According to a new UNCTAD report, released today, certain requirements placed on foreign investors can play a role in inducing firms to increase exports, provide training and recruit local staff. However, their usefulness depends on a range of factors, and they may actually deter foreign direct investment (FDI). The report shows that the use of performance requirements has declined in both developed and developing countries, reflecting increased competition for FDI and the need to comply with international commitments. Most performance requirements today are imposed as a condition for the provision of incentives. The study suggests that, subject to their existing international commitments, governments could be left free to weigh the benefits and costs of using performance requirements.
In the report, Foreign Direct Investment and Performance Requirements: New Evidence from Selected Countries (1), UNCTAD presents new evidence on the use and impact of performance requirements. Performance requirements are stipulations imposed on investors that require them to meet specified goals as a condition for their entering or expanding in a host country, or for receiving certain advantages.
The study analyses the experience of Chile, India, Malaysia and South Africa as well as that of developed countries. The focus is on requirements related to exports, technology transfer, R&D, employment, domestic ownership and joint ventures, i.e., performance requirements that are not covered by the WTO TRIMs Agreement.
While both developed and developing countries have used performance requirements as part of their development policies, the overall trends are similar in the two groups of countries: the incidence of performance requirements has declined and, to the extent that such policy measures are used, they are normally applied as a condition for the receipt of an incentive.
In developed countries, most traditional performance requirements have been abolished. At the same time, however, new strategic measures have been introduced to influence the behaviour of firms, such as rules of origin and locational incentives.
Although performance requirements are being used less frequently, a number of developing countries continue to view them as tools to enhance the benefits obtained from FDI. The effectiveness of measures has varied, however.
To the extent that mandatory requirements are imposed, they are typically applied to domestic market-seeking and resource-seeking FDI, in which cases host countries have a stronger bargaining power vis-à-vis investors than in export-oriented FDI.
Costs and benefits of requirements vary
The study underlines that countries need to weigh carefully the potential benefits that can be attained from the use of performance requirements against the risk of deterring FDI or of possible negative effects on the quality of the FDI attracted.
The effectiveness of various requirements depends, among other things, on the clarity of objectives, the capability of governments to implement various policies, the absorptive capacity of the workforce and of domestic enterprises, and the extent to which measures are compatible with other policies. Voluntary performance requirements, too, may be effective only when other locational determinants are in place. For example, R&D requirements and incentives may not generate tangible results if the necessary human resources are lacking.
Views diverge on how future agreements at various international levels should address performance requirements. A number of developing countries would like to see greater flexibility in the WTO TRIMs Agreement so as to allow developing countries more freedom to apply measures that are prohibited. Other countries, however, have also prohibited performance requirements that are not prohibited by the TRIMs Agreement in treaties concluded by them.
Thus the treatment of performance requirements in international investment agreements remains controversial, and there is no consensus either on their effectiveness in helping countries to promote development, or conversely on their distorting effects. As long as governments are aware of the possible costs of such requirements, they could be left free to weigh their costs and benefits, subject to existing international commitments.