Much has been written about the resignation of India’s former RBI governor Urjit Patel. He disagreed with the Modi government on monetary policy and the handling of non-performing assets at state-run banks before quitting his post.
As The Economist noted, the main argument “is the stuff of economics textbooks”. The government wants lower interest rates and a greater share of the Bank’s surplus reserves. This would presumably increase money supply, increase investment in social policies, encourage economic growth, and lead to a boom in the near future. What could be wrong with that?
Not much if you are a government soon-to-be facing tough elections. But as the previously referenced economics textbooks tell us, it would also likely stoke inflation and require a hike in interest rates in the future to meet the target inflation. So, should we take the short-term win or play the long-term game?
Another sticking point in the ongoing RBI v Modi-government saga is how to deal with the non-performing assets of public sector banks. While the RBI proposes tough measures to clean up the banking sector, the government prioritizes continued lending to spur consumer spending and corporate investment.
As with any organization, public or private, the government in power has to balance multiple objectives. But any government faces a “credible-commitment” problem. That is, their decisions may be driven by short-term incentives (such as electoral gains) that undermine long-term policy goals. To combat this issue, one solution is to transfer the decision-making power on certain issues out of the government’s hands and to an independent regulator – an entity established by statute to use legal tools to achieve policy objectives. This entity is supposed to balance the interests of the various stakeholders – governments, users and consumers, and corporate investors. Governments can provide their input to the regulator; but their preferences would have the same weight as those of other stakeholders. Because the objectives of the regulator are not necessarily the same as those of the government in power, they can resist pressures to adopt short-term policies at the expense of long-term policy objectives. And because their mandates are not tied to the electoral cycle, they do not respond to electoral pressures. Problem solved!
At least that is the theory. Around the world, there are a number of regulators in a wide-ranging set of issues, including electricity, airlines, banking, industry, etc. However, the operative word is independent. Regulators will only be effective if they are not unduly pressured by political actors, have the capacity to take and implement decisions, can attract and retain well-qualified board and agency heads, and have the requisite funding. And this is a hard thing to achieve in practice.
Hence the concerns raised by several commentators about the appointment of Mr Shaktikanta Das as Mr Patel’s replacement. He is generally viewed as being more responsive to government’s interests, but less likely to uphold independent policy decisions.
A similar issue is playing out in the US. Over the last couple of days, President Trump has turned up his criticism of the Chairman of the Federal Reserve as the said Chairman raised the benchmark interest rate for the fifth consecutive quarter. Press reports indicate that President Trump was so unhappy with the rate hike that he considered firing the Fed Chair – although it is not clear that he has the power to do so.
The governments may well be right in pushing for their agendas. Time will tell how the Indian or the US regulators respond to political pressures. But in the meantime, it is worth considering – as a recent OECD study reports – that the balance between due and undue influence is the central challenge of independent regulators.
The Belt and Road Initiative has lately been met with growing skepticism in some countries, as concerns about debt sustainability have emerged. A recent set-back is in Malaysia, where the newly elected government cancelled the construction of a major railway link between its east and west coasts. It was reported that the project owner – Malaysia Rail Link (MRL) – sent a letter to China Communications Construction Company (CCCC) suspending all work on the project. Not surprisingly, CCCC responded that it regretted the suspension and was upset and concerned about the project and its staff. Crucially, in announcing the project cancellation, the Malaysian government noted that several key details – including compensation – have to be worked out. Resolving compensation issues in a project as large and complex as this one would be difficult in general. In this case, it may be further complicated by the fact that CCCC is a Chinese state-owned company. And given the political significance of the project (and its cancellation), these challenges may impact the bilateral relationship between the two governments.
China, for its part, has foreseen the possibility of such disputes. Earlier this year, they announced plans to establish international courts in China to address trade and investment disputes in the Belt and Road projects. Notwithstanding skeptics’ fears of bias, Beijing promises that the courts will be “lean, clean, and green”.
One motivation for promoting such a legal structure might be the idea that these disputes should be treated as commercial conflicts, and not disputes that drag governments and political objectives into the mix. And the Chinese courts would be in good company to make such claims. The World Bank’s division dealing with investment disputes (ICSID), the United States Trade Representative (USTR), and others have long argued that an option that gives affected companies a legal alternative to resolve a dispute with a foreign government will mean that they don’t have to call on their home governments to intervene diplomatically in foreign countries, thus preventing a state-to-state conflict. Political motivations and foreign policy objectives will not have to be dragged into a commercial dispute. In other words, this would bring the dispute from the realm of politics into the realm of law.
While this line of reasoning certainly has a long history, there is little empirical evidence that home governments will refrain from representing the interests of affected companies in foreign markets. A new study in the journal World Development with my co-authors Geoffrey Gertz and Lauge Poulsen tested this assumption. Although we focus on US investors’ disputes with foreign governments during the late 1990s and 2000s (rather than the current Chinese disputes), the findings are striking. The data show that in our sample the United States government often involves itself in foreign investment disputes with different types of diplomatic efforts. Importantly, a company’s access to a legal dispute settlement option (through treaty-based investor-state arbitration) has no effecton the likelihood of diplomatic intervention. The US government is just as likely to intervene diplomatically when firms have access to a legal alternative as when they don’t. To put it another way, we find no empirical support that legal alternatives “de-politicize” investment disputes.
What does this mean for the current BRI disputes? The new courts may yet prove to be independent and fast. But don’t wait for Chinese companies – especially state-owned entities – to rush there at the first sign of trouble in foreign countries. Nor is it likely that the Chinese government will push firms to pursue a legal remedy if the dispute can be leveraged to gain a strategic, political, or foreign policy advantage.
Stateless companies, metanationals, or denationalized firms are all terms that have been used in the past two decades to denote a new type of global firm (see The Economist, Foreign Policy, Quartz, and Financial Times). One that is not bounded by its geography. A firm that is headquartered in one country, has its top management team in another, financial assets in a third, and employees in several others. Allegiance to or even affiliation with a political state is considered unnecessary, and even a distinct disadvantage. Some of the largest firms – GE, ExxonMobil, Amazon, Alibaba – are increasingly being seen as more powerful than many nation states. Tax considerations have led Facebook and Google to base their European arms in Ireland, and Pfizer to consider merging with Allergan (and incorporate itself in the low-tax country).
Recent events, however, seem to have brought that narrative to a screeching halt. Corporate nationality is back, whether by design or default. No longer can firms deny or overlook their nationality. Indeed, being blasé about corporate nationality has at least three implications: (a) managers will be ill-equipped to deal with hostility in foreign markets that has little to do with their firm or business, (b) firms will fail to leverage potential advantages of their nationality, or (c) companies neglect changes in perception of corporate nationality.
First, some firms have faced increased hostility in foreign markets not because of corporate actions but because of their corporate nationality. Take the case of Apple in Turkey. Two years ago, the Turkish President fighting a coup attempt appealed to his supporters using Apple’s video chat app FaceTime. But as the relations between the US and Turkey have deteriorated, stemming from the detention of an American pastor in Turkey, the Turkish President has in recent weeks called for a boycott of Apple phones and products in the country.
Qualcomm – an American chip maker – has a similar story to tell. In 2016, the company proposed the takeover of its Dutch counterpart NXP. The takeover received the required regulatory green light in eight jurisdictions, including the European Union and South Korea. But the lone holdout – China – let the clock run out on the proposed deal in July 2018, forcing Qualcomm to pay NXP a $2 billion break-up fee. Although the Chinese state media reported that the actions reflected the enforcement of antitrust laws, Qualcomm CEO Steve Mollenkopf highlighted geopolitical considerations. Indeed, China’s actions come right on the heels of what is potentially the most significant trade war between the US and China in recent history. In March 2018, the US blocked a $117 billion takeover of Qualcomm by its Chinese rival Broadcom. This was followed by a crippling ban on the Chinese telecommunications company ZTE in April. Although the American government eventually struck a deal allowing ZTE to continue operations, the US imposed tariffs on Chinese goods worth $34 billion. China responded in kind, but President Trump then threatened to target an additional $200 billion worth of Chinese products. Set against this background, Chinese actions in the Qualcomm case may not have been surprising. But, as Mollenkopf acknowledged in a Reuters report, “We obviously got caught up in something that was above us, so I don’t know if I would conclude anything about our own business, our ability to invest [in China] or partner with Chinese companies”.
American firms are not the only ones to have face increased hostility due to their corporate nationality. China’s Huawei has been subjected to increased scrutiny in their foreign investments. The most recent example of this challenge is in Australia. In August 2018, the Australian government banned Huawei from supplying equipment for the country’s planned 5G mobile network. Although Huawei’s Australian arm strongly denies being controlled by the Chinese government, Australian authorities continue to worry about the company’s Chinese roots open the possibility of the equipment being used for espionage, unauthorized access, or foreign interference.
While the previous illustrations allude to increased hostility in foreign markets stemming from corporate nationality, the opposite is also true in some cases. And perceptive firms are actively wearing their corporate nationalities on their sleeves to take advantage of a perceived national advantage. Indian aluminum and metals company Hindalco is one such example. In July 2018, the company announced a deal to acquire an Ohio-based aluminum maker Aleris for $2.6 billion. This deal has to be approved by US officials before it can be finalized. Yet, this is where things got sticky for Aleris a few months ago. The US administration blocked the sale of the company to a Chinese firm controlled by the metals magnate Liu Zhongtian. In spite of this history, the Indian company does not anticipate running into the same difficulties as the Chinese buyer. In this sense, their Indian nationality is a competitive advantage.
Another way firms can take advantage of their corporate nationalities is through the network of international agreements their home countries have signed. Of interest here is the recently announced restrictions by New Zealand of foreign home ownership. The country has been grappling with a housing crisis that has seen the average prices, for example, in Auckland almost double in the past decade. The new restrictions on foreign ownership are thought to ensure the growth of a domestic housing market and a boost to first-time home buyers. But, don’t fret the rules if you are Singaporean. Singaporeans are exempt from the foreign ownership ban under a free trade agreement between the two countries.
Finally, it is important to note that corporate nationality can turn from an advantage to a disadvantage (or the other way around). Take the case of Alrosa, the Russian state-controlled diamond giant. The company made a big push, especially in the American market, to highlight its Russian roots and mines. They gambled that discerning consumers will care (and perhaps even pay more) for rings and jewelry that don’t hold a conflict or blood diamond from Africa. And that the Russian firm will trigger associations with romance, classical music, and ballet. But then the relations between Moscow and Washington began to unravel. The conflicts in Ukraine and Syria, US sanctions on some Russian banks and commodities, and the Mueller investigations have resulted in considerable increase in tensions between the two countries. And Brand Russia is no longer the force it might have been in marketing diamonds.
Although nationality was always a key facet of the corporate entity, its relevance for multinational firms has waxed and waned over time. In the context of current events though, the relevance of corporate nationality is back – by design or by default. Identifying and developing strategies to best manage this new environment is the challenge of the next decade.
The Indian government recently passed the Prevention of Corruption (Amendment) Bill 2018, making a number of crucial changes to how corruption is defined, investigated, and prosecuted in the country. Some key changes include the definition of a corrupt public official, making bribe-giving an offence, and fast tracking the investigations of graft cases.
One important clause pertains to commercial organizations. Firms giving bribes will be liablefor prosecution and punishment. This brings the law in line with established international conventions on bribery that focus on the “supply side” of the bribery transaction. For instance, the OECD Anti-Bribery Conventionestablishes legally binding standards to criminalize bribery of foreign public officials in international business transactions. This means that companies from countries who are signatories of the OECD Anti-Bribery convention (35 OECD countries and 8 non-OECD countries) may be prosecuted in their home countries for actions they take in foreign markets, regardless of whether corporate bribe-giving is punishable in the foreign market. In a recent case, ENI and Shell were investigated in Italy for their roles in a $1.1 billion bribery scandal in Nigeria.
While the jury is still out on the effectiveness of international conventions in curbing corruption (research points to mixed evidence), it is clear that competition between foreign and domestic firms in India was “uneven” until now. That is, foreign firms from signatory countries could be prosecuted and punished in their home countries for bribing public officials in India while domestic firms (or firms from non-signatory countries) faced few penalties for the same behavior. This put foreign firms at a competitive disadvantage. Indeed, the OECD Convention itself came in to being after American firms complained that the US Foreign Corrupt Practices Act – a 1977 measure that penalized US firms for bribery abroad – put them at a competitive disadvantage vis-à-vis their European counterparts, some of whom could even get tax deductions for foreign bribes. And today, western companies complain of the competitive advantage that Chinese firmshave in bidding and winning contracts in Africa as the Chinese are not held to similar standards of regulation and enforcement.
What India’s new Anti-Corruption law could do, when enforced effectively, is make differences among firms’ home country regulations irrelevant. In other words, the new law makes bribe-giving by American, European, Chinese, or Indian firms an offense. Domestic firms can no longer hide behind different anti-corruption laws to gain a competitive edge against foreign firms. And among foreign firms, it would no longer matter whether the firm’s home country adopts and enforces international anti-bribery regulations because all firms may be subject to monitoring and enforcement under the new Indian law. The playing field is more level.
The governments of Mexico, Canada, and the U.S. have been in negotiations to draft a new and updated version of the North American Free Trade Agreement (NAFTA) for over a year now. And the talks have been bogged down by disagreements on many issues, including rules of origin, measures protecting agriculture, and opening government procurement.
The Energy sector was an apparent bright spot – the three countries agree that a new treaty should aid the growing energy trade. But the US government’s bid to drop a rulemeant to protect investors from government intervention is derailing progress even in this area.
The contentious issue is the Investor-State Dispute Settlement (ISDS) system. This system allows a firm to take legal action against a foreign government if it believes that the foreign government’s actions harmed its investments in that country. The U.S. Trade Representative Robert Lighthizer wants to scrap these NAFTA protections saying that they create an incentive for US companies to invest internationally and move jobs overseas. Energy companies, on the other hand, argue that dispute resolution provisions provide a critical safety net for US companies abroad. A senior at Sempra Energy was quoted in a recent articleas saying, “without that protection, you look at future investments in Mexico very differently and you may decide that because of that added risk you’re not willing to make those investments”.
To what extent do the actions of the energy industry match the rhetoric of their argument? My co-author, Robert Weiner, and I tested this argument in the context of the oil industry. Our study – published in the Journal of International Business Studiesin 2014 – examined detailed transaction-level data for sale of petroleum reserves in 45 countries. If firms really valued the dispute settlement option, we argued, then it should reflect in their valuation of the oil reserve and the price they pay for it. To test this argument, we compared two types of transactions. The first set of transactions offered firms access to treaty-based investor-state dispute settlement, i.e. the home country of the acquiring firm and the foreign country where the oil asset was located were party to an international agreement dealing with this issue. Other transactions did not have the same protections. We then examined if the price oil companies paid for each barrel of oil differed between the two. Because the price of oil reserves can also reflect other characteristics – such as depth of oil, type of oil, etc. – we account for these factors as well. We find that oil firms pay significantly higher amounts when buying petroleum reserves that are protected by international treaties than similar but unprotected assets. Moreover, the premium that firms pay for access to investor-state dispute settlement is higher for large firms than small; in other words, for firms that have the financial and managerial resources to undertake a long, expensive, and tedious legal process.
So, what does this mean for the NAFTA renegotiation? Given that any deal needs to be approved by the US Congress, the extent to which Representatives of Congress are sympathetic to energy firms concerns about access to international dispute settlement may determine the balance of the treaty, regardless of the views of the USTR.
In 2017, private investment in infrastructure projects has received renewed attention around the world (here, here). But many investors remain cautious (see here, here). Comments on how private investors can manage political risks in this sector are below.