Foreign direct investment and legal constraints on domestic environmental policies: Striking a "resonable" balance between stability and change

Law and Policy in International Business, Summer 1998 by Verhoosel, Gaetan

GAETAN VERHOOSEL*

I. INTRODUCTION

The interplay between foreign direct investment (FDI) and sustainable development is increasingly becoming the object of research and debate.1 Pursuant to the explosive growth of FDI in recent years,2 and the rising share of developing and transition economies in total FDI flows,3 the impact of FDI on the local and global environment has been examined in terms of both the risks and opportunities involved. Whereas the debate on "migrating industries" and "pollution havens" has attracted much public attention during the eighties and early nineties,4 more recent work has focused on the positive contribution which private direct investment can make towards ensuring sustainable development in developing and transition economies.5

Apart from generally promoting higher incomes, which possibly leads to higher levels of investment in pollution prevention and control facilities in developing and transition economies,6 FDI constitutes, more specifically, an important vector for the transfer of environmentally sound technologies (EST) transfer to those countries.7 For FDI to be an effective vehicle of EST transfer, however, a legal framework needs to be in place in developing and transition economies to stimulate both offer and demand for ESTs. On the one hand, these countries should stimulate the creation of a favorable investment environment for EST transfer.8 This implies that they should not only try to make foreign investment conditions more attractive in general9the nineties have already seen a global trend toward unilateral investment liberalization"--but also that their foreign investment legislation should be conducive to the influx of ESTs in particular.ll On the other hand, these countries should progressively develop and implement more stringent environmental legislation in order to strengthen the demand side.12

However, specific legal problems may arise from the attempt to stabilize investment conditions and upgrade environmental protection standards. While stricter environmental standards as such are not likely to deter multinational enterprises (MNEs) from investment,ls uncertainty regarding changes in regulatory frameworks will. Given the high capital risk and input often involved in foreign direct investment projects, the economic, political and regulatory stability of the host country is extremely important for attracting new investors. Over the last few years, therefore, a rapidly growing corpus juris14 of bilateral investment treaties (BITs) and multilateral investment treaties (MITs) aims at facilitating foreign investment in developing and transition economies by inserting stabilization techniques. Likewise, international investment agreements, such as those concerning the exploration or exploitation of natural resources, have included so-called "stabilization" or "freezing" clauses since the 1960s. More recently, a number of national investment codes have also included stability provisions. All these legal instruments have the common goal of "immunizing" MNEs against the impact of possible changes in domestic policies, such as fiscal treatment, repatriation of assets, and other state actions that were considered a traditional part of the political risks of investment.

Environmental regulation in developing and transition economies is currently one of the most unpredictable factors facing potential investors.l5 Not only has environmental legislation in those countries changed rapidly and frequently in the last decade, it has also had a considerable interpretative margin and been enforced with varying degrees of zeal.16 Environmental measures that were not anticipated when the investment decision was made may threaten the profitability or even the viability of an investment project.lv Therefore, for FDI to be an effective vehicle for EST transfer, environmental regulations in the host country must be at least predictable.l8 The fundamental question then arises of how the potential conflict between the concern for stability and the need to strengthen environmental regulation can be solved in legal terms, keeping in mind the essential interest in FDI for EST transfer.

This Article will begin by considering two situations in turn. In the first situation, environmental regulatory change clashes with some kind of stabilization technique-contractual, legislative, or treaty-based. In the second situation, the environmental regulatory change is such that it threatens the economic viability of the investment project. In this case, regardless of the applicability of some stabilization techniques, the extent to which such regulatory change may amount to an "environmental taking" must be examined and if so, whether compensation for expropriation may be due. Part IV will offer reflections on the ongoing and very lively debate regarding some of these issues in the framework of the OECD-sponsored negotiations on a Multilateral Agreement on Investment (MAI). The conclusion will consider means of reconciling the conflicting interests in investment stability and environmental regulatory change for the benefit of enhanced EST transfer and overseas sustainable development.