Trade Policy and WTO Accession for Economic Development: Application to Russia and the CIS Module 15 TRIMS and investment climate by Giorgio Barba Navaretti and Angelica Salvi del Pero December 19, 2004

Key questions Does trade liberalization affect inflows of Foreign Direct Investment (FDI)? Do measures regulating the activities of foreign owned firms (TRIMs) hinder trade? What is the TRIMs agreement within the WTO? Can TRIMs be justified for domestic welfare reasons? Is there scope for international policy coordination on measures and regulations concerning foreign direct investment beyond the domain of the TRIMs agreement? What is the investment climate in Russia?

Trade and FDI vs. FDI and Trade Double hedged issues 1.Trade restrictions may hinder FDI 2.Measures regulating FDI may hinder trade

Does trade liberalization affect FDI flows? Lesson 1 : Trade liberalisation can have a favourable effect on FDI flows Intra-firm trade accounts for a large share of world trade Consequence of investments aimed at reducing production costs –Fragmentation of production –Bilateral flows of trade of components and finished products Trade barriers raise the cost of carrying out these investments

Why measures regulating FDI may hinder trade? Lesson 2: –Many measures regulating the activities of foreign firms in the host country hinder trade flows => Trade Related Investment Measures (TRIMs)

Table 2.1: The most common measures regulating the activities of foreign firms Source: Greenaway (1992) from Mc Culloch, Winters and Cirera (2002).

Table 2.1 contd. : The most common measures regulating the activities of foreign firms Source: Greenaway (1992) from Mc Culloch, Winters and Cirera (2002).

What are the effects of TRIMs Lesson 3. TRIMs rarely improve domestic welfare of the country imposing them, rather they generally worsen it. =>They are not effective in achieving the stated objectives (alleviating balance of payment constraints and fostering domestic industry) =>They introduce distortions like trade barriers and they also discriminate between types of firm =>Ambivalent, as countermeasures to increasing incentives to attract FDI

Why TRIMs violate the GATT Equivalent to standard trade barriers: –e.g. by forcing firms to use domestic components they raise the domestic price of these components: same effect as tariffs or quantitative restrictions –If equivalent to quantitative restrictions they violate art. XI of GATT They discriminate between domestic and foreign goods –e.g. by forcing use of domestic components they discriminate agianst foreign goods within national borders –they violate art. III of GATT (National Treatment)

The TRIMs agreement within GATT The TRIMs agreement is one of the WTO multilateral agrements in trade and goods It does not regulate FDI as such (entry or exit of foreign firms), but only measures concerning discriminatory treatment of import and exports by foreign firms (violations of art. III and art. XI) Extention to broader investment measures controversial (Singapore measures)

Rationale for an agreement on FDI beyond TRIMs?  Lesson 4. The benefits of an international agreement on FDI are –i) to avoid international policy competition (race to the bottom); –ii) to counteract domestic vested interests favourable to the adoption of distortionary policies; –iii) to increase transparency and transaction costs; –iv) to balance the bargaining position of developing countries vs. advanced ones.  Lesson 5. However, up to now it has proven extremely difficult to negotiate a multilateral agreement on FDI extending beyond the scope of the TRIMs agreement

FDI in Russia Lesson 6. –Since the beginning of transition Russia has attracted a limited amount of FDI, much less than other transition countries, even with respect to the size of the domestic economy

Figure 6.1: The Russian inflows and outflows of FDI (billions US $ ) Source: UNCTAD, Trends in Russian FDI

Table 6.1: Global gross inward FDI flows (billions of dollars and percentages) Source: UNCTAD (2003) From Broadman and Recanatini (2001) Geographical distribution of world FDI: Where does Russia stand?

Figure 6.2: Inward FDI stock as a percentage of GDP in Central and Eastern Europe Source: UNCTAD, FDI and the size of domestic economies Where does Russia stand?

Where do FDI inflows into Russia go? Lesson 7: FDI in Russia are mostly concentrated in few urban areas. –Roughly 60 percent of FDI flows into the country go to Moscow and St. Petersburg and their neighbouring areas. –explained by differences in standard factors, like the size of the market, infrastructure, human capital, –but also by differences in the policy and the institutional environment.

Problems in Russia: regulatory framework Lesson 8 –The regulatory framework on FDI is contradictory, combining incentives and restrictions to foreign investors. –Both restrictions and preferential measures towards FDI should be phased out and replaced by a simplified, rule based regulatory system.

Problems in Russia: inconsistency with TRIMs agreement Lesson 9 Several measures are in conflict with TRIMs and needs to be phased out in the two years following accession into the WTO –Example: instances of imposition of local content requirement and supply to local markets (Production Sharing Agreements)

Problems in Russia: overall business environment Lesson 10 Although many efforts have been made to extend the playing field of the market in the economy, the overall business environment is not yet particularly conducive to private investments. Scarcely competitive markets Basic market institutions in their infancy Overlapping and inconsistent regulations Red tape and bureaucracy Foreign trade barriers still high Fragmented regional markets