Cato: Responding to the White House Response on ISDS

Yesterday, my colleague Dan Ikenson blogged here about an op-ed by Sen. Elizabeth Warren (D-MA) in which she was critical of investor-state dispute settlement (ISDS) provisions in trade agreement

[Reposted from the Cato Institute blog  |  Simon Lester  |  February 27, 2015]

Jeff Zients, director of the National Economic Council, posted a response to Warren on the White House website.  In this post, I’m going to comment briefly on his response, going through item by item. His statements are in bold; my comments follow in bullet points. 

Zients: “The purpose of investment provisions in our trade agreements is to provide American individuals and businesses who do business abroad with the same protections we provide to domestic and foreign investors alike in the United States.”

• It’s important to be clear that these protections go both ways. Under ISDS, foreign investors can also sue the U.S. government. Of course, they could already sue under U.S. domestic law. In effect, ISDS means that foreign investors in America have two avenues for a lawsuit, while U.S. investors in America only have one.

• With regard to protections abroad, the result of ISDS is that American investors have protections in foreign countries, but non-Americans do not have protections in those countries. That seems like a bad signal to send: American investors get good treatment, but non-Americans do not. If the concern is expanding protections, there is a better way to do it: encourage these protections to be incorporated into domestic law, so that everyone gets them.

Zients: “ISDS is an arbitration procedure—similar to procedures used every day by businesses, governments, and private citizens across the globe—that allows for an impartial, law-based approach to resolve conflicts and has been important to encouraging development, rule of law, and good governance around the world. ISDS does not undermine U.S. sovereignty, change U.S. law, nor grant any new substantive rights to multinational companies.”

• I’m not aware of any evidence that ISDS encourages “development, rule of law, and good governance around the world.” To some extent, it may discourage it. Rather than encouraging reform of domestic political and legal systems, it just takes judicial governance out of the hands of domestic actors. It allows the foreign government to avoid domestic reform entirely and simply add a special procedure for foreign investors.

• All branches of government in the United States, at all levels, may be forced by an international tribunal to pay compensation as a result of their actions. Certainly that affects U.S. sovereignty. Of course, sovereignty need not be absolute, and I don’t think an effect on sovereignty means a treaty should be avoided. All treaties affect sovereignty. But there is no question that ISDS has an effect on sovereignty.

• ISDS grants foreign investors the right to sue in an additional forum (domestic investors can only use domestic courts). Access to an additional procedural right is, in a sense, a substantive advantage. Beyond that, the rights are so vaguely defined in ISDS that there is no way to be sure what the substantive rights are. That could mostly be fixed by taking out the “minimum standard of treatment” provisions, such as “fair and equitable treatment,” and drafting other provisions more clearly, but this is not being considered.

Zients: “ISDS has come under criticism because of some legitimate complaints about poorly written agreements. The U.S. shares some of those concerns, and agrees with the need for new, higher standards, stronger safeguards and better transparency provisions. Through TPP and other agreements, that is exactly what we are putting in place.”

• Again, the “minimum standard of treatment,” including “fair and equitable treatment,” is an example of a “poorly written” provision, but removal of that provision is not being considered. If governments were willing to consider substantive changes, such as focusing the provisions on prohibiting discrimination against foreigners, it could fundamentally alter the nature of ISDS. But for whatever reason, they have refused.

Zients: “It is an often repeated, but inaccurate, claim that ISDS gives companies the right to weaken labor or environmental standards, for example, suggesting that a trade agreement could result in the United States having to lower its minimum wage.”

• I don’t know whether an ISDS complaint could be made against U.S. minimum wage laws, but it is certainly the case that environmental regulation can be challenged. (A U.S. company is currently challenging Canadian fracking regulations.) For that matter, ISDS complaints could probably be brought in order to raise labor and environmental standards! Some ISDS provisions are broad enough to cover just about anything.

Zients: “The reality is that ISDS does not and cannot require countries to change any law or regulation.”

• It can’t require governments to change laws or regulations, but it can make them pay compensation for their actions. The Takings Clause of the U.S. Constitution also just requires compensation, but that doesn’t mean it has no effect! (And keep in mind, ISDS can require compensation for any actions deemed to violate the rules, not just expropriations.)

Zients: “Similarly, the investment provisions under TPP are designed to protect American investors abroad from discrimination and denial of justice.”

• If these obligations were only about carefully drafted “discrimination” and “denial of justice” provisions, there would be few cases and we would never hear about these issues. The problem is, they are so broadly written that they cover a wide range of government action and inaction, and we just don’t know the scope.

Zients: “Under our Constitution, the Government has wide powers to regulate on behalf of the public interest even if that impacts private property. But when government takes its citizen’s property from them—be it a person’s home or their business—the government is required to provide compensation. This is a core principle reflected in the U.S. Constitution and recognized under international law and the legal systems of many countries.

Unfortunately, foreign courts have not always respected this principle, and U.S. investors often face a heightened risk of bias or discrimination when abroad. That’s why governments have looked to international arbitration to resolve such disputes for centuries. Earlier in our history, the United States used gunboat diplomacy, sending our military to defend our economic interests abroad. The decision was made by our predecessors that it was better to rely on neutral arbitration instead.”

• No doubt there is some bad treatment of investors by foreign governments (including their courts), but the problem has not been studied empirically. How often does this occur? What exactly are governments doing? And in which countries? What is the problem we are trying to address? Assertions and anecdotes are not enough. Policy responses need to be evidence-based. To address a problem through government action, such as a treaty, we need to understand it. We really don’t have any sense of the purpose of ISDS today. Historically, it was about expropriation, but that has declined considerably. So what is ISDS about today? Defenders of the system haven’t really offered much evidence of the problem they are trying to fix. The fact that Argentina and Venezuela treat investors badly sometimes does not justify the global proliferation of treaties we are seeing.

Zients: “Over the last 50 years, 180 countries have entered into more than 3,000 agreements that provide investment protections, the vast majority of which have some form of neutral arbitration. European countries are party to more than 1400 of those agreements. The U.S. is party to about 50.

Those thousands of agreements contain a wide range of standards, some that strongly protect a government’s right to regulate, others that do not. The U.S. has been at the leading edge of updating, upgrading and clarifying these standards; protecting the right to regulate; and drawing lessons from previous agreements to ensure that our agreements have the highest possible standards. TPP incorporates and builds on those efforts and goes beyond them by:

- Further raising the standards: TPP will make it absolutely clear that governments can regulate in the public interest, including with regard to health, safety and the environment, and narrowing the definition of what kinds of injuries investors can seek compensation for.

- Adding safeguards: TPP will include the ability to dismiss frivolous claims quickly and award fees against the claimant to deter such suits; making it possible for governments to provide binding direction to the arbitrators; and creating additional filters for cases having to do with financial services.

- Closing loopholes: For example, TPP will prevent sham corporations from accessing the investment protections provided by the agreement.

- Creating transparency: All arbitration proceedings under TPP will be open and non-parties, including labor unions and civil society organizations, will be able to file briefs to inform the outcome of cases.”

• From what I’ve seen, these changes are just fiddling around the edges. Unless governments are willing to take a serious look at the substantive standards (e.g., obligations such as “fair and equitable treatment”), nothing much will change.

Zients: “There have only been 13 cases brought to judgment against the United States in the three decades since we’ve been party to these agreements. By contrast, during the same period of time in our domestic system, individual and companies have brought hundreds of thousands of challenges against Federal, state, and local governments in U.S. courts under U.S. law.

We have never lost an ISDS case because of the strong safeguards in the U.S. approach. And because we have continued to raise standards through each agreement, in recent years we have seen a drop in ISDS claims, despite increased levels of investment.”

• Defending these cases can be very expensive. In that sense, even winning has some costs.

• The fact that the U.S. wins all its cases suggests either that making ISDS available against the U.S. government is a waste of everyone’s time and resources, or perhaps that we just haven’t had the right cases come yet. Either way, it doesn’t help much with a defense of the system.

Zients: “Senator Warren also questions the integrity of the arbitrators who decide cases, suggesting that they are biased against governments. In fact, ISDS panels more frequently side with respondent governments. The U.S. government, for example, has won every single case concluded against it. The arbitration rules used under TPP require the independence of arbitrators and provide for challenge and disqualification in the event of conflict of interest or bias. They also provide a central role for the government being sued to determine which arbitrators hear the case.”

• The key point about the arbitrators is that they can act as litigators one day and judges the next. That’s not a feature of a credible legal system.

• The win-loss record of investors and governments misses the point. You need to focus on the nature and substance of the obligations. The system is biased in the sense that foreign investors have access and others do not. Some governments treat people badly—foreign investors, yes, but also other people. Under ISDS, big foreign investors have access to an international tribunal when they believe they have not received “fair and equitable treatment.” The local dry cleaner does not. That’s the bias in the system, and the win-loss record doesn’t tell you much.

Zients: “We share a number of the theoretical concerns Senator Warren raises. But we disagree with her suggestion that we leave it to the free market to put in place basic rule of law and protections. That hasn’t worked in the past and government has a role to play.”

• In what sense does the market not work here? If you let the market run things, companies will not invest in countries with weak rule of law. That will give these countries an incentive to provide better rule of law. This change has been happening in recent years on its own, and many governments are now much friendlier to foreign investment than in the past.


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