80 per cent by the third year. 22

Previously, a somewhat less stringent policy had been in force which required motor vehicle assemblers to reach 40 per cent local content by the third year of production and 60 per cent local content by the fourth year. In its Accession Protocol, China committed itself to amend this policy.23

12. Chinese Taipei applied a local content requirement to motor vehicle assembly operations of 70 per cent until 1988, when the requirement was reduced to 50 per cent.24 Required levels of domestic content have more recently ranged from 31 to 40 per cent for automobiles, and to 90 per cent for motor cycles. Chinese Taipei has undertaken to eliminate these measures.25

15 WT/L/132, WTO (2000a) pp. 54, 90-92, and 233.16 Winham (1984). 17 WTO (1997).18 WT/DS139/R and WT/DS139/AB/R; WT/DS142/R and WT/DS142/AB/R; WT/DSB/M/101,

para. 116. 19 UNCTC (1983c) pp. 105 and 126.20 G/TRIMS/N/1/CHL/1. 21 G/C/W/172 and G/C/M/49. 22 Yuan (2001) p. 211.23 WT/ACC/CHN/49, para. 204.24 Hsieh (1997) p. 144.25 WT/ACC/TPKM/18, paras. 138 and 140.


13. During the 1970s and 1980s, the member States of the Andean Pact implemented a common policy of what has been termed "regional import substitution" in the motor vehicle sector, including through the allocation of production of specific categories of vehicles to individual countries and the establishment of local content requirements.26 More recently, Colombia, Ecuador and Venezuela applied local content requirements pursuant to a Complementarity Agreement concluded in 1993, which provided for minimum levels of regional content.27

14. Until the early 1990s in India, Phased Manufacturing Programmes, which were used in all major industries subject to industrial licensing, identified specific components that firms were required to produce in-house or to obtain from other domestic sources.28 In the case of the automobile industry, indigenous content requirements were introduced in 1953, when automotive assemblers were required to implement manufacturing programmes for the progressive production of components in India and a target of 50 per cent of domestic content was established. In the late 1960s, an export obligation was imposed requiring automobile producers to export at least 5 per cent of the volume of their annual output.29 The Phased Manufacturing Programmes were abolished in 1991 for new projects and in 1993 for existing projects. In 1995, India introduced new domestic content and export performance requirements as conditions for the granting of import licences for CKD/SKD kits to joint ventures with foreign participation. In 1997, a public notice was issued which provided that import licences would be granted only if such joint ventures accepted Memoranda of Understanding in which they committed not to engage only in assembly operations, to contribute a minimum amount of capital to the venture, and to meet certain domestic content and trade balancing conditions.30

15. During the 1970s and the 1980s, Indonesia applied local content measures to various industries through the use of "deletion lists" which identified specific parts and components to be sourced domestically or that could be imported; these were combined with restrictive licensing requirements to achieve a specified level of local content within a given timeframe. The measures were applied mainly with respect to transport equipment, machinery and engines.31 In 1993, these measures were replaced by a programme that provided for reductions of import duties on parts and components and exemptions of payment of a luxury sales tax depending upon the degree of local content attained in the production of passenger cars, light commercial vehicles and automotive parts and components. 32

Import duty reductions on parts and components and exemption from payment of luxury sales tax conditional upon local content requirements were also granted under a programme launched in 1996 aimed at the development of a capacity to produce "national" motor vehicles, i.e. vehicles produced at Indonesian-owned facilities, with a unique brand name owned by Indonesians, and developed with technology, construction, design and engineering based on national capability.33 The "national programme" was subsequently eliminated.34

16. In 1968 Ireland introduced "local assembly requirements associated with car imports", which were eliminated at the end of 1985.35

26 UNCTC (1983c) pp. 122-125. 27 G/TRIMS/N/1/Col/1; G/TRIMS/N/1/VEN/1; G/TRIMS/N/1/ECU/1. 28 GATT (1993a) p. 101.29 Krueger (1975) pp. 38 and 42-43.30 Pursell (2001) pp. 381-382.31 GATT (1991a) p. 99; GATT(1995) pp. 65-67.32 G/TRIMS/N/1/IDN/1; GATT (1995) p. 68; WTO (1998c) p. 113. 33 WTO (1998c) pp. 114-115.34 WT/DS54/R, and WTO (1998c) pp. 115 and 208.35 OECD (1989) p. 40. Another OECD study mentions local content requirements applied in the

automobile sector by Austria and Greece, but does not specify the precise nature of such measures and the time-period during which they were applied. OECD (1987) para. 17.


17. Korea initiated a policy aimed at shifting from assembly operations to full scale manufacturing of motor vehicles in 1974. It was implemented through various measures, including restrictions on imports of completely built-up vehicles, restrictions on FDI, government intervention to encourage industrial restructuring so as to limit the number of manufacturers, and the provision of incentives to ensure the international competitiveness of the industry.36 Local content requirements, which have been a general feature of Korea's industrial policies in a wide range of sectors 37, have also been applied to the automobile industry. According to one author, the Korean Government required motor vehicle assemblers to reach a level of 75 per cent of domestic sourcing after seven years.38 An OECD study reported local content requirements ranging from 20 to 95 per cent. 39 Automobile manufacturers were also subject to export performance requirements.40

18. Recent policies of Malaysia aimed at encouraging a shift from assembly to full-scale manufacturing of motor vehicles have involved the use local content requirements along with import licensing, tariff protection and industrial linkage programmes. In 1991, requirements were introduced of 45 per cent local content for certain categories of passenger cars and 60 per cent local content for commercial vehicles, to be attained by 1996. Non-compliance with these targets for a given model could be sanctioned by a requirement to reduce the net selling price of the model. A local content requirement for motor cycles was applied in 1981.41

19. Mexico introduced a local content requirement in the automobile industry in 1962, and export performance and trade-balancing requirements in 1969 and 1972.42 In 1977, the local content requirement was increased and a requirement introduced whereby each producer had to achieve a balanced foreign exchange budget.43 A decree issued in 1983 made the foreign exchange balancing requirement more restrictive and also limited the number of product lines and models that individual firms were allowed to produce, while permitting additional product lines and models if they were neutral in their foreign exchange impact and if more than 50 per cent of output was exported. This decree also raised the required level of local content for specified categories of vehicles, but allowed for a lesser degree of local content to be offset by increased exports.44 In 1989-90, a decree and regulations were passed which allowed firms with production facilities in Mexico to import automobiles of their own manufacture and brand name, subject to a limit expressed as a percentage of vehicles sold in Mexico. The foreign exchange balancing requirement was relaxed and the restrictions on the number of product lines and models were abolished. At the same time, the local content requirements which hitherto had been applied on a cost-of-parts basis were replaced with a domestic value added requirement. Restrictions on foreign ownership in the auto parts sector were relaxed.45 Amendments introduced in 1995 and 1997 provide for annual reductions of the value added and trade-balancing requirements.46

20. New Zealand adopted an import-substitution programme for the motor vehicle industry in 1950 through the use of import licensing, foreign exchange control, and domestic content requirements. A scheme introduced in 1961 allocated foreign exchange to motor vehicle manufacturers according to

36 Green (1992). 37 Westphal (1990) p. 48. 38 Auty (1994) p. 66.39 OECD (1987) p. 24.40 OECD (1989) p. 68. Auty observes that exports of motor vehicles were heavily subsidized especially

by allowing manufacturers to assemble one imported car kit, usually a large luxury car commanding a high price in the domestic market, for every five vehicles exported. Auty (1994) p. 68.

41 WTO (1997b) pp. 106-107; G/TRIMS/N/1/MYS/1/Rev.1; GATT (1993b) p. 91.42 Peres Nunez (1990) pp. 109-111.43 Pere Nunez (1990) pp. 111-113.44 GATT (1993b) p. 155; Peres Nunez (1990) pp. 115-116.45 GATT (1993b) p. 156. 46 WTO (1998d) pp. 120-121.


the degree of domestic content they attained, and in 1967 the Minister of Industry and Commerce called on the industry to achieve a domestic content level of 50 per cent.47

21. In 1987 and 1988, the Philippines introduced a Car Development Programme, a Commercial Vehicle Development Programme, and a Motorcycle Development Programme. Firms participating in these programmes received benefits in the form of import duty reductions if they met certain conditions, including with respect to local content and foreign exchange balancing.48

22. South Africa introduced a domestic content scheme for the motor vehicle industry in 1962. This expressed the required level of local content in physical rather than in value terms. 49 It was replaced in 1989 by a value-based system that provided that motor vehicle manufacturers who attained a local content level of at least 55 per cent were entitled to a rebate of excise duties at a rate of 50 per cent of the level of their local content, whereby exports were considered as local content.50

23. Thailand applied domestic content requirements to motor vehicles from the early 1970s pursuant to the Investment Promotion Act and the Factory Licensing Act. In addition to a local content requirement applicable to passenger vehicles, which was increased from 24 to 54 per cent in 1988, such requirements have been applied to commercial vehicles, engines and motorcycles.51 These requirements were eliminated in 1999.

24. In the United Kingdom, undertakings regarding the degree of local content have reportedly sometimes been a factor in decisions to provide incentives to investors in the automotive sector. It has been reported, for example, that incentives granted in connection with the establishment in 1983 by the Japanese car maker producer Nissan of an automobile assembly plant in Sunderland were conditioned on an undertaking by Nissan to achieve a local content level of 60 per cent.52

25. Uruguay initiated a policy aimed at the development of a domestic motor vehicle assembly industry in 1964 by raising tariffs on imports of completely built-up vehicles, and adopted legislation in 1970 that stipulated local content and compensatory export requirements.53 These requirements remained in force until 1992 when they were replaced by a decree that granted a tax incentive to the export of vehicles or parts.54

B. TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS APPLIED IN THE CONTEXT OF THE REGULATION OF FDI

26. The regulation of FDI has been an important policy context in which trade-related investment measures and other performance requirements have been applied by developed and developing countries.55 In particular, where legislation has provided for a procedure for the authorization of FDI on a case-by-case basis, its anticipated impact on factors such as export performance, use of domestic products and services, and contribution to domestic technological development, have at times been taken into account by host country authorities in deciding whether to approve FDI, to grant

47 Baranson (1969) pp. 61-62.48 G/TRIMS/N/1/PHIL/1. 49 Bell (1989).50 G/TRIMS/N/1/ZAF/1 and GATT (1993c) p. 163.51 WTO (1999c) p. 62; WTO (1995) pp. 52-53 and 106; GATT (1991b) pp. 218-219. See also

G/TRIMS/N/1/THA/1.52 Safarian (1993) p. 358; OECD (1998) p. 11. When in the late 1980s Nissan began to export cars

produced in the United Kingdom to other EEC Member States, controversy arose over whether the level of local content was sufficient to treat such cars as having their origin in the United Kingdom.

53 GATT (1992b) pp. 202-204; UNCTC (1983c) p. 105.54 G/TRIMS/N/1/URY/1 and Add.1. 55 See, for example, OECD (1987) pp. 8 and 10.


investment incentives, or to relax limitations on foreign equity participation. In some cases, host country authorities have actively sought to secure commitments by foreign investors in these areas.

27. This section provides a brief description of FDI review mechanisms applied by a number of developed and developing countries. It is not a comprehensive survey. Where specific provisions of national laws and regulations contain authority for the application of trade-related investment measures and other performance requirements, it is often difficult to ascertain whether the actual implementation of such provisions has been automatic, or discretionary and subject to negotiation.56

28. Until the liberalization of Argentina's FDI regime in the late 1980s, FDI was subject to a prior authorization requirement pursuant to a foreign investment law and implementing regulations that had been adopted in 1976-77. Approval of FDI was dependent on a determination by the authorities that FDI contributed positively to national economic development in terms of its impact on factors such as the balance-of-payments, import substitution, increased exports, and technological development.57 To the extent that performance requirements were imposed as conditions for the approval of investment proposals, evidence suggests that they pertained in particular to the transfer of technology. According to a 1989 OECD study, Argentina applied transfer of technology requirements in all sectors, but did not maintain local content or export performance requirements of general application.58

29. In the early 1970s, Australia's policy on FDI changed from an "open door" approach59 to a more qualified stance resulting in the establishment of a comprehensive mechanism for the case-by-case review of FDI pursuant to the Foreign Takeovers Act of 1975 and the subsequent creation of a Foreign Investment Review Board.60 Foreign investment proposals could be rejected if they were found to be "contrary to the national interest", based on an analysis of whether they would produce "net economic benefits" for Australia with regard to: competition, price levels and efficiency; the introduction of technology or managerial or workforce skills new to Australia; the improvement of the industrial or commercial structure of the economy or of the quality and variety of goods and services available in Australia; and the development of, or access to, new export markets. 61 In practice, the review process was not used to impose specific conditions on foreign investors with respect to matters such as trade, employment, and the conduct of research and development; the Foreign Investment Review Board explicitly rejected the imposition of such performance requirements.62 Australia's foreign investment review policies have been relaxed since the mid-1980s63, but the basic requirement for notification and review has been retained. The "net economic benefits" test has been replaced by the principle that proposals are to be automatically approved unless they are found to be contrary to the national interest, and thresholds for the notification and review of investment proposals have been increased.64

56 OECD (1989) p. 25; UNCTC (1991b) p. 29. 57 UNCTC (1983b) pp. 254-258.58 OECD (1989) p. 67.59 Brash (1970).60 Safarian (1993) pp. 81-87; Flint (1985) pp. 3-4. 61 If it was determined on the basis of these criteria that a proposal was not contrary to the national

interest, additional criteria could be taken into account. One was whether the business or project concerned could be expected to be conducted in a manner consistent with Australia's best interest in matters such as local processing of materials and the utilisation of Australian components and services, involvement of Australians on policy-making boards of businesses, research and development, royalty, licensing and patent arrangements, and industrial relations and employment opportunities. Safarian (1993) p. 90; Flint (1985) pp. 86-87.

62 Safarian (1993) pp. 101-103 and 107-109.63 Safarian (1993) pp. 96-97; GATT (1994) p. 36.64 Under current policy, notification and prior approval are required in respect of: acquisitions of

substantial interests in existing Australian businesses with total assets over $50 million or where the proposal values the business at over $50 million; proposals to establish new businesses involving a total investment of $10million or more; portfolio investments in the media of 5 per cent or more and all non-portfolio investments irrespective of size; takeovers of offshore companies whose Australian subsidiaries or assets are valued at


30. Canada's Foreign Investment Review Act of 1973 ("FIRA") was designed to optimize the performance of foreign affiliates. Underlying the adoption of FIRA was a view that the activities of such foreign affiliates did not contribute sufficiently to the trade and technological development of Canada because of the subordination of the affiliates to the commercial interests of their parent firms.65 FIRA subjected greenfield investments and foreign acquisitions to a requirement of prior authorization based on a determination of whether proposed investments were likely to be of "significant benefit" to Canada. The criteria to be considered in this regard were the effect of the investment on: the level and nature of economic activity in Canada, including employment, resource processing, the utilisation of parts, components and services produced in Canada, and exports; the degree and significance of Canadian participation in the business enterprise or new business and in any industry or industries in Canada of which the business enterprise or new business formed or would form a part; productivity, industrial efficiency, technological development, innovation and product variety in Canada; competition within any industry or industries in Canada; and the compatibility of the investment with national industrial and economic policies, taking into consideration industrial and economic policy objectives enunciated by the government or legislature of any province likely to be significantly affected by the investment.

31. Though in practice the vast majority of investments reviewed under FIRA were approved66, approval was often subject to specific undertakings made by foreign investors on matters such as the export performance of foreign affiliates and their use of Canadian goods and services 67; the conduct of research and development by foreign affiliates in Canada; the access of foreign affiliates to foreign technology; the introduction of new products and machinery in Canada; the ability of foreign affiliates to develop, manufacture and market innovative products; the assignment of responsibility to foreign affiliates for the specialized production and marketing of a product on a global or geographical basis; employment; and the appointment of Canadian officers.68 Performance-related undertakings were legally binding and enforceable and subject to monitoring by the Foreign Investment Review Agency, but there does not appear to have been any case in which firms were prosecuted for alleged failure to adhere to the terms of an undertaking.69

32. In 1985, FIRA was replaced by the Investment Canada Act (ICA). While retaining the mechanism for review of certain foreign investments, ICA places emphasis on the promotion of investment by both Canadians and non-Canadians and accords secondary importance to the case-by- case review of FDI. The scope of the review procedure under the ICA is considerably narrower than under FIRA, in that in principle it applies only to transactions involving the acquisition by non-Canadians of control of large-scale Canadian business enterprises.70 With respect to investments

$50 million or more, or account for more than 50 per cent of the target company's global assets; direct investments by foreign governments or their agencies irrespective of size; acquisitions of interests in urban land; and proposals where any doubt exists as to whether they are notifiable. FIRB (2000).

65 Conklin and Lecraw (1997) pp. 17-18; Safarian (1993) p. 122.66 Safarian (1993) p. 133.67 One source reports that "in the first 2600 cases approved by FIRA, over 60 per cent involved

commitments to increase the processing or use of Canadian goods and services while a further 37 per cent were accompanied by undertakings to increase exports from Canada." Leckow and Mallory (1991) p. 29. In February 1984, a GATT Panel Report in Canada-Administration of the Foreign Investment Review Act held that undertakings regarding domestic content were incompatible with Article III of the GATT. GATT, BISD 30S/140.

68 Leckow and Mallory (1991) pp. 29-30; Safarian (1993) pp. 520-531. 69 Conklin and Lecraw (1997) p. 104; Safarian (1993) p. 128.70 ICA currently requires a review of direct and indirect acquisitions of Canadian businesses by foreign

investors if the value of such businesses exceeds specified thresholds. These thresholds are higher in case of direct acquisitions by investors of WTO Members who are also exempt from the requirements for a review of indirect acquisitions. However, in certain sectors (uranium production, financial services, transportation services and cultural businesses) direct and indirect acquisitions by investors of WTO Members are subject to the generally applicable review thresholds. As an exception to these rules, the ICA provides that in the case of


that are subject to review under ICA, a determination must be made that the investment is of "net benefit" to Canada based on an examination of much the same criteria that were applied under the FIRA.71 No investment proposals have been formally disallowed since the passage of ICA.72 While ICA provides for the possibility of legally binding undertakings by foreign investors as a condition for the approval of reviewable investments, it appears that such undertakings have been demanded in relatively few cases. One study reported in 1994 that undertakings relating to performance requirements had been negotiated in only one tenth of the acquisitions reviewed and approved since the inception of ICA, mostly involving the oil and gas sector and technology-intensive Canadian companies.73

33. Trade-related investment measures and other performance requirements have been used by China in the context of legislation enacted in 1979 regarding the various forms in which foreign investment is permitted.74 China's law on Foreign Equity Joint Ventures of 1979, as amended in 1990, provides inter alia that an equity joint venture shall give priority to Chinese sources in the purchase of raw materials and equipment and that such a joint venture is encouraged to market its products outside China. In 1986, rules were adopted for the encouragement of foreign investment, which contained a broad range of incentives for export-oriented or technologically advanced investments, including tax exemptions, preferential land use fees, and privileged access to credit. The law on Wholly Foreign-Owned Enterprises of 1986 establishes that one of the conditions for the approval of FDI through a wholly foreign-owned enterprise is that the enterprise must use advanced technology or market all or most of its products outside China. Implementing rules issued in 1990 stipulate that such an enterprise must export at least 50 per cent of its annual production. The law on Foreign Contractual Joint Ventures of 1988 stipulates inter alia that the state shall encourage the establishment of productive joint ventures that are export-oriented or technologically advanced, and that contractual joint ventures shall purchase insurance within China. China's FDI legislation has also contained a general requirement that investors cover their own foreign exchange expenditure. While China's legislation is less explicit on local content requirements than on export performance requirements, it has been suggested that in practice local content requirements have often been imposed informally and are enforced more strictly than export performance requirements.75

investment in certain business activity related to Canada's cultural heritage or national identity, both the establishment of a new business and the acquisition of control, regardless of size, may be subject to review if a review is considered to be in the public interest. Transactions that are not subject to review (establishment of new businesses and the acquisition of control below the review thresholds) are subject to a notification requirement. WTO (2000b) pp. 11-12; WTO (1999a) pp. 15-16; WTO (1997a) pp. 44-45; Industry Canada (1994) pp. 245-248.

71 In the context of a recent WTO trade policy review, Canada stated that ICA "simply considers the potential impact of the proposed acquisition on, among other factors, the utilisation of parts, components and services produced in Canada, and on exports from Canada. It does not require that an investor undertake obligations in any of these areas as a condition of approval." WT/TPRM/78 pp. 93 and 101.

72 WTO (1999b) p. 16.73 Industry Canada (1994) p. 267. In the case of the oil and gas sector, undertakings have generally

called for increased levels of Canadian ownership and for commitments on investment spending by the foreign acquirer. In respect of technology-intensive Canadian firms, undertakings typically pertain to "assurances that the investor has, and is prepared to commit, the resources required for the Canadian business to grow as an internationally competitive enterprise, including financial, research, technological, production, marketing, and management resources; a commitment to significant levels of R&D spending in Canada; a commitment, where appropriate, to world product mandates for specified products and services…; a commitment to provide quality employment opportunities for Canadians; and assurances that any transfer of technology between the Canadian Business and the investor, or its affiliates will be on an arms-length basis."

74 Yuan (2001); Huang (2000); Wenhua (2000); Hickman (1997). 75 Rosen (1999) p. 69.


34. France's policy on FDI changed in the mid-1960s to what was described as an approach involving selective encouragement of inward FDI.76 Pursuant to a law adopted in 1966 on financial relations between France and foreign countries, FDI was subject to a requirement of prior declaration and authorization. An investment proposal would be allowed to proceed unless the Minister of the Economy and Finance requested "postponement" of the investment within two months from the date of receipt of such a declaration. Such a postponement could be temporary and lead to further examination and discussions on possible modification of the application, or it could be indefinite.77

Several analyses of the operation of the French foreign investment review procedures since the 1960s have suggested that performance-related conditions were an important aspect of the review process, but there is little information on the precise nature of commitments that were made in this regard by foreign investors. One author, reviewing the operation of policy in the early 1980s, commented that "there was no formal list of criteria or standard criteria against which investments were evaluated," but that factors taken into account in practice included employment creation, regional development, research and development, and development of export capacity.78 Such factors have also been identified in other studies.79 The emphasis on particular factors has varied over time.80 It would appear that conditions attached to the approval of investment proposals were often conveyed in writing and were quite specific, but that there was no formal mechanism for monitoring or enforcement of compliance with such conditions.81

35. In 1980, France abolished the prior declaration and authorization requirement with respect to FDI from EEC Member countries and replaced it by a procedure for prior notification, but certain categories of FDI from EEC Member countries remained subject to prior authorization. As regards FDI from non-EEC Member countries, the prior authorization procedure remained in force, subject to certain exceptions.82 Since the mid-1980s, substantial relaxation of the prior declaration and authorization requirements has occurred inter alia through the raising of the minimum thresholds above which investments by non-EEC investors were subject to prior authorization, the exemption from these requirements of investments involving the creation of new enterprises as distinct from acquisitions, and the reduction of the time periods within which the Minister must act on declarations.83 Until the early 1990s, however, the distinction between FDI from EEC Member countries and FDI from other sources was retained.84 In 1996, the Government abolished the prior authorization procedure for non-EEA investors.85

36. India's Foreign Exchange Regulation Act of 1973 prohibited FDI in certain sectors and established a general rule that, except with permission from the Federal Reserve Bank, foreign equity participation in Indian companies should not exceed 40 per cent. Export performance has been one of the factors considered in the granting of exceptions to this rule. Guidelines allowed for the possibility of up to 51 or 74 per cent foreign equity ownership in case of investments in designated priority sectrs, projects involving the use of sophisticated technology, and projects of which more than

76 Safarian (1993) p. 211.77 Bailey, Harte and Sugden (1994) p. 54; Safarian (1993) p. 214. 78 Safarian (1993) pp. 214-215. 79 UNCTC (1978) p. 173: noting that inward FDI is welcome in France "if it brings new technology,

increases exports or creates jobs in depressed areas"; OECD (1982) p. 22: "…certain authorisations are, in effect, conditional on the results which relate especially to the maintenance or the creation of jobs, regional development or exports." Industry Canada (1994) p. 14: "Commitments on job creation, technology transfer, and increased export activity are sought and receive considerable weight in the foreign investment review process. Companies that provide technology and employment through new or 'greenfield' investments in manufacturing facilities or research laboratories are highly favoured."

80 Bailey et al. (1994) pp. 195-200; Safarian (1993) p. 215.81 Safarian (1993) p. 216.82OECD (1982) p. 12.83 Baily et al. (1994) pp. 65-67; Safarian (1993) pp. 218-221.84OECD (1992) p. 80. 85 OECD (1996a) pp. 26-27


60 per cent of the production was exported.86 In 1980, India adopted a "Hundred Per Cent Export-Oriented Units Scheme" which permitted full foreign ownership in projects that were wholly export oriented. In 1991, India substantially revised its foreign investment policy as part of a New Industrial Policy. The reforms included the removal of the requirement that foreign investment be accompanied by transfer of technology and the estalishment of a procedure for automatic approval by the Federal Reserve Bank of foreign equity ownership up to 51 per cent in specified priority industries, on condition that the foreign equity cover the exchange required to import capital goods and that the payment of know-how fees and royalties met certain conditions.87 Subsequently, the scope of this automatic approval procedure was expanded by the inclusion of additional priority sectors in which 51 per cent foreign equity was allowed and the designation of certain industries in which up to 74 per cent foreign equity was permitted.88 Foreign investments that are not eligible for automatic approval are subject to approval on a case-by-case basis by the Foreign Investment Promotion Board. Guidelines that were issued in 1997 stipulate inter alia that 100 per cent foreign equity may be permitted in cases of predominantly export-oriented investments. In 22 industries, FDI has been subject to a requirement that dividend remittances by foreign investors be balanced by export earnings.89

37. From the mid-1960s, Indonesia adopted a more liberal approach towards FDI in its economy.90

A foreign investment law passed in 1967 permitted 100 per cent foreign ownership in most sectors of the economy, subject to a minimum capitalization requirement, and provided a 30-year guarantee against expropriation. In 1974, a new policy was introduced which prohibited full foreign ownership, limited foreign participation in joint ventures to 80 per cent, required that at least 51 per cent of share holdings be transferred to Indonesians within a period of ten years, and increased the number of sectors closed to FDI. In 1977, an annual Priority List of Investments was introduced as a basis for the review and approval of individual investment projects. FDI in sectors not included on this list could be approved depending upon the location and export-orientation of the investment and the employment created. The early-1980s saw a reinforcement of restrictions on FDI with a renewed emphasis on divestiture requirements, the reduction of the number of sectors in which FDI was permitted, and the revocation of tax holidays.

38. In the mid-1980s, measures were taken to relax the FDI policy regime as part of an effort to promote non-oil exports. These included a gradual relaxation of equity ownership restrictions and divestiture requirements, conditional upon factors such as the degree of export orientation of a project. A reform package introduced in 1986 allowed for 95 per cent ownership in investments in high risk ventures, investments in remote areas, investments requiring a large amount of capital, and investments that were 85 per cent export-oriented. In addition, the number of sectors in which FDI was permitted was increased. In 1987, measures were introduced allowing for 95 per cent foreign ownership in projects of which 100 per cent of the production was exported without a divestiture requirement. The measures also allowed for 95 per cent foreign ownership of companies with a minimum capital of $10 million, companies located in Eastern Indonesia, and companies exporting at least 65 per cent of their production. In 1989, the annual Priority List of Investments was replaced by a negative list and the number of sectors open to FDI was increased. 100 per cent foreign ownership in projects was permitted in the Batam Economic Zone. In 1992, Indonesia allowed 100 per cent foreign ownership for investments of over $50 million, investments located in Eastern Indonesia, and investments located in bonded zones if all production was exported, subject to a requirement to reduce the level of foreign ownership over time to a maximum of 80 per cent. 95 per cent foreign ownership

86 UNCTC (1983b) p. 62.87 OECD (1996b) pp. 30-31; GATT (1993a) p. 48. The requirement that foreign equity cover the

foreign exchange required for the import of capital goods was subsequently abolished. WTO (1998b) p. 231.88 WTO (1998b) pp. 37-39.89 GATT (1993a) p. 47; WTO (1998b) p. 39 and 190; G/TRIMS/N/1/IND/Add.1.90 See Lecraw (1996) and FIAS (1997) pp. 53-56, as well as information on Indonesia's investment

regime contained in reports prepared for GATT and WTO trade policy reviews in 1991, 1995 and 1998.


was allowed for labour intensive operations, projects exporting at least 65 per cent, and industries producing raw materials or intermediate goods, subject to a requirement to divest 51 per cent to Indonesians over a period of twenty years. In 1994, foreign ownership of 100 per cent was permitted in a large number of sectors without conditions as regards minimum capital requirements or the market orientation of the project, divestiture requirements were substantially relaxed, and nine public interest industries previously closed to FDI were opened to joint ventures. The negative list was reduced to very few sectors.

39. Until the early 1980s, FDI in Japan was subject to review and approval under the Foreign Exchange and Foreign Trade Control Law of 1949 and the Foreign Investment Law of 1950. Inward investment was approved only if it could be demonstrated that the investment: made a clear contribution to technological development of Japanese industry; made a contribution to exports or to saving imports; involved no significant competition with Japanese industry and involved a foreign equity share of less than 50 per cent.91 From 1967, a series of liberalization measures permitted specified maximum levels of foreign equity participation in various categories of industries92, and the Government issued a set of guidelines for foreign firms operating in Japan.93 In 1971, the positive list principle was replaced by a negative list of industries that remained subject to individual approval. In 1973, the Japanese Government permitted 100 per cent foreign ownership in newly established firms in all industries, with the exception of several sectors in which individual screening continued.94 In 1973-76, steps were also taken to remove restrictions on foreign acquisitions, but this was confined to cases where the target firms consented to the acquisition.95

40. In 1980, a new Foreign Exchange and Foreign Trade Law provided that, instead of foreign investment being prohibited in principle except when authorized on individual application, it was now free in principle subject to certain exceptions and prior notification requirement. These exceptions pertained to four specified industries96 and to cases in which individual investments were found undesirable on grounds of certain criteria defined in the law.97 While it appears that outside the four

91 Safarian (1993) p. 243. 92 Bailey et al. (1994) pp. 16-24; Safarian (1993) pp. 245-248.93 These guidelines, often referred to as the "ten commandments" of foreign investment in Japan,

provided that foreign firms should: seek coexistence and prosperity with Japanese enterprises through joint ventures on an equal partnership basis; avoid concentration of investment in specific industries; avoid suppressing small enterprises when entering into industries characterized by small firms; cooperate voluntarily with the Japanese effort to maintain proper industrial order; avoid entering into unduly restrictive arrangements with parent companies abroad and not resort to unreasonable restrictions concerning transactions or to unfair competition; take positive steps toward developing Japanese technology and not hamper the efforts of Japanese industries to develop their own technology; contribute to the improvement of Japan's balance-of-payments through exports and other means; appoint Japanese to the board of directors and top management positions and make share of company stock available to the public; avoid closures of plants or mass dismissal, and unnecessary confusion in employment and wage practices by paying due regard to the prevailing Japanese practices; conform to the government's economic policy. Yoshino (1975) p. 361.

94 Agriculture, forestry, fishing; petroleum refining and sale; leather goods; mining; and retail chains. The last sector was removed from the list in 1975. Safarian (1993) p. 245.

95Safarian (1993) p. 246.96 Agriculture; mining, oil refining and leather products. UNCTC (1988) p. 115.97 In the latter regard, the law allowed the relevant minister to seek a suspension of a transaction for a

maximum period of four months from the date of a notification in order to examine whether the investment should be modified or rejected. The criteria to be considered in such an examination pertained to: (1) whether the investment might imperil the national security, disturb the maintenance of public order, or hamper the safety of the general public; (2) whether the investment might adversely affect the activities of Japanese firms engaging in a line of business similar to or related to the one in which the proposed investment was to be made; (3) whether there was reciprocity of treatment of the Japanese investors in the home country of the foreign investor; and (4) whether the transaction involved capital transactions requiring approval because of their effect on balance of payments. UNCTC (1988) p. 115. Limitations on foreign acquisitions were also removed, except in the four restricted sectors, but until 1984 Japan designated a number of companies in which acquisition above


restricted sectors there were no cases of applications that were formally rejected under the legislation enacted in 1980, it has been suggested that in practice it remained possible for the Japanese authorities to screen and discourage investments by more informal means, for example in the context of discussions with potential investors prior to the submission of a notification.98 The Law was amended in 1992, and eliminated the prior notification requirement in respect of most inward FDI and instead provided for the submission of an ex post facto report within fifteen days after an investment had been made. Prior notification was henceforth mandatory only in regard to a limited number of cases involving investments which were liable to imperil national security, disturb the maintenance of public order or hamper the protection of the general public, investments in restricted industries covered by Japan's reservations to the OECD Code, investments from home countries not offering reciprocal treatment to Japanese investors, and investments involving capital transactions which were subject to authorization requirements.99

41. Japan's FDI policy has been described as forming part of an industrial policy that sought to protect domestic firms from competition by foreign affiliates and to secure access of domestic firms to foreign technology through licensing agreements, while minimizing the scope for foreign firms to exploit their technology in Japan through fully-owned subsidiaries.100 Thus, approval of FDI was often subject to conditions limiting the ability of foreign investors to expand in the Japanese market and to conditions regarding the terms of technology transfer agreements between foreign investors and Japanese firms. Several cases were reported in which authorization of majority foreign-owned investments was conditioned upon the licensing of technology to Japanese competitors. Japan's approach to the screening of FDI thus served somewhat different purposes than the investment review mechanisms used by several other developed countries. In this respect, one author has observed that Canada's FIRA "…did not seek to block further FDI but rather to improve the terms of its entry, especially by stressing export targets for the new subsidiary, technology transfer, employment, and local content…", whereas in the case of Japan, "…FDI did not provide a major source of capital …rather, FDI was used as part of the larger industrial policy of promoting selected high value-added industries, and the principal goal was obtaining the best foreign technology through FDI approvals. Employment, management, local content, and supply of capital rarely entered into Japanese screening priorities, in contrast to the Canadian case."101

42. Until the 1970s, Korea's development strategy reflected a preference for foreign loan capital and the acquisition of foreign technology through licensing arrangements, rather than through FDI.102 The regulation of the entry of FDI was closely coordinated with industrial development plans. The Foreign Capital Inducement Act of 1961 required prior authorization of FDI according to a positive list of priority industries and sector-specific restrictions on foreign equity participation. The requirement to conclude agreements with the Korean authorities, setting forth the conditions under which foreign investment was allowed, appears to have provided considerable scope for the application of a variety of performance requirements. Aside from joint venture requirements, such agreements imposed conditions regarding the amount of capital invested, export performance, the level and type of technology used, the supply of raw materials, the provision of access to foreign markets, and the divestiture of foreign equity within a specified period. 103 It has been suggested that

a certain threshold would trigger review. Safarian (1993) p. 255.98Bailey et al. (1994) p. 29; Industry Canada (1994) p. 183; Safarian (1993) p. 256. 99 Industry Canada (1994) pp. 160-161.100Bailey et al. (1994); Safarian (1993); Encarnation and Mason (1990); Averyt (1986); Yoshino

(1973).101 Averyt (1986) p. 52.102 Conklin and Lecraw (1997) pp. 24-25; Mardon (1990).103 As a result of a policy of systematically requiring foreign investors to form joint ventures with

Korean firms, except in case of exclusively export-oriented projects and projects involving technology considered necessary in the context of development plans, by 1985 only 13.3 per cent of FDI in Korea was accounted for by wholly-foreign owned firms. Mardon (1990) pp. 127 and 129.


"… in 1986, 38 per cent of agreements with foreign investors stated specific export-level requirements, 80 per cent stated specific technological transfer requirements, 36 stated specific requirements for raw material supply, and 28 per cent of the investors agreed to help their Korean partners gain access export markets. At least one of the above requirements was specified in the investment agreements of over 92 per cent of all foreign firms; at least two or more were specified in over 68 per cent."104 In 1984, the positive list was replaced by a negative list approach and a procedure was introduced for automatic approval of certain categories of FDI. The application of performance requirements as conditions for investment approval reportedly was abolished in 1989.105

During the 1990s, Korea's FDI policies have been further liberalized, notably through the replacement of prior authorization by a prior notification procedure and the relaxation or elimination of sector-specific restrictions on foreign equity participation.

43. Since the late 1960s, Malaysia has pursued an FDI policy that draws a clear distinction between FDI oriented toward exports and FDI oriented toward the domestic market. Guidelines issued pursuant to the Industrial Co-Ordination Act of 1975 have conditioned the level of foreign equity ownership permitted in a greenfield investment project on its degree of export orientation. Where less than 20 per cent of production was destined for export, foreign equity ownership was allowed up to a maximum of 30 per cent; where more than 80 per cent of production was destined for export, foreign equity ownership was allowed up to 100 per cent. As an exception to these rules, foreign equity ownership of 100 per cent could be permitted on a discretionary basis in case of production of high technology or priority products. Where foreign equity ownership was less than 100 per cent as a result of the application of these guidelines, specific requirements applied regarding minimum percentages of the balance of the equity that were reserved for Bumiputras.106 Since 1998, the equity restrictions based on export orientation have been relaxed on a temporary basis for FDI in manufacturing.107 Performance requirements have also been used in the context of various investment incentive programmes, including local content requirements as a condition for eligibility for tax incentives under the Pioneer Status and Investment Tax Allowance schemes, which were eliminated on 1 January 2000.108

44. From the 1920s until the early 1980s, Mexico pursued a foreign investment policy that has been characterised as increasingly restrictive.109 Until the adoption of a generic foreign investment law in 1973, no formal mechanism existed for the screening of FDI, but it has been suggested that the Mexican authorities secured commitments by foreign investors regarding performance and ownership by making the granting of import licences conditional upon undertakings by foreign investors with respect to domestic content, limitation of payments abroad and reduction of foreign equity holdings to less than 50 per cent over a specified period of time.110 A foreign investment law adopted in 1973 provided for a more formal, centralized approach to the regulation of FDI. It specified activities that were reserved for the Mexican State, activities that were reserved for Mexicans or Mexican companies with an "exclusion of foreigners" clause, and activities in which foreign participation was not to exceed certain limits. It also stipulated as a general rule that FDI in activities not specifically regulated by the law should not exceed 49 per cent of equity. A Foreign Investment Commission had authority to permit foreign participation in excess of 49 per cent of equity where it found that this was in the national interest. In practice, derogations from the 49 per cent threshold appear to have been rare and to have been subject to a requirement of eventual "Mexicanization". Among the factors that were taken into consideration in granting such derogations were the expected impact of an investment

104 Mardon (1990) p. 134.105 Kim (1993) p. 127.106 OECD (1999) p. 121; WTO (1997b) pp. 64-65; GATT (1993b) p. 50.107 OECD (1999) p. 124.108 G/TRIMS/N/1/MYS/1/Rev.1; G/C/W/210.109 GATT (1993c) p. 59.110 Maviglia (1986) p. 288.


on Mexican exports, use of domestic products, and technological development.111 The application of the general rule against more than 49 per cent foreign equity ownership was significantly relaxed in 1984 when Guidelines were issued indicating that foreign equity participation of up to 100 per cent would be possible in designated priority industries, without a requirement of "Mexicanization". 112

The adoption of these Guidelines was accompanied by a more explicit policy of requiring foreign investors to make commitments regarding export performance, the assimilation of foreign technology, and the conduct of research and development.113

45. Further liberalization of Mexico's FDI regime resulted from regulations adopted in 1989 which were codified in a new foreign investment law enacted in 1993.114 The law allowed for inward investment without the need for prior authorization, except for investment in certain sectors that are reserved for the Mexican State or for Mexicans, sectors where foreign ownership may not exceed specified percentages of equity, and sectors in which prior authorization is necessary for the acquisition of more than 49 per cent of equity. Prior authorization is also required for the acquisition by foreign investors of more than 49 per cent of the capital stock of any Mexican firm where the investment exceeds an amount to be specified by the Foreign Investment Commission. Where investment is subject to approval by the Foreign Investment Commission, Article 29 of the foreign investment law provides that the Commission must consider the impact of a proposed investment on employment and the training of workers, its technological contribution, compliance with environmental regulations, and its contribution to enhancing Mexico's competitiveness. The law provides that when deciding on an application, the Commission "may only impose requirements which will not distort international trade".

46. Until the mid-1960s, no laws specifically regulating FDI existed in New Zealand. According to one author "successive governments in the post-war era had adopted an essentially passive attitude towards inward FDI".115 The Aliens Act of 1948 provided for national treatment of foreign investors with respect to the acquisition and disposition of any kind of property in New Zealand. Pursuant to the Reserve Bank of New Zealand Act of 1964, several regulations were adopted which effectively amounted to the introduction of a review mechanism for inward FDI.116 The Overseas Investment Act of 1973 established an Overseas Investment Commission whose task was inter alia to provide advice to the Minister of Finance on whether specific investment proposals were in the national interest. Criteria for the assessment of the benefits of investment proposals in specific cases were set out in a

111 Maviglia (1986) p. 293; UNCTC (1983b) p. 320.112 Peres Nunez (1990) pp. 42-43; Maviglia (1986) p. 296. 113 Peres Nunez (1990) pp. 44-45 and 66-68.114 GATT(1993c) pp. 61-65; WTO (1998) pp. 34-36.115 Akoorie (1996) p. 179.116 Safarian (1993) pp. 154-155; Paterson (1975) pp. 182, 186-187.


policy statement issued in 1973.117 These criteria were revised in 1979.118 Notwithstanding the broad range of factors covered by these criteria, it has been stated that in practice the examination of investment proposals in light of these factors did not amount to a systematic cost-benefit analysis and that there was no attempt to extract undertakings from foreign investors with respect to performance requirements.119

47. While consideration was given in the 1980s to the possibility of replacing the general review procedure with a notification procedure, it was decided to retain the review mechanism. 120

Regulations currently in force distinguish between non-land transactions and land transactions. With respect to both, the regulations require consideration of whether the investor has business experience relevant to the proposed investment and has demonstrated a financial commitment to the investment, and of the character and immigration status of the investor.121 In the case of land transactions, a determination must be made that the investment is in the national interest.122

117 These criteria were: The extent to which New Zealand resources of raw material and human skills would be combined and developed to the most advanced stage which is economically feasible or desirable and having regard to the impact on employment opportunities; the compatibility of the proposal with Government policies on the protection of the environment and regional development; the degree to which the proposal would extend New Zealand's access to technological developments and scientific research conducted overseas and the extent to which research and development would be stimulated in New Zealand; the extent to which the proposal would promote New Zealand's industrial growth and efficiency by increasing the degree of export orientation and helping to provide access to new or expanded export markets; the impact of the proposal on productivity, with particular reference to the effects on costs and prices in New Zealand; the impact of the proposal on the structure and competitiveness of the industry or industries of which it would form part, and on linkages with other New Zealand industries; the contribution to product innovation, marketing expertise and consumer choice in New Zealand; where the interests concerned with the proposal were operating on a multinational basis, the role of the New Zealand proposal in their total operations, with particular regard to the firm's export and pricing policies, its other international strategies and New Zealand participation; the taxation yield to New Zealand in relation to the benefits which the overseas company derived from its New Zealand activities, with particular reference to the taxation aspects of its pricing policies and the ratio of equity to loan capital; the balance of payments implications of an investment, including the cost of servicing the investment, the amount of capital inflow and the extent to which this supplemented or added to the overseas capital available through other channels, either to the Government or to the private sector in New Zealand; the degree and significance of participation by New Zealand shareholders in relation to the nature of the individual overseas enterprise and the competing needs of New Zealand-owned enterprises for local equity capital. Paterson (1975) pp. 206-207.

118 The revised list of criteria provided that the Overseas Investment Commission would consider: (1) added competition to local industry, lower prices and greater efficiency; (2) the introduction of new export markets or increased market access; (3) the extent to which the proposal is likely to make a net positive contribution to the balance-of-payments; (4) the creation of new job opportunities; and (5) the promotion of New Zealand's economic growth. The following factors were also taken into account: (1) the degree of equity participation by local shareholders in relation to proposals which involve the ownership and control of New Zealand's natural resources; (2) the potential impact of the proposal on the environment and on regional development. (3) the implications of the proposal for the Government's other economic and industrial policies and other national policies which might be affected by the proposal; and (4) the relative opportunities of shareholders in small private companies to dispose of their shares to the best advantage. Safarian (1993) p. 159.

119 Safarian (1993) pp. 157 and 169.120 Safarian (1993) p. 170.121 WTO (1996) p. 12.122 The factors to be taken into account in making such a determination are: whether the investment

will result in the creation of new job opportunities or the retention of existing jobs; the introduction of new technology or business skills; the development of new export markets; added market competition, greater efficiency or productivity, or enhanced domestic services; additional investment for development purposes; increased processing in New Zealand of New Zealand's primary products. Where land is currently being used for agricultural purposes, the intended use of the land is taken into account. OIC (2001) p. 5.


48. Until January 1995, the main legislation regulating inward direct investment in Norway was the Concession Act of 1917. This Act provided the legal basis for the review of FDI not only in natural resources but also in other industries by requiring foreigners and foreign-controlled Norwegian companies to secure a concession to acquire waterfalls, mines and other real properties, including where such properties were used for industrial purposes.123 The Act stipulated certain basic conditions for the granting of concessions, including requirements that imports and exports take place at world market prices, that payments to parent firms for financial, technical and commercial assistance be approved by the Government, and that Norwegian labour and materials be used. It would appear that the last of these three conditions received special attention in the petroleum sector. 124 In 1963, in a policy statement the Department of Industry further specified the criteria to be considered in examining applications for concessions.125 The review process did not involve active bargaining by the Norwegian Government in order to maximize the benefits of foreign investment proposals, and with the exception of the petroleum sector the performance of foreign-owned firms would not appear to have been a major objective of the review process.126 In 1995, as a consequence of Norway's accession to the EEA, the review process based upon the Concession Act of 1917 was replaced with legislation that provided for uniform rules applicable to acquisitions by domestic and foreign investors. It subjects acquisitions by domestic and foreign investors above a certain threshold to a reporting requirement, with the possibility of a review by the Ministry of Industry and Energy.127

49. Portugal's Foreign Investment Code, adopted in 1977, provided for prior authorization of foreign investment proposals on the basis of an assessment of economic benefits in light of specified criteria.128 It is unclear whether the authorities also actively negotiated commitments from foreign investors with respect to their performance. In certain cases, including cases involving investment in designated priority sectors, approval was granted automatically. In the context of Portugal's accession to the EEC, this regime was liberalized in 1986 with the substitution of a prior declaration procedure for the prior approval requirement and the elimination of the assessment of economic benefits with respect to EEC investments. In relation to non-EEC investments, however, the possibility of an analysis of such benefits was retained in a procedure that provided for evaluation and possible negotiations with foreign investors. Criteria specified in this regard were identical to the criteria contained in the 1977 legislation. It would appear that in practice this possibility of evaluation and negotiation in respect of investments from non-EEC sources was never used and that such investments were allowed to be made upon a simple declaration.129 In 1995, the requirement for prior declaration was abolished and replaced with an ex post notification procedure. It should be noted that Portugal has also applied a special, "contractual" regime, applied to large foreign investments, which provides for tax, financial and other benefits depending upon compliance with specific commitments negotiated by the Portuguese authorities with foreign investors.130

123 Safarian (1993) pp. 173-175; UNCTC (1989) p. 252; OECD (1982) p. 23.124 Safarian (1993) pp. 174 and 177; UNCTC (1989) p. 252.125 These criteria were: the effects on income, production and employment; location of the project; the

extent of foreign financing; the development of new types of production; the possibility of receiving new knowledge; the possibility of cooperating with international concerns to secure better or more stable prices and guaranteed access to raw materials or exports; the extent to which the domestic sector was already developed; and the extent of competition on the home market with established Norwegian firms and the danger of monopoly practices. Safarian (1993) p. 175.

126 Safarian (1993) pp. 177, 181-182 and 430.127 OECD (1995).128 UNCTC (1986) p. 71; The criteria taken into account in the evaluation of individual investment

proposals were: job creation; effective contribution to the balance-of-payments; increased value of natural resources; utilisation of domestic goods and services; contribution to industrial reconversion; regional development; production of new goods or services; improvement of existing goods; introduction of advanced technology; high degree of value added; low dependence on domestic capital; training of Portuguese workers; and low industrial pollution. UNCTC (1986) p. 72.

129 OECD (1994) p. 34.


50. Under the Concession Act of 1916, foreign investment in real property and mining in Sweden was subject to prior authorization.131 The Act also applied to certain Swedish companies, except when their articles of association contained a clause limiting the acquisition of shares by foreign investors. Removal of such a clause required government approval. In 1982, laws were enacted which required approval of foreign investment resulting in the acquisition of more than 10 per cent of a Swedish firm's shares.132 The application of this legislation involved discussions with foreign investors on conditions attached to the approval of an acquisition, but it appears that there was no attempt to extract detailed and specific commitments with respect to long-term performance.133

51. Apart from certain restrictions on foreign ownership contained in the Alien Business Act 1972,134

the main policy instrument used to regulate FDI in Thailand has been the screening of FDI proposals in the context of applications for investment incentives. The Investment Promotion Act of 1977, amended in 1991, vests in the Thai Board of Investments authority to grant a wide range of tax incentives and non-tax benefits to domestic and foreign investors.135 In determining whether to accord promotional status to a project, the Board has considered general criteria, including the project's contribution to: the strengthening of the balance-of-payments; regional development; conservation of natural resources; development of public utilities and basic infrastructure; conservation of energy; the establishment of basic industries which form the basis for further stages of industrial development; and technological development.136 Additionally, the Board has applied specific criteria to projects involving foreign participation which have limited the eligibility for investment incentives by conditioning the level of foreign equity participation in a project on its market orientation. Thus, in case of manufacturing projects mainly oriented toward the domestic market, Thai nationals were required to own at least 51 per cent of the registered capital. Where more than 50 per cent of the production was exported, foreign investors were allowed to hold a majority of the shares, and where 100 per cent of the production was exported foreign investors were allowed to hold all the shares. These links between equity ownership and export orientation have been gradually relaxed over time. Thus, for example, in 1993 the requirement to export 100 per cent in case of 100 per cent fully foreign-owned investments was reduced to 80 per cent, and for manufacturing projects for the domestic market majority foreign ownership was allowed on a case-by-case basis in certain regions. 137

130 The following factors have been considered in such negotiations: (1) the technical, economic and financial feasibility of the projects; (2) sectors where foreign investment is considered to be of most interest, by reason of its contribution to regional development and technological modernisation; (3) forecasts of positive foreign exchange balance, high value added and opening up of new jobs; (4) significant financial coverage of projects from own resources; and (5) suitable development of technologies and the quality of personnel training programmes. OECD (1994) p. 37.

131 Safarian (1993) pp. 186-187132 OECD (1987) pp. 25-26.133 Safarian (1993) pp. 192-193.134 WTO (1999c) pp. 31-32; WTO (1995) pp. 127-128. The Alien Business Act 1972 was replaced in

March 2000 by the Foreign Business Act. 135 The incentives available to "promoted" projects under the Investment Promotion Act fall into four

main categories: (1) special permission to bring in foreign nationals to undertake investment feasibility studies, to bring in foreign technicians and experts and to own land for carrying out a promoted project; (2) guarantees against nationalization, competition by new state enterprises, state monopolization of the sale of products similar to those produced by a promoted project, price controls on the products of a promoted project, export prohibitions, imports by government agencies or state enterprises on a duty-free basis of products that compete with the promoted project; (3) trade protection through the imposition of a temporary surcharge on or a ban of imports of competitive products; (4) tax incentives in the form of an exemption from or reduction of import duties or business taxes on imported machinery or imported raw materials and components, and an exemption from corporate income tax. Special tax incentives have been applied to export-oriented projects and to projects in Investment Promotion Zones. Davidson and Ciambella (1995) pp. 260-265; WTO (1995) pp. 129-133; GATT (1991b) pp. 252-254.

136 OECD (1999) p. 234; Davidson and Ciambella (1995) p. 246.137 WTO (1995) p. 31.


In August 2000, the export requirements for projects involving majority foreign ownership were eliminated. The only remaining restriction on the eligibility for incentives is that, in certain sectors other than manufacturing, Thai nationals must own at least 51 per cent of the registered capital.138 In addition to the exemption of export-oriented projects from these recently removed foreign equity restrictions, another manner in which export performance has been a factor in Thailand's investment promotion policies is the granting of certain kinds of tax incentives conditional upon the degree of export orientation of a project.139

52. The United Kingdom's Exchange Control Act of 1947 regulated the financing of inward direct investment with a view to ensuring that it had a favourable impact on foreign exchange reserves. The Act required that inward direct investment be financed by an inflow of capital rather than borrowing on the UK market. Thus, the inflow of foreign currency had to be proportionate to the degree of control acquired by the foreign firm. Although the fact that under the Act all inward FDI required authorization meant that it was theoretically possible to review inward FDI in the light of a broader range of criteria than just the financing conditions, evidence suggests that in practice the Act was applied solely with reference to the financing criteria. It has been noted that refusals were rare and that no important case was declined by this review process as long as the financial conditions were met.140 In a few cases, involving major take-overs, authorization of inward FDI was made conditional on the foreign firm offering performance undertakings, but such undertakings were not systematically monitored. The financing restrictions were lifted in 1972 for EEC investors and in 1977 for all foreign investment in manufacturing. The restrictions were eliminated in October 1979.

III. POLICY OBJECTIVES OF TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS

53. The preceding section shows that countries have sought a range of policy objectives through trade-related investment measures and other performance requirements ("performance requirements"). This was confirmed in the documents circulated recently by several Members in the context of their requests for extensions of the TRIMs transition period.141

54. Most prominent among them has been Industrial development, aimed at encouraging the expansion of domestic manufacturing activities, including those that involve small and medium-scale enterprises, and, as industrialisation progresses, raising manufacturing productivity and moving into new technologies and into products with a higher skill component. A typical structure of trade restrictions to encourage import-substituting industrial development involves a certain degree of tariff escalation; i.e, high tariffs on finished products and low(er) tariffs on intermediate inputs and capital goods in order to protect the development of local, high-end manufacturing production. However, experience suggests that this may have the effect of leading to the development of only low value-added, assembly operations based on imported inputs. For many countries, the motor vehicle industry has been a case in point. It lends itself readily to the assembly of imported "knocked down kits", which has been the starting-point for many countries in developing a domestic motor vehicle industry. At the same time, it is also an industry that uses a relatively large proportion of low technology components, offering the possibility even at an early stage of industrial development of extending the import substitution process backwards from finished products into various linkage activities geared towards the supply of components.

138 Board of Investment Announcement No. 1/2543.139 WTO (1999c) pp. 59-60; OECD (1999) pp. 235-236; WTO (1995) pp. 129-133.140Bailey et al. (1994) p. 159.141 See the documents submitted by Argentina (G/C/W/295), Colombia (G/C/W/296), Malaysia

(G/C/W/291/Rev.2), Mexico (G/C/W/293), Pakistan (G/C/W/294), Philippines (G/C/W/289), Romania (G/C/W/290), Thailand (G/C/W/292).


55. One way of encouraging this would be to modify the tariff structure over time, raising tariffs on those imported inputs that the authorities wish to see, and expect can be, produced competitively by domestic industry. Some countries have preferred to apply local content requirements, accompanied in many cases by higher tariffs on imports of finished products, and in some cases by offering other forms of tax advantage aimed at maintaining the profitability of the producers of finished products. In contrast to the use of tariffs in this context, most local content requirements do not specify what particular components are to be sourced locally. Rather, the industrial policy objective has been expressed in terms of a proportion of total content. This can have the advantage of allowing producers of finished products to select which components they will source locally, as opposed to having the government make the selection for them when deciding which tariffs are to be raised. Typically, the proportion of local content required has been increased over time. In some cases, at a certain point the proportion has begun to be reduced; a parallel can be drawn here with the classic model of infant industry tariff protection, which proposes that tariffs should begin to be reduced once domestic producers have had time to become established so as to place pressure on them to increase their productivity and competitiveness.

56. Some countries have subsequently introduced requirements to export finished products, usually several years after the application of local content requirements. The objective appears either to have been to encourage a higher volume of production than would be warranted by sales on the domestic market alone, in the expectation of achieving greater efficiency of production through economies of scale, or more generally to try to inject greater export-orientation into the industrialization process. In some cases this objective has been pursued through export performance requirements alone. In others, a link has been created through trade-balancing requirements between export performance and access to imports on advantageous terms -- typically, reduced tariff rates for imported inputs -- in an attempt to encourage and assist producers of finished goods to compete on export markets by removing one of their cost disadvantages (higher priced inputs).

57. Performance requirements have been used widely with the aim of influencing the activities of foreign investors in host countries in favour of contributing to key elements of economic growth and development policy. Based on data in the previous section, in addition to targeting the contribution they make to industrial development, to import substitution, and to export promotion, performance requirements have been applied to try to strengthen the contribution of foreign investment to a host country's technological development, to the creation of employment, to its balance-of-payments situation, and to conditions of competition in the host country and the ownership of resources. In some cases, performance requirements have explicitly targeted the policy objective; in others, this has been pursued more indirectly through, for example, varying the level of equity that can be held by a foreign investor in a local subsidiary according to whether the investor agrees to meet targets in areas such as export performance, trade or foreign exchange balancing, or technology transfer.

58. Many countries which have applied procedures for review and authorization of foreign investment have taken the expected contribution to the transfer of technology into account. Some have applied explicit conditions requiring either that certain technologies be used by the foreign investor in the host country or that, once established, steps be taken by the foreign investor to ensure that technology and skills are shared with domestic firms. In some instances this has been pursued through explicit requirements that specific technologies be licensed to local firms; in some it has been pursued implicitly through local sourcing conditions that can only be fulfilled through technological collaboration between the foreign investor and local firms.

59. Some countries have attached conditions to foreign investment relating to the generation of employment and the accumulation of managerial and workforce skills. These have been included as policy objectives in procedures for reviewing and authorizing foreign investment projects, and some have applied specific performance requirements targeted at these goals, particularly on a sectoral basis.


60. Certain performance requirements have been applied to try to address balance-of-payments concerns, by reducing demand for imports, increasing exports, and managing foreign capital flows associated with the activities of foreign investors. They were used by some developed countries before the introduction of full currency convertibility and flexible exchange rates shifted the job of balance-of-payments adjustment away from trade and capital account controls and onto macroeconomic adjustment policy. Some developing countries, particularly those that consider themselves vulnerable to chronic balance-of-payments difficulties, continue to apply conditions to foreign investors on inflows and outflows of foreign exchange relating to the initial investment or to subsequent operations of the subsidiary firm.

61. Some countries have targeted the policy objectives of conditions of competition and ownership of enterprises through performance requirements. The underlying concerns in these cases appear to be the large commercial size and influence of foreign subsidiaries in a host country relative to their domestic counterparts, the potential for foreign subsidiaries to out-compete domestic firms and drive them out of key sectors or industries of the host economy, and on a broader level the exercise of political control over the ownership of the means of production in an economy. It has also been suggested that these performance requirements aim to offset an asymmetry in bargaining power between a foreign firm and the host country government over the distribution of the gains arising from an investment (Newfarmer 1985, and Balusbramanyam 1991).

62. Finally, some countries have used performance requirements in the context of regional development policies, within national borders, to encourage a more geographically diversified pattern of industrialization.

IV. THE IMPACT OF TRADE-RELATED INVESTMENT MEASURES AND OTHER PERFORMANCE REQUIREMENTS

A. IMPACT ON INTERNATIONAL TRADE FLOWS

1. Local content requirements

63. Under conditions of perfect competition142, the world price of imported components must be lower than the price of domestically produced substitutes in order for a local content requirement (LCR) to be binding;143 otherwise, one would expect that cheaper, domestically produced components of similar quality would be preferred automatically. Overall demand for the components will be a function of both the domestic price and the world price. The higher is the proportion of components that is required to be sourced domestically, the closer their average per unit cost will be to the prevailing domestic price.144 As a result, given the above assumptions:

the LCR will reduce imports of components;

the higher domestic price of components as a result of the LCR will mean that producers of finished products will need to be compensated by a tariff on competing imported products if they are to remain competitive in the domestic market; otherwise, imports of finished products will increase and undermine the effectiveness of the LCR. Hence, imports of finished products will fall;

142 See Vousden (1990). For analysis that relaxes the assumption of perfect competition, see Richardson (1993) on factor price effects, and Madan (1998, 2000) on transfer prices in intra-firm trade.

143 The trade effects of LCS will depend on the degree of differentiation between foreign and domestic inputs, and on the production technology (Mussa, 1987). The higher the degree of substitutability between the two, the greater will be the impact on trade for a given LCS.

144 Local content schemes can also be prescribed in terms of the value. Although analytically similar, there are some differences in their impacts on consumer behaviour as shown by Färe et al. (1989).


the effect on exports of finished products will be negative, or at best neutral, due to the higher costs of incorporating domestically produced components.

64. The dynamic effects of an LCR on trade are more speculative. If domestic producers of components who are benefiting from the guaranteed market created by the LCR do mature over time and eventually become competitive at world market prices, it will be possible to relax and eventually remove the LCR, to reduce the tariff on imported finished products, and possibly to develop an export capacity in components. If, on the other hand, the costs of local production of components remains high behind the protection of the LCR, the risk is that the entire domestic industry, including the production of finished goods, will remain uncompetitive and act as a drag on overall economic growth.

1. Export performance requirements

65. If a firm is able to export competitively at world market prices, one would expect it to do so in order to maximise its revenues and/or profits. Requiring a firm to export a certain percentage of its output beyond what is commercially viable will involve it in a loss-making activity. Given constant returns to scale, it will not change its output level (i.e. raise production to meet its export target, since this will increase its losses), but rather reduce its sales on the domestic market (Herander and Thomas, 1986). Given the above assumptions:

the trade effects will be increased exports, but also increased imports that are needed to make up the shortfall of production for the domestic market.

66. For a firm to continue producing profitably in such circumstances, a compensating advantage will be needed to offset the losses incurred on export sales (WTO, 1998). Typical examples are higher profits from domestic market sales deriving from tariff protection against imported goods that compete for a share of the domestic market, duty rebates on imported inputs which reduce production costs, and various forms of fiscal or financial incentives. These allow higher profits realised by the firm on sales on the domestic market to be used to cross-subsidize losses incurred through exporting. , Given the above assumptions:

a higher tariff on finished products will allow the firm to expand its production for the domestic market, and result in lower imports. Fiscal and financial incentives can have the same effect;

duty rebates will encourage higher imports of intermediate products.

67. One justification that is sometimes advanced for applying export performance requirements is that firms may be operating in imperfectly competitive market conditions. For example, if a subsidiary of a foreign company aims not to maximize its revenues or profits but rather to implement the worldwide production and marketing strategy of its parent company, the subsidiary may not export its production even if it is able to do so competitively at world market prices; export markets may be reserved for subsidiaries of the same foreign company operating in other host countries. In such a situation, exports from the host country will be less than is justified on competitiveness grounds, and an export performance requirement may help to correct for this.

68. As was the case for the LCR, the dynamic effects of an export performance requirement are more speculative. If the firm concerned raises its total output and is able to reap additional economies of scale, it may eventually be able to compete at world market prices without any offsetting advantage. Chao and Yu (1998a and b) analyse the situation where an export performance requirement is imposed in the presence of a tariff in one time-period, and both policies are removed in a second time-period. This allows for consumption and substitution effects across time periods, and for positive


effects on the trade balance in one time-period to offset negative effects in another. If the non-traded sector absorbs resources from the sectors affected by the import restraint and the export requirement, the result is higher overall national income and subsequent increases in both exports and imports.

2. Trade balancing requirements

69. Trade balancing requirements link the removal of restrictions on imports to the generation of additional exports. As such, if they are successful they can be expected to increase both imports and exports; if they are not, then existing trade flows may remain unchanged. Analysis by Herander and Thomas (1986) shows the ambiguity of the net effect on trade, and highlights the fact that it will depend primarily on the use of imported inputs relative to domestically-produced inputs.

EMPIRICAL EVIDENCE

70. The principal methodology adopted has been case studies of particular countries or industries, usually based on interviews with foreign investors. This is useful, but in most instances the conclusions drawn have not been supported through systematic cross-country analysis. Also, it makes it difficult to identify the specific effects of individual performance requirements, since the measures are often applied in combination.145 Nonetheless, certain insights can be derived.

71. The four most widely cited empirical studies on the trade effects of performance requirements date from the 1980s. They are the U.S. International Trade Commission (1982), Gray and Walter (1984), Guisinger and associates (1985), and Moran and Pearson (1987).146

72. The USITC study found it difficult to draw general conclusions because of differences across host countries and industries. Nevertheless, it concluded that the measures had only a marginal effect on trade and employment in the United States, as well as on the location of investment. In the specific case of the automotive industry, the study found that the net expansion of exports from the US that could be expected from abolishing performance requirements in host countries where the subsidiaries of US motor vehicle producers were established would have amounted to less than 1 per cent. Similar estimates were made for the chemical industry (a net increase in exports of 1.7 per cent) and computer and office equipment (0.5 per cent). The relatively low numbers involved were attributed to the fact that most respondents indicated that the location effect of performance requirements was very low (i.e., that the measures were only a minor factor in a foreign investor's decision about where to produce, and in themselves did not prompt investors to consider moving their production elsewhere).

73. These results were broadly confirmed by Guisinger, who found statistically significant trade effects only in the automotive industry.147 A weaker result still was obtained by Moran and Pearson, with UNCTC (1991b) concluding that "TRIMs did not, per se, significantly affect the pattern of trade".148

74. There are some grounds for believing that the methodology used in these studies may have biased the trade effects of performance requirements, by failing to differentiate between the value, volume and composition of trade flows.149 For example, aggregate trade changes predicted by the USITC do not include the possibility of substitution effects between trade in final and intermediate goods, yet some survey respondents indicated that in the absence of local content schemes, exports to the country

145 For example, on local content schemes UNIDO says that "in practice, however, it (local content schemes) has – at most – been seen as part of an overall policy of trade restriction, again supplementing existing tariffs and quotas, for a given sector". (p. 6)

146 These studies have been reviewed extensively, notably by UNCTC (1991b) and WTO (1998).147 Guisinger and associates (1985), pp. 154 and 319.148 UNCTC (1991b), p. 50149 UNCTC (1991b), p. 47.


in which they were investing could shift from intermediate to final goods. Some even indicated a change in the volume and value of intra-firm trade. Nonetheless, these studies suggest that the aggregate trade impact of performance requirements has been relatively small.

B. IMPACT ON INTERNATIONAL INVESTMENT FLOWS

75. The determinants of flows of foreign direct investment (FDI) are generally considered to differ between two broad categories of FDI. One category (market-seeking FDI) is attracted by the potential for sales on the host country market, and has no expectation necessarily of exporting from it. The second (efficiency-seeking FDI) is attracted by specific factor endowments in the host country, notably an abundance of natural resources or of labour, and usually it does have a clear export orientation. In both cases, several determinants come into play at the same time, of which one may be the existence of performance requirements.

1. Local content requirements

76. When an LCR is binding, the affected firm will be forced to purchase higher cost, domestically-produced components instead of imported substitutes. This raises the firm's costs of production, and lowers its profitability, which can influence whether the firm decides that an investment in the host country will be commercially viable.150 Prima facie, the existence of an LCR is likely to deter FDI inflows to a host country, although this will depend upon how significant the effect of the measure is on total costs of production. The profitability of an investment in a particular country is dependent on many factors, and cost advantages of the host country in other respects may outweigh the negative effect of the LCR. Also, other policy measures may be applied to compensate for the cost disadvantages of an LCR, most obviously fiscal or financial advantages that are offered to the foreign investor, and also in the case of market-seeking FDI the level of tariff protection which the investor enjoys in the host country. As long as this effectively protects the investor from import competition, the additional cost imposed by the LCR is relevant only inasmuch as it creates a cost disadvantage vis-à-vis other local producers, and they themselves may also be subject to the same LCR. In addition, the costs imposed by the LCR may be viewed as insignificant relative to other advantages the investor derives from being able to supply the host country market from a local subsidiary (e.g., specialized local knowledge of the market). Given the above assumptions:

An LCR will raise production costs and act as a deterrent to inflows of market-seeking and efficiency-seeking FDI.

However, compensating locational or policy advantages offered by the host country government may outweigh the effect of the LCR and have a positive effect on FDI flows.

1. Export performance requirements

77. The impact of export performance requirements (EPR) on investment flows also depends on the type of FDI that is involved. As indicated earlier, in order for an EPR to be binding it must be assumed that the firm is forced to some extent to cross-subsidize export sales. EPRs are therefore less likely to be relevant to efficiency-seeking FDI, which is attracted by locational advantages of the host country and which is likely to have a natural export orientation.

78. If the foreign investor has to pay for the cross-subsidization of exports from its own revenues, earned from selling on the host country market, the EPR would be likely to deter FDI since it implies lower overall profitability of the firm's activities in the host country. However, the cross-subsidization can be covered in other ways, for example by some form of compensating fiscal or financial advantage that the firm receives, in which case the costs imposed by the EPR may be

150 See Färe et al. (1989) for a formal treatment of this.


regarded by the foreign investor as being cancelled out. This situation can be common in the context of export processing zones, where foreign investment is encouraged on condition that output is exported. In return, a firm is generally able to take advantage of lower costs of production offered in the export processing zone, for example lower factor costs and duty free importation of imported inputs and capital goods.

An EPR is likely to act as a deterrent to inflows of market-seeking FDI.

However, compensating advantages offered by the host country government may offset the effect of the EPR and have a positive effect on FDI flows.

2. Trade balancing requirements

79. Since trade balancing requirements link the removal of restrictions on imports to the generation of additional exports, market-seeking FDI is likely to be deterred since it will face a potential penalty on both the export and the import side. Efficiency-seeking FDI, on the other hand, which has a strong export-orientation in the first place, may be little affected.

EMPIRICAL EVIDENCE

80. The problem of isolating the specific impact of performance requirements is compounded in the case of investment flows by the issue of whether the measures are imposed pre- or post-establishment of the subsidiary. If the existence of a performance requirement is known about before the subsidiary is established, the foreign investor may be able to design the investment so as to minimize whatever adverse effects on costs of production it may have. If, however, it is imposed on an existing subsidiary, its costs are likely to weigh more heavily on the investor's operations.

81. The four studies cited above in paragraph 71 are the main ones that provide empirical evidence of the impact of performance requirements on investment flows.151 The USITC study found that performance requirements had only a marginal effect on the location of investment; most respondents to the survey indicated that the existence of performance requirements was only a minor factor in their decision about where to invest and produce, and the existence of performance requirements did not in themselves prompt investors to consider moving their production elsewhere. The results of these four studies have been summarized as follows: "reported shifts in firm behaviour due to TRIM regulations are surprisingly small".152

82. Hackett and Srinivasan (1998) examined in detail the costs of performance requirements involved in switching from one set of suppliers of components to another. The costs taken into account were the loss of existing business relationships, the cost of finding satisfactory host country suppliers, the costs of negotiating contract terms and safeguards, and the costs of adapting production processes to the locally supplied component. The findings were that these "supplier-switching costs" were higher for Japanese firms than for US firms, and that for a sample of foreign subsidiaries over the period 1982-1988 the imposition of LCRs had had a negative, but insignificant, effect on US investments, and a positive and significant effect on Japanese effects, probably due to compensating advantages of one kind or another that were offered in conjunction with the performance requirements. The study found also that the effect on investment flows of EPRs was negative, but not significant.

C. IMPACT ON GROWTH AND DEVELOPMENT

83. Economic growth is generally viewed as a necessary, but not a sufficient, condition for development (Caves 1996). Development is the combination of a variety of factors: UNCTAD

151 Their results are summarized in UNCTC (1991b) and in WTO (1998).152 UNCTC (1991b) p. 54.


(1999), for example, identifies key factors in the relationship between FDI and development as financial resources, technology transfer, export competitiveness, human resource development, and the environment, and other studies have highlighted additional factors. Typically, performance requirements target one or more of these factors, rather than the process of economic growth and development at an aggregate level.

1. Impact on resource allocation and growth

84. Theory predicts that an economy which allocates its resources efficiently, which maintains a high rate of capital accumulation (either from domestic savings or inflows of foreign capital), and high total factor productivity (which depends in part on the technology that is used), should be able to achieve and sustain a high rate of economic growth. FDI can be of particular relevance, for developing countries in particular, in each of these areas -- for example, to the extent that FDI is a source of capital, or of technology, it can enhance the host economy's growth prospects -- and performance requirements may be used by the host country to target one or other of these attributes of FDI so as to try to increase their contribution to economic growth.

85. Recent research has explored how FDI contributes to the accumulation of physical inputs in specific sectors and industries in a host country, which can then generate increasing returns to scale that help raise the growth rate; in other words, a process whereby increases in output can in themselves stimulate more sustained growth.153 Encouraging a concentration of FDI in a particular sector or industry in the host country may then also be a policy target for performance requirements. However, the potential advantages gained from this particular strategy need to be gauged case-by-case against the extent to which FDI may crowd out domestic investment, and as a result lead to only a small net increase, if any, in the total capital stock of an industry (Caves, 1996).154 More generally, this strategy needs to be considered in the context of its potentially adverse effects on the efficiency of resource allocation in the economy overall, and not just in the targeted industry.

86. As far as resource allocation is concerned, the overwhelming evidence is that production and consumption decisions at world prices reflect a more positive outcome for any country. However, Lipsey and Lancaster (1956) showed that in the presence of a distortion to a perfectly competitive market (i.e., a second best situation), welfare could be improved in specific circumstances if the government introduces a policy that creates a second distortion but which at the same time offsets the first. This insight has been used repeatedly in the international trade literature, especially in the context of policies used to protect industries from international competition (Bhagwati, 1971). This is a highly stylised line of argument. It assumes policy-makers are in a position to evaluate accurately distortions to market conditions, and to design corrective policy interventions with equal accuracy -- all in all, a combination that is difficult to realise in practice. Nonetheless, the use of performance requirements has been analysed in this context, and compared with the use of tariffs as an alternative policy approach (Vousden, 1990).

87. Take as an example a host country government that wishes to expand production by encouraging domestic manufacturing to supply a foreign subsidiary with components. It decides to choose between applying a local content requirement (LCR) in combination with preferentially low tariffs on imports of intermediate goods that are not sourced locally, or applying higher tariffs on all imports of intermediate inputs to induce the foreign subsidiary to source as much as possible locally. The effect on the host country economy in both cases is to misallocate resources into the protected industries. However, using static analysis, and assuming perfect competition in the intermediate goods sector of the host economy, a tariff on intermediate products is inferior, in a welfare sense, to an LCR as long as the LCR is not set at 100 percent (Vousden, 1987 and 1990). The intuition behind this is that the

153 The openness and growth literature can be found in Grossman and Helpman (1991) and Barro and Sala-I-Martin (1995).

154 See also chapter 6 of UNCTAD (1999).


final domestic price of the intermediate goods will be a weighted average of the domestic and world price. The LCR continues to provide access at, or near to, world prices for the proportion of intermediate goods that continues to be imported, whereas the tariff raises the domestic price for all intermediate goods, hence creating a larger consumer welfare loss.

88. This result is subject to many assumptions and constraints, including the market structure of the intermediate goods sector and the degree of vertical integration. If the intermediate goods sector is dominated by a monopoly, for example, a tariff can become a superior instrument, since the monopolist will find it profitable to take advantage of the higher inelasticity of the demand curve arising from the quantity restriction imposed by the LCR, and to restrict the quantity and raise the domestic price of intermediate goods.

89. Attempts have been made to derive results on protection-induced capital flows in the context of a general equilibrium model (Johnson, 1967; Brecher and Diaz-Alejandro, 1977). Richardson (1993) develops a model of LCRs with capital flows and a market structure that allows foreign and domestic firms to compete in the intermediate goods sector. In this case, a result, which is consistent with the empirical evidence, is that an LCR can induce foreign capital inflows so that foreign subsidiaries displace some of the domestic firms. If these foreign subsidiaries source some of their intermediate inputs from the world market, imports could actually increase. As a result for low proportion LCRs it is possible that the negative effect of higher domestic prices could be offset through an increase in tariff revenues.

90. One contribution on the role of LCRs is a study by Kim (1997). Using an inter-temporal model that explicitly considers labour supply decisions, he finds that the long-run effects of an LCR are to lower the level of the capital stock, improve the current account, and decrease employment.

91. In the case of export performance requirements (EPRs), to the extent that a protected host country market, or some other fiscal or financial advantage, is necessary to induce foreign investment in the first place, the imposition of an EPR has been shown under certain circumstances to lead to potentially higher welfare (Rodrik, 1987). Since an import tariff is in place to protect the domestic market, production and consumption decisions in the host economy take place with respect to the tariff-distorted domestic price. An EPR can reduce this distortion by ensuring that a proportion of domestic production (the proportion that is exported) takes place at world prices, thereby increasing welfare. Once again, however, the underlying assumptions are all important in reaching this result. If the host country could be made better off in a tariff-distorted environment by forcing some output to be produced at world prices, then welfare would be improved even more by ensuring that all output is produced at that price, which implies removing the original tariff-distortion.155

92. A potential source of resource misallocation in the host country can arise if there are restrictive business practices of foreign subsidiaries. This has been advanced as justifying the use of certain performance requirements (Puri and Brusick, 1989, and Morrissey and Rai, 1995, and Mashayekhi, 2000). However, the case is weak in light of the general rule in economic policy that the best policy is always the one that is targeted directly at the distortion (Bhagwati, 1971). In the case of restrictive business practices, the information required by policy-makers to gauge whether an LCR or an EPR is an appropriate remedy is very high. As shown above, even in the context of a monopolistic market structure, a quantity-based LCR is an inferior instrument to price-based tariff protection, since the LCR more readily accommodates the exercise of monopoly power because of the price elasticity of demand.156

155 Bhagwati (1971).156 Hollander (1987) showed that if an LCR were devised to replicate rate-of-return regulation policies,

typically applied to natural monopolies, there is scope for welfare improvements. However, the key assumption of Hollander’s work is that the monopoly power is in the final, not the intermediate, goods market.


93. In summary, Moran (1998) concludes that "… under neoclassical assumptions of perfect competition, the imposition of domestic content and/or export requirements on foreign firms damages the prospects for economic development of the country that adopts them".157 In an imperfect market context, it is possible in theory to construct examples of situations in which the imposition of a performance requirement can be shown to improve resource allocation, and to improve it by more than would be the case if a tariff were used instead. However, the results of this type of analysis are highly sensitive to the assumptions that are made about the existence of market distortions, and they are not sufficient to support a general statement that performance requirements are likely to improve resource allocation. On the contrary, in most practical instances, performance requirements are likely to produce a less efficient allocation of resources than a measure, such as a production subsidy, which addresses the source of the distortion directly.

EMPIRICAL EVIDENCE

94. An early study of the effects of industrial and trade policies on resource allocation and growth is a cross-country study done under the auspices of the OECD (Little, et. al, 1970). The general conclusion drawn was that promoting industrialisation through import substitution policies created a bias against exports and obscured comparative advantage. Policies that encouraged industrial expansion, but were export neutral, were viewed as being more conducive for development.

95. In the case of Brazil, Bergsman (1970) concluded that LCRs "forced foreign investors to use and even to develop Brazilian sources of supply", and "drastically reduced the demand for imports of manufactured products", but that they led to the establishment of manufacturing processes in Brazil that were inefficient, usually because of their small scale of operation.

96. Munk (1969) arrived at a similar result from his study of local content protection in the car and truck industries in Argentina, Brazil and Mexico -- the principal cause of resource misallocation was the inability of these industries to exploit economies of scale, although he found that the Brazil light truck industry at the time was producing at lower cost than the world price despite a local content level of 94 per cent. Similar problems of insufficient economies of scale were also recorded in the automotive industries in Chile (Johnson, 1965), Canada (Eastman and Stykolt, 1967), Argentina, India, Mexico, New Zealand and Yugoslavia (Baranson, 1969), and Australia (Gregory, 1987), although factors other than simply the use of LCRs were recognized also to be involved, for example an overvalued exchange rate and a costly regional development strategy in the case of Chile. Munk's overall conclusion was that an LCR was a costly policy tool in terms of resource misallocation unless there was a steady narrowing over time of the price differential between domestic and imported components. UNIDO (1986), in its assessment of local content schemes across a number of developing countries, concluded that local content schemes "were also often very costly, both in the sense of driving up local prices and of misallocating scarce resources". (p. 75).

97. More recent research has tended to confirm the results of these studies. Okamoto and Sjoholm (2000), for example, studied the automotive industry in Indonesia and concluded that the policies being used there, including performance requirements, had created a highly protected environment where low competition allowed establishments to operate inefficiently. They concluded, for the period 1990-95, that the industry failed to achieve international competitiveness, that productivity growth (value-added per employee) declined, and the industry failed to develop any export capability. These results were confirmed by a cross-country study of the automotive industry in South-East Asia.158 An analysis of the local content ratio of Japanese electronics affiliates in 24 countries found

157 Moran (1998) p. 32.158 The countries studied were Indonesia (Aswicahyono et al., 2000), Malaysia (Tyndall, 2000), the

Philippines (Abrenica, 2000), and Thailand (Poapongsakorn, 2000).


that local content regulations were modestly effective in raising local content, but not in stimulating procurement from domestic suppliers (Belberdos et al., 2001).

98. A study by CEPAL (1998) of the global automotive industry also came to the general conclusion that investment policies, including performance requirements, had been inefficient and costly for several countries in Latin America: "the investment necessary to modernize the automotive industrial base was not made, and production capacity remained stagnant and technologically antiquated, which was an obstacle to accessing the foreign markets; even more importantly, production capacity sufficient to achieve efficient minimal economies of scale was not attained."159 The ineffectiveness of the policies led to the decline of the industry in all countries except Argentina, Brazil and Mexico, but even in Argentina and Brazil productivity remained low, at only about half the level in Mexico where the industry was placed under strong competitive pressure for production destined for the US market.

99. Moran (1998) concluded from an extensive review of the empirical literature on performance requirements that: "The imposition of domestic-content requirements in protected local markets leads to less efficient production and provides less valuable backward linkages than does allowing foreign firms to set up operations oriented toward global or regional markets".160 He also concluded, however, that export performance requirements in the automotive, petrochemical and electronics/computer sectors had played an important role in establishing backward linkages.161

1. Impact on technology transfer

100. Developed countries are the principal sources of technology, and transnational corporations are an important conduit for the international transfer of technology (UNCTAD, 1999). However, the mechanisms for such transfers and the conditions for the generation of technology in host countries are prone to a variety of market failures. Some host country governments have therefore used performance requirements to try to improve the conditions for technology generation and transfer, targeting both the linkages between parent companies and their foreign subsidiaries, and between foreign subsidiaries and domestic firms in the host country. Local content requirements, for example, may aim to encourage foreign companies to transfer technology to local component suppliers in the host country, or more explicit technology transfer requirements can be included in licensing agreements.

101. In using these measures to try to address market failures, there is an ever present difficulty of balancing the public benefit from the diffusion of technology with the private incentive to generate technologies (Saggi, 2000). Furthermore, the success of the measures is not automatic. Kokko (1992) suggests that the transfer of technology depends a great deal on the host country's technological capability and the level of competition.

102. Empirical evidence of the use of performance requirements in this context is scant. Kokko and Blomstrom (1995) found that the imposition of requirements on the behaviour of foreign subsidiaries was negatively associated with technology flows into the host country. The performance requirements studied included mandates to use the most advanced technology available, perform research and development locally, have access to the parent company's patents, or transfer skills to local personnel.

103. UNIDO (1986) concluded that, based on their empirical evidence, local content schemes "have often failed to contribute to the indigenous technological development of the country and represented only a pseudo-transfer of technology, not trained entrepreneur or managers in the developing countries and therefore led to poorly managed enterprises, and not generated significant –

159 CEPAL (1998), p. 242.160 Moran (1998), p. 161.161 Ibid, p. 6.


if any – foreign exchange savings" (p. vii). Although they do qualify this conclusion by highlighting that the overall impact does depend on a complementary comprehensive macroeconomic policy.

104. More generally, by measuring technology transfer in terms of spillover effects from one firm to another, usually from a foreign subsidiary to a domestic firm, productivity levels of domestic firms have been found to increase along with the foreign subsidiary share of the industry in Canada (Globerman, 1979) and Mexico (Blomstrom, 1986), but not in Morocco (Haddad and Harrison, 1993) or Venezuela where in fact the opposite was found to have occurred (Aitken and Harrison, 1999). A more recent study of industrialized countries, on the other hand, did find a statistically significant and positive relationship between the stock of FDI and domestic manufacturing efficiency (Barrell and Pain, 1997). However, none of the studies tested whether the magnitude and sign of the spillover effects were functions of government policy, and more specifically of performance requirements.

2. Impact on employment and wages

105. The theoretical issue involved in whether performance requirements create employment and skill upgrading, and raise wages, is how efficient they are as policy tools. Policies designed to increase production in a particular sector will most likely increase employment in that sector, but the level of employment in the economy overall is determined by macroeconomic factors so that increased employment in one particular sector may come only at the expense of reduced employment elsewhere. Furthermore, there will be a resource cost to the economy associated with each job created and, as indicated earlier, performance requirements are not generally considered to allocate resources efficiently so the resource cost involved in using them for this purpose may be high. As regards wages, the wage rate is a function of value of the product for which labour is an input and its productivity level.

106. As in the case of technology transfer, empirical evidence of the impact of performance requirements on employment is very thin. There is support for the proposition that local content requirements have raised employment in the sectors in which they are applied. In the case of Malaysia, for example, employment in the automotive sector, which is subject to a high local content requirement, is 3.5 per cent of total manufacturing employment (Tyndall, 2000). There would surely be far fewer jobs in this industry in the absence of the government's import-substitution policies, including performance requirements, but there is no evidence on whether the policies have reduced unemployment overall or simply shifted jobs from elsewhere in the economy.

107. There is an extensive empirical literature on wages paid in foreign firms relative to domestic firms, although none specifically relating the use of performance requirements to wage levels. Markusen and Venables (1997 and 1999) find general support for the proposition that, on average, foreign subsidiaries have higher productivity levels and pay higher wages than domestic firms, and Caves (1996) also finds there is a wage premium to workers in foreign firms that is robust across a variety of methodologies. Aitken et. al (1996) too found support for the hypothesis using data from Mexico, Venezuela and Morocco. Globerman et. al (1994) found that the premium was 20 per cent in Canada, and Doms and Jensen (1998) derived the same result for the United States. Feliciano and Lipsey (1999) found a much lower premium when firm size and location were controlled for, and Bora and Wooden (1998, 1999) quantified the premium at about 3 per cent in Australia.

3. Impact on competition

108. Performance requirements tend to be used most widely in industries that are imperfectly competitive, where the opportunity exists to shift rents from one firm to another. Government policies can play a role in this regard, either directly through rent shifting policies, or indirectly by affecting the environment in which the firms compete (Krishna and Itoh, 1988; Richardson, 1991). The standard hypothesis is that a host country government would wish either to shift rents from a


foreign subsidiary to a domestic firm, or simply extract rents from the foreign firm (Vousden, 1990). However, Richardson (1991) shows how a perverse result could arise where a foreign subsidiary's profits increase at the expense of a domestic firm competing against it a final goods market.

109. The most comprehensive empirical work on the issue of power and transnational corporations is in Newfarmer (1985)162, which found that industries with high foreign investment (transnational control) are characterised by less competition, measured using a concentration index. The study considers issues related to the use of performance requirements as a mechanism to counter the power of large firms, but it does not empirically test whether or not such policies have been successful.

162 See UNCTAD (1997) for a good survey of the issue of competition policy and FDI.


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