Building capacity to help Africa trade better

The Relationship between Investment and Mode Three of Trade in Services – implications for the AfCFTA negotiations


The Relationship between Investment and Mode Three of Trade in Services – implications for the AfCFTA negotiations

The Relationship between Investment and Mode Three of Trade in Services – implications for the AfCFTA negotiations

The market for investors is an increasingly competitive one. Investors are better informed about conditions in host countries. Companies seeking to expand their global presence will assess their options before deciding on an investment location. One of the first decisions will be about access. Will an investor be allowed to enter and operate in a specific market? It has been pointed out that while primary and manufacturing sectors are largely open to foreign investment, many industries, particularly in services sectors such as media, transport, energy, finance, and telecommunications, remain restricted in most economies.[1] This applies to many host nations, including the larger and more advanced ones.

Another serious concern for investors is the prevalence of post-establishment difficulties and impediments. Examples are quantitative restrictions on the scale of commercial presence, limits placed on the ability to acquire or lease land, limitations on the nature and geographical scope of operations, restrictions on the hiring of foreign personnel, limits placed on payments and transfers, local sourcing obligations, restrictions related to ownership structures etc. These can easily deter entry or inflate the cost of operating abroad.[2]

These and related issues will be on the agenda when the AfCFTA Investment Protocol is negotiated. An AfCFTA Investment Protocol limited to State Party cooperation only, will result in important matters not receiving sufficient attention, such as the relationship between Mode 3 in the AfCFTA Protocol on Trade in Services and the overall investment regime which will be adopted for the AfCFTA. The AfCFTA principles applicable to trade in services via Mode 3 have already been decided, when the AfCFTA Protocol on Trade in Services was negotiated, and “commercial presence” was defined. According to Article 1 of the AfCFTA Protocol on Trade in Services “Commercial presence” means “any type of business or professional establishment, including through the constitution, acquisition or maintenance of a juridical person, or the creation or maintenance of a branch or a representative office, within the territory of a State Party for the purpose of supplying a service”.[3] 

The rules governing Mode 3 – establishment of commercial presence – determine, to a considerable extent, how foreign companies make investments by setting up subsidiaries or branches to provide services in another country. An example would be a bank setting up a branch in a foreign jurisdiction. The ensuing commercial activity is typically linked to new foreign direct investment (FDI).

A recent World Bank study explains why this is so and what the implications are:

Of all modes of supply, Mode 3 (commercial presence, or investment) remains by far the most important means of selling services abroad. The WTO estimates that Mode 3 transactions account for over three-fifths of aggregate services trade. This is so even as Mode 3 trade tends to be particularly vulnerable to risks deriving from host country conduct, typically confronts a range of trade-cost inducing measures in host country markets, particularly of a discriminatory nature, and as technological advances induce modal substitution effects favoring the remote (i.e. cross-border) supply of services over digital networks in the long-run.[4]

Additional related factors have to be considered. The adoption of the AfCFTA Protocol on Investment takes place at a time when core issues about the regulation of investment and services are internationally debated and new approaches are being adopted. WTO members are implementing the Trade Facilitation Agreement, which entered into force in February 2017. Investment facilitation has become an area of particular attention. More than 100 WTO members are now participating in the Joint Statement Initiative on Investment Facilitation. These members also undertake outreach activities, in particular to developing and least-developed countries, to ensure that the future framework does address their investment facilitation priorities and needs.[5]  Will and should the AfCFTA investment negotiations do the same?

We believe investment facilitation should be high on the list of matters to be debated and decided when the AfCFTA Investment Protocol is negotiated. Investment facilitation is not only about making it easier for investors to establish commercial presence, to conduct their day-to-day business and to expand their existing investments in host countries. It encompasses the full cycle of the investment process and how associated practices will be governed by host governments. This applies to the attraction of FDI, establishment of commercial presence, expansion of activities, and linkages to regional economies.

Investment facilitation is directly related to governance issues such as transparency, consistency in the regulation of investment related activities, non-discrimination, due process, and the availability of legal remedies. It should, for example, be possible for local firms as well as established new investors to take the decisions of regulators on review in domestic courts. National governance (and the reforms that will be required) is not only about the treatment of foreign investors or firms. It is about good governance at home for the benefit of all. Recent research conducted at the World Bank Group has shown that a significant number of investment projects – as much as one in every four – are either withdrawn or their expansion curtailed in host developing countries. This is so not because of firm-specific factors or macro-economic conditions but because of problems deriving from the irregular or erratic conduct of subnational government or specialized regulatory agencies. Examples of such conduct include a lack of transparency, arbitrary regulatory changes, contract breaches, expropriations, or currency convertibility restrictions.[6]

[1] Roberto Echandi and Pierre Sauvé, Investment Facilitation and Mode 3 Trade in Services: Are Current Discussions Addressing the Key Issues? World Bank Document

[2] Ibid.

[3] This definition in the AfCFTA draws on the definition in the General Agreement on Trade in Services (Article XXVIII – Definitions), for details see: https://www.wto.org/english/res_e/publications_e/ai17_e/gats_art28_oth.pdf

[4] Ibid.

[5] https://www.wto.org/english/news_e/news21_e/infac_09mar21_e.htm

[6] Ibid.

About the Author(s)

Gerhard Erasmus

Gerhard Erasmus is a founder of tralac and Professor Emeritus (Law Faculty), University of Stellenbosch. He holds degrees from the University of the Free State, Bloemfontein (B.Iuris, LL.B), Leiden in the Netherlands (LLD) and a Master’s from the Fletcher School of Law and Diplomacy. He has consulted for governments, the private sector and regional organisations in southern Africa. He has also been involved in the drafting of the South African and Namibian constitutions. He grew up in Namibia.

Trudi Hartzenberg

Trudi Hartzenberg is the Executive Director of tralac. She has a special interest in trade-related capacity building. Her research areas include trade policy issues, regional integration, investment, industrial and competition policy.

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