PERVASIVENESS, USEFULNESS, AND LIMITATIONS OF INVESTMENT CODES

CHAPTER 2: PERVASIVENESS, USEFULNESS, AND LIMITATIONS OF INVESTMENT CODES

This chapter looks at the “universe” of investment codes. 3 How widespread such codes are and why do

Box 11. International Distribution

some countries choose to have an investment code,

of Investment Codes

and others not? What is the usefulness, actual or perceived of investment codes and what are their

Investment codes exist in all types of economies

limitations?

− large and small, industrialized and developing, socialist and market-oriented, and transitional.

Contrary to common belief, investment codes

Pervasiveness (“To Have or Have Not”)

are not a “developing country” phenomenon: Canada, New Zealand, and several EU

Since 1992 the number of countries around the

countries have or until recently had investment

world having national investment codes has

codes.

considerably increased and Box 11 shows the

diversity of countries that had or have investment Investment codes are not reserved to a

particular legal tradition: Common law

codes. The list dispels the often-heard myth that

countries with an investment code include

this instrument is used mainly by developing

Bangladesh, Ghana, Kenya, Malawi, Pakistan,

countries and countries with romano-germanic

Tanzania, and Uganda.

legal tradition.

Civil law (Napoleonic or “romano-germanic” tradition) countries with an investment code 3 The term “investment code” is a general term for a wide

include countries as diverse as Brazil, the range of legislative instruments: foreign company act,

Democratic Republic of Congo, Kazakhstan, foreign investment promotion act, foreign investment

statute, legislation on foreign capital, and others. Because

Senegal, and Turkey.

using all these terms here might be confusing, the handbook limits itself to “investment code” or “investment law/legislation.”

fundamental rights under which investors expect to operate. The legislative vehicle that governments use to effectively introduce and enforce such principles and guarantees in the country is less important.

However, there is an obvious advantage in having one central piece of legislation that specifies which sectors are open to foreign investors, what the entry requirements are, what guarantees investors have, and which public institutions (such as IPIs or one-stop shops [OSS]) they can access for assistance. Box 12 lists additional advantages.

One host-country legislative instrument that foreign investors usually want to review themselves, rather than through a local lawyer, is the investment code (another one is a summary

Countries without investment codes: Is investment unregulated?

France, Singapore, and the United States are interesting examples of countries that do not have an investment code and yet attract large levels of FDI. From the 1950s through the 1970s, Brazil was the leading FDI recipient among developing countries, without having an investment code.

Does it mean that these countries do not regulate foreign investment, that investment is totally free, or that investors have no guarantees?

The answer, of course, is no. In such countries, the guarantees, restrictions, and rules governing investment simply are found elsewhere in the legal framework: in the Constitution; in separate laws and regulations dealing with commercial activity, expropriation, taxation, and foreign exchange; or in laws governing specific sectors (such as

banking, finance, insurance, telecommunications, mining, or tourism). It is therefore important to move away from the notion that “no investment code equates no rule governing investment, no guarantee, or total freedom.”

As stated above, some countries choose to centralize investment-related regulations in a special piece of legislation called an investment code, while others regulate these regulations through various national laws. The fact that the same guarantees or conditions can be as effectively introduced through other laws and regulations actually supports the notion that a key function of investment codes is investment promotion.

Is there any strong advantage of one approach over the other?

In choosing between the two approaches, the government’s principal consideration should be to ensure that the legal framework clearly recognizes and effectively protects the

Box 12. Advantages of Consolidating Investment Regulations into a Code

For government, drafting and adopting one piece of legislation can:

Save time

Save scarce resources*

Be easier to amend than several laws and regulations (when circumstances necessitate revisions)

Be easier to implement

For a prospective investor, finding most of the guarantees and rules applicable to its invest- ment in a single text is much more convenient than having to review a number of disparate laws and regulations to understand how open the country is and to be immediately reassured about the security of investment and property.

*Although it is doubtful that a serious flaw or gap in the overall legal framework can be redressed simply by inserting

a provision or two in the investment code. An expropriation clause in the code is no substitute for a good expropriation act.

of the tax system for businesses). So, if a country Europe. Although investment codes appeared in does not have an investment code, it could, at

that region prior to 1989 (in Hungary and least in theory, miss the opportunity of receiving

Poland), they became pervasive throughout the the interest from this potential foreign investor.

region after the collapse of the communist system. In effect, the new governments used

In addition, from a practical point of view, investment codes to send a clear signal to governments with low capacity and capabilities

investors that there had been a major change in would do better to have a single investment code

policy toward private/foreign investment, and in which government officials can find most of

that they were now “fully open for business” and what they need to know about investment

offering necessary guarantees starting with the regulation in their country.

recognition of private property rights (which most socialist economies did not recognize). The signaling function of investment codes is not to

be underestimated and has been extensively used

Usefulness

by many developing countries including in Africa, Asia, and Latin America, following

Developing an investment code has been popular important changes in economic policies. 4 for some time and shows no sign of abating. One

successful example is Turkey (see the case study in Investment codes are obviously also a legal tool Appendix 2).

that may augment legal security and trans- parency, by providing the fundamental guaran-

Clearly, the policymakers and nations that have tees that investors expect, by correcting gaps or adopted an investment code must see the benefit

inconsistencies in the legal framework, and by of such a tool.

clearly stating the entry requirements and sectoral restrictions that exist in the country.

Why do countries choose to have an investment code?

By informing potential investors of the conditions to invest in the country, as well as of

Investment codes serve two key purposes: the guarantees that they will receive, investment codes, if enforceable, can provide investors with

1. They help to implement government policy the comfort they seek when investing in a foreign on private investment (domestic or foreign).

jurisdiction, particularly a developing economy. They translate policy into legislative

This is why we often take the view that the language, and embed it in a normative

investment code is not “just” a legal tool but also instrument that has the force of law.

a potentially important promotional tool that Administrative agencies can then apply the

can support the government’s effort to attract instrument, and parties can use it in a court

more private investment, particularly FDI. of law or arbitration proceedings.

Box 13 summarizes the various purposes that

2. They also are an important tool for

investment codes serve.

supporting investment generation. As we have shown, investment codes can serve

As a policy implementation instrument, invest- several purposes. However, they are not a ment codes have been particularly useful in

countries that have undergone a radical change in economic orientation, notably the former

4 On the “signaling” function of investment codes in

command economies of Central and Eastern

transition economies see Gray and Jarosz (1995).

Box 13. Purposes of Investment Codes

1. An investment law:

It is an instrument of policy implementation

n is an instrument of policy implementation in terms of: a. the role of the private sector in the economic development.

b. industrial policy (that is, which sectors to favor or not and for

whom). c. the role of FDI in economic development.

n contributes to setting up or clarifying rights and obligations of inves- tors, of the host government and its administrative agencies, and of

other investment stakeholders. n is a vehicle to strengthen the rule of law in this field of paramount

economic importance. n deals with institutions related to investments, and their operations and

impact. n establishes a governmental framework for the protection and

promotion of investment, which is an essential ingredient of economic development.

2. Promotion starts with informing potential and existing investors, and the

It is a tool for investment

code certainly contributes to this. But an investment code can also help to

promotion and investment improve the country’s investment climate through a reduction of legal and

climate reform

institutional barriers to private investments. The establishment of a stable and consistent framework is in itself an incentive and a signal to investors, and a mean to expand domestic enterprise and access international investment markets.

3. A peculiar feature of most investment operations, compared with trade

It provides security to

transactions, is their duration. Because their timeframe is much longer,

private investments

investors look for a stable and predictable legal framework and for institutions with authority over their investments. Investors value the legal security provided by investment legislation, and this influences their investment decisions.

4. Faced with the complexities and uncertainties of many national legal

It enhances transparency

systems, investors look for a single piece of legislation that brings

in investment operations

consistency and homogeneity to the legal framework covering their

contributing to good

investments, instead of myriad legal provisions and administrative

governance

rulings. Transparency implies that all relevant legislative and regulatory provisions have been published and that they are made easily available in a comprehensive form to interested investors.

Source: IC research Source: IC research

costs. To foster the development of a good investment climate, those factors need to be addressed in conjunction with the invest- ment code to form a coherent system attrac- Limitations tive to potential investors, domestic and foreign. Obviously, each investor will have a

There are limits to what even the best investment different view on the relative importance for code can achieve.

their business of these different dimensions of the investment climate, but, generally

First limitation: An investment code does speaking, they are all important factors and not constitute the entire legal and regulatory

need to be addressed to establish an attractive framework applicable to economic activities.

business environment. Investors, foreign or domestic, are subject to

all the laws and regulations of the country of investment. If such laws are overly restrictive of private business, even a well-written

Box 14. Usefulness and Limits of

investment code will not produce an environment conducive to investment.

Investment Codes

Second limitation: Investment legislation

Investment codes are useful in the following ways:

must be well implemented and enforced.

As the chief instrument to implement

While well-crafted legislation is essential to

government policy on investment

implementation and enforcement, the

As a binding legal tool for security and

legislation is worthless if administrative

predictability that investors can invoke in court or arbitration proceedings