The rule of law: A magnet for foreign investment

ariel nepomuceno_1WHAT particular characteristics of a country does a foreign investor consider important in deciding whether to invest? Vital but not enough is a good financial and sociopolitical climate for such a major undertaking.  Financials would pertain to a fair and reasonable rate of return on investment, current tax regimes and the ability to repatriate profits and other incentives being provided.

On the other hand, the political atmosphere focuses on the stability of a nation’s government, how the latter enables  its institutions to assure the investor a level playing field, a competitive environment within which to operate. Multinational companies and enterprises, for instance, fear low security of their investment either in the areas of irrational state action, particularly in nationalization of assets, arbitrary acts of expropriation or total disrespect for sanctity of contracts.  However, one other crucial factor is evident if one is to assess statistical data on what particular jurisdictions do foreign investors gravitate toward to. This is the rule of law.

The Philippines Development Forum of which the Department of Justice is an active member of, defined the rule of law as “a principle of governance in which all persons, institutions and entities, public and private, including the state itself, are accountable to laws that are publicly promulgated, equally enforced and independently adjudicated, and which are consistent with international human-rights norms and standards.  It requires, as well, measures to ensure adherence to the principles of supremacy of the law, equality before the law, accountability to the law, fairness in application of the law, separation of powers, participating in decision-making, legal certainty, avoidance of arbitrariness and legal/procedural transparency.”

This rule of law framework includes the Constitution, a clear and consistent legal framework and implementation; strong institutions of justice, governance, security and human rights; transitional justice processes and mechanisms; and a public and civil society that contributes to strengthening the rule of law.

Simply put, a judicial and legal system that is fiercely independent from the government decision-makers, one which has forward- looking legislation, interprets and enforces the law openly and fairly is a powerful enticement to foreign investors. The World Bank’s 1999 publication, entitled Initiatives in Legal and Judicial Reform, stressed that the massive move by developing and transition countries toward market economies necessitated the adoption of strategies for the encouragement of private investment, domestic and foreign.  Naturally, there was a general realization that such an objective could not be achieved without modifying, and sometimes, completely overhauling the legal and institutional framework and firmly establishing the rule of law, thereby creating the necessary climate of stability and predictability.

In the July 16, 2015 editorial of the BusinessMirror, it was highlighted that the amount of foreign direct investment as a percentage of the GDP is smaller today than it was a decade ago and that the Philippines lags behind the rest of Southeast Asia.  The causes?  The ease of doing business and the rule of law, particularly the space of  constitutional and legal restrictions on foreign capital.

General problems in the legal infrastructure:

Contract stability

A key concern is the recognition of contract stability.  In most developing or emerging nations, a contract duly entered into is changed in the middle of the game by local laws that either make it difficult for a particular phase of operation to occur due to some new tax, permit or license. Sometimes, the contract itself is interpreted differently by regulatory authorities or courts, although the terms are clear and the intentions behind why a contract was stipulated that way were precisely to attract the entry of such investor.  The sanctity of contracts is pushed aside either due to sheer political positioning or to bring unfair monetary advantage to some people in the government or a particular economic class or family.  This is a big problem in the oil, gas and mining industry where the risk of failure is extremely high because the success of a discovery is most uncertain.  Worst of all,  when the weight of political power results to nationalization of the investor’s assets, the latter is left suffering with the predicament of how he can be compensated fairly and equitably.

Protection of property rights

ON the other hand, when the host country decides to illegally expropriate or confiscate property belonging to an investor,  the latter suffers from a terrible disadvantage posed by “hometown” decisions rendered by domestic courts.  Unfortunately, the recourse to international law remedies are limited when there are no investment treaties entered into by and between the domestic state and the investor’s country.  As a result, the company just decides to pull out its investment and bear the consequences—its property rights denigrated. Net effect? A loss of reputation for the host country and a black mark in the international investment community.

Sovereign immunity and economic sanctions are also issues that deter investment opportunities in countries that are in conflict  due to contract disputes.  More often, these disputes are not purely economic in flavor, but are greatly driven by political considerations.  These political risks penalizes foreign investors in that it produces direct financial loss and impact on profit retention or repatriation. They are calculated, too, in order to arrive at an investment decision.

Laws and enforcement

The area of legislation is also of utmost concern. The absence of investment-friendly laws and the lack of governance in the way laws are interpreted or carried out turn off foreign investors.  Where countries’ legal and judicial regimes are unstable, politicized and are heavily influenced by the state, companies shy away from it for pretty obvious reasons.  Flip-flopping, inconsistent laws and implementing regulations make it extremely difficult for the foreign investor to make a sound economic planning, forecasting and decision-making.

The Judiciary

BY far,  one of the most significant factors that discourages global companies from investing in a country is their perception about the independence of the judiciary,  the efficiency of its processes and its ability to enforce decisions that impact foreign investors’ rights.

Sadly, there are still lingering negative perceptions about the impartiality, quality and soundness of courts’ outcomes. A common observation is the influence of politics in the appointments to plum positions in the Judiciary. Despite the protective mechanisms provided in the Constitution, such as the role given to the Judicial and Bar Council in the appointment process, some observers maintain that those who capture the highest posts reflect the economic interests of a few.

The sheer length of the court processes in the Philippines—from filing, conduct of hearings, appellate procedures, issuance of a final decision from the Supreme Court (SC), together with enforcement activity—is a major disincentive.  Because of the considerable time spent in litigation and dispute resolution together with the costs associated with it, a company would think more than twice to take its chances.

Way forward

However, the SC and all other agencies involved in judicial and enforcement activities are currently undertaking initiatives in modernizing and improving the judicial system. Well-meaning private organizations and non-governmental organizations, local and international  bar associations and foreign chambers of commerce are all helping in making court processes more efficient and responsive by automation of case-management systems, strengthening contract enforcement and encouraging alternative dispute resolution. The overriding objective is to foster a healthy investment climate and to stimulate economic growth for our country.

Encouraging results

And we are somehow getting there. The recent 2015 results of the World Justice Project’s Index on the rule of law showed that from last year’s 60th out of 99 nations,  the Philippines got the 51st spot.  This index surveys how the rule of law is felt in day-to-day situations by ordinary people around the world. The rankings are based on indicators, such as constraints on government powers, corruption, fundamental rights, order and security, regulatory enforcement, civil and criminal justice, among others. The Philippines earned a relatively good score of 0.53 out of a perfect score of 1. Gladly, the Philippines is ninth out of 15 countries in the Asia-Pacific region, together with the likes of Singapore, Australia and New Zealand.

Not bad, considering our very poor performance in the last 10 years. If we really want massive inflows of direct foreign investment in the Philippines, we need to begin with the basics and the obvious.  We have to listen to global opinion and the international community’s call for creating a fair, stable and robust commercial environment for investors. This begins with transforming our legal and judicial system into one that is open, transparent, efficient and just.

Oftentimes, the rule of law is the rule of who inspires more investors’ confidence.



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