# **4.2.3 Governance quality**

Policy makers frequently focus on attracting FDI through various investment incentives, eliminating red tape affecting establishment, and proactive investment promotion. While these aspects are important, evidence gathered from recent WBG surveys suggests that investors are more concerned with irregular government conduct affecting their possibility to maintain and expand their operations in the host country (Echandi, 2019). Such an observation is consistent with recent empirical research suggesting that the bulk of trade costs for services relate to the governance performance of a host country. Indeed, van der Marel and Shepherd (2019) show that the strongest cost variable explaining services trade is captured by governance indicators. Such findings confirm that enhanced regulatory transparency and certainty matter for trade and investment facilitation in services.

A recent WBG research project found that investors - including service suppliers operating through a commercial presence, ranked regulatory risks – i.e. risks deriving from irregular or erratic government conduct - at the very top of the constraints affecting their operations in developing economies.<sup>40</sup> More than 75% of investors faced problems relating to government conduct in developing countries (GIC, 2017). Although most of the reported problems do not escalate into full-fledged grievances triggering investorstate litigation, the impact of unresolved grievances deriving from government conduct can generate significant adverse reputational effects for host countries.

Investor surveys conducted annually between 2009 and 2013 and again in 2017 have shown consistently that more than 25% of investors have withdrawn or canceled FDI expansion projects due to irregular government conduct (MIGA, 2009-13; GIC, 2017). Combining that figure with UNCTAD’s data on the value and number of net-cross border M&A and announced greenfield FDI projects for each survey’s corresponding period, a conservative estimate suggests that, focusing solely on trade in services through commercial presence in 70 developing countries where surveyed investors had operations, irregular government conduct lies behind decisions to withdraw or cancel expansion plans in up to 900 FDI projects a year valued at approximately US$65 billion.<sup>41</sup> The most common source of irregular governmental conduct generating investor-state conflicts relates to administrative actions, including by sub-national and specialized regulatory agencies. Up to the 1970s, expropriations used to be the most prominent and impactful source of irregular government conduct generating investor-state conflicts (MIGA 2009). Although perceived unlawful expropriations still rank among the leading types of irregular governmental conduct prompting FDI project discontinuation, the most common source of conflict today relates to a lack of transparency and predictability in dealing with public agencies and sudden/arbitrary changes in the enactment or interpretation of laws and regulations with negative effects on companies. This is followed by issues relating to payments and transfers and restrictions on currency convertibility. Although less frequent, contract breaches and expropriations perceived as unlawful constitute the most impactful types of irregular governmental conduct, leading between a third and half of investors to totally withdraw and/or cancel project expansions in 2017 (MIGA, 2009/13, GIC 2017; see Figure 12).

WBG research has revealed growing tensions between the single state paradigm at the core of domestic and international legal systems on the one hand, and the multilayered agency composition of

> 41 Authors’ calculations based on data from WBG (2019).

40 See WBG (2019).

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