The Challenges of Attracting FDI

The Challenges of Attracting Foreign Direct Investment for Latin America’s Sustainable and Diversified Economy: Lessons Learned From Ecuador Nathalie Cely S.1 and Gustavo Domínguez

1. Latin America: a decade of sustained growth and recovery of the middle class

For the last decade Latin America has been, an important actor in the growth of world economy, experiencing economic growth rates above 4% according to the ECLAC. The region has also experienced a reduction in overall poverty rates -- from 43% in the year 2000 to 32% in 2009 and 29.4% in 2011, and extreme poverty has dropped from 19% to 11.5% during this same time period. Additionally, since 1998 and with greater force in the past decade, the concentration of income has begun to give way, so that the GINI inequality reduction coefficient was reduced in 13 countries.

These improvements in income have not only arisen as a result of a greater growth and the creation of more and better jobs, but also because of redistributive social policies undertaken by countries such as Ecuador. In spite of these advances, growth has been uneven; 32% of the Latin American population saw cumulative measured growth at rates smaller than an annual 1% per capita from 1982 t0 2012, and income inequality remains a challenge, the given that the richer 10% concentrates 32% of total income, while the poorer 40% only receives 15% (ECLAC 2013).

One positive effect of growth, and of public policies promoting access to social provisions such as education, healthcare, job creation, and a more equitable redistribution of income, is a growing middle class2. According to the World Bank3, the middle-class population in Latin America and the Caribbean has grown by 50% − from 103 million people in 2003 to 152 million, or 30% of the continent’s population, in 2009. According to the same report, today in the region the middle class and the poor represent approximately the same proportion of the population.

Historically, Latin American elites and upper classes have shown very little commitment towards the equal development of their countries and had very few expectations for their governments, which is to say, they paid very little taxes and did

The opinions issued herein are personal and do not represent the views of the Ecuadorian Government.

A report by the World Bank defines as middle class those with incomes between US.10 and US.50 per day and per capita.

2 A report by the World Bank defines as middle class those with incomes between US.10 and US.50 per day and per 3 World Bank, Economic Mobility and the Rise of the Latin American Middle Class, 2012. capita.

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World Bank, Economic Mobility and the Rise of the Latin American Middle Class, 2012.

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not expect to receive much for their money when it came to public services. As a result of those policies, the State was typically small and very weak, and even the middle class used to avoid using public services, choosing instead to pay for private basic services, such as education and security. In some Latin American countries, this reality has started to change; the State is playing a greater role in the provision of public services, giving citizens better access to health and education, for example. In fact, as the same World Bank report notes, one of the most important factors in contributing to the growth of Latin America’s middle class are a better educational level among workers, a greater level of formal employment, more people living in urban areas, more women in the workforce, and smaller families. (World Bank 2012).

Even though there have been important economic and social advances in Latin America, there are concerns over the nature of this growth and its sustainability. Some argue that much of this growth is due to better terms of trade and undeniably better macroeconomic policies. In most cases, this growth was characterized by an increase in internal demand for goods and services caused by a greater flow of external resources and, undoubtedly, by the growth in exports mainly provoked by the huge demand for goods and services generated by the growth of China, India and other emerging markets, as well as foreign financing and investment. This is to say that Latin America’s growth is no where near the levels of Asian growth, which are characterized by an external growth based on the productivity of their exports -- especially those of middle and high technology -- high internal savings rates and competitive terms of trade. The continuing challenge facing Latin America is how to increase productivity rates and restructure the productive matrix in order to have a more competitive export portfolio with greater added value, which in turn will make it possible to and generate new employment opportunities and improve average wage and pay scales.

Addressing this challenge will require increasing technology transfer rates, , investing in human talent and improving job training opportunities to develop a skilled labor force better able to meet the demands of these new jobs, and generating competitive conditions to promote innovation in a sustainable manner.

The challenge of increasing productivity and diversifying the economy is no easy task, and it requires coordination and synchronization between industrial, trade and investment promotion policies, as well as the generation of instruments and incentives to create business environments that foster innovation. Undoubtedly, foreign direct investment can play a key role in the transfer of technologies, the generation of new productive capacities and of local content with added value. But this is not an automatic or immediate process, and it requires active public policies that generate adequate incentives so that private investment may fulfill this role.

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This challenge is even greater for countries with abundant natural resources, which require attracting foreign direct investment that also provides high-end technology, and is committed to protecting human and environmental rights. In the vast majority of countries in Latin America, oil and mining resources are settled in regions that are ecologically diverse, economically underdeveloped, and predominantly inhabited by indigenous communities.

In many of these regions, citizens suffered because companies disrespected their human and environmental rights, and national governments have not invested adequately in their social and economic development, nor provided the necessary regulatory oversight of these sectors so as to protect their rights.

For decades the accepted path to attracting foreign direct investment was through the signing of bilateral or multilateral investment treaties. However, many of these treaties were signed without a full understanding our appreciation of the potentially negative consequences of doing so – such as the almost: omnipotent power of international arbitrators to interpret these treaties; the lack of transparency in the process; and the reduced capacity of the state to implement oversight and monitoring policies , as we will discuss later on.

2. The problem of productivity in Latin America and the need to attract Foreign Direct

Investment (FDI).

In spite of last decades of high growth, Latin America continues to face a productivity gap – both internally and externally – which is prohibiting countries in the region from experiencing sustained growth. A recent report on the “state of competitiveness and productivity” in the region4 shows that “the productivity gap in most Latin American countries and the Caribbean, in comparison with developed countries continues to widen, while in Asian countries it has been reduced,” and that productivity differences between countries have also grown. Another proof of technological lag is the reduction in the relative weight of exports with greater added value, so according to the same report, “in 2011, raw material exports represented 60% of the total exports in the region, compared to 40% in 2000. The value of the exports in the region has grown in the past decade, but half of such increase was due to an increase in prices and not to the growth in volume, as was the case in the ‘90s.

At the same time, the increase in exports of raw materials has meant substituting national goods with imports, slowing down the region’s manufacturing production.”

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OECD, CAF, ECLAC, Latin American Economic Outlook 2014, Logistics and Competitiveness for Development

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These factors leave the region more exposed to fluctuations in the price of raw materials. In addition, and as many authors (Fung, Garcia-Herrero and Ospina 2013) have demonstrated, China’s growth and the competitiveness of its exports have been contributing factors to this concentration of exports in primary products in Latin America.

The conditions for productivity and for diversification are varied within Latin America. f we exclude Mexico, for example, the concentrations of exports in raw materials increase to 80%. This average hides big differences in productive structures, given that, while in Mexico raw material exports represent less than 30% of exports, in other countries, such as Chile and Venezuela, they represent a much more greater percentage of total exports.

Specialization and concentration of raw materials also varies from one country to another; Chile and Peru have a high concentration of metals, copper being the predominant export in Chile, while in Peru the exporting structure is multi-metallic. We then have Venezuela, Ecuador, Colombia, Bolivia and Mexico, where hydrocarbon exports are predominant. Uruguay, Paraguay and Argentina focus on food exports, as is the case with Brazil, although iron is starting to gain relative importance.

This exporting pattern has made several countries in the region more vulnerable to a deceleration in demand for exports in China -given the impact that the price of raw materials would have, plus the possible challenges that it potentially represents for medium-term growth.

Structural change and economic diversification of the region should be a key priority. This is no easy task, because it needs to be accomplished while governments are also working to ensure that the demands of the growing middle class are met, and addressing the new skills’ challenges that a knowledge-based economy will bring.

When analyzing the last decade of economic progress, the World Bank notes in a recent report5 that growth in the region was financed by internal demand and by a vigorous expansion of investment, to the point that the region’s investment ratio is comparable to the one for medium-income countries in Eastern Asia. The financing of account deficits in Latin America has been done in part with foreign direct investment, and not with short-term portfolio investments. Despite this fact, the World Bank claims that Latin America’s good performance in terms of attraction of foreign direct

World Bank, Latin America and the Caribbean as Tailwinds Recede, In Search of Higher Growth, April 2013

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investment and the expansion of that investment, does not guarantee that the region will manage to solve the matters of productivity that afflict it. Furthermore, it notes that the quality of investment, and of foreign direct investment is yet an unresolved empirical matter6.

Even though portfolio and venture capital investments are generally considered important sources of funding, foreign direct investment contributes with a combination of capital, technologies and specialized knowledge, including technological externalities; these do not entail the two first sources of funding mentioned. As we have indicated, however, it is not an automatic process, and a government should have coordinated policies in place so that foreign direct investment can create such technological externalities and promote the generation of local added value. The challenge lies in developing investment treaties and commercial agreements that leave enough space to apply these policies.

Economist Ha-Joon Chang affirms that developing countries should lay foundations for their industrialization strategy in a selective and targeted manner7. He considers that industrial policy can at times be spectacularly useful, but that at other times, it can fail mercilessly. Economic development is simply not possible without good execution of industrial policies. He states that economic development requires advanced technology imports, be it in the form of machinery or technological licenses, for which money has to be paid, be it through exports, cooperation or with the flow of foreign direct investment. Latin American economies have not been as successful as Eastern Asian ones in this regard, given their failure in promoting high added value exports. This does not, however, mean that exports are the only key that can open the doors to economic development. It is necessary that we discuss exactly how free trade, the promotion of exports and protection of rising industry – in sectors and in time – can be combined in a way that helps a country improve and transform its industrial structure and grow fast8.

Economist Joseph Stiglitz maintains that governments need to play an important role in any economy, be it by correcting market failures or promoting the building of the “knowledge economy”9. Industrial policy, he states, can affect structures to

De la Torre, Augusto, Eduardo Levy Yeyati, Samuel Pienknagura. 2013. “Latin America’s Deceleration and the Exchange Rate Buffer.” LAC Semiannual Report (October), World Bank, Washington, DC. doi: 10.1596/978-1- 4648-0117-4. License: Creative Commons with Recognition CC BY 3.0.

7 Ha-Joon Chang, Industrial Policy: From Ideology to Pragmatism, Faculty of Economics and Centre of Development Studies, University of Cambridge.

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Ha-Joon Chang, “Globalization, Transnational Corporations, and Economic Development” Steve Denning explains in the article “is the US in a phase change to the creative Economy?” published by Forbes, and commenting Joseph Stiglitz previous Vanity Fair http://www.vanityfair.com/politics/2012/01/stiglitz-depression201201) publication about US economy going through a fundamental shift, what is the Creative Economy? He states

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promote knowledge and learning, and can also function as an effective tool to promote greater equality and more environmental responsibility10.

Choosing the right industrial policy for a country is no minor task, and it should adjust to its historical context and its own potential and capabilities. What is unacceptable, and in this we agree with Ha-Joon Chang, is that the difficulties in the application of “industrial policies the Asian way” is no excuse for not attempting to do it. In countries with an abundance of natural resources, the challenge posed by the application of an adequate industrial policy can be even greater. Many have heard of the so-called “paradox of plenty,” which is to say, economies where the extractive sector is so big that it generates negative incentives so that others do not develop and flourish. The situation is even worse when the foreign investment often attracted does not generate opportunities in other sectors of the economy and when there is no deliberate technological transfer procedure while learning how to perform new activities. This is to say that, where designing and implementing industrial policies in economies with a diverse productive structure is already a difficult task, it proves to be even more complex, though not impossible, in structures that focus in a handful of natural extraction sectors. It is our opinion that industrial policy should correct market and government failures, resolve coordination and information asymmetry problems, and generate the necessary incentives to change the relative pricing of prioritized sectors where public and private investment is to be attracted.

It is regrettable that industrial policy discussions often focus on choosing priority sectors instead of discussing which instruments are more effective than others. Because of this, we believe that professor Stiglitz contributes greatly to the debate when he argues that industrial policy, in its broadest sense, should not only be used for productive restructuring and the generation of growth, better redistribution, and regional and environmental development policies, but to create a learning society. We also agree with the policies he suggested, such as: i)

Investing in human talent.

ii)

Public promotion and investment in innovation, because knowledge is a public good, because of the existence of externalities and spillovers, and because costs of innovation are risky and hard to fund, as there are no

that is one in which both manufacturing and services play a role. It is an economy in which the driving force is innovation. The Creative Economy is an economy in which companies focus not on short-term financial returns but rather on creating long-term customer value based on trust. It is described in Chapter 3 of Richard Florida’s classic book, The Rise of the Creative Class (2003).

10 Joseph E. Stiglitz, “Industrial Policy and Creating a Learning Society”, World Bank, October 2013.

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collateral, and fixed costs associated with learning naturally lead to the existence of imperfect markets. iii)

Developing an intellectual property system that leads to the growth of priority sectors, and

iv)

Considering each level of development, which implies that most of the “learning” is done in increments and is not based on one-time primary innovations.

One of the considerations set forth by Stiglitz and with which we also agree is that state efforts should be prioritized in sectors with a high potential for knowledge transfer to various other sectors of the economy, taking in consideration that there are differences between a country’s learning ability and the efficiency to assign resources, and that there should be tolerance for costs associated with this process. In short, what Stiglitz is pointing out is that industrial policy should not focus only in “choosing winners,” but on identifying which technologies and sectors have a greater ability to generate positive externalities and technological spillovers in the economy, so as to reach a critical mass of knowledge and innovation that allows structural changes to be implemented. Stiglitz also argues that there is no doubt that the industrial and service sectors are the ones with highest learning elasticity and greater transferences to the agricultural and rural sectors, and that there is undoubtedly great value in the State dedicating time and resources to the discovery of those sub-sectors with greater elasticity and externalities for the transfer of knowledge.

Ha-Joon Chang puts emphasis on the competitiveness and productivity levels that prioritized sectors should reach following the internal development stage.. This is not a minor matter, as it requires clear and pre-established criteria and , and state discipline, so that it will not become controlled by private interests. Other important factors are the need to reach a consensus, and for incentives and programs to be sustainable and continuous, and flexible enough to adapt and innovate.

The dilemmas posed by industrial policy are greater for countries with natural resource extracting industries, which generate fewer learning externalities and technological spillovers to other sectors of economy, and this is why it is so important for revenue obtained from these activities to be used efficiently in the productive restructuring and generation of institutional capacities for their successful application.

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In the application of industrial policy, attracting foreign direct investment that contributes to the generation of a local knowledge and technology is necessary for success. This is why it is so important to establish and enforce institutional and legal frameworks and instruments that make it possible to fulfill all of these objectives at once.

3. The challenges of attracting foreign investment under the current international

regulatory framework.

At present, there are more than three thousand bilateral and regional agreements for the protection of investments around the world which provide the legal structure for the international system of investments; these have been subject to a large wave of criticism, especially in the past few years. Stiglitz11 has been very critical of these systems, because he believes that they significantly inhibit the ability of developing countries’ governments to protect their environment from extracting activities carried out by mining and oil companies; their citizens’ health from the tobacco companies; and their economies from the ruinous financial products that played such a large role in the 2008 global financial crisis. He notes that investment treaties could restrict governments even from placing temporary capital controls on short-term capital flows that have so often brought uncertainty in financial markets and fueled crises in developing countries.

As mentioned above, the policies for the attraction of foreign investment should be in line with the needs of public policies for the economic and social development of each nation. However, for the intent of attracting new investment to become real, big multinational companies demand legal and contractual conditions which reduce the capacity of the states to decide on the above mentioned policies, and in many cases question the sovereignty and independence of their judicial systems.

States are increasingly facing more multi-million dollar complaints from foreign companies using the legal framework of Bilateral Investment Treaties and an excessively costly nontransparent arbitration system where decisions cannot be appealed, interpretations of the mandates contained in those treaties are lengthy and extensive, and their regulatory capacity can be frozen in some cases, all of which adversely effects sensitive sectors such as health, environment and human rights.

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Joseph E. Stiglitz, “South Africa Breaks Out”. http://www.project-­‐syndicate.org/commentary/joseph-­‐e-­‐-­‐stiglitz-­‐on-­‐the-­‐ dangers-­‐of-­‐bilateral-­‐investment-­‐agreements#dwF5GMKyczuz2fml.99.

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In a recent article, Elizabeth Orson12 mentions how arbitration disputes which resulted in multimillion dollar rewards against governments were initiated by companies and investors claiming that their investments or future profits were affected by governmental policies which implied the non-fulfillment of the agreements for the implementation of measures aimed at improving health, environmental or economic conditions for their citizens. According to this same author, most of the cases were heard by the International Centre for Settlement of Investment Disputes (ICSID), an agency of the World Bank based in Washington, which has been criticized for a lack of transparency, conflicts of interest and little information available on their procedure toward cases and their results. Ecuador, in acknowledging these systemic shortcomings, decided to withdraw from the ICSID after submitting its complaint in July 2009.

The ease with which investors may file international arbitrations against sovereign states and succeed on a wide variety of issues originates from the nature of investment agreements, of which there are two types: bilateral treaties of investment signed between governments and of which there are 3,000 in the world, and the chapter on investments contained in bilateral or regional free trade agreements.

There are several controversial issues in relation to investment agreements. We will mention the most important ones, including but not limited to the following: First, the definition of "investment" is generally broad and includes everything from direct to indirect investments, and from portfolio investments to loans, licenses, agreements and intellectual property. Investors may file claims alleging a violation of their rights of any of their operations.

Second, investors can file claims alleging a violation of the protections afforded to their "investment", regardless of the fact that in some cases those investments have a contract in which it was agreed to use local courts of the recipient state as a method of dispute resolution; this makes a mockery of the use of international treaties and what was freely agreed to between the parties to a contract.

Third, investment treaties guarantee national treatment, "fair and equitable" treatment and full protection and security of investments. The definitions in these categories are so flexible that investors can claim a violation of their rights based on a wide range of reasons. This has allowed tribunals to reach interpretations of these

Elizabeth Orson, The growth in global disputes brings big profits for attorneys, New York Times, August 26, 2013.

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provisions that have been considered expansive and have granted protections not previously provided by States when negotiating and signing these treaties.

Fourth, several of these treaties prevent governments from controlling or regulating capital inflows and outflows, and some prevent them from imposing performance requirements, such as technology transfers, on foreign companies. The latter is a clear example of the limitations that these treaties impose on the implementation of industrial policies that enable greater levels of technology transfer and aggregation of local value, key to the growth of productivity and economic diversification in developing nations.

Fifth, some treaties prohibit the expropriation of investments without due compensation and must be “just, timely and effective”. The definition of "expropriation" is also very broad, and in addition to the direct definition includes indirect expropriation, as in and confiscation or application of new measures that affect any possible revenues and investment earnings. If investors ask for treatment no less favorable than that granted to domestic investors who are not protected by these treaties and are equally affected by changes in public policies, the potential compensations that arbitrary decisions would grant would grow become asymmetrical and seriously distorted, prejudicing domestic investors while benefitting only foreign investors.

Sixth, the vast majority of these treaties allow investors to take governments directly before an international tribunal without first exhausting local administrative and judicial resources; this causes meager state resources to be diverted toward defending legal cases internationally without allowing the State to redress any damage that may have been caused by the very mechanisms that guarantee the said State.

Seventh, the arbitration system is plagued by deficiencies that are not found in normal tribunals. What often occurs, for example, is that Tribunal members act as counsel for investors in other legal cases, or there is some form of a conflict of interest.

Chakravarthi Raghavan, an expert on commerce and international investment maintains “the panels of the ICSD are constituted by attorneys who at times are on the panel, while others participate in trials of companies against governments and have no obligation to reveal their conflicts of interest.” In his opinion, “It’s time to denounce investment treaties and the ICSID system, as well as those arbitrary ‘arbitration’ panels.”

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Eighth, arbitration cases on investment treaties are treated with maximum reserve. The cases are not openly handled, and their existence and results are not officially recognized. Suffice it to say, the levels of transparency are significantly reduced.

Ninth, it is difficult for a country to withdraw from an investment treaty with immediate effect, even if it has decided that it is against its interests, since the same treaties often include a "survival clause" – a provision that obligates the State to maintain the protections afforded to the treaty for between ten and fifteen years after its concrete retirement, depending on the terms provided in each treaty.

Tenth, in investment treaties, although investors are not part of the same treaties, they are conceded the opportunity to be plaintiffs in an arbitrary process against States receiving investment, and yet, to the contrary, States generally cannot present claims against investors. Thus, the arbitration proceedings do not grant reciprocal rights to encourage the promotion of responsible investments to benefit both recipient States of investments and investors alike.

Eleventh, Courts base their decisions on references from others, without considering the interpretations of States themselves over the terms of their agreements.

The proliferation of complaints against States has grown rapidly – from 38 cases filed in 1996 to 250 cases filed in 2011. In addition to various stated issues, this has caused several countries to take initiatives to assure a balance between national public interests and transnational private interests. Several countries have adopted recent measures to review or amend their investment treaties. South Africa, after completing a review of its investment treaties, has decided not to sign any more, will attempt to abandon or renegotiate existing ones, and will formulate a new model. Australia has announced it will not agree to any more provisions on disputes between investors and states in its investment and free trade treaties, as these provisions would limit the governmental capacity to write laws on social, environmental and economic matters.

India is reviewing its investment treaties, especially the provisions related to conflict resolution, after having faced the threat of complaints derived from an order issued by the Supreme Court to cancel the granting of 2G telephone licenses to several foreign telecommunications companies, as it was considered to be unconstitutional. Ecuador is bound by its new Constitution to renegotiate or report the bilateral treaties it has negotiated, and Venezuela is evaluating a similar decision.

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The United States spent several years reviewing its negotiation model of bilateral investment treaties, and counted on a broad participation of public institutions, academia and experts on the matter to do so. In a document13 published by the Columbia University’s Vale Columbia Center on Sustainable Foreign Investment, it was mentioned that “the few changes made seem to reflect the efforts to address the issues caused by recent events, such as the growth of investment in and from China, as well as the world financial crisis, and the increase of persistent problems in relation to when and how to reconcile Investment Treaties with national or international policies with labor and environmental standards.”

Among the provisions included in the new model to increase the regulatory capacity of States, the document lists the following: •

More accurate definitions for what is understood as investment, minimum standards and compensation for expropriations;

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Allows exceptions to the express prohibition of compliance requirements for investors, which would favor the application of industrial policies in certain cases;

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Expressly includes the regulatory capacity of states over financial services, and

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Modifies some aspects of Investor-State disputes to grant greater power to signatory states in order to determine which matters could be subject to a binding interpretation in court.

Notwithstanding the new provisions, much of the 2004 model was kept intact in the text of the 2012 model. One of the most debated provisions, which remained intact, deals with the investor-state arbitration system, even though critics of the said system, including Ecuador, have argued in favor of its elimination of reorganization.

Also remaining is the obligation for States to offer “minimum standards of treatment,” without clarifying notification on the reaches of those standards. Finally, the elimination of restrictions on capital transfers also remains, and many consider this as binding the hands of governments in responding to or avoiding financial crises.

Lise Johnson, Political Risk Insurance News Letter, Volumen III, Issue 2, November 2012, Vale, Columbia University, http://www.vcc.columbia.edu/files/vale/content/Political_Risk_Insurance_Newsletter__The_2012_US_Model_BIT_-_Nov_2012.pdf

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In short, the most important changes identified in these two models may be divided into three segments: the first directed to grant facilities for the promotion of international investments, the second directed to improve provisions to regulate financial services, and the third on provisions for the protection of the environment and labor rights.

The first segment, which includes”facilitation for foreign investment”, contains provisions on transparency in the defining process of public policy, including articles that necessitate private sector participation in discussions of the said issues, in addition to providing advance notice to investors of any changes in laws and regulations that could modify topics in the said treaty. It notes the need to have enough time to discuss regulatory changes, which should be sufficiently motivated and communicated. There are exceptions to these requirements regarding rules related to food security, human health and the environment. This chapter also includes relative provisions that expressly prohibit States from requiring the use of specific technologies with the intent of protecting local industry, with exceptions made for public purchases, and health, animal and environmental security. It also requires that public companies and all levels of government comply with the mandates in the treaties.

The second important change in the document refers to provisions to regulate financial services. Although the changes are modest when compared to the 2004 model, they clarify and provide procedural and substantive protection for States to regulate financial services. Another variation in the 2012 model is that it clarifies that the Treaty should not be interpreted as to prevent State parties from adopting or applying determined relative measures to regulate financial institutions, including those which are necessary to prevent misleading or fraudulent practices in financial services.

The governmental decision to leave the above provision intact regarding the free transfer of capitals indicates that the United States government considers its current investment treaties have the proper level of authority to regulate financial services and to develop and implement monetary policies.

The last change refers to provisions on environmental and labor rights protections, and acknowledges that member states hold a right to exercise at their discretion the terms of implementing environmental policies and regulations. The respective policies toward the labor market broaden the scope of coverage in “labor laws,” and include issues related to non-discrimination, including clauses by which the signatory States reaffirm their obligations under the instruments of the International Labour Organization.

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Just as the United States has acknowledged to a certain extent the issues that the current application of investment treaties could cause to the States, the European Commission has also shown some concern. In a fact sheet14 issued by the European Union in November 2013, entitled "Investment Protection and Investor-State Dispute Settlement in EU agreements,” the European Commission holds that the provisions for the protection of investments, including Investor-State Dispute Settlements, are important for investment flows. However, the commission acknowledges that the system needs significant improvements. These improvements should seek a better balance between the right of sovereign States to regulate and the need to protect investors, as well as ensuring that the arbitration system is unquestionably transparent in the appointment of arbitrators and the assignment of procedural costs. The position of the commission is balanced given that it also acknowledges there are issues which could not be resolved through national courts, which could include those rare but existing cases of expropriations made by the host country by force, discrimination, expropriation without appropriate compensation, revocation of business licenses and abuses committed by the State such as the lack of due process, or the impossibility of making international transfers of capital. When creating legal security and foreseeable capacity for companies, the protection of investments is also a tool for the States around the world to attract and keep direct foreign investment so as to strengthen their economies.

The European Union has announced that the Commission is working to implement improvements in two specific fronts: I.

Explaining and improving the investment protection rules with the purpose of achieving legitimate public policies. The European Union agreements ratify the right of parties to regulate. (a) Some provision details are proposed in order to provide guide to

arbitrators on how to decide if a government policy constitutes indirect expropriation or not. The rights of the government should prevail over the economic impact of those measures on investors.

(b) Better defining the standards for the "fair and equal treatment" often

invoked by investors The Commission has had a wide margin for interpretation.

European Commission Fact Sheet “Investment Protection and Investor-to-State Dispute Settlement in EU agreements”.

November 2013. http://trade.ec.europa.eu/doclib/docs/2013/november/tradoc_151916.pdf

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II. Improving the manner in which the dispute settlement system operates. Preventing

investors from bringing complaints considered frivolous and making the arbitration system more transparent, dealing with conflicts of interest and introducing safeguards for the parties.

4.

Lessons learned from the Texaco-Chevron case in the historical context of Ecuador

The Texaco-Chevron case in Ecuador brings important lessons to the international community for the formulation of policies to attract foreign investment, as well as for the reform of arbitration systems in investor-state litigation. Before discussing them, it is first necessary to place these lessons in the context of Ecuador’s recent history.

4.1 Ecuador: history of disparities and truncated efforts of development.

The history of Ecuador does not differ much from most other countries in Latin America. In the sixties, oil was discovered in the Ecuadorean Amazon and its exploitation began with foreign investment from the Texaco oil company. The decade of the seventies was defined largely by investment in infrastructure. The eighties by contrast was a lost decade, marred by indebtedness. The nineties saw unstable growth, characterized by internal imbalance and external financial problems, in addition to political instability and a lack of governance with no precedents since the return of democracy at the end of the seventies.

Like many other countries in Latin America, Ecuador has suffered from institutional weakness that undermined its possibilities to formulate public policies and properly regulate its markets. This weakness created a context in which the applicability of laws was proven to be relatively low, along with its institutional strength.

The formulation of laws in this environment changes rapidly and often, rarely surviving power fluctuations15.

To the detriment of the structural design of sustainable public and state policies, institutional weakness in the country historically facilitated the imposition of

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See, Steven Levitsky, María Victoria Murillo, Continuity and change in a Weak Institutional Environment

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group interests clearly identified with economic power and with the status quo of an elitist society divorced from less fortunate groups. The lack of commitment from elites and upper and middle classes in a social pact whereby all classes would contribute to the inclusive development of the nation characterized the Ecuadorean tax system. The country simply lacked a culture of paying taxes.

Multiple and unsuccessful external debt negotiations in the eighties weakened the capacity of governments at that time to exercise greater control over their policies, which inexorably compromised the future of the country. The demands of the International Monetary Fund favored the wellness of international markets over the situation and social effects, which conveyed its demands in the economies fulfilling its criteria. In this decade, Ecuadorian politics was almost exclusively aimed at providing payment capacity to the country to service its external debt.

This lack of strength in democratic institutions combined with an economic, political and social environment which sustained processes of ungovernability guided Ecuador from the decade of the nineties through one of the most serious and extended crisis of its republican history. This decade, which deeply marked the foundations for the configuration of Ecuadorian society at the beginning of the 21st century, witnessed the first indigenous uprising against the injustices of their historical subjection. In 1994, financial regulations were reformed and liberalized, causing companies and banking entities to become indebted in an irresponsible and accelerated manner. By the mid-nineties, Ecuador entered into an armed conflict with Peru in the Alto Cenepa War, a conflict that offset highly negative effects in the external sector, and which weakened the financial system as a result of an unprecedented increase in interest rates. Then, the country became embroiled in political crisis, which would precede many others within the lapse of a few years. This macroeconomic environment -- weakened by a series of errors that were influenced by neoliberal economic policies, weak institutions and political disputes – was a “perfect storm,” creating all the necessary conditions for the greatest financial crisis of the second half of the decade.

Between 1997 and 199916 several events occurred which worsened Ecuador´s situation. Ecuador suffered the consequences of a climatic phenomenon known as El Niño, a very sharp fall in oil prices, and the effects of the Asian financial crisis. In the midst of a severe financial crisis in February 1999 that caused the closure of several institutions including four large banks, the recently independent Central Bank of

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See, Correa Rafael, La Crisis de 1999 y sus secuelas, page 55, Ecuador: de Banana Republic a la No República.

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Ecuador17 committed a grave error in economic policy when it implemented a free floating system to replace a system of exchange rate bands which was maintained for many years. The free flotation of the dollar, in addition to the existing excess liquidity and speculation generated by pessimistic expectations of economic agents, generated a violent depreciation in the Ecuadorian currency. In that time, the private and public sectors kept a large amount of liabilities in dollars, which provided an additional aggravation to the crisis, and that became a drag on the country. Then, at the beginning of the year 2000, when the Sucre had depreciated almost 25% in less than a week, the dollarization of the Ecuadorean economy was announced.

From a social point of view, there is no doubt that the crisis at the end of the decade represents one of the most accelerated processes of impoverishment in Ecuadorean and Latin American history. Unemployment and underemployment significantly increased, and between 300,000 and 1,000,000 citizens are estimated to have left the country as a result of the crisis, generating an unbearable national tragedy with serious impacts on the wellbeing of Ecuadorean society18.

In 2003, during the government of Lucio Gutiérrez, Ecuador signed its thirteenth Letter of Intent with the International Monetary Fund that set out a series of measures which obliged Ecuador to undergo a deep austerity process in spending and to further pay its external debt, alleging a wrong fiscal discipline clearly imposed by the criteria of the Washington Consensus. The Gutiérrez government signed along with the letter of intent the beginning of his removal in addition to a number of political mistakes that finally caused his popular dismissal from the political power in April 2005.

The difficult political, economic and social period which Ecuador experienced during the second half of the nineties and the first five years of the 21st century also resulted in nine Presidents to be dismissed from political office: Abdalá Bucaram, Rosalía Arteaga, Fabián Alarcón, Jamil Mahuad, the triumvirate made up of Antonio Vargas, Lucio Gutiérrez and Carlos Solórzano; Gustavo Noboa and Lucio Gutiérrez.

The lack of institutional strength and numerous errors in economic policy decisions during this critical period left caused Ecuadoreans to become skeptics and critics of political actors, and they demanded change.

Such was the backdrop against which the Ecuadorean people democratically elected Rafael Correa as President of the Republic in November 2006. The message of

17 18

The Constitution of Ecuador of 1998 confirmed the independence of Banco Central of Ecuador.

Correa Rafael, El costo social de la crisis y la emigración, Ecuador: de Banana Republic a la No República.

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change and support for issues in health, education, labor and well-being, and the creation of a new country permeated the Ecuadorean citizenry. Since that time the electorate has strongly supported all of the proposals presented by the new government for popular referendum.

On January 15, 2007, Rafael Correa assumed the Presidency of the Republic with the offer of convoking an Assembly to draft a new Constitution. A few months later, a referendum was called with the purpose of asking the citizenry about the possibility of convoking a Constitutional Assembly, obtaining in consequence an overwhelming victory. Once the Constitutional Assembly was convoked, the text for a new Constitution was approved. The text was submitted to a new referendum for approval, which resulted in a wide margin of support from the Ecuadorean people.

With the lessons learned from a costly exploitation of petroleum in terms of harm done to the environment and the health of the Ecuadorean people, one of the political priorities of the new Constitution was to create legal institutions to protect human rights and the environment. This national interest was successfully included in the recent 2008 Constitution.19 The second title incorporated the declaration of a series of rights, including the right to “well-being or suma kawsay” and the “rights of nature,” making it the Constitution with the largest number of guarantees in the history of the Republic.20 Furthermore, the 2008 version became the first Constitution in the world to acknowledge the “Rights of Nature”.

The stability and growth in the Ecuadorean economy during the last years have made Ecuador a regional leader in many ways. The rate of growth experienced by the Ecuadorian economy since 2008 is higher than that of Brazil, Mexico, Chile and Colombia, among other economies in Latin America, and surpassed only by Peru.21 During the period between 2007 and 2013, the Ecuadorean economy grew at a rate of 4.3% of GDP. Likewise, according to the World Bank, the country has advanced from being a middle-income economy to an upper-middle income one. High public investment was made possible thanks to an increase in tax revenue of about 5% of GDP, while higher oil prices have made Ecuador an important regional leader in infrastructure investment, health and education, to name a few, as is reflected in the high indices of public investment as a percentage of GDP (12% for Ecuador).22 At the same time, Ecuador is among other economies with the lowest debt to GDP ratio.

See Constitution of Ecuador, sections 71 – 74. http://www.asambleanacional.gov.ec/documentos/constitucion_de_bolsillo.pdf 20 21 See annex 7 22 See annex 8 19

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The social investment in the country grew 3.4 times its value between 2006 and 2013, from $1.934 million in 2006 to $6.647 million in 2013. 23It is worth mentioning that between 2007-2012 Ecuador was one of four countries experiencing the highest advances in human development, one of the most important social indicators measured by the United Nations. Achieving 10 higher levels in ranking and transforming from a country of Medium Human Development to one of High Human Development, Ecuador is also ranked among the three best countries in terms of poverty reduction, and number one in inequality reduction according to data issued by the United Nations, ECLAC (2013).

In terms of education, Ecuador has taken great steps toward democratizing access to quality education and implementing profound reforms at each level of the education system. The accomplishments in the accreditation of institutions and teachers, the tuition-free nature of the system and historical investment directed toward emblematic efforts such as the scholarship program have made it possible to place about 7,000 students in the best universities around the world. Education reform has generated an important increase in school attendance indices, rising from 91.2% in 2006 to 95.6% in 2012, and making primary education almost universal; middle school attendance rates increased from 47.9% to 63.9% in the same period. Access to postsecondary education has expanded considerably, achieving rates of 30%. Particularly benefitting from this increase in access to education at all levels are lower income demographics, Indigenous peoples and Afro-Ecuadoreans. Furthermore, the achievements attained in the increase in access to health services, malnutrition assistance, social protection and inclusion are also notable.

Finally, thanks to public investment in infrastructure (highways, ports and new airports), changes in the energy grid, investment in human talent and innovation, Ecuador has managed to continuously improve its competitiveness, as was recently acknowledged by the Global Competitiveness Report of the World Economic Forum (2013-2014), in which Ecuador scaled up 15 positions and reached its highest level of competitiveness since the index was established.

4.2 The Texaco- Chevron Case

23

See annex 11

19

The relationship which started with Texaco in 1964, and which would finally rival the Republic of Ecuador with Chevron, began with the exploration for petroleum in an important zone of the Ecuadorean Amazon when Texpet formed part of a consortium charged with the exploration and exploitation of petroleum in an area of approximately 500,000 hectares of Amazonian rainforest. In such a fragile and priceless ecological space, not only had Texaco drilled24 356 wells and dug approximately 800 holes to bury mud and contaminated material, the company also poured millions of gallons of toxic material (waste water and produced water) and 16.8 million gallons of crude oil into rivers from the property where it operated oil wells.25 The Amazonian rainforest is considered as one of the most bio diverse habitats in the world, and yet its ecology has suffered devastating damages as a result of the callous techniques used almost a quarter of century ago by Texaco.

The company Texaco, now Chevron because of the acquisition made by the later at the beginning of 2001, was the only operator of the consortium for 25 years. In June of 2004, Chevron Corporation and Texaco Petroleum Company filed suit against Petroecuador on the basis of a clause included in the joint operation agreement (known as JOA), signed in 1964 by Gulf and Texaco, the two original participants.

Chevron/Texaco alleged that Petroecuador was also subject to the clause that obligated the non-operating parties to compensate the operator for any sentence decided against it. Ecuador opposed such arbitration before a NY Court. On July 24, 2009, a judge of the New York federal Court accepted Ecuador’s position in the sense that Petroecuador did not have to go to arbitration with Chevron/Texaco. The Supreme Court of the United States denied hearing the case, ratifying the decision pronounced by the lower courts.

During the time in which Texaco was in charge of the exploration and exploitation, it neither observed the recommendations made in 1963 by the American Petroleum Institute, contained in a complete manual of technical recommendations for remediation, nor did it use a remediation system patented by the same Texaco, considered as a cutting-edge technology system for that time. Texaco, in order to reduce costs used a system that mistreated the Ecuadorian Amazon’s nature, with the well-known consequences upon human life, flora, fauna, aquatic species, etc.

Ministry of Foreign Affairs and Human Mobility of Ecuador, “La huella de Chevron-Texaco en el mundo”.

Ministry of Foreign Affairs and Human Mobility of the Republic of Ecuador. “Chevron-­‐Texaco’s Footprint on the World.” November 2013. http://www.serpajchile.cl/web/wp-­‐content/uploads/2013/11/Folleto-­‐explicativo-­‐espa%C3%B1ol-­‐La-­‐Huella-­‐de-­‐Chevron-­‐Texaco-­‐en-­‐el-­‐ Mundo.pdf

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The first type of disputes to which we will refer only involves private sectors, directly harmed citizens of local ethnic groups and mestizo residing in the Amazonia, filed judicial claims more than 20 years ago against Texaco initially, and then against Chevron. The second type of disputes involves arbitration complaints filed by Chevron against the Ecuadorian State, this is an investor-state type of complaint, despite of the fact that Chevron has never invested in Ecuador, and that the Bilateral Treaty of Investments came into effect only five years after Texaco left the country. The court set up under the Ecuador-United States Bilateral Investment applying the Arbitration Rules of the United Nations Commission on International Trade Law, UNCITRAL, has declared its jurisdiction retroactively. Details of this case will be discussed below.

4.2.1. Communities of Lago Agrio vs. Texaco-Chevron The case of the Lago Agrio communities vs. Texaco-Chevron is one of a completely private nature, in which the affected citizens had their first attempt at seeking justice through the Aguinda case, where seventy-four Ecuadorians representing over 30,000 people residing in the affected area filed a lawsuit against Chevron-Texaco in 1993 in the Court of the second district of New York. The Plaintiffs claimed: (i) compensation for damages and losses, (ii) judicial protection to remediate pollution and contamination of the environment, and (iii) compensation for physical damages and damages to the property, caused by contamination.

For nearly 10 years the Ecuadorians fought without succeeding in a foreign court. Chevron’s argument did. The affidavits of an important list of attorneys requested by Chevron, convinced Judge Rakoff of the district court for the second district of New York, and then confirmed by the appeal court of the second circuit26 of

See Lucien J. Dhooge, Aguinda V. Chevron: Mandatory Grounds For The Non-Recognition Of Foreign Judgments For Environmental Injury In The United States, Litigation in the United States, Texaco in Ecuador: the resulting litigation, bottom of page 58, Aguinda v. Texaco, Inc., 303 F.3d 470, 480 (2nd circuit. 2002). At the beginning Texaco claimed to disregard the case based on the failure of plaintiffs of joining the Republic of Ecuador, forum no conveniens, and international courtesy. Aguinda v. Texaco, subsection num. 93 Civ. 7527, 1994 the United States. Dist. LÉXIS 4718, at *2 (south district of New York. on April 11 of 1994). The district court requested investigation as to if the central office of Texaco of the United States directed the activities of its Ecuadorian affiliates and the need of using localized evidence in Ecuador to prove the defendants' claims. Id. at *3. The district court then granted the request made by Texaco of rejecting such claims based on forum no conveniens. Aguinda v. Texaco, subsection 945 F. Supp. 625, 627 (south district of New York 1996) (subpoena to Sequihua v. Texaco, subsection 847 F. Supp. 61 (south district of Texas 1994)).

However, this dismissal was reverted by the appeal court of the second district of the United States. The appeal court for the second district due to the absence of a requirement that Texaco submits to the personal jurisdiction of Ecuador.

Jota v. Texaco, subsection 157 F.3d 153, 155 (2nd Cir. 1998). After the reconsideration, the district court rejected again the claim based on forum no conveniens, but only after obtaining the written consent from Texaco to "be sued for these claims (or their equivalent Ecuadorians) in Ecuador, to accept the process service in Ecuador and waive during 60 days after the date of this dismissal any defense based on the statute of limitations which may have exhausted since the introduction of the immediate claims". Aguinda v. Texaco, subsection 142 F. Supp. second 534, 539-554 (south district of New York 2001). The Federal Second Court of Appeals asserted this disregard with the modification that Texaco "should waive to any defense based on the statute of limitations during periods of limitation, expiring between the

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New York, which based on the forum no conveniens thesis, returned the case to be definitely heard in Ecuador, after assuring that Chevron accepted in writing to submit to the courts of Ecuador, with an implicit acknowledgement of the capacity of the Ecuadorian judicial system to solve the claims filed by the company. Chevron obtained what it had been seeking during a significant period of time and repeated the same argument before a Californian court that also accepted the forum no conveniens thesis claimed by Chevron in 2007.

The same plaintiffs, after failing in the New York courts, decided to file an action in Lago Agrio, Ecuador, where they sought the same environmental remediation as in the case Aguinda filed in New York.

In general terms, their petition included the eradication or removal of contaminating substances that are still threatening the environment and the health of the inhabitants including: I.

The removal and appropriate treatment and disposal of contaminating material and waste maintained in the raw wells of oil.

II.

Cleaning of rivers, estuaries, lakes, swamps and natural and artificial streams.

III.

In general terms, cleaning of lands, fields, sown fields, streets, roads and buildings, which may be still contaminated by the waste derived from Texaco operations.

IV.

Design and implementation of a medical monitoring plan.

After a process of around seven years of duration, on February 7, 2011, Judge Nicolás Zambrano declared Texaco-Chevron guilty of contamination and ordered payment by Chevron of the following items: a. $600 million for remediation of underground waters. b. $5,396 million for remediation of lands. c. $200 million for restoring the flora, fauna and native aquatic life. d. $150 million to implement a system of drinking water in the affected

areas.

request date of the actions proposed in the United States and one year (instead of 60 days) following the disregard of these actions. ” Aguinda, 303 F.3d at 478-80.

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e. $1,400 million to establish a health system, which serves the needs of the

general people of the affected areas.

f.

$800 million for health plan to include potential treatment for cancer.

g. $100 million to reconstruct ethnic communities and indigenous groups.

The judge order doubling the compensation amount if Chevron did not publicly apologize to the plaintiffs. In other words, punitive sanctions were made against Chevron.

The Court of appeals ratified the judgment and so did after the National Court of Justice as to the substance, but the punitive damages ordered by Judge Zambrano were reverted, and on November 12, 2013 Chevron was ordered to pay the amount of $9,500 million. Chevron subsequently presented a request to the Constitutional Court of Ecuador in December 23, 2013, requiring the cancellation of the environmental award against the company. To this date, the petition is pending.

4.3 The RICO Case This case, just like the Aguinda case and the Lago Agrio case, is a lawsuit between private parties, where the Ecuadorian state does not participate nor is an interested party.

In this case, Chevron directed its attacks on the people affected by the contamination and their lawyers, using the legal framework known as "Racketeer Influenced and Corrupt Organizations Act" (RICO).

Chevron's intent with this action is to obtain a decision from the Court of the Southern District of New York stating that the Lago Agrio plaintiffs have acted fraudulently in the process and affected the first instance judgment of Ecuadorian courts. In order to avoid a jury trial, Chevron chose to withdraw any claim seeking money damages in the RICO case. Chevron instead chose to seek only "equitable" relief from the RICO defendants. Among other forms of equitable relief, Chevron is asking Judge Kaplan (in charge of this case) to grant "injunctive" relief—an order requiring the RICO defendants to do something, or to refrain from doing something. Specifically, Chevron is seeking an order from Judge Kaplan directing the

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RICO defendants to refrain from seeking enforcement on the Lago Agrio Judgment.

The process that is taking place in the district court of the United States in the Southern District of New York has sparked controversy and criticism in the international law specialized circles, which agree that there is no court in the United States with jurisdiction on the judicial system of another country. Another critical legal issue in the RICO case is whether US law even allows a private party to obtain "injunctive" relief in a RICO case. Chevron says it does. The RICO defendants say it does not. This issue is currently before the Court of Appeals for the Second Circuit in another case (the Sykes case). In that unrelated case, Gibson Dunn, Chevron´s legal firm is ironically representing the defendant and argues there that the plaintiff is not entitled to injunctive relief. As a result, Gibson Dunn is in a rather awkward position, arguing two different legal positions in two different cases. If Gibson Dunn prevails in the Sykes case, then Chevron will not be entitled to injunctive relief in the RICO case.

This case is ongoing as we write this essay, but it is very probable that even if Judge Kaplan agrees with Chevron that injunctive relief is available as a remedy to them, the RICO defendants will appeal that decision to the US Court of Appeals for the Second Circuit – the same court that will be deciding the issue in the Sykes case.

4.4 Chevron vs. Ecuador 4.4.1. The second international arbitration (2006-2011) In December 2006, Chevron filed an arbitration notice based on the EcuadorUnited States Bilateral Investment Treaty, arguing that the Ecuadorian courts had violated the treaty signed by Ecuador by not solving seven commercial cases that Texaco had presented against the Republic towards the beginning of the 90s, related to the operations of the consortium. The court assumed jurisdiction on December 1, 2008, and in a partial award issued on March 30, 2010, the court determined that Ecuador has not complied with section II (7) of the Investment Treaty and was responsible for the damages caused to Chevron.

The court ruled on August 31, 2011, in favor of Chevron, granting them approximately $96 million plus interest. The court determined that a 15-year delay in solving commercial cases constituted a breach of the treaty, but did not conclude that

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the Ecuadorian court system was unfair, corrupt or acting with a prejudice against Chevron.

The Ecuadorian position, represented by the State Attorney General, has been that an arbitration court cannot create, in the Bilateral Investment Treaty (BIT), a protection standard different to the one agreed on by the parties, and in this specific case, far from what the court expressed, the clause at stake was nothing more than the denial of justice standard as established in Customary International Law, as it was established by another Arbitration Tribunal with respect to the same regulation.

However, the Court concluded that: a. Section II (7) of the TBI sets for an independent standard of “effective media,” which is to say a lex specialis, different from the denial of justice standard agreed on by the parties. b. This standard requires a different and less demanding test in comparison to the Denial of Justice standard under Customary International Law. Ecuador disagrees with the interpretation made by the Court of Arbitration, because Section II (7) of the BIT does not provide for protection of investors that is different from the one established by the Denial of Justice standard, in accordance with Customary International Law. Section II (7) does not constitute a standard that is independent from the Denial of Justice standard under Customary International Law, accordingly, a Court of arbitration could not “replace” local judges, because this means a manifest excess of power.

It is for this and other reasons, such as the obvious lack of jurisdiction of the Court who agreed to give retroactive effect to the Bilateral Treaty for the Protection of Investment between Ecuador and the United States, that the defense of Ecuador introduced in late 2011 before the Hague Court—which applies since the city is the location of the arbitration court—a request for annulment of arbitral awards made in the arbitral process, which is in the appeal stage.

4.4.2 The third international arbitration (2009 – present) 27.

On September 23, 2009, Ecuador received notice for an arbitration process before

27

Carrión Diego, Presentation of Chevron-Texaco–Ecuador Case, State Attorney General’s Office, 2013.

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the Permanent Court of Arbitration of The Hague, requested by Chevron, which would take place under the CNUDMI-UNCITRAL arbitration rules, given the bilateral investment treaty between the United States and the Republic of Ecuador. In broad terms, Chevron claims denial of justice, unfair and unequal treatment and discrimination. This proceeding has as a precedent the lawsuit filed by the communities of Lago Agrio against the company in May 2003.

In May 2010, following the integration of the panel of arbitrators, the court began deliberations and analysis of the court’s jurisdiction on the matters claimed by Chevron, arriving to the conclusion on February 27, 2010, that the court had jurisdiction over the matter.

On April 1, 2010, the court initiated the analysis to take preventive measures, which were issued in a temporary award on February 7, 2013.

The respective hearings to support the plaintiff and the defense were split into three tracks. The first track related to the legal nature of the release agreements signed

by Ecuador and Texaco. The hearing took place on November 28, 2012, and the court issued an award on September 17, 2013. The second track took place on February 18, 2013; the matters of this track include Chevron’s accusations against the Republic of Ecuador on breach of BIT and denial of justice. On December 16, 2013, Ecuador filed a written rebuttal to Chevron’s accusations, and currently, as a result of the presentations of Ecuador regarding the effect of the appeal judgment on the process of Lago Agrio, which changed the assumptions of Chevron´s claim, a new calendar was issued, in which a further exchange of letters between the parties, of the phase one and two, will run until April 2015, when a hearing on the second track will be held.

The schedule for the third track is not officially determined. If deem necessary this phase will cover the determination of the compensation values, among which the amount of environmental damage caused by Chevron must be taken into account.

The existence of a new calendar shows that it is wrong to expect a resolution to this arbitration in the short term, that claims raised by Chevron have been premature and that, contrary to a basic rule for analysis of denial of justice, no opportunity was given to the Ecuadorian legal system in its entirety to rule on the process of Lago Agrio since it was just November 2013, when the National Court of justice delivered its appeal judgment,. It also must be taken into account that the Constitutional Court ruling is pending

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On January 7, 2014, the state of Ecuador submitted, before the Court of The Hague, a request for nullification of the partial award on Stage I of arbitration initiated

by Chevron against Ecuador on September 23, 2009. Additionally, the request for nullification includes the temporary awards issued by the court on preventive measures issued on January 25 and February 26, 2012, and on February 7, 2013. The same measure was requested on the temporary award on jurisdiction and admissibility issued on February 27, 2012.

One of the most controversial matters of this case and on which the Republic of Ecuador bases its defense is the retroactivity the court incurred in by accepting jurisdiction on the case on the basis of BIT, since the Court considered that the Treaty protected the investment Chevron finalized in 1992. Regarding this matter, the court ruled that: a) The investment did not end in 1992, as there is a close link between the Concession Agreement from 1973 and the Transaction Agreement of 1995. The 1995 Transaction Agreement is part of the global investment invoked by TexPet, and with the Lago Agrio lawsuit, such an investment has not yet fully and completely disappeared. b) The BIT does not impose a time limit to the investment. c) The definition of investment established in Section I (1) (a) of the BIT, lists a wide variety of different ways, and Section I (3) establishes that any later changes to the manner of investment or reinvestment shall not affect the nature of the investment.

The Republic of Ecuador claims the following, regarding the arbitrators’ decisions on jurisdiction: a) The non-retroactivity of the Bilateral Investment Treaty arguing that the disputes invoked as precedents for arbitration arose before the Bilateral Investment Treaty was in force, and, therefore, are beyond its time scope. The Courts cannot exercise jurisdiction on facts and rights prior to the applicability of the treaty, under the non-retroactivity principle of the treaties. b) Nonexistence of the investment to be protected by the Bilateral Investment Treaty, given that:

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•

TexPet had made an investment in the hydrocarbon sector of Ecuador, but that investment was voluntarily terminated in 1992, five years prior to the validity of the Bilateral Investment Treaty entered into with the United States.

Since then, neither TexPet nor Chevron had maintained any business or any actives in the hydrocarbon sector of Ecuador, nor in any other sector.

•

17 years have gone by between TexPet’s voluntary abandonment of their investment in Ecuador and the beginning of the disputes of this arbitration.

•

The Plaintiffs cannot use TexPet’s previous investment in Ecuador as grounds for the allegation of jurisdiction for ratione materiae regarding the differences presented before the courts of arbitration.

Regarding the matters of Liability, Chevron's aspirations can be summarized in the following matters: a) For the court to declare that, in accordance with the Transaction and Release of Liability Agreements of 1995, 1996 and 1998, and in accordance with the Concession Agreement entered into between the parties, Chevron and TexPet have no legal or general responsibilities: a. For the adverse effects caused to the environment, human health, the ecosystem, indigenous cultures, infrastructure, etc. b. Nor for carrying out any environmental remedies originated in the old relationship between TexPet and Ecuador. b) For it to be declared that Ecuador has violated the Transaction and Release Agreements of 1995, 1996 and 1998 and the BIT between the United States and Ecuador, including their obligations to give fair and equal treatment, full protection and safety, an effective means to exercise their rights, non-arbitrary treatment, non-discriminatory treatment and the observance of the obligations contracted by Ecuador in accordance with the investment agreements. c) For it to be declared that, in accordance with the Treaty and applicable international law, Chevron is not legally liable for any sentences that may be ruled in the Lago Agrio Lawsuit.

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d) For it to be declared that Ecuador has committed denial of justice pursuant to customary international law.

During stage 1 of this lawsuit, the legal nature of the release agreements entered into by Ecuador and Texaco was discussed, and a partial award was reached on September 17, 2013, which entailed the following: a) The ruling was made over the nature of the Release Agreement signed in 1995 between the Ministry of Energy and Mines of the time, Petroecuador and Texaco. The court established that: i) Chevron, like TexPet is free of liability with the Ecuadorean State, ii) the agreement forbids third parties from presenting claims related to collective or diffuse rights, and iii) the agreement does not forbid third parties from filing suits related to individual rights. b) Additionally, the Court expressly abstained from i) passing sentence on the alleged noncompliance with the Release Agreement, ii) on the collective or legal nature of the rights claimed by the Lago Agrio plaintiffs, iii) the effects of the changes in Ecuadorean regulations after the liberating agreements were signed, specifically the Environmental Management Law (1999); additionally, no sentence was passed on the validity of the Lago Agrio lawsuit, nor on the jurisdiction of Ecuadorian judges.

The position of the Ecuadorian State, represented by the State Attorney General, in regards to this partial award can be summarized in the following allegations: a)

By characterizing the nature of the Minutes of Release signed between Texpet and the Ecuadorian State, the court does not take into consideration that these minutes are “Transaction Agreements” and the State only appears as a “contractual party”.

The release agreement of 1995 does not release or waive the potential claims filed by third parties. The Agreements of 1995 only refer to the intervening parties in it: The Government of Ecuador, Petroecuador and Texaco. The parties were aware that the Agreement they had entered into was only applicable to them and did not extend to claims belonging to third parties.

b)

Chevron is not entitled to file claims under the Release Agreement of 1995. The parties agreed that the settlement could not provide a concession of benefits

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to third parties who were not part of this agreement. The parties in the agreement are the Government of Ecuador, Petroecuador and Texaco. c)

The Court is wrong in not considering that according to Ecuadorian law, Texaco and Chevron have no right to claim noncompliance with the 1995 Agreement, given the amount of time passed since these claims. Chevron-Texaco’s claims fall under the statute of limitations, as 14 years have gone by since the execution of the 1995 Agreement, and therefore any noncompliance thereof has expired.

d)

The court is wrong in its definition of diffusion rights. The right to live in an environment free of contamination is a diffuse right, acknowledged in Ecuadorian Constitution in favor of all citizens. To claim this right, only the potential threat is need it.

e)

The Court is wrong in not considering that the action of the Civil Code is exercised because when the lawsuit was filed, a damage threatening indefinite people persisted. It is indifferent, for the exercise of this right, whether a third party has contractually released responsibility of the one obliged to carry out remedial work.

f)

The Court is wrong in concluding that only those who have suffered damages may exercise popular action. Environmental damage threatens indefinite people (pollution of aquifers, for example) and the lawsuit does not claim personal damages. What is demanded is that an end is limited to the potential dangers to health, still in existence at the time of the lawsuit.

Track two of the lawsuit is focused in determining whether Ecuador's behavior and the sentence in Lago Agrio constitutes a denial of justice as alleged by Chevron, in accordance with customary international law, given the existence of: • • • • • •

Fraud and corruption Fundamental violations to due process Interference by the Government Arbitrariness Discriminating, partial or prejudiced behaviors Excessive public pressure

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According to Chevron, Ecuador violated the standards of protection set forth in the Bilateral Investment Treaty. Their arguments are summarized as follows: a) Section II (7) of the BIT imposes on Ecuador a positive obligation to allow the Plaintiffs to protect their rights based on agreements, the law and the Treaty. b) Ecuador has not granted the plaintiffs’ investments fair and equal treatment. c) Ecuador has foiled the plaintiffs’ legitimate expectations in plotting with the plaintiffs and politicizing the lawsuit in Lago Agrio. d) Ecuador violated their obligation to provide full protection and safety to the Plaintiffs’ investments. e) The arbitrary and discriminating measures of Ecuador damage the plaintiffs’ investment.

Additionally, at this stage Ecuador presented its environmental case, i.e. Ecuador has technically demonstrated to the court the persistence of pollution caused by the operation of TexPet as well as Chevron’s conduct in the Lago Agrio process in which it presented unrealistic evidence regarding the pollution in the area or evidence produced with the express purpose of hiding the environmental damage in the area.

The Republic of Ecuador’s arguments, presented by the Attorney General, on denial of justice are as follows: a) Chevron has not depleted internal resources: Chevron has not depleted the

internal resources available from the Ecuadorian justice system, such as the Appeal for Cassation and the Extraordinary Protection Action. In order for there to be denial of justice according to Customary International law, it must persist after the analysis by the whole justice system.

b) The citations made by Chevron and Texaco on bad judicial conduct in Ecuador are isolated examples and do not accuse the Ecuadorian legal system, more than similar behaviors would then accuse the legal systems of the United States or the United Kingdom. c) It is not the Ecuadorian judicial power what is being judged in arbitration, but rather whether the judicial proceedings in the Lago Agrio lawsuit complied with the minimum equity ruled demanded by customary international law.

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d) Chevron has not demonstrated that any resource before the legal system of

Ecuador would prove useless: They have not submitted any evidence that the Judicial Office holds a biased opinion against them, or that it cannot or will not provide adequate revision of the sentence. The true state of the Legal System of Ecuador is very different from the one deceitfully shown by Chevron-Texaco.

In addition, the State's defense has emphasized the fact that Chevron has chosen not to use the mechanisms provided by the Ecuadorian law to resolve its complaints, so, for example, the company, despite having claims on alleged collusion between the Lago Agrio plaintiffs and the trial judge, has not filed the request for this course, which is established by law for Prosecution of Collusion.

Based on the review of the mentioned arguments and their merits, as well as the rebuttal28 to Chevron’s accusations by the Republic, filed on December 16, 2013, in our opinion, Ecuador has, to date, shown: a) The environmental devastation caused by Texpet and Chevron when merged with Texaco, and their liability for it. b) The illegal tactics used by Chevron in the Lago Agrio proceedings to deliberately establish mechanisms to hide existing pollution. c) The lack of proof of the alleged collusion between the State and the Lago Agrio plaintiffs. d) Chevron’s illegitimate tactics in the arbitration. Since they have not hesitated to get witnesses in its favor via payments, or by attacking opposing witnesses through litigation.

In the aforementioned rejoinder, a 183–page-long document developed in six chapters, the arguments to the accusations against the Republic of Ecuador made by the multinational company are detailed.

28

Procuraduría General del Estado, Winston & Strawn LLP, Track 2 Rejoinder On The Merits Of The Republic Of Ecuador (Part I: Response To Factual Predicate To Claimants’ Claims), Diciembre 16,2013

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In the introduction of the document, the Republic of Ecuador lets the court of arbitration know that the plaintiffs have superimposed a series of charges, ever changing, against the government of Ecuador, its officers and courts. In fact, they have found themselves having to change accusations given that Chevron chose to initiate arbitration proceedings prematurely, while the current pollution case continued to be a pending resolution in courts of the first instance. In quick succession, Chevron has changed both their allegations on the facts and their theories, while continuously affirming the need for immediate intervention by the court.

This fishing in troubled waters technique has unfairly damaged the Republic.

Making accusations is simple; responding to these accusations in a significant manner requires a considerable effort to access the information, time to review and present the necessary evidence.

The most relevant part of this piece, in connection with the concerns that this document intends to set forth, is related to the unquestionable international responsibility of the states and the product of their justice-bringing system. In this way, the plaintiff’s attack on the decision of a single judge is out of place, as the judicial decision from February 2011 has been asserted by a panel of appeals made up by three judges, and more recently reaffirmed in part by the National Court on November 12, 2013. To date, the plaintiffs have failed to allege, or even more, offer any proof that the Court of Appeals based their verdict on nothing more that the Ecuadorian laws.

The plaintiffs have not challenged the decision reached by the National Court in the arbitration process, and they are now committed to not doing so.29 At the time of adopting their decision, the National Court of Justice granted Chevron repairs regarding their claim made to the court of the first instance, on the grant of punitive damages. This benefit is not compatible with Ecuadorian law, and therefore the National Court eliminated this amount in its pertinent part, and reduced the sentence by more than US $9.5 billion. Much to the contrary of Chevron’s

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See Procedural H’rg Tr. (Dec. 3, 2013) at 25-26 (“ARBITRATOR LOWE: If I could just ask a follow-up question, is it the Claimants’ position, then, that that pleading on the denial of justice is completely unchanged by the Cassation Decision? MR. BISHOP: Yes. Our view is that we have pleaded certainly denial of justice--excuse me, certainly violations of the Bilateral Investment Treaty which are a separate category of international violations, as the Tribunal well knows, and separately denials of justice that are completed denials of justice. They were completed, as Professor Paulsson has set forth in his opinion, when the Judgment went through the First Instance Appellate Decision and it was made enforceable by the courts of Ecuador sometime in 2012. So, yes, it’s our position that we have pleaded a complete, ripe denial of justice under international law. But as I said, I would also point out that that is separate from the BIT violations. ARBITRATOR LOWE: Of course, my question was very slightly different from that. It’s not whether you have already pleaded a case, which is self-contained and sufficient. It’s whether that case stems as the exhaustive statement of Claimants’ case on this point. And you’re saying that you have nothing to add to that case, to that pleading, in the light of the Cassation Decision? MR. BISHOP: I believe that is a correct statement, yes. ARBITRATOR LOWE: Thank you.”).

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accusations, the company has been favored by the judicial system a number of times, and it only states that the system is corrupt or biased when it loses.

Going back to the National Court’ sentence, it determined the elimination of punitive damages, but rejected the allegations of procedural fraud. In doing this, the National Court correctly clarified that (1) the Courts of Appeals have no jurisdiction over this kind of claim, but (2) Chevron has recourse in Law for the Judgment of the Collusion30, the action that this Law grants expires in 5 years. Chevron has until February 14, 2016 to utilize this resource but to date it has been ignored.

That the National Court has no jurisdiction to consider Chevron's claim of a “great display of collusion” should not come as a surprise. Each jurisdiction has the right to determine the field of jurisdiction of the Courts of Appeals. In the United States, a party may request that a lawsuit be reopened for up to a year, based on intrinsic or extrinsic fraud, but the court has no jurisdiction to consider such a motion, including finding new evidence of fraud, after a year has passed31. It comes as no surprise that the Courts of Appeals of Ecuador, like the Courts all over the globe, have limitations to review the processes.

Despite that fact Chevron has previously dismissed a similar discovery by the Court of Appeals and instead dismissed the Court as lacking the capacity to issue any provisional measures or even consider the merits of their accusations of fraud32. With regard to the specific remedy that Chevron has to resolve its collusion accusations, it is necessary to clarify that the Ecuadorian legislative body has created an exclusive action to the claims that declare that a procedure has been tainted by fraud. Pursuant to the “Law for Judgment of Collusion,” referred to by the National Court33, the action may be filed by one of the wronged parties alleging that a procedure has been tainted by fraud, and that in accordance with Section 7 of the Law, “Should the claim have foundation, the appropriate measures for the collusive proceeding to be rendered void, to nullify the act or acts, agreement or agreements that were affected by it, depending on the case, and for the damages and losses caused to be repaired, restoring the possession or ownership of the goods in question to the affected party,

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See Law for Judgment of Collusion. http://www.superley.ec/superley/Legislacion/DERECHO%20PENAL/Ley%20Para%20el%20Juzagamiento%20de%20la%20Colusi% F3n.htm 31 See U.S. Federal Rule of Civil Procedure 60(b)(3) 32 Letter dated December 2, 2013, to the court: “It is particularly notable that the Court of Cassation does not substantially revise or analyze any of the allegations by Chevron for fraud or corruption in the issue of the ruling, even suggesting that this is not under its jurisdiction, just as the inferior Court of Appeals did too. In accordance with the legal system of Ecuador, apparently no Court of Appeals has direct jurisdiction to void a lawsuit for fraud or corruption at the time of issuing a ruling. In this way, the claim of denial of justice alleged by the plaintiffs is left uncorrected.”

33 See National Court decision at 95

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or the enjoyment of the respective right and, in general terms, for things to be returned to the state they were in prior to the collusion…”

If Ecuador is found liable on Chevron’s accusations, track three will focus on quantification of the compensation for Chevron and the amount it would have to pay for the pollution in the Ecuadorian Amazon. The calendar has not yet been defined to date.

5. Lessons learned from the Chevron Case Today´s main Ecuadorian challenge resides in the transformation of its production matrix in order to make it greener and knowledge-intensive based. By investing in this new paradigm, the extraction of natural resources will be done in the appropriate way and create a new paradigm for attracting foreign interest. In order to attract responsible foreign direct investment without facing the challenges described, Ecuador needs to renegotiate its bilateral investment treaties.

Also, as we have discussed, Ecuador needs to implement industrial policy in order to diversify its economy, and its implementation needs to be compatible with those treaties. These challenges are not minor, and therefore the lessons learned from the Chevron Case need to be known and understood by the international community, so it too can join Ecuador’s efforts to find solutions to the current investor-state arbitrator system as well as to renew the commitment to find binding human and environmental codes of conducts for multinationals.

The history of Ecuador’s relationship with Texaco leaves many lessons for Ecuador and the world in countless areas, especially regarding human rights, international relationships, corporate ethics, international law and international arbitration, which are among the most important ones. In the remaining portion of this paper, we will focus on the areas of international arbitration and industrial policy reform.

5.1. The need to transform investment treaties and arbitration mechanisms for sustainable development and productive transformation As we have discussed, the current investment-state treaty-based system needs to be reformed in order to achieve adequate levels of legitimacy, predictability and 35

consistency. By legitimacy, we mean that the system should allow states to exercise its sovereignty and its policymaking capacity. Further, we must establish an adequate system for selecting private arbitrators and develop viable solutions rather than face annulment of contracts. In the predictability categories we include issues such as the duration of litigations, their costs and enforceability of the awards. And by consistency, we mean the need to address the lack of jurisprudence, many contradictory decisions and the lack of incorporating international investment law.

It is important to emphasize how each government values the right to decide matters of public policy for themselves. The lawmaking process and the provision of justice, on the other hand, is a process affecting all branches of state, and traditionally reflects local standards, priorities and habits of a nation. It is very common to see the states jealously clinging to their sovereignty, so that international treaties are analyzed with considerable caution and there is a reasonable reluctance to submit their conduct for trials in foreign courts. As a reflection of this natural disposition, for example, the Senate of the United States in recent years refused to sign a treaty for the treatment of disabilities, arguing that its adoption would diminish its sovereignty in favor of international organizations. Similarly the United States and Somalia are the only states that have not signed the Convention on the Rights of Children.

The question of sovereignty in Latin America should be understood in the context of its history of colonialism. Almost 150 years ago, the famous Argentinean jurist Carlos Calvo articulated the doctrine that when in a conflict between a foreigner and a government, the foreigner should turn to internal resources and not apply their own government’s diplomatic protection. In the French edition of his treaty, Calvo referred to his doctrine, according to which: (1) all States have the inherent right to be free, independent and equal, (2) States, in equal conditions and sovereignty, have the right to expect no interference by other States, and (3) foreigners should comply with a state’s local laws. This doctrine is currently reflected in the Constitution of most Latin American countries.

In the light of this piece of history, the decision of the majority of the States – and this is undoubtedly the case of Ecuador – to enter into a treaty or convention that modestly circumscribes their sovereignty is a matter of great importance. The decision made by Ecuador nearly two decades ago to enter into a bilateral investment treaty (BIT) with several countries shows both the recognition that the world investing community needed warranties to promote local investment, and the judgment by the then Ecuadorian authorities that the Treaty entailed only a modest and acceptable abdication from their sovereignty. History now tells us that the assessment by the

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Ecuadorian authorities was either wrong or limited, or that the courts of arbitration, whose task it is to interpret that treaty, have done so in ways that were either unforeseen or not expressly accepted. In any case, the BIT, as interpreted in practice, is perceived as a great intrusion to the sovereign powers of the State, with little or none of the economic benefit foreseen for the State.

International courts of arbitration make decisions knowing that these are practically unappealable. They understand that the right to judicial review is limited, and that it, in time, seems to encourage courts to interpret their jurisdiction extensively and to resolve conflicts in a way that they believe is close to justice. All too often they do not take into consideration the limitations of their jurisdiction and, at the same time, limit the rights it offers to claimants. By acting against international regulations and the expectations of those States that are traditionally reluctant to relinquish any sovereignty whatsoever, these international courts have caused a serious reevaluation of the costs and benefits of bilateral investment treaties. In the way that these have been interpreted, treaties affect the sovereignty of a State in unforeseen ways, and with costs that are also beyond what is expected. And, regrettably, the benefits are hard to find.

The Chevron case not only offers evidence of the impacts on sovereignty, but also on the lack of benefits in using the arbitration system to the Ecuadorian State. In the case of the Occidental vs. Ecuador award, one of the three appointed arbitrators deeply disagreed with the legal principles applied in quantifying the damage in favor of the plaintiff. That arbitrator also complained of the “gross underestimation” by the court of “the illegal acts by the plaintiff, who violated Ecuadorian law,” and qualified the position of the majority, when analyzing the effects of an agreement that gave way to the controversy, as being “scandalous in legal terms and contradiction,” which obliged the arbitrator to voice a dissenting opinion34. The arbitrator’s discomfort was founded in countless legal and equality questionings made to the same court the arbitrator was a part of, and as a consequence questions its unfair final result. The result is the same as in the Chevron case, which is to say a State is being forced to pay for the consequences of having signed a Bilateral Investment Agreement, putting it at the hands of courts of arbitration that continuously err on the side of corporate favoritism.

In another case, several years after the dispute began, the defending lawyers for the Ecuadorian position discovered that a member appointed to participate as

Stern Brigitte, Dissenting Opinion, https://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC2673_Sp&caseId=C80

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member of the court had been elected as arbitrator for eight different cases in a particularly short time by request of the group of American lawyers representing the opposing party. This was a strange favoritism, which leads to serious questions and doubts on the reasons behind the predilection for that arbitrator by the group of lawyers who were constantly nominating him. However, the most disturbing element of the situation is that, firstly, arbitrators not in question did not reach a decision to disqualify the other member of the court who was being investigated, or that the arbitrator in question himself did not apologize and voluntarily remove himself from the case. The President of the Administrative Council of the ICSID finally made a decision35 — following several months of controversy — and accepted the Ecuadorian proposal to disqualify the arbitrator in question.

These kinds of happenings not only generate questions about the ethics of certain arbitrators, but also contribute to uncomfortable suspicions about the law firms, which are generally the same groups handling different cases and parties within arbitration lawsuits. This is thanks to their great knowledge of the system, be it because they reside in the key cities where arbitration proceedings take place or, obviously, because they know the language. However, it is even more questionable to us that the system has no efficient controls in place. Stricter and more transparent rules do not allow for situations like these to cloud complex, delicate and costly proceedings that are generally exhausting for the States.

These scenarios, which take place more often than the international arbitration system would like to admit, generate legal, ethical and moral questionings that have overwhelmed the response capacity of courts and have laid the foundation for the thesis that deep changes in the way that these courts operate and assume jurisdiction are needed.

The Chevron case leaves us many lessons in how the current investor-state arbitration system has been unable to find an appropriate remedy to the contamination suffered by Amazonian communities. Twenty years after the lawsuit was first filed in the court of New York, the indigenous communities are still awaiting justice and are still suffering the impact of the environmental pollution caused by Texaco-Chevron.

The unbalanced and asymmetry of power that developing states face when fighting with multinational companies with extraordinary resources is clear. In 2013

See, Decision on the proposal for disqualification of professor Francisco Orrego Vicuña, https://icsid.worldbank.org/ICSID/FrontServlet?requestType=CasesRH&actionVal=showDoc&docId=DC3972_En&caseId=C300

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Fortune 500 considered Chevron36 to be the third-largest company in the United States, and the eleventh in the world37. Disputes are not necessarily resolved in courts either, but in the corridors of Congress and in State organs with the collaborations of public opinion makers.

In this specific case, some political figures succumbed to the pressure exerted by Chevron officers who used political pressure mechanisms seeking that the USTR suspend Ecuador from the Andean and SGP preference program, as shown in governments documents declassified by the Department of State38 of the United States. To this we should add the untold millions dollars spent by Chevron in a farreaching public relations campaign in a bid to discredit the Republic of Ecuador. That included paying out witnesses and reports by alleged professional experts as well as using tactics of intimidation against those who questioned the company’s corporate ethics and administration. Even high government officers of Ecuador have suffered espionage and theft of information from their email accounts, which Chevron intended to use in one of the ongoing legal proceedings.

In a series of communications recently released by the United States Department of State, thanks to the requirement under the FOIA law39 made by analyst Ted Folkman from Letters Blogatory40, it has been possible to prove the extent and force of Chevron lobbying and public relation efforts to exert pressure on the Department of State and other United States government institutions, like the U.S. House of Representatives and the U.S. Senate, so that they execute mechanisms of economic pressure on the Ecuadorian state, specifically the suspension of the preferential tariff systems, ATPDEA and GSP. The Chevron-Ecuador case is only one of countless examples that may be viewed through this lens of political pressures, openly denounced by many international actors.

Based on the lessons learned by Ecuador in its investor-state treaty-based international litigation cases, we believe that reform should address the legitimacy, consistency and predictability of the system, with at least the following:

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http://money.cnn.com/magazines/fortune/fortune500/ http://money.cnn.com/magazines/fortune/global500/2013/full_list/?iid=G500_sp_full 38 See U.S. Department of State Case No F-2011-06987 Doc. No. C05427722 See U.S. Department of State Case No F-2011-06987 Doc. No. C05446151 See U.S. Department of State Case No F-2011-06987 Doc. No. C05465219 See U.S. Department of State Case No F-2011-06987 Doc. No. C05446265 See U.S. Department of State Case No F-2011-06987 Doc. No. C05465164 39 See FOIA Act, http://www.foia.gov 40 See Letters Blogatory by Ted Folkman of Murphy & King, Request for FOIA Documents. http://lettersblogatory.com/2013/12/13/requests-foia-docs/ 37

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a) Transparent selection of arbitrators who only exercise this role and do not exercise the defense of companies, which can result in future interest conflicts. b) Establishment of an appellate body within the arbitration system. c) Incorporation in investment treaties investors’ obligation to file claims only after local resources have been exhausted. d) Incorporation in investment treaties of the right of States to exercise their regulatory capacity on issues related to health, environment and industrial policy, among others.

Also, states should work together to limit the immense power that arbitrators currently have in the interpretation of treaties while the system is being reformed, because even if countries decide to leave the system, all treaties have survival clauses of between 10 and 15 years, which would condemn their country to further litigation with the shortcomings under the system. In this sense, Lise Johnson’s contributions in her document “State Control Over Treaty Interpretation41” are very valuable, as she presents a potential roadmap with procedural proposals that would allow States to clarify uncertainties and ambiguities so that texts better reflect the intentions of the signing states.

Regarding treaty interpretation, Johnson’s suggestion is that States may insert provisions applying the following recommendations: a) Ensuring that their joint interpretations in one or all questions are binding in court; b) Encouraging (or requiring) State actors to consult and cooperate in the resolution of questioned interpretation and/or application ambiguities; c) Requiring that states or other actors (parties) that are not in disputes (i) be notified of claims filed according to their treaties, (ii) receive documents filed in court and/or published by court, and (iii) may make presentations before courts on the matter of treaty interpretation.

In the case of disputes, Johnson recommends that States may:

Johnson Lise, “State Control Over Treaty Interpretation”, Vale Columbia center on Sustainable International Investment, December 2013

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a) Remain informed on the interpretation and application of their treaties; b) Make their deliveries (presentations) public; c) Participate as an acting state, not participating in disputes originated under the agreements (treaties); and d) Make it clear when they are in disagreement with the interpretations given by courts.

Lastly, States may take individual action or joint action with other countries. For example: a) Making public their understanding of the ambiguous stipulations of the treaty or the uncertain provisions in a treaty through unilateral action (for example, publications on a web site with a list of their treaties); b) Monitoring declarations (statements) and practices by their counterparts in treaties to identify the areas of agreement and disagreement; and c) Cooperating with other states to establish an agreement clarifying ambiguous language and whether it is their desire for those agreements to be binding.

Some States are considering the option of renegotiating their bilateral investment treaties, or multilateral treaties in the case of treaties with the European Union. The proposed joint State discussion on lessons learned through years of implementation of investment treaties and reaching multilateral consensus with capitalexporting countries like the U.S. and China, as well others, is essential so that bilateral renegotiations between small countries suffering from less bargaining power can be successful.

Finally, we would like to highlight the effort carried out by Ecuador and collectively by UNASUR nations to reform the arbitration system and correct the aforementioned problems. Ecuador has led the initiative to create a center for arbitration under the umbrella of UNASUR. In June 2009, in the thirty-ninth session of the General Assembly of the Organization of American States, the Foreign Minister of Ecuador proposed that UNASUR create a center for arbitration as an alternative to

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World Bank’s ICSID. On July 6 of the same year, Ecuador notified of its leaving the ICSID Convention. President Rafael Correa, through an executive decree, noted that the Constitution of Ecuador in its Article 422 forbade the Ecuadorian state to submit to international arbitration courts. At the meeting of Foreign Ministers of UNASUR in December 2010 in Guyana, it was unanimously decided that Ecuador lead the group to propose an arbitration and dispute center within UNASUR. At the same meeting, Ecuador submitted draft proposals for a set of rules for the center and President Correa advocated for them at the Mercosur Summit in 2011. In August of 2013, during the summit in Suriname, UNASUR member countries comprising 12 states of South America came forward with details to create the arbitration center proposed by the President of Ecuador. The project, which includes a Center for Dispute Resolution, also includes mechanisms such as mediation and facilitation. Both Brazil and Bolivia do not accept international arbitration as mechanisms for resolving disputes, but mediation and facilitation have been established as important alternatives.

The aim of the center to resolve disputes is based on providing a regulatory framework initially for disputes between member states of UNASUR. It will also resolve disputes facing investor-state, but the idea is that different investors and other states outside the region, as it progresses, use the center.

The jurisdiction of the Center excludes disputes concerning health, taxes, energy, among others, unless treaties express otherwise. Members may request, as a precondition to arbitration, that all instances as well as possible actions first be exhausted within the domestic courts. Although it is estimated that this condition can take the plaintiff several years before the case can be brought to the UNASUR center for arbitration, adequate maximum deadlines shall be adjusted for the processes to be treated within national courts, before they are passed to the center of UNASUR for arbitration.

We hope this effort is implemented and becomes a valid option so that investors and states can access transparent and fair mechanisms for resolving disputes.

5.2.

Strengthening the multilateral framework to generate accountability in multinational corporations: The role of the United Nations.

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The United Nations Office of the High Commissioner for Human Rights42 considers that “the process of globalization and other global developments over the past decades have seen non-state actors such as transnational corporations and other business play an increasingly important role internationally, and also at the national and local levels. The growing reach and impact of business enterprises have given rise to a debate about the roles and responsibilities of such actors with regard to human rights.

International human rights standards have traditionally been the responsibility of governments, aimed at regulating relations between the State and individuals and groups. But with the increased role of corporate actors, nationally and internationally, and the issue of business’ impact on the enjoyment of human rights has been placed on the agenda of the United Nations. Over the past decade, the United Nations’ Human Rights machinery has been considering the scope of business’ human rights responsibilities and exploring ways for corporate actors to be accountable for the impact of their activities on human rights.”

With the purpose of generating a framework of general principles, the Human Rights Council endorsed, in its resolution 17/4 dated June 16, 2011, the Guiding Principles on Business and Human Rights, which were presented by the UN Special Representative of the Secretary-General, John Ruggie, in its final report to the Human Rights Council43. The principles, divided into three sections, circumscribe the duties of the state regarding the protection of human rights, corporate responsibility regarding human rights and access to remediation.

The document highlights as a first basic principle the obligation states have to protect human rights within their territory or jurisdiction against abuse by third parties, including commercial companies. It also addresses the obligation based on international law, which demands that the states respect, protect and comply with the human rights of citizens within their territories. Unfortunately, this is a principle that international courts of arbitration dealing with investments usually forget, especially when analyzing public policies affecting the commercial interests of a company, thus undermining the obligation states have to guarantee “the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care and necessary social services44”.

Special consideration must be paid to the Ninth Guiding Principle, which states that “States should maintain adequate domestic policy space to meet their human

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See Business and Human Rights, Overview, United Nations Human Rights, http://www.ohchr.org/EN/ISSUES/BUSINESS/Pages/BusinessIndex.aspx 43 See, United Nations Human Rights Reports, http://www.ohchr.org/EN/Issues/TransnationalCorporations/Pages/Reports.aspx 44 See section 25 of the Universal Declaration of Human Rights, http://www.un.org/es/documents/udhr/

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rights obligations when pursuing business-related policy objectives with other States or business enterprises, for instance through investment treaties or contracts.” In the commentary on this principle, it is observed that the terms of Bilateral Investment Treaties could limit the states in their right to implement new human rights legislation.

Therefore, states should make sure that while investors are given protection, they should also maintain adequate space to protect human rights under those treaties.

On the corporate side, the Guiding Principles establish that business enterprises should respect human rights. This means they should avoid infringing on the human rights of others and should address adverse human rights impacts with which they are involved. The responsibility of business enterprises to respect human rights refers to internationally recognized human rights—understood, at a minimum, as those expressed in the United Nations Universal Declaration of Human Rights. In practice, some human rights may be at greater risk than others in particular industries or contexts. Therefore, companies involved in hydrocarbon exploration and exploitation must consider the topics of pollution and immediate remediation of any impacts they cause as operators of oil consortiums to be their top priority. Corporate responsibility, Ruggie's document adds, requires that they avoid causing or contributing to adverse human rights impacts through their own activities. Texaco operating for 25 years in the Ecuadorian Amazon never properly assumed these principles and priorities.

In the introduction to the Guiding Principles, Special Representative Ruggie comments that the principles set forth in the document should be implemented in a non-discriminatory manner, with particular attention to the rights and needs of, as well as the challenges faced by, individuals from groups or populations that may be at heightened risk of becoming vulnerable or marginalized. However, as this United Nations document lacks the binding character of other formal human rights treaties, it has not drawn attention in international courts of arbitration.

The main problem posed by the application of the Guiding Principles in the world is that they are not a binding international instrument that forces companies and states to comply with them, under penalty of being taken to task and receiving penalties from the International Community. On the contrary, they are recommendations or guidelines for state authorities and private entities, so that they may at once protect and respect the human rights of populations directly or indirectly involved in the operations of companies. However, this “soft law” mechanism is not enough to guarantee that companies will respect the human rights of their workers and of the populations adjacent to their operations. And, sadly the global expansion of the even less ambitious concept of corporate social responsibility has not been enough either.

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Claims of human rights violations in textile factories and manufacturing companies in Central America and Southeastern Asia continue to be made, as well as ecological catastrophes and the impacts they have on the populations as a result of adverse business activity. The memory of the public opinion tends to forget with relative speed events like the oil spill caused by the Exxon Valdez freighter in Alaska, the explosion at the pesticide factory in Bhopal, India, in 1984, or the recent oil spill in the Gulf of Mexico, the collapse of a textile factory in Daca, Bangladesh, and the Texaco-Chevron case in Ecuador. Because large corporations possess vast resources to invest in massive media campaigns to try to cleanse their corporate image, it is necessary to go beyond the Guiding Principles and work to adopt a binding international legal instrument in the matter of Human Rights and Transnational Corporations.

5.3 Acknowledgement of Nature’s Rights and strengthening of regulatory framework Ecuador had a vested interested in taking the unprecedented step of providing constitutional rights focused on nature because so much is at stake in our country.

Ecuador is considered one of the most bio-diverse countries in the world and is ranked by the Convention on Biological Diversity as one of the 17-mega diverse countries on the planet.45 In terms of conservation, the country is divided into four natural geographic regions containing three of the world’s 10 most bio-diverse areas. Ecuador is home to the Galapagos National Park, a UNESCO world heritage site, and the Yasuni National Park, a 982,000 hectares stretch of the Amazon rainforest that has more species of frogs, toads and trees than the entire continental U.S. and Canada combined. 46 Ecuadorians are now aware of the enormous responsibility they have to protect biodiversity for future generations. The government has contributed to the awareness of Ecuadorians regarding these challenges, and there is now a national commitment to protect our environment that was not there just seven years ago.

One of the most powerful lessons learned in our country after decades of oil exploitation and its consequences on the environment, is the need to implement a new development model, which will balance the satisfaction of our needs with nature. The new model that Ecuador is currently implementing is based on the concept of "good

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Convention on Biological Diversity, Ecuador Country Profile, http://www.cbd.int/countries/profile/default.shtml?country=ec Bass MS, Finer M, Jenkins CN, Kreft H, Cisneros-Heredia DF, et al. (2010) Global Conservation Significance of Ecuador’s Yasunı´ National Park. PLoS ONE 5(1): e8767. doi:10.1371/journal.pone.0008767 (Pages 4 and 7)

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living " which takes its terminology "Sumak Kawsay" from the ancestral Quechua worldview of life. In its original Quechua meaning, sumak refers to the embodiment of an ideal and beautiful planet while kawsay means "life", a decent life lived to the fullest. The "Sumak Kawsay" ancestral concept considers people as an element of the Pachamama or Mother Earth. So, unlike other paradigms, good modern living, inspired by the indigenous tradition, seek balance with nature in the satisfaction of needs, and ultimately "take only what is necessary" for its growth.

The concept of the Good Living is at the center of the new Constitution of Ecuador and has also enabled the development of new laws and concepts such as the Rights of Mother Nature. The constitution of Ecuador incorporates the principles of the good living or Sumak Kawsay in Articles 275-278, which specify that: "The Good Living requires that individuals, communities, peoples and nationalities effectively enjoy their rights and exercise responsibilities under multiculturalism, respect for diversity, and harmonious coexistence with nature."

The inclusion of these rights of nature in the Constitution is given in four articles ( art. 71 to 74) and expresses the deep respect with which we regard our environment.

The articles state that "Nature or Pachamama, where life is reproduced and realized, is entitled to its existence, maintenance and regeneration of its vital cycles, structure, functions and evolutionary processes are fully respected. Any person, community, village or nationality may require the public authority to enforce the rights of nature ...

The State will encourage natural and legal persons and groups to protect nature, and promote respect for all the elements that form an ecosystem." It clearly reflects the deep commitment by Ecuador that the country has elevated this issue to a constitutional level. Since the enactment of the Constitution, the National Assembly adopted the Law Amending the Law on Mining, Water Management Act, Environmental Law and Development.

Dr. Duval Llaguno holds in an analysis47 on the rights of nature that "the challenge will be, as in the practice and exercise of the rights, that the necessity for the use and industrialization of natural resources be harmonized with conservation and sustainability. The balance that will be aimed for will be complex, as everyone will have the ability to demand. Obviously, he concludes, this is in line with rights of third generation ("diffuse" because they require the demonstration of the entitlement) and the universally accepted precautionary principle."

Llaguno Duval Dr., “El Proyecto de la Nueva Constitución del Ecuador y su relación con el Derecho Ambiental y el Derecho Internacional Público”, Sociedad Ecuatoriana de Derecho Forestal y Ambiental.

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Despite the difficulties of implementing this new environmental legal framework, between 2008 and 2013, the National Judicial Council registered 1,164 cases filed in connection with crimes against nature, of which 550 were resolved and 614 cases are pending settlement. So far in 2013, there have been 570 cases of which 278 cases were resolved. Also in the recent approved Legal Organic Code, environmental crimes were better defined and a new Environmental Code is being discussed to send to the National Assembly in the coming months.

One of the greater challenges will be the oil extraction in the Yasuni Park. As we have discussed, this decision was taken after a failed attempt to move forward with an innovative proposal to preserve the oil in the Amazon territory, preventing the emission of millions of polluting gases in exchange for a major international financial donation.

Although the funding would have been substantially less than what the Ecuadorian people would have received for the non-extraction, the government of Ecuador announced the decision to drill for oil in a one part per thousand of the Amazonian Yasuni reserve. Unfortunately, the world was not ready for this proposal, and the contributions received were far below what would have made this plan feasible.

In October 2013, the National Assembly authorized the drilling within the small part of the Amazon territory. The Ishpingo, Tambococha and Tiputini (ITT) fields represent 20% of Ecuador 's oil reserves. Ecuador expects revenue of some $ 19,000 million, which will be used in the fight against poverty mainly in the Amazon region, which has been historically neglected and excluded from oil revenues obtained through the exploitation of their territory. The project was approved by the National Ecuadorian Assembly in light of the rights of nature, enshrined in the Constitution of the Republic that states, "In the environmental impacts caused by the exploitation of these resources, the State provides the most effective mechanisms to achieve the restoration and the appropriate measures to eliminate or mitigate adverse environmental consequences".

The plan for drilling in the Yasuni will test the new institutional framework and the balances among policy setting, regulation and control. The last phase of this framework, which is the setting of the environmental superintendence requires the approval of the environmental code, which is key in this process, and it is the centerpiece missing to guarantee independence and separation between regulation and control.

We have learned from the Chevron case was that it is crucial for the state to count with institutional strength – which enable its control and regulatory capacity as

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well as its policy making. We cannot cease to accept that during the 1980’s and 1990’s, the capacities the Ecuadorian State had to formulate public policies and establish regulations were weakened. These capacities and political will would have allowed the State to stop the implementation of technologies that would later prove damaging to the environment. It is also important to stress the need to count with a multivariable, technical and practical framework that makes it possible to evaluate in detail the impact that investments have on the country’s natural resource sectors. The National Secretariat for Planning (SENPLADES) has been working on defining policies and models that make it possible to make assessments to prioritize public investment at all stages of the investment cycles, as well as design public institutional strength to support their adequate implementation. Likewise, regarding strategic sectors, there are models to assess public associations at the level of technological compliance, transparency in the relationship with communities, profitability levels, and others.

There are many advances in the strengthening of the policy making and regulatory capacity, since the Government of Ecuador has been implementing a state reform that has three work axles: 1) Institutional Reform, 2) managing for results, and 3) training of the Human Talent in the Public Sector.

In the institutional framework, the Ecuadorian public sector counts with an institution that governs the processes for planning and assessing the impact of public management, SENPLADES, and with another institution in charge of following up on the efficiency and efficacy of programs, the National Secretariat of Public Administration. Likewise, the Ecuadorian administration counts with six inter-ministry coordination cabinets per sector (human talent, social production, security, strategic sectors and economy), in charge of coordinating, monitoring and following the ministries and institutions that are part of each cabinet.

In the same way, in the institutional sphere, there are clear advances in the definition and separation of the roles of regulation, execution and control for each sector of the economy, and a deep decentralization of the public services has began, so as to improve their coverage, quality and efficiency.

The implementation of the System for the Public Management by Results began in the year 2011. It seeks to implement the National Plan for a Good Life 2013-2017 (Plan Nacional del Buen Vivir), ensuring the maximum performance efficacy, efficiency and effectiveness in the achievement of the Government’s goals and the continuous and effective improvement of their institutions through five pillars: (i) Strategic

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Planning; (ii) Budget for results, emphasizing public investment; (iii) Execution; and (iv) Monitoring and evaluation.

The Public Management for Results system also has four transversal axis, whose scope is as follows: (i) Participation by the citizens, where planning processes at all levels shall be participatory at all of their stages, and therefore the social control and citizen auditing systems shall be implemented; (ii) Electronic Government, that implies that the Management System should count with electronic administrative and operational instruments, which make it possible to fulfill the corresponding transactions in real time; (iii) Public Purchases, which shall work with total coverage for the executive function and ensure transparency in the purchase processes in the public sectors, as well as contribute to the optimization of resources; and (iv) Civil Service, through the new Law that shall allow for the implementation of administrative career policies based on performance indicators, which will in time contribute to guaranteeing high-quality levels in the provision of public services.

To ensure the success of implementing this innovative public administration model, there is also an integral training program for public servants, to change the culture and direct it to the quality of service, as well as the implementation of information and monitoring systems, as well as communication systems and roles for the participation of the civil society.

This institutional reform of the Ecuadorian Executive Power has also been accompanied by an audacious transformation of the Judicial System where the executive power has also had participation as a consequence of the citizen mandate passed during the referendum held in May 2011.

As a result of this summons, a constitutional reform that would open the doors to transforming and reorganizing the Ecuadorian legal system, comprising five basic goals considered to be part of the Strategic Plan for the Judicial Office 2013-2019, was decided on by a majority of votes48.

•

The first goal establishes “Ensuring transparency and quality in the provision of legal services,” through the development and strengthening of orality and immediacy in procedural laws, improvement of the imprisonment on remand and substitute measures systems, and the creation of audience control units.

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See, Judiciary Council, Strategic Plan for the Judicial Office 2013-2019, http://www.funcionjudicial.gob.ec/index.php/saladeprensa/multimedia/index.php?option=com_flippingbook&view=book&id=10: plan-estrategico-de-la-funcion-judicial&catid=1:default-category&tmpl=component

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The reforms proposed, pursuant to section 86 of the Constitution of the Republic of Ecuador, are based on the Codes of Criminal Procedure49, Labor Code50, Code of Childhood and Adolescence51.

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The second and third goals contemplate optimal access to justice and driving permanent improvement and the modernization of services, through the development and strengthening of a national mediation system, the decentralization of the legal services and the efficiency and efficacy of legal processes. The processes undertaken in the National Mediation system have enabled an increase from five Mediation Centers to 51 spread over the different provinces of the country. In the matter of the decentralization of justice, establishing defense judges and district attorneys for every 100,000 inhabitants, Ecuador hopes to surpass the regional mean by 2017, going from a rate of 7 judges to 12, from 4 district attorneys to 8, and from 1 defense attorney to 5. In the matter of efficiency and efficacy of legal processes, it is also expected that the regional mean will have been surpassed by 201752.

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Goals four and five establish the institutionalization of meritocracy in the Judicial Office and fight against impunity, contributing to citizen safety. To achieve these goals, the judicial school was established, along with rules for professionals in the judicial office career, a new expert system and the creation of flagrancy units.

As of 2012, when the Judicial Office reorganization process began, Ecuador has become the country with the largest percentage of investment in the Judicial Office in relation to the general budget of the state in the region53. Even though the results of the administrative reorganization of the legal system obtained to date are encouraging, there is still much to do, and there is a long road until Ecuador finally has a fully independent, professional and technical judiciary system.

Finally, we consider that these deep reforms that have led the Ecuadorian State to recover its capacity to formulate public policies, regulate and control, should have models for the assessment of sustainable foreign investment, especially in their participation in the strategic sectors of the economy.

49 50 51 52 53

See Supplement 360 dated January 13, 2000, http://www.oas.org/juridico/spanish/mesicic2_ecu_anexo10.pdf See Supplement 167 dated December 16, 2005, http://www.oas.org/juridico/spanish/mesicic2_ecu_anexo10.pdf See R.O. 737 dated January 3, 2003, http://www.law.yale.edu/rcw/rcw/jurisdictions/ams/ecuador/Ecuador_Code.htm See annex 14 See annex 15

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For this assessment to be made, it is imperative to go beyond the models that only focus on evaluation economic effects and supported on financial assessment tools.

We must include others with a greater scope, such as eco-systemic sustainability and systemic productivity. These variables aren’t easily captured and assessed, but there are several methodologies and experiences to learn from.

When it comes to the participation of foreign investment in strategic sectors, we have learned from the Texaco-Chevron case that choosing technology is a crucial matter to be assessed, and that the States should count with their own capacities to analyze and assess different alternatives. We strongly suggest that states join efforts with international institutions and universities at the technological frontier of research to create an academic independent network that can aid countries in their analysis and evaluations.

Finally, informed and apolitical participation by the civil society, as well as transparency in the process of the selection of technologies for the harvesting natural resources as well as of the strategic partner to participate in the exploration and exploitation are vital to not repeat the mistakes of the past. Even though we should avoid extremism and there is a risk of political abuse of this participation process, we consider that a transparent and civic monitoring and follow-up exercise is crucial to the success of future exploration processes. The Yasuni decision is a very good example, where not only Ecuadorians by the international community will focus its attention.

5.4 Coordination of the Investment Promotion, Industrial and Trade policies.

Latin America and Ecuador face common challenges to gain competitiveness and diversify the economy for transforming its production matrix. Latin America has been the recipient of large flows of foreign direct investment. In fact, the region is in second place in receiving foreign direct investment, after Asia. In 2012, Latin America received US $240 billion, the main beneficiaries being the sectors involved in the exploitation of natural resources, manufacturing, transportation and services. Brazil and Mexico, countries with large national markets, were the recipients of the largest inflows of FDI in the middle and low technology manufacturing sector. A different case that is interesting to analyze is Costa Rica, a country that, though small, has been a large recipient of foreign investment for exports in middle technology level products.

Logistics and high level of investment in education, science and technology for the last 20 years might be the answers.

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More in-depth studies are required to draw definitive conclusions about the role of the size of internal markets, the degree of commercial openness, localization, logistics and the existence of a large share of trained human talent as determining factors for greater foreign direct investment in the Latin American manufacturing sectors. What we can affirm is that the role of foreign direct investment in the process of technological transfer, generation of local productive capacities, and in the generation of local content value oriented to exports is not an automatic process.

Quite to the contrary, it is necessary to coordinate and synchronize industrial policies with investment and trade promotion policies. Therefore, it is key that investment treaties provide enough policy making space for the implementation of policies that provide incentives and the regulation for FDI to generate the economic linkage and interaction across different sectors in the economy.

In Ecuador, a great effort was made to implement a legal framework oriented to promote investment, this legal framework is the Code of Production, which was approved by the National Assembly in December 2010, and it became effective in January 2011. This legal body contains the rules that regulate the role of the state and the private sector in economy, as well as economic policies, instruments and incentives to achieve a green and diverse production matrix with added value and based on the exploitation of certain prioritized sectors, and with an incentive also dedicated to a more balanced regional growth. Thus, the Code contemplates general incentives, such as lowering income tax from 25% to 23%, implementing regulations for the facilitation and efficiency in customs and logistics processes, eliminating minimum and income tax for investments made in certain prioritized sectors, and creating special development economic areas for the transfer of technology, logistics and manufacturing for export products. These special economic areas come with income tax and tariff incentives for periods of time lasting up to 15 years.

Additionally, the Code of Production offers investors the possibility to sign an investment agreement between the investor and the Ecuadorian State, which allows them to obtain a warranty over the incentives established in the code, as well as the possibility of international dispute arbitration, except in the case of disputes related to tax policy.

Lastly, the Code also included a package of incentives for the technological and innovation of medium enterprises, the adoption of green and eco-efficient processes above the standards established by the Ministry of Environment, as well as incentives to reactivate the depressed areas, mostly rural, of the country.

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Even though investments have been made as a result of the implementation of the Code of Production, there are doubts about whether the incentives are changing the relative prices of prioritized sectors, given other tax policies which were introduced afterwards and since there is much left to do to synchronize industrial policies with financing, innovation, trade and investment policies. This alignment will finally allow changing the relative prices to attract more private investment to prioritized sectors.

We suggest that the government conduct an impact evaluation of the implementation of Code of Production and other tax policies that were introduced later in order to make corrections if needed.

Regarding trade policy, it is important to secure access of manufactured products to current markets as well as to reach agreements to access to new ones with high growth potential. Access to international markets is crucial for the change of production matrix, since economies of scale are need for some sectors in order to be competitive and when local demand is not enough. However, in the negotiation of trade agreements, which will guarantee permanent competitive access to our renovated production matrix, it is imperative to gain spaces of flexibility for the application of industrial policy, for example the use of public procurement as a tool for SME development, or the establishment of local added value requirements, both for national production and for exports, technological transfer and the incorporation of small and medium enterprises to global chains with a high value, among others.

Finally, it is also necessary to foster the development of public-private innovation ecosystems, and to this end, there are some advances such as: 1) an educational reform at all levels and particularly in the post-secondary sector, 2) two mega projects: Yachay, city of knowledge, and Ikiam, biodiversity research university and park, 3) the excellence program which provides scholarships to the top universities of the world, and 4) acknowledgment of the need for a powerful risk capital fund that lowers the risk and encourages the discovery of new sectors of the economy.

Within the first topic, Ecuador has initiated a deep process for the reform of higher education and for educational restructuring, so as to promote the formation of advanced human talent and the development of research, innovation and technological transfer. The process is coordinated by three specialized organizations: the Higher Education Council; the Council for the Evaluation, Crediting and Quality Assurance of Higher Education; and the Ministry of Education, Science and Technology The most relevant projects in this process include the creation of four specialized studies university centers and the program called “Universidades de

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Excelencia” [“Universities of Excellence”]. These university centers specialized in four different fields of academic studies include: (1) Yachay, city of knowledge for scientific research; (2) Universidad Nacional de Educación for the formation of teachers; (3) Universidad de las artes for art; (4) Ikiam for life sciences. It is estimated that public investment for the execution of these projects in the 2013-2017 period is going to be $1.1 billion.

The most ambitious project involves the creation of “Yachay54, city of knowledge”, the first planned city of its kind. At the heart of the city will be the experimental scientific university, the institution that will pay a central role in the development of cross-sectorial dynamics, and particularly in the preparation of top world graduates. Yachay will concentrate in the following areas: i) life sciences, ii) information and communication technology, iii) renewable energies and climate change, iv) petro chemistry, and v) nano science.

In addition to the experimental scientific university, Yachay also will be the home of a group of public and private research institutes, technological transfer centers, high-technology companies with focus on biopharmaceutical, biotechnology, software and robotics as well as valued-added agribusiness. The project is considered to be the most important to the country’s development and is being developed with technical assistance from the South Korea government.

Another program that will contribute to the creation of human talent and new skills is the “Universidades de Excelencia”55 program, which consists in assigning fully funded scholarships (referential limit US$250,000.00) to Ecuadorian students residing within and outside the country and who wish to follow third or fourth level studies in a university that is considered to be among the best 100 Universities in the world. The program gives assignation priority to the following areas: Life Sciences, Natural Resource Sciences, Production and Innovation Sciences, Social Sciences, Arts and Culture. As of November 2013, there is a total of 6,956 scholarship holders56 spread through Universities in Europe, Asia, United States, Canada, Latin America and Oceania. The design of this program contemplates the return home of scholarship recipients once they have finished their studies, and so far scholarship holders who have returned to the country have an employment rate that exceeds 90%.

Ciudad de Conocimiento, Yachay, http://www.yachay.gob.ec/yachay-la-ciudad-del-conocimiento/ See, Senescyt, http://programasbecas.educacionsuperior.gob.ec/descripcion-del-programa-7/ 56 See Scholarship Holders Networks, Senescyt, http://redbecarios.senescyt.gob.ec/index.php?option=com_content&view=article&id=134:becarios-ecuatorianosnuevos-embajadores-turisticos-y-culturales-del-pais&catid=8:anuncios&Itemid=220 54 55

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Additionally, the reform of the higher education, science and technology system has highlighted the need to strengthen public research institutions, and therefore the system has committed a large investment to it, which is making it possible to strengthen their infrastructure as well research competences. This kind of initiative is laying the bricks to be able to adequately absorb the scientific diaspora that is currently overseas. However, the full picture will also be marked by the private sector, where a series of investments necessary in terms of technology will be triggered, where specialized human talent will have a fundamental role in guaranteeing the transition towards a more diverse economy with a greater added value.

To sum up to these efforts, it is crucial that Ecuador works with public-private programs and allocates enough resources to enhance businesses productivity as well as technology transfer. Pilots programs such as EmprendeEcuador and InnovaEcuador needs to be evaluated and scaled up, as well as efforts to implement a powerful risk capital fund which should provide incentives and encourage national and foreign private investment in new sectors with greater potential to generate new learning processes, which is to say, those sectors that Stiglitz calls the launchers of the systemic adoption of technologies, and of the systemic impact on the increase in productivity and diversification of economy.

As we have previously mentioned, there are great advances in Ecuador, but there is a need to conduct a self-learning process through the evaluation of the design and implementation of industrial public policies, as well as their institutional framework, effectiveness and impact, in order to ensure institutional learning and guarantee the scalability and sustainability of efforts.

It is evident that the change of the production matrix would face serious difficulties without the participation of an important contingent of local or foreign private and public investment. Therefore, Ecuador should lead world efforts to reform the dominant arbitration system, while continuing to improve its investment climate, its regulatory capacity and the synergic application of industrial, commercial and innovation policies. This is no easy task, and it will require working jointly with the international community, obtaining consensus that will allow the successful renegotiation of investment treaties, while at the same time signing trade agreements that are flexible for the application of modern industrial policies. There are also shortterm goals to which the country should dedicate also its energy, such as unifying the treaty interpretation criteria as a measure to limit the power of interpretation of arbitration courts.

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Setting this multi-sector strategy that would simultaneously act on several fronts of public policy and getting them in motion is particularly difficult and requires a high degree of coordination, both in the public sector and between the public and private sectors. This task requires the existence of a clear Production Transformation Agenda, with monitoring mechanisms and both public and private periodic evaluations, transparency in communication of results, and generation of internal mechanisms for learning from the results. The implementation of this Agenda, which in practice means the alignment of industrial policies, trade and investment promotion has to be on par with the country conducting a successful international agenda for the reform of investment agreements, it is clear 21st Century investor-state relationships are different and need of a new legal and institutional framework.

Finally, we like to emphasize that Ecuador can never allow the existence of another Texaco-Chevron, when, as a result of irresponsible exploitation, weak institutions and the nonexistence of international obligations for corporations in terms of compliance with human and environmental rights, as well as the lack of adequate local hydrocarbon laws, generated a devastating environmental and human catastrophe as well as deep external technological dependence.

The hard lessons we learned in Ecuador must not be for naught; they are instructive to countries in every region of the world. As globalization shortens the distance between countries and corporations and as we come to the realization that 20th Century progress has taken a toll on our planet, it is time we all evaluate what worked and what did not and move forward with a commitment and regulatory and legal framework suited for 21st Century progress as well as 21st Century protection of what we hold most dear. The international community, members large and small, must change the way that corporate social responsibility is measured. It must include provisions that value human rights equally with profits or that measure will remain flawed. Those who do not learn from history will be doomed to repeat it and we, Ecuador working with the international community, cannot let this come to pass.

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