Navigating economic diplomacy–I

Spiraling electricity bills and the resulting unbearable burden on the ordinary consumers has brought the agreements with the IPPs under renewed focus and the entire blame for the woes of power sector is being allocated to the governments who entered into these agreements. Existence of corrupt objectives as the motivation for concluding these agreements on unfavorable terms is taken as a self-evident truth. However, like all narratives this narrative of corruption has never been subjected to a rigorous scrutiny.

The governments that entered into the power purchase agreements were succeeded by largely hostile governments both in the 1990s and in the second decade of the current century. The successor governments persecuted their predecessors and considerable energies were devoted to finding any evidence of wrongdoing that could permanently remove their political opponents. Reportedly, the IPPs were also grilled and pressurized to testify against the governments with whom the power purchase agreements were concluded. However, the agreements are still in place and were acted upon by the successive governments.

The dominant narrative fails to consider the state in which power purchase agreements were made. On both occasions the country was facing a severe power crisis crippling the industrial sector and tormenting the citizens. On both occasions the crisis was the direct result of inaction by authoritarian rulers who enjoyed absolute power and also had ten years each to undertake and complete long-term projects. Each of them was at the receiving end of US benevolence due to the war in the neighboring country but failed to make any significant additions to the power production to cater for the increasing demand.

Their successor political governments did not have the luxury of time or financial resources to undertake projects for cheaper generation of electricity as they had to find immediate solutions or risk losing political support. There was no money to build power generation capacity by the government. Pakistan had also lost its utility to the US due to the geo-political realities. There was no alternative but to go for purchase of electricity from private parties for which lucrative terms had to be offered. Otherwise, foreign companies would not have come forward.

This article is not intended as a defence of the power purchase agreements with IPPs despite the fact that it may be possible to do so on commercial grounds. The contracts for purchase of electricity were not free from flaws and probably could have better protected the interests of the country. This article will attempt to argue that the reasons for sub-optimal power purchase agreements have to be found elsewhere than in the convenient and popular narrative of corruption and in fact are symptomatic of a deep-rooted systemic malaise.

Research has shown that the decision-makers in complex organisations like governments or corporations are prone to making decisions that depart from flawless economic rationality since they are limited by mental capacity, the information available to them and time constraints. Instead of striving to make the optimum choices, they often settle on making merely satisfactory choices. They are not disposed to find all the necessary information to make a rational decision due to cognitive limitations and time restrictions. This restriction causes them to make choices that are merely satisfactory rather than continuing to search for the best option. Their choices may still be reasonable considering the information realistically available to them, but not in terms of all the possible information that can be acquired. While it is difficult to behave according to perfect economic rationality maximising benefits while minimising costs, making decisions in these circumstances can cause them in ways that are detrimental to their objectives.

Reverting to the example of agreements with IPPs, the governments of the day did their best to resolve the crisis that was not of their making but of the predecessor regimes. But if they were better assisted by the technocrats and civil servants who must have negotiated the terms of the power purchase agreements on behalf of the government of Pakistan, the arrangements could have been more congenial for the country.

This article will attempt to show that this phenomenon was not unique to the power purchase agreement, extends to all facets of economic diplomacy and is not peculiar to Pakistan but is manifested to varying degrees by all developing countries. This will be done by discussing in the subsequent sections two types of international economic agreements that provide the basis of global economic order, namely the Bilateral Investment Treaties (BITs) and the Bilateral Tax Treaties (DTAs).

The concerned ministries take pride in the number of BITs and the DTAs that they have concluded and the governments of the developing countries showcase these as an evidence of being responsible members of the global economy and attractive destinations for the much-aspired foreign investment. However, they lose sight of the fact that these treaties enthusiastically entered into, have been the biggest reasons for surrendering of their economic sovereignty and questionable benefits. Researchers have questioned the negotiations that have resulted in thousands of tax and investment treaties on the grounds that these bind lower-income countries into an unfavorable international regime on the one hand, and that this regime may cost them more than they gain, on the other.

Pakistanis have been rudely introduced to the BITs in the form of multiple claims for financial compensation from the foreign investors that were lodged in the International Centre for Settlement of Investment Disputes (ICSID). Dr Lauge N. Skovgaard Poulsen in his book “Bounded Rationality and Economic Diplomacy” has argued that governments in developing countries typically overestimated the economic benefits of investment treaties and practically ignored their implications and risks.

Interestingly, the book starts with the example of Pakistan and based on his extensive interaction with Pakistani authorities narrates that how despite Pakistan being the first country to ever sign a BIT in 1959 with West Germany, and concluding a total of 40 similar treaties since then, there was no documentation as to how they had been negotiated. The treaties had been deemed as a diplomatic token of goodwill. There was just an expectation that the treaties would lead to foreign investment, but no one thought that these can have any potential liabilities or costs. He cites a communication within the government according to which BITs were considered to be instruments that were signed during visits of high-level delegations to provide for photo opportunities. It was not until Pakistan was hit by multi-billion-dollar arbitration claims that that the implications of treaties signed by successive governments were realized.

It has to be admitted that Pakistan was not unique in pursuing these treaties. According to an UNCTAD report of 2013, between 1994 and 1996 an average of four BITs were signed every week. Practically, all developing countries swiftly signed basically identical treaties, which significantly limited their sovereignty. Developing countries agreed to give all-embracing protections to foreign investors in return for the prospect of more capital.

But, although foreign investors got what they wanted in the form of extensive protections from arbitrary actions by the host countries that could damage their investment, the treaties have rarely been important to attract investments. The World Bank published a survey of foreign investors in 1991 and concluded that BITs had an insignificant role, if any, in investment decisions. This makes the readiness to jump headlong into these treaties for securing trivial benefits coming at an unbearably high costs even more puzzling.

Dr Lauge in his above-mentioned book quotes Chief Justice Roberts of the US Supreme Court who wrote in 2014 that by consenting to investment arbitration “a state permits private adjudicators to review its public policies and effectively annul the authoritative acts of its legislature, executive, and judiciary.” Pakistan is all too familiar with this phenomenon as the opinion of its Supreme Court regarding a well-known international contract was given no weightage and completely disregarded during the arbitration proceedings at ICSID resulting in Pakistan being slapped a penalty running into billions of dollars.

(To be continued)

Copyright Business Recorder, 2024