WORLD TRADE
ORGANIZATIONWT/WGTI/W/154
7 April 2003
(03-1901)
Working Group on the Relationship
between Trade and InvestmentOriginal:  English
COMMUNICATION FROM THE EUROPEAN COMMUNITY
AND ITS MEMBER STATES
The following communication, dated 3 April 2003, has been received from the Permanent
Delegation of the European Commission.
_______________
CONCEPT PAPER ON POLICY SPACE FOR DEVELOPMENT
1. The Doha Declaration states in paragraph 22 that any future investment framework "should
reflect in a balanced manner the interests of home and host countries, and take due account of thedevelopment policies and objectives of host governments as well as their right to regulate in the
public interest". This paper addresses some of the concerns expressed in this working group regarding
the need of host countries, and in particular of developing countries, to preserve policy space for the
purpose of regulating in the public interest and for development purposes.
2. The EC fully supports the view that developing countries should maintain their right and their
policy space to pursue their policies and that no international agreement should prevent them fromdoing so. Following the previous EC paper on the "I mpact of international investment rules on current
national policies" that we presented in June 2000
1, we would like to deepen the discussion about the
right to regulate of host countries and the possible impact that a multilateral "Investment for
Development Framework" (IDF) would have on the policies of developing countries in particular.
During the last 4 meetings of the Working Group on the Relationship between Trade and Investment(WGTI) some options for investment rules that would allow policy flexibility have been presented
and discussed. However, some members still fear  that any investment framework would prevent
developing countries from pursuing particular policies. We feel that the time has come to try to clarify
and substantiate these statements. In particular, it would be useful to start by giving concrete examples
of the policies that have been brought forward as impeded by the possible rules that have beenproposed in the WGTI by several members. This paper aims at giving a concrete contribution to this
debate.
3. In the last part of this paper we also comment briefly on the argument that has been put
forward a few times in this group according to  which FDI produces a "crowding-out" effect on
domestic investment. Although this argument is not directly linked to the negotiation of an IDF, itseems to us that it has been used consistently to imply that an investment framework would increase
the supposed negative effect that FDI can produce on host countries. First, we have found no evidence
in real life that there is any "crowding-out effe ct" problem caused by FDI. Second, we do not see how
an IDF would amplify any such feared negative effect caused by FDI in host countries.
                                                     
1Communication from the European Community and its Member States WT/WGTI/W/84 of
16 June 2000.WT/WGTI/W/154
Page 2
I. WOULD A MULTILATERAL FRAMEWORK RESTRICT "POLICY SPACE" FOR
DEVELOPMENT?
4. A few members have often referred2 to the flexibility (and thus, potential benefits) that
bilateral investment agreements provide to their economies as opposed to the believed inflexibility
(and implied damages) that multilateral investment rules would impose on their policy space. This
striking difference is not corroborated by any evidence, as far as we know. The only explanation
given was that in most bilateral investment treaties concluded by these countries "national treatment
and MFN treatment were accorded with respect to the post-establishment phase once investments had
been admitted in accordance with the applicable policy framework", and that "bilateral investment
treaties provided protection of foreign investment and did not deal with market access issues".3
5. One could conclude from the above that, according to these members, their policy spacewould be impeded mainly by pre-establishment rules. This will be the main focus of this paper.
6. We should also ask ourselves: what are host country development objectives? Are they
universal or do they differ from country to country?  Some of them, such as generation ofemployment and income growth, seem to be universa l. We also know that some policies are applied
specifically by some countries to develop particular regions, or to protect minority groups, or to
promote local small and medium enterprises. Some of these policies are pursued through positive
discrimination in favour of these regions, groups or sectors. It has also been argued by some
developing countries that mandatory performance requirements imposed on foreign investors areessential policy tools for development.
7. We believe that the intended objectives of these instruments are better achieved through
means other than performance requirements.
4 Backward linkages and technology transfer through
foreign investment depend mainly on the absorption capacity of the host country. For instance,governments can maximise backward linkages and technology transfers by providing better domestic
skills, capabilities, supplier networks and infrastructure.
5 Having said this, the point is whether a
multilateral framework would prevent countries from using these instruments or not. In particular, we
should analyse whether pre-establishment rules would prevent the use of these policies, in light of the
fact that BITs, most of which do not include pre-establishment rules, are regularly concluded by many
developing countries.
1. Some concrete examples
8. Paragraph 22 of the Doha Declaration refers to "pre-establishment commitments based on a
GATS-type, positive list approach", among the issues to be addressed by this working group in the
period until the next ministerial conference. Thus, assuming that a future multilateral framework
would include pre-establishment rules based on a GATS-type, positive list approach, woulddeveloping countries be prevented from pursuing their general or specific policies?
9. Under the GATS-type approach, members first decide, for each sector, whether to take
commitments or not. If a member decides not to take any commitment in a given sector, it remains
free to be as open or as closed to foreign investment as it chooses, at any given time. If it decides totake commitments in a given sector, then the member may include in its schedule of commitments
                                                     
2 See for instance statements in WT/WGTI/M/8 paras. 47-49, and WT/WGTI/M/18, para. 74.
3 Ibid.
4 See EC statement in WT/WGTI/M/19, para. 65.
5 See UNCTAD World Investment Report 1999: Foreign Direct Investment and the Challenge of
Development.WT/WGTI/W/154
Page 3
limitations to National Treatment (NT) and Market Access (MA). The limitations to the NT principle
and MA can also be included as horizontal commitments, which means that they may apply to all
sectors of the economy, and not just to one specific sector. Even after taking commitments, a member
may still modify or withdraw any commitment in it s schedule, provided it follows certain procedures6.
Indeed, this may not always be straightforward in practice, but WTO members will be able to drawlessons from the GATS experience. Under this system, each member has to strike its own balance
between providing certainty (thus, increasing the possibilities of attracting FDI) and retaining
flexibility. The following examples show how certain  specific policies can be dealt with under the
GATS-type approach.
A. P
OLICIES AIMED AT INCREASING EMPLOYMENT
10. Employment-generation is an objective that mo st countries wish to pursue throughout their
economy. The different policies adopted by governments to maximise employment generation
through investment may vary. UNCTAD lists7 the following among the policy tools to generate
employment: (1) measures to attract FDI in ge neral (improving the regulatory framework;
liberalisation; targeted promotion;  (2) targeting specific employment-intensive industries or
promoting FDI in specific regions through incentives;  (3) fiscal incentives linked to employmentgeneration;  (4) industrial parks or export processing zones.
11. In addition, the following have been listed as policies to upgrade employment and skills,
particularly in developing countries:  (1) use of official development assistance to implement training
programmes;  (2) promotion of public-private training partnerships by granting tax deductions andsubsidising training costs.
12. The above policies are generally applied in a non-discriminatory way and do not restrict
market access. To the extent that these conditions are fulfilled, these policies would not even need to
be listed as limitations to NT and MA in the schedule of commitments of the member that appliesthem. However, even if a country decided to discriminate in favour of its own domestic enterprises,
for instance by providing them with special tax exem ptions, it would not be required to remove these
advantages under the GATS-type approach. If the country wished to have the possibility to offer such
fiscal advantages for its domestic enterprises it could include them as horizontal limitations to NT if
they applied to the whole economy, or it could include them as sector-specific limitations to NT if
they were limited to specific areas of activity.
B. P
OLICIES DESIGNED TO GENERATE AND TRANSFER TECHNOLOGY
13. Technology transfer from FDI is maximised when the host country provides local capacity to
absorb it. Some countries try to encourage domestic companies to develop indigenous technology by
providing them with a protected domestic market in which FDI is restricted or completely prohibited.
Others require foreign investors to establish partnerships with local partners through joint ventures, asa condition for their access to the market. Although most countries have realised that these policies do
not work
8 and are gradually removing them, some may still wish to maintain these restrictions or
conditions to FDI.
                                                     
6 GATS Article XXI.
7 UNCTAD, World Investment Report 1999, p. 278.
8 As demonstrated by empirical research. Cfr. T. H. Moran, Parental Supervision: The New Paradigm
for Foreign Direct Investment and Development , Institute for International Economics, 2001; S. Urata and H.
Kawai, Intrafirm Technology Transfer by Japanese Manufacturing Firms in Asia , The role of Foreign Direct
Investment in East Asian Economic Development, eds. Takatoshi Ito and Anne O. Krueger, 2000; International
Finance Corporation and Foreign Investment Advisory Service, Foreign Direct Investment: Lessons ofWT/WGTI/W/154
Page 4
14. Would the GATS-style approach prevent them from maintaining these instruments? No. They
could either keep a sector "unbound" from NT or they could include specific limitations on MA such
as joint venture requirements or other technology transfer requirements, insofar as they constitute
market access restrictions.
15. Market-friendly measures aimed at promot ing technology transfer, such as providing
incentives for specific high technology industries, if applied in a non-discriminatory manner would
not even need to be included as limitations to NT or MA in the schedule of commitments.
C. POLICIES AIMED AT PROTECTING MINORITIES
16. Some governments grant specific advantages to ethnic or linguistic minorities, in terms of
preferential treatment such as positive discrimination. Whatever the reasons are for adopting such
policies (protection of diversity, cultural heritage, improving social conditions, equal opportunities,
etc.), the question is whether they could be maintained or not under a GATS-type approach.
17. The GATS experience clearly shows that these policies could perfectly be included as
limitations to NT in any given country’s schedule of commitments. Thus, it seems safe to conclude
that these policies that address particularly sensitive concerns could also be preserved without
interference, in the presence of pre-establishment rules based on a GATS-type approach.
D. OTHER HOST COUNTRY POLICIES
18. A country might wish, for some reason, to completely exclude FDI in certain sensitive
sectors. Would the GATS-style approach prevent the host country from doing so?  Again, the answer
is no. The GATS shows that a number of developing  countries have kept "unbound" some sectors of
their economy. This does not necessarily mean that th ey are completely closed to FDI in those sectors,
but simply, that they remain free to take all the measures they wish on those sectors, whenever theylike, even if the measures are not in conformity  with NT and MA, subject to MFN and transparency
principles.
19. It has been said in this working group that "D eveloping countries needed to retain the ability
to screen and channel foreign investment in accordance with their domestic interests and priorities"
9.
We would like to know from those members that have implied that this ability to screen foreign
investment would be impeded by any pre-establishment rule, if the GATS has prevented them fromscreening foreign investment in the services sectors. In our view the answer is no. One of our
examples (D) in the annex shows that it is possible for members to include, in their schedule of
commitments, the right to screen the entry of foreign investors.
II. WOULD A MULTILATERAL FRAMEWORK REALLY INCREASE THE
"CROWDING-OUT" EFFECT ON DOMESTIC INVESTMENT ?
20. Some members brought into debate a fear th at FDI can produce a "crowding-out" effect on
domestic investment. Some have argued that, if this is so, an investment framework should not be
negotiated since the crowding-out effect would be further enhanced, damaging first and foremostdeveloping countries. We would like to briefly reflect on this assumption.
                                                                                                                                                                    
Experience, No 5,  World Bank Group, 1997; A. Kokko and M. Blomstrom, Policies to Encourage Inflows of
Technology Through Foreign Multinationals, World Development 23, no. 3 (March) 1995.
9 See WT/WGTI/M/18, paras. 74 and 137.WT/WGTI/W/154
Page 5
21. The first question to be asked is: does FDI really "crowd-out" domestic investment?
Supposing it does, is the host country really affected negatively? We have not seen any compelling
evidence supporting this view.10  In our view, foreign investment would actually displace domestic
investment if the two were perfect substitutes. Even in this case, the total output in the host country is
likely to remain unchanged. If FDI and domestic in vestment were complementary, there would be a
growth in total investment and output in the host country.11  FDI would "crowd out" in cases where it
outcompeted domestic investments, although the latter could find better investment opportunities in
other areas of the economy. Some may still argue, following the "infant industry" argument, that FDI
may, in a specific sector, establish all the capacity that can be sustained by the available market, and
that this would in consequence crowd out domestic investments, even if these potential investments
would also have had over time a potential comparative advantage. Even in this specific case, it is
acknowledged that FDI tends to stimulate competition and promote domestic investments.
22. Leaving this aside, what can definitely be observed today is that almost every country in the
world is striving to attract FDI and devoting incr easing resources to investment promotion. This is
also reflected in the Trade Policy Review Mechanism, in which most WTO members are eager to
show the openness of their investment regime to FDI. Thus, it is not plausible to conclude that mostcountries in the world would be wrong in trying to attract FDI as they do not realise that their
companies risk being crowded out by foreign investors.
23. Even admitting that FDI crowds-out domestic investment, the second question to be asked is:
what would be the impact of a multilateral framework on this? There are 2 alternative possibilities.Either:  (1) a multilateral framework would enhance FDI flows, thus, allegedly increasing the risk of
crowding-out domestic investment; or (2) a multila teral framework would not significantly increase
FDI flows, hence with no impact on the "crowding-out" effect. What cannot be said is that, at the
same time, a multilateral framework will increase the risk of "crowding out" domestic investment but
it will not increase FDI flow s for developing countries.
24. In any case, one of the merits of the GATS-type approach is that it would allow those
members that were willing to take, on a sector-by-sector basis, pre-establishment commitments,
allowing the entry of foreign investors and perhaps at risk of "crowding out" their domestic
investment, to do so only of they wished. Others, who would prefer not to risk the crowding-out effect
in certain sectors or even in the whole economy, could simply keep those sectors or their whole
economy "unbound", or, in other words, free from FDI. It would be a choice left to each government.Their policy space would be preserved.
III. CONCLUSION
25. All countries have legitimate reasons for preserving their right to regulate the activities of
domestic and foreign investors. The reasons may be different: development objectives, protection ofenvironment and health standards and other public interests. Some countries may not make any
difference in their regulations between domestic and foreign operators while others might wish to
                                                     
10 See for instance: UNCTAD WIR 1999; OECD, "Foreign Direct Investment for Development,
Maximising Benefits, Minimising Costs", 2002; Saggi, Kamal. "Trade, Foreign Direct Investment, and
International Technology Transfer." World Bank, May 2000; Sharma, Kishor, "Export Growth in India: Has
FDI Played a Role?", Economic Growth Center at Yale University, July 2000; B. Smarzynska, "Does ForeignDirect Investment Increase the Productivity of Domestic  Firms? In Search of Spillovers through Backward
Linkages", World Bank working paper, 2002.
11 For instance, according to the World Bank working paper " Trade, Growth, and Poverty ", by
D. Dollar and A. Kraay (2001), a one percentage point increase in FDI inflows as a share of GDP would result
in a positive effect on average incomes over the course of a decade of around 10 per cent.WT/WGTI/W/154
Page 6
differentiate the treatment and conditions in which national and foreign companies operate within
their territory.
26. We wish to emphasise that an Investment for Development Framework can and indeed must
be shaped in a way not to inhibit any country’s policy space for development or, in general its right toregulate. The purpose of this paper is to try to move this fundamental debate towards a more concrete
level, rather than continuing an abstract discus sion between those who maintain that any investment
rule would undermine their policy space and those who reply that this would not be true. We look
forward to addressing in an open-minded way any other examples that other members may provide, in
order to move this debate forward. In particular we would welcome the possibility of discussing any
specific development policy or programme that some countries feel might be threatened by an
investment framework.
27. As for the possible "crowding out" effect of FDI on domestic enterprises, we are not
persuaded that it would be enhanced by an Investment for Development Framework. Having said this,
we are willing to further discuss and deepen the analysis of the "crowding out" effect and on its
possible relation with a future investment framework. This framework, as we see it, should leave eachcountry free to strike its own balance between an appropriate policy space required to pursue national
development objectives with an appropriate stable, predictable and transparent FDI framework
through which firms are encouraged to operate. This balance can be reflected in each country’s
schedule of commitments.WT/WGTI/W/154
Page 7
ANNEX
Examples of pre-establishment commitments in a GATS-type approach
The following examples are deliberately extreme and do not necessarily represent realistic
scenarios. They have been made only for explanatory reasons.
A. Example of a country that wishes to maintain policies aimed at generating employment in
domestic enterprises, in sector A
Commitments Limitations on market access Limitations on national
treatment
Horizontal commitments(on all sectors)
Sector A Unbound for all existing
subsidies to domestic
enterprises, for the purpose
of upgrading the level of
workers’ skills
Sector B
Sector C
B. Example of a country that wishes to maintain measures requiring foreign investors to adopt
specific types of legal entities, in sector B
Commitments Limitations on market access Limitations on national
treatment
Horizontal commitments(on all sectors)
Sector A
Sector B Foreign investors can only
operate through jointventures, in which they shall
not own more than 50% of
the capital .
Sector C
C. Example of a country that wishes to maintain preferences for a specific minority group
without extending them to foreign investors, on all sectors
Commitments Limitations on market access Limitations on national
treatment
Horizontal commitments(on all sectors)Unbound for special
preferences granted to
"special minority" personsor companies.
Sector A
Sector B
Sector CWT/WGTI/W/154
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D. Example of a country that wishes to maintain its right to screen the entry of foreign investors
in sector C
Commitments Limitations on market access Limitations on national
treatment
Horizontal commitments(on all sectors)
Sector A
Sector B
Sector C Prior approval by the State
authority is required for the
establishment of new
companies or the acquisitionof existing local companies.
__________