Chapter 3. Reaping the full benefits of large infrastructure projects

This chapter focuses on ways to help economies linked to the Belt and Road Initiative (BRI) to maximise the longer-term benefits of infrastructure projects as recipient countries and to ensure an open and transparent environment for international investment. This means ensuring a level playing field for investors from both emerging and advanced economies. Asia’s longer-term infrastructure needs will require much more investment than any one country can ultimately provide (USD 26 trillion to 2030, according to the Asian Development Bank) so efficient and cost effective solutions are essential. Host countries are likely to benefit most, with positive spill-over effects resulting for other economies when the process is based on level playing field considerations.

Five broad areas that could benefit from the implementation of, and wider adherence to, international standards for promoting a level playing field have been identified: the role of SOEs, given their growing presence in the international market; competition and the integrity of processes in procurement; mitigating corruption risk and ensuring responsible business conduct; incorporating environmental impact assessments in projects; and ensuring openness to international investment. In all areas, OECD standards provide useful guidance for both infrastructure-recipient economies and supplying economies.

    

The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.

3.1. Introduction

Globalisation involves the opening up of markets for trade and investment. Its history includes the early World Trade Organisation (WTO) rounds, the formation of the European Union and the creation of the North American Free Trade Agreement (NAFTA). International trade and investment need considerable infrastructure: ports, road, rail, air, and ancillary services. Most recently, the Belt and Road Initiative (BRI) is perhaps one of the most ambitious global transformations in its potential scope. It is not a formal treaty arrangement as such, nor is it based on any international organisation. Rather, it is a series of bilateral co-operation agreements promoted by China, which opens the possibility of contracts for infrastructure building and broader strategic, cultural and educational co-operation.1

As noted in Chapter 2, the Asian Development Bank (ADB) estimates that developing Asia will require USD 26 trillion in infrastructure investment between 2017 and 2030 to maintain current growth rates and adapt to climate change (ADB, 2017). Meeting these needs in the coming decades will require diversified and efficient project selection and funding. For the BRI, there is a strong need to dismantle trade and investment barriers by building roads, rail, ports, sea transportation facilities, electricity grids and telecommunication networks across six land-based economic corridors and a maritime corridor. Such connectivity is important to further develop supply chains, helping to improve well-being, reduce poverty and raise living standards around the world. No single country can provide the funding required for this initiative because the sums are huge and all financial systems have leverage limits if debt sustainability is to be achieved. Global infrastructure needs extend well beyond the BRI to all corners of the globe, including Latin America, Australasia and sub-Saharan Africa. Estimates for global infrastructure needs lay within the range of USD 50-100 trillion (Table 2.1). Wherever the investment occurs, it is always important to respect sustainable growth motivations that encompass many aspects: not only connectivity investment but also procurement principles, anti-bid rigging, anticorruption practices, corporate governance, responsible business conduct and a commitment to openness in trade and investment.

This need for a broader approach fits very well with OECD guiding principles and instruments, and also opens avenues for potential support through engaging the use of these OECD tools. They may help to inform some of the specific decisions that are going to be taken in the years to come and from which all countries involved in the push for connectivity infrastructure and sustainability goals can benefit.

This chapter focuses on four broad areas particularly relevant to infrastructure projects, and where applying internationally agreed standards and using tools that inform decision making may prove conducive to cost-effective solutions and fairness to all stakeholders in both developing and advanced economies, while also taking into account social and environmental impacts:

  1. The role of state-owned enterprises (SOEs). Closeness to government raises three broad types of concerns:

    1. The level playing field: Closeness to government can involve mixing economic and non-economic objectives and SOEs governed this way can be the beneficiaries of subsidies and other advantages (or disadvantages) that create an uneven playing field in achieving their goals. This can result in resource misallocation, including excessive debt levels, if full life-cycle costs and benefits of projects do not derive from transparent and competitive processes.

    2. National security concerns can emerge where SOEs are involved. Examples include: the loss of strategically sensitive technology – a concern not limited to, but sometimes aggravated by, state ownership of the acquiring company; and strategic infrastructure assets falling under the control of other sovereign governments.

    3. Possible gaps in legal accountability for SOEs in their operations abroad relating to potential claims of foreign state immunity.

    Section 3.2 focuses on issues related to the role of SOEs and presents some illustrations of these.

  2. Open competition in procurement. Infrastructure is very costly up front, and benefits are uncertain and accrue over a long period of time. Projects therefore need to be open to international competition on a level playing field to ensure host countries achieve the lowest cost and highest quality facilities, not distorted by undue influence of governments. These issues are discussed in section 3.3.

  3. Anti-corruption, responsible business conduct and the environment. The cost of infrastructure investment also needs to take into account the heavy cost of bribery and corruption and the social and environmental impacts of projects undertaken.

    1. Bribery and corruption is often associated with SOEs and not least in the area of large scale infrastructure projects. This can influence contracts that are awarded, making the playing field less even, and corruption always wastes societies’ resources (see OECD, 2017a).

    2. Responsible business conduct (RBC) is required in order for projects to be carried out with the least disruption to local communities and the environment. The absence of RBC risks unforeseen costs in mitigation, labour disputes, delays and cancellations.

    3. Environmental impact assessments (EIAs) are also a cornerstone of sustainable development and complement the RBC requirements of multinational companies working to build facilities and infrastructure consistent with long-term development plans that meet environmental goals.

    Domestic policies and international co-operation for managing corruption risks, and implementing RBC and environment strategies are discussed in section 3.4.

  4. The need for openness to international investment. The longer-term goal of building connectivity in developing economies is to boost trade and investment so that well-being and living standards can rise. Excessive restrictions on inflows and outflows of investment reduce these potential benefits by increasing costs, limiting technological choices, and working against the very connectivity that infrastructure strategies are supposed to build. Such inefficiencies can be reduced over the longer run by promoting transparent rules and liberalising cross-border investment, if infrastructure investment is to fully deliver the desired benefits. These issues are taken up in section 3.5.

    Finally, section 3.6 offers concluding remarks.

3.2. State-owned enterprises and corporate governance

SOE governance and the level playing field

SOEs play an important role in the world economy, particularly in natural monopoly sectors such as utilities. This role has been growing due to the rapid growth of emerging economies.2 Table 3.1 shows where the Fortune 500 world’s largest companies are headquartered. While Chinese companies feature prominently, this must be seen in the context of China’s rapid growth and its centrally-planned economic structure starting point. Whereas 9 out of 10 Fortune 500 companies were state-owned in 2000, this has declined to 75 out of 109 in 2017, or 69%, as growth has been combined with economic reforms over the intervening period.

Table 3.1. Location of the headquarters of the Fortune 500 world’s largest companies: Changes 2000-2017

 

2000

2017

Change

United States

179

132

-47

China

10

109

99

Japan

107

51

-56

France

37

29

-8

Germany

37

29

-8

United Kingdom

38

24

-14

Korea

12

15

3

Netherlands

10

14

4

Switzerland

11

14

3

Canada

12

11

-1

Other economies

47

72

25

of which SOEs

27

102

75

of which Chinese SOEs

9

75

66

Source: Ernst and Young (2017).

 StatLink http://dx.doi.org/10.1787/888933786743

At a general level, an uneven playing field can emerge as the simple result of state support for SOEs. This can include: export tax rebates (which can be considerable since the early stages of infrastructure projects boost construction material exports); below-market interest rate loans from state-controlled financial institutions; and preferential treatment in procurement. This can apply to the activity of SOEs anywhere in the world. Geopolitical, cultural and other non-economic objectives may also play an important role. Government-to-government and SOE-to-SOE negotiations therefore become a factor in concluding transactions.

Table 3.2 provides an indication of state ownership based on stock-market listed SOEs for selected economies. It shows that SOE operations tend to be concentrated in the public utilities sector (energy; telecommunication; public transportation).

Table 3.2. State ownership of listed companies in selected economies

Country

State’s share of equity market capitalisation

Percentage of SOEs found in the public utilities sector1

India

20%

65%

Indonesia

16%

61%

Korea

13%

54%

Malaysia

33%

47%

Singapore

10%

47%

Thailand

10%

65%

Viet Nam

14%

35%

Turkey

9%

50%

Poland

9%

23%

1. In OECD countries, the share is calculated on the basis of all SOEs, whether listed or not.

Source: OECD (2017b) and OECD (2017c). The data are based on Factset, and authors’ calculations.

 StatLink http://dx.doi.org/10.1787/888933786762

China, the United Arab Emirates, Russia, Indonesia, Malaysia, Saudi Arabia, India, Brazil, Norway and Thailand are the ten countries with the highest SOE-shares of GDP. OECD (2013) finds that sectors with a high SOE presence also tend to be intensely traded (including raw materials, merchandise and services). With respect to foreign subsidiaries, the report finds that larger advanced country privately-owned companies are most prevalent in activities abroad (particularly the United States), and that subsidiaries with SOE parents tend to be less active in this sense. Where companies do have SOE parents, however, the study finds that non-OECD economies tend to be relatively more internationally active. OECD (2013) concludes inter alia: “This suggests that there is a potential for economic distortions in world markets if the SOEs operating in these sectors benefit from unfair advantages granted to them by governments. The large state presence and international orientation of SOEs in some non-OECD countries highlight the need for enhanced dialogue on cross-border effects of state ownership going beyond the OECD membership”. These observations suggest scope for greater engagement with the OECD corporate governance guidelines to ensure maintenance of a level playing field among state-owned and privately-owned companies operating on a commercial basis.

If SOEs are properly separated from other public sector functions, held to high standards of governance and accountability and operate on a “level playing field” with private competitors, this should not give rise to concerns. The OECD Guidelines on Corporate Governance of State-Owned Enterprises (see Box 3.1) provide detailed guidance on how this can be obtained in practice. Conversely, if good practices of ownership and governance are not implemented, commercial relationships between SOEs may effectively become state "contracts" with low levels of transparency and accountability.

Transparency and accountability in the SOE sector will also help reduce the risk of countries becoming compromised by corruption (see below), or other non-transparent practices. Most recent OECD research shows heightened risks among SOEs operating with significant non-commercial objectives in sectors with high economic rents and, not least, in public utilities where large public procurement contracts predominate.3 Adequate internal control and risk management at SOE and state levels, consistent with the OECD Guidelines on Corporate Governance of SOEs, will help to manage the risks that could arise in the corporate value chains of SOEs involved with the BRI and in other parts of the world.

These issues are important, both because of level playing field considerations with respect to private companies, and because host countries entering into contracts with SOEs face very real economic constraints. If resource misallocation results from the influence of non-economic objectives, leading to excessively costly projects that are not justified by economic benefits, then the host’s ability to repay debt may be reduced, leading to further sets of economic and social problems. A recent study finds that eight developing economies associated with BRI projects may have run up excessive debts (see Hurley et al., 2018).

Box 3.1. OECD standards for corporate governance

The OECD has, thus far, developed two standards to help governments and enterprises improve corporate governance, with a view to enhancing companies’ access to finance and ensuring a level playing field in the marketplace. Implementation of these standards is underpinned by OECD Council Recommendations.

  • The G20/OECD Principles of Corporate Governance (OECD, 2015a) provide policy makers with the key legal, regulatory and institutional building blocks that help companies’ access to capital markets and reassure investors that their rights are protected. They provide recommendations in a number of critical areas, such as the rights of shareholders, the functioning of the investment intermediation, stock market practices, the role of stakeholders, corporate disclosure, and the responsibilities of the board of directors. They also address the quality of supervision and enforcement. The Principles were last revised in 2015 and are one of the Financial Stability Board’s twelve key standards for sound financial systems.

  • The OECD Guidelines on Corporate Governance of State-Owned Enterprises (OECD, 2015b) advise public authorities on how to effectively manage their responsibilities as company owners, making SOEs more efficient and transparent. They provide concrete guidance on how to ensure that SOEs do not have any undue competitive advantages when they operate in markets, and establish good practices for financial and non-financial disclosure by SOEs and their owners. From their inception in 2005, the Guidelines have served as an international benchmark for the corporatisation and commercialisation of SOEs. Increasingly, they have also come to serve as a reference for international trade and investment regulators for assessing internationally active SOEs. The Guidelines were last revised in 2015.

Implementation of the relevant OECD standards for corporate governance shown in Box 3.1 would help to reduce concerns about unfair practices in the global economy in general and within the BRI in particular.

National security concerns

Since the 2000s, a growing number of countries have introduced or tightened the screening and review of foreign investment projects to mitigate risks to national security.

Box 3.2. Security concerns related to infrastructure investment

Concern about strategic infrastructure being controlled by foreign governments is hardly new, and a number of OECD countries are evolving policies to evaluate and deal with the issues. A useful survey of practices can be found in Wehrlé et al., (2016). Transport infrastructure and energy grids have been of some concern in this respect when government-linked entities attempt to buy or obtain contracts to run such facilities. Issues can also arise when government entities are involved in building new facilities. The problem seems to arise when transactions result in excessive debt levels that cannot be serviced. This is sometimes resolved through the handing of strategic assets to foreign governments (essentially as debt-for-equity swaps). This may occur: (i) after construction, when financing terms prove to have been too costly and revenue less than anticipated (creditor countries can accept equity in the assets to reduce the debt, resulting in the de facto transfer of strategic infrastructure to other countries); or (ii) at the start of negotiations, when essential projects are not affordable by the host country and costs can be reduced by granting large equity positions to the investor.

An example of the former is the USD 1.1 billion BRI project for Port Hambantota in Sri Lanka that has substantial strategic importance of both a commercial and non-commercial nature.1 The project loan was based on a non-concessional 6.3% interest rate applied to an excessive level of debt. This resulted in a foreign government taking a 70% equity stake and 6000 hectares of land around the port in order for Sri Lanka to avoid defaulting.2 An example of the latter arrangement is the 70% equity stake in the port of Kyauk Pyu (Myanmar) and nearby Madae Island, essential for twin gas and crude oil pipelines through to Yunnan Province in China, which allows a short-cut for shipping (to avoid the congested Malacca Straits and the South China Sea).

Concern about such issues has resulted in a number of countries denying or cancelling projects.3 As with advanced countries, these tensions could be avoided by all SOEs adopting Santiago Principles-like arrangements which might address concerns about the role of the state and national security.

1. From William and Mary, AidData: http://china.aiddata.org/projects/33256

2. This has been followed up with the government granting tax concessions for China to develop other projects around the port. See Schultz (2017).

3. Examples include Pakistan’s Diamar-Bhasha USD14bn dam project in 2017. The too harsh financial conditions attached to the loan are considered to be the main reason for the subsequent cancellation of the project (see Dasgupta, 2017). Nepal cancelled the USD2.5bn Guda Gandaki hydro dam project for similar reasons (see Bagchil, 2017).

A recent OECD study shows that over a third of the 58 advanced and emerging economies that participate in the OECD-hosted Freedom of Investment policy dialogue now operate such mechanisms (see Wehrlé, et al., 2016, and Box 3.2). The growing presence of foreign SOEs in the international marketplace explains this trend to a large extent. In several of these economies, investment proposals involving SOEs are subject to greater scrutiny.

Santiago Principles-like arrangements

Concerns about international investment by SOEs could be significantly attenuated if investors would agree to abide by specific standards of transparency and good governance. This approach was successfully implemented a decade ago, when similar concerns arose from high profile investors participating in the International Forum of Sovereign Wealth Funds (IFSWFs). The “Santiago Principles”, a set of Generally Accepted Principles and Practices adopted in 2008 by the International Working Group of Sovereign Wealth Funds (IWG),4 commit SWFs to transparent governance that helps to avoid countries using national security arguments as a cover for protectionism against foreign SWFs.

A decade later, the upsurge of SOEs in global investment has triggered similar concerns, especially as many SOEs are less transparent than private firms (OECD, 2015b). However, the imposition of outright or unqualified restrictions on SOE investments in recipient countries benefits neither host nor home countries, as opportunities for mutually beneficial international investment are forgone.

To alleviate these legitimate concerns in host countries and reap the benefits of investment, SOEs would need to commit to respect good practices for governance, disclosure, accountability and transparency (OECD, 2015b). These principles are part of the OECD Guidelines on Corporate Governance of SOEs and include specific provisions on the legal and regulatory framework for SOEs, as well as for their practices, that promote a level playing field and fair competition in the marketplace when SOEs engage in economic activities.

Translated to an international market context, these provisions could address concerns that investment regulators may have. The last element required to emulate the “Santiago Principles” would be to secure a commitment by SOEs to abide by these standards.

Reciprocally, recipient economies should commit themselves not to use national security as a cover for protectionism and follow the principle of non-discrimination, transparency/ predictability, regulatory proportionality and accountability to guide their investment policies relating to national security, as recommended by OECD Guidelines for Recipient Country Investment Policies Relating to National Security, which were adopted in parallel with the Santiago Principles.5

Possible gaps in legal accountability for SOEs abroad

Concerns about uneven playing fields and national security reviews for SOEs, discussed above, are also affected by the broader legal environment for SOEs, private companies and governments. OECD-hosted investment policy dialogue, which regularly gathers government representatives of OECD countries, the G20 and others, has seen concerns raised about whether the doctrine of foreign state immunity may create gaps in the legal accountability of certain SOEs which are active as investors abroad (Gaukrodger, 2010). Among other issues, these gaps may be relevant to competitive neutrality between SOEs and other companies.

Resolving possible gaps in the legal accountability of SOEs abroad would improve trust with respect to their investments, particularly if coupled with attention to other recommendations, such as implementation of the OECD Guidelines on Corporate Governance of SOEs.

Two particular areas of concern have been identified:

  • whether foreign state immunity as applied to SOEs may make it difficult for private parties to pursue legitimate claims against them; and

  • whether the doctrine creates regulatory enforcement gaps for host countries.

Foreign state immunity and private party claims

Under the doctrine of foreign state immunity, a sovereign state is not subject to the full force of rules applicable in another state. National courts are barred from adjudicating or enforcing certain claims or judgments against foreign states. At one time, states enjoyed “absolute” immunity: all proceedings against foreign states were barred unless the foreign state consented. With the greater involvement of governments in commercial activities, many jurisdictions began to apply a “restrictive” theory of immunity, at least in cases brought by private parties. Under the restrictive approach, courts continue to recognise immunity for “sovereign” acts, but deny immunity for “commercial” acts. The commercial exception helps protect business partners that engage in commercial transactions with foreign states and foreign state entities.

The restrictive approach is reflected in case law, national statutes and international conventions, although with significant variations. The United Nations Convention on the Jurisdictional Immunities of States and their Property, adopted by the United Nations General Assembly in 2004 (the UN Immunity Convention), incorporates a restrictive approach and was negotiated over many years by many countries. However, it has not entered into force.

The restrictive approach is not universally recognised. China, in particular, has taken a clear position in favour of absolute immunity in a recent high-profile case in Hong Kong, China. China has signed, but not ratified, the UN Immunity Convention.

China’s affirmation of absolute immunity is noteworthy for BRI projects and other Chinese investments abroad. For some aspects, the foreign state’s views on absolute, as opposed to restrictive, immunity may not be of great practical importance. State immunity is governed in the first instance by the law where the court is situated (the forum state, which may often be the host state). When it is well-established in the forum state that restrictive immunity applies, it is likely that the foreign state’s views on immunity will not affect the court’s approach. Depending on the circumstances, however, the foreign state’s views on immunity could be an important factor in the overall political climate of a case in the host state, the scope of co-operation with regard to the gathering of evidence, or the attitude of host state regulators. In addition to rules in the host state and the home state of the foreign entity, the rules on immunity in third states where assets may be available for enforcement of judgments or awards against the entity can also be relevant. Advance clarification of the rules can be valuable.

With regard to SOEs, two general legal issues can be noted:

  • whether SOEs, as entities, fall within the domain of the “foreign state” for purposes of foreign state immunity; and

  • if, in some situations, an SOE entity can be considered to be part of a broad conception of the “foreign state”, whether its actions are commercial or sovereign. This is generally only relevant if restrictive immunity applies.

International conventions and different national legal systems vary in their definition of what constitutes a “foreign state”. OECD-hosted investment policy discussions in the late 2000s took into account two broad approaches to the relationship between SOEs and the foreign state.6 Under the European Convention on State Immunity (ECSI), and in the United Kingdom and most civil law jurisdictions, it appears that such entities have generally been considered to fall outside the domain of the foreign state providing they operate independently from the state.7 The ECSI uses separate legal personality and the capacity to sue and be sued as factors to determine whether an entity or company operates independently of the state.8 In general, separate entities are not entitled to immunity from adjudication or execution. Such entities are immune only if they carry out acts in the exercise of sovereign authority.

In contrast to the ECSI-type approach, the US Foreign Sovereign Immunities Act (FSIA) defines the overall foreign state more broadly. It includes certain majority state-owned companies under its definition of “agencies and instrumentalities” of the foreign state. Less information was available for many other jurisdictions. The UN Immunity Convention has been described as somewhat ambivalent on the issue of SOEs (see Fox, 2005).

Some Chinese SOEs have claimed immunity in recent cases. Some cases and declarations have suggested application of a “control” test for separateness of Chinese state entities from the state for immunity purposes and that the legal form of the entity is important.9 Control is a flexible concept and may be subject to more interpretation than the ECSI criteria. The notion of state control has been narrowly interpreted by China in some recent contexts, suggesting a view that SOEs generally would not be considered to be part of the state when they operate abroad.10 At the same time, recent statements and actions to ensure that the Communist Party of China (CPC) maintains control over Chinese SOEs, and possible variations in SOE governance over the course of projects, may need to be considered in this context.11

Possible regulatory gaps in host countries

The second broad concern raised in OECD-hosted investment policy discussions is the possible impact of the doctrine of foreign state immunity on host country regulation of SOEs. While there is extensive commentary and many cases addressing foreign state immunity in the context of private lawsuits, little attention has been paid to the issue of its impact on regulation. It has been suggested in OECD-hosted discussions of state immunity that regulation may best be analysed in functional terms on a sliding scale depending on a number of factors which would affect the strength of the case for applying a restrictive theory of immunity (or otherwise limiting, or excluding, immunity). Key factors could include the applicable definition of the foreign state and type of foreign state entity at issue, the nature of regulatory remedies to be applied (e.g. whether they are compensatory or punitive in nature) and the public or private nature of the enforcement agency. Where a regulated entity is from a state that applies absolute immunity, the definition of the “foreign state” and whether the entity in question might be covered, could be critically important issues for the political context for regulation (Gordon and Gaukrodger, 2012).

Another factor meriting consideration is whether relevant entities, or their owners or affiliates, have a track record of making relatively aggressive assertions of immunity. Depending on applicable law, even an assertion of immunity can delay cases and increase costs for private parties and regulators.

Policy recommendations

In light of these developments and considerations, the OECD suggests that governments and companies interested in attracting investment from foreign SOEs, or which are considering transactions with foreign SOEs, should examine and clarify the applicable law on immunities in advance in order to ensure that immunity will not raise unexpected issues in the event of disputes.12 Waivers of state immunity are widely used to ensure that other entities, that could conceivably assert a claim for state immunity at a later date, waive any claims to immunity in advance when transactions are being negotiated. Where there is a shared view about the rules in advance, waivers can document it for the duration of projects. Waivers are particularly important if there are areas of legal uncertainty in relevant international or national law on immunity. Waivers may need to address both immunity from jurisdiction (barring a state’s courts from judging the actions of another state) and immunity from execution (barring a state from taking coercive measures against another state’s assets for the purpose of enforcing a judgement). In addition to the content of waivers, their legal basis and form can be important. In some contexts, it has been suggested that some waivers must be in treaties, rather than contracts, to be effective.13

Increased international co-operation in articulating approaches to similar regulatory issues and in seeking common approaches would provide many benefits. It could assist in providing a clear and predictable framework for foreign investment by SOEs and regulatory action affecting them, reducing the likelihood of costly and politically sensitive investment disputes.

3.3. Open competition in procurement

As indicated earlier, the massive presence of SOEs and the closeness of regulatory regimes for foreign investment favour the role of government-to-government deal making. While this may speed up agreements and get the job done on time, it may not necessarily be at the lowest cost.

This has resulted in some lack of diversity. According to the Reconnecting Asia Database, 89% of projects financed by Chinese banks go to Chinese companies, 7.6% to local companies (which are usually a part of a joint venture with a Chinese firm) and 3.4% goes to foreign companies (defined as neither Chinese nor local). Many projects also receive joint funding by Chinese banks and Multilateral Development Banks (MDBs), such as the World Bank or the ADB, though the scale of the latter is smaller. In comparison to Chinese banks, 29% of MDB funding goes to Chinese companies, 40.8% to local firms and 30.2% to foreign firms.

Foreign construction and logistics firms may not always be aware of project opportunities. Projects documented in the database involving Chinese banks show no evidence of early stage announcements (open calls for tender). The risk for recipient economies is that the lack of diversity and openness in bidding, where present, may not lead to the lowest cost and stakeholder friendly outcomes for host economies. Costs might be higher, and the oft-given reason for awarding a contract being based on speed of execution can be at the expense of local communities and the environment (see below).14

Competition in bidding

Open, transparent and competitive procurement processes help to avoid undesirable outcomes. It will be recalled from Chapter 2 that an Oxford academic study (Ansar et al., 2016), using detailed project data, found that Chinese transport construction companies tend: to under-estimate costs (30.6% average overruns); to finish on time, but at the expense of quality and the environment; and that evidence of misallocation is present (under-usage of road and rail in the majority of cases and congestion in others). This kind of outcome is not confined only to Chinese SOEs. The study found that these findings were not statistically different to a sample of company projects from a ‘rich democracy’ sample. Similar findings have been found for India (see Singh, 2010), where in a sample of 894 projects 40% experienced serious cost overruns and 82% had completion delays. Referring to November 2017 data, the Times of India reports that of 1 289 projects, 359 face cost overruns and time delays.15 That is, these issues concern all countries. To achieve better benefit/cost outcomes over the long-term requires a realistic picture of the upfront and full life-cycle costs. Examples of recent transactions in Box 3.3 illustrate why processes need to be improved.

Box 3.3. Illustrations of procurement issues from BRI projects

Belgrade-Budapest high speed rail link

China’s first rail line project in Europe was with Hungary and Serbia, consisting of a USD 2.89 billion, 350 kilometre Belgrade-Budapest high-speed railway by the China Railway International Corporation, with financing from China’s Export-Import Bank. This project has been delayed after questions arose as to whether an open procurement process should have been used under the terms of the EU’s procurement laws (see European Commission, 2017; and Qiong, 2017).

Bandra-Worli sealink (India)

This project was to link Worli and central Mumbai to Bandra and the western suburbs with a cable-stay bridge. Compared to its original cost estimate of Rs 300 crore (around USD 3 billion), the final cost proved to be Rs 1600 crore (around USD 16 billion). The project was completed 5 years after its original scheduled opening (Singh, 2010).

Matiari-to-Lahore high voltage transmission line

Pakistan is very short of power and the USD 1.7 billion project to build the transmission line from the coal power station being built on the coast (Matiari) to industry in Lahore was awarded to State Grid with funding from the China Development Bank and Exim Bank, despite initial discussions with large advanced country firms (General Electric and Siemens). This was in the form of a government-to-government contract with no formal open procurement process. It is reported that this was in spite of a significantly lower estimate for the convertor stations (the most significant part of the cost) by an advanced country company, and that the telling factor was timeliness (see Jorgic, 2017). To fully prepare and execute the project was estimated by the advanced country firm to be 48 months, versus a 27-month estimate from State Grid. Withholding tax concessions were offered but only to the Chinese firm.

To achieve the most beneficial outcomes for all countries, bids need to be based on open processes and a level playing field for all competent suppliers of construction and related services.16 Instruments that provide a useful starting point to improve transparency and openness in procurement processes are discussed in Box 3.4.

Where these instruments do not apply there is a risk that trade distortions, of the type envisaged at the time of their agreement, will unfold. Since the agreements appear to have proved effective at preventing trade distortions based on export credits between signatories, it would appear sensible to look at ways to renew efforts towards building participation in these or similar agreements, either multilaterally or incrementally (for example, through bilateral trade agreements).

As economies participating in BRI projects become more open and continue the reform process, OECD tools on detailed competition policy will become increasingly relevant. These tools include the OECD Competition Toolkit (OECD, 2017e), and the framework that the OECD has developed to counter bid rigging (OECD, 2009b).

Box 3.4. Instruments to improve transparency and openness in procurement processes
  1. The OECD Recommendation of the Council on Public Procurement is the overarching OECD guiding principle on public procurement that promotes its strategic and holistic use. It is a reference for modernising procurement systems and can be applied across all levels of government and SOEs. It addresses the entire procurement cycle while integrating public procurement with other elements of strategic governance, such as budgeting, financial management and additional forms of services delivery. The 2015 Recommendation builds upon the foundational principles of the 2008 OECD Recommendation on Enhancing Integrity in Public Procurement, expanding them to reflect the critical role governance of public procurement must play in achieving efficiency and advancing public policy objectives. www.oecd.org/gov/public-procurement/recommendation.

    In order to support implementation of the Recommendation, the Public Procurement Toolbox was also developed and made available online. In addition to exploring each of the 12 principles of the Recommendation, the Toolbox provides policy tools, country examples and indicators to measure a country’s public procurement system.

  2. The OECD Arrangement on Officially Supported Export Credits (the Arrangement), sets out the most generous export credit terms and conditions that may be supported by its participants. It places limitations on the terms and conditions of officially supported export credits (e.g. minimum interest rates, risk fees and maximum repayment terms) and the provision of tied aid. Originally agreed in 1978, the Arrangement is a “gentleman’s agreement”, i.e. soft law. Current participants to the Arrangement are: Australia, Canada, the European Union, Japan, Korea, New Zealand, Norway, Switzerland and the United States. www.oecd.org/tad/xcred/arrangement.htm.

    The Arrangement, which is routinely updated, includes procedures for prior notification, consultation, information exchange and review for export credit offers that are exceptions to or derogations of the rules, as well as tied aid offers. The main purpose of the Arrangement is to provide a framework for the orderly use of officially supported export credits. In practice, this means removing the scope for governments to undercut one another by providing ever more attractive financial terms in support of exporters that compete for overseas sales. Prior to these rules, many governments provided financial subsidies in favour of their national exports, thereby creating trade distortions. Thus, the intention of the Arrangement was to provide a level playing field where firms competed on the basis of price and quality of the exported goods and not on the quality of the financial support that was provided by their government.

  3. The WTO General Procurement Agreement (the GPA) aims to open government procurement markets mutually among its parties, with a view to achieving greater liberalisation and expansion of, and improving the framework for, the conduct of international trade. The GPA therefore establishes rules requiring that open, fair and transparent conditions of competition be ensured in procurements by covered entities purchasing listed goods, services and construction services of a value exceeding specified threshold values.

    www.wto.org/english/tratop_e/gproc_e/gp_gpa_e.htm.

    This agreement is plurilateral within the framework of the WTO, meaning that not all WTO members are parties to the GPA. At present, the GPA has 19 parties comprising 47 WTO members.1 Another 31 WTO members participate in the GPA Committee as observers. Out of these, ten members (including China) are in the process of acceding to the Agreement.2

1. The 19 are: Armenia, Canada, EU (including its members), Hong Kong (China), Iceland, Israel, Japan, Korea, Lichtenstein, Moldova, Montenegro, Aruba, New Zealand, Norway, Singapore, Switzerland (updating), Chinese Taipei, Ukraine, and the United States.

2. The ten are: Albania; Australia; China; Georgia; Jordan; Kyrgyzstan; Oman; Russian Federation; Tajikistan; the Former Yugoslav Republic of Macedonia.

3.4. Fighting corruption and promoting responsible business conduct

Infrastructure projects often involve enormous sums of money and can be lucrative so bidding between companies for these contracts is highly competitive. One means of winning contracts, whilst still offering competitive quotes, can be to accompany the proposal with a bribe. These cost considerations also create an incentive to minimise the financial aspects associated with social and environmental cost mitigation. This section looks at each issue and proposes options.

Fighting bribery and corruption

Bribery is still widespread in many economies and is a very corrosive crime. It erodes the integrity of economic and political institutions, weakens market competition and undermines the trust of citizens. Through its work on the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (the OECD Anti-Bribery Convention), the OECD spearheads the fight against the supply-side of bribery – that is, against givers of bribes to foreign public officials in international business transactions.

This issue is very relevant to public procurement (and particularly in utilities and infrastructure), which is at the heart of efforts to close infrastructure gaps. The OECD Foreign Bribery Report documents around 57% of bribes were paid to obtain public procurement contracts (OECD, 2014b, p.27). With regard to the infrastructure sector, the OECD’s G20 contribution on corruption and growth suggests a reason for this: “One of the characteristics that make this sector especially prone to corruption is the frequent monopoly situation, in which those who control the entities receive large rents. Additionally, due to the need for constant government intervention in this sector, there are many opportunities for misuse of authority and demand for bribes” (OECD, 2015e, p.9).

As part of this work, the OECD keeps track of cases of international bribery that have ended with sanctions for individuals or companies that engaged in bribery. The OECD data show that public officials of 39 out of 72 economies that participate in the BRI were the bribe recipients in 226 of the 270 bribery schemes that the Working Group on Bribery (WGB) database contains. These cases are merely the tip of the iceberg because they omit cases that were never detected, prosecuted and sanctioned and only cover cases where the briber was subject to the jurisdiction of a member to the WGB. Nevertheless, they shed light on these economies’ experiences with bribery of their public officials. Indeed, the cases highlight the importance of two key features of bribery: the relative predominance of SOEs as a source of heightened corruption risks, and the cross-border nature of bribery. First, countries with a relative predominance of SOEs are more vulnerable, because these firms tend to be both involved in high-risk sectors and sometimes have weak governance frameworks. The WGB database shows that officials from SOEs are major recipients of bribes – executives of SOEs and other associated parties were, by far, the most common bribe recipients, accounting for 86 of the 184 bribery cases for which information is available on who was bribed (see Figure 3.1).

Furthermore, SOE cases were heavily concentrated in the energy sector (accounting for 51 cases) and telecommunications (10 cases). These are known to be high-risk sectors for bribery. The largest sanction ever imposed for foreign bribery in the OECD cases was for a USD 331 million bribe paid to a close relative of the then-president of a country participating in the BRI. This relative was also a public official who used her influence over telecommunications regulation to help the company effect market entry.  As noted in Box 3.1, the OECD Guidelines on Corporate Governance of SOEs can help economies deal with the significant bribery risks associated with their SOEs, while also achieving the non-commercial objectives that they might have for their SOEs in high-risk sectors, such as telecommunications.

Second, all economies that want to fight corruption need to engage in international co-operation – they cannot wage this fight on their own. Many of the 226 bribes in the sample were part of bribery schemes straddling large numbers of countries. These are schemes run by multinational companies, including some which are state-owned, that are well versed in managing global legal risks using intermediaries, offshore jurisdictions and complex corporate groups. By way of illustration, the top-three bribing companies in the BRI sample – measured in terms of the number of jurisdictions they bribed in – were:

  • An automobile manufacturer that paid bribes in a total of 20 countries, including in 16 that participate in the BRI; the bribe scheme also involved Chinese, German and Russian subsidiaries, as well as US and Latvian bank accounts held by shell companies.

  • An engineering and electronics firm that bribed in 20 countries, 10 of which were linked with the BRI. The cash for these bribes was funnelled through numerous off-the-books entities, including several slush funds held in the name of US shell companies.

  • An engineering and manufacturing company that bribed in 14 countries, 10 of which were linked with BRI projects. The scheme also involved intermediaries in Monaco, Portugal, Panama, Singapore, Thailand, and the United Kingdom.

In this list, the economies participating in BRI projects are not necessarily over-represented in terms of their numbers and economic weight—all countries face these issues. The point is that these bribe schemes are international in scope. Detection, investigation and sanctioning of bribery of their public officials poses challenges that extend well beyond their own jurisdictions. The global nature of the crime of bribery requires a global response from the law enforcement community.

Faced with these challenges, law enforcement agencies in all economies need to be as sophisticated and international as the businesses that seek to bribe. They need to keep up with recent law enforcement developments (e.g. case information processing technology) and to collaborate with other law enforcement agencies. They also need to focus on domestic legal frameworks, including legislation and courts.

The WGB provides a platform in which law enforcement officials can share information and experiences and forge social ties that can help expedite the more formal processes of mutual legal assistance. G20 member economies that have not yet joined the Convention should consider doing so, as encouraged by the G20 Anti-Corruption Working Group.

Figure 3.1. SOE officials as recipients in sanctioned bribery transactions
(Out of 226 sanctioned bribery transactions, where bribe recipients were in economies participating in the BRI)
picture

Source: Calculations from the OECD Working Group on Bribery case database.

 StatLink http://dx.doi.org/10.1787/888933786629

It is also worth noting that foreign direct investment (FDI) is affected by bribery and corruption, which is relevant for all developing economies trying to attract investment from OECD countries. An OECD empirical study shows that, once countries have adhered to the OECD Anti-Bribery Convention, their companies invest less in corrupt geographies and more in countries with sound property rights and accountability (see Blundell-Wignall and Roulet, 2016). More corrupt countries therefore forego the benefits of more investment (and hence better potential for productivity growth) from Parties to the Convention and notably OECD countries that are amongst the largest international investors.

Third, bribery is not the only corruption risk in infrastructure projects. Policy capture, embezzlement, abuse of functions, and trading in influence are common examples of corrupt acts, although the exact legal definitions of these vary across countries. Corruption allegations concerning government-financed infrastructure projects are common. Indeed, the extent of public officials’ discretion over the investment decision, the large sums of money involved, and the multiple stages and stakeholders implicated, contributes to making them more vulnerable to undue influence.

Promoting responsible business conduct

While infrastructure investments are generally intended to provide improvements to societies, in terms of access to energy, transport and connectivity, in certain cases they can also bring large-scale negative impacts. RBC is critical to ensuring sustainable development and avoiding serious social and environmental harms.

The OECD Guidelines for Multinational Enterprises (OECD Guidelines) provide the leading international guidance on RBC (OECD, 2011). The OECD Guidelines are supplemented by due diligence guidance which targets specific sectors.17

Evidence from cases arising in connection with the OECD Guidelines shows that ensuring an adequate framework for investment and promoting and enabling RBC is important for developed and developing economies alike. The OECD Guidelines reflect the expectation that businesses will undertake risk-based due diligence on issues such as human rights, employment and industrial relations, environment,18 and other areas to avoid and address any negative impacts of their operations, including in their supply chain and business relationships.19 Each Adherent to the OECD Guidelines establishes a National Contact Point (NCP).20 NCPs are mandated to promote the recommendations of the OECD Guidelines and to resolve issues in the event that an enterprise does not observe them, thereby acting as a grievance mechanism. All OECD countries and, as of 2018, 18 out of the 72 economies participating in the BRI (of which five are not OECD countries) adhere to this important international standard on RBC.21

Figure 3.2. Host countries of cases filed with NCPs for the OECD Guidelines for Multinational Enterprises
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Note: The database contains information about complaints relating to the activities of MNEs headquartered in countries adhering to the OECD Guidelines. It does not reflect information about the operations of MNEs headquartered in countries that have not adhered to the OECD Guidelines in other non-adhering countries. The database does, however, give an indication of the nature of the RBC problems that can be encountered in BRI-participating countries.

Source: OECD Guidelines for Multinational Enterprises Database for Specific Instances, http://mneguidelines.oecd.org/database/.

 StatLink http://dx.doi.org/10.1787/888933786648

To date, complaints filed with the NCPs ("specific instances") have involved issues arising in 42 of the economies participating in the BRI.22 Out of 389 complaints filed with NCPs,23 148 concern issues arising in these economies (38% of all complaints filed). Six (2%) of these 389 complaints involve issues arising in both BRI-participating and other economies (as issues filed with NCPs may arise in multiple countries and territories). Issues reported to NCPs represent only those that are linked to the operations, products or services of multinational enterprises operating in or from one of the 48 Adherents to the OECD Guidelines. As such, they represent only a small proportion of possible RBC-related impacts in the global economy.

The leading themes raised in complaints filed with NCPs involving issues arising in economies participating in the BRI have been: employment and industrial relations (referenced in 59% of these complaints (88 complaints)); human rights (referenced in 37% of these complaints (55 cases)); and the environment (referenced in 15% of all cases (23 complaints)). These rates are above those for complaints filed involving issues arising in other economies in relation to human rights issues and employment and industrial relations.

Figure 3.3. Key issues raised in cases with OECD NCPs, 2000-2017
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Source: OECD Guidelines for Multinational Enterprises Database for Specific Instances, http://mneguidelines.oecd.org/database/.

 StatLink http://dx.doi.org/10.1787/888933786667

Figure 3.4. Main sectors implicated in complaints filed with OECD NCPs, 2000-2017
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Source: OECD Guidelines for Multinational Enterprises Database for Specific Instances, http://mneguidelines.oecd.org/database/.

 StatLink http://dx.doi.org/10.1787/888933786686

The main sectors implicated in complaints involving issues arising in economies that participate in the BRI are: manufacturing (64 complaints, or 43% of the total); mining and quarrying (14 complaints, or 9% of the total); financial and insurance activities (13 complaints, or 9% of the total); and construction (10 complaints, or 7% of the total). Among cases filed involving issues arising in other economies, these rates are significantly lower for manufacturing (27%) and construction (2%), the sectors most directly concerned with physical infrastructure building (Figure 3.4).

Box 3.5. Promoting responsible business conduct in Southeast Asia: Findings from the OECD Investment Policy Review of Southeast Asia

Southeast Asia has been one of the most successful emerging regions, in terms of export-led development, in part through foreign direct investment (FDI). The Association of Southeast Asian Nations (ASEAN) economies have already recognised the importance of RBC in certain policy areas. This is true both at the regional level, as seen by the inclusion of RBC expectations in various ASEAN Blueprints, and at the national level, even if specific government actions vary widely across the region. A promising trend has been the inclusion of RBC provisions in a recent wave of investment strategies and laws, as well as the elaboration of comprehensive national action plans related to RBC. Such initiatives can bring about improved outcomes from investment, in terms of broader value creation and sustainable development, and also help to position the region as a reliable location for production and safe sourcing by helping to reduce the reputational risks faced by investors.

Nevertheless, more can be done to support and encourage responsible businesses and quality investment. Several objectives envisioned for the integrated ASEAN Economic Community will depend in large part on improving the business environment beyond investment liberalisation.

To further promote and enable RBC, ASEAN could develop a regional action plan in the context of integration in global supply chains to set out an expectation for investors and ASEAN businesses to adopt RBC principles and standards consistent with international standards, such as those contained in the OECD Guidelines for Multinational Enterprises. Elements of RBC could also be included in investment incentives schemes.

Both national governments and the ASEAN Secretariat could clearly communicate RBC expectations to investors, including as part of investment promotion efforts on the “Invest in ASEAN” website and in supplier databases and matchmaking events. At the same time, policy dialogue among ASEAN members could be strengthened with a view to position ASEAN as a responsible investment region.

The processes related to environmental and social impact assessments could be harmonised, clarified and strengthened, while encouraging early participation by affected stakeholders. Governments in the region could also promote National Action Plans on Responsible Business Conduct in order to mainstream RBC across government agencies and as a way to prioritise and advance reforms needed to ensure an adequate legal framework that protects the public interest and underpins RBC.

The 2018 OECD Investment Policy Review of Southeast Asia builds on national reviews of seven countries in Southeast Asia and looks at common challenges across the region and at the interplay between regional initiatives and national reforms.

Source: OECD (2018a).

Issues raised in complaints filed with NCPs show some of the significant social and environmental risks that can arise in the context of infrastructure projects. For example, in 2017, the Swiss NCP considered a specific instance related to human rights violations of migrant workers in the construction of facilities for the 2022 FIFA World Cup in Qatar. The Swiss NCP accepted and mediated the instance, which led to an agreement between the parties in a number of areas, including development of processes for monitoring labour conditions, establishment of an on-the-ground oversight body, and mechanisms to address workers’ complaints and labour conditions.

Ensuring that government decisions on infrastructure investment meet high integrity and governance standards, including adequate stakeholder engagement, can go a long way for the success of these projects. For example, secure and well-defined land rights are a critical component of avoiding conflicts. Without a credible mechanism for meaningful, effective and good-faith consultation with land rights holders, in particular indigenous peoples or local communities, (e.g. clear and transparent criteria on resettlement, compensation, and tendering and lease/concession contract terms), projects can be at a significant risk (OECD, 2015). Such cases have come up in the context of the BRI (see Box 3.3).

One way to ensure greater uptake of RBC practices is co-operation between economies linked with the BRI and adherents to the OECD Guidelines in promoting RBC practices in infrastructure investment. The OECD has been working with Southeast Asian partners on creating an enabling framework for investment and RBC (Box 3.5). In addition, co-operation with China on the implementation of RBC standards in overseas investment can help raise awareness of the economic and social benefits of engaging in RBC practices. Large capital-exporting partners in the BRI that have not yet adhered to the OECD Guidelines are encouraged to enhance the social and environmental benefits of their infrastructure projects by adhering to this international standard for conducting business responsibly and establish an NCP to ensure their effective observance.

Promoting environmental impact assessment

While the OECD Guidelines expect companies to have sound environmental management systems, the OECD Recommendation on the Assessment of Projects with Significant Impact on the Environment (OECD, 1979) is for adhering governments to apply environmental assessment prior to implementing proposed projects for facilities and infrastructure. Assessment is a process of systematic prior analysis and evaluation of the environmental impacts of the proposed activity and the consideration of alternatives. It includes consultation with affected parties and the inclusion of the results of the assessment in the planning and authorisation process before any implementation of the activity. This OECD Recommendation also advocates the participation of the affected parties in order to find socially acceptable solutions.

The OECD Recommendation is currently being revised to include Strategic Environmental Assessment (SEA). SEA is implemented in various countries and regions (e.g. the European Union, which was first to mandate SEA in 2001, Canada, Korea and Chile). SEA aims to integrate environmental considerations into country and regional strategies that evaluate plans in terms of their linkages with both economic and social considerations with full transparency of the decision-making process.24 The OECD is also using SEA in its development co-operation work, which is highly relevant for all developing countries (see OECD, 2006).

Mitigating corruption risks in public investment

The costs of fraud and corruption in public investment are not only economic, but also institutional and political, with serious implications for the legitimacy of the state apparatus and the ability of elected leaders and government institutions to function effectively. The OECD Integrity Framework for Public Investment helps governments and private sector actors to mitigate corruption risks in public investment by identifying corruption entry points over the entire public investment cycle. The framework identifies tools and mechanisms to promote integrity in public investment, including measures for promoting ethical standards, managing conflict of interest, strengthening monitoring and controls, and increasing transparency. The instrument can be applied at national and sub-national levels and across sectors, including transport, construction, extractive industries, and energy supply, taking into account the needs and characteristics of the specific investment at stake.

3.5. Towards greater openness to international investment

The longer-term goal of investing in infrastructure and building connectivity in the global economy is to boost trade and investment in order for living standards to rise sustainably over time. Excessive restrictions on inflows of FDI reduce these potential benefits by reducing choice and increasing costs. Reducing restrictions on capital flows over time is therefore important if these longer-run benefits are to be realised.

Barriers to foreign direct investment

Figure 3.5. OECD FDI Regulatory Restrictiveness Index, 2016
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Note: The OECD FDI Regulatory Restrictiveness Index covers only statutory measures discriminating against foreign investors (e.g. foreign equity limits, screening & approval procedures, restriction on key foreign personnel, and other operational measures). Other important aspects of an investment climate (e.g. the implementation of regulations, the presence of state monopolies, the preferential treatment for export-oriented investors and the special economic zone (SEZ) regimes among other) are not considered. The FDI Index reflects regulatory restrictions as of December 2016. The FDI Index is available for only 36 of the 72 BRI-participating economies. Data are preliminary for the following countries: Albania, Bosnia and Herzegovina, Brunei Darussalam, Former Yugoslav Republic of Macedonia, Montenegro, Serbia, Singapore and Thailand. Please refer to Kalinova et al., (2010) for further information on the methodology.

Source: OECD FDI Regulatory Restrictiveness Index database, www.oecd.org/investment/fdiindex.htm.

 StatLink http://dx.doi.org/10.1787/888933786705

OECD countries have limited restrictions on inward FDI. Emerging economies, while much less open, have been making their regulatory regimes less restrictive over time. The OECD’s FDI regulatory restrictiveness index is shown in Figure 3.5. This index covers statutory measures discriminating against foreign investors (e.g. foreign equity limits, and screening and approval procedures), though it cannot take account of the extent to which these restrictions are enforced. In Figure 3.5, OECD and economies linked with the BRI are distinguished in a number of ways.

While FDI in manufacturing is generally allowed without restrictions, except when a horizontal measure applies across the board, many primary and service sectors remain partly off limits to foreign investors in emerging countries, holding back potential economy-wide productivity gains.25 Some significant liberalisation has been achieved recently across several BRI-participating economies, mostly on a unilateral basis (where the bars for 2016 lie below the markers for earlier years). However, foreign investors still face relatively higher barriers to entry and discriminatory treatment than in OECD countries in various sectors, including agriculture, mining, construction, distribution, transport, media and business services.26

OECD countries participating in the BRI tend to have fewer restrictions than non-OECD participating economies. The average for the latter (the horizontal line) sits above that for the OECD groups. Restrictiveness is particularly strong in Asia. Restrictions on FDI cut off sources of investment and technology for host countries. The question arises, therefore, as to whether further trade and investment reforms in the BRI could see greater and more affordable benefits from infrastructure investments coming from diverse and more cost effective sources.

Figure 3.6. Index of restrictions on capital inflows by asset class, 2015
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Note: OECD countries participating in the BRI: Czech Republic, Hungary, Israel, Korea, Latvia, New Zealand, Poland, Slovenia, Turkey. Non-OECD economies identified in the BRI: Bahrain, Bangladesh, Brunei Darussalam, Bulgaria, China, Egypt, Ethiopia, Georgia, India, Indonesia, Islamic Republic of Iran, Kazakhstan, Kenya, Kuwait, Kyrgyzstan, Lebanon, Malaysia, Republic of Moldova, Morocco, Myanmar, Oman, Pakistan, Panama, Philippines, Qatar, Romania, Russian Federation, Saudi Arabia, Singapore, South Africa, Sri Lanka, Thailand, Ukraine, United Arab Emirates, Uzbekistan, Viet Nam, Yemen. Other OECD countries: Australia, Austria, Belgium, Canada, Chile, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Mexico, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom, United States.

Source: Fernandez, Andrés, Michael Klein, Alessandro Rebucci, Martin Schindler, and Martin Uribe (2016), “Capital Control Measures: A New Dataset”, IMF Economic Review, vol. 64, 548-574, www.columbia.edu/~mu2166/fkrsu/.

 StatLink http://dx.doi.org/10.1787/888933786724

Figure 3.6 focuses on restrictions on financial flows and is based on the IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions. Like the OECD FDI measure, it consists of de jure legal restrictions and provides data on a wide range of asset classes and countries. OECD countries are bound to high standards of openness and transparency through the OECD Code of Liberalisation of Capital Movements (see Box 3.6) and so have lower restrictiveness on these financial flows, whether or not they participate in the BRI.

Vast investment from China in participants in the BRI (documented in Chapter 2) occurs despite the presence of strong barriers to investment in the region. This may be due to the presence of government-to-government transactions (including direct appointments to contracts not subject to restrictions).

Potential benefits of greater openness

Connectivity infrastructure plays a critical role in allowing countries to integrate better within geographical regions and to join up to other regions, thus increasing participation in the benefits. This is a key objective of the BRI. Its success would contribute to spreading development opportunities in many participating economies which inevitably will spill into other regions.

Chapter 2 uses a gravity model of bilateral trade relationships to test two types of benefits in trade that come about from regional trade blocs in the world economy:

  • the intra-bloc benefits that accrue to bloc members; and

  • the extra-bloc benefits that arise for non-members due to increased income and productivity, as scale economies improve and as supply chain connectivity increases.

The intra-bloc findings suggest that, while trading blocs generally “create” trade for members, this is most evident for the more open OECD exporting countries. The extra-bloc flow-on effects to other economies are strongest for blocs where China is a member (such as ASEAN+1, and the Bangkok Agreement), the European Union and, most of all, NAFTA.

These findings suggest that linkages between developing and advanced economies have the potential to enhance benefits through greater FDI openness, particularly given the central role that FDI plays in the development and organisation of global and regional value chains (OECD, WTO and UNCTAD, 2013).

To capture the full benefits of infrastructure connectivity, BRI economic corridors need to be viewed within a broader global trade and investment strategy for sustainable economic development. Expected multiplier and long-term effects of hard infrastructure investments do not accrue automatically, often proving lower than expected. In the long-run, the economic benefits of such investments are sustained by improved economic activity and services provided over the installed infrastructure. This requires complementary soft-infrastructure systems, such as: consistent border regulations and procedures; strong logistics services; and compatible behind-the-border regulations, including appropriately-open services sectors regulations.

The BRI foresees greater co-operation on a number of relevant policy areas in this respect, e.g. enhancing economic and trade co-operation and expanding production capacity and investment co-operation (see Government of China, 2017). To date, however, China’s focus on infrastructure investments has overshadowed the importance of addressing such complementary policies.

An international framework for managing capital flows

A large part of the problem of not attracting more diversified funding for BRI projects is the bilateral nature of transactions between countries that are not a part of any framework of common globally-accepted rules of the game. The OECD Code of Liberalisation provides such a framework, and does not require countries to be members of the OECD in order to adhere. The Code is designed to make capital account management policies more transparent and to provide a framework for moving towards more openness in the longer run, while still allowing for different stages of economic development (Box 3.6). Adherence to the Code by China and other major investment players would be welcome, as encouraged by the G20, and would constitute an important step towards a more transparent global approach to capital flows, which will also benefit the BRI.

Box 3.6. The OECD Code of Liberalisation of Capital Movements

The OECD Code of Liberalisation of Capital Movements (OECD, 2016b) is an international agreement under which adherents commit to progressively liberalise capital flows. They may lodge reservations as regards operations they are not in a position to liberalise at the time of adherence, and at any time as regards short-term capital flow operations. In situations of serious balance of payment difficulties or economic and financial disturbance, adherents can also avail themselves of the derogation clauses of the Code for new restrictions on other operations.

The Code’s system of notification and peer monitoring ensures transparency and mutual accountability in adherents’ policies related to capital flows.

Countries have adhered to the Code in recognition of the fact that open capital accounts bring market disciplines that foster productivity, facilitate investment financing and provide opportunity to expand and diversify businesses abroad. By adhering to the Code, countries have agreed to abstain from a “beggar-thy-neighbour” approach to capital flow restrictions, as this can prompt countermeasures and lead to negative collective outcomes in the end.

Today, adherents to the Code have more open capital accounts than non-adherents. This divided situation contributes to imbalances and distortions in the global economy. The Code was opened in 2012 for adherence by non-OECD countries and those countries that are interested are encouraged to join. By doing so, non-OECD countries will build a reputation as responsible international players while enjoying the benefit of the protection provided by the Code against potential discrimination on the part of their peers.

3.6. Policy recommendations

This chapter focussed on four broad areas: the role of SOEs; competition and processes in procurement; bribery and other acts of corruption, responsible business conduct and the environment; and investment openness. In all four areas, a strong case can be made for developing a common set of transparency principles that are consistent with mutually-beneficial outcomes and which will help promote quality and sustainable infrastructure projects that work for all. More than this, OECD guidelines and standards all have associated toolboxes that help countries drill down to specifics. That is, to inform decision-making with analytical tools that countries are welcome to take advantage of when decisions are being made, whether or not they are members of the OECD.

To achieve this, the OECD recommends:

  1. With respect to SOEs:

    1. Improve the governance of SOEs engaged in cross-border activities. Concern about subsidies and non-transparent processes which work to create an uneven playing field must be addressed. Governance of SOEs in their cross-border activities needs to be improved, based on global standards. OECD guidelines provide an effective framework to achieve this. They encourage arms-length relationships between SOE ownership and other functions exercised by the state.

    2. Develop a Santiago-Principles-like set of arrangements. Concerns reflected in the move towards tougher national security reviews, in cases where SOEs are involved, need to be addressed. Santiago-Principles-like arrangements have proved effective in resolving these problems where sovereign wealth fund investments were concerned.

    3. Examine and clarify the applicable law on immunities in advance. To reduce uncertainty about gaps in legal accountability for SOEs in their activities abroad (inter alia where the issue of foreign state immunity is concerned), governments and companies are encouraged to examine and clarify the applicable law on immunities in advance. Waivers of sovereign immunity should be included in the initial negotiations of contracts. In the longer term, a clear and predictable framework is needed for foreign investment by SOEs, including legal enforcement and regulatory action affecting them, which would reduce the likelihood of costly and politically-sensitive investment disputes.

  2. Embrace clear principles on open competition in procurement based on OECD procurement recommendations, the OECD arrangement on export credits and the WTO general procurement agreement. These principles have proved effective in preventing trade distortions between signatories. Where gaps still exist, clear standards for procurement in infrastructure investment projects will need to be established. The same goes with respect to how relationships between developing economies and OECD investors will be conducted. There are also detailed tools for assessing competition frameworks within countries that also condition cross-border activities.27

  3. Anti-bribery, responsible business conduct considerations in infrastructure project negotiations, and environmental impact. Corruption is most closely linked to SOEs, not least in large scale infrastructure projects where the bribery of public officials is commonplace. At the same time, unforeseen problems and costly disruptions to local communities and the environment have been a feature of projects in economies benefiting from infrastructure investment through the BRI once construction was underway. These issues need to be addressed in advance.

    1. Adhere to the OECD Anti-Bribery Convention. Countries that take the fight against corruption seriously are encouraged to address this by adherence to the OECD’s Anti-Bribery Convention which comprises both principles and, most importantly, rigorous monitoring and peer-review processes. Using the OECD Integrity Framework for Public Investment is a useful adjunct to the Convention.

    2. Establish a policy environment conducive to RBC. Countries are encouraged to promote corporate due diligence in addressing social and environmental risks associated with infrastructure and consider adhering to the OECD Guidelines for Multilateral Enterprises.

    3. Governments themselves need to lead by example and integrate environment impact assessments in infrastructure projects they sponsor.

  4. Be open to the lowest-cost and best-technology investments. Cost-effective solutions based on a diverse universe of investors, including from OECD countries, will be essential to meet infrastructure needs, to contain debt burdens for developing countries and to avoid handing equity to foreign governments that give them control of sensitive strategic assets. Countries are encouraged to adhere to the OECD Code of Liberalisation of Capital Movements. The Code fully recognises different levels of economic development and provides a sound framework for improving openness between OECD and developing economies to enhance investment and trade linkages.

  5. Take advantage of OECD co-operation initiatives in the region. A considerable power imbalance often exists between large and/or more developed economies operating in less developed economies. Less developed economies may be ill-placed to negotiate contracts and develop policies that enable them to get the most out connectivity strategies and projects. OECD programmes such as “The Central Asia Competitiveness Initiative”, the Eurasia Competitiveness Programme more generally and the Southeast Asia Regional programme all aim to help countries create a business climate to enhance productivity through entrepreneurship, private sector development, and the knowledge-based economy. These programmes draw on the expertise of OECD committees in all of the areas discussed in this chapter.

References

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Annex 3.A. List of economies by group

Two groups of economies are defined following the IMF country group classification: advanced economies and emerging and developing economies.

Advanced economies

Australia, Austria, Belgium, Canada, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hong Kong (China), Iceland, Ireland, Israel, Italy, Japan, Korea, Latvia, Lithuania, Luxembourg, Macau, China, Malta, Netherlands, New Zealand, Norway, Portugal, Puerto Rico, San Marino, Singapore, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Chinese Taipei.

Emerging and developing economies

Afghanistan, Albania, Algeria, Angola, Antigua and Barbuda, Argentina, Armenia, Azerbaijan, Bahamas , Bahrain, Bangladesh, Barbados, Belarus, Belize, Benin, Bhutan, Plurinational State of Bolivia, Bosnia and Herzegovina, Botswana, Brazil, Brunei Darussalam, Bulgaria, Burkina Faso, Burundi, Cabo Verde, Cambodia, Cameroon, Central African Republic, Chad, Chile, People’s Republic of China, Colombia, Comoros, Democratic Republic of the Congo, Republic of the Congo, Costa Rica, Côte d’Ivoire, Croatia, Djibouti, Dominica, Dominican Republic, Ecuador, Egypt, El Salvador, Equatorial Guinea, Eritrea, Ethiopia, Fiji, Gabon, Gambia, Georgia, Ghana, Grenada, Guatemala, Guinea, Guinea-Bissau, Guyana, Haiti, Honduras, Hungary, India, Indonesia, Islamic Republic of Iran, Iraq, Jamaica, Jordan, Kazakhstan, Kenya, Kiribati, Kosovo, Kuwait, Kyrgyzstan, Lao People’s Democratic Republic, Lebanon, Lesotho, Liberia, Libya, Former Yugoslav Republic of Macedonia, Madagascar, Malawi, Malaysia, Maldives, Mali, Marshall Islands, Mauritania, Mauritius, Mexico, Federated States of Micronesia, Republic of Moldova, Mongolia, Montenegro, Morocco, Mozambique, Myanmar, Namibia, Nauru, Nepal, Nicaragua, Niger, Nigeria, Oman, Pakistan, Palau, Panama, Papua New Guinea, Paraguay, Peru, Philippines, Poland, Qatar, Romania, Russian Federation, Rwanda, Samoa, Sao Tome and Principe, Saudi Arabia, Senegal, Serbia, Seychelles, Sierra Leone, Solomon Islands, Somalia, South Africa, South Sudan, Sri Lanka, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and the Grenadines, Sudan, Suriname, Swaziland, Syrian Arab Republic, Tajikistan, United Republic of Tanzania, Thailand, Timor-Leste, Togo, Tonga, Trinidad and Tobago, Tunisia, Turkey, Turkmenistan, Tuvalu, Uganda, Ukraine, United Arab Emirates, Uruguay, Uzbekistan, Vanuatu, Bolivarian Republic of Venezuela, Viet Nam, Yemen.

Notes

← 1. As noted in Chapter 2, the initiative involves 72 economies, which include 12 OECD countries and five OECD Key Partners (see Box 2.1).

← 2. Based on 2015-16 data, Norway is at the high end with 8.9% SOE employment versus total employment, France 3%, China 2.6% and Italy 2.2%.

← 3. See OECD (2018b), which draws on a survey of 300+ SOEs on perceptions of corruption and integrity risks.

← 4. The IWG consists of Australia, Azerbaijan, Bahrain, Botswana, Canada, Chile, China, Equatorial Guinea, Islamic Republic of Iran, Ireland, Korea, Kuwait, Libya, Mexico, New Zealand, Norway, Qatar, Russian Federation, Singapore, Timor-Leste, Trinidad and Tobago, the United Arab Emirates, and the United States. Permanent observers of the IWG are Oman, Saudi Arabia, Viet Nam, the OECD, and the World Bank (see the Santiago Principles, note 5, www.ifswf.org/sites/default/files/santiagoprinciples_0_0.pdf).

← 5. See OECD (2009a) for the Recommendation. In 2008, the International Working Group of Sovereign Wealth Funds published the Generally Accepted Principles and Practices (GAPP), known as the ‘Santiago Principles’, see IWG (2008). The GAPP cross references the OECD Investment Committee report on sovereign wealth funds, OECD (2008).

← 6. Such enterprises are addressed under national laws and treaties under various rubrics, including “separate entities” (United Kingdom), “agencies and instrumentalities” (United States) and “legal entities” (ECSI).

← 7. See Gaukrodger (2010), page 15, and references and discussions therein.

← 8. The ECSI (art. 27) distinguishes agencies of the state from its organs by excluding from the expression “Contracting State” any legal entity of a Contracting State which is distinct therefrom and is capable or suing and being sued. Such distinct entities are not part of the state even if they have been entrusted with public functions. Under Article 27(2), proceedings may be brought against such entities “in the same manner as a private person” except in respect of sovereign acts.

← 9. See, for example, Cheng, T. and A. Lai (2011) addressing whether PRC state entities, including both “Guoyou Qiye” and “Shiye Danwei” type entities, ”can plead, assert and enjoy state immunity under the auspices of the state of the PRC when sued in a foreign court”, and whether they would be considered to be “under the control of the state and hence [could] be considered part of the state”; arguing that “Guoyou Qiye” entities would not benefit from state immunity abroad). The authors acted as counsel in both cases they discuss. Ms. Cheng was appointed Secretary for Justice in Hong Kong (China) on 6 January 2018.

← 10. Id.; see also TNB Fuel Services Sdn Bhd v. China National Coal Group Corp., [2017] HKCU 1439 (Hong Kong Court of First Instance 8 June 2017) (based in part on a submission by the PRC, narrow application of the possibly related concept of “Crown immunity” of PRC entities in Hong Kong (China) to reject a claim of immunity by a Chinese SOE).

← 11. See, for example, Feng (2016), quoting a Xinhua report on statements by Xi Jinping at a meeting with Chinese SOEs that “Party leadership and building the role of the party are the root and soul for state-owned enterprises. … The party’s leadership in state-owned enterprises is a major political principle, and that principle must be insisted on.” See also Hughes (2017), reporting on changes to articles of association by more than 30 SOEs to add references to the role of the CPC. See also Chen (2016), who states “senior management personnel of SOEs is controlled and managed by a special committee of the CPC. Hence, the CPC and the government not only control the appointment and dismissal of managers, but they also control much of the micro-level operation of companies.”.

← 12. See Gaukrodger (2010) which reports on work related to the OECD Freedom of Investment Roundtable, page 14.

← 13. Waivers in the context of agreements to commercial arbitration and participation in dispute settlement raise specific issues that are not addressed here.

← 14. For example, in Box 3.3 the timeliness factor is reported to have trumped the cost factor, in that one of the bidders from a developed economy had a lower estimate for the bulk of the project costs (the converter stations). Examples from India are also presented.

← 15. https://timesofindia.indiatimes.com/business/india-business/359-infrastructure-projects-show-cost-overrun-of-rs-2-05-lakh-crore/articleshow/63156392.cms

← 16. There is an interesting issue here about the best route to achieve lowest cost outcomes. On the one hand host countries might benefit from not requiring competitive neutrality. This may enable them to extract additional guarantees and special deals from one bidder versus another with only a few participants. However, it is not clear that special deals with local content requirements provide the most affordable outcomes. There are gains to be had if host countries and bidders play by the global rules that are set out in the OECD & WTO rules in an open transparent process at the global level.

← 17. OECD Due Diligence Guidance for Responsible Supply Chains in the Garment and Footwear Sector; OECD Due Diligence Guidance for Meaningful Stakeholder Engagement in the Extractive Sector; OECD-FAO Guidance for Responsible Agricultural Supply Chains and OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas; and Responsible Business Conduct for Institutional Investors. https://mneguidelines.oecd.org/duediligence/.

← 18. And see, for example, very early work in this area in OECD (2004).

← 19. OECD co-operates with China in the area of RBC. Chinese government hosted a peer exchange on National Contact Points in 2015. In 2016, co-operation focused on implementation of the Chinese Due Diligence Guidelines for Responsible Minerals Supply Chains, which were set out in 2015 on the basis of the OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas. For more information, see OECD (2017c).

← 20. The Declaration and its Guidelines are open to adherence by non-OECD economies. There are currently 48 Adherents, which include 14 G20 members.

← 21. Czech Republic, Egypt, Estonia, Hungary, Israel, Jordan, Kazakhstan, Korea, Latvia, Lithuania, Morocco, New Zealand, Poland, Romania, Slovakia, Slovenia, Turkey, Ukraine. Economies related to BRI projects are listed on China’s official BRI Portal - https://eng.yidaiyilu.gov.cn/info/iList.jsp?site_id=CMSydylyw&cat_id=10076&cur_page=1. Adherents to the OECD Declaration and its Guidelines are listed at https://mneguidelines.oecd.org/about.htm.

← 22. Bahrain, Bangladesh, China (People’s Republic of), Czech Republic, Ethiopia, Georgia, Hungary, India, Indonesia, Iraq, Israel, Kazakhstan, Korea, Republic of (South), Lao People's Democratic Republic, Latvia, Malaysia, Maldives, Mongolia, Montenegro, Morocco, Myanmar, New Zealand, Pakistan, Palestinian Administered Areas, Philippines, Poland, Qatar, Romania, Russian Federation, Saudi Arabia, South Africa, Sri Lanka, Thailand, Turkey, Ukraine, United Arab Emirates, Uzbekistan, Yemen.

← 23. The OECD specific instance database registers 389 complaints filed with NCPs since 2000, as of 10 March 2018. As some NCPs only report on complaints when they are concluded which means that the database does not yet reflect these ongoing cases, http://mneguidelines.oecd.org/database/.

← 24. See for example: http://ec.europa.eu/environment/eia/sea-legalcontext.htm

← 25. See, inter alia, Nordås and Kim (2013); Arnold, Javorcik and Mattoo (2011); Arnold et al. (2012); Fernandes and Paunov (2012); Duggan, Rahardja and Varela (2013).

← 26. China announced in April 2018 the intention to relax FDI restrictions in a number of industries, including finance and transport equipment, while also committing to improve the investment climate and better enforce the protection of property rights, including intellectual ones. See “Highlights of Xi’s keynote speech at Boao Forum”, www.chinadaily.com.cn/a/201804/10/WS5acc15a6a3105cdcf6517259.html.

← 27. Such as competitive neutrality with respect to SOEs, merger analysis, OECD work on bid rigging and competition assessments in procurement.