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Positive Impact of Investment Agreement and ISDS on Foreign Investment

The United Nations Conference on Trade and Development (UNCTAD) recently released a paper on the relationship between International Investment Agreement (IIA) and Foreign Direct Investment (FDI). The research concludes the followings:

a. The majority of empirical studies found that IIA does have a positive impact on the flow of FDI.

b. IIA plays a complementary role among several factors which may boost FDI, among others economic, political and social stability as well as protection of property rights.

c. The existence of ISDS was associated with a positive impact of IIA on FDI.

The roles of IIA, however, have to be seen within the context. The report notes that since its role is complementary; it cannot substitute for the need of sound domestic policies, regulatory and institutional frameworks. IIA is not an insurance that more FDI will come, if the country’s domestic policies are not favorable and stimulating enough for foreign investors. Similarly, we may not expect that IIA can turn a weak domestic policy into a strong one.

Let’s take renewable energy as an illustration. Investment in renewable energy is of great importance since it is seen as one of the solutions to tackle climate change. Many countries have great potentials for renewable energy, but not all have favorable domestic policy to support its development. It would be hard to imagine that foreign investment will come just because of the fact that a country has an IIA in place; domestic policy is also a necessary prerequisite.

As addressed in the paper, attracting FDI is neither the prime nor the only role of IIAs. Its key role is to contribute to predictability, stability and transparency in investor relation. IIA thus ensures that for example a renewable energy investor can reasonably rely on the laws and regulations currently in place when making the investment,  and also that the investor should be able to rely on permits and contracts with government. This stability allows foreign investors to plan its investment – which in the end will boost investor’s confidence.

The fact that IIA has a positive impact on the flow of FDI opens up opportunities for governments to boost investment in a particular area, such as for example sustainable development. ISDS, in turn, safeguards the implementation of the IIA by providing an efficient enforcement mechanism for the terms of the treaty.