Investor-State Arbitration in Trade Agreements: A Bad Idea?

Dan Ikenson at the CATO Institute has just published a must-read policy memo on the issue of including investor-state arbitration in trade agreements. With President Obama’s ambitious trade agenda stalled in Congress, Ikenson suggests a radical, but to my mind rather sensible, move to break the impasse--drop the provision from the Trans-Pacific Partnership (TPP) and future U.S. trade agreements.

Investor-state dispute settlement (ISDS) has existed in international treaties dating back to the 1950s, and was intended to protect multinational companies from having their assets expropriated by governments, primarily in developing countries. ISDS allows the companies to sue these governments in neutral international courts for compensation. Such provisions are now part of 41 U.S. bilateral investment treaties and most U.S. bilateral trade agreements.

But as Ikenson explains in detail, ISDS has morphed from a fairly narrow tool to deal with blatant expropriation to a much broader weapon that companies can use to challenge government policies and regulations that they believe harm their businesses. In the process, ISDS has become far more controversial, feeding public fears that trade agreements will be used to undermine the sovereign right of governments to protect consumer health and welfare and safeguard the environment. This is one of the biggest reasons for growing congressional opposition to the Obama trade agenda.

I was particularly struck by these numbers in Ikenson’s paper; from 1959 to 2002, there were fewer that 100 ISDS claims filed worldwide, but since 2003 there have been 514 cases, including a record number of new claims in 2012. Not surprisingly, ISDS has become increasingly controversial. The United States is facing opposition from many TPP governments that do not want to include the provision, and there is similar skepticism in the Trans-Atlantic Trade and Investment Partnership (TTIP) talks with Europe.

If such dispute settlement mechanisms were vital to the effective workings of a trade agreement, then it would make sense for the U.S. government to ignore the criticisms and insist on the provision. But Ikenson makes a strong argument that this is simply not the case. He writes:

[I]nvestment is a risky proposition. Foreign investment is usually more risky. But that doesn’t necessitate the creation of institutions to protect MNCs from the consequences of their business decisions. Multinational companies are among the most successful and sophisticated companies in the world. They are quite capable of evaluating risk and determining whether the expected returns cover that risk. Although MNCs may want assurances, they don’t need them.

And he makes another argument that I find very persuasive. The United States, like most countries, is struggling to attract foreign investment and create jobs at home, and the U.S. share of global FDI has fallen sharply over the past decade.By insisting that other countries offer special protection to foreign investors, the United States is weakening some of its biggest advantages in the competition for investment – respect for the rule of law, a transparent regulatory system, and strong courts. Other countries would be wise to emulate the United States if they want to attract FDI, but there’s no reason the U.S. government should be insisting on it (and “paying” with other trade concessions) in international negotiations.

There are plenty of other interesting arguments in Ikenson’s paper. And surely they will all be challenged by the corporations that are pushing hardest for including investor-state provisions in the TPP and all future trade agreements. I would be interested in hearing arguments as to why Ikenson is wrong, but he seems to me to have built a compelling case.