Hostname: page-component-78c5997874-dh8gc Total loading time: 0 Render date: 2024-11-10T11:05:54.489Z Has data issue: false hasContentIssue false
  • English
  • Français

Effective Legal Systems and Foreign Direct Investment: In Search of the Evidence

Published online by Cambridge University Press:  17 January 2008

Amanda Perry
Amanda Perry
Affiliation:
Lecturer, Department of Law, QMW, University of London, a.j.perry@qmw.ac.uk. Thanks for assistance from Peter Muchlinski, Sol Picciotto and Amazu Asouzo.
Get access Rights & Permissions [Opens in a new window]

Extract

What do we know about the role of legal systems as determinants of the location of foreign direct investment (FDI)? The short answer to this question is: not enough.1 In recent decades, most governments have come to believe that FDI is an important source of the capital and technology necessary for economic development, and to seek new ways to induce foreign investors to locate within their jurisdiction.2 Commentators and development agencies regularly argue or imply that FDI flows are to some extent determined by the effectiveness of the host State's legal system.3 That is, it is suggested that the manner in which laws are implemented in a State can act as a deterrent or an attraction to potential foreign investors.4

Type
Articles
Information
International & Comparative Law Quarterly , Volume 49 , Issue 4 , October 2000 , pp. 779 - 799
Copyright
Copyright © British Institute of International and Comparative Law 2000

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

1. Most fields of inquiry could benefit from more evidence. However, the immense implications (financial and moral) of lack of evidence in the field of development assistance was made clear by the former chief economist of the World Bank in a recent article on the IMF and the Asian Financial Crisis: “if we believed our policies were helping East Asia, where was the evidence? As a participant in these debates, I got to see the evidence. There was none.” Stiglitz, , “What I learned at the world economic crisis”, The New Republic (04 2000) http://www.thenewrepubttc.com/04170/stiglitz041700.htmlGoogle Scholar

2. See Stopford, and Strange, , Rival Stales, Rival Firms Competition for World Market Shares (1995)Google Scholar; UNCTAD, World Investment Report 1995: Trends and Determinants (1995)Google Scholar; UNCTAD, World Investment Report 1998: Trends and Determinants (1998)Google Scholar; UNCTC, The Determinants of Foreign Direct Investment: A Survey of the Evidence (1992a)Google Scholar and Formulation and Implementation of Foreign Investment Policies (1992b)Google Scholar; Meier, , Leading Issues in Economic Development (1995), pp.247–251Google Scholar; and Todaro, , Economics for a Developing World (1992), pp.397–400.Google Scholar

3. The term “legal system” is used here to describe all the institutions, including courts and bureaucracies, through which laws are implemented. It is not intended to refer to the content of those laws.

4. The role of legal systems as a determinant of portfolio investment is not addressed in this article.

5. In 1998, questionnaires were sent to the CEOs of each of the 402 companies in Sri Lanka which are offered extra incentives by the government because they are either export oriented, or are operating in a priority sector of the economy. Respondents were asked to describe their perceptions of the Sri Lankan legal system; to indicate whether they had made a pre-investent investigation of the legal system, had been surprised by the legal system, and would invest in hindsight of the legal system; and to indicate the impact (good, bad, variable or none) which they expected an “ineffective” legal system to have upon the value of their investment. Sixty seven usable questionnaires were returned. These are the (partially self-selecting) respondents upon which the Sri Lanka survey results reported in this article are based.

6. In 1997, the author conducted 35 semi-structured interviews in Sri Lanka with local and foreign business people, non-legal advisers, lawyers, NGO workers, diplomats, development workers and government officials. Interviewees were asked to comment upon issues surrounding the effectiveness of the Sri Lankan legal system, and the sensitivity of foreign investors to the legal system.

7. Tshuma, , “The Political Economy of the World Bank's Legal Framework for Economic Development” (1999) 8:1 Social and Legal Studies 75, p.76CrossRefGoogle Scholar. See also Wälde, and Gunderson, , “Legislative Reform in Transition Economies: Western Transplants—A Short Cut to Social Market Economy Status?” (1994) 43 I.C.L.Q. 347CrossRefGoogle Scholar; Webb, , “Legal System Reform and Private Sector Development in Developing Countries” in Pritchard, (Ed.), Economic Development, Foreign Investment and the Law (1996)Google Scholar; World Bank Legal Department, The World Bank and Technical Legal Assistance: Initial Lessons, Policy Research Working Paper No. 1414 (1995)Google Scholar; and World Bank, World Development Report 1996: From Plan to Market (1996)Google Scholar and World Development Report 1997: The Role of the State in a Changing World (1997).Google Scholar

8. European Bank for Reconstruction and Development, Transition Report (1996), p. 101.Google Scholar

9. Department for International Development, Eliminating World Poverty: A Challenge for the 21st Century, White Paper on International Development Presented to Parliament by the Secretary of State for International Development, November 1997, para. 3.27.

10. Athukorala, , “Foreign Direct Investment and Manufacturing for Export in a New Exporting Country: The Case of Sri Lanka” (1995) 18:4 The World Economy, 543, pp.544–548.CrossRefGoogle Scholar

11. Shibata, , World Bank in a Changing World (1995), p.234.Google Scholar

12. World Bank (1997), op. cit. supra n.7, at p.43.

13. Foreign Investment Advisory Service (FIAS), Administrative Barriers at http;// www.fias.net/services/barriers.htm on 31 August 1999.

14. See the work of the FIAS which, for example, assisted Sri Lanka “in the development of a new institutional and procedural framework to attract foreign direct investment,” and “in the preparation of an investment policy and institutional framework for foreign direct investment” in 1991 and 1993: FIAS, op. cit. supra n.13.

15. In the context of the choice between trade, licensing and investment, investors will choose to invest abroad—that is, to undertake transactions within the confines of a single economic unit, where such an “inlernalisation” of transactions results in lower costs than the alternatives of trade or licensing: Coase, , The Firm, the Market and the Law (1988), at pp.6–7Google Scholar and Hood, and Young, , The Economics of Multinational Enterprise (1979), pp.46–54.Google Scholar

16. Coarse, op cit. supra n.15 (1988), pp.6–7. See also Cooter, and Ulen, , Law and Economics (1997), pp.86–87.Google Scholar

17. Sherwood, , Shepherd, and de Sousa, (1994) “Judicial Systems and Economic Performance” 34, The Quarterly Review of Economics and Finance 101–116, pp.101–105CrossRefGoogle Scholar; Commission of the European Communities Directorate General for Economic and Financial Affairs (1993) European Economy: Reports and Studies No.2, 25-38, pp.25–32Google Scholar; Webb, op. cit. supra n.7, at pp.47–48; Shihata, “Preface Good Governance and the Role of Law in Economic Development” in Seidman, Seidman, and Wälde, (Eds) Making Development Work (1999), p.xixGoogle Scholar; Shihata (1995), op. cit. supra n.11, at pp.234 and 590; and Guislan, , The Privatisation Challenge: A Strategic, Legal and Institutional Analysis of International Experience (1997), pp.47–84.Google Scholar

18. World Bank (1996), op. cit. supra n.7, at pp.94–95 and (1997), op. cit. supra n.7, at pp.7–8 and 99–100; Trebilcock, , “What Makes Poor Countries Poor?: The Role of Institutional Capital in Economic Development” in Buscaglia, , Ratliff, and Robert, (Eds) The Law and Economics of Development (1997), p.42Google Scholar; Sherwood et al., op. cit. supra n.17, at pp.104–105 and 113; Stopford et al., op. cit. supra n.2, at p.126; FIAS, op. cit. supra n.13; and UNCTAD (1995), op. cit. supra n.2, at p.277.

19. Flint, , Pritchard, and Chu, , “Constitutional and Legislative Safeguards for FDI: A Comparative Review Utilising Australia and China” in Pritchard (Ed.) Economic Development, Foreign Investment and the Law (1996), p.104Google Scholar; Stopford et al., op. cit. supra n.2, at p.222; and Shihata (1999), op. cit. supra n.17, at pp.xxiii–xxiv.

20. Stopford et al., op. cit supra n.2, at p.222. See also Trebilcock, op. cit. supra n.18, at p.40; Sherwood et al., op. cit. supra n.17, at pp.104–105; and Commission of the European Communities Directorate General for Economic and Financial Affairs, op. cit supra n.17, at pp.25–32.

21. Trebilcock, op. cit. supra n.18, at p.41; Sherwood et al., op. cit. supra n.17, at pp.104–105; Stopford et al., op. cit. supra n.2, at p.126; and Webb, op. cit. supra n.7, at p.48.

22. Tshuma, op. cit. supra n.7, at p.78; FIAS, et al., op. cit. supra n.13; World Bank (1996), op. cit. supra n.7, at pp.93–97 and (1997), op. cit. supra n.7, at pp.8 and 103–106; Trebilcock, op. cit. supra n.18, at pp.30–31 and 41; Root, op. cit. supra n.22, at pp.139–149; Shihata (1999), op. cit. supra n.17, at p.xxii; Stopford et al, op. cit. supra n.2, at pp.126 and 138; Stone, , Levy, and Paredes, , “Public Institutions and Private Transactions: a Comparative Analysis of the Legal and Regulatory Environment for Business Transactions in Brazil and Chile” in Alston, , Eggertsson, and North, (Eds), Empirical Studies in Institutional Change (1996), 95–128, pp.95–98CrossRefGoogle Scholar; Clark, “The Many Meanings of the Rule of Law” in Jayasuriya, (ed.) Law, Capitalism and Power in Asia (1999), p.32Google Scholar; Pistor, and Wellons, , The Role of Law and Legal Institutions in Asian Economic Development 1960–1995 (1999), p.53.Google Scholar

23. World Bank (1996), op. cit supra n.7, at pp.93–97 and (1997), op. cit. supra n.7, at pp.8, 36 and 103–106. The World Bank argues that although predictable corruption (i.e. when the need for, and the results of, corruption are predictable) results in higher levels of investment than unpredictable corruption, it is still true that the highest levels of investment are found in countries where there is the lowest corruption.

24. Shihata (1999), op. cit supra n.17, at p.xviii; and Trebilcock, op. cit supra n.18, at pp.30–31.

25. World Bank (1996), op. cit. supra n.7, at pp.94–95 and (1997), op. cit supra n.7, at pp.7–8; Gray (1998), op. cit. supra n.25, at pp.151–153 and (1999), op. cit. supra n.25, at p.63; Ratliff et al., op. cit. supra n.24, at p.323; Clark, op. cit. supra n.22, at p32; Root, op. cit. supra n.22, at pp.154–155 and Sherwood et al., op. cit. supra n.17, at pp.104–105.

26. Although this assertion is frequently made, commentators rarely take the lime to spell out its theoretical roots in any detail, let alone to prove it empirically.

27. Interview 10. Similarly, Vandevelde acknowledges that the claim that BITs increase general economic prosperity is not supported by empirical evidence, but nonetheless contends that BITs do “reduce risk for foreign investors by stabilizing the legal framework within which the investment will operate”: Vandevelde, , “Investment Liberalization and Economic Development: The Role of Bilateral Investment Treaties” (1998) 36:3 Columbia Journal of Transnational Law 501–527, p.525.Google Scholar

28. See for example, those summarised in UNCTC (1992a), op. cit. supra n.28.

29. Kennedy, , Political Risk Management: International Lending and Investing under Environmental Uncertainty (1987), p.3Google Scholar. See also Stopford et al, op. cit. supra n.2 at p.142.

30. Comeaüx, and Kinsella, , Protection of Foreign Investment under International Law: Legal Aspects of Political Risk (1997), pp.1–2 and 21–22.Google Scholar

31. UNCTC (1992a), op. cit supra n.28, at p.43.

32. See for example a survey of 40 U.K. companies conducted on behalf of the non-governmental organisation World Aware and the Commonwealth Secretariat: Deol, Promoting Investment in the Commonwealth: Survey of Responses from the UK Private Sector (1998).

33. Borner, , Brunetti, and Weder, , Political Credibility and Economic Development (1995)Google Scholar. The study surveyed private sector perceptions of government in 28 developing countries. A further survey by Borner Brunetti and Kisunko of 69 countries was commissioned for the World Development Report 1997, and produced similar results: World Bank (1997), op. cit. supra n.7, at pp.32 and 43.

34. Messick, . “Judicial Reform and Economic Development” (1999) 14:1, The World Bank Research Observer 117–136, p.122.CrossRefGoogle Scholar

35. Klavens, and Zamparutti, , Foreign Direct Investment Participation and Environment in Central and Eastern Europe: A Survey Report for the Environmental Action Programme for Central and Eastern Europe (1995), pp.5–7Google Scholar . The study surveyed 77 firms which had considered investing in Hungary, Poland, and the former Soviet Union.

36. Only 43% of respondents had made a pre-investment investigation into the effectiveness of the legal system before investing in Sri Lanka, while 46% had made no such investigation. Furthermore, of those who had made a pre-investment investigation, more than half indicated that they had relied upon a superficial investigation of the content of laws, rather than the arguably more reliable method of consulting a foreign or local lawyer.

37. This may be either because those investors are not interested in the effectiveness of legal systems, or because those investors have a different understanding of what is an effective legal system. There is reason to doubt the accuracy of the dominant view of development agencies and commentators as to exactly what characteristics make a legal system efficient and predictable. For example, bureaucratic decision making which appears to be unpredictable to an American investor may appear to be perfectly predictable to a Taiwanese investor. This issue is explored further in Perry, “An Ideal Legal System to Attract Foreign Direct Investment? Some Theory and Reality”, American University International Law Review (2000 forthcoming)Google Scholar; and Perry, , “International Economic Organisations and the Modern Law and Development Movement” in ***Seidman, , Seidman, and Wălde, (Eds) Making Development Work: Legislative Reform for Institutional Trans formation and Good Governance (1999) 19–32.Google Scholar

38. Not to mention the differences in how, when and why policymakers would like investors to take account of legal systems.

39. Gray, , False Dawn: The Delusions of Global Capitalism (1998), pp.67–68Google Scholar. Aharoni notes that economic theory offered a good deal of advice as to how investors should decide to invest, but little evidence as to how they do decide to invest: Aharoni, , The Foreign Investment Decision Making Process (1966), pp.8 and 36Google Scholar; and Coase notes that economists have little interest in or understanding of the institutions and individuals who make the choices, so that “the rational utility maximizer of economic theory bears no resemblance to the man on the Clapham bus, or indeed, to any man (or woman) on any bus”: Coase, op. cit. supra n.15 at pp.3–5.

40. Mercuro, and Medema, , Economics and the Law: From Posner to Post Modernism (1997), p.130Google Scholar. See also Langiois, (Ed.) Economics as Process: Essays in the New Institutional Economics (1986), p.174.Google Scholar

41. Cooter, , “The Rule of State Law Versus the Rule-Of-Law State: Economic Analysis of the Legal Foundations of Development” in ***Buscaglia, , Ratliff, and Cooter, (Eds) The Law and Economics of Development, 101-148, p.102Google Scholar; Posner, , Overcoming Law (1995), pp.442–443Google Scholar; and Zacharakis, and Meyer, , “A Lack of Insight: Do Venture Capitalists Really Understand Their Own Decision Process?” (1998) 13 Journal of Business Venturing 57–76, p.58CrossRefGoogle Scholar. However, Aharoni argues that there is a direct and positive correlation between the availability of information, and the willingness of investors to make pre-investment investigations: op. cit. supra n.39, at p.80.

42. Stopford et al., op. cit. supra n.2, at p.142. Knight, , Risk, Uncertainty and Profit (1921), p.199.Google Scholar

43. See for example Gray, , “Reforming Legal Systems in Developing and Transition Countries” in Seidman, , Seidman, and Wälde, (Eds), Making Development Work: Legislative Reform for Institutional Transformation and Good Governance (1999) 61–66, p.62Google Scholar ; Shihata (1995), op. cit. supra n.22, at p.xxi; and Stone et al., op. cit. supra n.22, at pp.95–98 and 116–123. For the use of informal rules, rather than formal laws, see Ellickson, , Order Without Law: How Neighbors Settle Disputes (1991).Google Scholar

44. Macaulay, , “Non-contractual Relations in Business: A Preliminary Study” reprinted in Buckley, and Mitchies, (Eds), firms, Organisations and Contracts (1996), 339–358, pp.344–355.Google Scholar

45. Stone et al., op. cit. supra n.22, at pp.116–123.

46. Gray (1998), op. cit. supra n.25, at pp.169 and 183–185; see also Jones, , “Capitalism, Globalization and Rule of Law: An Alternative Trajectory of Legal Change in China” (1994) 3:1 Social and Legal Studies, 195–221CrossRefGoogle Scholar; Rajbhandary, , “Protecting Trade Secrets through Family Business—A Case Study of Nepal” (1996) 16:4 International Review of Law and Economics, 483–490CrossRefGoogle Scholar; and Winn, , “Relational Practices and the Marginalisation of Law: Informal Financial Practices of Small Businesses in Taiwan” (1994) 28:2 Law and Society Review, 193–231.CrossRefGoogle Scholar

47. Gray (1999), op. cit. supra n.25, at p.62.

48. Miller, , Glen, , Jaspersen, and Karmokolias, , “International Joint Ventures in Developing Countries: Happy Marriages?” (1996) International Finance Corporation Discussion Paper 29Google Scholar. See also Stopford et al., op. cit. supra n.2, at p.93 on alliances between firms.

49. Jayasuriya, , “Introduction: A Framework for Analysis” in Jayasuriya, (ed.) Law, Capitalism and Power in Asia (1999), 1–27 p.10.Google Scholar

50. Pistor et al., op. cit. supra n.22, at p.281. See also on Korea: Gray (1998), op. at. supra n.25, at p.169; on the East Asian “tiger economies”: Root, , Small Countries: Big Lessons: Governance and the Rise of East Asia (1996), pp.170–171Google Scholar; and on the willingness of foreign investors to take advantage of these informal relationships: Stopford et al., op. at. supra n.*, at pp.13 and 135.

51. Kamarul, and Tomasic, , “The Rule of Law and Corporate Insolvency in Six Asian Legal Systems” in Jayasuriya, (Ed.) Law, Capitalism and Power in Asia, 151–172, pp.151–173Google Scholar . See also Pistor et al., op. cit. supra n.22, on the continuing disparity between Asian and Western states with regard to the use of discretionary, rather than rule-based, decision making techniques.

52. See for example Hawkins, who notes that “in pollution control the conditions under which formal intervention is deemed to be morally and organizationally permissible are very narrowly construed indeed”:“Law as a Last Resort” in Baldwin, , Scott, and Hood, (Eds) A Reader on Regulation (1998) 288–306, p.288.CrossRefGoogle Scholar

53. See Campbell, and Picciotto, , “Exploring the Interaction between Law and Economics: the Limits of Formalism” (1998) 18:3 Legal Studies 246–278, p.253Google Scholar on economists' frustrating habit of treating all social arrangements as transaction costs, rather than as arrangements which are “facilitative” of transactions, and without which transactions would not take place.

54. Stone et al., op. cit. supra n.22, at p.104; Messick, op. cit. supra n.34, at p.120, and Tshuma, op. cit, supra n.7, at p.91.

55. FIAS, op. cit. supra n.13. FIAS argues that informal legal systems “can be a particularly strong deterrent for foreign investors who may not be politically connected, operate under strict internal corporate guidelines, or who do not have local partners to take care of a multitude of procedural obstacles and associated payments.” It concludes that states with such legal systems “may lose the ‘good’ foreign investors they all attempt to attract”.

56. Gray (1999), op. cit., supra n.25, at p.62.

57. In fact, the increased emphasis placed by states upon encouraging FDI may result in a corresponding increase in the willingness of states to allow investors to maintain a degree of independence from formal legal systems.

58. However, some authors have made detailed reference to the political economy of multinational enterprise when discussing the effect of the content of laws upon FDI flows. See Muchlinski, , Multinational Enterprises and the Law (1995), Part 1Google Scholar; and Kofele-Kale, , “The Political Economy of Foreign Direct Investment: A Framework for Analysing Investment Laws and Regulations in Developing Countries” (1992) 23 Law Policy and International Business 619.Google Scholar

59. Dunning, , Multinational Enterprises and the Global Economy (1995), pp.57–61.Google Scholar

60. Caves, , Multinational Enterprise and Economic Analysis (1996), pp.37, 46 and 52–53.Google Scholar

61. See Dunning, op. cit. supra n.59. See also UNCTC, (1992a) op. cit. supra n.2; Hood et al., op. cit. supra n.15, at pp.44–47; and Coase, op. at supra n.15, at pp.6–7.

62. Sec n.37 above.

63. Respondents presented a good sectoral representation of priority status companies with foreign investment: in four out of the nine sectors, respondents comprised over 20% of the existing population of such companies; respondents made up at least 10% of the general population in a further three sectors; and two sectors were poorly represented, since there were no respondents from the paper, paper product printing and publishing paper sectors, and only six per cent (2) of the non-metallic and mineral products sector was represented. The respondent firms also mirrored the general population of priority status companies in the characteristics of ownership nationality. In both the sample and the wider population, the most frequently represented nationality of ownership is Sri Lankan, followed by East Asian.

64. Ratliff, and Buscaglia, , “Judicial Reform: Institutionalizing Change in the Americas” in Buscaglia, , Ratliff, and Cooter, (Eds) The Law and Economics of Development (1997) 313–340, p.323.Google Scholar

65. Vandevelde (1998b), op. cit. supra n.27, at p.526.

66. Gray (1999), op. cit. supra n.25, at p.62.

67. Interviews 6, 9, 13, 16, 22, 23, 24, 26, 31 and 32.

68. Athukorala, , “Foreign Direct Investment and Manufacturing for Export in a New Exporting Country The Case of Sri Lanka” (1995) 18:4 The World Economy, 543–564, p.561CrossRefGoogle Scholar

69. Interviews 1, 5, 7, 8, 13, 14, 15, 16, 18, 20, 21, 22, 23, 24, 27, 32 and 34.

70. Interviews 7, 8, 14, 15, 16, 18, 22, 23, 24, 27, 32 and 34.

71. Interviews 1, 5, 8, 13, 15, 16, 18, 20, 21, 22, 23, 24, 26, 32 and 34.

72. Omalu, , NAFTA and the ECT—Compliance with Implementation and Effectiveness of International Investment Agreements (1998).Google Scholar

73. UNCTC (1992a), op. tit. supra n.2, at p.43.

74. Interviews 8, 15, 21, 25, 26 and 32.

75. Landes, (1998) The Wealth and Poverty of Nations, p.524Google Scholar

76. UCTAD (1998), op. cit, supra, n.2, at pp.47–54.

77. See UNCTC (1992a), op. cit. supra n.2, at p.59.

78. Aharoni, op. at. supra n.39, at pp.15, 29–40 and 80. See also Stopford et al., op. cit. supra n.2, at p.142.; and Buckley, , Foreign Direct Investment and Multinational Enterprises (1995), pp.5–6.Google Scholar

79. However donors and recipients of development assistance work within an intensely complex web of agendas—political and economic, national and international. It could be argued that a developing country with an irresponsible leadership might have an incentive to create as much need for development assistance as possible, in order to maximise the amount of foreign currency available for their misuse—but that is another article.

80. Consider the reliance on informality by the private sector in Asia, Africa and Eastern Europe, and by the state in Asia, as outlined in Part II(B) above.

81. Although, if the World Development Report of 1999 is to be believed, the World Bank is about to usher in a new more sophisticated era in development, in which intuition might more readily be set aside in favour of fact: “a deeper understanding of development involves a recognition that sweeping beliefs are often incomplete, that layers of complexity are buried not far beneath the surface, and that wisdom is often contingent on the particular conditions of time and place In any given country, progress depends on a constellation of factors, and on shifts in their configuration that take place over time. What is required is to step beyond the debates over the roles of governments and markets, recognizing that they need to complement each other, and to put to rest claims that any particular policy intervention… is the magic formula that will inspire development in all times and places.” World Bank Word Development Report 1999/2000 (1999), p.2.Google Scholar