Sunday, May 20, 2007

Book Review: 'Making Foriegn Investments Safe'


How shady deals, corrupt government go together

May 20, 2007

Vincent Lingga,
The Jakarta Post, (Jakarta Indonesia)
Copyright 2007

Making Foriegn Investment Safe
Property Rights and National Sovereignty
Louis T. Wells & Rafiq Ahmed
Oxford University Press (2007)
pp. 378

Should the sanctity of an investment contract always be honored, or indeed, should business contracts be held sacred?

Not always, argue Louis T. Wells and Rafiq Ahmed, business management experts, in their newly published book Making Foreign Investment Safe: Property Rights and National Sovereignty.

They reckon that the "magic" of property rights in the industrialized countries comes not from being absolute, but rather from a balance between individual or corporate rights and fairness, and, especially, overall economic benefits.

When circumstances change after a contract is formed and make it impossible or impractical, or uneconomic or inefficient, to comply with contractual obligations, courts may relieve a party of its commitments.

Consequently, Wells and Ahmed further argue, a nation may be excused from honoring a treaty if (1) the existence of the circumstances that changed constituted an essential basis of the consent of the parties to be bound by the treaty and (2) the effect of the change radically transforms the obligations that are to be performed under the treaty.

The book contains real case studies on a telecommunications project and power generation contracts the Indonesian government awarded to foreign investors in 1967 and 1992-1994, respectively, under Soeharto's authoritarian rule, which was notorious for its corruption, collusion and cronyism.

The authors recount blow by blow how the power contracts were negotiated amid a corruption- and cronyism-infested climate and how these contracts eventually led to disputes, and some of them into messy court battles, between foreign investors and the government.

The cases explore big-power politics, corruption and political influence, poor organization and, on occasions, incompetence that led to some rather one-sided deals.

The first relates to the 1967 government contract with then International Telephone and Telegraph (ITT) of the United States for the development of satellite communications.

It recounts why the ITT subsidiary (PT Indonesian Satellite Corporation or Indosat) was nationalized in 1980 but without any damage to Indonesia's international credibility.

Timely lessons

The book devotes five chapters to the ITT contract, revealing a lot of inside and background information on how ITT, riding on the back of its technology and Indonesia's weakness, gained a greedily lucrative contract that would give it an annual rate of return on equity of over 80 percent during its 13 years of operations before the Indonesian government decided to nationalize it in 1980 through commercial negotiations.

The book is able, it seems, to provide so many details on the ITT case because Wells was one of the foreign advisers hired by the Indonesian government as part of the team to renegotiate the contract with ITT.

Since then, Wells of the Harvard Business School, served for 30 years as a consultant to the government mainly through the Harvard Institute for International Development.

Rafiq Ahmed is also a well-experienced manager who worked for Exxon Corporation for 20 years, including five years in Indonesia between 1981 and 1986 as a project team and country manager.

The other case studies recount the negotiations for 27 independent power generation contracts, which all involved foreign investors and members of then president Soeharto's family, other senior officials and Soeharto's business cronies.

It explains why all these contracts eventually led to disputes immediately after the financial crisis of 1997.

It is shown how the power contracts, if carried through, would have led the nation to bankruptcy because all of them set their power sales prices (to the State Electricity Company or PLN as sole buyer) way above standard international prices and four times as high as PLN's sale price for power.

Of the 27 projects, seven were eventually terminated, 14 were renegotiated, one was acquired by Pertamina, another by PLN.

Both authors suggest changes in the international property rights system, calling for the establishment of an appeals body within the Washington-based International Center for Settlement of Investment Dispute (ICSID) framework.

Arbitrators should base their decisions with less emphasis on a legalistic approach but with more attention paid to consideration of what is just and fair.

Even courts in industrialized countries may excuse parties from fulfilling contracts if they were entered into under compulsion (duress) or corruption or if one party is not competent, the book states.

Sometimes in such cases, a high standard of proof is not required as courts may simply assume that something has been amiss if there is at least a substantial hint of compulsion or corruption and the terms of investment arrangements seem imbalanced.

Along this line of thought, most of the power contracts the Indonesian government awarded between 1992 and 1995 should have fallen into the category of deals that should not be fully honored due to changes in the circumstances.

Demand for power plunged and the rupiah exchange rate crashed after the economic crisis, and there were hints of corruption, cronyism and unreasonable terms including unusually steep power sales prices set by the investors in dollars.

The case studies on contracts in infrastructure development are timely and especially relevant in view of the government's concerted campaign to woo new investment into electricity, telecommunications, toll roads, seaports and airports, and water supply.

The book not only offers lessons to officials and investors on how to negotiate and write investment contracts in infrastructure but also provides new horizons on property rights and contractual relationships in infrastructure.

The rationale is that large infrastructure projects have certain characteristics that make them frequent subjects of conflict with host governments because these deals almost inevitably require some kind of special agreement and an element of monopoly.

Moreover, infrastructure, like mining projects, is almost always politically sensitive because infrastructure is fundamental to an economy, and mines involve national patrimony, both authors rightly argue.

© 2007 The Jakarta Post:

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