# 4.5 Investment and Services

The creation of the WTO in 1995 includes new agreements related to investment and services. In this section, we consider these new agreements and discuss economic research utilizing the termsof-trade theory that interprets and evaluates the provisions contained therein.

Foreign direct investment, local content, and international cross-ownership We start with the treatment of investment in the GATT/WTO, with an initial focus on foreign direct investment (FDI). The past two decades have witnessed a signi...cant growth in FDI activity.<sup>87</sup> This growth encourages consideration of the investment measures that host governments may impose and the appropriate treatment of those measures in the GATT/WTO. Investment measures interact with GATT rules when they have direct e¤ects on trade; in particular, local content, export and trade-balancing requirements may distort investment decisions and generate tension with basic GATT rules concerning national treatment and quantitative restrictions.<sup>88</sup> As Trebilcock, Howse and Eliason (2013, Chapter 15) discuss, the WTO Trade-Related Investment Measures Agreement (TRIMs) builds on GATT rules to subject some measures with direct e¤ects on trade, such as local content requirements and quantitative restrictions, to explicit scrutiny under GATT norms. The appeal of additional restrictions on investment measures, however, is controversial, with some countries expressing concerns about the broader implications of extensive investor-protection provisions in trade agreements. Investment has been removed as a topic for further discussion in the WTO Doha Round. A number of investment agreements have arisen, however, via Bilateral Investment Treaties (BITs) and as part of investor-protection provisions in PTAs.

The purpose of restrictions on investment measures in a trade agreement can be developed at several levels. We mention two here.<sup>89</sup> First, in the absence of a trade agreement that imposes restrictions on investment measures, a government might be tempted to impose measures favoring local input suppliers as a means of generating advantageous price changes for its country. Second, a trade agreement that appropriately restricts investment measures may also encourage e¢ ciencyenhancing FDI when the host government is otherwise unable to commit not to expropriate foreign rents once the foreign ...rm has sunk costs. We brie‡y discuss the ...rst purpose next and note that

> 87 FDI may be attractive to ...rms for a variety of reasons. For example, FDI may provide access to cheap inputs, reduce trade costs and facilitate “tari¤ jumping.”FDI also may be advantageous relative to outsourcing as a means of maintaining tighter control over technology. At the same time, ...rms considering FDI confront a variety of possible costs, including the possibility of rent expropriation via government policy changes after sunk costs are incurred. For a survey of research on multinational ...rms, see Antràs and Yeaple (2014).

> 88 Local content requirements concern measures that require foreign-owned ...rms to discriminate between domestic and imported goods that are used as inputs for production in the host country; export requirements concern measures that require exportation of a certain percentage of the foreign-owned ...rm’s output; and trade-balancing requirements concern measures that impose a relationship between what the foreign-owned ...rm is allowed to import into the host country and the value of its exports. In some situations, trade-balancing requirements may be defended under GATT rules if they are necessary to address a balance-of-payment crisis. See Trebilcock, Howse and Eliason (2013, Chapter 15) for further discussion of the implications of GATT rules for the treatment of investment measures.

> 89 Another possible consideration is that restrictions on investment measures may play an e¢ ciency-enhancing role in managing unilateral policies designed to enhance technology spillover. A full analysis of the international externalities associated with such policies requires a comparison of the market-access bene...ts that ...rms may enjoy via FDI with the technological knowledge that they may provide.

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